Repurchases, Redemptions, And The Reduction Of Capital

AuthorJames D. Cox/Thomas Lee Hazen
ProfessionProfessor of Law at Duke University/Professor of Law at the University of North Carolina, Chapel Hill
§ 21.1 A merican Rules on Share Repurchases
It is important to understand t he financial difference between a
corporation’s purchase of its own shares and its purchase of shares
issued by an independent enterprise. Shares in another entit y are
assets of possible value to creditors. On a surrender of a corporation’s
own shares, the purchase price is simply withdrawn f rom the issuer’s
business. Nothing of value to creditors takes its place except what is
in reality an unissued share, which cannot profitably be reissued when
there is a financial reversal. Today all American jurisdictions permit a
corporation to purchase its own shares, subject to various limitations
such as impairment of capital.
The underlying reason for limiting share purchases is t he same as
that of dividends. Safeguards should be imposed against a corporation’s
depletion of its assets and the impair ment of its capital needed for the
protection of creditors and other shareholders. This ha s sometimes been
expressed in terms of t he trust fu nd doctrine,1 which has been used to
protect creditors. 2
Exceptions to a Res trictive Rule. There are certain situations
that are considered to give little opportunity for abuse, in which the
corporation is generally recognized to have the authority to purchase
its own shares even out of capital. Exceptions include: the purchases
of preferred shares subject to a redemption provision in the articles of
incorporation; purchases to compensate dissenting shareholders under
appraisal statutes; employee stock purchase plans that have an option
or agreement to repurchase; and purchases pursuant to an authorized
statutory method of reduct ion of legal capital.3
The Solvency Limitation. Many statutes retain an insolvency test,
however, along with the surplus or capital impairment tests.4 As will
be seen later in this chapter, the timing of these tests assumes special
importance when shares are repu rchased over a long period, perhaps
on an install ment basis. The courts are badly div ided over whether the
surplus and solvency tests are each applied to each installment payment
or whether either of these tests should be applied only when the contrac t
of purchase is entered into.
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