Repurchases, Redemptions, And The Reduction Of Capital

• Author: James D. Cox/Thomas Lee Hazen
• Profession: Professor of Law at Duke University/Professor of Law at the University of North Carolina, Chapel Hill
• Pages: 486-498

PART A. SHARE PURCHASES AND REDEMPTIONS

§ 21.1 A merican Rules on Share Repurchases

It is important to understand the financial difference between a

corporation’s purchase of its own shares and its purchase of shares

issued by an independent enterprise. Shares in another entity are

assets of possible value to creditors. On a surrender of a corporation’s

own shares, the purchase price is simply withdrawn from the issuer’s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 the same as

that of dividends. Safeguards should be imposed against a corporation’s

depletion of its assets and the impairment of its capital needed for the

protection of creditors and other shareholders. This ha s sometimes been

expressed in terms of the trust fund doctrine,1 which has been used to

protect creditors.2

Exceptions to a Restrictive 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 repurchased over a long period, perhaps

on an installment basis. The courts are badly divided 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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