02.06.2021

Treasury Stock

Origin of “Treasury Stock”

The term “Treasury Stock” was introduced into Spanish legislation through European Directives. Historically it has been used when a Company acquires its own shares or holdings. Or when it acquires those issued by its parent Company. The latter in the case of a group of companies.

The term treasury stock refers to the acquisition by the company of its own shares. That is, the company in question acquires its own holdings or shares (or those of its parent company).

The Capital Companies Act (In Spanish, “Ley de Sociedades de Capital” – “LSC”) distinguishes between original and derivative acquisitions. The acquisition regime is very restrictive and is limited to certain transactions.

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What is the point of restricting treasury stock?

Traditionally, this practice has been distrusted because of the serious consequences it may entail. From a dogmatic perspective, therefore, it has been stated that companies cannot be its own partners.

It all starts with the need to overcome an asset imbalance. In most cases, these are eventual situations in the face of which it is not known how to act. It is a temptation. The temptation of “treasury stock”.

This is how treasury stock transactions arise. They are often a very useful tool for companies in difficult economic situations.

However, extreme caution should be exercised before carrying out this type of operation. They can have a very negative impact on the economic and financial future of the company. And furthermore, it may entail penalties for the entity, as well as liability for the company’s administrators.

Financial Assistance

Arguments against “treasury stock”.

As mentioned above, there are arguments against the practice of treasury stock. Among others, we highlight the following:

It is a contradictory situation and the company lacks the capacity to acquire its shares or participations.
In addition, there may be possible undesirable effects. All of the foregoing, taking into account the possible negative impact of treasury stock on the company’s economic and financial situation. That is to say, with its double aspect of emptying the function of guarantee of the diluted capital and of diminishing its solvency. It can also reduce the company’s economic capacity.
In addition to the above, there is also the risk that treasury stock may be used in a misappropriated manner. In other words, using it as a tool to modify the correlation of power in the corporate-internal sphere. It would thus be implemented through its use by directors in a discriminatory and arbitrary manner. It would therefore lead to the removal of fractious minority shareholders and the strengthening of others.
In addition, another argument against treasury stock is the inadequate disclosure of the equity contributed by the shareholders.
Finally, it is alleged that this practice can affect the value of the company in the market. Especially in the case of companies with dispersed capital. This can be seen in Supreme Court Ruling No. 79/2012 of March 1, 2012.

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Venture capital and financial assistance: an ordered pair

Until well into 2010, there was practically no Venture Capital without financial assistance. It was in fact an intrinsic part of the business model.

Original acquisitions

Shares or participations are issued or created by the Company at incorporation or by way of capital increase. In such cases, the assumption or subscription by the Company of its own shares or participations is prohibited. The same applies with respect to shares/shares created or issued by its parent company.

To understand this, think of a capital increase. The company must seek funds from its partners or new partners. If the partnership itself were to acquire, there would be no cash flow.

Derivative acquisitions

These are acquisitions that take place between a third partner and the Company.

For these acquisitions, there is “greater flexibility”, although the regime is still restrictive.

In the case of SLs, the permitted cases of treasury stock are as follows:

a) Shares acquired universally, or free of charge, or by judicial adjudication in payment of credits of the company.

b) Shares acquired in execution of a resolution to reduce the capital adopted by the general meeting.

c) Shares acquired in a compulsory execution procedure.

d) Acquisition authorized by the General Meeting, against profits or unrestricted reserves, of shares:

- From the partner separated or excluded from the partnership,
- Acquired as a consequence of the application of a clause restricting the transfer of the same ones,
- Shares transmitted mortis causa.

A Corporation may acquire its own shares in the following cases:

(a) In execution of a resolution to reduce capital adopted by the meeting.

b) Shares acquired universally.

c) Fully paid-up shares acquired free of charge.

d) Fully paid-up shares acquired in judicial adjudication to satisfy a claim of the company against the holder.

The corporation may also acquire treasury stock when the following requirements are met:

That the acquisition has been authorized by the General Meeting. The maximum term of such authorization is five years.
The par value of the shares acquired, added to those already held by the company and its subsidiaries, must not result in the net worth being less than the amount of the share capital, plus the legal or statutorily unavailable reserves.
The shares acquired must be fully paid up.

Failure to comply with these requirements will result in the obligation to dispose of the shares within one year of their acquisition.

If the company fails to do so, it will be obliged to redeem them immediately by means of a capital reduction.

Purpose of the restrictions

The fact that the regulation is so restrictive serves two purposes:

To protect the Corporate patrimony;
To protect the Corporate regime and majorities.

At the equity level, treasury stock could lead to a fraudulent liquidation of the company’s assets. The acquisition of treasury stock/shares results in the company’s assets having to cover such acquisition.

At the organizational level, treasury stock alters the majority system of the company. Who decides and who has the voting rights of those shares or holdings in “treasury stock” is the company. That is, the administrative body.

Therefore, the directors could decisively influence/control the future of the company’s governance. And all this free of charge.

The aforementioned restrictions also apply to subsidiaries with respect to their parent companies. This is because the voting rights of the parent company are in the hands of its subsidiary, whose decisions will be taken by the parent company. In short, the decision would be taken by the parent company’s administrative body.

Regime for own shares and shares of the Parent Company

When a company acquires its own shares or participations/shares of its parent company the following rules apply:

Voting rights and other political rights shall be suspended.
The economic rights will be attributed proportionally to the remaining shares.

Treasury shares are deprived of:

The right to a dividend and the liquidation quota.
Preferential subscription rights.

Obligation to sell the treasury stock/shares.

For Limited Liability Companies (In Spanish Sociedad Limitada, “SL”):

Three years and, at least, for their fair value (art. 141.1 LSC).
One year for shares held by a limited liability company in its parent company (art. 141.3 LSC).

Effects of non-compliance:

The company must immediately agree to their redemption and the reduction of capital. Otherwise any interested party may request it to the judicial Secretary or to the Commercial Registrar of the domicile.

For joint stock companies (In Spanish Sociedad Anonima, “SA”):

Three years in cases mentioned above, unless they do not exceed 20% of the share capital.

Penalties

Infringement of the provisions of the LSC regarding treasury stock may entail the liability of the company’s directors. Thus, fines could be imposed up to the nominal value of the shares held. Or of the shares subscribed or acquired, or those not disposed of or redeemed.

Failure to comply with the duty to dispose of or redeem will be considered as an independent infringement.

Consequently, the directors of the offending company will be held responsible for the infringement. And, as the case may be, of the parent company. The managers or persons with power of representation will also be considered as administrators.