Share Buyback Procedures and Distribution Limits: Purchasing Shares from a Departing Shareholder

Hello, I am Noriaki Asato, Representative Attorney at LegalAgent.

When a co-founder or an early team member leaves a company, someone needs to consider who will acquire that person's shares. If a sale to another shareholder cannot be agreed, the departing member may ask the company to buy them. A company share buyback may therefore be considered alongside negotiations over the terms of departure.

Leaving employment and ceasing to be a shareholder are separate matters. In addition to agreeing a price with the seller, the company needs to complete the required shareholder and other corporate procedures and check its distributable amount under the Companies Act. A promise in a shareholders' agreement that the company will buy the shares does not remove these procedures or financial restrictions.

This article focuses on an unlisted company buying shares for cash by agreement with a departing shareholder. I believe the rights of other shareholders, the company's ability to pay, and voting percentages after the acquisition should all be checked before preparing the resolutions and contract.

The Acquisition Authorization and Purchases from a Specified Shareholder

For an acquisition for consideration by agreement, a shareholders' resolution generally sets the acquisition authorization under Article 156 of the Companies Act. It specifies the number of shares, the nature and aggregate amount of the consideration, and the acquisition period. A company with multiple classes of shares must also identify the class, and the period must be no longer than one year.

Within that authorization, Article 157 requires the company to determine the number of shares for each acquisition, the consideration per share, the aggregate consideration, and the date for applications to sell. At a company with a board of directors, the board makes this decision. The shareholders' authorization and the decision on the specific acquisition terms need to be considered separately.

If the departing shareholder is to be the sole specified seller, the shareholders must also resolve to acquire shares from that specified shareholder under Article 160(1). The board then determines the specific Article 157 terms in accordance with that resolution.

This requires a special resolution under Article 309(2)(ii). As a general rule, shareholders holding a majority of the voting rights exercisable on the matter must attend, and at least two-thirds of the voting rights represented must support the resolution. The articles of incorporation may reduce the quorum to no less than one-third or increase the required approval percentage, so the current articles must be checked.

The specified selling shareholder generally cannot vote on this resolution. The relevant provision is Article 160(4). There is an exception where none of the other shareholders can exercise voting rights. If the departing shareholder owns a substantial stake, the requirements for passing the resolution after excluding the seller's voting rights should be calculated before the meeting is convened.

Other Shareholders' Right to Be Added as Sellers

The procedure for acquiring shares from a specified shareholder generally gives other shareholders an opportunity to ask to be added as sellers. This is the notice and additional-seller request mechanism in Article 160(2) and (3). The company should check the applicable notice and request deadlines and incorporate them into the meeting timetable.

For example, a company may intend to buy 100 shares from the departing shareholder, but other shareholders may join as sellers and offer more shares than the acquisition authorization covers. If applications exceed the number to be acquired, the proportional acquisition rule in Article 159 becomes relevant. The intended contractual outcome of acquiring all of the departing shareholder's shares may differ from the result under the statutory procedure. This should be checked before signing the contract.

Under Article 164, the articles of incorporation may provide that Article 160(2) and (3) do not apply. However, introducing that provision after the relevant shares have been issued requires more than an ordinary special resolution amending the articles. All shareholders holding the affected shares must consent. For a company with multiple share classes, the company should identify the class covered by the exclusion and confirm the consent of its holders.

If an exclusion already exists in the articles, its wording should be checked against the proposed acquisition. Consent obtained from a particular investor under a shareholders' agreement does not automatically exclude other shareholders' statutory rights. The treatment under the articles and the contractual consent requirements need separate review.

Article 162 also provides an exception for acquisitions from heirs and certain other successors. It does not apply to a public company within the meaning of the Companies Act or, among other cases, where the heir or successor has already exercised voting rights attached to the shares. An acquisition from the departing co-founder personally cannot use the inheritance exception. I also believe the Article 161 exception for shares with a market price should not be assumed to provide the ordinary procedure for buying unlisted shares.

The Distributable Amount and Cash Available at Acquisition

Shareholder approval does not permit an acquisition that breaches the financial restrictions. For the acquisitions it covers, Article 461 prohibits the aggregate book value of money or other property delivered to shareholders from exceeding the distributable amount on the effective date. For a cash buyback, the acquisition consideration is compared with that amount.

The distributable amount is not the company's bank balance. It starts from the amount of surplus and applies statutory additions and deductions, including the book value of treasury shares. Retained earnings alone are also insufficient to determine it. The calculation should reflect the latest financial statements, subsequent dividends or buybacks, and other changes affecting the amount available on the proposed acquisition date.

For example, a financing may increase cash deposits without making the entire amount available for a buyback. Conversely, sufficient statutory distributable funds do not guarantee that the company can pay salaries, suppliers, and loan repayments after paying the purchase price. The legal limit and the cash flow needed to continue the business require separate checks.

Preparing extraordinary financial statements may be considered as a way to reflect profits earned during the financial year. Preparation alone does not make those profits freely available for this purpose. The company should work with its accounting team and tax advisers to confirm the approvals and other procedures under Article 441 and the rules for calculating the distributable amount.

If signing and closing are separated in time, the company should also check whether intervening dividends or another buyback could change the available amount. The contract may make the necessary corporate approvals and availability of distributable funds conditions to closing, and specify what happens if those conditions are not met.

Liability for Breaching the Limit and Tax Treatment of the Price

If the financial restrictions are breached, Article 462 may impose payment obligations to the company on the shareholder receiving the consideration and the business executors and other persons involved in the acquisition. Directors who proposed the relevant resolutions may also fall within the statutory categories. The provision distinguishes the persons covered and the applicable requirements, and provides a defense for business executors and other specified persons who prove that they exercised due care in performing their duties.

The company therefore needs to confirm the legally available funds in addition to obtaining unanimous shareholder support or agreeing departure terms. Those responsible should retain the calculations used for the resolutions, the checks immediately before acquisition, and the basis for the price. The selling shareholder should also confirm that the company can lawfully pay the consideration.

The latest financing price cannot necessarily be adopted unchanged. Preferred and common shares may carry different rights, and performance and financial conditions may have changed since the financing. The parties should consider the rights attached to the shares, net assets, and earnings prospects, and record the valuation method and assumptions used.

For tax purposes, a sale to the issuing company also cannot simply be treated as an ordinary sale to a third party. As explained by the National Tax Agency, money or other property received through a company share buyback is treated as proceeds for share capital-gains purposes after excluding the portion treated as a deemed dividend. A deemed dividend may arise even where the transaction uses an appropriate fair market price.

Separately from the tax issues associated with a price substantially different from market value, tax advisers should confirm whether a deemed dividend arises, its amount, the seller's capital gain, and any withholding obligations of the company. The agreed gross price may differ from the seller's net receipt. I believe the tax treatment should be confirmed before the payment terms are settled.

Preparing for Closing and Managing Treasury Shares

Before execution, gather the current articles of incorporation, shareholder register, shareholders' agreement, and latest financial statements. Identify the shares and seller, and check the additional-seller request mechanism, investor consent requirements, and distributable amount before scheduling shareholder and board or other corporate decisions. A company that issues share certificates must also check whether certificates have been issued and the procedures for delivering them.

The resolution materials and share purchase agreement should align on the number of shares, price, payment date, and closing conditions. If the departure agreement also addresses the shares, check that its payment timing and conditions are consistent. After closing, record the acquisition as treasury shares in the shareholder register and retain the payment records.

Treasury shares have no voting rights. Under Article 308(2), this means that the percentage of total voting rights held by other shareholders changes even if their number of shares remains the same. In addition to the departing shareholder's exit, calculate the voting structure after acquisition, including whether the remaining founders or investors can block a special resolution.

The company may continue holding the shares or cancel them under Article 178. At a company with a board of directors, the board decides the number of shares and other required cancellation particulars. A later allocation to a third party or delivery upon exercise of stock options requires the procedures applicable to that disposal or other action. The capital plan should reflect whether the shares will be held, canceled, or disposed of later. Recording the reasoning will also help explain the transaction to investors during the next financing.