May 12, 2020 | Cash Used For Share Buybacks Can Be Clawed Back

As I have mentioned many times, in recent years public corporations have squandered trillions in cash on stock buybacks (deemed illegal until 1982) at the expense of their balance sheet strength and cash reserves for unexpected events (which always happen).

Adding insult to injury, in many cases, the companies took on imprudent levels of debt to pay for said buybacks.  In this way, short-term ‘activist’ shareholders, including company executives and board members, were enriched by dividends and pushing up share prices at the expense of the company’s longer-term stability and resilience.  And then came COVID-19.

Now cash deficits, debt weight, and a sudden stop/loss of cash flow are, not surprisingly, proving financially fatal for many businesses.  Notwithstanding mindboggling taxpayer support and ongoing re-opening efforts, the largest wave of bankruptcies in many years is already in motion.

The plot thickens because when a company enters bankruptcy proceedings, cash that was used for previous share buybacks may be clawed back as a fraudulent transfer and the directors who authorized the transactions can be held liable for a breach of their fiduciary duty to shareholders, creditors and employee pension plans.  See Are recipients of stock buybacks the next time bomb for bankruptcy clawbacks?

The results of all of this create a precarious position not only for corporate shareholders that received cash in exchange for the stock buybacks, but also for members of boards of directors that have authorized the stock buybacks. If these entities were to need to seek bankruptcy court protection, the shareholders who were the recipients of stock buyback cash which left the corporate entities cash poor once the economic slowdown hit can easily become the targets of claw back actions to recover the cash paid for the stock buybacks.

Additionally, non-bankruptcy courts have held that members of boards of directors have certain fiduciary duties to shareholders and creditors. It remains to be seen whether in light of the economic slowdown created by the pandemic crisis, members of boards of directors who authorized stock buybacks will be held to have breached their fiduciary duty in authorizing the stock buybacks. If this is the case, it could lead to a proliferation of D and O claims against the directors and their insurers.

Nothing sobers up business people and shareholders like cash clawbacks and personal liability suits.  The executives who sold their personal shares into the buyback flow they were directing on behalf of the corporations should be particularly vulnerable here.

This is the type of accountability needed to re-orient thinking and policies toward prudent balance sheet management and away from enriching ‘activist’ short-sighted shareholders ahead of, and at the expense of, the enterprise, its employees, creditors, long-term investors and taxpayers.

Investors are supposed to be at the back of the payment line bearing financial risk for the possibility of longer-term rewards.  It’s called capitalism.

Danielle Park May 12th, 2020

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