When a corporation considers buying back its own shares, it’s not just a financial decision—it’s a legal one, too. In Ohio, corporate stock repurchases are governed by Ohio Revised Code Section 1701.35, which provides both the authority and the guardrails for these transactions. If your corporation is contemplating a share redemption or stock buyback, understanding the scope and limitations of this statute is critical to ensuring compliance and avoiding unintended legal consequences.
What Does ORC Section 1701.35 Allow?
Section 1701.35(A) authorizes a corporation to purchase its own shares under a limited number of circumstances. These include when the articles authorize the redemption, for the collection of a debt, to avoid the issuance of fractional shares, and from a shareholder who by reason of dissent is entitled to be paid the fair cash value of his shares. So long as the repurchase aligns with one of the enumerated purposes, the door is open…ish.
Financial Safeguards: Section 1701.35(B)
Section 1701.35 further limits when a corporation may purchase its own shares by imposing strict financial constraints which are designed to protect both the corporation’s solvency and its creditors. Under Section 1701.35(B), a stock repurchase is prohibited if:
- The corporation’s assets would be less than its liabilities plus its stated capital immediately following the repurchase;
- The corporation is insolvent at the time of the transaction; or
- There are reasonable grounds to believe the corporation would become insolvent as a result of the repurchase.
These aren’t just accounting guidelines—they’re statutory mandates. Violating them can render a redemption agreement void and open the corporation to litigation.
Book Value vs. Fair Market Value: How Are Assets Measured?
The statute doesn’t explicitly define whether “assets” must be measured by book value or fair market value, leaving room for interpretation. However, courts analyzing transactions under Section 1701.35 have referred to a corporation’s “stipulated financial records,” which suggests that book value is typically the reference point. While this may vary case by case, it’s important for corporations and their counsel to understand that financial statements – not speculative valuations – are likely to be the benchmark if a transaction is to undergo judicial review.
Timing Matters: When Must Solvency Be Determined?
An equally important – and often misunderstood – aspect of compliance is when solvency must be assessed. Two key Ohio cases, In re Salem Tool Co.,[1] and Milo v. The Milo Co.,[2] offer some clarity on the issue: solvency must exist at the time each payment is made, not just at the time the redemption agreement is signed.
The main reason behind these findings is that the purpose of Section 1701.35 is to protect creditors. Allowing installment payments from a company that later becomes insolvent undermines this core principle. As a result, even if a redemption agreement is valid at signing, subsequent payments can still violate Section 1701.35 if the corporation is insolvent at the time they are made.
What About Guarantors?
Interestingly, in spite of the general principal that if an underlying agreement to a guaranty becomes unenforceable the guaranty is likewise rendered unenforceable, if a redemption agreement becomes unenforceable due to insolvency, this does not invalidate a personal or third-party guaranty. Here our courts have drawn a clear line: the prohibition on corporate stock repurchases doesn’t extend to guarantors, since enforcing the guaranty doesn’t compromise the rights of the corporation’s creditors.
Key Takeaways for Ohio Corporations
- Know your purpose. A repurchase must fit within the statute’s allowable reasons.
- Watch your books. Ensure your assets exceed your liabilities and stated capital—using book value unless advised otherwise.
- Check solvency often. Don’t just look at the corporation’s condition at the agreement’s signing; review solvency before each payment.
- Understand guarantor risk. Guarantors may still be on the hook even if the underlying agreement is voided.
Final Thoughts
Stock repurchases can be a smart financial strategy, but in Ohio, they require more than just board approval – they demand careful legal and financial planning. Section 1701.35 reflects a balance between corporate flexibility and fiscal responsibility. When in doubt, consult with legal counsel to ensure that your repurchase plan doesn’t just make business sense – it makes legal sense, too.
[1] 82 B.R. 52, 52 (Bankr.N.D.Ohio 1988)
[2] 1992 Ohio App. LEXIS 3143, at *5 (June 17, 1992)