Publications - Corporate
What is Unlawful Financial Assistance?
Introduction
The aim of this note is to assist the reader in identifying some common actions which may fall foul of the rule against the giving of financial assistance contained in the Companies Act 1985 (as amended) (the "Act"). Failure by a company to abide by this rule can result in the company being fined and its directors becoming liable to imprisonment or a fine or both.
The note is however, not intended to be exhaustive and as this area of law can be particularly complex, it should not be used as an alternative to seeking specific legal advice in any particular case.
The Rule
Subject to the exceptions mentioned below, the Act outlaws any company (the "Target") or any of its subsidiaries (together with the Target (the "Target Group")) directly or indirectly giving financial assistance in connection with an acquisition of the Target's shares (by a Buyer), whether before, at or after completion of the acquisition.
It prevents any member of the Target Group lending or giving cash or other assets to the Buyer for the purpose, directly or indirectly, of reducing or discharging a liability incurred in connection with the acquisition.
Common forms of "financial assistance"
- Use of Target Group's resources
As the Act prohibits the Target Group giving financial assistance for the purpose of reducing or discharging any liability incurred (by the Buyer or any other person) for the purpose of the acquisition, it makes it unlawful for the Buyer to use any assets (including cash) of the Target Group to reduce or repay borrowings made to finance the acquisition.
The Act also prohibits the giving of assistance aimed at restoring a party's financial position to what it was before the acquisition. This means that even if the Buyer uses its own resources to fund the acquisition any subsequent receipt of assets (including cash) from the Target Group, for example, by a purchase at less than market value, is likely to be prohibited.
Financial assistance given by way of gift or by way of loan is prohibited - The giving by the Target Group of guarantees and/or
security in support of the Buyer's Bank facility
Financial assistance includes the giving of guarantees, security or indemnities.
The entering into of any guarantee, security or indemnity arrangements by the Target Group which have the effect of securing or supporting the bank facility which will fund or funded the acquisition (even if the facility is or was also provided for Target's working capital purposes) is likely to be prohibited. - The payment or reimbursement by the Target Group of
any costs or expenses incurred by any of the parties in connection with
the acquisition
Any payment by the Target Group of legal, accounting, other costs or expenses incurred by any Seller, Buyer, funders or advisers is likely to be prohibited. - The disposal by the Target Group of any non-cash asset
to any Seller or related party in anticipation of or at completion of
the acquisition
Any transaction whereby any non-cash asset of the Target Group is sold to such person at less than its market value or whereby an asset is acquired by the Target Group at more than its market value from such a person, is likely to be prohibited. - The transfer of any non-cash asset from the Target Group
to the Buyer's Group after completion
Any transfer of any non-cash asset out of the Target Group to the Buyer's Group at less than its market value is likely to be prohibited. A "hive-up" of the Target's business after completion (which involves a transfer of assets) will therefore need special consideration and may be prohibited.
Exceptions to the rule
An action which, on the face of it, is prohibited by the rule might fall within a specific exception set out in the Act or be capable of approval under the "whitewash" procedure referred to below.
- Specific exceptions in the Act
These include:- - a distribution of a company's assets by way of lawful dividend;
- a distribution in the course of a company's winding
up;
the allotment of bonus shares; - a reduction of capital confirmed by Court Order;
- a redemption or purchase of own shares in compliance with the Act;
- anything done in pursuance of a Court Order under Section 425 of the Act (certain compromise arrangements involving creditors and members); and
- anything done under an arrangement made in pursuance of Section 110 of the Insolvency Act 1986 (acceptance of shares by liquidator in winding up as consideration for sale of property).
The exception which is usually most relevant in the context of an acquisition of shares is a distribution by way of lawful dividend. Although other restrictions contained in the Act limit the extent to which a dividend may lawfully be paid by a company, where there are sufficient distributable reserves this can be a useful exception. The exception allows borrowings incurred to lawfully be repaid out of the proceeds of dividend declared after completion by the Target Group.
- The "whitewash" procedure
If Target and its subsidiaries are private companies they may be able to take advantage of a statutory procedure known as a "whitewash".
A whitewash may only be used to enable a company to give what would otherwise be unlawful financial assistance, if that company has net assets which are not thereby reduced, or to the extent that they are reduced, if the assistance is provided out of distributable profits.
Where the financial assistance in question is the giving of a guarantee or involves a contingent liability, it is necessary to consider the extent to which that guarantee or liability should be provided for in the company's accounts. In the case of guarantees, (except when guaranteeing a liability of a company which is insolvent or whose ability to meet its obligations is in doubt) no provision will usually be necessary
The whitewash procedure requires:-
- special resolutions of the company which is giving the financial assistance (and sometimes associated companies);
- a statutory declaration from all directors of
the company giving the assistance (and sometimes associates companies),
in which they must swear that in their opinion, as regards the company's
initial situation immediately following the proposed date of the giving
of the assistance, there will be no ground on which it could then be
found to be unable to pay its debts and either:-
if it is intended to wind up the company within 12 months of that date, that the company will be able to settle its debts in full within 12 months of the start of the winding up; or
in any other case, that the company will be able to pay its debts as they fall due within the 12 months of that date; and
- a report from the company's auditors stating the auditors
have:-
"enquired into the state of the affairs of the company, and that they are not aware of anything to indicate that the opinion expressed by the directors in the declaration is unreasonable in all the circumstances".
Written July 2001. Reviewed January 2002.
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