Until 30 September 2008, there was a total prohibition on Italian limited liability entities (both SpAs and Srls) providing any financial support in connection with the purchase or subscription of their own shares by any third party (the so-called ‘financial assistance prohibition’).
New provisions implementing EU Directive 2006/68/CE amending Council Directive 77/91/EEC on the formation of public limited liability companies and the maintenance and alteration of their capital (the EU Directive) were enacted by Legislative Decree No. 142 of 15 September 2008, which, in certain circumstances, allow Italian SpAs to provide financial assistance. This briefing provides a short overview of the new provisions and the potential preliminary issues arising in connection with leveraged buy-out transactions (LBO).
The legal framework
Before the implementation of the new provisions, article 2358 of the Italian Civil Code (ICC) prevented any company incorporated in Italy in the form of a stock company (società per azioni or SpA) from granting loans and/or guarantees (to its shareholders or any third party) to facilitate the purchase or the subscription of its own shares.
For the purposes of article 2358 of the ICC, reference to loans has been construed to include any financing arrangement granted by a company in any form whatsoever, such as loans, credit facilities, advance payments, discounts etc, and reference to guarantees has been construed to include any and all forms of specific, personal guarantee (garanzie personali) and/or security interests (garanzie reali), as well as other kinds of financial facilities, such as stock lending agreements or the granting of payment extensions.
In addition, the prohibition set forth by article 2358 was also deemed to be applicable:
- if the financial support is provided not at the time of the acquisition of the relevant company’s shares but at a later stage;
- if the refinancing of an acquisition facility is made available by a third party; or
- if an Italian entity provides financial support for the acquisition of its (direct or indirect) holding company, irrespective of whether that holding company is an Italian or non-Italian entity.
Article 2474 of the ICC extends the financial assistance prohibition to Italian limited liability companies (società a responsabilità limitata or Srl) substantially in the same terms as set out in article 2358.
Articles 2358 and 2474 of the ICC restricted the implementation of LBO transactions in Italy to those transactions that comply with article 2501-bis of the ICC. Article 2501-bis provides for a detailed set of rules and procedures on the merger of companies involved in LBO transactions (merger LBO).
Before the enactment of article 2501-bis of the ICC, it was debated whether the various steps of a merger LBO (ie borrowing of acquisition facility, purchase of target shares and merger between the acquisition vehicle and target company) had to be considered as a single transaction or whether each step had to be assessed individually to verify if article 2358 of the ICC had been complied with. While none of the steps of a merger LBO – if analysed on a stand-alone basis – might breach article 2358, if the various steps were considered as a single transaction, a merger LBO might indirectly breach article 2358, based on the fact that the merger between the acquisition vehicle and the target company would have aimed at reducing at target level the acquisition debt and securing the repayment of such debt by means of the target company’s assets1. In other words, the validity of any transaction would be tested on the basis of its ‘economic rationale’.
Under article 2501-bis, the target company is allowed to merge with the acquisition vehicle that has borrowed the acquisition debt, if, in addition to the general requirements and formalities applicable to Italian merger transactions:
- the merger plan (progetto di fusione) specifies the expected financial sources for fulfilling the obligations of the company resulting from the merger (the merger company);
- the directors’ reports (relazione dell’organo amministrativo) of the target company and the acquisition vehicle clarify the reasons on which the transaction is grounded and contain a financial and economic plan for the merger company, which also has to specify the source of the financing and the goals to be achieved; and
- an expert’s report and an auditor’s report on the merger each confirm the reasonableness of the conclusions contained in the merger plan and the adequacy of the exchange ratio (rapporto di cambio) between the shares/quotas of the merging entities.
The legislative decree implementing the EU directive
Article 2501-bis of the ICC neither repealed nor amended the financial assistance prohibition set out in article 2358 of the ICC, though clarified in which circumstances a merger LBO – where the outcome is to push down debt at the target level – is permitted.
The new provisions are intended to modify the financial assistance regime set out in article 2358. The main features of the new provisions can be summarised as follows:
- the granting of loans and security interests for the purposes of the acquisition or subscription of its own shares must be authorised by the extraordinary shareholders’ meeting of the relevant company;
- the directors of the relevant company shall draft a written report (which shall be deposited at the company’s registered office during the 30 days before the meeting) describing (from a legal and economic perspective) the proposed transaction, its underlying rationale, the business purposes, the specific interest, the related liquidity and solvency risks for the relevant company and the shares’ purchase price payable by the third party acquiror. The directors shall also confirm that the transaction will be implemented at fair market conditions (in particular regarding the security package to be granted and the applicable interest rate under the relevant financing arrangements) and that they have duly investigated the creditworthiness of the counterparty;
- in circumstances in which the party benefiting from the financial assistance is going to acquire shares owned by the company granting the financial assistance, then (i) the extraordinary shareholders’ meeting (as opposed to the ordinary meeting) shall authorise the disposal of those shares and (ii) the purchase price of such shares shall be calculated on the basis of the criteria set out in article 2437-ter of the ICC2;
- the aggregate amount of the loans and the security interests granted by any company for the purposes of the acquisition or subscription of its own shares shall not exceed the aggregate amount of the profits and reserves available for distribution as shown in the company’s latest approved balance sheet (net of any amount applied by the company for the acquisition of its own shares in accordance with article 2357 of the ICC);
- the relevant company shall ?? record, among its liabilities in the balance sheet, a reserve, not available for distribution, of the amount of the aggregate financial assistance granted to third parties;
- as long as the relevant company is required to provide financial assistance for the purchase of its shares by its directors, the directors of its parent company or the parent itself, the report referred to in the second bullet point above shall also confirm that the transaction ‘realises the best interest of the company’; and
- neither the shareholders’ authorisation nor any other requirements (except for the need to record details in its balance sheet as described above) will apply to transactions aimed at allowing the employees of a company, or of any other company controlling, or controlled by, such company to acquire its own shares.
The application of articles 2391-bis and 2501-bis of the ICC will remain unfettered by the new article 2358.
Companies incorporated in the form of Italian Srl are still prevented by article 2474 of the ICC from giving financial assistance because the new provisions have not amended the current regime.
Preliminary issues arising from the application of the new rules
In principle, the new article 2358 of the ICC seems to have a substantial effect on LBO transactions, but the granting of financial assistance by the target company (and its group) in connection with the acquisition of its shares needs to be tested on a case-by-case basis taking into account the following issues:
- given the need for an extraordinary shareholders’ meeting to approve the transaction, it is likely that the new provisions will apply in circumstances where the presence of minority shareholders does not exist at all or is negligible;
- providing financial assistance will be possible only if there are profits and distributable reserves. Therefore, it should be considered whether the company has net assets but it will also be necessary to assess the quantity available for distribution. Assuming that profits and reserves are available at the target company level, lenders often prefer (and this has been the trend in the recent past) to lend directly to the target company, thereby obtaining direct asset security and allowing a distribution. It may still be that lenders would still prefer to follow such a route. In addition, due to the need to create a non-distributable reserve, in an amount equal to the aggregate financial assistance granted to third parties, it would be more difficult for the target company to upstream dividends; and
- the requirement for the directors to prepare a report will also impose a business (and not only financial) analysis on the target company’s directors; this report may need to be discussed with the sellers and directors of the target company well in advance, if the envisaged transaction implies a change of control and the replacement of the board members.