Abolition of the general prohibition on financial assistance
The much anticipated Companies Act 2006 is now law. The new act will, by the end of its implementation period, replace the majority of the Companies Act 1985 with the aim of modernising corporate governance and making it easier to set up and run companies. Of particular interest to bankers and other funders is that the new act will, from 1 October 2009, abolish the general prohibition on private companies providing financial assistance for the purchase of their own (or their parent company’s) shares. Likewise, the “whitewash” procedure needed for private companies to lawfully give such assistance will be abolished.
The classic (but not the only) situation where financial assistance arises is when an acquiror purchases a target company using bank financing that is secured and guaranteed by the target company itself (and any subsidiary of that company). This security and guarantee constitutes financial assistance and, if done illegally, can be declared void by the courts and exposes the target group’s directors to criminal penalties. In order to prevent this from happening, private companies must whitewash the proposed financial assistance (and any bank financing should be conditional on this whitewash being completed).
A whitewash essentially involves all the directors of the relevant company swearing a statutory declaration as to that company’s solvency. This declaration is supported by an auditor’s report as to the reasonableness of that declaration. Often banks will also require the auditor to provide them with a separate report as to the impact of the proposed financial assistance on the net asset position of the company or companies providing that assistance. An unfortunate consequence of these requirements, however, is that a borrower is generally faced with increased legal and accounting fees. Whitewashes can also add an extra layer of complexity to transactions.
The immediate effect of the change of law should be to remove this inconvenience from banking transactions. However, companies will not be able to enter into financial assistance style transactions free from any restraint. In particular, company directors will have to ensure that the proposed transaction will not breach:
- the company’s capital maintenance duties;
- their own duties to the company as directors (notably those introduced by the Companies Act 2006); and
- insolvency law (e.g. transactions at an undervalue, preferences and unlawful trading).
In addition, the Companies Act 2006 will continue the absolute prohibition on public limited companies, and their subsidiaries, providing any financial assistance. As is the case today, any public company that wishes to provide financial assistance, or is a holding company of a private company that wishes to provide such assistance, will have to re-register as a private company prior to doing so.
Furthermore, the whitewash process serves a useful means of providing banks with verification as to the current and future solvency of a target group. It is therefore almost certain that banks will seek to continue the whitewash in some form after its abolition. However, unless and until industry-wide standards are developed, we are likely to move from the standardised world of whitewashes under the Companies Act 1985, to a world where the negotiating strength of borrowers may create quasi-whitewashes which vary in form and substance from transaction to transaction.
The impact of the Companies Act 2006 on banking and other finance transactions extends well beyond financial assistance. More prosaically, banks that are accustomed to receiving company secretary certificates from borrower companies should be aware that, from April 2008, private companies will no longer need to appoint company secretaries. Equally, so called “Slavenberg” registrations (the registration of security by overseas companies not formally registered as an overseas company at Companies House) will be abolished on 1 October 2009.
What is more, checking a company’s memorandum of association to verify whether it can borrow money, grant security or guarantee third party debt will no longer be possible after 1 October 2009. Why? Because from this date, the memorandum of association of a company will no longer contain an objects clause but will only contain historic details of the company’s initial subscribers. Instead, any objects clause will be moved to the articles of association of the company. In addition, the objects of all companies will be unlimited unless specifically restricted by the articles.
As briefly touched upon above, directors must ensure that, in entering into any banking or finance transaction, they appropriately discharge their duties to the company. Since 1 October 2007, the new act codifies directors’ duties and, as a result, new duties have been created such as the duty to “promote the success of the company for the benefit of the members as a whole”. In exercising this duty, directors are required to have regard to a series of factors such as the likely long-term consequences of the company’s actions, the interests of the company’s employees, the impact of the company’s operations on the environment and the community, the need to foster business relationships with customers, suppliers and other parties, the need to act fairly between members of the company and the desirability of maintaining a reputation for high standards of business conduct. Any transaction entered into in breach may be declared void by the courts and the directors could incur civil liability under a derivative action claim brought by a shareholder under the act.
The new Companies Act will have a far reaching impact on corporate banking transactions and, given that it is the longest piece of legislation ever passed by Parliament containing more than 1,300 sections and 16 schedules, there is sadly not enough space in this article to discuss this in full. The size of the act will also inevitably mean that it will fall victim to the law of unintended consequences and will, as a consequence, affect banking and finance transactions in ways that are not presently anticipated. However, from a banking perspective, the success of the new act will depend on whether it makes transactions easier to complete, while, at the same time, providing banks with at least the same level of protection that they would have expected prior to the implementation of the new act.