Restriction to be lifted
This briefing considers the impact of the removal of the restriction on a private company giving financial assistance in connection with the acquisition or purchase of its own shares. The removal of this restriction will take place on 1 October 2008.
The general prohibition on the giving of financial assistance by a public company (or by its private company subsidiary) for the purchase of shares in the public company remains (for the time being at least) and from 1 October 2009 criminal liability for breach will extend to the company as well as every officer of the company in default.
What is financial assistance?
Currently it is unlawful for a company or any of its subsidiaries to give any financial assistance, for the purpose of the purchase of its own shares or any shares in its holding company. This is only an issue where shares are being acquired, not assets. The type of assistance prohibited can take a variety of forms: from the straightforward provision of a loan or payment of fees to the granting of security over the company’s assets or the giving of a guarantee. Unfortunately, exactly what constitutes financial assistance is not clear. There are severe penalties for breach, namely a fine for the company and fines and/or criminal liability for directors.
However, there is a statutory get-out, known as a “whitewash”, that enables a solvent private company to give the assistance, provided that a complicated and often expensive statutory procedure is followed.
Why is the law being changed?
While the restriction is not an everyday concern for companies, it often raises its head in structuring the finance for the sale of a company or the introduction of new shareholders. The restriction has led to convoluted deal structures being put together to try to get round the problem, or, if this proves impossible, the company carrying out an expensive “whitewash”.
Many of the objections to the prohibition come from people who are trying to comply with the law, if only they knew what it was. As a result of the ambiguities in the current law, the cost to companies of obtaining legal advice about what the restriction means is high (reputed to be approximately £20 million per year).
What does the new law do?
The prohibition on the giving of financial assistance by a private company for the purchase of shares in itself and the “whitewash” procedure will be abolished on 1 October 2008. The removal of the prohibition applies to financial assistance given on or after 1 October 2008 even if the shares in question were acquired, and the liability incurred, before that date.
What impact will the change have?
When the restriction is lifted for private companies on 1 October 2008, it is likely that transactions will be more straightforward and this should have a knock-on effect on advisory fees. A private company director should be able to rest more easily in the knowledge that the threat of a term of imprisonment if he got it wrong will have been lifted.
But private company directors should not be lulled into a false sense of security. Although the “whitewash” procedure is time consuming and expensive, it does offer an effective statutory checklist providing a degree of comfort to directors that they are operating in a proper manner. With the checklist gone, banks and other finance providers may be more anxious to ensure that other concerns, which are still of relevance now, but which can be buried by the “whitewash” procedure, have been addressed properly.
Existing concerns to the fore
The abolition of the “whitewash” procedure is likely to result in much more detailed board consideration of issues such as:
- Corporate benefit – directors of a company now have a statutory duty to act in a way that they consider to be most likely to promote the success of the company for the benefit of its members as a whole and, in that context, must consider whether they can justify providing to another company the support proposed. For example, the risk of giving security to a third party must be balanced against the actual or potential reward.
- Directors’ duties – with the codification of directors’ duties, but uncertainty over the interpretation of the new law, directors will be keen to ensure they comply with the new requirements.
- Insolvency analysis – directors will still be cautious on this and banks are also still likely to require comfort in the form of financial due diligence into the solvency of the company providing the assistance - supported by auditor’s reports.
Directors should note that situations might arise where a private company giving financial assistance on or after 1 October 2008 will still be in breach of company law. For example, a private company giving money to a shareholder to fund the purchase of more shares in the company, without sufficient distributable reserves to cover the gift, would amount to an unlawful reduction of capital. If the company were to make a loan instead, but at the time of lending it was aware that there was no reasonable prospect of repayment (thus necessitating a provision), then this would amount to an unlawful reduction of capital also.
Fear of revival of common law restrictions
Some commentators feared that when the statutory prohibition on financial assistance was removed, pre-existing common law rules on maintenance of capital would still operate in some situations to stop a private company giving assistance for the purchase of its own shares. However, the publication of the fifth commencement order (and its accompanying explanatory memorandum) in December 2007 has allayed these fears. A savings provision is included, intended to make it clear that the removal of the financial assistance prohibition will not stop private companies from entering into transactions that they can lawfully enter into now by carrying out a “whitewash” procedure.
Is it in force?
The Companies Act 2006 received Royal Assent on 8 November 2006 and is being introduced via a staggered timetable. Some provisions were introduced in January and April 2007. A substantial part, including some of the more controversial provisions relating to directors’ duties and the new shareholders’ derivative action, went live on 1 October 2007. The remainder was expected to be phased in on 6 April and 1 October 2008. Whilst some provisions will still come into force on those dates, full implementation will not now occur until 1 October 2009. BERR (formerly DTI) has published a revised table of commencement dates taking into account the delays.
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