Two cheers for the loosening of the Financial Assistance restriction

One of the more welcome changes introduced by the 2006 Act is the removal of the prohibition on a private company giving financial assistance for the purpose of the acquisition of its own shares. This change will come into effect on 1 October 2008.

The possibility of unlawful financial assistance can arise in many different situations, but one of the most common is when the acquisition of a company is being financed by bank debt. In those circumstances, any guarantees and associated security provided by the target company and its subsidiaries have been potentially unlawful unless a strict statutory ‘whitewash’ procedure has been followed. Therefore the loosening of the financial assistance restriction will soon make life easier in many instances for those involved in acquisitions.

Current Regime

Up until now it has been unlawful for a company to provide financial assistance for the purpose of the acquisition of its shares or the shares of its holding company. Equally, where an acquisition has taken place, it has been unlawful to provide financial assistance for the purpose of reducing or discharging a liability incurred for the acquisition.

The rules have been notoriously difficult to apply, with many grey areas. Because of the potential consequences of failing to spot financial assistance, including criminal sanctions for the directors and invalid security for the lenders, a cautious approach has generally been adopted.

Furthermore, whilst the whitewash procedure has been available to sanction financial assistance for private companies, it suffers from a number of significant disadvantages. Firstly, it is only available for a company which has positive net assets. Secondly, it requires the directors to give a statutory declaration as to the solvency of the company in the year to come and for the auditors to report on the reasonableness of that declaration. This can be an expensive process. Thirdly, the procedure is very non-user friendly and the cause of much debate in the past as to what is and is not permitted: for instance if the directors are not all in one place, is it permissible to have the statutory declaration signed on two separate forms? Does the auditors’ report have to be signed before or after the statutory declaration? Contrary to what some clients may think, this is not the type of thing which gets a solicitor out of bed in the morning, and the passing of the procedure will be welcomed by solicitors as much as anyone.

New Regime

From 1 October 2008 financial assistance will no longer be prohibited for private companies and the whitewash procedure will become redundant.

However, despite this change, there will still be issues to consider. Firstly, the restriction on financial assistance will still apply to public companies and also to private company subsidiaries of public companies.

Secondly, where guarantees and security are being sought on an acquisition, the directors of the company concerned will still need to consider many of the same matters before giving approval. For instance:

  • commercial benefit: the directors will still need to satisfy themselves that the giving of the guarantee is in the interests of the company itself. Note that it cannot be assumed that, just because the transaction benefits a parent company, it will automatically be for the benefit of a subsidiary;
  • whether any provision needs to be made in the company’s accounts for a contingent liability in respect of the guarantee? If so, is there any chance that this might represent an unlawful distribution to a parent company;
  • does the giving of the guarantee raise any insolvency concerns?

One of the most interesting questions that arises with the new regime is whether an auditors’ report ought to be commissioned even though that is no longer a statutory requirement. We expect that the directors would usually feel sufficiently comfortable about the state of their company’s finances to be able to proceed without an auditors’ review. It remains to be seen whether lenders take a more cautious approach and insist on the involvement of the auditors as a condition of advancing their money. This is likely to vary from situation to situation, but we would predict that in most cases the company will be spared the additional expense.