RSS feedsQ: What is financial assistance and what changes has the Companies Act brought into effect?
A: Financial assistance is any help given by a company to assist a third party to buy shares in itself or in its holding company. For example, a target company providing cross-guarantees or security over its assets to support a loan made to a third party who is purchasing the target’s shares. Broadly speaking up until 1 October 2008 a private company could only lawfully give financial assistance if it had positive net assets and complied with a pre-approval process (known as a ‘whitewash’) involving statutory declarations, auditors’ reports and shareholder approval, which was lengthy and costly but provided comfort to lenders in respect of the company’s solvency.
Q: What does the prohibition on financial assistance actually mean in practice?
A: It has been abolished for private companies but not public ones. It will now be legal for a private company to give financial assistance without needing to have positive net assets or go through the whitewash procedure.
Q: What will private companies and their directors now need to consider before financial assistance can be given?
A: Despite not being unlawful per se any more, any financial assistance given by a private company must still be in the best interests of the company, in line with the company’s constitution and consistent with directors’ duties.
The assistance must not be an illegal distribution or an illegal reduction in the capital of the company. That said, if the assistance does not require an immediate accounting loss or a provision to be made in the company’s accounts there will be no effect on net assets. If there is an effect on net assets, this must be met out of the company’s distributable reserves.
In the board meeting approving the giving of the financial assistance, dire ctors must identify the corporate benefit to the company and they should consider the effect of the financial assistance on net assets. This is important if the company is at risk of insolvency as a result of the assistance because it may lead to the transaction being set aside as a preference or a transaction at an undervalue.
As an additional comfort, directors could also seek approval of the transaction by the shareholders of the company.
Q: What is the effect on transactions as a whole and what will lenders require?
A: It remains to be seen whether lenders will continue to seek comfort by alternative means instead of the whitewash procedure, for example, a detailed review of the distributable reserves positions, formal comfort from the directors or provisions in loan agreements prohibiting financial assistance without the lender’s consent. This is likely to be a matter of bargaining power but it is to be hoped that the additional layer of comfort instead of a whitewash, will prove to be the exception rather than the rule.
If market practice develops in this way, these transactions will be simpler and cheaper from 1 October, both in terms of types of structures used and advisers’ costs.
Q: What procedures can a private company go through now to reduce its share capital?
A: A new procedure, both cheaper and simpler than its predecessor, has been introduced so a private company can reduce its share capital by passing a special resolution supported by solvency statements from the company’s directors. The existing court-based procedure will still be available but it is widely thought the formal, cumbersome nature of the court process previously discouraged many companies from undertaking a reduction of share capital.
Before the special resolution can be passed by the company’s shareholders, each director must consider the solvency of the company and in particular its l iabilities and give a statement that in their opinion there is no ground on which the company could then or during the next 12 months be found unable to discharge its debts.
A reduction of share capital using this procedure will give rise to a distributable reserve to be treated as a realised profit.
Q: Will my position as a director of a private company be affected by the changes to directors’ duties?
A: Directors’ responsibilities will be widened by the changes. The provisions on conflicts of interest will have the most impact. Directors now have a statutory duty to avoid conflicts of interest. The Companies Act 2006 now allows for the independent directors of a company to authorise a director’s conflict of interest where appropriate.
It is thought the statutory duty to avoid conflicts of interest, while intended to codify the existing law, is of wider application. Directors are at greater risk of breaching this duty. It is advisable that potential conflicts be pre-authorised.
The directors will still have a duty to disclose any interests in existing or proposed transactions with the company but must now disclose the extent of any such interest.
Failure to declare an interest in an existing transaction or arrangement with the company is a criminal offence (a breach of the other duties could only give rise to civil claims against a director).
A useful test is to regard an ‘interest’ as a very broad term that includes anything or any connection which could potentially divert a director’s mind from giving sole consideration to promoting the company’s success.
If in doubt as to any conflict or potential conflict, disclosure to the
company is the safest option.
Nigel Stanford is a partner at
Cripps Harries Hall LLP
