Financial assistance: still a thorn in our side?

Published: 15th August 2008

Background

At the time that shares in a company (Target) are acquired, it is well-known that there are certain things that Target may not do, directly or indirectly for the purpose of the acquisition, unless this assistance can be "whitewashed".

What is less well-known is that actions of Target after the acquisition may equally need to be whitewashed.

This bulletin considers briefly a couple of common scenarios where this situation may arise against the background of the forthcoming repeal of the financial assistance rules in relation to private companies.

1. Refinancing of acquisition finance

It is likely that a bank (First Bank) which provided finance at the time of the share acquisition has taken a guarantee from Target of the liabilities to the bank of the acquiring company (Parent).

If this funding is later refinanced, it is equally likely that the new bank will also want such a guarantee. The grant by Target of a new guarantee will be for the purpose of discharging the liabilities incurred by Parent and Target to First Bank at the time of the share acquisition. This guarantee will therefore need to be whitewashed.

Comment

It is commonly believed that there is a time limit beyond which refinance can safely take place without the need to whitewash. If the original acquisition loan has already been repaid, and the refinance relates simply to working capital, such a belief is reasonably held. But the position is not always clear. What if, for example, Target has over-stretched other financial resources in order to repay the acquisition finance early? New finance may then be required in part to restore such other resources (thereby indirectly reducing the original liability to First Bank).

2. Group reorganisation: transfer of business

What happens if, following the share acquisition, Target later transfers its business to another member of its group, typically to Parent?

Such a transfer may need to be whitewashed, where the price for the transfer is to be left outstanding as a debt between group companies. In this case, Target obligations (to transfer the business) are fulfilled at a time when Parent's obligations (to pay for it) remain unfulfilled.

Comment

A transfer expected at the time of the acquisition to take place shortly after the acquisition, is often whitewashed at the time of the acquisition, as there are then in place arrangements to transfer.

If there are genuinely no such arrangements in place at the time of the acquisition, is there then any requirement to whitewash? Probably not. It depends on whether Target is doing something now for the purpose of reducing any liabilities incurred at the time of the share acquisition.

Note

The bank's group security structure is likely to remain in place immediately post-transfer. Whilst Target is likely to have any overdraft cleared off as a result of the transfer, and eventually the bank's guarantee from Target may be discharged, the transfer will not take place for this purpose. In any event, to the extent that the overdraft facility was utilised for the purpose of meeting costs of the acquisition, it is probable that the facility has been cleared by items credited since.

General Comment

In October 2008 the long heralded repeal of the financial assistance rules for private companies comes into force when the relevant sections of the Companies Act 2006 are finally introduced.

It may be worth considering whether to defer an affected transaction until after repeal. This may be particularly relevant if whitewash will not be available for lack of net assets or adequate distributable reserves.

However, the CA 2006 also placed on a statutory footing for the first time the fiduciary duties that directors owe their companies. Some commentators take the view that in order to be satisfied that the directors have carefully considered their duties when resolving to (e.g.) allow Target to offer an upstream guarantee for its new parent company's acquisition funding, they will need to carefully minute their decision making in a manner not dissimilar to that customary under the old regime.