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Financial assistance laws overhaul: Harmonisation or headache?

24 September 2008

1 October 2008 sees the eagerly anticipated repeal of the prohibition on UK private companies giving financial assistance

The acquisition finance industry has grown up with a restriction on companies giving assistance to someone acquiring shares in themselves and the need to structure deals around the resulting limited guarantee and security packages available from European target group companies.

Despite UK companies having been able to take advantage of the whitewash procedure to get round the problem, it is document intensive, time consuming and expensive to implement. Detailed advice from lawyers and accountants (the latter having to issue a statutory report as part of the process) is required. The current system is also administratively burdensome, as every director of the company must make a statutory declaration in front of an independent solicitor in support of the financial assistance. Completion meetings become tedious affairs as a result.

The Companies Act 2006 has brought about the most fundamental changes to UK Company law for more than 20 years. These changes have been implemented in stages since April 2007, and on 1 October 2008 the long awaited prohibition on the giving of financial assistance by a private company for the purchase of shares in itself will be abolished together with the whitewash procedure. Public companies, however, will continue to be prohibited from giving financial assistance.

The impact of the repeal will be most noticeable on the acquisition of private companies because target security will be readily available on or shortly after completion.

Sounds like music to directors’ ears; sadly not, for the laws on maintenance of capital for the protection of shareholders have instead topped the Government’s agenda. This has resulted in the issue of somewhat uncertain rules on capital maintenance for private companies to comply with if they want to give upstream guarantees and security to support the acquisition debt of a purchaser post- October 2008.

The rules are detailed, but essentially resurrect the obligations on directors to consider their fiduciary duties, insolvency issues and capital maintenance principles when giving the assistance – the transaction must not breach the rules on dividends or other distributions or amount to an illegal reduction of capital.

Under the whitewash procedure, directors of a target company currently have to review the base case models, financial projections and cashflows, and financial covenants to determine whether the company’s net assets are impacted by the transactions they have been asked to enter into to secure the acquisition finance.

From 1 October, directors will still need to go through the same procedure to determine whether or not there would be an unlawful reduction of capital. Similar documentation to authorise the entry into the documents by the company will still need to be drafted by the company’s advisors. The new process could prove to be just as costly and protracted as before.

So whilst these changes to the UK’s financial assistance regime should, in theory, soothe the experience of all parties involved on leveraged finance transactions, in practice directors and advisors could still be reaching for the headache pills.

Are any of the issues in this article giving you a headache? If so, we want to know

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Debra Mitchell

Solicitor
T: 08700 86 4214
I: +44 (0)121 625 4214
E: debra.mitchell@shoosmiths.co.uk