Financial Assistance | DFA Law Northampton Solicitors News

Financial Assistance: Is it really going away?

On 1 October 2008, the financial assistance provisions of the Companies Act 1985 were repealed for most private companies. The repeal applies to financial assistance given on or after 1 October 2008 by a private company for the purpose of the acquisition of shares in itself or another private company. The whitewash procedure has also gone.

When is financial assistance appropriate?

The repeal does not mean that financial assistance which previously needed to be whitewashed can now simply be given without further thought. Other factors continue to be relevant when deciding whether it is appropriate to give financial assistance. These are explained below.

Solvency

If there is any doubt as to a company’s solvency, the directors will need to consider the interests of the company’s creditors, and the company should not give financial assistance. Directors should consider the cash flow and net asset position of the company to ensure there are no solvency issues.

Although there is no longer a strict requirement for a company to have positive net assets in order to give financial assistance, the existence of net assets is relevant to the question of the company’s solvency.

Any transaction entered into when a company is insolvent is vulnerable to being set aside, under the Insolvency Act 1986 either as a transaction at an undervalue or as a preference. This could clearly be a matter of concern to a lender.

Directors’ duties

Assuming the company is solvent, the directors’ primary duty will be to satisfy themselves that entering into the transaction promotes the success of the company. A shareholder resolution may assist where compliance with directors’ duties is in doubt.

Capacity and authority

The directors will need to check that the company has the capacity to give financial assistance (older articles of association prohibit this and will need to be amended). The transaction should also be authorised properly and this should be documented in board minutes.

Capital maintenance

The transaction must not constitute an unlawful reduction of capital. This can be a complex area and may require careful legal analysis. The simplest way to summarise the relevant considerations is by looking at some examples:

* In the case of an upstream guarantee, a loan, or a transfer of assets for deferred consideration, the key question is whether the company needs to make a provision in its accounts. If it does not, there is no capital maintenance issue. If it does, the company can only enter into the transaction if it has sufficient distributable profits to cover the amount of the provision.

* In the case of a gift, the company must have sufficient distributable profits to cover the gift (a gift includes any gratuitous transaction, such as the target company paying fees on behalf of the buyer).

* In relation to a transfer of assets at less than market value, provided the transfer is above book value, the company will not be treated as making a distribution and may enter into the transaction provided it has some distributable profits. If, however, the transfer is also below book value, then the company will need to have sufficient distributable profits to cover the deficit.

Is it really going away?

While the repeal has been welcomed, there remains the question of what comfort directors and lenders will require when contemplating financial assistance. Will they require anything in place of the whitewash procedure?

This question has been discussed in various legal and banking circles and the emerging consensus is that it should not, other than in exceptional circumstances, be necessary or appropriate to ask the auditors of the relevant company to give comfort or an opinion; there should be no need for a de facto whitewash exercise. It will, however, remain best practice to ensure that all the relevant factors are considered and recorded appropriately in board minutes, and lenders will want to satisfy themselves that this has been.

Inevitably in the post “age of irresponsibility” financial climate, some lenders will adopt a belt and braces approach, and may seek something akin to an accountants report and a directors’ declaration (albeit in a non-statutory form).

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