FINANCIAL ASSISTANCE
Key Points
The Prohibition
Subject to certain exceptions, a UK company is prohibited from giving financial assistance in connection with an acquisition of shares in it or its holding company.
"Financial Assistance"
Financial Assistance is widely defined:
Section 151(1) of the Companies Act, prohibits the giving of financial assistance before or at the same time as the acquisition of shares. The section provides:
"...Where a person is acquiring or proposing to acquire shares in a company, it is not lawful for the company or any of its subsidiaries to give financial assistance directly or indirectly for the purpose of that acquisition before or at the same time as the acquisition takes place."
Section 151(2) prohibits the giving of financial assistance after the acquisition of shares. The section states:
"...Where a person has acquired shares in a company and any liability has been incurred (by that or any other person), for the purpose of that acquisition, it is not lawful for the company or any of its subsidiaries to give financial assistance directly or indirectly for the purpose of reducing or discharging the liability so incurred."
An example would be where a target company enters into a guarantee and security in relation to the loans made available to a buyer of its shares.
"The Whitewash Procedure"
A private company is permitted to give financial assistance in connection with an acquisition of shares in it or its holding company if the statutory "whitewash" procedure is adhered to:
- the financial assistance must not reduce the net assets of the company, or to the extent it does, the reduction in the net assets must be made out of distributable reserves of the company;
- a statutory declaration must be made by all the directors of the company giving details of the nature of the financial assistance, to whom the financial assistance is to be given and the principal purpose for the giving of the financial assistance. In addition, the directors are required to confirm in the statutory declaration that:-
(i) the Company will be able to pay its debts immediately following the financial assistance having been given; and
(ii) the Company will be able to pay its debts as they fall due during the period of 12 months thereafter;
- the auditors of the Company are required to report that they have enquired into the state of affairs of the Company and that they are not aware of anything to indicate that the opinion of the directors in the statutory declaration in relation to the matters referred to in paragraph (b) is unreasonable in all the circumstances.
- certain time limits are adhered to.
Other Exceptions
Section 153(1) provides that financial assistance is not in breach of section 151(1) if:
"the company's principal purpose in giving that assistance is not to give it for the purpose of acquisition, or the giving of the assistance for that purpose is but an incidental part of some larger purpose of the company, and (b) the assistance is given in good faith in the interests of the company."
Benefit to the Company
The directors of the company must act in what they consider to be the best interests of the company and must not disregard the interests of the company in favour of the interests of the group of which the company is a party.
BREAK FEES
Break fees (or termination, inducement or broken deal fees as they are sometimes called) are arrangements entered into between a bidder and a target company whereby a fee is paid if a specified event occurs which prevents the transaction from completing.
Break fee arrangements have become increasingly complex and it is now common for undertakings to pay break fees to be given by both parties to the transaction. Other examples of the development of break fees are that they have in some cases been given by the shareholders of a target company to a bidder and have even taken the form of a conditional subscription for shares in a bidder by a shareholder of the target company.
The exact nature of the trigger events for payment of a break fee will depend on the strength of the negotiating position of the parties involved and the time when the break fee agreement is entered into.
Some examples of when a break fee may become payable are:
- a prospective bidder does not announce an offer after a formal approach to the target company on account of unsatisfactory due diligence (although this would be unusual);
- a substantial shareholder does not accept an offer made by the bidder at an agreed level;
- a bidder makes a formal approach and announces an offer at an agreed level but the board of the target company does not recommend it or withdraws, adversely modifies or fails to reconfirm its recommendation of the offer;
- an offer is made by a bidder but it does not become or is not declared unconditional in all respects other than due to the wrongful act or omission of the bidder (normally because a higher competing offer becomes wholly unconditional);
- the shareholders of a target (or bidder) fail to pass the necessary resolutions where they are required to do so to enable the deal to complete;
- having signed a non-solicitation agreement with the bidder, the target company, directly or indirectly, solicits or initiates any discussions or negotiations with a third party in contemplation of a higher competing offer by the third party or the target company breaches a warranty or representation it has made about itself to the bidder. However, in these cases it will be necessary to structure the break fee so that it does not amount to a penalty; or
- the board of a target company negotiates with a third party in relation to an unsolicited counter offer (again the doctrine of penalties will be relevant). Such a trigger event may also give rise to issues for the board of the target company since any agreement by them not to consider an unsolicited approach or offer by a third party may fetter their fiduciary duties.
It is essential that the payment of a break fee is addressed in detail as a successful bidder for a target company may seek to declare that the payment to an unsuccessful bidder was not valid and it could potentially try to reclaim such fee from the directors personally.
It is vital to first check that the Memorandum of Association of the target allow the company to pay a break fee, and it is not acting outside its capacity. Also, the directors are bound not to enter into a contract that might fetter their discretion but are also bound by their duties of acting in good faith. Both of these issues could present a problem should the directors be found to have acted in contravention to their powers. One of the most important tests is stated in the Takeover Code. This sets a cap on the break fee of 1% of the value of the offeree company. If the break fee is below this threshold then any dispute will be harder to bring. The entrance into a break fee may also constitute unlawful financial assistance, as, without the break fee agreement in place, the bidder would not continue with its offer for the target’s shares. However, this argument has, as yet, been untested in the courts.