Summary
From 1 October 2008, two key provisions of the Companies Act 2006 (the "2006 Act") come into force which will make private acquisitions and re-organisations in the UK simpler. Most significantly:
- The financial assistance regime in the Companies Act 1985 (the "1985 Act") will be repealed and replaced by 2006 Act provisions which will not prohibit a private company from giving financial assistance for the acquisition of its own shares or the shares in its holding company (so long as that company is also a private company).
- The existing reduction of capital regime will also be relaxed. Under the new regime, private companies will be able to choose between a court procedure and a new directors' solvency statement procedure.
Finally, a third area of the 2006 Act which has been in force since 6 April 2008 clarifies the law relating to intra-group asset transfers, an area of law especially relevant to post-acquisition reorganisations. The 2006 Act provides that so long as a company has positive distributable reserves which are sufficient for the purpose, the amount of any distribution arising from a disposition by a company of a non-cash asset should be determined by reference to the asset's book (not market) value.
Financial Assistance – 1 October 2008
Current position
The current regime prohibiting financial assistance (contained in the Companies Act 1985 and developed by a number of cases) provides that, except for very limited exceptions, neither a company nor its UK subsidiaries may give financial assistance for the acquisition of that company's shares, whether before, during or after the acquisition. The rule has attracted attention both because of its lack of clarity (there have been a number of cases delimiting the meaning of "financial assistance") and also because officers of a company contravening the rule may be fined and imprisoned.
The financial assistance prohibition has operated to prohibit (a) payment of transaction fees/costs by the target or its UK subsidiaries; (b) the giving of security and guarantees by target companies (e.g. in a typical leveraged buy-out where the group's borrowing is secured by target group assets); and (c) post-acquisition transfers/reorganisations (e.g. where the transfers have been effected at less than market value).
Under the current regime (as set out in the 1985 Act), financial assistance given by private companies and certain of their private subsidiaries which would otherwise be unlawful may be "whitewashed" by following a statutory procedure. Implementing a whitewash procedure has its drawbacks, however, including additional legal and accounting costs and an inflexible statutory timetable for making statutory declarations, getting shareholder consents and giving the financial assistance. In addition, the whitewashing directors assume personal liability for the contents of the statutory declarations which they must give as to the solvency of the relevant target group company(s).
The 2006 Act
As from 1 October 2008, the prohibition on the giving of financial assistance by a private company is (largely) abolished by the Companies Act 2006. This means that a private company may give financial assistance (a) for the purchase of its shares, or (b) the shares of its parent, if that company is also a private company. The whitewash procedure (which is consequently no longer needed) is also abolished. The prohibition against unlawful financial assistance has been retained in its current form for public companies, and it is unlawful for a public company subsidiary to give financial assistance for the purpose of an acquisition of shares in its private holding company.
Issues
The abolition of the financial assistance prohibition will allow significantly more flexibility in private acquisitions in the UK going forward. It will not, however, usher in an age where a company can give financial assistance free from legal constraints. Directors of private companies, and those that advise them, will still need to be mindful of: (a) directors' duties and, in particular, whether the financial assistance promotes the success of the company; (b) the impact of insolvency legislation; (c) whether the company has the capacity and authority to give such financial assistance; and (d) both statutory and common law capital maintenance rules, particularly where a gift is being made or assets are being transferred at an undervalue.
Reductions of capital – 1 October 2008
Reductions of capital are often effected following an acquisition, for instance to clear a dividend block in a target company. Presently, a limited company having a share capital may, by complying with the provisions of the Companies Act 1985 ("1985 Act"), reduce its share capital so long as its creditors are not adversely affected. The procedure set out in the 1985 Act requires a special resolution of the shareholders and court confirmation of the capital reduction. Before giving its confirmation, the court must satisfy itself that the rights of the company's creditors have been safeguarded.
The 2006 Act
From 1 October 2008, a private company having a share capital will be able to reduce its share capital without going through the court procedure outlined above. It would instead follow a new solvency statement procedure. The court procedure will, however, remain available to private (as well as public) companies, and may at times be preferred (for instance where there have been mistakes in a company's capital history and it would benefit the company for the court to endorse a statement of the company's capital in the form of the minute mentioned above).
In addition, whereas under the 1985 Act, a company could only reduce its share capital if its articles permitted capital reductions, under the 2006 Act a company will be able to reduce its capital (whether by court procedure or by solvency statement procedure) so long as it is not prohibited from doing so by its articles.
Solvency statement procedure
Similar to the whitewash procedure referred to above, the new solvency statement procedure involves each director of the company making a declaration that the company is a going concern and will be able to pay its debts either: (a) in the following year; or (b) (where it is intended to commence the winding up of the company within a year of the declaration) within a year of the commencement of winding up.
Where a director makes the solvency statement without having reasonable grounds for the opinions expressed in it, he may be imprisoned and/or fined.
The solvency statement procedure described above is broadly similar to the court procedure (where the solvency statement replaces the court confirmation of reduction), except that under the new procedure the company's creditors do not have the opportunity to object to the proposed reduction.
Intra-group transactions at an undervalue – 6 April 2008
A final way in which the 2006 Act makes re-organisations in the UK simpler is by clarifying some of the law surrounding intra-group transfers (for instance, where business assets are transferred from a target group company to a member of the buyer's group post-acquisition). In particular, the 2006 Act clarifies the application to intra-group transfers of the common law rule established in the case Aveling Barford v Perion [1989] BCLC 626. The rule is especially relevant in the context of post-acquisition reorganisations.
The rule in Aveling Barford
In Aveling Barford, the High Court held that if a company transfers assets at an undervalue to another company controlled by the same shareholder as the transferor, then the amount of any such undervalue will be deemed to be a distribution. The judge in Aveling Barford considered the consequences of such a distribution for the purposes of the common law rules relating to maintenance of capital. He found that the amount of any undervalue which was not funded by distributable reserves would constitute an unlawful return of capital.
Aveling Barford spelled out the consequences of making a transfer at an undervalue which is not covered by distributable reserves. First, the transfer would be outside the powers of the transferring company (and, as a result, not binding). Secondly, the transfer cannot be ratified. And finally, the recipient of the assets transferred could be liable to return the assets to the transferor.
The issue
Although Aveling Barford has made it easier for practitioners to identify where there might be an unlawful return of capital, it did not clarify what constitutes an "undervalue". The more commonly held view has been that, for the purpose of determining whether the transfer was or would be at an undervalue, the transferring asset should be valued at book value. However, prior to 6 April there was a danger that the courts might instead look to an asset's market value to determine whether it had been transferred at an undervalue. As a result of lobbying, the 2006 Act clarified the position.
The 2006 Act
Part 23 of the 2006 Act, which came into force on 6 April 2008 and applies to sales, transfers and dispositions of non-cash assets, clarifies when a non-cash asset may be valued at its book value. In brief, where a company is determining the amount of any distribution in kind, the company may value the asset at book value to the extent that: (a) the company has distributable reserves; and (b) those reserves are sufficient to cover the difference between the consideration paid for the asset and its book value. A transfer at book value will be a distribution, for the purposes of the 2006 Act, with a value of zero.
Conclusion
Between the repeal of the financial assistance regime in the 1985 Act, the introduction of the new reduction of capital procedure for private companies and the clarification of the accounting treatment surrounding intra-group transfers, the 2006 Act is to be welcomed for offering considerably greater flexibility and clarity to parties engaged in private acquisitions in the UK.
Further Information
If you have any questions or would like to discuss anything in this article in more detail, please contact Sam Kessler at Kemp Little LLP on 020 7600 8080 or by email to sam.kessler@kemplittle.com.
