Finland: Financial Assistance and Other Restrictions on Corporate Lending in Finland

By Lauri Peltola and Sami Martola

Finnish company law may, in general, be characterised as very flexible and accommodating and it should contain very little that would surprise a non-Finnish investor. There are, however, exceptions. For example, before making decisions on certain financing transactions, particular attention must be paid to the restrictions governing grant of financial contributions within international groups (or within Finnish companies, in general). If neglected, these restrictions may have unforeseen and dire consequences under Finnish law. This applies especially to the lending or granting of collateral by a Finnish company for the purposes that the receiving party acquires shares in the company or in another company within the same group of companies (financial assistance), but also to Finnish subsidiary companies lending or granting collateral to their parent or sister companies abroad.

This article will focus on the prohibition against financial assistance and on the limitations for the grant of a loan to the so-called "inner circle" of the company. In addition to regulations currently in force, the recent proposal for a new Companies Act which would amend the current regulations is also discussed in this article.

According to the Companies Act, a Finnish limited liability company may grant loans to or provide collateral for the obligations of a party belonging to the inner circle of the company only within the limits of the freely distributable equity of the company and against obtaining itself adequate collateral. According to the Companies Act, the inner circle of a limited liability company includes, inter alia, a shareholder holding a minimum of one per cent of the shares or the votes in the company. Accordingly, this provision restricts heavily the possibilities of a Finnish limited company to provide such facilities to its shareholders.

There are, however, certain exemptions from the above rule. Monetary loans or collateral may, without the above restrictions, be granted to a party belonging to the inner circle of the company, inter alia, if the debtor is a group company limited by shares ("group exemption") or the debtor is an entity conducting business and is not a member of the same group as the creditor, and the loan granted is based on "commercial considerations". "Commercial considerations" is an extremely vague description and subject to interpretation. It is understood to mean, as a minimum, that the loan is used for the debtors’ business activities and does not have an unusually long maturity. Loans granted under this exemption must be specifically recorded in the minutes of the Board of Directors of the lender company.

Pursuant to the above "group exemption", loans or collateral may be granted to a company belonging to the same group as the lender. A group of companies is defined in the Companies Act as to include the parent company (a limited liability company) and its subsidiary companies (whether limited liability companies or other legal entities). A subsidiary company is defined as an entity in which the parent company, directly or indirectly through its other subsidiary companies, exercises control.

The interpretation of the above "group exemption" has, in practice, proven also very difficult, especially with respect to international groups. It has been rather unclear which entities incorporated outside Finland qualify for the group exemption. For example, foreign entities not limited by shares are considered not to be included in the group exemption, unless they are co-operative societies. Therefore, if a group’s ultimate parent company is, e.g., a partnership, such a structure may affect the ability of the Finnish subsidiary to grant a loan or provide collateral within the group. Another uncertainty relates to the treatment of foreign sister companies of a Finnish group subsidiary (assuming that all companies have a common non-Finnish parent). It is somewhat unclear whether a Finnish subsidiary may, for instance, enter into a guarantee undertaking on behalf of its foreign sister company, as such sister company may be considered to be outside the application of the "group exemption".

The above ambiguity concerning foreign sister companies has caused a lot of concern regarding, for example, group cash pooling arrangements. In particular, with respect to sister companies incorporated in the EU, it has been discussed in Finnish legal literature whether the prohibition could be in breach of the principle of free establishment in the EU. There are, however, no precedents on these issues to give any guidance.

The Companies Act stipulates that a Finnish limited liability company may not grant a loan or provide collateral or other assets for the purpose that the receiving party (or any party belonging to its inner circle) acquires shares in the company or in another company within the same group of companies.

The regulations related to such financial assistance origin from the EU Directives, and the travaux préparatoires to the Companies Act stipulate that the prohibition is intended to prevent the financing of the acquisition of the company’s own shares or the shares in another company in the same group by applying the company’s own funds.

The wording used in the prohibition against financial assistance is, however, ambiguous and causes, in practice, serious problems of interpretation. The problem originates from the travaux préparatoires to the Companies Act which do not thoroughly account for the prohibited forms of financial assistance, but only refer to the argument that financial assistance in any manner is prohibited. The risks relating to the interpretational problems are accentuated by the fact that a breach of the prohibition against financial assistance can have very severe consequences for the parties involved.

For example, although the wording of the said provision of the Companies Act would seem to suggest that the prohibition would not cover a situation where a company lends funds to a person and such funds are used by someone else than that person or a person belonging to the inner circle thereof to acquire the shares in the company or in another company within the same group of companies, it is generally considered that such practice would nevertheless not be permissible, because lending of funds for the above purpose would fall outside of the scope of objects of the company and the intention of the legislator has been to prohibit the financing of the acquisition of the company’s own shares that takes place in any manner.

In addition, pursuant to the travaux préparatoires it may be concluded that it is prohibited to lend funds for the financing of the acquisition of the company’s own shares even if the funds are transferred only after the acquisition has taken place, if it can be shown that the purpose for the use of such funds was the financing of the acquisition.

It remains, however, unclear whether a Finnish company could provide assistance in financing the acquisition of shares in a foreign parent or sister company. The wording of the Companies Act does not cover the foreign parent or sister company of a Finnish company. In the absence of comprehensive legal precedents on financial assistance in Finland, it is not possible to confirm the correct interpretation of the Act.

The prohibition on financial assistance must be taken into account very carefully when planning acquisition finance involving a Finnish group company. The sanctions are very severe, and further, under Finnish law, there is no whitewash procedure available which would enable a Finnish company to participate in such acquisition, i.e., no exemption from the prohibition against financial assistance is possible.

A breach of the prohibition against financial assistance or the restrictions on inner circle lending may constitute a criminal offence and the arrangement may be declared null and void. Further, the funds lent may be ordered to be repaid, with interest. Furthermore, the granting of loans or provision of collateral in favour of a group company in circumstances where there is a real risk that this group company may be unable to repay the loan/release the collateral, may be construed by Finnish courts as a breach of the corporate powers and/or an unlawful distribution of funds, despite that the provisions of the Companies Act have been otherwise complied with.

Further, the representatives of the company (the board and/or the managing director) authorizing the lending/provision of collateral contrary to the aforementioned provisions may also be deemed to have exceeded its/his authority under the Companies Act. As the board and the managing director are, under a general duty to act diligently and in the best interest of the company and its shareholders, the board and the managing director may become liable for any loss caused to the company.

In February 2001, the Finnish Ministry of Justice appointed a Working Group to prepare a proposal for a new Companies Act. The aim is to prepare a more flexible Act that would enhance the possibilities of limited liability companies incorporated in Finland to arrange their operations more efficiently, and thereby, to enhance their competitiveness. The Working Group submitted its proposal to the Ministry of Justice in May 2003 and the proposed amendments are now under public scrutiny. Therefore, the proposal is expected to be updated before it will be submitted to the Parliament for approval. Due to the extensive nature of the reform, the new Companies Act is not expected to become effective before 2005.

The proposal includes major amendments to the current regulation. Of particular interest is the proposed abolition of the limitations on inner circle lending. Under the new Act, inner circle lending would be governed by the general principles of Finnish company law. The Working Group argues that the current limitations on inner circle lending, and especially, the exemptions thereof, are on certain occasions inconsistent. Finally, the Working Group notes that the application of possible future exemptions from the Finnish Companies Act should not be limited to Finnish companies, but be applied also to parent and sister companies incorporated within the EEA.

Instead, the Working Group proposes that the prohibition against financial assistance be retained, however, amended to certain extent. Under the new Act, the scope of application of the prohibition against financial assistance would be limited to the acquisition of the company’s own shares and the shares of the parent company. Consequently, the financing of the acquisition of the shares in a sister company would not, as a general rule, be prohibited. Furthermore, the Working Group proposes that the prohibition against financial assistance would not prohibit management buy out ("MBO") arrangements where the target company is (after the acquisition of the shares in the target company) merged with the acquiror company. However, the Working Group emphasises that the circumstances in the financing of the acquisition of the shares of a sister company and MBO or similar arrangements may in some cases, also under the new Act, constitute a breach of the prohibition against financial assistance. In addition, due to the fact that the prohibition against financial assistance is open to interpretation, the Working Group proposes that under the new Act a breach would not constitute a criminal act. However, as financial assistance may be construed by the Finnish courts as an unlawful distribution of funds, which also under the new Act would constitute a criminal offence, financial assistance may, nevertheless, also under the new Act become subject to criminal sanctions.

The prohibition against financial assistance and the limitations concerning inner circle lending are, largely, very difficult to apply in a cross-border transaction and a breach against the prohibitions may have exceptionally severe consequences. The proposed reform of the Companies Act would remove some of the current difficulties. The abolition of the provisions concerning lending to the inner circle, and especially the exemptions thereof, would simplify the current regulations. However, as regards financial assistance, the application of these provisions in the financing of a complex cross-border transaction would remain, regrettably, unclear.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances