Before October 2008, it was unlawful for a company, or its subsidiary, to give financial assistance for the purchase of its own or any shares in its holding company.

This restriction was abolished with effect from 1 October 2008 for private companies.

The prohibition will continue to apply to public companies (and to their private company subsidiaries) and, from 1 October 2009, criminal liability for breach will extend to the company and every officer of the company in default.

Rules on financial assistance apply only where shares are being acquired; they do not apply to the sale and purchase of assets.

Why has the law changed?

Financial assistance provisions were ambiguous and, while the issues did not arise on a daily basis, they would often become a concern where a company was being sold or where a new shareholder was being introduced.

Deals would often be structured in a convoluted way in order to avoid the provisions altogether, or, where that was not possible, the company concerned would have to expend additional time and money going through the 'whitewash' procedure. It has been estimated that legal advice relating to the financial assistance provisions cost British companies approximately £20 million per year.

So what now?

The prohibition has been removed in respect of private companies where financial assistance was given on or after 1 October 2008, even where the shares concerned were acquired, and the liability incurred, before that date.

This should result in transactions becoming more straightforward and in advisory fees being reduced accordingly. In addition, company directors will no longer face the threat of criminal liability and imprisonment should they get it wrong.

While the 'whitewash' procedure was both time consuming and expensive, it did have the advantage of providing directors with a framework for checking that they were acting in a proper manner. With the framework removed, banks and other providers of finance may be anxious to ascertain that all relevant concerns have been adequately addressed and may require the board to confirm the solvency of the company providing the assistance, supported, as relevant, by auditors' reports.

In addition, the board will still need to satisfy itself that the transaction is 'likely to promote the success of the company for the benefit of the members as a whole'. It would be advisable for relevant board minutes to identify the commercial benefit of the transaction and directors may want to obtain an ordinary resolution of the non-connected shareholders indicating their approval of the transaction. Banks may insist on the resolution being unanimous where there is no obvious commercial benefit.

Transactions involving financial assistance may still be in breach of company law. This may be the case, for example, where a company with insufficient distributable reserves makes a gift of money to an existing shareholder to enable him to buy additional shares in the company or in a situation in which a company with insufficient distributable reserves makes a loan to a shareholder to enable him to buy shares and there is no reasonable prospect of the loan being repaid so that an immediate provision for the loan would be required. Both instances would amount to an unlawful reduction in capital.

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.