When the Companies Act 2006 received Royal Assent on 8 November 2006 it had the notable distinction of being the longest piece of legislation to have gone through British Parliament, running to 701 pages and containing 1,300 separate sections. As well as restating the existing law and codifying common law principles, one of the aims of the new act was, in the words of Margaret Hodge MP (then Minister of State for Industry and the Regions), "to bring major benefits to business by modernising and simplifying company law".

Due to the sheer size of the Companies Act 2006, a staggered timetable for implementation has been put into place which will give companies time to prepare for changes in the law. Already parts of the new act have been implemented during January, April and October 2007 and at the beginning of April this year. Further changes are due to come into force later this year on 1 October 2008 and the remainder in October 2009.

One such change due be implemented on 1 October 2008 is the abolition of the current law which prohibits a private company from giving financial assistance in connection with the purchase of its own shares. In relation to the acquisition or investment into English companies the removal of this prohibition is an example of modernisation and the simplification of a law which has become costly and time-consuming.

Financial Assistance - the current law
Under the Companies Act 1985 it is currently unlawful for an English registered public or private company to provide financial assistance in connection with the purchase of its own shares (or the purchase of shares in its parent company). The assistance can take many forms including the provision by the company, whose shares are being purchased to the purchaser of the shares, of a loan, gift, guarantee, security or anything else which would materially reduce the company's net assets. Breach of this provision is not only punishable by way of fine it is also a criminal offence.

The most common example of financial assistance occurs in a leveraged acquisition where a lender (be it institutional lender, investment bank or private equity house) requires security over the assets of, or a guarantee from, the target company (and if relevant, each of its subsidiaries) to secure or guarantee the money that the acquiring company is borrowing to finance the purchase of the shares in the target company.

For public companies this is an absolute prohibition.  However, for private companies financial assistance can be given if the target company undergoes a "whitewash" procedure, which, in a nutshell, requires from each company giving financial assistance (i.e. target and any subsidiaries):

1. board approval of the giving of financial assistance;
2. unless it is a wholly-owned subsidiary, shareholder approval of the same, either by way of written shareholder resolutions signed by at least 75% of the shareholders or the holding of an extraordinary general meeting where at least 75% of the shareholders present would need to vote in favour of giving the financial assistance (ideally both resolutions should be unanimous otherwise a 4 week wait is required between the passing of the resolution and the giving of the financial assistance during which 10% of the dissenting shareholders may apply to the court to cancel the resolution);
3. a statutory declaration by all of the directors of the company as to the solvency of the company (and if subsidiary companies are giving financial assistance then declarations in relation to each subsidiary) ; and
4. a report by the auditors of the company, which is attached to the directors' declaration, supporting the directors' declaration of solvency.

It is the last two requirements which often prove to be the more time-consuming and costly aspects of a leveraged acquisition, particularly when the target has multiple subsidiaries.

It is quite common that previous financial assistance given by subsidiary companies (either in relation to previous acquisition funding or the re-financing of the funding of previous acquisitions) will need to be "whitewashed" as the provision of new funding to discharge previous funding liabilities will constitute financial assistance. Therefore it is often found that even on the most standard of leveraged acquisitions multiple declarations are required from all the directors on the board of the target company and each subsidiary prior to the completion of the acquisition. If you couple this with the requirement that declarations for each company must be given by all the directors on the same day (and technically at the same time), and add the extra complexity of having directors situated in various international locations, the result is a "whitewash" exercise which can be a logistical headache, not to mention the cause of unwanted business disruption.

When even with the most standard of "whitewash" exercises auditors costs for a report will start from £5,000 (and increase depending on the number of subsidiaries the target has and on the complexities of the acquisition and funding structure), this procedure is seen by the legal and financial communities as expensive, laborious and often far from simple. So it seems apt that the new legislation seeking to modernise and simplify would seek to remove the need for such a procedure that is required in the overwhelming majority of leveraged acquisitions.

Financial Assistance - from 1 October 2008
1 October 2008 is the date on which it is now envisaged that the prohibition of financial assistance by private companies will be abolished and the legal requirement for the "whitewash" procedure swept away. The prohibition will still remain in respect of public companies, if the target company is a public company and financial assistance will not be able to be given by any subsidiary which is a public company. However financial assistance will be able to be given if the procedure for the re-registration of a public company as a private company is undertaken prior to completion.
So what will be required of companies proposing to give financial assistance from 1 October 2008 onwards? Although there will be no need for the "whitewash" procedure to be followed the target company and each of its subsidiaries will need to give careful consideration as to whether the giving of the financial assistance:

1. would be for the commercial benefit of the company and in the company's best interests (the concept of which is now more extensive under provisions of the Companies Act 2006 which came into force on 1 October 2007);
2. would fall foul of the laws regulating distributions and dividends (if the financial assistance could be construed as a distribution or dividend the company must have sufficient distributable profits otherwise the making of which would be unlawful) ; and
3. could be challenged on the occurrence of an insolvency.

So with the statutory "whitewash" procedure gone, what will lenders require from the target company (and any subsidiaries) by way of documentation to approve the entry into security documentation prior to lending any money to finance a transaction? The answer is unfortunately unclear. It currently appears that the company giving financial assistance will need to:

1. as an absolute minimum minute board approval considering the giving of financial assistance as being in the best interests of the company, the reasoning why and identifying the commercial benefit of giving the financial assistance; and
2. if there are concerns over the commercial benefit to the company by entering into the security documentation obtain shareholder approval of the financial assistance, to eliminate the prospect of shareholder action.

What is clear however is that it will not be legally necessary for either a declaration from the all of the directors as to the company's solvency or an auditors' report in support of such declaration to be produced and this represents a major logistic, time and cost saving.

However rumblings have begun suggesting that where lenders have concerns over the solvency of either the target company or any subsidiary giving financial assistance, some form of evidence as to the company's financial position will be required from the company's auditors. In addition given the extensive list of codified considerations directors must give before approving transactions it may be likely that directors will also seek independent confirmation from the auditors as to a company's solvency before approving the giving of financial assistance.

With the City of London Law Society Committee still due to provide guidance on the financial assistance procedure from 1 October 2008 onwards and lenders unwilling to pin their colours to the mast as regards their requirements, it appears that the ins and outs of the new financial assistance procedure won't become clear until 1 October 2008 comes around and market practice dictates the way forward.

Christopher Marrable