Financial Assistance – Some Good News at Last?

The prohibition on "financial assistance" forms part of the wider maintenance of capital regime in English company law. It is a criminal offence for a company (or any of its subsidiaries) to give financial assistance for the purpose of the acquisition of shares in that company. The current rules are based on the Second Company Law Directive, although the prohibition has its origins in the Companies Act 1929.

Many people take the view that the current prohibition on "financial assistance" creates potential traps for the unwary without effectively protecting creditors against the abuse of limited liability by the dishonest. The Company Law Review Steering Group, reporting in November 2000, recommended that in future the "financial assistance" prohibition should only apply to public companies. In the White Paper entitled "Modernising Company Law" (July 2002), the Government welcomed the Steering Group’s proposal and draft legislation to remove the prohibition on the giving of "financial assistance" by private companies for the acquisition of their own shares is expected in due course.

The current law is set out in Sections 151 to 158 Companies Act 1985 (as amended). There are two basic provisions:

• Section 151(1): where a person is acquiring or is 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; and
• Section 151(2): 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.

There are a number of exemptions from the prohibition – such as, for example, the payment of a lawful dividend – but the law on the purpose of any particular "financial assistance" is notoriously difficult to apply.

There are also certain additional restrictions for public companies. The regime can be relaxed for private limited companies, through what is known as the "whitewash" procedure. However, that procedure is onerous and requires, amongst other things, the preparation of an auditors’ report and the swearing by the directors of a statutory declaration to the effect that the company will be able to pay its debts as they fall due during the next 12 months.

The combined effect of the provisions referred to above is that, in many cases, considerable time and effort is required to avoid the prohibition on "financial assistance" in situations where it arguably has little logical application. Furthermore, there is a tendency for certain transaction structures to become over-complicated as companies and their advisers strive to fall outside the provisions because of the threat of imprisonment. It has been estimated that the additional expense for business arising from the prohibition on "financial assistance" may be as much as £20 million each year.

There is also evidence that the provisions may not contribute to creditor protection in the way it was once hoped that they might do. The rules do not deter the determined criminal and the "whitewash" procedure and certain other maintenance of capital rules for private companies remain open to abuse.

Viewed overall, the proposal in the White Paper to relax the prohibition on "financial assistance" by private companies is to be welcomed.

One consequence, which should benefit corporates, banks and practitioners alike, is that it should be possible for certain transactions involving private companies to be structured more simply and to take place more quickly and cheaply.

The approach in the White Paper reflects a shift in attitudes to the value of the prohibition on "financial assistance" as a creditor protection tool. If the law is changed as envisaged by the White Paper, creditors will become more reliant on contractual protection and can be expected to look to other areas of the law to prevent abuse of the privilege of limited liability.

The prohibition will remain in place for public companies, as a result of European law. However, it is expected that the scope of the law will be clarified by the new legislation and this of itself would be welcome.

The Government has said that it intends to publish in due course the detail of its proposed changes to the "financial assistance" prohibition. Unfortunately, it may yet take several years for the new legislation to reach the Statute Book.