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Financial Assistance in the Acquisition by a Company of its Own Shares
The Companies Act 1985 (UK) regulates the maintenance and reduction of share capital and other capital accounts. A company’s share capital must not be reduced, subject to certain exemptions, ensuring capital is maintained to meet creditor liabilities. Not only is the acquisition of its own shares by a company normally unlawful but also, where there are insufficent profits to allow a company to do so within the limitations of the Act and funding is needed to enable a company to do so, it is also unlawful. It effectively constitutes "financial assistance" and Section 151 of the Companies Act prohibits financial assistance, whether direct or indirect.
Financial assistance is widely defined in section 152 of the Companies Act and covers gifts, guarantees, indemnities, releases or waivers of rights or obligations, loans and any other situation which may result in the company incurring a liability in connection with the acquisition of its shares in the company.
The Bigger Picture
In order to determine whether financial assistance is being given, it is necessary to look at the whole of the transaction in the light of its commercial context. As a general rule, if the company benefits more than it suffers, there is no financial assistance.
A public company may only rely on the exceptions if it does not reduce its net assets or, if it does reduce them, the financial assistance is provided out of distributable profits.
Directors and Company Officers - Penalties and Remedies
Ignoring the legislation renders every officer of the company, directors and secretary liable to a fine up to £5,000 in the Magistrate’s Court – the fine is unlimited in the Crown Court; and imprisonment for up to six months in a Magistrate’s Court and two years in a Crown Court.
There are also civil remedies. By breaching Section 151, a director is in breach of their fiduciary duties to the company rendering them personally liable to account to the company for its loss.
The shareholders may also have the right to sue by means of a derivative action: normally a shareholder cannot sue in their own name to remedy a wrong done to the company. In these cases, though they are entitled to do so, the shareholder must show that the wrong would be unremedied if the shareholder were not allowed to sue. The shareholder may also have a personal action against the company and may obtain injunctive relief on the grounds that any action in breach of Section 151 would be both ultra vires (i.e. outside their actual authority to act) and unlawful. This is not intended to be an exhaustive list of potential claims but an illustration of some of the consequences of ignoring the section.
Other Consequences of breach
An unlawful transaction in breach of section 151 is not merely void but also illegal. Therefore, no property or rights are transferred under any agreement and if a company lends money to the buyer, money technically still belongs to the company and yet it will not be able to recover the money from the buyer. Therefore, any security given in exchange for an illegal loan will also be void. With regard to the shares transferred, they remain in the ownership of the vendor. Therefore, the consequences for the purchaser are substantial, not least since the contract with the vendor would be unenforceable and the buyer would therefore have no remedies for breach of contract.
The Whitewash Procedure
For private companies there is a procedure called the whitewash procedure which allows companies to provide financial assistance in limited circumstances. A strict timetable of events applies and other requirements to satisfy. The governing section is section 155 of the Companies Act 1985. It requires that:
1. A special resolution is made to that effect by the shareholders;
2. A declaration of solvency is provided in the prescribed form by the directors of the company; and
3. The members have a right of objection.
Once a special resolution has been passed by the company, the financial assistance cannot be given until at least 4 weeks have elapsed since the date of the resolution (or the latest resolution where there is more than one resolution) unless there has been unanimous agreement to the resolution. If the written resolution procedure is adopted, the financial assistance can proceed immediately. However, financial assistance cannot be provided more than 8 weeks after the date of the director’s statutory declaration of solvency (or after the last declaration where a number are required). For the purpose of the period is to allow members to object. Payment cannot be made more than 8 weeks after the declaration to make sure that information is up to date (unless a court order is obtained allowing financial assistance to proceed outside that 8 week period).
Another aspect of the strict timetable involved in the whitewash procedure under Section 155 is that the special resolutions must be passed within 7 days of the making of the director’s declaration of solvency. Another important technicality that must be followed is that the director’s declaration of solvency and the auditor’s report must be available for inspection by shareholders at the meeting in which the resolution is passed. The court may exercise its power to cancel the resolution upon application of a dissenting shareholder.
Content of Declaration of Solvency
The directors’ declaration of solvency must contain details of the assistance being given, the business of the company and must identify the person to whom the assistance is to be given. In the declaration, the directors must state that they believe that there will be no ground on which the company could be found unable to pay its debts. In doing so, they have to have regard to the situation as it stands immediately after the giving of assistance, not the date of the declaration. The statutory declaration is required to state that the directors believe that they will be able to pay their debts for the year following the date of financial assistance.
Also, the statutory declaration must be supported by an auditor’s report addressed to the directors after the auditors have enquired into the company’s affairs and satisfied themselves that there is nothing to indicate that the directors’ opinions are unreasonable in all the circumstances.
There is a fine and a potential imprisonment for a director who does not have reasonable grounds for making the statement in the statutory declaration.
This effectively exposes directors to personal liability for all debts of the company for a period of 12 months after the date of financial assistance. In many circumstances therefore this whitewash procedure will not be an attractive option. The advantages of the financial assistance have to be weighed against this potential liability which they would not otherwise face.
Consenting Member’s Right of Objection
Holders of 10% or more of the nominal value of the company’s shares - or 10% of any class of shares - may apply to the court to cancel a special resolution authorising financial assistance. Only members who did not vote in favour of the resolution may apply. If such an application is made, the company must notify the Registrar of Companies immediately.
Financial assistance can come up as an issue when it is least expected. Even innocuous, small transactions (on which it is possible people may not have taken legal advice) may involve such issues.
Penalties
Perhaps surprisingly for a provision that is designed to preserve the company’s assets, the company itself is liable to a fine for breach of Section 151, as well as its officers.
Because the effect of Section 151 is broad and far reaching, it may have an impact in circumstances where it is far from obvious. More obvious forms of financial assistance include the following:
1. Where the company lends money to a person/company to enable that personal company to purchase shares in the lender company.
2. Perhaps more commonly, the company gives security for repayment of a loan which has been taken out by the buyer in order to fund the purchase of the company’s shares.
Indirect assistance can often be hidden, sometimes quite innocently. Less obvious examples of financial assistance include things as innocuous as payment of legal fees incurred in connection with the negotiation of a shareholder’s agreement at the time of the acquisition of shares. Whilst it is proper for the company to pay its own costs in being separately represented in that agreement, it is not proper for the costs of representing the purchaser of shares to be borne by the company.
Exceptions to liability under Section 151
Section 153 provides that a company is not prohibited from giving financial assistance for the purpose of an acquisition of shares in it or its holding company if:
a. The company’s principle purpose in giving that assistance is not to give it for the purpose of any such acquisition or the giving of assistance for that purpose but is an incidental part of some larger purpose of the company; and
b. The assistance is given in good faith and in the interest of the company.
Section 151 also does not prohibit a distribution of the company’s assets by way of a lawful dividend or distribution made in the course of the company’s winding up, an allotment of bonus shares, a reduction of share capital confirmed by the court under Section 137, a redemption of purchase of shares made in accordance with Chapter VII of Part V of the Companies Act 1985, any court sanctioned arrangement with creditors under Section 425 of the Act or any arrangement under the Insolvency Act (Section 110) and a number of other circumstances including employee share schemes.
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