Financial Assistance: When an Acquisition Needs a Whitewash

A buyer typically forms a new company to make the purchase and borrows in that company's name. On completion day the new company owns shares and owes the lender; the stock, debtors, plant and cash flow are all in the target. The lender's first security is a pledge of the target's shares, which the buyer can give. What the lender wants next is a guarantee from the target and security over its assets, so that it does not rank behind the target's own creditors.

That guarantee is financial assistance: the target is helping its buyer pay for its shares. So is a loan from the target to the buyer to meet interest on the acquisition debt, and, depending on each Act's wording, security given later to refinance that debt. The rules exist because such assistance moves the target's value toward the buyer's lender, and the people who bear the risk are the target's creditors and any shareholders who did not sell.

Australia's Corporations Act allows financial assistance on three grounds: it does not materially prejudice the company's or its shareholders' interests or its ability to pay its creditors; shareholders approve it under the whitewash procedure; or a specific exemption applies. The whitewash needs a special resolution with no votes cast in favour by the acquirer or its associates, or a resolution agreed at a general meeting by all ordinary shareholders, plus a special resolution of the company's listed Australian parent or, if it has none, of its top Australian holding company, as each will stand after the acquisition. The notice of meeting and its explanatory documents are lodged with ASIC before they go to members, and the assistance cannot be given until at least 14 days after the company lodges notice that it has been approved.

New Zealand's Companies Act allows it only after the board resolves that the assistance is in the company's best interests and on fair and reasonable terms, with the grounds set out in full, and the directors in favour certify that, and that the company will satisfy the solvency test immediately afterwards. Then one of three routes applies: written consent of all shareholders, a special procedure, with a further board resolution that the assistance benefits the shareholders not receiving it and a disclosure document sent to every shareholder between ten working days and 12 months before, or assistance within 5% of shareholders' funds.

The UK lifted the prohibition for private companies from 1 October 2008. It remains for a public company and its subsidiaries assisting the purchase of the public company's shares, and for a public company assisting the purchase of shares in its private holding company, subject to exceptions.

A buyer, constructed for this page, pays US$52m for a New Zealand distributor, funded by US$22m of equity and a US$30m loan to its new acquisition company. After completion the target is to guarantee the loan, grant security and lend the buyer US$4m to meet its first year's interest. The target's directors value its assets at US$66m; its own liabilities are US$14m. All figures are the example's.

For financial assistance, New Zealand's Act adjusts the solvency test: the target's liabilities include the face value of liabilities it incurs in connection with the assistance, contingent or not, and its assets exclude loans it makes as assistance. How far the ordinary allowance for the likelihood of a contingency still applies is a point for the target's advisers. Taken at face value:

The directors must also be satisfied that the target can pay its debts as they fall due with the US$4m gone, and the lender reads that cash-flow limb beside the balance sheet. The same purchase of an Australian target would turn on timing: the target's new sole shareholder and the buyer's top Australian company can pass their resolutions soon after completion, but the guarantee and security cannot be given until at least 14 days after the approval notice is lodged with ASIC.

Corporate benefit is a question about directors' duties, and it arises with any guarantee for another's debt. Financial assistance is a statutory rule about one transaction, helping a buyer acquire the company's shares or its holding company's. In Australia and New Zealand an acquisition guarantee needs both: completing the procedure does not show the target benefits, and benefit does not replace the procedure. In the UK, the private-company target's guarantee no longer needs a procedure, but its directors still have to justify it to that company.

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It decides the order of events. Because the procedure is in practice run once the buyer owns the target and controls its board and its vote, the lender funds on completion against the share pledge and the buyer's own security, and makes the target's accession as guarantor, with its security, a condition subsequent due within a stated number of days. Until accession the lender is structurally behind the target's creditors. In a UK take-private the equivalent step is commonly the target's re-registration as a private company before it guarantees.

It also decides what a breach costs. In Australia a contravention does not affect the validity of the transaction, but a person involved in it can face civil penalties, and a lender that knowingly takes part can itself be a person involved. New Zealand's Act likewise preserves the validity of the transaction while keeping alive any liability of a director or another person, including as a constructive trustee. A lender's protection is a procedure followed and documented, not the hope that the security survives a mistake.

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