Financial Assistance - an outdated regime?
Do you know what financial assistance is? If not, you’re definitely not alone – this is an area of corporate law that many overlook when contemplating a capital transaction but is one that can have serious consequences if ignored.
This article explores what financial assistance is and the many issues with financial assistance rules. Such issues include an unhelpfully broad term, limited protection despite its purpose and creating an administratively tedious process for companies and their stakeholders. In light of these issues, our house view is that reform is needed. We make some suggestions as to how the rules could be reformed at the end of this article.
What is financial assistance and when is it relevant?
When a company provides "financial assistance" in relation to the acquisition of shares either in itself or in a holding company, such assistance is prohibited by the Corporations Act 2001 (Cth) (the “Act”) unless an exemption applies.
The purpose of the financial assistance rules is to prevent improper use of a company’s assets to benefit an acquirer of the company’s shares (or shares in its holding company) to the detriment of the company, the company’s shareholders or the company’s creditors.
The legislation provides that financial assistance is only allowed in three scenarios:
where the assistance does not materially prejudice the interests of the company or its shareholders and/or the company’s ability to pay its creditors (effectively requiring directors to “take a view” with attendant risk and potential liability);
where the financial assistance has been approved by a special resolution of the company’s shareholders (commonly referred to as a “whitewash” process); or
where the financial assistance falls within a limited number of exceptions set out in the Act.
Issues with financial assistance
Broad meaning
A threshold issue arises due to the lack of a statutory definition of “financial assistance”, and therefore the need to rely on case law to determine whether particular steps in a proposed transaction may come within the prohibition.
The breadth of the term was confirmed in Connective Services Pty Ltd v Slea Pty Ltd [2019] HCA 33 (Connective Services) at [22] where the High Court said that financial assistance need not involve a monetary payment by the company to the acquirer, and that any action by the company can be financial assistance if it eases the financial burden that would be involved in the process of acquisition or if it improves the person's net balance of financial advantage in relation to the acquisition. Put simply, financial assistance involves a company giving some form of assistance of a financial nature, either directly or indirectly, before or after (in a temporal sense), to another person (the acquirer) to help that person acquire shares in the company, a holding company of it (at any level) or any of its subsidiaries.
While there is no clear definition, here are some examples of some of the transactions which may constitute financial assistance, depending on the circumstances:
anything which reduces or applies cash or other assets of the company to financially assist the acquisition of its shares by repaying any financing entered into by the acquirer (directly or indirectly), such as:
an intercompany loan repayment or set-off arrangement by the company;
provision of a new loan by the company to the acquirer;
payment of a special dividend by the company;
an internal servicing or management agreement under which the company pays fees to an acquirer; and
an asset sale or novation of obligations by the company from an acquirer;
provision of a guarantee or security by the company to support an acquirer’s acquisition financing or, potentially, its refinancing (e.g. refinancing short term acquisition bridge financing);
the substitution of one creditor for another (if it was plain that the original creditor would not have claimed payment of the debt, whereas the substituted creditor would do so);
entering into tax sharing, tax funding, tax consolidation arrangements, GST consolidation etc type arrangements with an acquirer;
entering into ASIC class order cross guarantees with an acquirer; or
entering into a group cash pooling arrangement with an acquirer.
Importantly, financial assistance may be held to have been made to “acquire shares” even if the assistance comes after the completion of the acquisition, possibly some time after its completion, provided there is a link between the transaction and the assistance which draws the transaction within the policy concerns which the section addresses (intended to prevent “handshake” deals that are only subsequently consummated).
In Connective Services at [26] it was also made clear that the issue of material prejudice to the interests of the company or its shareholders or creditors requires an assessment of and comparison between the position before the giving of the financial assistance and the position after it to see whether the company or its shareholders or its ability to pay its creditors is in a worse position.
In that case, the High Court adopted a simple approach in determining whether there was material prejudice: after the giving of financial assistance will the company or its shareholders or its ability to pay its creditors be in a worse position? The High Court discounted the value of arbitrary rules (such as percentage impact on profit) and of considering whether there was a “net transfer of value” for determining “material prejudice”, stating it “does not assist to gloss the concept of material prejudice by the introduction of further concepts”.
Limited protection for creditors
Despite part of the policy behind the prohibition being to protect creditors, the whitewash process itself does not require notice to creditors (beyond basic ASIC filings including generally “high-level” disclosure statements), or creditor approval, and only directors, and where directors aren't comfortable "taking a view", shareholders of the company, are required to approve the financial assistance.
Having assisted numerous clients working through the whitewash process, in our experience the rules often do not provide practical protection for a company’s shareholders and creditors (beyond the protection afforded by the directors’ duties, insolvent trading and oppression regimes) and create additional costs and delays in transactions.
Tedious whitewash process
As you’ll see below, the whitewash process is a tedious (and often costly) process that can have significant consequences if not done properly. That is because directors of the company (and others involved in a breach of the Act) can be held personally liable where whitewash has not been undertaken at all or not correctly undertaken. Additionally, it is worth noting that financiers often require companies to undertake the whitewash process as a condition of finance.
The whitewash process involves the preparation and physical lodgement of several documents, including shareholder notices, director and member resolutions, disclosure statements and multiple ASIC forms. In addition to those documents, the Company is required to hold board meetings and shareholder meetings which directors and shareholders must attend to approve the required documents and, ultimately, the proposed financial assistance.
To add to the complexity, those documents each have their own specific timing requirements as to when they need to be approved and lodged. As such, the process, which generally takes around 20 days at minimum, requires careful planning to ensure that all timing requirements are satisfied (and to make sure that financial assistance can be provided at the required time). If not planned properly, it is likely that the process will hold up an important transaction.
Importantly, for larger transactions (such as multi-entity corporate restructures) there can be a large volume of documents that need to be prepared for each entity. This process can quickly spiral out of control if not carefully planned and managed from the outset.
What to do if there is financial assistance?
If there is any question of whether a transaction may involve financial assistance, there are essentially two options available to the directors of the company:
if the financial assistance is immaterial (meaning that the company, its shareholders, or creditors will not be prejudiced), the directors can determine as much by resolution; or
undertake a whitewash process to come within the shareholder approval exemption under the Act.
While the first option removes the need to undertake the administrative whitewash process, directors are exposed to personal liability if it is later found that the company, its shareholders and/or creditors have been prejudiced because of the financial assistance. In our experience, we have not acted on a matter which clearly involved the giving of financial assistance where the board, given the broad meaning of both "financial assistance" and "material prejudice" has been prepared to "take a view" and not undertaken a whitewash process.
Reform?
Given the above issues with the whitewash process, many have expressed the view that reform is needed in this area. We are inclined to agree. One area that seems ripe for change is in respect of creditor protection. Given the clear policy concern of the legislation, we think that good arguments could be made that material creditors should be given express and direct notice of the proposed transaction. If material creditors receive notice at the same time as shareholders, this would allow a creditor with concerns to seek further information from the company (or to commence proceedings if solvency or directors’ duties are in issue).
Another reform that would pay dividends is the complete digitisation and streamlining of the ASIC forms, given that many still require paper forms to be signed in wet ink and physically lodged by post. This change should be effected by ASIC as a priority, particularly given that it should not require legislative amendment.
More fundamentally though, it is not clear to us that the prohibition with its attendant imposition in terms of time and cost should remain in its current form, at least in respect of private companies for whom the cost can prove prohibitive. Indeed, one of the key purposes of the UK Companies Act 2006 was to liberalise company law for private companies, and as part of those reforms, the prohibition against financial assistance was abolished for all UK private company transactions taking place on or after 1 October 2008.
However, we consider that the policy underpinnings of the prohibition remain sound, and that it is not necessary to go as far as in the UK to address the problems. The difficulties with the prohibition could be avoided, in a great deal of private company transactions, by a more modest change to the law. In our view, allowing any private company with annual turnover of less than, say $25 million, to proceed with a transaction involving financial assistance, providing that no shareholder who has been issued a disclosure statement gives notice within 7 days requiring the company to go through the remainder of the whitewash process, would have significant advantages. We view $25 million annual turnover as an appropriate threshold given that this is the threshold for small proprietary companies under section 45A(2) of the Act. Alternatively, applying this approach to all "small proprietary companies" would achieve a similar result.
In most of the matters we see, given the nature of shareholdings and management of companies of that size, no shareholder would issue such a notice and the transaction would proceed without the time and cost of a whitewash. Of course, the company, its shareholders, and its creditors, would still have the benefit of the protections afforded by directors’ duties, insolvent trading, and oppression laws. Simply put, allowing financial assistance for smaller private companies without whitewash in the proposed way where no shareholder or material creditor objects would not absolve directors of their ordinary responsibilities and duties.
We're optimistic that law reform in this area will be up for debate in the near future. In the meantime, while current rules apply, if you are concerned that any upcoming transaction may involve financial assistance, it is important that you seek legal advice as to whether the transaction may involve financial assistance. The team at Tiger & Bear Partners is experienced in supporting clients through financial assistance issues and managing complex whitewash processes, so please reach out if you have any questions.