By Mark Ellis
The provision of assistance by a company for the purchase of its shares has long been a difficult area of law. The practice was prohibited until the 1981 Companies Act came into force, when a ‘whitewash’ procedure was introduced which allowed private companies to give financial assistance for the purchase of their shares provided that a number of requirements were met.
The problem with the provision by a company of financial assistance (e.g. a loan) for the purchase of its shares has rested in the possibility that this can, when used without sufficient scruples, undermine the interests of other shareholders or creditors of the company.
The downside of the equation is that the prevention of such assistance sometimes makes it difficult for shares to be issued and this could be to the detriment of the company. For example, it might be considered to be in the company’s interests to offer shares to an executive as an incentive, but the person concerned might be unable to raise the money to buy them. Without setting up a rather complex (and sometimes expensive and/or inappropriate) mechanism, the company’s wish to have the executive obtain an interest in its shares might be frustrated. It could also prevent corporate acquisitions and investments from being structured as the parties would wish.
The whitewash procedure, where available, required a declaration of solvency from the company’s directors and effectively an audit of the company to be carried out. In many cases a large amount of additional paperwork was also required to enable the transaction in question to proceed.
Relief is now to hand in the form of the Companies Act 2006 which, from October 2008, will allow a private company to provide financial assistance for the purchase of its shares. Public companies are still prohibited from giving financial assistance except where certain limited exceptions apply.
The right is not unlimited, however. Protection for shareholders and creditors also now depends on the requirement that the company’s directors consider whether the proposed share transaction is consistent with their duty to promote the success of the company for the benefit of the shareholders as a whole. If the proposed share transaction does not achieve that end, the directors cannot authorise it. Their duty also extends to the protection of the creditors — for example, where financial assistance is given for the acquisition of shares in a company which is insolvent, the directors could be found personally liable for any losses to creditors which may result.
The relaxation of the rules does give private companies increased flexibility in dealing with their shares. However, it places the ultimate responsibility for any decision to give assistance for the acquisition of shares in the company on the directors who authorised the transaction. It is a burden which should not be discharged lightly and professional advice is recommended before such transactions are carried out. It is also likely that in cases where there is significant bank borrowing, the bank may require extra comfort to ensure its position is protected.
For more information, help and assistance in this area I recommend that you get in touch with Stuart Scott-Goldstone, Head of the Corporate/Commercial Team at corporate law firm, Aaron & Partners. Email him at firstname.lastname@example.org
Mark Ellis is an employment law solicitor and CEO at Ellis Whittham – Find out more www.elliswhittam.com