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17 February 2014
With the abolition of the whitewash procedure in relation to private companies, a bugbear for acquisition finance lawyers appears to have been removed. Future trainees may never experience the angst of having to amend countless statutory declarations and board and shareholder resolutions every time a minor change is made to the financing arrangements of a buyout or ‘take-private’.
As part of the reform to the financial assistance regime, the removal of the requirement to go through the whitewash procedure will no doubt bring some relief and simplicity to the completion process.
But it could be argued that the whitewash procedure has focused lawyers’ minds on adhering to a process designed to validate circumstances where something constituted ‘financial assistance’, as well as affirming the positive net asset position and solvency of a relevant company. The procedure has performed this function rather than examining the issues in isolation.
As a result, these issues have not received a large degree of attention as they were dealt with under a regime by which auditors and directors alike were required to statutorily confirm them.
Under the previous regime, when resolving whether their companies should grant financial assistance, directors took into account contingent liabilities such as guarantees and security and the likelihood of these being called.
Auditors took into account these resolutions and the statutory declarations sworn by the directors regarding the company’s ongoing solvency when preparing their statutory reports pursuant to the Companies Act 1985.
The issue now for lawyers, funders and companies is to agree a process that will give both funders and directors comfort that target companies and their subsidiaries can now grant contingent liabilities, such as guarantees and security, having regard to the company’s net asset position and ongoing solvency.
There are a number of considerations to be taken into account:
• Directors will be concerned about ensuring that they have not breached their duties to maintain the capital of their companies by allowing them to enter into arrangements that could reduce the company’s net assets to an extent greater than its distributable reserves. Previously they were able to rely on their auditors to confirm the status of the company’s balance sheet through the review they conducted to produce their statutory reports for directors and non-statutory reports for funders.
• Directors have to consider whether the transaction promotes the success of the company. Although this has always been a requirement at common law, it has typically been addressed in the board resolutions prepared as part of the whitewash process. One benefit that was sometimes attributable to the granting of the financial assistance was the additional capital that would be made available to the group as a whole via working capital facilities that usually accompanied the acquisition funding from the lender.
• There is a growing concern that such contingent liabilities are more likely to be called in the current climate than they were 12 to 18 months ago, thereby impacting on the predictability of the net asset positions of assisting companies.
An important question, therefore, is: where will comfort be found if auditors are no longer compelled to provide both statutory and non-statutory reports to directors and funders regarding the solvency of assisting companies? Will the other reports usually commissioned for acquisitions provide the answer?
If it becomes practice for the legal and financial due diligence reports to be consulted for these additional purposes, both the nature of their preparation and the ability of parties to rely on them will need to be readdressed. The authors of these reports may need to reconsider their liability caps. They will also need to adjust the wording of these reports if they are being prepared in contemplation of directors and funders relying on them to assist in deciding the future solvency or the net asset position of a target group.
In addition, in their reporting analyses, financial due diligence and financial modelling currently do not ordinarily consider in depth the contingent nature of the security and guarantees to be provided by the target group. They also do not consider the likelihood that such guarantees and security may be called. If these reports and models are to provide an alternative solution following the removal of the whitewash procedure, they will also need to address such points. In the current climate, report providers may be reluctant to expand the issues they report on to cover these additional areas.
Due to the lack of a new, defined route to replace a well-trodden path, it may well be that funders place the onus to find a solution at the feet of their panel lawyers. As fewer acquisitions are being completed at present, this situation may take longer to achieve market acceptance.
Tony Anderson is a partner at Pinsent Masons