The rules prohibiting granting financial assistance have never received the attention they deserve in Spain. In comparison to other European jurisdictions, Spanish rules are rather severe and leave little room for manoeuvre. The only exemptions preventing a company from giving financial assistance for the acquisition of its own shares, or the shares of its parent company, stem directly from the Second Directive on Company Law: Financial Assistance to Employees and Financial Assistance given by Banks. A whitewash procedure, similar to that in the UK or Italy, is a concept foreign to Spanish law.
This formal lack of flexibility, however, has not prevented the growth of the Spanish market for heavily leveraged acquisitions. Leveraged buyouts (LBOs) are now commonplace in the country. The Amadeus LBO transaction, one of the largest LBOs ever undertaken in Europe, gives a good indication of the buoyancy of the Spanish buyout market.
The different players in the market have happily adapted to the existing rules. The debate regarding the interpretation of the current financial assistance regime has taken place among legal scholars, rather than in court. As a result, case law sheds little light on this issue. Courts, at least publicly, have only been faced with financial assistance scenarios where the breach of these rules was crystal clear.
Two recent high profile M&A transactions, the Amadeus LBO and the utilities Gas Natural takeover offer for Endesa, have stimulated a lively debate (for different reasons) as to whether their complex structures were tainted by a breach of financial assistance rules. Arguments have been made for and against this alleged breach of the law. While a literal interpretation of the law may, in some cases, lead to absurd results, a more flexible approach may damage third-party interests (those of mi+H24nority shareholders, employees and so on).
The rules on financial assistance are contained in the laws on limited-liability companies. Under these rules, the direct consequence of a breach is that directors will have to pay a fine. This law does not take into account the effect of the breach on the unlawful transaction itself. That is, it would appear that granting illegal financial assistance only entails risks for directors. However, some lower court decisions, as well as the opinions of numerous legal scholars, have affirmed that, in addition to the fines on directors, the underlying transaction should be declared void. Their argument rests on a general provision of the Spanish civil code rendering void any action in breach of a mandatory law, provided the latter does not specify a different result. Certainly, Spanish company law expressly stipulates the consequences of a breach (fines on directors). Therefore the civil code article should not apply. However, those same lower courts and legal scholars counter-argue that the civil code refers to a private law ‘specific consequence’, as opposed to a public law one. They add that the fine on directors would fall within the latter category only.
A smaller group of legal scholars, who in this case find support in some recent court decisions, take a more conservative approach. They think that the transaction’s validity may not be affected as the law clearly sets forth a consequence for the breach. The civil code’s provision on nullity, they add, is to be interpreted very restrictively.
Can transactions be voided?
Let us assume for a moment that transactions involving illegal financial assistance may be voided. Simple transactions (for example, a share transfer where the target company has advanced funds to the purchaser) could arguably be easily unravelled, especially if little time has elapsed.
However, it is not clear at all, if transactions are to be found void, how far one needs to go. That is, again in an LBO, let us imagine that security has been granted by the target company in favour of the financing bank, breaching financial assistance rules. The security contract should probably be rendered void. But what happens to the underlying loan? And if we extend nullity to this latter transaction, should we not do the same in respect of the share transfer? If, in the meantime, a forward merger has been effected (where all legal steps, including those in protection of creditors’ interests, have been satisfied), this merger would need to be unravelled as well.
The implications could be endless. Put off by this somewhat dramatic scenario, one could prefer to declare the security document void only, and thus avoid all the above. This would be unfair, as the acquisition debt would be left unsecured and the bank would be put in a difficult position (actually, to the benefit of the purchaser). That said, it is likely that cross default mechanisms would be triggered in the different transaction documents, and the whole structure would fall apart anyway.
Where does all this leave us?
Much attention has been paid to high-profile deals and the fact that they may be undermined by unlawful financial assistance. Moving one step ahead of this debate, it should be more important to focus on what the actual consequences of that would be. As Spanish law stands, those consequences are far from clear. If the time comes when a court decides to examine critically a complex transaction tainted by financial assistance, it would seem difficult to strike the right balance that protects everyone’s interests without creating an enormous muddle.
Given the lack of conclusive case law, Spanish law should be reformed to provide clear rules on the consequences of financial assistance. But, more importantly, Spanish law should be brought in line with other European jurisdictions to provide for a sort of ‘whitewash’ procedure. This would give legal certainty to complex transactions and clearly allocate the respective liability of the different players. If the right procedure is followed, transactions can be made legally secure, substantially reducing the risk that they are later found to be void.
Jose Sánchez-Dafos is a partner at DLA Piper Rudnick Gray Cary in Madrid