Company law affecting leveraged buy-outs (LBOs) is about to change in the UK. The law prohibits a company or its subsidiary from giving financial assistance to acquire the company's shares or to reduce or discharge a liability incurred for that purpose. The changes, which the Companies Act 2006 brings in, will make LBOs with UK target companies easier to complete. The new law differs from the German and French position on the acquisition of a target company incorporated in either of those jurisdictions.

Whitewashing

In October 2008 the Companies Act's rules on financial assistance will take effect. The law on financial assistance prohibits assistance being given for the proscribed purposes for both public and private companies, subject to a variety of exceptions (some of which are broadly considered unreliable in practice). It grants an exemption for private companies in certain circumstances. This is called the whitewash procedure. Public to private deals have been able to be completed by employing a whitewash before giving security to a lending bank after the public target has been reregistered as a private company. The lender's ability to perfect its security over the target's assets is delayed. This prohibition has become a problem for LBOs because it creates extra cost, complexity and delays. The Law Commission estimated that the whitewash procedure cost the UK economy £20 million ($39.45 million) in 2000; and with the explosion in leveraged buyout activity since then, that sum must now be much higher.

A whitewash cleanses what would otherwise constitute the giving of unlawful financial assistance by a private company. In the whitewash procedure, before the assistance is given, the directors satisfy themselves that the company giving the assistance is solvent. They swear a statutory declaration, backed up by an auditors' report, confirming that the company will be able to pay its debts for at least 12 months after providing the assistance. These requirements cost money. And if it emerges that the statutory declaration was not based on a reasonable belief held at the time it was given, the directors are exposed to personal liability. The risk of personal liability can cause nervousness among management buyout teams, which may not be intimately involved in the structuring of the loan – the incident that will need to be whitewashed.

Fewer restrictions

The new law will now allow UK companies to give financial assistance, removing the need for the whitewash procedure. But it will still not be possible for a private company to grant financial assistance for the proscribed purposes in an acquisition of shares in its public holding company, or for a public company to grant financial assistance for the proscribed purposes relating to an acquisition of shares in its private holding company. The prohibition on the giving of financial assistance by public companies remains in place. It is likely that this would have been removed as well, had it not been that EU law – ironically heavily influenced by UK company law – prevents its removal. At the EU level, proposals now exist to relax the prohibition on public companies when the amount of financial assistance does not exceed the company's distributable reserves, and when certain other requirements are also met.

Three aspects of a typical deal reveal the practical impact of this legislation for leveraged buyouts. First, regarding the target company's granting of security over its assets to secure the bank loan that makes an LBO possible, the new legislation will remove the restriction preventing a private company from giving financial assistance, in many circumstances, from October 2008. Thus it removes the need for the whitewash procedure. This development has advantages in the context of LBOs. It eliminates the need for the complex structures that have been employed to avoid problems relating to financial assistance. It also reduces the legal and audit fees associated with the whitewash procedure and compliance with the legislation. Some commentators have speculated that banks will ask companies engaged in a leveraged buyout to go through a process as cumbersome and expensive as the whitewash, even without the formal need to do so. But banks do not require such procedures for other loans, and it seems unlikely that they would require it for a leveraged buyout in the absence of the legal requirement. Second, the issue of what amount (if any) might not be considered material for the purposes of the statutory prohibition as a proportion of a private target company's net assets, and therefore might be paid towards the LBO team's professional fees without whitewash, no longer exists. Last, the lifting of the restrictions on financial assistance for private companies will solve the often highly contentious issue of the directors' declarations that have been required under the whitewash procedure.

And on the Continent

The new UK law is much more liberal than German and French legislation. Some similarities exist between legislation for German limited liability companies (GmbHs) and limited companies in the UK. But in the past the UK need for the whitewash procedure made its laws more cumbersome than those of Germany. Under German law the key factor is the maintenance of equity capital (non-freely available equity of the company). This is reflected in the requirement that the assets of a GmbH cannot be reduced by the grant of financial assistance to below the level of free equity capital. The definition of financial assistance under German law includes the grant of security over the company's assets for the liability of shareholders to a third party. Following the implementation of the new law in the UK, the German stance will seem much more restrictive. For German public companies (AGs) the prohibition covers all the company's assets. As with UK laws on public companies, it is possible that the German public companies position will be amended as a result of any change in European legislation.

French legislation states that a company may not advance funds, grant loans or give guarantees in view of the subscription or the acquisition of its own shares by a third party. This general prohibition applies to French sociétés anonymes (SA), sociétés en commandite par actions (SCA) and sociétés par actions simplifiées (SAS). The prohibition on financial assistance applies to all schemes that could be directly or indirectly considered as granting a loan or giving guarantees by the company for the purpose of the subscription or the acquisition of its own shares. Some legal exceptions to this prohibition exist, and there are practical ways of dealing with it, subject to certain conditions. But unlike the UK, France does not have the equivalent of the whitewash procedure, making the French position more restrictive. As with Germany, the UK's new stance on giving financial assistance will be substantially more liberal than that in France.

The impact of the removal of the prohibition of financial assistance by private companies will be positive for the LBO industry in the UK, reducing the costs and complexity of leveraged buyouts. It remains to be seen whether the increased permissiveness of UK law will result in calls to reform the laws in Germany or France, to bring them in line with the UK position.