Poland: Easier buyouts

Author: | Published: 1 Jul 2008
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One of the leading private equity (PE) funds in central Europe, Enterprise Investors, invested e791 million ($1.237 billion) in 96 companies in Poland last year. Some suggest the PE market is now mature; the search for investments with high rates of return is becoming more difficult. But then, on April 18 Advent International completed a round of fundraising that resulted in ACEE IV, with e1 billion to invest in central and eastern Europe. Between 20% and 40% of ACEE IV funds will be invested in Poland.

Paradoxical

There are two types of corporations in Poland. A limited liability company is a strictly private entity; joint stock companies can be either public or private. Leveraged buy-out transactions (LBOs) are not allowed for joint-stock companies because of provisions of the Polish Commercial Companies Code (CCC). This Code replicates the Council's Article 23 of Directive 77/91/EEC, dated December 19 1976 and commonly referred to as the Capital Directive or Second Directive. The CCC prohibits joint-stock companies from making loans or advance payments and establishing security interest, and from financing the purchase or taking-up of its own shares, directly or indirectly.

The CCC provides two exceptions to the general prohibition, but given their lack of economic viability the exceptions have no practical application. Article 23 of the Second Directive has been implemented in its original wording across Europe, with some jurisdictions establishing express exceptions for private companies, and some states allowing LBOs for joint-stock companies under certain conditions (for example, Italy with la società per azioni).

In a classic LBO structure, the target company and SPV, which has acquired shares in the target for borrowed funds, merge, and the SPV disappears. The target's cashflow can then service the debt originally incurred by the SPV. As a result, the target's assets are used to collateralise the debt. One could execute an upstream merger, with the SPV as a surviving entity, but it is unlikely that lenders would finance this.

Given the limitations, LBO transactions in Poland have been aimed solely at limited liability companies. This is paradoxical given that in the early eighties in the US, where LBO originated, most publicly traded companies were taken over using LBOs. In Poland, LBOs of joint-stock companies (whether public or private) are likely to be challenged as against the provisions of the CCC. Such actions are void under Poland's legal regime. So the market for PE is limited to mid-size private businesses. One could always transform a joint-stock company into a limited liability company before the LBO, but this is time-consuming and costly. Similarly, if the investor chooses an IPO as its exit, the limited liability company will have to become a joint-stock company.

New approach needed

The Polish Parliament is working on amendments to the CCC. The Bill implements Directive 2006/68/EC dated September 6 2006, which amends the 30-year-old Second Directive. The Directive was to be implemented by April 15 2008.

The Directive was driven by criticism of share capital's so-called guarantee function and the way it affects company law in Europe. The traditional approach to protecting creditors against corporation insolvency stressed share capital's guarantee function, and maintained stiff rules on a company's purchase of its own shares and the financing of that purchase. The report of the High Level Group of Company Law Experts on the Modern Regulatory Framework for Company Law in Europe prepared for the European Commission in 2002 and the Commission's acceptance of the report's conclusions indicate that the traditional approach is no longer plausible.

The Bill does away with the flat prohibition of financial assistance regarding joint-stock companies. It expressly allows it under four conditions.

First, the financing is to be provided on "fair market conditions", especially in relation to interest received by the company or security interest established in its favour. The financial condition of the debtor or any third party must also be also verified. Second, the shares are to be purchased or taken up for a "fair price". Neither the Bill nor its written justification provides any guidelines about how this should be interpreted. Third, a prior establishment of reserve capital is required, under the provisions of the CCC. Fourth, a prior resolution at the company's general meeting is needed. This will lay down the terms of assistance. The resolution will require a qualified majority of two-thirds, or a simple majority if at least half the share capital is present.

A written report from the company's board will be the basis for the resolution. It will include: i) the purpose of and reasons for financing; ii) the company's interest in it; iii) the terms and how the company will be secured; iv) the impact on the company's liquidity and solvency; v) the purchase or taking-up price of the shares and a statement that is it fair. The company has to publish the report and submit it to the court where the company is registered.

In the market's hands

It is good to remove the general prohibition of financial assistance. But it won't necessarily attract investors. Although the Warsaw Stock Exchange is predicted to have a record number of IPOs this year, there is a risk that not all securities will find investors. So PE is becoming even more attractive for enterprises in search of both capital and managerial skills.

The proposed amendments would seem to open the door for private equity. But they add yet another layer of liability for boards, and the requirement to create reserve capital could sabotage the whole idea. The report of the High Level Group and the Directive leave no doubt that financial assistance is allowed only as far as the distributable reserves provide full cover of the risks associated with financial assistance.

By Bartosz Karolczyk of Hogan & Hartson, Warsaw

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