Financial assistance and whitewash in financing transactions
The financial assistance provisions in the Corporations Act 2001 (Cth) (Act) have been around for many years and arise as a consideration in a wide range of commercial transactions. This article provides a summary of when the financial assistance legislation applies, and the options available to comply with the applicable requirements in the context of a financing transaction.
The financial assistance regime in Australia is regulated by Part 2J.3 of the Act. Section 260A of the Act provides that a company may financially assist a person to acquire shares in that company (or its holding company) only if:
- giving the financial assistance does not materially prejudice the interests of the company or its shareholders or the company’s ability to pay its creditors (No Material Prejudice);
- the company obtains approval from the shareholders of the company under section 260B of the Act (known as a Whitewash Procedure); or
- an exemption applies under section 260C of the Act.
What is ‘financial assistance’?
While not specifically defined in the Act, the term ‘financial assistance’ covers a broad range of scenarios where some benefit is provided by the company in connection with the acquisition of its shares and can occur directly or indirectly.
In a financing context, the most common example of financial assistance arises when a target company (Target Company) provides a guarantee and indemnity or security in favour of a lender to support a loan being advanced to an acquiring company (Acquisition Co) and the funding is then utilised by Acquisition Co to purchase the shares in the Target Company. This scenario is widely acknowledged to constitute financial assistance, necessitating either a determination of No Material Prejudice, or the completion of a Whitewash Procedure, to ensure that the Target Company complies with the requirements of the Act.
It is also generally accepted that a direct refinance of the loan described above will also require a determination of No Material Prejudice or completion of a Whitewash Procedure (notwithstanding that the share acquisition occurred previously).
No Material Prejudice
A determination of ‘No Material Prejudice’ is an objective test as to whether, after the giving of financial assistance, the Target Company, its shareholders or its ability to pay its creditors would be in a worse position. Ultimately, whether financial assistance is considered materially prejudicial is to be determined by the court and recent case law suggests that courts will generally apply a reasonably low bar as to what might constitute material prejudice. Given the risks involved, it is advisable for parties to adopt a conservative approach. In financing transactions in Australia, the standard market practice is to complete a Whitewash Procedure.
Section 260B of the Act outlines the requirements for the Whitewash Procedure. The procedure is largely administrative but can be cumbersome (particularly when there are multiple entities involved). Essentially, the Target Company’s shareholders must approve the financial assistance (either via a special resolution passed at a general meeting of the company, or a resolution agreed to at a general meeting of all ordinary shareholders). There are a number of related forms which must be lodged with ASIC.
If, following the share acquisition, the Target Company will become a subsidiary of a listed domestic corporation or have an ultimate Australian holding company, the shareholders of the listed domestic corporation or Australian holding company (as applicable) must also approve the financial assistance.
A key consideration for a Whitewash Procedure is timing: the giving of the financial assistance (i.e. the execution of the guarantee and indemnity or security by the Target Company in the example outlined above) cannot occur until 14 days after the passing of the relevant member resolutions and lodgement of the ASIC Form 2601. Depending on the circumstances, the entire process can take anywhere between 3 to 10 weeks. This timeframe needs to be considered in the context of timing for completion of the particular transaction and the lender’s requirements in relation to the security (i.e. whether the lender is relying on the security being in place prior to drawdown, or if the lender will agree to completion of the whitewash and execution of security as a condition subsequent).
The exemptions outlined in section 260C of the Act include if the Target Company’s ordinary business includes providing finance and the financial assistance is given in the ordinary course of that business, and certain other transactions involving share buy-backs and reductions of share capital. These exemptions are generally not applicable to financing transactions.
Consequences for failure to comply
If financial assistance is provided by a company in contravention of section 260A, the contravention will not affect the validity of the transaction (or any contracts, agreements or security entered into in connection with that financial assistance) nor will the company providing the financial assistance be guilty of an offence.
However, any person knowingly involved in the contravention may be subject to civil penalties and, if that person acted dishonestly, criminal penalties. A person is considered ‘involved’ if they aided, abetted, counselled, procured or induced, or have in any way been knowingly concerned in, the contravention.
For lenders, the risk arises when the lender is aware of financial assistance being given on a transaction it is funding, and the lender does not take any steps to ensure the requirements of section 260A of the Act have been met. In Hunters Products Group Ltd (In Liq) v Kindly Products Pty Ltd (1996) 14 ACLC 826, a lender was found to have ‘aided and abetted’ the contravention of the financial assistance provisions, after providing an overdraft to assist with payment of the purchase price for shares and receiving security from the target company to support the overdraft. The lender was ordered to pay compensation in an amount of $4.348 million.
It is crucial for both lenders and borrowers to have a clear understanding of the financial assistance provisions contained in section 260A of the Act and to be familiar with the associated procedures.
Identification of financial assistance early and prompt commencement of a Whitewash Procedure can prevent unnecessary delays to a financing transaction. Our Finance team provides specialist advice to both lenders and borrowers in relation to compliance with the legislative regime. For assistance or for further information, please contact the team below.
This publication covers legal and technical issues in a general way. It is not designed to express opinions on specific cases. It is intended for information purposes only and should not be regarded as legal advice. Further advice should be obtained before taking action on any issue dealt with in this publication.