This section provides a number of exceptions to the general prohibition on financial assistance.
Subsection (1). Provides an exception from the prohibition on financial assistance before the acquisition of shares (section 151(1)) where the following conditions are met:
a) the company’s principal purpose in giving the assistance is not to give it for the purpose of the acquisition; or the giving of assistance is an incidental part of some larger purpose of the company; and
b) the assistance is given in good faith in the interests of the company.
This provision was introduced in 1981 in an attempt to meet concerns that the earlier provision (section 54 of the 1948 Act) was unreasonably inhibiting innocent or beneficial transactions. It was considered that the wording of Article 23 of the Second Directive “the company may not advance funds ... with a view to the acquisition of its shares ....” permitted an exception defined by reference to the company’s purpose.
The decision of the House of Lords in Brady v. Brady, discussed at length in Gower (Fifth edition, pp. 231-233) has led practitioners to conclude that a) above failed to achieve its objective. Lord Oliver in his judgement in the Brady case indicated that “purpose” was a narrower concept than “reason” or “motive”.
The Department therefore proposed the replacement of the “principal purpose” test with one of
“predominant reason”, supported by a Ministerial statement explaining the intention behind the change, and this was widely supported in consultation.
However, companies do not give financial assistance for the acquisition of their shares without any ulterior purpose/reason/motive. Some such purposes etc are innocuous or even beneficial – eg to promote wider ownership of the company’s shares, or to reward a venture capitalist for undertaking a risky investment in the company. But others, eg using the company’s own funds to repay loans taken out to finance its hostile takeover, or to assist a “supporters club” to buy the company’s shares and help it to resist a takeover, are the mischiefs against which the prohibition
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on financial assistance was introduced. It is unclear how any variant on the “principal purpose”
test can distinguish between desirable and undesirable ulterior motives. It is therefore for consideration whether the replacement of the “principal purpose” test with one of “predominant reason” would materially reduce the extent to which the prohibition on financial assistance catches innocent transactions.
Subsection (2). Provides an exception in the same terms as subsection (1) but for the case where the assistance is given after the acquisition, to discharge a liability incurred for the purpose of the acquisition (ie section 151(2)). The above comments on the value of such a provision apply equally here. If it is decided to include it, it will need to be reformulated as an exemption from the prohibition on entering into an understanding with a third party before an acquisition of shares whereby the company will discharge the liability of that party subsequently (see above on section 151(2)).
Subsection (3). Provides a number of exceptions to cover transactions specifically provided for in or under the legislation. These are:
a) a distribution of assets by way of a lawful dividend;
b) a distribution in the course of winding up;
c) an allotment of bonus shares;
d) a reduction of capital confirmed by order of the court;
e) the redemption or buy back of shares in accordance with sections 159-181;
f) anything done in pursuance of a court order relating to a company’s compromise or arrangement with its members or creditors;
g) anything done in pursuance of an arrangement under section 110 of the Insolvency Act; and
h) anything done under an arrangement between a company and its creditors which is binding by virtue of Part I of the Insolvency Act.
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These exemptions were included in case they involve a payment by the company to a third party at or about the time that he is acquiring the company’s shares, which might otherwise be regarded as financial assistance. The above list was included in the legislation in 1981 on the basis that Article 23 is not to be understood as prohibiting transactions specifically provided for elsewhere in the Second Directive or in other Directives. It is for consideration whether it is necessary to retain these as express exceptions, against the risk that they might in some
circumstances be held to constitute financial assistance. (It should be noted that the exception for lawful dividend distributions may leave considerable scope for using the assets of a cash rich company to finance its takeover.)
If a list on these lines is included, it is proposed to make two minor adjustments: a) would be widened to cover all distributions permitted under Part VIII, and not merely dividends; and d) would become “a reduction of capital duly made”, in line with the above proposals on capital reduction (see on sections 135ff).
The Department has proposed to include an additional exception for lawful commissions and fees, indemnities and warranties for underwriting share issues. The Second Directive clearly envisages that shares will be issued and acquired, and costs incurred, in connection with new issues and acquisitions of shares. The Department has therefore proposed an exemption to enable companies to set up the mechanisms and infra-structure to enable them to issue or transfer shares by contracting for services (eg professional advisers, underwriters) which will facilitate the issue or transfer.
The Department has also proposed a further exemption that financial assistance by a company or its subsidiary for the purpose of a transaction by the company which is itself the subject of a specific exemption under section 153(3) or (4) (eg the purchase of a company’s own shares) is permitted, eg giving a charge to a bank to secure a borrowing of funds to be used to pay a dividend or to purchase the company’s own shares. It is proposed to include both of these further exemptions in new legislation. It is also proposed that there should be a new exception, for private companies only, for financial assistance to facilitate transfers of shares between members of a company where there is difficulty matching buyers and sellers.
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Subsection (4). Provides a number of further exceptions which are expressly covered in Article 23.
Paragraph (a) provides an exception for the lending of money in the ordinary course of business by a company a part of whose business is the lending of money. This exception for banks etc is covered by Article 23.2.
Paragraph (b) provides a general exception for the provision of financial assistance for the purposes of an employee share scheme. The assistance must also be in the interests of the company.
This is covered by Article 23.2. A similar exception goes back (at least) to the 1948 Act.
Paragraph (bb) this elaboration of the exception for the acquisition of shares by employees was introduced in the Financial Services Act 1986 in order to ensure that share schemes which enabled employee shareholders and their families to buy and sell their shares among themselves were covered.
The Department’s proposals include one to broaden this paragraph further by including transactions between employees or employee trusts and outside investors.
Paragraph (c) covers the making of loans by companies to enable employees (other than directors) to acquire fully paid shares in the company to be held by way of beneficial ownership.
This is also covered by Article 23.2 and goes back (at least) to the 1948 Act.
Subsection (5) defines “a company in the same group” for the purposes of paragraph (bb) of subsection (4).
It is proposed to include the substance of subsections (4) and (5) in new legislation. But it is of interest that subsection (4) paragraphs (b), (bb) and (c), plus subsection (5) and the Department’s proposal to extend subsection (4)(bb), all implement the words of Article 23.2 that the
prohibition on financial assistance shall not apply to “..transactions effected with a view to the acquisition of shares by or for the company’s employees or the employees of an associate company”. It is for consideration whether this elaboration of an apparently simple and
straightforward Directive provision has gained more in certainty than it has lost in accessibility.