Over the years, the prohibition on financial assistance in respect to acquisition and structured finance transactions has often come into question. This was most evident during the recent privatization exercise conducted in the Nigerian Electricity Power Sector where large-scale debt finance was required to acquire the shares of the PHCN successor companies. Lenders would most likely have preferred that the acquisition debt was guaranteed and secured by the assets of the target company. What is financial assistance under the Companies and Allied Matters Act (CAMA) of Nigeria and what is its impact on commercial transactions?
Financial assistance under the Companies and Allied Matters Act
Financial Assistance per Section 159(1) of CAMA has been described to include any gift, guarantee, security or indemnity, loan, any form of credit and any financial assistance given by a company to a third party, provided that the net assets of the company are thereby reduced to a material extent or such company has no net assets. It goes beyond monetary support and does not make a distinction as to the type of company being prohibited, therefore applying to both private and public companies.
In the context of acquisition finance, this would involve the target company providing any assistance listed in Section 159(1) with a view to aid the acquisition of its shares by a third party. This is expressly prohibited under Section 159(2) of CAMA, which states that where a person is acquiring or is proposing to acquire shares in a company, it shall not be lawful for the company or any of its subsidiaries to offer financial assistance directly or indirectly for the purpose of acquiring its shares, either before or at the time where the acquisition takes place.
In addition, where a person has acquired shares in a company and any liability has been incurred (by that or any other person), for the purpose of this acquisition, it will be unlawful for the company or any of its subsidiaries to give financial assistance directly or indirectly in order to reduce or discharge that liability. A company convicted of breaching this provision shall have itself and every officer complicit in the contravention of the breach fined with a monetary penalty not exceeding N500, in accordance to Section 159(4).
The basis for prohibiting financial assistance is to protect shareholders, especially the minority who are more likely to suffer a greater impact as a result of such assistance. From an economic standpoint if a company supports the purchase of its own shares, the net asset of the company is depleted and returns to existing shareholders is affected thus causing a de facto diminution in the company’s value in the hands of existing shareholders. Another rationale for this prohibition, particularly with public companies, is to avoid artificial inflation of the company’s share value in order to influence the market demand for such shares.
Impact of Section 159
The main impact of Section 159 is that it limits the collateral or security available to lenders. In financing the acquisition of all or majority shares in a target company, lenders will in addition to the security provided the acquiring company, seek to use the target company’s assets for security to support the borrowings. This is particularly common where the acquirer is a shell company which neither has any assets nor income of its own. Typically, lenders will require a guarantee from the target company or security over some or all of the target company’s assets.
This is a problem most borrowers would have faced during the power privatization process, as most bidders were vehicles created specifically for the purpose of acquiring the successor companies and thus possessed no assets. It is worth noting that this restriction, especially on private companies, is capable of hindering viable acquisitions that can promote economic growth and there might be a need to re-evaluate this position of law.
Re-evaluation of Section 159
When compared to UK Company Law, the UK initially provided an avenue that allowed private companies offer financial assistance in the form of the Whitewash procedure. This process required directors (of private companies) to submit a statutory declaration of solvency, an auditors report verifying the accuracy of the company’s accounts and a special resolution of the company’s shareholders approving the assistance. This gave comfort to lenders as it indicated the company’s solvency and ensured it was acting within the confines of the law.
After finding the Whitewash procedure time consuming; involving a rigorous process of document review and preparation; and increasing advisory fees, the UK Companies Act abolished it leaving private companies free to offer financial assistance. Minority shareholders’ are still however, protected by other safeguards under the Act including, amongst others:
i. the company’s articles having to authorize the provision of financial assistance;
ii. the company had to be solvent
iii. the directors, as part of their statutory obligation under Section 172, were to always act in good faith and in a manner that will promote the success of the company and benefit all members; and.
iv. assistance such must not have resulted in the reduction of the share capital of the company.
It should be highlighted that public companies are still prohibited from offering financial assistance.
As indicated, the main purpose for restricting financial assistance is to protect shareholders. CAMA also has other provisions that perform this function most notably under Section 300. This sets out scenarios whereby a shareholder may restrain the company, by injunction or declaration, from performing certain actions for example entering into transactions which are either illegal or outside the scope of its powers or one where the directors are likely to derive a profit or benefit.
Furthermore, each director owes a duty of care to the company by virtue of their fiduciary relationship. In simple terms, they are duty bound to always act in good faith towards the company and the members, meaning all conduct carried out must be in the best interests of the company as a whole with the underlying objective of protecting its members, preserving its assets and furthering its business.
A conclusion can be made that the reason public companies remain excluded from offering financial assistance (in the UK) is due to absence of an appropriate mechanism to protect minorities. Private companies enjoy the luxury of size, which enables all members, including minorities, to be identifiable and more importantly provides the opportunity for their consent to be attained. Minority shareholders in public companies on the other hand run the risk of being unidentifiable and unaware the company is carrying out such activities. In addition, the UK as a member of the European Economic Community is required to comply with Article 23(1) of the Second Company Law Directive (77/91/EEC), which expressly prohibits public companies from advancing funds, making loans or providing any form of security for the purpose of assisting a third party acquire its shares.
The difficulties caused by Section 159 of CAMA outlined above and the evolution of the concept under English Company Law generates reason for the need to revisit this provision. While an outright reform of the CAMA may be deemed extreme and lengthy, an amendment targeting Section 159 in this regard can be made. Using the UK as a yardstick, private companies ought to be given free reign to offer financial assistance while taking into consideration the other laws that protect the shareholders’ of the company. This has worked under UK law thus far in protecting minority shareholders’ while still permitting financial assistance. The issues that arose during the PHCN privatization process takes the scope of re-evaluation a step further to consider granting public companies an opportunity to consider offering financial assistance; perhaps by the introduction of a similar whitewash procedure previously used under English Company law. Although deemed cumbersome and increased overall transaction fees, it nevertheless has the potential of bringing bring forth some much-needed flexibility in financing transactions. The appointment of an authority for example the Corporate Affairs Commission or the Securities and Exchange Commission to provide regulatory oversight of the process will give additional protection over minorities. This can be the first step in creating a more robust framework for Nigerian Company Law and future transactions.
For further information regarding the contents of this newsletter please contact:
Dami Ogedengbe (Solicitor) at email@example.com