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Topical legal issues for investment bankers involved in UK private M&A

September 2008

Overview

Investment bankers will welcome the following legal developments in private M&A in the UK:-

From 1 October 2008, the law prohibiting a private company or its UK subsidiaries from giving financial assistance in connection with the acquisition of its shares will be largely abolished. This change in the law will result in the simplification of a number of aspects of most private M&A transactions, including the payment of advisors’ fees, the giving of guarantees or security by a target or its UK subsidiaries and post-acquisition reorganisations.
Recent case law in England and Wales reinforces the view that investment bankers can avoid liability for statements in information memoranda where they have acted in good faith and included appropriate disclaimer language, so long as their actions are consistent with such language.

Financial Assistance – 1 October 2008

Current position

Roughly stated, the current regime prohibiting financial assistance (contained in the Companies Act 1985 and developed by a number of cases) provides that, except for very limited exceptions, neither a company nor its UK subsidiaries may give financial assistance for the acquisition of that company’s shares, whether before, during or after the acquisition. The rule has attracted attention both because of its lack of clarity (there have been a number of cases delimiting the meaning of ‘financial assistance’) and also because officers of a company contravening the rules may be fined and imprisoned.

In the context of structuring private M&A transactions in the UK, the prohibition bites most noticeably in three areas. The first relates to payment of advisors’ fees and, in particular, those which are incurred once there has been external contact with a possible buyer (i.e. once the deal has gone beyond the preparatory stage). The advisory fees that may be caught by the prohibition range from the investment banker’s ‘success’ fee to those relating to the provision of information as part of the diligence and disclosure process. The second area concerns the giving of guarantees or security by the target or its UK subsidiaries, e.g. in a typical leveraged buy-out, where the group’s borrowing is secured by target group assets. The giving of such guarantees and securities clearly falls foul of the prohibition on giving financial assistance. The third area relates to post-acquisition reorganisations, where assets in the target group are transferred to a member of the buyer’s group. Such transfers may constitute unlawful financial assistance, especially where they have been effected for less than market value.

Under the current regime, financial assistance given by private companies and certain of their private subsidiaries which would otherwise be unlawful may be ‘whitewashed’ by following a statutory procedure. Implementing a whitewash procedure has its drawbacks, however, including additional legal costs and an inflexible statutory timetable for making statutory declarations, getting shareholder consents and giving the financial assistance. In addition, the whitewashing directors assume personal liability for the contents of the statutory declarations which they must give as to the solvency of the relevant target group company(s). As a result, on smaller deals, the parties typically ensure that the target group avoids giving financial assistance (e.g. the selling shareholders will often pay all of the advisory fees).

Change

As from the beginning of next month (1 October 2008), the prohibition on the giving of financial assistance by a private company is (largely) abolished by the Companies Act 2006. This means that a private company may give financial assistance (a) for the purchase of its shares, or (b) the shares of its parent, if that company is also a private company. The whitewash procedure (which is consequently no longer needed) is also abolished. The prohibition against unlawful financial assistance has been retained in its current form for public companies, and it is unlawful for a public company subsidiary to give financial assistance for the purpose of an acquisition of shares in its private holding company.

Issues

The abolition of the financial assistance prohibition will allow significantly more flexibility in structuring transactions moving forwards including in relation to the payment of advisors’ fees.

It will not, however, usher in an age where a company can give financial assistance free from legal constraints. Directors of private companies, and those that advise them, will still need to be mindful of: (a) directors’ duties and, in particular, whether the financial assistance promotes the success of the company; (b) the impact of insolvency legislation; (c) whether the company has the capacity and authority to give such financial assistance; and (d) both statutory and common law capital maintenance rules, particularly where a gift is being made or assets are being transferred at an undervalue.

Marketing a deal – Be careful what you say

Frequently, as part of marketing a deal, an investment banker will issue an information memorandum to potential acquirers. This exposes the investment banker to claims from third parties (and, in particular, an acquirer) if information in the information memorandum proves to be incorrect or misleading.

An investment banker, acting in good faith, should be able to avoid liability for such claims by including disclaimer language in the information memoranda which is appropriate to the transaction in question. This is seen (by analogy) in cases such as IFE Fund SA v. Goldman Sachs International (2007).

In the IFE Fund case, Goldman Sachs International ("GSI") acted as arranger and underwriter of syndicated debt facilities for Autodis SA to enable it to purchase an English company, Finelist Group PLC (“Finelist”). GSI, as arranger, had circulated an investment memorandum (“IM”) and accountants’ due diligence report to potential investors including IFE Fund SA ("IFE"). Following the circulation of the information memorandum, IFE acquired bonds and warrants issued by Autodis SA (for €20 million) from GSI. It was discovered, after the acquisition of Finelist, that Finelist had deceived its auditors and its financial position was materially worse than that shown in its audited accounts.

The IM contained financial information and preliminary reports from Finelist’s accountants based on Finelist’s misleading audited accounts. The misleading picture of Finelist’s financial position painted by the IM was not corrected or qualified by GS after it received further information from Finelist’s accountants which indicated that earlier reports might have been incorrect.

Finelist went into receivership and IFE suffered a loss. Subsequently, IFE claimed damages against GSI on the basis that: (i) GSI had impliedly made representations to IFE that it was not aware of information that showed the facts or opinions in the IM or accountants reports were or might be untrue (the misrepresentation claim); and (ii) GSI had a duty of care to inform IFE before completion of the transaction of any facts or matters which might cast doubt on the information contained in the IM and accountants’ report (the duty of care claim).

No dishonesty on the part of GSI or any of its employees was alleged.

After considering the disclaimer language in the IM, which included language to the effect that GSI was not making any representation as to the accuracy or completeness of the information in the IM and that GSI had no obligation to update the information in the IM, the court found:-

in relation to the misrepresentation claim, no representation of the nature claimed had been made. Rather, GSI supplied information it received from other sources; and
in relation to the duty of care claim, that no such duty of care was owed, the disclaimer language in the IM making clear it did not assume such a duty.

In addition to drafting an appropriate disclaimer, investment bankers should ensure that their actions are consistent with the disclaimer language in the investment memorandum. If subsequent to the investment memorandum an investment banker gives assurances to a buyer as to the target, it could well find itself subject to a successful claim notwithstanding the wording of any disclaimer.

Conclusion

As a result of these legal developments in the UK, investment bankers will find that structuring private M&A deals has become simpler and that, by adopting robust disclaimer language (which is consistent with their actions), they can minimise the risk of misrepresentation claims from the marketing of deals.

Further Information

If you have any questions or would like to discuss anything in this article in more detail, please contact Charles Claisse at Kemp Little LLP on 020 7600 8080.