The new Companies Act, 2008 has introduced a few principles that are aimed at preventing abuse of corporate structures to the disadvantage of others.

One of those abuses is the provision of financial assistance to group companies.  In principle, there is nothing wrong with group companies assisting each other. In some cases the group is actually structured specifically so that one entity acts as “treasury” for the rest of the group.  In other cases it may just be that one entity has funds available at a time when another needs finance on a short or long term basis.  As a business decision, this makes total sense.

Where it doesn’t make sense, however, is where the lender is not strong enough and any financial assistance provided to another company may weaken its own situation to a point where it may have difficulty in meeting its own obligations.  In normal circumstances, it wouldn’t make business sense to provide such financial assistance and most reasonable lenders wouldn’t even consider doing it.

But where there is a relationship between the borrower and the lender it is sometimes possible to “force” the lender to provide such assistance to its own detriment.  For example, where a director of the borrower is also a director of the lending company, that director can influence the lending decision to a point where the lender doesn’t actually have a choice.  (In some cases it is even possible for the director of the lending company to authorise a loan to himself / herself!)

Once again, such action may be totally reasonable and commercially justified, but the legislators considered it necessary to strengthen the existing safeguards – probably as a result of reported cases where the lender ended in financial distress simply because it made group loans that it couldn’t afford to make.

The new Act now provides in section 45 that, except where money lending is the ordinary business of the company, for employee share schemes or to disburse the director for expenses incurred, financial assistance can only be provided to directors or companies that are related to them if:

  1. The transaction is authorised by a special resolution of shareholders that was adopted within the previous two years, and
  2. The board is satisfied that the lender will still be solvent and liquid after providing the financial assistance and that the terms of the loan are reasonable to the company, and
  3. Written notice is provided to shareholders, and trade unions if applicable, within a prescribed period.

 

Loans that do not comply with the above requirements could result in personal liability for the directors.

The Act was implemented in 2011 already but, although the reasoning behind the new section is understood, there are still many uncertainties.  For example, what is financial assistance?  Would a trading account between two group companies constitute financial assistance?  What about a director who is also a customer of the company and enjoys credit facilities?  Or the treasury function that was referred to above?

Some of these uncertainties will probably not be clarified for a long time, but the important message can only be:

  1. Be careful when providing assistance that is not part of the normal course of business, especially where the lender is not in such a strong financial position. 
  2. When in doubt, get professional advice BEFORE entering into a transaction.  For example, the special resolution referred to above must be taken before the transaction, it can’t be ratified later.

In fact, if you read the previous two recommendations again, you will agree that it is just common business sense, regardless of the provisions of the Companies Act.

Henk Heymans
Audit Partner, Johannesburg