When may an intra-group loan or guarantee become a distribution?
04 / 07 / 2018
The Law Society of England and Wales and the City of London Law Society have recently published two joint papers analysing the circumstances in which an intra-group loan or cross guarantee may constitute a distribution. The notes were prompted by a significant shift of position in the updated Guidance on Realised and Distributed Profits under the Companies Act 2006 produced last year by the Institute of Chartered Accountants in England and Wales (ICAEW) and the Institute of Chartered Accountants of Scotland (ICAS) (TECH 02/17) from the prior technical guidance (TECH 02/10).
ICAEW and ICAS set out a number of new black and white treatments on TECH 02/17 which do not seem to reflect current law and practice. In particular, that:
- an interest-free term loan from a subsidiary to a parent is a partial distribution to the extent to which it is at undervalue;
- an intra-group interest-free loan which is legally repayable on demand will constitute a distribution if it is at undervalue; and
- guaranteeing the debt of a parent or fellow subsidiary without receiving an appropriate fee necessarily involves a distribution.
The Law Society is of the view that a normal on-demand intra-group loan (whether or not interest-bearing) will not amount to a distribution because the lender retains the ability to demand repayment whenever it needs the cash for its business. A “normal on demand intra-group loan” is one where the subsidiary’s board concludes, at the time the loan is made, that the borrower is likely to be able to repay the loan when this is demanded. Such a loan may, however, amount to a distribution if, objectively on the facts, it is likely that the borrower will not be able to repay the loan when demanded, and the subsidiary does not receive appropriate value for assuming that risk. If there is no intention that the borrower should ever be required to repay the loan it is likely that the transaction would be a distribution.
In its note on intra-group guarantees, the Law Society expresses its opinion that a guarantee given in relation to a normal financing transaction does not constitute a
distribution, whether or not a fee is payable. A “normal financing transaction” is a transaction in which, at the time the guarantee is given, the guarantor’s board considers the financial position of the member of the group to whom the credit is provided and concludes, in good faith and on reasonable grounds, that it is likely to be able to repay or refinance the credit when due and therefore that a claim is unlikely to be made on the guarantee. In such circumstances, a corporate benefit may be identified.
What is obvious is that the position is not clear. If the legal and accounting professional bodies are unable to agree on the position, having long debated the issues and been to counsel, there is surely a need for the rules to be reconsidered. The Law Society is calling on government to bring greater clarity more generally to this complex area of law where law, market practice and accounting standards meet in order to deliver certainty to companies and company directors. No director wishes to be informed post-event that he or she has made an unapproved or unlawful distribution or return of capital.