The Prohibition
Article 110(1) of the Companies Act (Chapter 386 of the Laws of Malta) (the “Companies Act”) sets out two related restrictions. The first, in article 110(1)(a) of the Companies Act, prohibits an undertaking from subscribing for, holding, acquiring or otherwise dealing in shares in its own parent company. The second, in article 110(1)(b) of the Companies Act, is the prohibition of financial assistance. It prohibits a company from giving financial assistance, whether directly or indirectly, for the purpose of the acquisition of, or subscription for, shares in the company itself or shares of its parent company. The prohibition applies to assistance given in connection with an acquisition or subscription “made or to be made”, and extends to loans, guarantees and the provision of security, as well as to assistance given “or otherwise”. Read on its own, article 110(1)(b) of the Companies Act appears to be an absolute ban. However, it has exceptions. In particular, it does not apply to:
- transactions effected with a view to the acquisition of shares by or for the company’s employees or the employees of a group company; and
- the provision of financial assistance by an investment company with fixed share capital for the purpose of or in connection with the acquisition of its fully paid up shares by another undertaking.
Both exceptions are subject to a condition. Following the provision of financial assistance, the company’s net assets must not fall below the amount of its called-up issued share capital plus any reserves that the Companies Act or the company’s memorandum or articles of association do not allow it to distribute.
Scope and Rationale of the Prohibition of Financial Assistance
Financial assistance typically arises in M&A transactions in which a third party provides external financing to a purchaser and the target company provides guarantees and/or security for that financing. In line with market practice, these are usually provided on a post-closing basis, that is, once the purchaser has acquired the shares in the target company. This does not take the transaction outside the prohibition under article 110 of the Companies Act, which expressly covers assistance for an acquisition or subscription “made or to be made”. Furthermore, the prohibition may apply in both domestic and cross-border M&A transactions.
Article 110 of the Companies Act does not define financial assistance, and the words “or otherwise” indicate that the term extends beyond the granting of loans, guarantees and security to other more complex transactions. Nor is financial assistance limited to transactions that result in a transfer of funds from the company to the purchaser without any obligation of repayment, or that diminish the company’s assets. For example, where a loan is granted, the purchaser remains liable to repay it, and guarantees and the provision of security do not diminish the value of the company’s assets unless they are enforced, yet each is expressly caught by the prohibition.1
This raises the question of why financial assistance is prohibited. The principal rationale is capital maintenance and creditor protection. Since shareholders in a limited liability company are not personally liable for the company’s debts, creditors may seek repayment only from the company’s assets, and the capital contributed by shareholders serves as a fund on which creditors rely. The law permits such capital to be returned to shareholders only through prescribed procedures that include safeguards for creditors, such as a formal reduction of capital or a regulated share buy-back, while distributions may otherwise be made only out of profits available for distribution (by way of dividends). Financial assistance could be used to circumvent these safeguards. If a company lends part of its capital to a purchaser who uses the loan to buy shares in the company from the existing shareholders, the outgoing shareholders in effect receive the company’s capital, leaving the company with only a claim against the purchaser. Similarly, where the company guarantees the purchaser’s borrowing or grants security over its assets, the company’s resources are exposed to a liability incurred to finance the purchase of its own shares, to the potential detriment of its other creditors and minority shareholders. A further rationale is that this prohibition prevents market manipulation whereby a company that finances the purchase of its own shares, or those of its parent company, may artificially support a share price that does not reflect the shares’ true value, a concern particularly relevant to public and listed companies. Lastly, the prohibition prevents directors from using company resources to influence who owns the company.
The Whitewash Procedure
The prohibition was first introduced into Maltese law in 1965 through the Commercial Partnerships Ordinance (Chapter 168 of the Laws of Malta) (the “Ordinance”), and was modelled on section 54(1) of the UK Companies Act 1948. When the Companies Act replaced the Ordinance with effect from 1 January 1996, the prohibition was retained in article 110 of the Companies Act. Although the Maltese legislator never adopted the reforms introduced in the UK by the UK Companies Act 1985 (which eased the prohibition of financial assistance) and the UK Companies Act 2006 (which removed the prohibition of financial assistance for private companies), the prohibition was significantly eased by Act IX of 2008. This amendment introduced a mechanism by which a private company may disapply the prohibition by completing a procedure before granting the financial assistance, commonly referred to among practitioners as the whitewash procedure. Significantly, the whitewash procedure is not available to public companies.
The whitewash procedure requires the following conditions to be satisfied before a private company may grant financial assistance:
- That the board of directors of the company has, after taking into account the financial position of the company and the obligations of the directors as set out in article 136A, resolved by the affirmative vote of a majority of all the directors forming the board at the time of the particular resolution, to authorise the grant of financial assistance for a specific transaction;
- That an extraordinary resolution has been passed affirming the resolution taken by the board of directors pursuant to paragraph (a); and
- That a declaration in the prescribed form (the “Form S”), signed by two directors (or by one director if the board of directors consists of one director) and confirming that the resolutions referred to in (a) and (b) have been passed, is duly filed with the Malta Business Registry before the financial assistance is granted.
The filing of the Form S is presumably intended to alert third parties, particularly creditors, to the grant of the financial assistance. However, since the Form S does not require the details of the transaction to be included and the resolutions themselves are not required to be filed with the Malta Business Registry together with the Form S, such details remain confidential.2
The whitewash procedure places primary responsibility on the board of directors. Before authorising the financial assistance, the directors have a duty to review the company’s financial position, solvency, accounting records and all other relevant documents, in order to consider whether granting the financial assistance will compromise the company’s financial position. While the shareholders are required to affirm the board’s resolution, it is the board that initiates and bears primary responsibility for the decision.3
Practical Implications for Transactions
In practice, if a transaction amounts to financial assistance, it must first be determined whether the company is able to use the whitewash procedure. If it cannot, the transaction will need to be structured differently. If it can, the board resolutions and extraordinary resolutions must be passed and the Form S must be signed and filed with the Malta Business Registry before the transaction takes effect. Therefore, the transaction timelines must allow sufficient time for the whitewash procedure to take place before the transaction documents granting the financial assistance are signed.
Consequences of Breaching the Prohibition
Article 110 of the Companies Act does not specify any sanction for a breach of the provisions on financial assistance. It does not, for instance, impose a penalty on the company or personal liability on the directors, nor does it state that the transaction is null and void. While this leaves the consequences of a breach open to question, it has been argued that, since the law declares it unlawful for a company to grant financial assistance, a transaction that breaches article 110 of the Companies Act would be null and unenforceable or subject to rescission under civil law. Moreover, the directors of a company that breaches the provisions on financial assistance would be acting in breach of their duties as directors.4
Conclusion
The whitewash procedure operates as a preventative mechanism whereby, before any financial assistance is granted, the board must consider the company’s financial position, the shareholders must affirm the board’s decision by extraordinary resolution and the Form S has to be filed with the Malta Business Registry in order to alert third parties that assistance is to be given by that company, albeit without disclosing the details of the transaction. Whether the prohibition should be retained for private companies remains a matter of debate, not least because the UK Companies Act 2006 abolished the prohibition for private companies, save where a private company gives financial assistance for the acquisition of shares in its public parent company. The UK reform was based on the view that private companies should not bear the cost of complying with these rules, given that abusive transactions can be addressed through other means, such as the wrongful trading provisions and directors’ duties.
Those favouring repeal of the prohibition in Malta advance similar arguments by stating that the prohibition often catches intra-group transactions that pose little risk to third parties, adds cost and time to transactions, and overlaps with directors’ duties. Those favouring retention of the prohibition argue that the prohibition complements the rules on reductions of capital and the acquisition by a company of its own shares and is also consistent with the doctrine of capital maintenance, which could, should financial assistance not be prohibited, otherwise be circumvented indirectly, and that, whereas the wrongful trading provisions and directors’ duties operate largely after the event, the whitewash procedure operates before the assistance is granted. Whether the current regime strikes the right balance between commercial flexibility and the protection of creditors and shareholders is ultimately a policy choice for the Maltese legislator.
Footnotes
1 Andrew Muscat, Principles of Maltese Company Law, Vol. 2 (2nd edn, Malta University Press, 2019) 1007-1029.
2 ibid.
3 ibid.
4 ibid.
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