We are often asked to guide lenders on the issue of commercial benefit when advising on the structuring of transaction security in the context of a group of companies. The Companies Act 2006 (the “2006 Act”) places a statutory on directors to consider commercial benefit when entering into any transaction. Why is it so important that lenders consider the issues at play?
Is the benefit for this company?
Something that can be overlooked when a guarantee (or third party security) is being granted by group companies is that, for the purposes of the 2006 Act, it is not enough for the guarantee to benefit the group to which the guarantor belongs. There must be a benefit to each company granting the guarantee, and sometimes it can be hard to work out whether that is the case.
Whenever a parent company guarantees the obligations of its subsidiary, it is typically evident that the parent is gaining a benefit. That is because the loan made to the subsidiary will help it to be successful, and, assuming it is, that success will normally benefit its parent, by, for example, increasing its subsidiary’s value or improving its financial performance, resulting in larger dividends paid to the parent.
However, in situations where a subsidiary grants a guarantee for the debts of its parent or holding company, where guarantees are being created across groups, or where guarantees are being granted by sister companies, the answer is not always clear. This can get especially thorny when a guarantee is granted by a company that is not in the same group as the borrower. This does not mean that a commercial benefit does not exist, but it can be less obvious how it arises. In situations like these ones, it is extremely useful to have a record of the directors’ thought processes in reaching the conclusion that there is a commercial benefit.
The importance of detailed board minutes
When taking a guarantee, we always recommend that lenders take steps to ensure that the board minutes of each guarantor states exactly what the commercial benefit was to that company and why the directors have reached this conclusion. If this is not done, it can be very difficult for anyone to remember what that benefit was if this is called into question in future. It is important, though, that lenders do not take on this role for their customer –the directors are the people with intimate knowledge of the company, and they are the ones in the position to determine where the benefit may lie in granting a guarantee. However, thinking about where benefit might be is still a useful exercise for lenders to undertake when structuring security in a transaction.
What if there is no commercial benefit?
If there is no benefit, then, potentially, the company’s shareholders may take action to overturn the guarantee. Where this is a concern, obtaining a written resolution from the shareholders before the guarantee is entered into, whereby they also approve the transaction, will usually prevent them from trying to dispute it later, although this is not a panacea for all lack of benefit issues.
Commercial benefit is also important if any issues around solvency arise for the company concerned. A guarantee can be set aside by the court as a transaction at undervalue under insolvency legislation if the guarantee is given within a certain time period of the guarantor becoming insolvent. This might arise if, for example, the company was insolvent when it gave the guarantee (or became insolvent as a result of granting the guarantee), the value the company received from granting the guarantee was significantly less than the value it gave, or if the directors did not enter into the guarantee in good faith and with reasonable grounds for believing that granting the guarantee would benefit the company giving it. By actively considering commercial benefit at the outset and recording the reasons for approval in a detailed set of minutes, any possible issues are flushed out at the beginning and, potentially, trouble is avoided down the line.
For more information and guidance, please contact Sarah Naylor or a member of our Banking & Finance team at DMHS.