White out

Legislative changes removing the need to 'whitewash' financial assistance have the potential to dramatically reduce deal costs when buying brokers. Tony Anderson and Liz Johnson caution, however, that a colourful array of obligations continue

This week, provisions of the Companies Act 2006 come into effect that may assist both insurers and brokers to achieve a greater market share in the consolidating intermediary sector.

These provisions allow private companies to grant financial assistance towards the acquisition of their own shares or that of their holding company without the need to 'whitewash' such financial assistance. This usually takes the form of guarantees or security provided by the assisting company to the lender funding the acquisition proceeds to the purchaser. It also includes loans made up to the purchaser from its subsidiaries to enable it to repay the acquisition loan.

These provisions should dramatically reduce the deal costs associated with the acquisition of insurance brokers, particularly where the consideration paid for the target broker is relatively small. Currently, all the directors of the company providing the assistance, in addition to the directors of the holding companies of the assisting company - up to and including the target company - are each required to swear a statutory declaration as to the solvency of the assisting company for 12 months following the granting of that assistance. The auditors of the assisting company are also required to author a statutory report confirming the solvency declarations made by the directors of the various companies.

Comforting words

It has become customary for the auditors to also provide a letter of 'comfort' to the lender regarding the net asset position of the assisting company. Where this company is also not wholly owned, shareholder approval of such assistance is required. Lenders, however, generally require shareholder approval even where the assisting company is wholly owned. These various steps are collectively known as the 'whitewash'.

This whitewash usually results in considerable amounts of additional time and cost being incurred in such acquisitions due to the need to retain auditors to review the assisting company's balance sheet and solvency position. In addition, lawyers need to produce large amounts of documentation and co-ordinate its execution by directors and shareholders - usually after hours.

Naturally, this has made it unattractive for insurers lending acquisition proceeds to acquiring brokers to seek security or guarantees from the target broker. It has then sometimes been difficult from a credit perspective for the insurer to justify making the loan for the acquisition without the benefit of security or guarantees from the target.

However, as of 1 October this year, there will no longer be a need to follow the whitewash procedure. While these restrictions have been removed, there will still be a need to consider the maintenance of capital of the assisting company and whether any unlawful distributions have been made. At common law, a company's capital needs to be protected for the benefit of its creditors.

There still remains a need to ensure that any reductions in the company's net assets, as a result of the financial assistance, can be provided out of the distributable profits of that company; and, more obviously, where a company is providing assistance, the provision of such assistance must be in the best interests of that company and likely to promote its financial success.

The company directors have a duty to consider this in their board resolutions. Directors can get comfort from obtaining shareholder approval about the provision of assistance as this will avoid the possibility of a shareholder challenging the transaction on the basis that the directors had breached their duties. The company's solvency will still also need to be considered.

It is interesting to note that these provisions concerning net asset reduction, promotion of financial success and solvency have always existed and were not affected by the whitewash regime being repealed. But, by its nature, this regime enabled the satisfaction of these common law considerations. It is important to remember that, if the company providing the assistance is insolvent or at risk of becoming insolvent, there is a potential for the transaction to be challenged on the basis that the directors have breached their duties or that it is a transaction at undervalue. This will be a further factor for directors to consider at board level.

While auditors will no longer be providing statutory reports or net asset letters to give lenders comfort with respect to the acquisition, it will become incumbent on insurers that are lending to assess the solvency of the assisting companies as part of their financial due diligence of the loan transaction. To do this, they will need to look at the assisting companies' net asset positions and the sufficiency of their cash flows going forward.

Conflicts of interest

These requirements will be in addition to any considerations of conflicts of interest under the Financial Services Authority's Principles for Businesses regarding the insurer and its relationship with its brokers. An insurer should ordinarily be taking into account these requirements where it is providing funding by way of equity or debt towards the acquisition of a brokerage by another broker. This will be particularly relevant where there are common directorships between the insurer and the insurance broker providing the assistance.

These considerations will also be relevant where an insurer is, for example, a shareholder of an assisting company prior to the assistance being given.

It is evident that in the current market some insurers are either providing funding by way of loans to brokers, or equity stakes in brokers, to enable them to acquire other broking businesses as a means of obtaining market share for the sale of their products. It will be interesting to see what impact the removal of the whitewash requirement will have on these funding initiatives.

- Tony Anderson is a banking partner, and Liz Johnson an insurance partner, in the banking and insurance groups at law firm Pinsent Masons.

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