You are on the board of a profitable UK subsidiary (“UKCo”). Your US parent company (“Parent”) has just sent you a whole set of group refinancing documents. On closer inspection, it becomes apparent that UKCo is being asked to guarantee the loans and charge all its assets to secure such borrowings of the Parent. The guarantee is uncapped and the amount of the loan materially exceeds UKCo’s balance sheet.
Should the UKCo board merely sign on the dotted line? What factors should its directors consider when deciding whether to sign up? What are the likely consequences if they reject this request?
Understanding their position
Even if the Parent has taken legal advice, the UKCo should consider whether it needs independent legal advice to not only explain/negotiate the terms of the documents, but also to advise the board on their director obligations/duties.
Directors are responsible for the day to day running of a company’s business. The Companies Act 2006 codified directors’ duties for the first time.
There are 7 duties but probably the most relevant here are:
- to act within the company’s constitution and only exercise powers for a proper purpose
- to act in good faith to promote the success of the company
- to exercise independent judgement (this does not restrict a director seeking informed advice)
- to exercise reasonable care, skill and diligence
- to avoid conflicts of interest
Who are such duties owed to?
When a company is solvent, these duties are predominantly owed to the company’s shareholders. As such, if the group is in a strong financial position, the directors can probably legitimately enter into the documents (even if the UKCo is not a direct borrower and is not able to access the borrowed funds directly).
However if UKCo is in financial difficulties, there is clear case law to demonstrate that the directors’ duties are then owed to UKCo’s creditors generally. As such, the directors would need to consider whether it is in the UKCo creditors’ interest, that they enter into the refinancing arrangements and take on further debt/encumber UKCo’s assets.
What happens if I get it wrong?
If the UKCo enters into the guarantee and debenture and subsequently enters into an insolvency process within the couple of next years, it is possible that any appointed administrator/liquidator will examine the entering into of the guarantee and debenture, and possibly seek to challenge them as a transaction at undervalue/preference.
The concern for the directors may also be that they are held to be in breach of their duties by signing the documents, or alternatively are guilty of wrongful trading i.e. that they should have put the company into insolvency rather than continuing to trade.
Often UKCo will have representatives of the Parent sitting on its board who are domiciled overseas. For such an overseas director, concerns about being pursued by a subsequently appointed liquidator are likely to be less of an issue than UK resident directors with assets in the UK.
Often UKCo will have banking arrangements (such as an overdraft/credit card facilities) with a UK clearing bank. If a US bank is suddenly demanding a debenture, it may be that a deed of priority has to be entered into to regulate the respective security.
What’s in it for UKCo?
If the board are not happy, they are perfectly entitled to seek changes to the documents or some concessions to demonstrate that it is in the UKCo’s interests to sign on the dotted line. Examples, which the author of this article has seen, include;
1. A request that the guarantee is capped
2. That the charge is restricted to only certain of the UKCo’s assets
3. That a fee is paid to UKCo for entering into the arrangements.
4. Agreement that the UKCo can at the same time make an additional payment to part fund an employee pension fund.
However, more often than not, a UKCo will agree to sign up without any additional consideration having regard to the overall benefit to the group in having access to the new facilities.
Letter of support
Particularly if the UKCo is not a direct borrower, another request could be that UKCo enters into an inter-group loan agreement with the Parent. Alternatively, a letter of support could be executed, whereby the Parent confirms that it is their current intention to fund UKCo for the next 12 months. Often this document will be needed to persuade an accountant to sign off on the accounts.
It is very important that a full and frank board discussion takes place which is properly minuted. More often than not, the board will be legitimately able to enter into the documents, but it is prudent to make sure that the commercial rationale for such a decision is properly set out.
Just say no
If a Parent company has representatives on the UKCo board, a UK director may be a lone dissenting voice. Again it is important that this is minuted.
If the UKCo board decides not to enter into the arrangements, they should be aware that the Parent could, in short order, appoint additional directors to vote through the financing.
Also, if the directors of UKCo are employees, they may also want to check their service agreements to see if provisions are included about following lawful instructions of any particular group officer.
Resignation should only be a very last resort.
The vast majority of group re-financings go through without any dissent. However, UK company boards should be conscious of their duties and should take proper advice before putting pen to paper.