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Print articleA Growing Practice for Leveraged Acquisition and Certain Related Corporate Constraints
May, 2007 - Carmen Peli, Partner
Romania¡¦s yearly economic growth has triggered in the past few years an increased interest for investment in the existing domestic companies. Most of the financial investors seek to leverage their acquisitions and expect the possibility to use the target companies¡¦ assets to such purpose. This article will briefly review corporate limits and prevailing interpretation.
Prohibition of financial assistance
Romania has implemented the provisions of art. 23 of European Union¡¦s Second Council Directive 77/91/CEE of 13 December 1976 regarding the creation of public limited liability companies, the maintenance and reduction of their capital (the ¡§Directive¡¨). Consequently, art. 106 (1) of the Company Law provides that a company may not grant advance payment, loans provide security in view of subscription or acquisition by a third party of its own shares. An exception is made in art. 106 (2) for transactions made as part of a bank or financial institution¡¦s credit operations.
Although the company law was substantially amended in December 2006, a whitewash procedure such as that contemplated in the European Parliament and Council¡¦s Directive 68/2006/EC was not adopted. To our knowledge, a draft law seeking to implement such directive in Romania was not yet proposed.
There are no court decisions interpreting such interdiction. Various principles of interpretation may apply concurrently and, depending on the weight given to one or another, the outcome of the interpretation of a legal provision may be different.
We will outline briefly below what could be the mainstream interpretations and the consequences thereof:
Interpretation through the legal purpose of the restriction. The interpretation of any legal provision should start with the understanding of the purpose sought by such provision. In case of art. 106 (1), it seems uncontroversial that such provision was enacted with a double purpose: on one hand, it protects minority shareholders against potential abuses by majority shareholders seeking to benefit abusively from a company¡¦s assets; on another hand, it protects existing creditors of a company against a potential loss of their debtor¡¦s assets or patrimonial value. A judge seeking to ensure that the purpose of the law is reached might be tempted to interpret this provision extensively, and decide that any form of a transaction by which a target company would end up in actually incurring all or part of the transaction expenses for one party falls within the legal prohibition.
Restrictive interpretation. On another hand, even though the purpose of the law is uncontested, one may consider that art. 106 contains a restriction to the general principle establishing the commercial freedom of the parties, including to the freedom to enter into any transactions. According to the general principles of law, any restrictions to a principle need to be interpreted in a limited manner and may not be extended by analogy to similar operations. According to such interpretation, the legal restrictions provided in art. 106 (1) of the Company Law shall not be applicable as long as the target company does not directly grant a loan or establish guarantees in relation with the shares acquisition. This interpretation might serve in narrowing the scope of the legal prohibition, confining more precisely what actions should be indeed restricted. Accordingly, one may argue that, for example, an upstream merger by which the target would be merged into a special purpose acquisition vehicle should not fall within the scope of the financial assistance restriction, due to the following reasons:
„X The target does not grant any loan or security for the purpose of the acquisition of its own shares. Instead, the acquisition vehicle obtains financing from shareholders or other lenders, secured with its own assets (including a pledge over the shares of the target, or a pledge over all its existing or future movable assets or fonds de commerce);
„X Following the merger, the target disappears. The resulting entity (the acquisition vehicle or a new company) is a distinct legal person and it faces a distinct restriction regarding financial assistance of its own shares;
„X A merger is not performed without consideration, provided that it is based on careful fair market value assessments endorsed by accounting/financial experts;
„X During the merger, the shareholders debate the legality and opportunity thereof and may challenge the merger decision. Creditors as well are allowed to challenge the merger plan. If the merger is not contested, or if the claims are settled, it might be considered that no third party interest is harmed by the merger and therefore there would be no grounds to prohibit it.
The form of the companies. The financial assistance restriction is included in the company law chapter regarding joint stock companies. Equally the Directive is only concerned with joint stock companies, while it leaves discretion to the Member States to further extend the restriction to limited liability companies (SRL). For such reasons and it might be argued that financial assistance restrictions do not apply for companies set as SRLs. The risk of an adverse court interpretation based on analogy with joint stock companies cannot however be totally excluded.
Potential sanctions. Another most significant aspects that need be considered are the criminal penalties for the shareholders or directors and executives of a company. According to the Company Law, the bad faith use of a company¡¦s credit or assets by a founding shareholder, director (i.e., member of the Board of Directors), manager, executive manager or legal representative of that company, for own use or to favor a company where such person holds direct or indirect interests is also qualified as a criminal offence. This offence is punished by prison from one month to 3 years (art. 272 (2) of the Company Law). The concept of ¡§founding shareholder¡¨ includes the signatory persons of the constitutive documents. An extensive interpretation of such concept might include therefore any shareholder, as ultimately additional acts to the company¡¦s constitutive documents are signed by shareholders (directly or through their representatives). However, logic and language arguments may be put forward, to interpret that by ¡§founding shareholders¡¨ the Company Law means only the initial shareholders that have established the company, and not successors thereof. Pursuant to the latest amendments to the Romanian Criminal Code, as of October 2006, are also companies may be punished for criminal offences. Thus pursuant to the general principles applicable to the criminal liability of legal persons, as regulated under Law 278/2006 amending the Criminal Code, a legal person may be held liable to the extent to which the criminal offence is committed in its interest or in its name, or in the performance of its activity. The punishment that might be applicable for the above criminal offences had they been committed by a legal person, would be a fine ranging between RON 5,000 and RON 600,000 (currently approx. EUR 180,000), accompanied by complementary punishments which may amount to suspension or closing of working points, the prohibition to attend public procurement procedures for a period of 1 to 3 years, or even dissolution of the criminal company, which shall be established depending of the circumstances of the criminal offence and the behavior of the company.
Conflict of interests. Under the Company Law, a shareholder cannot vote if it has any conflicts of interest with the company. In particular, the shareholder that, in a certain matter, has, either on its own name or on behalf of a third party, a contrary interest to that of the company, has to refrain from voting in respect of that particular matter. If the shareholder breaches such restriction, he would be liable for damages to the company. The conflicts of interest are not defined in the laws or in the corporate or courts practice so far. The purpose of the above prohibitions seems to be the protection of the shareholders and also of the creditors. In case of a parent-subsidiary merger structure, it might be interpreted that the parent company has a particular interests in obtaining the subsidiary¡¦s assets at the lowest price and therefore, its vote might become questionable. The sound financial/accounting reports and evaluations for the target would mitigate the above risk.
Prohibition of financial assistance
Romania has implemented the provisions of art. 23 of European Union¡¦s Second Council Directive 77/91/CEE of 13 December 1976 regarding the creation of public limited liability companies, the maintenance and reduction of their capital (the ¡§Directive¡¨). Consequently, art. 106 (1) of the Company Law provides that a company may not grant advance payment, loans provide security in view of subscription or acquisition by a third party of its own shares. An exception is made in art. 106 (2) for transactions made as part of a bank or financial institution¡¦s credit operations.
Although the company law was substantially amended in December 2006, a whitewash procedure such as that contemplated in the European Parliament and Council¡¦s Directive 68/2006/EC was not adopted. To our knowledge, a draft law seeking to implement such directive in Romania was not yet proposed.
There are no court decisions interpreting such interdiction. Various principles of interpretation may apply concurrently and, depending on the weight given to one or another, the outcome of the interpretation of a legal provision may be different.
We will outline briefly below what could be the mainstream interpretations and the consequences thereof:
Interpretation through the legal purpose of the restriction. The interpretation of any legal provision should start with the understanding of the purpose sought by such provision. In case of art. 106 (1), it seems uncontroversial that such provision was enacted with a double purpose: on one hand, it protects minority shareholders against potential abuses by majority shareholders seeking to benefit abusively from a company¡¦s assets; on another hand, it protects existing creditors of a company against a potential loss of their debtor¡¦s assets or patrimonial value. A judge seeking to ensure that the purpose of the law is reached might be tempted to interpret this provision extensively, and decide that any form of a transaction by which a target company would end up in actually incurring all or part of the transaction expenses for one party falls within the legal prohibition.
Restrictive interpretation. On another hand, even though the purpose of the law is uncontested, one may consider that art. 106 contains a restriction to the general principle establishing the commercial freedom of the parties, including to the freedom to enter into any transactions. According to the general principles of law, any restrictions to a principle need to be interpreted in a limited manner and may not be extended by analogy to similar operations. According to such interpretation, the legal restrictions provided in art. 106 (1) of the Company Law shall not be applicable as long as the target company does not directly grant a loan or establish guarantees in relation with the shares acquisition. This interpretation might serve in narrowing the scope of the legal prohibition, confining more precisely what actions should be indeed restricted. Accordingly, one may argue that, for example, an upstream merger by which the target would be merged into a special purpose acquisition vehicle should not fall within the scope of the financial assistance restriction, due to the following reasons:
„X The target does not grant any loan or security for the purpose of the acquisition of its own shares. Instead, the acquisition vehicle obtains financing from shareholders or other lenders, secured with its own assets (including a pledge over the shares of the target, or a pledge over all its existing or future movable assets or fonds de commerce);
„X Following the merger, the target disappears. The resulting entity (the acquisition vehicle or a new company) is a distinct legal person and it faces a distinct restriction regarding financial assistance of its own shares;
„X A merger is not performed without consideration, provided that it is based on careful fair market value assessments endorsed by accounting/financial experts;
„X During the merger, the shareholders debate the legality and opportunity thereof and may challenge the merger decision. Creditors as well are allowed to challenge the merger plan. If the merger is not contested, or if the claims are settled, it might be considered that no third party interest is harmed by the merger and therefore there would be no grounds to prohibit it.
The form of the companies. The financial assistance restriction is included in the company law chapter regarding joint stock companies. Equally the Directive is only concerned with joint stock companies, while it leaves discretion to the Member States to further extend the restriction to limited liability companies (SRL). For such reasons and it might be argued that financial assistance restrictions do not apply for companies set as SRLs. The risk of an adverse court interpretation based on analogy with joint stock companies cannot however be totally excluded.
Potential sanctions. Another most significant aspects that need be considered are the criminal penalties for the shareholders or directors and executives of a company. According to the Company Law, the bad faith use of a company¡¦s credit or assets by a founding shareholder, director (i.e., member of the Board of Directors), manager, executive manager or legal representative of that company, for own use or to favor a company where such person holds direct or indirect interests is also qualified as a criminal offence. This offence is punished by prison from one month to 3 years (art. 272 (2) of the Company Law). The concept of ¡§founding shareholder¡¨ includes the signatory persons of the constitutive documents. An extensive interpretation of such concept might include therefore any shareholder, as ultimately additional acts to the company¡¦s constitutive documents are signed by shareholders (directly or through their representatives). However, logic and language arguments may be put forward, to interpret that by ¡§founding shareholders¡¨ the Company Law means only the initial shareholders that have established the company, and not successors thereof. Pursuant to the latest amendments to the Romanian Criminal Code, as of October 2006, are also companies may be punished for criminal offences. Thus pursuant to the general principles applicable to the criminal liability of legal persons, as regulated under Law 278/2006 amending the Criminal Code, a legal person may be held liable to the extent to which the criminal offence is committed in its interest or in its name, or in the performance of its activity. The punishment that might be applicable for the above criminal offences had they been committed by a legal person, would be a fine ranging between RON 5,000 and RON 600,000 (currently approx. EUR 180,000), accompanied by complementary punishments which may amount to suspension or closing of working points, the prohibition to attend public procurement procedures for a period of 1 to 3 years, or even dissolution of the criminal company, which shall be established depending of the circumstances of the criminal offence and the behavior of the company.
Conflict of interests. Under the Company Law, a shareholder cannot vote if it has any conflicts of interest with the company. In particular, the shareholder that, in a certain matter, has, either on its own name or on behalf of a third party, a contrary interest to that of the company, has to refrain from voting in respect of that particular matter. If the shareholder breaches such restriction, he would be liable for damages to the company. The conflicts of interest are not defined in the laws or in the corporate or courts practice so far. The purpose of the above prohibitions seems to be the protection of the shareholders and also of the creditors. In case of a parent-subsidiary merger structure, it might be interpreted that the parent company has a particular interests in obtaining the subsidiary¡¦s assets at the lowest price and therefore, its vote might become questionable. The sound financial/accounting reports and evaluations for the target would mitigate the above risk.
