Intra Group Loans and Guarantees – are they distributions?
15 June 2018
Practice Area: Banking & Finance
Loans and cross guarantees between members of the same group of companies are common features of many group funding structures.
In 2017 the Institute of Chartered Accountants in England and Wales and the Institute of Chartered Accountants in Scotland produced a paper which raised questions on the circumstances in which intra group transactions amounted to a distribution.
These queries have now been addressed from a legal perspective by the City of London Law Society which recently published guidance addressing when intra group loans and guarantees provided by a company constitute a distribution of assets to its members.
Intra Group Loans
A “normal intra group loan” from a company to its parent or fellow subsidiary, is not a distribution of assets to its members. A “normal intra group loan” is, generally one where the lender’s board concludes at the time the loan is made, that the borrower is likely to be able to repay the loan when it is demanded.
The loan will amount to a distribution where it is likely the borrower will not be able to repay the loan when it is demanded, and the lender does not receive appropriate value for assuming that risk.
If there is no intention the borrower will ever be required to repay the loan, it is likely the transaction will be deemed a distribution.
Intra Group Guarantees
A guarantee given by a company to a creditor of its parent or fellow subsidiary, in relation to a “normal financing transaction”, will not constitute a distribution of assets to its members. A “normal financing transaction” is essentially one where the guarantor’s board concludes in good faith at the time of giving the guarantee, that the group member receiving the credit is likely to be able to repay or refinance the associated liability when due.
However, if at the time the guarantee is entered into the guarantor’s directors believe it is likely that the guarantee will be called, there is a risk the court could deem the entering into the guarantee a distribution. In these circumstances if the subsidiary receives full value for entering into the guarantee it will not constitute a distribution.
The guidance also focuses on the definition of distribution, stressing that the purpose and the substance of a transaction are of significant importance. The key point is not whether there is an intention to effect a distribution, but whether the substance of the transaction is a distribution.
The guidance will provide comfort to banks and company directors that the approach generally being taken is the correct one, whilst also re-emphasising the need to consider and prepare an adequate record of how they arrive at their decisions assessing the risk of the underlying liability not being repaid or not being capable of refinance.