Law Society guidance on intra-group guarantees and intra-group loans

Posted: 26/06/2018

The Law Society has issued guidance on the legal implications of intra-group guarantees and intra-group loans in response to a paper produced by the Institute of Chartered Accountants (ICA) which stated, for the first time that:

an upstream or guarantee (or guarantee of a sister company's obligations) would be a distribution where no market fee is paid to the surety for the grant of the guarantee; and
the grant of an interest-free on demand loan by a subsidiary to a parent or other sister company could constitute a distribution, because of the interest foregone on the loan by the subsidiary.

The statements made by the ICA have raised a question mark over existing transactions that were previously considered lawful and could, if correct, impact the way in which group companies finance themselves going forwards, particularly where there are no distributable profits available in subsidiary companies.

The Law Society has therefore produced two notes addressing the issues raised which confirm the position prior to the ICA notes being published.

The notes acknowledge that businesses are now rarely constituted in one corporate entity and the Law Society comments that, in its opinion, a guarantee given by a subsidiary in relation to a normal financing transaction does not constitute a distribution whether or not a fee is payable. A subsidiary entering into a guarantee in favour of a creditor of its parent or sister company may however amount to a distribution where:

the intention is that the guarantee will be called for (or, viewed as likely); and
the subsidiary does not receive appropriate value for assuming that contingent liability.

It is commonplace for creditors of a parent company to require intra-group guarantees and security to provide lenders with access to assets across the group, rather than just the assets of the parent to which it is lending. When considering whether to provide a guarantee, the directors of the relevant subsidiary/sister company must consider their directors’ duties and relevant insolvency law. For more information on directors' duties, please see here. The main consideration for the board should be whether the guarantee is likely to be called, or the security enforced.

In practice, subsidiaries/group companies will often benefit from the monies advanced under a loan to a parent company that they are guaranteeing or providing security for. For example, the subsidiary may benefit from being able to access the financing provided or simply from being part of a financially stable group of companies from which it can access shared services and management.

Similarly, the Law Society guidance considers that a ‘normal on demand intra-group loan’ made by a subsidiary to a parent company (or sister company) that is repayable on demand and interest free, is not a distribution where, at the time the loan is made, the board of directors of the subsidiary properly considers the borrower's financial position and concludes, in good faith and on reasonable grounds, that it is likely to be able to repay the loan when repayment is demanded. The loan may be viewed as a distribution if:

viewed objectively, it is likely that the borrower will not be able to repay the loan when demanded, and
the subsidiary does not receive appropriate value for assuming the risk. If there is no intention that the borrower should ever be required to repay the loan, then it is likely that the transaction would be a distribution.

The conclusion is that the status quo prevails, but the Law Society guidance is a good reminder of the considerations that directors should have when considering intra-group guarantees, security or loans.

The full Law Society guidance notes can be accessed here.

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