Financial assistance in connection with acquisitions
After the cooling in 2020, the acquisition market is experiencing a boom and growth is expected in the future. In connection with the acquisition of mainly real estate projects, the Business Corporations Act regulates an institute called financial assistance. Even before the acquisition process begins, the existence of financial assistance must be taken into account and the structure of the transaction must be adapted accordingly.
Definition of financial assistance
The legal regulation of financial assistance in Czech law is based on the European Directive regulating certain issues of company law and is regulated in the Business Corporations Act.
Financial assistance is defined as a situation where the target company provides a certain advance, loan, credit or security to the buyer for the purpose of acquiring a share in the company. The essence of financial assistance is that the buyer enters into a contractual relationship with the shareholders of the target company whose shares it wishes to acquire. The target company then provides either direct funds or some form of security for the transaction.
In practice, cases of financial assistance are usually limited to the provision of collateral. The issue of financial assistance is particularly relevant in the case of acquisitions of real estate companies.
An illustrative example is a transaction in which the buyer acquires a share in a company whose only significant asset is a certain piece of real estate. Normally, such transactions are financed through bank loans. A prerequisite for a bank loan is the creation of a lien on the property. The buyer must therefore ensure, in cooperation with the target company, that the latter concludes a lien agreement with the bank and registers the lien in the Land Register. The establishment of a lien in such a case constitutes financial assistance, which is subject to a number of formal legal rules.
The above can be illustrated in the case of real estate acquisitions by the following diagram:
General conditions for providing financial assistance
The provision of financial assistance was completely prohibited by the previous legislation. The current legislation does not prohibit financial assistance but makes it subject to a number of rules.
As a general rule, a company must not cause itself to become insolvent or overindebted by providing financial assistance.
The rules governing financial assistance are different for limited liability companies and joint-stock companies.
Financial assistance – specifics of a limited liability company
A limited liability company may provide financial assistance if the managing director of the company executes a written report specifying the terms of the assistance and the risks and benefits to the company.
A further condition is that the financial assistance is provided on fair terms (in particular, a market rate of interest, an amount of collateral commensurate with the amount lent, etc.).
The granting of the financial assistance will be decided by the shareholders at a general meeting.
Financial assistance – specifics of a joint-stock company
The financial assistance regime in the case of a joint-stock company is more robust and complex compared to the rules for a limited liability company.
The conditions for granting financial assistance are as follows:
a. Financial assistance is provided on fair terms (i.e. the same rule applies here as in the case of a limited liability company);
b. The statutory body will investigate the financial capacity of the person to whom the assistance is provided;
c. The statutory body will prepare a written report stating:
a. the factual justification for the financial assistance;
b. the conditions under which the assistance is provided;
c. the reasons why the financial assistance is in the company's interest;
d. conclusions on the financial capacity of the person to whom the assistance is provided;
d. The provision of financial assistance must not cause the reduction of equity capital below the subscribed share capital increased by funds that cannot be distributed to shareholders under this Act or the company's articles of association;
e. The company must establish a special reserve fund in the amount of the financial assistance provided.
The granting of financial assistance is decided by the general meeting of the company in the same way as in the case of a limited liability company.
Financial assistance is problematic in the case of a joint-stock company, primarily because the company is obliged to create a special reserve fund in the amount of the financial assistance provided, which significantly limits its practical use. Few companies have sufficient liquidity of their own to create such a fund. This is particularly true if the company's only significant asset is a piece of real estate.
Another method of acquisition without financial assistance
The financial assistance itself represents a potential complication of the acquisition transaction, with associated time and organisational costs. In the case of joint-stock companies, the rules on financial assistance are so strict that they make it virtually impossible for many companies to use it.
A similar result can be achieved by means of a transaction in the form of an asset deal – a direct purchase of real estate, purchase of a commercial enterprise or part thereof.
Particularly in the case of a joint-stock company, it is then advisable to consider the possibility of changing the legal form to a limited liability company or using one of the more complex acquisition schemes.
Financial assistance has formal rules that must be followed. It is advisable to keep them in mind before structuring the transaction itself and to check whether the characteristics of financial assistance are materially fulfilled in the course of the acquisition. Whether financial assistance is provided in an acquisition depends on the underlying timing of the acquisition, the manner in which it is carried out and the potential tax consequences.