Impact of long-awaited new UK company law on buyouts

After eight years of consultation, on a subject that doesn’t sound like it ought to be politically charged, it is surprising that the British government’s much-trailed attempt to reform UK company law has occupied so many headlines.

Company law underpins the economy, and regulates the operation of most significant businesses. But after nearly a decade of consensus-building for reforms that are billed as deregulatory, there are still some important debates to be had as the draft law navigates the parliamentary process.

Of course, the media – and the politicians – focus on the points of difference, rather than the many points of agreement. In fact, there are many changes that are largely uncontested – and many of those will benefit private equity investors.

Perhaps the prime example is the proposed abolition of the law restricting private companies from giving “financial assistance” for the acquisition of their own shares. The government is constrained from abolishing the rules for all companies by European law, which requires all member states to restrict “financial assistance” for public companies, but is free to sweep away the laws for others.

In response to calls from a range of parties over many years, the new law will (to some extent) end the ritual dance that has to follow any leveraged buyout in order to “whitewash” the security arrangements entered into by the target company.

Under the law as it stands, a company is not allowed to give “assistance” that helps another party to acquire that company’s shares. The rule is an old one, originally designed to protect creditors and minority shareholders from misuse of company funds by the shareholders.

In its purest form, of course, it would frustrate most leveraged buyouts – where the assets of the company that is being bought are used as security for the bank finance used to acquire it.

For that reason, most European countries have introduced rules (at least for private companies) to facilitate that kind of arrangement, and in the UK those rules take the form of an exemption from the prohibition for companies that are solvent – and can get auditors and directors to swear that – and have given minority shareholders a chance to have their say.

Going through the “whitewash” takes time, costs money, and (according to the government and most company lawyers) is pointless. Other company law rules offer perfectly good protection to anyone who might be prejudiced by the arrangements, and these additional rules (notoriously hard to interpret) just cause expensive head scratching in unusual cases, and fees for lawyers and accountants in straightforward ones.

So the (uncontested) abolition of that rule is deregulatory, as the government says, and should make life a little easier for the buyout community.

It won’t make all the problems disappear – directors are still constrained in what they can do if the company isn’t solvent, and owe important duties act in the best interests of the company as a whole (including its minority shareholders). And banks are a cautious bunch, and will no doubt replace the statutory rules with some safeguards of their own to protect the integrity of their security package. But this long overdue law reform is certainly something that private equity investors will welcome.

The government also says that the new rules will make life simpler for the vast majority of companies – small and medium sized businesses, with relatively few shareholders. If true, that would also be a benefit to the private equity world, which largely invests in those types of companies, and which is likely to be the biggest beneficiary from any cost savings that they achieve.

Some have doubted whether a new law that is longer that the existing one, and which supplements rather than replaces that old law, can make life simpler. But that argument is a little unfair. The effect of many of the changes that are directed at private companies will indeed be to simplify the rules that apply to their internal procedures.

So, for example, it will be quicker and easier for the shareholders to take decisions (including through written resolutions), there will be no need to appoint a company secretary, and it will be easier to use electronic communications.

These changes are uncontroversial, and sensible. Whether they will actually achieve much in cost savings to business is a moot point, but it must be better to have a company law framework that is designed for private companies, rather than one designed for public companies with exemptions and modifications clumsily grafted on to it – which is what we have at the moment.

Most of the issues that have generated debate have been those that are more important to managers and owners of publicly quoted companies, or at least those with a widely dispersed shareholder base.

There are some areas of concern for the private equity community – most notably, the rewriting of directors’ duties, which (if enacted in its current form) will make life more difficult for the NEDs appointed by private equity houses. That is something that the BVCA has taken up with the government.

But for the most part, controversy has focused on questions of shareholder accountability, auditor liability and directors’ duties to wider stakeholders. While there are some consequences for private equity in those debates, the main effects will be for public companies and their shareholders.

On the whole, private companies and their shareholders will be beneficiaries of the changes when they come into effect – currently expected to be some time in 2007.