Does your group still process inter company loans by:
- consolidating the daily bank balances of group companies into a single bank account on an overnight basis, or
- operating a structured inter company deposit & loan business via a finance subsidiary, where group companies are obliged to deposit or borrow funds instead of using their bankers?
Inter company loans
Traditionally inter company loans were often granted with little regard given to the ability of the borrower company to repay such debt. After all, these are usually subsidiaries with common directors and operating under the tight direction and control of head office. What can possibly be wrong with that?
Beware.
Before a company may grant financial assistance to another company or corporation which is related to it, the provision of such assistance must have been approved by a special resolution adopted by the shareholders within the previous two years.
The approval may either be for the specific recipient or generally for a category of potential recipients (for example, the companies or corporations which are related or inter-related to the company).
It is now the responsibility of every board member of every company involved in overnight cash consolidations and / or inter company financing activities, to ensure that the provisions of Sections 4, 45 and 46 of the Companies Act are being adhered to, as regards inter company loans.
The Journal of Global Accounting Alliance carried a good article on the subject which is worth reading in detail.
Also read our related article on the solvency and liquidity test which the board must review.
Solvency and liquidity test
Section 4 deals with the solvency and liquidity test to be performed by the Board in respect of any inter company loans, amongst others, as follows:
1. the solvency and liquidity test is applicable for any purpose of the Act, and
2. the company satisfies the test at a particular point in time if;
- considering all reasonably forseeable financial circumstances at that time, including any reasonably forseeable contingent assets and liabilities;
- the fairly valued assets exceed the fairly valued liabilities of the company,
- based on accounting records and financial statements as defined in Sections28 and 29, and
- the company will be able to pay its debts as it becomes due in the ordinary course of business;
for a period of 12 months after the test is performed, or
for a period of 12 months after a “distribution” is made.
Financial assistance
Section 45 regulates financial assistance to an extended group of persons or companies when compared to the previous Act.
In terms of this section, unless the company’s MOI provides otherwise, the board may authorise direct or indirect financial assistance to the following parties:
- a director and prescribed officer of the company or of a related or inter-related company;
- a related or inter-related company or corporation;
- a member of a related or inter-related corporation; or
- a person related to any of the above parties.
Section 2 of the Act covers the definition of related and inter-related companies, corporations and persons. It also addresses the definition of control, which essentially includes subsidiaries, entities exercising control or entities under joint control.
Please note that Section 45 extends to more than a traditional group of companies. It incorporates a wider group of companies, close corporations, trusts and individuals.
Group management should already have identified all relationships within the group, its directors and associated businesses. An analysis should be maintained which shows every company, subsidiary, close corporation or trust which falls within the definition of a related or inter-related person.
This schedule needs to be constantly updated if and when the structure or relationships change.
Section 4 deals with the solvency and liquidity test to be performed by the Board in respect of any inter company loans, amongst others, as follows:
1. the solvency and liquidity test is applicable for any purpose of the Act, and
2. the company satisfies the test at a particular point in time if;
- considering all reasonably forseeable financial circumstances at that time, including any reasonably forseeable contingent assets and liabilities;
- the fairly valued assets exceed the fairly valued liabilities of the company,
- based on accounting records and financial statements as defined in Sections28 and 29, and
- the company will be able to pay its debts as it becomes due in the ordinary course of business;
for a period of 12 months after the test is performed, or
for a period of 12 months after a “distribution” is made.
Financial assistance
Section 45 regulates financial assistance to an extended group of persons or companies when compared to the previous Act.
In terms of this section, unless the company’s MOI provides otherwise, the board may authorise direct or indirect financial assistance to the following parties:
- a director and prescribed officer of the company or of a related or inter-related company;
- a related or inter-related company or corporation;
- a member of a related or inter-related corporation; or
- a person related to any of the above parties.
Section 2 of the Act covers the definition of related and inter-related companies, corporations and persons. It also addresses the definition of control, which essentially includes subsidiaries, entities exercising control or entities under joint control.
Please note that Section 45 extends to more than a traditional group of companies. It incorporates a wider group of companies, close corporations, trusts and individuals.
Group management should already have identified all relationships within the group, its directors and associated businesses. An analysis should be maintained which shows every company, subsidiary, close corporation or trust which falls within the definition of a related or inter-related person.
This schedule needs to be constantly updated if and when the structure or relationships change.
Disbursements
Section 46 covers the actual disbursement of funds and provides that a company must not make a distribution unless:
- it is made pursuant to an existing legal obligation of the company, or a court order, or
- the board of the company has authorised the distribution, and
- it reasonably appears that the company will satisfy the solvency and liquidity test per Section 4 immediately after completing the transaction, and
- the board, by resolution, acknowledges that it has applied the solvency and liquidity test and reasonably concluded that the company will satisfy such test after completing the transaction.
Failure to comply with these conditions render the distribution void. Every director is personally liable if he/she was present at the meeting and failed to vote against the resolution, despite knowing that the disbursement is inconsistent with these sections.
EACH TIME such a cash consolidation is done or funds deposited with or borrowed from the group finance company:
- the boards of both companies involved have to specifically approve such a transaction, and
- both boards must each time have sight of such documents as they reasonably require in order to satisfy themselves that such a disbursement meets the solvency and liquidity test.