COMMENT: Polish law change could lead to more vibrant LBO market

By bne IntelliNews July 11, 2008

Tomasz Ujejski of Squire, Sanders & Dempsey -

The Polish parliament recently liberalised the so-called "Financial Assistance" provisions of the Polish Commercial Companies Code (CCC) which, prior to these changes, prohibited joint stock companies from providing financial support to third parties for the purpose of assisting such third parties in the purchase of such joint stock companies' own shares.

The changes to Article 345 of the CCC will come into force in October 2008 and will provide a firmer legal basis for financing company acquisitions with the assistance of the target companies themselves (or their subsidiaries), allowing the buyer to rely on the assets and balance sheet of the target in the financing of the acquisition. The changes could open the door to a more dynamic market in leveraged buy-outs (LBOs).

In its current form, the CCC has severely limited the ability of buyers of companies to rely on the assets of target companies, no matter how healthy their balance sheets, to secure financing for their proposed acquisitions. The prohibitions contained in the Code are not unique to Poland, as they reflect the concepts set out in the EU's Second Directive of December 13, 1976 which prohibited a joint stock company from lending or otherwise advancing funds, or allowing its assets to be used as security, for the financing by a third party of the acquisition of its shares.

The language that enshrined the "Financial Assistance" prohibitions in the CCC was potentially even more far reaching than that of the Second Directive and, in the ambiguity of some its language, created some uncertainty as to what was and was not permissible. Current provisions state that such financial assistance can't be provided by a joint stock company in "whatever form, directly or indirectly." This formulation is potentially very far reaching and has inevitably raised concerns over what may or may not be considered to constitute financial assistance in the context of an acquisition. M&A practitioners even raise concerns as to whether costs incurred by companies in the context of acquisitions of their shares by third parties might be considered "financial assistance" contrary to the CCC. These circumstances are discouraging to buyers, particularly private equity firms and similar institutions that are in the business of acquiring companies. Banks are also wary of providing acquisition finance in situations where sophisticated financing techniques and structures are used to indirectly leverage the assets of the target, for fear of falling foul of the language of the CCC.

It is true that the CCC only applies to the acquisition of shares of joint stock companies and that financial assistance in relation to the acquisition of limited liability companies has been permissible. Nevertheless, the restrictions applicable to joint stock companies have constituted a significant barrier to LBOs in Poland, as many substantial companies are in fact joint stock companies, including all companies listed on the Warsaw Stock Exchange.

The changes to the CCC reflect the amendment of the Second Directive of 1976 by EU Directive 2006/68/WE of September 6, 2006, which permits companies "to grant financial assistance with a view to the acquisition of their shares by a third party up to the limit of the company's distributable reserves." In keeping with the provisions of this recent European Directive, the amendment to the Polish CCC expressly states that a company may, directly or indirectly, finance the acquisition of its shares, in particular through loans, advancing funds, and by granting security.

The draft new CCC goes on to set out the conditions under which a company could finance the acquisition of its own shares, which includes the requirement that financing is provided at market rates and that the shares are acquired by the buyer at a "fair" price.

The most significant requirement is set out in paragraph 4 of Article 345, which in the draft states that a company may finance the acquisition of its own shares if it has established reserve capital designated for this purpose from distributable funds. The amended provisions then set out the procedural requirements for carrying out such a financing, including a shareholders resolution and a management board report setting out the purposes of the financing; confirming that it lies in the interests of the company; setting out the terms of the financing; analyzing the effect of the financing on the financial liquidity of the company; and confirming that the acquisition price of the shares is a "fair" price.

Although it appears that the relaxation of the "Financial Assistance" restrictions will be limited to acquisition targets with healthy balance sheets and won't be applicable to companies in financial distress, the amendments to Article 345 of the CCC nevertheless are a significant change. They should provide buyers of companies and their bankers the ability to leverage the assets of target companies directly without resorting to complex structures which, in addition to the high costs and in many cases significant implementation time, run the risk of running foul of the broad scope of the language of the pre-amendment prohibitions of the CCC.

As has been noted, following the changes, financial assistance will be limited to the amount of the companies' distributable reserves. How this provision will work in practice remains to be seen.

Where the company is lending cash to assist in the purchase of shares, the amount of leverage available is easily calculable. Where, however, assistance is provided by allowing third parties or their financing banks to secure themselves against assets of the company, differences may arise between the value of security on such assets as assessed by financing banks and the book value of such assets in the companies accounts. Where the assessed value of such assets is significantly higher than book value (real estate, for example) there may be opportunities to achieve higher leverage than would prima facie appear to be the case based upon the companies distributable reserves. More analysis will be required over the coming months (including analysis of tax implications) to determine what the prospects are of exploiting differences in book value of assets and assessed value of some asset classes in order to achieve higher leverage than might otherwise seen possible.

Tomasz Ujejski, Partner in the Warsaw and London offices of international law firm Squire, Sanders & Dempsey.

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COMMENT: Polish law change could lead to more vibrant LBO market

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