Are there any issues that lenders should be aware of when requesting guarantees (for example, financial assistance or lack of corporate benefit)?

Lending & Secured Finance

Croatia Small Flag Croatia

There are some restrictions against providing guarantees and/or security to support borrowings incurred for the purposes of acquiring, directly or indirectly, shares of the company, shares of any company which, directly or indirectly, owns shares in that company, or shares in a related company, which restrictions are described in more detail under question 12.

Even when the provision of an advance payment, loan or security for the acquisition of shares is permitted, the following conditions have to be met:

  1. the market price of shares must be fair;
  2. approval of the general meeting of shareholders must be obtained;
  3. the financial assistance cannot lead to a decrease of the company's net assets under the legally required level.

Czech Republic Small Flag Czech Republic

For financial assistance, please see answer No. 10 above. Guarantees are also subject to corporate approval process which shall be duly evidenced to the other party to verify its compliance. Again, potential conflict of interest of directors who often hold multiple positions within a group needs to be assessed.

Finland Small Flag Finland

Finnish law includes rules on financial assistance, corporate benefit and unlawful distribution of assets.

  1. Financial assistance

    Finnish companies are prohibited from providing loans, funds or security for the purpose of the acquisition of shares of the company or of any of its direct or indirect parent companies. This prohibition applies both before and after the acquisition. Therefore, also any re-financing of acquisition debt is generally considered to fall within the scope of the financial assistance prohibition. There are no set whitewash procedures available in Finland or specific time limits after which the limitation would cease to apply.

    Accordingly, the relevant loan and security documentation typically include an appropriate Finnish law limitation clause limiting the liability and obligations of the Finnish companies re financial assistance. However, mergers are fairly commonly used as a post-acquisition solution to eliminate financial assistance concerns, where the group structure is suitable for this.

  2. Corporate benefit

    All arrangements entered into by a Finnish company must provide “adequate” corporate benefit for the relevant Finnish company. Naturally, this is something that cannot be mathematically measured and since there is no universal definition for corporate benefit under Finnish law, the matter needs to be assessed on a case by case basis taking into account the unique properties of each company, the then current circumstances and information available to the company/Board of Directors. Accordingly, it is the duty of the Board of Directors to satisfy itself that such adequate corporate benefit (e.g. in the form of the company itself being able to draw loans under the arrangement, or to reduce the borrowing costs or similar) is, indeed, available. Lenders generally require board and shareholder resolutions evidencing the corporate benefit assessment made by the Board of Directors.
  3. Unlawful distribution of a company’s assets

    The concept of unlawful distribution of a company’s assets included in the Companies Act entails in essence that any acts that diminish the company’s assets or increase its debts without a business rationale. Since the concept of unlawful distribution of a company’s assets is linked to the concept of business rationale, it is much entwined with the concept of corporate benefit, albeit they are two separate issues. Consequently, provided that a Finnish company receives adequate corporate benefit from entering into the contemplated transaction, it is less likely that the rules on unlawful distribution of assets would be breached either. An appropriate limitation language is typically included to address the unlawful distribution of a company’s assets.

Germany Small Flag Germany

German law provides for a more general corporate benefit test, i.e. when granting security this must be in the interest of the relevant company. However, this is not a strict corporate benefit test (as known in other jurisdictions) which follows certain formal requirements on resolution and documentation of certain measures and their benefit for the company.

Spain Small Flag Spain

There is no corporate benefit requirement in Spanish law. Nevertheless the application of certain general principles of Spanish law aimed at protecting shareholders, employees or other creditors may affect the actions of a company. For example:

- minority shareholders may challenge a transaction on the basis that the directors were acting against the law (e.g., abuse of the controlling position (abuso de derecho)) or negligently;

- a company must act in good faith; and

- on insolvency of the chargor, if there are insufficient funds to satisfy all creditors, creditors could challenge certain transfers or security (see answer to question 24 below).

The financial assistance prohibition states that a company may not advance payments, grant credit or loans, give any kind of security or personal guarantee or provide financial assistance for the acquisition of its own shares or: (i) shares in its controlling companies by third parties (in the case of a SA); or (ii) shares in any of its group companies (in the case of a SL).

Philippines Small Flag Philippines

The authority of the requested company should be confirmed from its articles of incorporation. As discussed in item 10, the requested undertaking which does not only lack benefit, but is actually disadvantageous to the company has been found by the SEC to be outside the power of the company and thus, an invalid act of the company.

Sweden Small Flag Sweden

Lenders should be aware of that a guarantee or security provided by a Swedish limited liability company (Sw: aktiebolag) for obligations of any person that is not a wholly owned subsidiary of it may be considered as a value transfer unless the guarantor or pledgor receive consideration on market terms for its undertakings or that otherwise sufficient corporate benefit accrues to it. Such value transfer is unlawful if and to the extent it, at the time when the guarantee or security is granted, impairs the restricted equity of the company providing the guarantee or security, as per its most recently adopted balance sheet (taking any subsequent adjustments into account).

An unlawful value transfer must be reimbursed by the recipient (e.g. a lender) if the company that provided the guarantee or security shows that the recipient knew, or ought to have known, that the guarantee or security constituted a value transfer.

It should also be noted that a Swedish limited liability company may not provide security or a guarantee as security for a loan raised by certain closely related parties from a third party (subject to certain exceptions, including if such closely related party is part of the same group as the security provider).

Turkey Small Flag Turkey

Please refer to our responses to Question 10 and Question 12.

United States Small Flag United States

Intercorporate guarantees may be challenged as fraudulent transfers under §548 of the United States Bankruptcy Code, or under state law, whose relevant statutes are, in most cases, modeled after the Uniform Fraudulent Transfer Act. Such challenges are generally made either by a trustee or estate representative in bankruptcy, although individual creditors can bring such claims. In the context of challenges to intercorporate guarantees, these are typically based on a theory of constructive fraud, for which the basic elements are essentially the same under both the Bankruptcy Code and state law. Generally speaking, to prevail on such a claim, the creditor or a trustee in bankruptcy must demonstrate that (1) the guarantor received less than “reasonably equivalent value” in exchange for the making of the guarantee, and (2) that the guarantor either (a) was insolvent or became insolvent as the result of the making of the guarantee (or pledging of related collateral), (b) was engaged or about to engage in business or a transaction for which any property remaining with the guarantor was an unreasonably small capital, or (c) intended to incur, or believed that it would incur, debts beyond its ability to pay as they mature.

Typically, lenders do not face significant constructive fraudulent transfer issues in the context of so-called 'downstream guarantee' where the parent company guarantees the obligations of a direct or indirect subsidiary. In that context, the parent directly benefits through its equity interests from any value given to the subsidiary, so the 'reasonably equivalent value' prong of any fraudulent transfer claim is met.

On the other hand, in underwriting a loan, a lender always has to consider potential fraudulent transfer risks if a subsidiary or an affiliate of the borrower whose stock is owned by the same direct or indirect parent is delivering the guarantee. These types of guarantees (known as upstream and cross-stream guarantees) have the potential to be problematic because the subsidiary or affiliate is taking on a significant liability under the guarantee, but may not receive the proceeds of the loan or other clear, direct benefits. As a result, a creditor or trustee is likely to claim that there was not “reasonably equivalent value” and the incurrence of the guarantee rendered the subsidiary or affiliate insolvent.

Switzerland Small Flag Switzerland

The granting of a guarantee, indemnity or security interest for obligations of a Swiss company’s (direct or indirect) shareholder (upstream) or affiliate or subsidiary of such (direct or indirect) shareholder (cross-stream) is subject to the following limitations:

a. it must be allowed by the Swiss company’s articles of incorporation which shall include in its purpose group support and financial assistance;

b. it must be in the interest of the Swiss company (i.e. dealing at arm’s length, service against adequate consideration, significance of the security interest compared to the other assets of the subsidiary, financial capacity of the parent company or the affiliates to repay the loan, etc.);

c. it shall not constitute a repayment of the restricted equity (i.e. share capital and statutory reserves) of the Swiss company or an unjustifiable payment of benefits or contributions; and

d. otherwise, in case of any doubt, the amount of the guarantee, indemnity or security interest shall be limited to the freely distributable equity (i.e. equity available for distribution as dividends) of the Swiss company and the granting of such guarantee, indemnity or security interest shall be approved by the Swiss company’s shareholders’ meeting.

United Kingdom Small Flag United Kingdom

(i) Financial assistance
Please see paragraph 12 below

(ii) Corporate benefit
The directors of a company incorporated in the United Kingdom are under a duty to act in what they consider to be the best interests of that company. Where that company is being asked/required to provide security or guarantees in relation to another company's obligations, it will not be enough for them to show that there is a benefit to the group as a whole, such benefit must be in relation to that specific company. The directors of a company being asked to provide security or guarantees in relation to the obligations of another company will have to weigh up the risk of giving that security/guarantee against the actual or potential benefits to the company. The higher the risk, the greater the corporate benefit will need to be. It is considered much easier for the directors of a company being asked to give a downstream security/guarantee (i.e. from any company above the borrowing company in the corporate chain, such as the borrower’s direct parent) to show corporate benefit as the parent company would hope to benefit from higher dividend payments (directly or indirectly), an increased value in the shares of the subsidiary and an increased profitability of the subsidiary company. It is much more difficult for a subsidiary or sister company to show corporate benefit for upstream or cross-stream security or a guarantee i.e. security or a guarantee in relation to its parent's or sister company's obligations (see below).

The lender's lawyers should ensure that consideration of commercial benefit to the company is covered in its board minutes approving the transaction. In addition, often a resolution of the shareholders of the company giving the guarantee / third party security is sought by lender's counsel to avoid those shareholders later attempting to challenge the guarantee/security on the grounds of lack of corporate benefit. It is considered that security may still be given even where there is insufficient corporate benefit if the shareholders' unanimous approval is obtained, although if the company is insolvent or becomes insolvent because of the transaction such a resolution will not necessarily help the secured creditor against challenge by other creditors of the company granting the security.

(iii) Capacity
A guarantee may be void under common law if the guarantor lacked capacity at the time of its entry into the guarantee. In relation to a corporate guarantor, the constitutional documents of the relevant corporate entity should be reviewed to check that it has the power and capacity to give a guarantee or enter into an indemnity. The relevant documents to be reviewed will depend upon the type of corporate entity. In relation to guarantors who are individuals, there is a presumption that all individuals aged 16 or over have capacity to enter into a contract, however, a guarantee would become voidable if the guarantor was to claim and prove that they lacked capacity (which may be for e.g. legal, physical or mental reasons) at the time the guarantee was entered into.

(iv) Overseas guarantors
In relation to guarantors who are resident in jurisdictions outside England and Wales, local law advice should always be taken to ensure that the enforcement of an English law guarantee would be recognised in that jurisdiction and also to ensure that any local law issues are taken into account.

(v) Enforceability
The English courts have traditionally been protective of guarantors and other sureties and have evolved a number of doctrines to protect them. While it is common in guarantees and third party securities governed by English law to include provisions which counteract the effect of these doctrines (for example, without limitation, by providing that the liability of the guarantor may be more extensive than that of the principal debtor) in the absence of case law authority it is not possible to establish definitively whether or not such clauses are effective although the general approach of the English courts is to uphold such provisions in commercial transactions involving companies.

(vi) Insolvency of guarantor
Guarantees may be at risk of being set aside under English insolvency law if the guarantee was granted by a company with a certain period of time prior to the onset of insolvency. This would be the case, for example, if the company giving the guarantee received considerably less consideration, and as such, the transaction was at an undervalue. For such a transaction to be set aside, certain statutory criteria would have to be met, including that the guarantee was given within six months (or two years for connected parties) of the onset of insolvency of the affected party. Guarantees may also be challenged on other grounds relating to insolvency. Note that where a guarantee is given to a related company, the circumstances in which it can be set aside are far wider and, in particular, there is no requirement in these circumstances that the guarantor was insolvent at the time the guarantee was given.

(vii) Existing contractual restrictions on giving guarantee
Steps should be taken to ensure that the guarantor has not granted an undertaking to another creditor which restricts that guarantor’s ability to give guarantees in favour of another creditor.

(viii) Form
English law guarantees must be in writing and signed by or on behalf of the guarantor. They are normally entered into by way of deed to deal with any potential issues around consideration (the passing of valuable consideration between the parties being one of the elements required to form a valid contract under English law) as consideration is not a requirement where the parties are entering into a formal deed rather than a simple contract.

(ix) Duty of disclosure of lender to guarantor
Generally, a lender who is due to become the beneficiary of a guarantee is under no duty to disclose any material facts to the prospective guarantor.

(x) Undue influence, duress and misrepresentation
A guarantee is voidable if it is entered into under duress or procured by misrepresentation or undue influence of the beneficiary of the guarantee. To avoid these issues, a lender should direct the guarantor to take independent legal advice and obtain confirmation from the relevant solicitor that such advice has been given to the guarantor.

Jersey Small Flag Jersey

Corporate Benefit. Corporate Benefit. The directors of a Jersey company granting a guarantee must be satisfied that the granting of the guarantee does not give rise to corporate benefit issues and the entry into the guarantee is in the best interests of the company. If there is no discernible corporate benefit to the company, shareholder approval or ratification should be obtained in accordance with the CJL.

Droit de Division and Droit de Discussion. Any guarantee entered into by a Jersey company should include express wording waiving two Jersey customary law procedural rights known as the droit de division and the droit de discussion. These rights may qualify the enforceability of the guarantee against the guarantor. Under the droit de division, a co-obligor may require the joint obligations of the various co-obligors to be divided equally so that they become several obligations only of each co-obligor. Under the droit de discussion, a guarantor may require the creditor to exhaust its remedies against the principal debtor (the person whose obligations have been guaranteed) before seeking recourse from the guarantor.

Distribution. Where a Jersey company provides a guarantee in respect of the obligations of its parent, consideration would be given as to whether such a guarantee could be deemed a distribution. Under the CJL, a distribution includes a distribution of any assets of a company to its members. Should the entry into a guarantee be deemed to be a distribution, certain requirements of the CJL will need to be complied with.

Financial Assistance. Financial assistance has been abolished in Jersey. The directors of a Jersey company granting a guarantee must be satisfied that the granting of the guarantee does not give rise to corporate benefit issues and the entry into the guarantee is in the best interests of the company. If there is no discernible corporate benefit to the company, shareholder approval or ratification should be obtained in accordance with the CJL.

Droit de Division and Droit de Discussion. Any guarantee entered into by a Jersey company should include express wording waiving two Jersey customary law procedural rights known as the droit de division and the droit de discussion. These rights may qualify the enforceability of the guarantee against the guarantor. Under the droit de division, a co-obligor may require the joint obligations of the various co-obligors to be divided equally so that they become several obligations only of each co-obligor. Under the droit de discussion, a guarantor may require the creditor to exhaust its remedies against the principal debtor (the person whose obligations have been guaranteed) before seeking recourse from the guarantor.

Distribution. Where a Jersey company provides a guarantee in respect of the obligations of its parent, consideration would be given as to whether such a guarantee could be deemed a distribution. Under the CJL, a distribution includes a distribution of any assets of a company to its members. Should the entry into a guarantee be deemed to be a distribution, certain requirements of the CJL will need to be complied with.

Financial Assistance. Financial assistance has been abolished in Jersey.

Hong Kong Small Flag Hong Kong

Financial Assistance

As a general rule, a Hong Kong company or any of its Hong Kong-incorporated subsidiaries cannot directly or indirectly provide financial assistance:

  • for any acquisition of its shares; or
  • to reduce or discharge any liability incurred for such acquisition (there being no time limit for which refinancing takes place).

The meaning of the term "financial assistance" includes financial assistance given by way of loan, transfer of rights in respect of loans, guarantee, security, indemnity, release, waiver, gift or other financial assistance if the net assets of the company are reduced to a material extent by the giving of the assistance or if the company has no net assets. Under the CO, companies (whether listed or unlisted) are allowed to provide financial assistance to another party to acquire the company's own shares or the shares of its Hong Kong incorporated holding company, if it satisfies the solvency test and one of the following conditions:

  • if the financial assistance, and all other financial assistance previously given and not repaid, is in aggregate not more than 5% of the paid up share capital and reserves (i.e. shareholders funds) (s283 CO);
  • if the financial assistance is approved by written resolution of all members of the company (s284 CO); or
  • if the financial assistance is approved by an ordinary resolution (s285 CO), and no court order is pending or has been made restraining the giving of the assistance on the application of shareholders holding at least 5% of the total voting rights or members representing at least 5% of the members of the company (ss286 to 288 CO).

More importantly, the CO provides that, where a company gives financial assistance in contravention of the CO, the financial assistance and any contract or transaction connected with it will not be invalidated solely because of that contravention (s276 CO). Although commentaries argue what is meant by the word "solely", it seems that the rights of third parties, usually the lenders, are not affected by the restriction on financial assistance. However, generally, lenders would not ignore these issues and will require that the relevant parties obtain necessary approvals.

Corporate Authority
Companies must act in accordance with their constitutional documents (articles of association). Under the CO, a Hong Kong-incorporated company is required to have articles of association, but no longer memorandum of association (which traditionally contained a company's objects clause) since amendments under the CO came into force on 3 March 2014. For existing companies, the provisions of its memorandum are considered to be provisions of it articles. If a company either elects not to have an objects clause or removes it, the company's powers are unfettered: it will have the capacity, rights, powers and privileges of a natural person. However, if a company does state its objects in its articles (although it is not obliged to do so), it must not carry on a business which is not authorised by its articles.

If a company does an act in breach of any objects clause it may have in its articles or contrary to an express exclusion or modification in its articles, that act will not be invalid just because of the breach (s116(5) CO). There must be some other "negative factor" present (e.g. the third party was dealing with the company in bad faith or was actually aware that the act was in breach of the company's memorandum and articles) before the act will be invalid, as the breach is not then the only problem. s116(5) CO should be read in conjunction with s120 CO, which provides that a person is not to be regarded as having notice of the articles, return or resolution filed with the Companies Registry merely because they are available for inspection at the Companies Registry. The difficulty with both these sections is the inclusion of the words "only" (s116(5) CO) and "merely" (s120 CO). As these sections have not been tested by the Hong Kong courts, their exact effect is unclear. Presumably those acting in bad faith or who actually knew of a breach would not be protected by these provisions. But it is unclear about those who would in the normal course of their business carry out a company search to check on the capacity of their contractual counterparties, but for some reason omitted to do so. Possibly the failure to carry out a search or check which a reasonable person in the same position as the third party would have carried out (especially in suspicious circumstances) will be treated as a "negative factor" making the company's act invalid, as under the old law. Hence, lenders should always carry out company searches and check to ensure there are requisite powers to enter into the proposed transaction.

Corporate Benefit and Directors' Duties

Directors of a Hong Kong-incorporated company have a fiduciary duty to act in what they believe is for the commercial benefit of the company, and not just in the interests of the corporate group as a whole. Determining this is a matter of fact and directors are advised to seek shareholders' approval in uncertain circumstances. This duty is particularly significant in relation to upstream guarantee, cross guarantee and third party security transactions. In order to negate potential shareholder claims that there was no corporate benefit, it is common to require the company to pass a shareholder resolution (in addition to a board resolution) confirming the transaction irrespective of whether the company derived any commercial or other benefit (sufficient or otherwise) from the transaction.

Loans to directors

Subject to a few exceptions (such as, transactions among group companies and a loan, quasi-loan and credit transaction of value not exceeding 5% of the net assets or called-up share capital of the company), a Hong Kong company cannot make loans to, or guarantee or provide security for the obligations of, its directors or persons connected to, or controlled by, the directors of such Hong Kong company, without prior shareholders' approval obtained in accordance with a prescribed procedure (in cases involving public companies, the approval of disinterested shareholders is needed).

Breach of this prohibition may affect the enforceability of the underlying loan agreement, guarantee or security document.

Austria Small Flag Austria

A guarantee is a non-accessory (nicht akzessorisch) security, meaning that it does not dependent on the existence and validity of the underlying agreement. Lenders have to be aware that the declaration of the guarantor must be in writing, otherwise the guarantee is not valid under Austrian law.

Further, capital maintenance rules could be violated if another group company, for instance a subsidiary company, acts as a guarantor for the holding company. For further information regarding the violation of capital maintenance rules, please refer to question 10 above.

Mexico Small Flag Mexico

Lenders may be exposed to a number of situations when acting in such capacity, depending on the credit structure, the borrower's credit worthiness, sector, industry and/or project.

When structuring a transaction, lenders should take in consideration, inter alia, if the borrower/debtor/guarantor is a Mexican or foreign person (individual or legal entity), in order to determine the documents and information required to accept any security interest or guarantee, the credit worthiness evidenced in a credit report issued by the entities authorized by the competent authorities.

Moreover, in any case, if the borrower/debtor/guarantor is a legal entity, a lender should conduct due diligence on 1) indebtedness, leverage ratios, intercompany arrangements and any other solvency-related relation, and 2) organizational documents and corporate authorization expressly approving the financing transactions and documentation.

In requesting security interests or guarantees from such persons, lenders should be mindful of the importance of timely registration and/or recordation of security interests and guarantees with a state public registries of property and the RUG.

Bosnia & Herzegovina Small Flag Bosnia & Herzegovina

The lenders should be aware of the financial assistance rules and rules of corporate authorizations when requesting guarantees from local companies. Assistance by local experts is strongly recommended for all foreign lenders in structuring any guarantees or security in any form.

Updated: June 5, 2019