Debt Pushdown: A Means to Avoid Financial Assistance?

For acquisitions in Nigeria, a key issue that resonates particularly in providing sufficient comfort to lenders in financing acquisitions is the concern of Financial Assistance. Nigerian law prohibits taking of security over the assets of a Target Company or using the Target Company’s income to pay off the acquisition debt as this will constitute Financial Assistance. A prohibition, which if violated, will render any such security obtained unenforceable.

In a typical acquisition transaction, investors usually setup a new company (Special Purpose Vehicle or “SPV”) as the Acquisition Vehicle (“Purchaser”) and often finance the acquisition with a combination of debt and equity using the SPV. Depending on the nature of the Target Company, the loan is often on a limited or non-recourse basis (which in principle excludes any liability risk for the investors). To ensure repayment of the debt, the lenders financing such acquisition generally expect repayment of the loan and applicable interest to be generated from the Target Company’s operating cash flows, which as opposed to the Acquisition Vehicle, conducts an operating business.

However, repayment of an acquisition debt by a Target Company falls under the category of Financial Assistance, which is prohibited under Nigerian law. To circumvent this prohibition, a number of debt pushdown structures have been developed and used in various countries such as USA, Netherlands, UK, Switzerland and China.[1]

This article seeks to explore how debt pushdown can be used to enable lenders take security over assets of the Target Company and use its revenues as a direct source of repayment of Acquisition Debt without violating the Financial Assistance provisions under Nigerian Company Law.

Financial Assistance is defined to include “a gift, guarantee, security or indemnity, loan, any form of credit and any financial assistance given by a company, the net assets of which are reduced to a material extent or which has no net assets”.[2]

Section 159 (2) (a) of the Companies and Allied Matters Act (CAMA) 2004provides that “where a person is acquiring or is proposing to acquire shares in a company, it shall not be lawful for the company or any of its subsidiaries to give financial assistance directly or indirectly for the purpose of that acquisition before or at the same time as the acquisition takes place.” Given the definition of Financial Assistance, granting security over the assets of the Target Company to lenders would constitute a Financial Assistance by the Target Company.

In addition, section 159 (2) (b) of CAMA provides that “where a person has acquired shares in a company and any liability has been incurred (by that or any other person), for the purpose of this acquisition, it shall not be lawful for the company or any of its subsidiaries to give financial assistance directly or indirectly for the purpose of reducing or discharging the liability so incurred”.

Therefore, Nigerian law makes it unlawful for a Target Company or its subsidiaries to provide financial assistance to a Purchaser who is acquiring its shares. Equally, the Target Company cannot provide financial assistance to reduce or discharge any Acquisition Debt incurred by the Purchaser during the share purchase. Therefore, where an acquisition by way of share purchase is to be financed partly or wholly through debt, the lenders will neither be able to access the cash-flow of the Target Company as a direct source of repayment, nor take security over its assets as doing so will constitute financial assistance.

The problem this creates for lenders and investors, particularly where the financing is on non-recourse basis, is that repayment of the Acquisition Debt and interest can only be generated from dividends paid on the acquired shares. Under Nigerian Law, dividends can only be paid out of distributable profits (section 379(5) CAMA) and based on the recommendation of company directors (section 379 CAMA). This means that where the directors fail to recommend dividends, or dividends paid are insufficient to service the Debt, or the Target Company has no distributable profits (which can only be determined after payment of taxes and other deductions), the Purchaser will be unable to service its debts. Whereas, if the lenders have access to the cash-flow of the Target Company, the interest and principal repayments of the Acquisition Debt would be payable directly from the operating cash flows of the Target Company before payment of taxes and other deductions.

In terms of security for the financing, although the lenders can take an all assets debenture over the assets of the Acquisition Vehicle and a charge over the acquired shares, their security will only rank over the assets of the Acquisition Vehicle, and not over the assets of the Target Company.

From the Purchaser’s standpoint, the inability of the lenders to obtain security over the Target Company’s assets and secure repayments directly from the Target Company’s cash-flow essentially affects the bankability of the acquisition as lenders may not have sufficient comfort to finance the acquisition. This has created the need for a financing structure that will achieve this without violating the legal limitations of financial assistance.

Debt Pushdown is an accounting practice used in acquisitions whereby debt incurred by the Purchaser during the acquisition of a Target Company (Acquisition Debt) is placed on the books of the Target Company thereby “pushing it down” from the Purchaser to the Target Company’s balance sheet. It is a structure commonly used in International Mergers and Acquisition (M&As) transactions, and is achieved using different financing structures depending on the laws of the applicable jurisdiction. Typically, this is done where it is intended that the Target Company’s assets will be used as security and its income will be used as the source of repayment of the Purchaser’s Acquisition Debt.

The most popular financing structure used to achieve debt pushdown in International M&As is a Post-acquisition Merger. This is done by creating a local Acquisition Vehicle in the same jurisdiction as the Target Company. The Acquisition Vehicle is then financed through debt to acquire the Target Company and upon completion of the acquisition, the Target is merged with Acquisition Vehicle.[3]

Another financing structure commonly used for debt pushdown is up-streaming the operational debt of the Target Company to the Acquisition Vehicle (“debt upstream”)[4]. Under this structure, the Target Company obtains a loan in similar amount to the acquisition debt from the same lender to the Acquisition Vehicle. The proceeds of the loan are then up-streamed as an inter-company loan to the Acquisition Vehicle to pay off the acquisition debt. In obtaining the loan from the acquisition lender, the Target Company is able to grant security over its assets and use its cash flow as a source of repayment for the loan. However, this structure is only used where the Target is a private company and is situated in a jurisdiction where financial assistance is not prohibited for private companies.[5]

The use of “debt upstream” structure will not be feasible in Nigeria as it will be in violation of the financial assistance principle because the debt is incurred by the Target Company to discharge the Acquisition debt which is prohibited under s.159 (2) (b) of CAMA. However, the use of Post-acquisition merger may be feasible under Nigerian law and is further considered below.

A post-acquisition merger entails merging the Target Company with the Acquisition Vehicle after completion of the Acquisition. This will effectively merge the balance sheet of the two companies and the Acquisition Debt being an existing senior debt of the Acquisition Vehicle will become a senior debt of the merged entity. Therefore, the revenues generated from the assets of the merged entity can be used to service the Acquisition Debt. Post-acquisition mergers are commonly used in Europe and USA, primarily for tax reasons, but also as a means of providing lenders with adequate comfort to finance acquisitions without violating the financial assistance principle.

It is submitted that a Post-acquisition merger will not be in violation of the prohibition of financial assistance under Nigerian law because the two entities will be merged and there would be no distinction between the Target Company and Acquisition Company. Therefore, the merged entity can legally assume the acquisition Debt. Moreover, financial assistance under CAMA applies to acquisition of shares in a company, not to mergers.

However, to successfully implement a post-acquisition merger, the following issues have to be considered and resolved:

a.     Requirement of SEC approval of the merger: Mergers in Nigeria are categorised into Small, Intermediate and Large mergers. This is relevant as it determines whether a notification to, and approval of the Securities and Exchange Commission (SEC) is required. According to the 2013 SEC Rules[6], the thresholds for small merger is below one billion naira (N1,000,000,000.00) of either combined assets or turnover of the merging entities, the threshold of intermediate merger is between one billion naira (N1,000,000,000.00) and five billion naira (N5,000,000,000.00), while the threshold for a large merger is above five billion naira (N5,000,000,000.00). Notification and approval of SEC will only be required for intermediate and large mergers therefore where the mergers fall under the category of a small merger SEC approval will not be required.

b.     Procedure and timeline for completion of a merger in Nigeria: The procedural steps for obtaining approval for an intermediate and large merger includes the following:

   i.       filing of a pre-merger notification to SEC for evaluation;

   ii.      filing of an application in the Federal High Court seeking an order to convene a court ordered meeting;

   iii.     filing of a formal application to SEC for approval of merger following a resolution of shareholder at the court ordered meetings; and

   iv.     compliance with post-approval requirements.

The timeline for completion of the listed steps may take more than six months. This should be taken into consideration when concluding terms for the financing with the lenders and a moratorium period covering the anticipated timeline for completion of the merger (i.e. six months or more) should be negotiated particularly where the Purchaser may be unable to service the Acquisition Debt until completion of the merger (i.e. when the debt is pushed down).

c.     Lenders Comfort/security pre-debt pushdown: Since the debt can only be pushed down after completion of the acquisition and the merger, an issue that may arise is the form of comfort that will be given to lenders before the acquisition as some lenders may require this. An option that may be available to the Purchaser is for its investors to give the lenders some form of credit enhancement (i.e. other forms of security or a guarantee) which can be documented to lapse after the completion of the merger and the debt pushdown.

d.     Impact on transaction documents or constitutive documents of the Target Company: Transaction documents such as Shareholders Agreements and Share Sale Agreements should be drafted or reviewed carefully to ensure that the merger will not violate any of its terms. It is also important to ensure that the memorandum and articles of association of the Target Company do not prohibit or restrict the company from entering into a merger. However, if such restriction exists, the constitutive documents can be amended before the merger.

Debt pushdown is a way out of financial assistance because if properly structured, it can provide the highest level of comfort to acquisition lenders whilst not violating the principle of financial assistance. In addition, using a post-acquisition merger for debt pushdown will allow an acquisition lender to obtain security over the assets, and generate repayments from cash flows of the merged entity (which includes the Target Company) without flouting the financial assistance principle because once the merger is completed, financial assistance will no longer apply.

Furthermore, the use of debt pushdown will also encourage an increase in participation of foreign lenders in acquisition transactions in Nigeria as foreign lenders are usually able to obtain security and repayments directly from a Target Company in other jurisdictions[7]where debt pushdown is frequently employed.

However, since debt can only be pushed down after completion of an acquisition, a difficulty that the Purchaser may encounter is providing adequate security to the lenders, where required, prior to the acquisition. An option available to the Purchaser is provision of temporary credit enhancement but this may not be advantageous to a Purchaser seeking to obtain finance on a non-recourse basis (no recourse to its investors).

As demonstrated above, the prohibition of financial assistance has wide reaching impact in financing acquisitions in Nigeria. The need for debt pushdown structures in Nigeria is premised on its ability to provide the highest level of comfort to lenders without flouting financial assistance provisions.

In countries such as the United Kingdom, steps have been taken to restrict the impact of financial assistance prohibition by abolishing its application to private companies’ thereby simplifying acquisition transactions for private companies and making acquisitions more bankable.

However, pending when similar steps are taken in Nigeria, a structure such as the debt push down by post-acquisition merger is an attractive option which can be explored and which would strengthen the bankability of acquisition transactions without flouting the financial assistance prohibition.