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Norwegian financial assistance rules in connection with leveraged buyouts

June 2009 - Finance. Legal Developments by Wikborg Rein.

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Leveraged buyout activity in European markets has risen to unprecedented levels in recent years. A leveraged buyout, or LBO, shall for the purpose of this letter mean the acquisition of all or a substantial number of the shares in a public or private company (the “Target”) in which a large portion of the purchase price is funded with money borrowed from a bank or other third party. In structuring an LBO, the Target and/or its subsidiaries are frequently required to grant security and guarantees for loans raised by their (future) parent or parent’s holding company (the “Financial Sponsor”) in order to finance the purchase of the shares in the Target. We have below discussed the Norwegian financial assistance rules in connection with LBOs.

NORWEGIAN FINANCIAL ASSISTANCE RULES IN CONNECTION WITH LEVERAGED BUYOUTS

Leveraged buyout activity in European markets has risen to unprecedented levels in recent years. A leveraged buyout, or LBO, shall for the purpose of this letter mean the acquisition of all or a substantial number of the shares in a public or private company (the "Target") in which a large portion of the purchase price is funded with money borrowed from a bank or other third party. In structuring an LBO, the Target and/or its subsidiaries are frequently required to grant security and guarantees for loans raised by their (future) parent or parent's holding company (the "Financial Sponsor") in order to finance the purchase of the shares in the Target. We have below discussed the Norwegian financial assistance rules in connection with LBOs.

The granting of such upstream securities and guarantees will in most cases constitute an illegal financial assistance under Norwegian company law. In our experience, the security package in connection with an LBO of a Norwegian public (ASA) or private (AS) limited liability company (a "Norwegian Company") may differ substantially from the security package typically employed in international LBO transactions. In Norwegian LBO transactions, the banks may in many cases only receive security in the shares of the Target and the shares/assets of the Financial Sponsor, but not the underlying assets of the Target. In addition to such securities, the Financial Sponsor and Target will also in general be subject to certain covenants restricting inter alia their ability to raise further loans, distribute equity, and dispose/collateralise assets/rights. Therefore, when considering an LBO of a Norwegian Company, one should carefully consider the Norwegian prohibition against financial assistance. In this respect it is important to acknowledge, at least for scheduling purposes, that Nordic banks have experience and are comfortable with the typical security package in Norwegian LBO's while many international banks will need to be educated in more detail in order to be comfortable with financing a Norwegian LBO.

The legal framework
The prohibition against financial assistance from the Target in connection with the acquisition of shares in the Target (or its parent company) (the "Prohibition") is stipulated by both the Norwegian Public and Private Limited Liability Companies Acts (together the "Companies Act") section 8-10 (1) of which reads as follows (office translation):

"The company shall not make funds available or give loans or grant security in connection with the acquisition of shares or a right to shares in the company or the company's parent company."

As a starting point and according to its wording, and especially the phrase "make funds available", the Prohibition may be said to cover nearly all types of transactions which imply any financial support from the Target, by way of granting loans, credit facilities, making advance payments, deferring payments, granting guarantees or other security, or by way of distributions, gifts, subscription of equity etc. The Prohibition applies only to financial assistance rendered "in connection with" the acquisition of shares. However, this condition is given a wide interpretation, and may include transactions taking place before, simultaneously with or after the acquisition, provided a reasonable connection is found to exist between the relevant transaction(s) and the acquisition. When considering whether there is a "connection", the timing and background of the potential financial assistance will be of importance.

Notwithstanding the above, it is generally understood that the Prohibition shall in other aspects be subject to a narrow interpretation. However, it has proven in practice to be challenging to determine with certainty the scope of the Prohibition due to limited case law and other relevant legal sources of determinant effect on this particular issue. We will below discuss the most practical limitations of the Prohibition in respect of LBOs of Norwegian Companies and certain debt push-down strategies.

Certain limitations to the Prohibition/Debt push-down strategies
In most LBOs the Target's existing financing will be refinanced in connection with the LBO. The Target's debt will often be refinanced together with the financing of the Financial Sponsor and the Target's debt may also in certain cases be increased substantially post the LBO in order to finance legal distributions to the Financial Sponsor. This is not deemed to be in conflict with the Prohibition provided that the refinancing is, after an overall assessment, in the best interest of the Target. The theoretical question is whether the Target is better off with a financing on a standalone basis or whether the Target benefits from the refinancing (or at least does not have any disadvantages of the refinancing).

Further, an important limitation to the Prohibition is that legal distributions of equity by the Target (i.e. distributions made in accordance with the Companies Act) are allowed. Therefore, the Target may distribute dividends or resolve to decrease its share capital or share premium through distributions to its shareholders in connection with an LBO and thereby enabling the Financial Sponsor to (partly) repay its acquisition financing.

The Prohibition only applies to acquisitions of shares in Norwegian Companies. Therefore, if the buyout is structured as an asset acquisition rather than a share acquisition, the Prohibition does not apply. Further, if the Target has non-Norwegian subsidiaries, these subsidiaries will in general not be subject to the Prohibition. Therefore, a US subsidiary of the Target may, subject to the law of its jurisdiction of incorporation, in general provide security in respect of the acquisition financing of the Target. A Norwegian subsidiary of the Target will on the other hand not have this opportunity.

In contrast to IFRS, the general rule under the Norwegian GAAP is that the assets of a Norwegian Company shall be recorded at their relevant acquisition cost, and that these carrying values may not be written up to their actual values. We have previously been advised by some of the major accounting firms in Norway that if the Target transfers an asset (A) to another non-Norwegian subsidiary (B), and the purchase price for A is the market value of A, and 25 percent of the purchase price is settled by issuance of new shares in B and minimum 75 percent of the purchase price is settled in cash, by raising third party debt in B, the Target may record this intra-group sale as a transaction for accounting purpose under NGAAP. If there is a substantial difference between the carrying value of A and its actual value, the intragroup sale will consequently create distributable reserves in the Target once the Target's financial accounts for the year the transaction is completed has been duly approved. The Financial Sponsor will therefore, by completing this intragroup sale, be able to push down debt in the amount of up to 75 percent of the unrecorded values in the Target. This will typically be relevant for companies with a market value substantial above their book value.

In connection with statutory mergers in accordance with the Companies Act, the acquiring company in the merger takes over all the assets, rights and obligations of the assigning company as a whole, and the assigning company is dissolved upon completion of the merger. If a merger takes place between the Financial Sponsor and the Target following completion of an LBO, the assets of the Target and the acquisition debt of the Financial Sponsor will be in the same company, which will satisfy the lender's need for security. However, if such merger is deemed to occur "in connection with" with the LBO, the merger will generally be in conflict with the Prohibition.

Even though the Target may to a certain extent provide financial assistance in connection with an LBO without breaching the Prohibition, such financial assistance may violate the requirement for equal treatment of the shareholders of the Target and the Companies Act's prohibition against abuse of authority. If the Target will have minority shareholders post completion of an LBO, upstream guarantees will therefore normally not be feasible.


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Andreas Kildal
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