With the millennium less than 365 days away banks and equity investors funding acquisitions of private companies need to consider what impact Year 2000 issues will have on the ability of target companies and their directors to comply with the financial assistance "whitewash" procedure set out in sections 155-158 of the Companies Act 1985.
The Procedure
The financial assistance whitewash procedure requires that:
Also typically the bank funder will require a letter from the auditors to confirm the target has net assets (the "Net Asset Letter").
The Issue
Auditors need to consider Year 2000 issues for both the Statutory Report and the Net Asset Letter. Recently some accountancy firms have expressed disquiet about issuing the Statutory Report or the Net Asset Letter in the current forms.
The Net Asset Letter is a statement about a company's balance sheet whereas the Statutory Report looks at a company's going concern position. The Auditing Practices Board issued two bulletins in 1998 (1998/1 and 1998/5) giving advice on the balance sheet and going concern statements in the context of the audit of a company which are directly relevant to the whitewash procedure.
The Auditing Practices Board has suggested that where the auditors are concerned that management has not adequately considered and addressed Year 2000 issues the audit report would "need to respond appropriately". In other words the auditors would either have to refuse to sign off on the audited accounts as representing a true and fair view or qualify those accounts.
For the financial assistance whitewash procedure auditors may seek to qualify the Net Asset Letter (if the bank will accept it) but cannot qualify the Statutory Report - their only sanction is to refuse to sign it. However, the Statutory Report imposes a less onerous responsibility on auditors than the audit report. The Statutory Report is merely a statement by the auditors that the directors' declaration is not unreasonable in all the circumstances. It is not a statement as to "true and fair" view.
Conclusions
Year 2000 is firstly a due diligence issue. Obviously some businesses will not have any significant Year 2000 plans because they have very limited exposure to Year 2000 problems. However, if due diligence does show Year 2000 problems which impact on the solvency or viability of a target business this should not be treated as simply a pricing issue. Provided those issues have a balance sheet impact only, then in principle the whitewash procedure could be followed. In any event the Net Asset Letter would undoubtedly be suitably qualified. It would be unusual for a Year 2000 issue to just have a balance sheet impact and not an impact on cash flow. If the cashflow impact is sufficiently serious then the auditors would have to refuse to issue the Statutory Report. In those circumstances the whole deal structure would need to be changed.
The one certainty about Year 2000 is that we cannot change the deadline. As that deadline gets closer auditors will expect a higher degree of preparedness from companies both in the context of the audit and the whitewash procedure. Acquisitions of companies with inadequate Year 2000 plans or poor implementation of plans will inevitably become more difficult. However these problems should not be overstated. In many companies poor plans or poor implementation will probably not threaten overall business solvency or viability. The price might be reduced but the whitewash procedure can still be carried out.
Typical Auditing Issues
Should you write down the value of assets affected by Year 2000?
For further information please contact Gwen Griffiths, e-mail: Click Contact Link , 7 Devonshire Square, Cutlers Gardens, London EC2M 4YH, UK, Tel: + 44 171 655 1000
This article was first published in the Winter 1998/1999 Hammond Suddards Banking Newsletter
The information and opinions contained in this article are provided by Hammond Suddards. They should not be applied to any particular set of facts without appropriate legal or other professional advice.
The Procedure
The financial assistance whitewash procedure requires that:
- the financial assistance being given must not reduce net assets (or that a reduction can be funded from distributable reserves);
- the directors of the target company must provide a statutory declaration that the company can pay its debts as they fall due over the following 12 months; and
- the auditors of the target company have to provide a report to be attached to the directors' declaration that the auditors consider the declaration to be "not unreasonable in all the circumstances" (the "Statutory Report").
Also typically the bank funder will require a letter from the auditors to confirm the target has net assets (the "Net Asset Letter").
The Issue
Auditors need to consider Year 2000 issues for both the Statutory Report and the Net Asset Letter. Recently some accountancy firms have expressed disquiet about issuing the Statutory Report or the Net Asset Letter in the current forms.
The Net Asset Letter is a statement about a company's balance sheet whereas the Statutory Report looks at a company's going concern position. The Auditing Practices Board issued two bulletins in 1998 (1998/1 and 1998/5) giving advice on the balance sheet and going concern statements in the context of the audit of a company which are directly relevant to the whitewash procedure.
The Auditing Practices Board has suggested that where the auditors are concerned that management has not adequately considered and addressed Year 2000 issues the audit report would "need to respond appropriately". In other words the auditors would either have to refuse to sign off on the audited accounts as representing a true and fair view or qualify those accounts.
For the financial assistance whitewash procedure auditors may seek to qualify the Net Asset Letter (if the bank will accept it) but cannot qualify the Statutory Report - their only sanction is to refuse to sign it. However, the Statutory Report imposes a less onerous responsibility on auditors than the audit report. The Statutory Report is merely a statement by the auditors that the directors' declaration is not unreasonable in all the circumstances. It is not a statement as to "true and fair" view.
Conclusions
Year 2000 is firstly a due diligence issue. Obviously some businesses will not have any significant Year 2000 plans because they have very limited exposure to Year 2000 problems. However, if due diligence does show Year 2000 problems which impact on the solvency or viability of a target business this should not be treated as simply a pricing issue. Provided those issues have a balance sheet impact only, then in principle the whitewash procedure could be followed. In any event the Net Asset Letter would undoubtedly be suitably qualified. It would be unusual for a Year 2000 issue to just have a balance sheet impact and not an impact on cash flow. If the cashflow impact is sufficiently serious then the auditors would have to refuse to issue the Statutory Report. In those circumstances the whole deal structure would need to be changed.
The one certainty about Year 2000 is that we cannot change the deadline. As that deadline gets closer auditors will expect a higher degree of preparedness from companies both in the context of the audit and the whitewash procedure. Acquisitions of companies with inadequate Year 2000 plans or poor implementation of plans will inevitably become more difficult. However these problems should not be overstated. In many companies poor plans or poor implementation will probably not threaten overall business solvency or viability. The price might be reduced but the whitewash procedure can still be carried out.
Typical Auditing Issues
Should you write down the value of assets affected by Year 2000?
- Provisioning against the costs of Year 2000 remedial plans
- Should provisions be made for litigation or warranty claims for Year 2000 problems (particularly relevant for computer software companies)?
- If critical business systems or equipment fail because of Year 2000 can they be replaced and how will it be paid for?
- What if key suppliers or customers have Year 2000 problems and how does that impact on cash flow?
For further information please contact Gwen Griffiths, e-mail: Click Contact Link , 7 Devonshire Square, Cutlers Gardens, London EC2M 4YH, UK, Tel: + 44 171 655 1000
This article was first published in the Winter 1998/1999 Hammond Suddards Banking Newsletter
The information and opinions contained in this article are provided by Hammond Suddards. They should not be applied to any particular set of facts without appropriate legal or other professional advice.
