Self-financing – when is it legal and when is it unlawful?

What does self-financing mean?

Self-financing means that a Danish company directly or indirectly advances funds, grants loans or provides security for a third party’s acquisition of shares in the company or in its parent company. In general, self-financing is prohibited.

The term “third party” includes any person other than the company itself. Therefore, the term “self-financing” also includes financial support to an existing shareholder or to the companies’ parent company for the purpose of acquiring shares in the company or its parent company.

In what situations should you pay attention to the rules?

It is often not in situations where companies directly support third parties to acquire shares in the company or its parent company that the rules on self-financing are forgotten. However, in situations where the support is indirect, many companies forget the rules, and this often leads to illegal self-financing.

Often the self-financing rules are violated in connection with loans to parent companies, which are legal under certain conditions, read more here. If the parent company has financed the acquisition of the subsidiary, a loan from the subsidiary to the parent company is very likely to be covered by the rules on self-financing, as the parent company will be able to use this loan to settle the loan taken out by the parent company to finance the acquisition of the subsidiary. As soon as the loan used to finance the acquisition of the subsidiary is paid, a loan from the subsidiary to the parent company will no longer be subject to the rules on self-financing.

After the company has been acquired, the same problem may arise if the company forms part of a cash pool scheme with the parent company and eventual other group companies, where the company potentially makes available funds to the parent company, which the parent company can use to pay off the debt that the acquisition was financed by. It is important to note that the problem of self-financing occurs only if the purchase of the company is loan-financed. If the parent company has purchased the company with own funds or the loan has been settled by the time of entering the cash pool scheme, the rules on self-financing will not apply.

A third situation could be that a company is acquired and then merged with the buyer company. If the purchase is loan-financed, the merger may constitute self-financing.

When is self-financing legal?

Notwithstanding the general prohibition on self-financing, it is legal for a company to provide indirect or direct financial support for the purpose of acquiring shares in the company or its parent company if the following conditions are met:

Firstly, the central governing body of the company must ensure that any third party receiving financial assistance is credit rated.

Secondly, the decision to provide financial support for the purpose of self-financing must be approved by the general meeting by the same majority of votes that is required to amend the articles of association and must be registered in the Danish CVR-register.

On the general meeting, the companies’ governing body, meaning the board of directors or the board of management, depending on whether the company has a board of directors, must present a written report to the general meeting, including information about:

• the reason for the proposed financial assistance;
• the company's interest in entering into the transaction;
• the conditions on which the transaction is entered into;
• the consequences of the transaction for the company's liquidity and solvency; and
• the price to be paid by the third party for the shares.

Third, it is a condition that the total financial assistance granted by the company to third parties may at no time exceed what is reasonable regarding the company's financial position. If the company is a parent company, the aggregate financial assistance may not exceed what is reasonable in regard to the group's financial position. For this purpose, the company may only use funds that can be distributed as dividends.

Finally, the financial support must be granted at arm's length, meaning that interest, payment plan, security etc. must be on the same terms as if the loan was granted by a bank.

Notwithstanding the above, it is legal for a company to grant financial assistance transactions for the acquisition of shares from, or the transfer of shares to, employees of the company or any subsidiary.

Unlawful self-financing

The consequences of unlawful self-financing are quite severe for both the third party who has received financial support, the people involved in the transaction (for example the management), and for the company itself.

Thus, a person who has received financial assistance in violation of the self-financing prohibition must repay the amount to the company. Additionally, the person who received the financial assistance must pay interest from the time the assistance was incurred and until the amount is repaid. The interest rate is stipulated in the Danish Interest Rate Act and is currently 8.05% plus 2.0% according to the Danish Companies Act, i.e. a total interest of 10.05% p.a.

If the amount cannot be repaid, the people who made the agreement or maintained the transaction in contravention of the self-financing prohibition are objectively liable for the loss which the disposition may have caused to the company.

Finally, the company is fined, and the companies’ management may be held liable under the special rules that apply to management members liability.

What companies are subject to the rules?

According to the wording of the provision, it only includes loans from Danish companies. However, the Danish Business Authority is of the opinion that foreign subsidiaries must also comply with the rules if they have a Danish parent company. In this case, it is the opinion of the Danish Business Authority that the Danish parent company must use its controlling influence of its foreign subsidiaries to ensure that the Danish rules regarding self-financing are complied with.

IUNO’s opinion

At IUNO, we believe that the self-financing rules should be taken seriously as the consequences for violating the rules are severe for all parties involved. Unfortunately, situations often arise where the companies’ management does not think about the rules, e.g. in connection with loan-financed acquisitions of companies and subsequently intra-group transactions. It is, therefore, important to ally with the right advisors who can ensure compliance and help you keep track of the many requirements.