A guide to hive-ups, intra-group loans and distributions

Intra-group loans often arise on group reorganisations involving a transfer of business and assets from a subsidiary to its parent – known as a ‘hive-up’. On this type of transaction, the consideration due from the parent is often based on the book value of the relevant assets but, rather than cash actually being paid, the consideration is left outstanding on an intra-group loan account due from the parent to the subsidiary. So, the subsidiary has effectively made a loan of that amount to the parent and can demand (re)payment of that loan at any time.

What is a distribution?

Leaving the consideration outstanding as an intra-group loan brings the transaction into the scope of the Guidance issued by the City of London Law Society. In particular, that Guidance was concerned with whether an interest-free loan would be classed as a distribution by the subsidiary (the lender). A “distribution” for this purpose includes every description of distribution of a company’s assets to its shareholders. The most common type of distribution is a cash dividend paid to shareholders, but the definition is very wide and catches many other transactions.

There are strict statutory rules about distributions including a requirement that they can only be made out of distributable profits. If an interest-free loan was classed as a distribution, but the subsidiary did not have sufficient distributable profits to make that distribution, the transaction would be unlawful.

“Normal” intra-group loans are not distributions

The good news is that the Guidance says that a “normal on demand intra-group loan” is not a distribution.

To be classed as a “normal” loan the subsidiary-lender’s directors must have considered the financial position of the parent-borrower when the loan was made (i.e. when the hive-up completed). Based on those considerations, the directors must have decided, in good faith and on reasonable grounds, that the parent was likely to be able to repay the loan when demanded.

When might an intra-group loan be a distribution?

The loan will be classed as a distribution if, on an objective view of the parent-borrower’s circumstances, it is likely that the parent-borrower will not be able to repay the loan when demanded, and the subsidiary does not receive appropriate value for assuming that risk (such as an increased interest rate on the loan).

The transaction is also likely to be classed as a distribution if, at the time the intra-group loan is made, there is no intention that the parent-borrower will ever be required to repay the loan.

What should directors do?

Considering the financial condition of the parent-borrower is a requirement for the directors of the subsidiary-lender in order to comply with their fiduciary duties, particularly the duty to exercise their powers in the best interests of the subsidiary alone, rather than the interests of the wider group of which it is a part.

If there are no concerns about the parent’s ability to repay the loan when demanded, an interest-free loan is unlikely to be classed as a distribution (although the directors should still consider what the wider benefit is to the subsidiary in making the loan in order to satisfy their fiduciary duties).

If there are concerns about the parent’s ability to repay an interest-free loan on demand, or if there is no intention to ever require repayment, the loan is likely to amount to a distribution and the subsidiary will need to have distributable profits equal to the amount of the loan in order for it not to be an unlawful distribution.

What are the consequences if an intra-group loan is classed as a distribution?

If an intra-group loan is caught by the above rules and the subsidiary-lender did not have sufficient distributable profits, it will have made an unlawful distribution. This means that:

• the parent-borrower can be required to repay the unlawful distribution (although arguably this puts the borrower in no worse position than being required to repay the original on demand loan); and
• the directors of the subsidiary-lender may be personally liable to repay the unlawful distribution due to the related breaches of their duties made in authorising it.

In addition, the lawfulness of subsequent distributions could be impacted where available distributable profits have effectively been eroded by the loan transaction.

Directors need to consider carefully all the consequences of an intra-group transaction, including the unintended ones, in order to avoid hidden dangers and personal liabilities.