FINANCE : A critique of S.57 on ‘financial assistance’ by companies—10

In this tenth part of our 30-part article series, we analyze Section 57 of the Tanzanian Companies Act 2002 (‘CA 2002’) on the prohibition of financial assistance to a company for the purchase or subscription of its own shares or shares in its holding company. In addition, we explain why banks should care about the provisions of the Section and we offer a proposal for amending it.

Section 57(1) of the CA 2002 prohibits a company from directly or indirectly giving any financial assistance for the purpose of or in connection with a purchase or subscription made or to be made by any person of or for any shares in the company, or in its holding company. The term ‘financial assistance’ is not defined in the section; nevertheless, the section refers to “by means of a loan, guarantee, the provision of security or otherwise.”

Thus, the financial assistance transactions prohibited under Section 57(1) of the CA 2002 are not restricted to just those referred to in the section, but cover any financial support transactions. It is important to also note that the prohibition applies to public companies in accordance with Section 57(4). The justification of the prohibition is to prevent asset stripping (whose benefits generally go to corporate raiders) and the reduction of the share capital of such companies.

However, the proviso to Section 57(1) prescribes four exceptions to financial assistance prohibition. These are (1) loans granted as part of the ordinary business of banks and other lenders; (2) money availed for the purchase or subscription of shares by trustees of or for shares to be held by or for the benefit of employees or former employees or the dependents of any of the employees in the company or its holding company; (3) loans to bona fide employees of the company for their purchase or subscription of shares in the company or its holding company; and (4) the lawful distribution by a company of any of its assets by way of dividends or otherwise.

Closer examination

A closer examination of Section 57(1) of the CA 2002 however reveals that where financial assistance is given, there are two transactions; the transfer of shares, and the financial assistance for the share price payment. The provision only forecasts that the financing transaction shall be unlawful and therefore void. It does not prescribe any legal effects to the share transfer!

From the above, it appears that the share transfer transaction undertaken with the financial assistance transaction—which will be deemed unlawful—shall be valid and effective. Hence, the only transaction that would be unlawful and void would be the financing transaction.

This could be the basis for the company or even some of its creditors to claim that the borrowings are void, and consequently, unenforceable. In any acquisition finance, therefore, it behooves of banks and other lenders to take care and ensure that companies do not provide financial assistance (for example, by giving guarantee or providing collateral security) in contravention of Section 57 of the CA 2002.

Irrespective of the effect of the transaction, there is no financial limit on the fine that a court, not being inferior to a District court, can impose on the company and every officer of the company for contravening Section 57 of the CA 2002.

It may be perceived that the company and its officers could escape liability if the Capital Markets and Securities Authority (CMSA) is found to have misled the company and its officers into error and into illegality after certifying that the prohibition does not apply to a company in respect of any particular transaction in accordance with Section 57(3). But this may not always be the case because the CMSA’s exercise of its power to certify is discretionary.

Wrapping up, then, there is a need to amend the Section 57 financial assistance prohibition of the CA 2002. There is no clarity around the legal definition of ‘in connection with’; the circumstances under which a company can take part in such transactions remain vague.

This should stimulate the amendment of Section 57(1) by replacing it with ‘it shall not be lawful for a company to give any financial assistance for the purpose of an acquisition made or to be made by any person of any shares in the company, or where the company is a subsidiary, in its holding company,’ effectively deleting the ambiguous ‘in connection with’ standard and including the principle purpose test (PPT) to help determine if the transaction is lawful under the Section.