Bär & Karrer’s Till Spillmann and Luca Jagmetti discuss its practical consequences.
The Swiss Federal Supreme Court ruled in a recent decision that up-stream and cross-stream loans granted by Swiss companies must be entered into on arm’s-length terms. If not at arm’s length, the decision seems to suggest that such loans constitute de facto distributions and may only be granted for an amount not exceeding the lender’s freely distributable reserves. If already granted, it reduces the lender’s ability for future dividend distributions by the amount corresponding to the nominal value of the loan. The court also imposed stringent requirements on satisfying the arm’s length test.
Further, the court raised the question of whether Swiss companies are allowed to participate in zero-balancing cash pools at all.
Background
The case related to a Swiss subsidiary of the former Swissair group, which participated in a zero-balance cash pooling arrangement. As of 31 December 2000, the subsidiary was a lender under up-stream and cross-stream loans in an aggregate amount of approximately CHF24m and had retained earnings of approximately CHF29m. Based on the audited financial statements of 2000, a dividend of CHF28.5m was resolved after the subsidiary’s auditors confirmed such dividend to be in compliance with the law. Following the Swissair grounding in autumn 2001, the administrator of the subsidiary sued the auditors for issuing such confirmation, arguing the two loans should have been deducted from the subsidiary’s freely distributable reserves.
What the Swiss Federal Supreme Court Decided
High standards for up-stream and cross-stream loans to pass the arm’s-length test
In short, the court held that a non-arm’s-length intra-group loan granted by a Swiss subsidiary to its shareholder or a sister company may constitute a de facto distribution rather than a loan and it seems to suggest that such loan may only be granted for an amount not exceeding the subsidiary’s freely distributable reserves. Until now, the majority of Swiss legal doctrine has only imposed this requirement on fictitious loans and similar financing arrangements under which repayment is unlikely or not even intended.
In addition, the court’s decision suggests that surprisingly high standards have to be imposed for up-stream loans to pass the arm’s-length test. While the court did not specify what constituted arm’s-length terms in the case at hand, it held that none of the loans were arm’s length because they were unsecured and the creditor did not analyse the debtors’ credit-worthiness at the time of the grant.
Intra-group loans that are not at arm’s length restrict the ability to pay future dividends and access cash
According to the court, if up-stream and cross-stream loans were granted not at arm’s-length terms, a reserve in the nominal amount of such loan must be created, reducing the freely distributable equity and hence the ability to pay dividends. In combination with the exacerbated standards for such loans, this constitutes a challenging new requirement for Swiss companies as it requires them to closely monitor freely distributable reserves in light of their intra-group financing arrangements and to assess whether these may have been entered into at market terms. The new court order may also restrict access to cash in leveraged structures.
Permissibility of (zero-balancing) cash pool arrangements left open
The court also raised the question of whether the participation by a Swiss company in a cash pooling arrangement in which the participant disposes over its liquidity is at all capable of constituting an arm’s-length transaction. However, the court held that the question could remain unanswered in this particular case.
What the Decision Means for Swiss Companies
In light of this recent decision, we recommend that Swiss companies review their intra-group financing arrangements. The review should focus on, inter alia, the following key topics:
- Up-stream and cross-stream loans should only be granted at arm’s-length terms.
- If there is any doubt as to whether the loan constitutes an arm’s-length transaction, additional cautionary measures should be taken.
- Cash pooling arrangements involving Swiss companies should generally be assessed in light of the recent decision.
- The auditors should be involved when granting up-stream or cross-stream loans as they will need to get comfortable with the arm’s-length nature of such loans in connection with the audit.
Furthermore, the decision should be considered in the context of leveraged financing transactions where the ability to up-stream cash by Swiss companies may be relevant.
As the court appears to deviate from past precedents and established legal doctrine without discussing that in depth, this may suggest that part of the decision may rather have to be seen in the context of the particular case, which at that time caused great political waves in Switzerland, and less in more general terms. The practical impact of the decision will also depend on how auditors will implement it, as they have to give confirmation that dividend distributions comply with the legal requirements. First indications on the way such implementation will be made may be gathered from the Q&A that the Treuhand-Kammer Swiss Chamber of Certified Accountants and Tax Experts issued in December 2014.
It remains to be seen whether the Swiss Federal Supreme Court will clarify at least some of the open questions raised by its recent decision. Fortunately, an additional decision on a similar topic is expected to be rendered by the court later this year.
Till Spillmann’s practice focuses on cross-border financing, capital markets and M&A transactions. He co-heads Bär & Karrer’s finance and capital markets group. Furthermore, he is chairman of the editorial board of GesKR, a leading Swiss corporate and capital markets law journal.
Luca Jagmetti’s practice focuses on M&A transactions, corporate restructurings and general corporate matters, as well as related litigation proceedings. He has gained particular experience in leveraged private equity transactions, as well as domestic and cross-border asset deals. He earned his doctorate with a thesis on intra-group cash pooling.
For more information, please contact:
Till Spillmann, partner
T: +41 582 615 287
E: till.spillmann@baerkarrer.ch
Luca Jagmetti, partner
T: +41 582 615 262
E: luca.jagmetti@baerkarrer.ch
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