Accession To Cash Pools – Dos And Don’ts - Corporate and Company Law

When a Swiss company shall become a member of a group-wide cash pool, certain restrictions and conditions imposed by Swiss corporate and tax law must be carefully considered. Particular caution should be taken if any upstream securities are to be provided by the Swiss pool member. Non-compliance can in particular lead to invalidity, adverse tax consequences and personal liability for directors and officers.

1. INTRODUCTION

International corporate groups often have a group-wide central management of the cash and liquidity positions of their affiliates ("Cash Pool"), for the purpose of optimizing group-wide liquidity management, reducing overall financing costs and improving yields on excess liquidity.

In a "Physical Cash Pool", a group finance company assumes the role of "Pool Master" and operates a "Master Account" with a third-party "Pool Bank", to which all bank accounts of the group's affiliates ("Pool Members") are automatically transferred and credited or debited on a regular basis. The individual accounts of the affiliates are either balanced-out to zero ("Zero Balance Cash Pool") or to a determined target amount, leaving a certain liquidity cushion outside of the Cash Pool at the disposal of each of the Pool Members ("Target Balance Cash Pool").

Unlike a Physical Cash Pool, a "Notional Cash Pool" is based on a virtual pooling of the individual cash positions of a corporate group for the purpose of calculating the interest on the aggregate consolidated credit or debit balance amount. Each Pool Member keeps its own account with the Pool Bank, without its credit or debit balance being physically transferred to a Master Account.

In both Physical and Notional Cash Pools, the Pool Members are occasionally requested by the Pool Bank to agree to joint and several liability, or to post an upstream guarantee, pledge or other security ("Upstream Security") for any possible payment default by the Pool Master or by any other Pool Member.

For the purposes of this newsletter, we assume that a Swiss affiliate of an international corporate group is considering to join a Physical Cash Pool operated by its direct or indirect parent company, or by any of the parent's direct or indirect subsidiaries ("Upstream Cash Pool"). We further assume that the Swiss Pool Member contributes a positive credit balance to the Cash Pool.

If the Swiss Pool Member contributes a negative debit balance to a Cash Pool or if the Pool Master is a direct or indirect subsidiary of the Swiss Pool Member ("Downstream Cash Pool"), there is less concern, since Swiss law imposes fewer restrictions in those cases. Accordingly, this newsletter does not discuss such cases, nor does it consider the implications where a Swiss company serves as the Pool Master.

2. SWISS LAW RESTRICTIONS FOR UPSTREAM CASH POOLINGS IN GENERAL

The Swiss Pool Member contributing a positive credit balance to an Upstream Cash Pool grants an upstream (or cross-stream) loan ("Upstream Loan") to the Pool Master. Like cross- or upstream loans in general, such an Upstream Loan into a Cash Pool is only permissible subject to several conditions and restrictions, the most relevant of which are outlined in greater detail below.

Non-compliance may lead notably to the invalidity of the Upstream Loan as well as to personal liability of directors and officers. Further, non-compliance may have adverse tax implications and, under certain conditions, constitute fraudulent conveyance under applicable bankruptcy laws and even a criminal offense (e.g. , creditor preference or disloyal management).

An automatic Physical Zero Balance Cash Pool is highly unlikely to be fully at arm's In the absence of clear-cut statutory or case law, it is often difficult to assess in a particular case whether and to what extent the said general Swiss law restrictions and limitations apply and are complied with, respectively. As a result of this uncertainty, and given the potentially harsh consequences of non-compliance, the directors and officers of a Swiss company must carefully analyze the specific facts of the case before deciding whether to participate in an Upstream Cash Pool. When in doubt, a prudent approach should be taken. This is particularly important where there are reasonable doubts as to whether the terms of the Upstream Loan to the Pool Master are at arm's length and in line with a diligent liquidity management of the Swiss Pool Member, as discussed further below.

It is important to note that Swiss corporate law does not recognize the legal concept of a consolidated group of companies. Consequently, the directors and officers of a Swiss Pool Member may not rely on a consolidated group view and act by considering only the overall interests of the entire corporate group. Rather, the financial status of the Swiss Pool Member must be assessed and secured independently, focusing on the distinct identity and status of the Pool Member as a legally separate Swiss corporate entity.

3. THE "ARM'S LENGTH" PRINCIPLE AS A GENERAL RU LE OF GUIDANCE

Like any other intra-group dealings, Upstream Loans to a Cash Pool must generally be on arm's length terms, namely, in an amount and on terms on which an unrelated third party (e.g. , a bank) would grant the same loan to the Pool Master in question.

Based on this general principle, the Upstream Loan granted to the Pool Master:

must have customary terms of duration, termination, interest and amortization;
must be in the interests of the Pool Member; and
may have to be adequately secured by the Pool Master (e.g. , by a third party guarantee).

Further, the Swiss Pool Member must carefully examine and continuously monitor the Pool Master's creditworthiness as well as its willingness and ability to repay the Upstream Loan.

An automatic Physical Zero Balance Cash Pool is highly unlikely to fully comply with the arm's length principle. This is even more the case if the Pool Member is thereby requested to provide an Upstream Security to the Pool Bank without getting adequate consideration. Consequently, a Swiss Pool Member must generally follow in particular each of the principles set forth below.

4. CORPORATE LAW RESTRICTIONS FOR UPSTREAM CASH POOLINGS

4.1 Company Purpose

In order to avoid the risk that joining an Upstream Cash Pool would be deemed ultra vires and thus null and void from the outset, the corporate purpose provision in the articles of association of the Swiss Pool Member should explicitly include the granting of financing to other group companies, including through Upstream Loans and participations in Cash Pools. In addition, in most cases it is advisable that the purpose provision explicitly refers to the Swiss Pool Member's being an affiliate of a group of companies.

4.2 Adequate Risk Diversification

The directors and officers of a Swiss Pool Member must secure an adequate risk diversification and avoid any undue risk concentration, respectively. This would not be achieved, for example, if the balance sheet assets of the Swiss Pool Member mainly consisted of an Upstream Loan to an Upstream Cash Pool.

4.3 Diligent Liquidity Management

The directors and officers of the Swiss Pool Member must ensure that the company is always in a position to meet its liquidity needs, even (and most importantly) if the Pool Master is likely to head towards financial distress. The Pool Member may thus have to preserve an adequate portion of its liquidity outside of the Cash Pool and/or refuse to be submitted to automatic cash pooling.

The Swiss Pool Member must ensure that it has access to appropriate information and a monitoring system in place to assess continually the financial strength of the Pool Master. In addition, it must take precautionary measures to react immediately and if necessary to cancel the further pooling of its liquidity account and to recover its outstanding credit balance in the Cash Pool, if the creditworthiness of the Pool Master becomes questionable. It must thereby be taken into account that repayment of the Upstream Loan may be inhibited by applicable insolvency laws.

4.4 Limitation to the Pool Member's Free Equity

Unless the Upstream Loan in question clearly meets the arm's length test and all other relevant prerequisites and conditions outlined above, the Swiss Pool Member's overall exposure in an Upstream Cash Pool should be limited to an amount corresponding to the "Free Equity" as defined below. This is particularly important if the Pool Master's ability to pay the Pool Member's credit back on demand becomes questionable. Free Equity is the amount of the Swiss Pool Member's total equity (as shown in the statutory balance sheet), minus 150% (or, in the case of a holding company, 120%) of the nominal value of the issued share capital, minus any remaining special reserves which are not available for dividend distributions.

Any possible Upstream Security of the Swiss Pool Member to the Pool Bank securing any payment obligations of the Pool Master or of any other Pool Members must be taken into account, since such an Upstream Security can almost never be justified as being in the interest of the Swiss Pool Member granting them. Especially given the severe practical difficulties of ensuring that the Free Equity limitation is not exceeded, Swiss Pool Members are often entirely released from granting Upstream Securities when participating in an Upstream Cash Pool.

4.5 Approval by the Shareholders' Meeting

For various reasons, it is advisable that the participation of a Swiss Pool Member in an Upstream Cash Pool be formally approved at a shareholders' meeting of the Pool Member concerned. This may help to prevent participation in the Cash Pool from being deemed to be a constructive dividend. In addition, shareholder approval gives the directors and officers of the Pool Member a certain degree of protection against potential liability claims of the Pool Member and its consenting shareholders.

5. POTENTIAL ADVERSE TAX IMPLICATIONS

The participation in an Upstream Cash Pool may trigger adverse Swiss withholding and income tax consequences if an Upstream Loan or Upstream Security to the Pool Master is deemed to be not at arm's length and thus regarded as a constructive dividend. Whether a constructive dividend exists for tax purposes is typically determined based on the following three criteria:

Interest Rate: If the Upstream Loan is granted with an interest rate lower than the rate accepted by the Swiss tax authorities for tax purposes, any difference is considered a constructive dividend. The applicable interest rates differ from currency to currency and are published periodically by the Federal Tax Administration.
Upstream Loan Amount: Under certain conditions, the tax authorities might characterize the total Upstream Loan as a constructive dividend. This can be the case if, at the time the Upstream Loan was granted or renewed, the Pool Master was in such poor financial situation that timely repayment of the loan could not reasonably be expected and a third party would thus not have granted or renewed such loan on substantially the same terms and conditions.
Factual Liquidation: If the Upstream Loan is not repaid and if that leads to the bankruptcy or liquidation of the Swiss Pool Member, the granting of the Upstream Loan may retroactively be characterized as having been the first step in the liquidation of the Swiss Pool Member under the concept of factual liquidation. As a result, not only the amount of the Upstream Loan in question, but rather the Swiss Pool Member's total net assets, calculated on the basis of their fair market values at the time the Upstream Loan was granted, might constitute factual liquidation proceeds.

Constructive dividends and factual liquidation proceeds from Swiss resident companies are subject to Swiss withholding tax at source (currently at 35%). Upon request, the tax may be fully or partially refunded to the recipient of the profit distribution. For non-Swiss recipients, such a refund may be granted only pursuant to a double tax treaty between Switzerland and the country of residence of the recipient.

Since the withholding tax of 35% must be withheld at source, the tax authorities consider any constructive dividend or factual liquidation proceeds to be 65% of the taxable amount. Hence, they first gross up such amount to 100% and then levy the 35% withholding tax on the grossed up amount.

Consequently, the potential withholding tax liability of a Swiss Pool Member, and possibly of its responsible directors and officers personally, could amount to as much as 53.8% of the constructive dividend or factual liquidation proceeds.

In addition to those potential withholding tax consequences, losses occurred on Upstream Loans constituting constructive dividends are not deductible in computing taxable income of the Swiss Pool Member and any inadequate interest income on Upstream Loans may result in an add-up of the deemed interest income to the Swiss Pool Member's taxable profit.

6. CONCLUSION

Before acceding to an Upstream Cash Pool, the responsible body of a Swiss Pool Member must carefully analyze the relevant restrictions and conditions imposed by Swiss corporate and tax law. As a result of such analysis, the Swiss Pool Member may in particular be forced (i) to accede to a Notional (instead of a Physical) Cash Pool only, (ii) accept a Target (instead of a Zero) Balance Cash Pool only, (iii) accept a manual (instead of an automatic) pooling only and (iv) refuse to grant the Pool Bank any Upstream Security.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

Switzerland: Accession To Cash Pools – Dos And Don’ts