Romania: Leveraged Buyout Structures And Private Equity. The Romanian Legal Perspective

Last Updated: 26 January 2018
Article by Gabriela Anton and Raluca Sanucean

Private equity (PE) firms are specialised investment firms that typically use leveraged buyouts (LBOs) when structuring their acquisitions. In an LBO, a company (the Target) is acquired using a combination of equity and external debt financing, the latter being the largest component. This technique is also called "bootstrap acquisition", considering the smaller amount of own equity invested in the Target, while the repayment of the external debt is typically serviced by the Target through its cash flows.

This financing technique is economically based on the tax shield gained by the Target, which assumes that it has sufficient debt capacity and that it generates cash flows in excess of its ongoing needs and so may increase its leverage1. Corporate tax law allows for the deduction of interest payment (subject to thin capitalisation rules) but not dividends, thus using maximum leverage in an acquisition in which the return on assets exceeds the interest expenses, leading to a higher return on equity.

The public have previously taken a dim view of this type of leveraged transaction, perceiving it as coming at the expense of employees who suffer job cuts and salary reductions. Nowadays, the benefits for the Target company, which enhances its performance through the use of the financial and corporate governance knowledge of PE firms, are largely accepted.

The favourable credit market coupled with attractive interest rates led to a comeback for leveraged loans following the financial crisis. In the light of this renewed lending activity, a substantive part of the work of our lawyers in the Banking & Finance team is related to this type of finance structure, mainly driven by PE firms or sometimes by strategic (non-financial) investors who seek to fund the acquisition of related industry companies with a portion of debt. In the transactions where our lawyers provided legal assistance, the Target companies had a strong market position, with consistent revenue growth and stable operations which generated predictable cash flows.

Romanian law places certain restrictions on this type of operation, which need to be carefully assessed when structuring the financing transaction.

Financial Assistance and LBOs

The Romanian Companies Law2 reflects the capital maintenance principles set forth in the Second Council Directive 77/91/EEC3, which bans joint stock companies from acquiring their own shares. The corollary of this restriction is that the financing or guarantees for the acquisition of own shares (operations known as "financial assistance") are also expressly prohibited.

Limiting the financial assistance granted by a company (i.e. the Target) in order to acquire its own shares by a third party is established by law in many European continental countries, following implementation of the Second Council Directive 77/91/EEC. This restrictive approach by European legislators in relation to the use of financial assistance led to a close to impossible implementation of financing schemes secured by the assets of the Target and was widely criticised for bringing unjustified restrictions to the M&A market and imposing a rigid approach with a standard protection level that was not always necessary.

Since 2006, and especially during 2012, the EU financing market was significantly restructured in order to address its dynamics. One of the pillars of the reform was Directive 2006/68/EC, reinforced through Directive 2012/30/EU of the European Parliament and of the Council4 which, among other measures, set forth a more permissive approach to financial assistance, subject to certain standards, thresholds and internal approvals known as "whitewash proceedings". Pursuant to these rules, transactions can take place under fair market conditions, under the responsibility of the management, which is required to prepare a written report, indicating among other things the risks to the liquidity and solvency of the company, and finally were to be subject to the prior approval of the general meeting of shareholders, under certain quorum and majority conditions. Moreover, companies must take into consideration that the aggregate financial assistance granted to third parties must at no time result in the reduction of net assets below the share capital.

Romania has not transposed the "whitewash proceedings" permitted by Directive 2006/68/EC and then by Directive 2012/30/EU, given that no such obligation was imposed on Member States. At a domestic level, Romanian company law expressly prohibits financial assistance granted by way of advancing funds or providing security interest rights. The penalties are very severe and directors, executive manager or legal representatives of companies that advance funds or loans for the company's shares are committing an offense punishable by prison. Furthermore, it is largely accepted in the doctrine5 that transactions which breach the financial assistance rules are null and void. This renders inapplicable the use of LBO structures which involve financial assistance for the Romanian joint stock Target companies.

However, there are a number of structures that have developed and that are used in practice in acquisition transactions.

Use of LBOs for Limited Liability Companies

Romanian company law regulates the financial assistance restrictions only with respect to joint stock companies, in Chapter IV – Joint Stock companies – Section 1 – About Shares. Limited liability companies have a separate regulation which reflects their status of "partnership" as they are owned by a limited number of shareholders (minimum one and maximum 50). Nevertheless, various doctrinal opinions have considered certain provisions related to joint stock companies as representing corporate law principles and therefore held that they should be extended also to limited liability companies. The question would then be if such financial assistance rules represented a corporate law principle, which naturally should apply also to limited liability companies. Our view is that this extension should not apply with respect to financial assistance rules, based on the following arguments:

1. There is no indication that legislators' intention was to regulate financial assistance as a corporate principle that should extend to all companies, including partnerships. On the contrary, these rules transpose the Second Council Directive, which expressly provides that its coordination measures apply in Romania only to joint stock companies, and not to other types of companies.

2. The regulation which transposes into a criminal sanction the breach of financial assistance expressly refers as being applicable with respect to "shares" (which in Romania are issued only by joint stock companies). A limited liability company may issue only "social parts", and therefore this sanction is not applicable to this type of company. The authors may only be individuals holding the position of director, executive manager or legal representative of a joint stock company6.

3. The High Court of Cassation and Justice has ruled that with limited liability companies, the rules provided for other types of companies may apply only if there is a specific reference norm, while "the absence of such reference norms, which are limited and of strict interpretation, to joint stock companies leads indubitably to the conclusion that the administration of a limited liability company is governed by different rules than those provided for joint stock companies" 7. As indicated, there is no reference norm to the financial assistance rules provided for joint stock companies; therefore these rules should not be applicable to limited liability companies.

Nevertheless, as the financial assistance rules have not been tested in Romanian courts as far as limited liability companies are concerned, and owing to the gravity of the sanctions, parties tend to be very cautious when structuring LBOs that include a financial assistance element.

Merger with Debt Push-Down

The financing structure of LBOs may include the immediate merger of the Target company into the acquisition vehicle (or, if suitable, and depending on the specifics of each transaction, sometimes it is the acquisition vehicle that is merged into the Target). This operation is also referred to as a debt push-down structure, because the acquisition financing (obtained at the level of the acquisition vehicle and generally financed by equity and not directly by the Target) is pushed down to the merged entity level. If a company does this, it could also be argued that any financial assistance issue no longer applies, as the prohibition only addresses the Target company, which ceases to exist after completion of the merger. In such a structure, the security for the acquisition finance is granted after the merger takes place.

Notwithstanding the above, the legality of a merger LBO involving a joint stock company as Target is uncertain given the obvious linkage between the merger and the financing structure. In such transactions, the merger would not be a separate, autonomous transaction but just the final part of the acquisition process. However, this risk does not apply to limited liability companies, which are not covered by the financial assistance rules.

Furthermore, the use of a merger with debt push-down needs to be carefully reviewed from a tax perspective to ensure it is done in a tax neutral manner. Under the Romanian Fiscal Code, a merger is a tax neutral event, from a corporate income tax perspective, if it meets certain requirements, in brief:

  • It has economic substance and is not performed with the purpose of tax avoidance or tax evasion;
  • The fiscal value of the shares received by the shareholders of the absorbed company in the absorbing entity is equal to the fiscal value of the shares held in the absorbed company prior to the merger;
  • The fiscal value of any assets transferred in the merger process is preserved at the level of the absorbing company.

In other European jurisdictions (such as Switzerland and Italy) in the case of mergers with a debt push-down structure where the acquisition vehicle has been specifically incorporated for the purpose of acquiring the Target company, the deductibility of the interest has been questioned as potential tax avoidance. The key issue raised was that at the end of the acquisition process a significant debt was allocated to the Target and the interest generated by this debt was used to reduce the company's taxable income. However, in many cases, an acquisition followed by a merger of the acquisition vehicle with debt push-down is not tax-driven at all. The primary reason for the use of the acquisition vehicle is to separate the liability for this acquisition from other investments, a fairly standard practice for PE firms. After the acquisition is completed, there is no justification for having two separate entities (the acquisition vehicle and the Target) and through the merger the costs of maintaining the acquisition company can be saved, the corporate governance is simplified and the debt/equity ratio is optimised. Therefore, it can be successfully argued that the tax benefit is not the aim of the acquisition structure and that the interest deduction is just a consequence of the application of general rules given the lack of any specific provisions for merger LBOs.

Looking to a More Permissive Future?

Given the market dynamics, it is recommended that the Romanian legislation adopts a more flexible approach in terms of allowing financial assistance, subject to clear and predictable conditions, so as to encourage LBO transactions. This is because a very strict creditor protection regime may sometimes lead to undesirable consequences, such as establishing and enhancing protection for subjects that neither need nor desire it. Currently, the financial assistance prohibition applies to joint stock companies regardless of whether or not they have creditors, or whether, hypothetically, the creditors of a financially stable company approved a transaction involving financial assistance. On the contrary, financial assistance prohibition does not cover the acquisition of the company's assets, as it solely relates to the subscription or acquisition of its shares; such limitation is hard to justify from a practical perspective, as asset deals may be as detrimental to a company and its creditors as share deals. In order to prevent market players from engaging in various complex mechanisms to circumvent the financial assistance prohibition, and, implicitly, to stimulate the domestic economy in terms of time and cost efficiency, Romanian legislators should consider adopting a more permissive legal framework in respect of financial assistance, such as the one permitted by Directive 2006/68/EC. Moreover, by following the EU example establishing the responsibility of the management body for transactions involving financial assistance, the local regulations would also reduce moral hazard, simultaneously enhancing the corporate governance regime. Creditors and shareholders would benefit from clear debt information, which is an essential instrument for risk mitigation. In the long run, creditors' interest is that their debtors remain solvent on an ex post financial assistance basis, and, therefore, a creditor mutual agreement, together with a shareholder resolution passed with a high majority, would represent a viable solution for addressing the risks related to financial assistance and enhance the acquisition market.

Footnotes

1 This calculation is based on the Miller-Modigliani propositions, developed by the Nobel laureates Morton Miller and Franco Modigliani in their papers published in 1958 and 1961. Their "irrelevance propositions" asserted that under a restrictive set of conditions, neither a company's financing activity nor its dividend policy should be expected to affect its current market value.

2 Companies Law No. 31/1990, as further amended and restated.

3 Council Directive 77/91/EEC on the coordination of safeguards which, for the protection of the interests of members and others, are required by Member States of companies within the meaning of the second paragraph of Article 58 of the Treaty, in respect of the formation of public limited liability companies and the maintenance and alteration of their capital, with a view to making such safeguards equivalent (the Second Council Directive). The Second Council Directive was amended by Directive 2006/68/EC of the European Parliament and of the Council of 6 September 2006 amending Council Directive 77/91/EEC and then replaced by Directive 2012/30/EU of the European Parliament and of the Council. Competition Law and Data, 10 May 2016, http://www.autoritedelaconcurrence.fr/doc/reportcompetitionlawanddatafinal.pdf.

4 Directive 2012/30/EU of the European Parliament and of the Council of 25 October 2012 on the coordination of safeguards which, for the protection of the interests of members and others, are required by Member States of companies within the meaning of the second paragraph of Article 54 of the Treaty on the Functioning of the European Union, in respect of the formation of public limited liability companies and the maintenance and alteration of their capital, with a view to making such safeguards equivalent.

5 St.D. Cărpenaru, Gh. Piperea, S. David, Legea societăţilor, comentariu pe articole, 5th edition, Ed. C.H. Beck, Bucharest, 2014.

6 I. Schiau, T. Prescure, Legea societăţilor comerciale nr. 31/1990. Analize și comentarii pe articole, 2-nd edition, Ed. Hamangiu, 2009; C. Voicu, Al. Boroi et al. Dreptul penal al afacerilor, 4th edition, Ed. CH Beck, 2008.

7 High Court of Cassation and Justice, 2nd Civil Section, Decision No. 3679 from 31 October 2013.

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.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
 
Some comments from our readers…
“The articles are extremely timely and highly applicable”
“I often find critical information not available elsewhere”
“As in-house counsel, Mondaq’s service is of great value”

Related Topics
 
Related Articles
 
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
 
Email Address
Company Name
Password
Confirm Password
Position
Mondaq Topics -- Select your Interests
 Accounting
 Anti-trust
 Commercial
 Compliance
 Consumer
 Criminal
 Employment
 Energy
 Environment
 Family
 Finance
 Government
 Healthcare
 Immigration
 Insolvency
 Insurance
 International
 IP
 Law Performance
 Law Practice
 Litigation
 Media & IT
 Privacy
 Real Estate
 Strategy
 Tax
 Technology
 Transport
 Wealth Mgt
Regions
Africa
Asia
Asia Pacific
Australasia
Canada
Caribbean
Europe
European Union
Latin America
Middle East
U.K.
United States
Worldwide Updates
Registration (you must scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions

Mondaq.com (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of www.mondaq.com

To Use Mondaq.com you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these Terms or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.

Disclaimer

The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use of the Content or performance of Mondaq’s Services.

General

Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions