There can be a real conundrum with commercial justification or commercial benefit when it comes to organising a business loan or commercial finance for your organisation…let me explain.
UK legislation in the form of the Companies Act 2006, requires the directors of limited companies/members of LLPs to always act in good faith and in the best interests of the Company/LLP.
The simple version of this is directors can be held personally responsible for their decisions in their capacity as a director. Meaning the decisions they make must be to the benefit of the company as a whole rather than themselves personally.
The fundamental responsibility around satisfying the ‘benefit’ test lies with the Company/LLP and its directors/members but a conscientious lender needs to gauge the degree of benefit demonstrated as there is a risk that the absence of benefit may result in the security being void or unenforceable.
What’s the issue?
The biggest example can be found with something known as Corporate and Social Responsibility (CSR). CSR is all about the contribution and impact of the company in the wider world, which covers charitable, environmental, social and ethical responsibilities.
CSR has become a substantial policy, most large and corporate companies have a CSR policy and some small companies have one as well, even if it is not written down.
As with anything, you could take this one step further and consider scenarios such as;
- A company moving to a more expensive supplier with a and less quality product because the supplier uses electric or low carbon vehicles for deliveries
- Allowing a local charity or startup to use your warehouse for free, you cover the costs but choose to let the charity use your warehouse then let space commercially
Both these are good Corporately social and responsible practices. However, will the company benefit? It wouldn’t take much to argue that there is no ‘Commercial Benefit’ and should result in the company not following these through. In reality, they are good moral practices.
What is the real-world impact?
The principle of demonstrating commercial justification/benefit first came to the fore in the landmark Rolled Steel Products (Holdings) Ltd -v- British Steel Corporation case from 1986 (the ‘Rolled Steel’ case). In this case, it was held that the purpose of an act (such as the granting of third party security) must be to assist in the attainment of the Company’s objects. An act that did not go towards the attainment of the Company’s objects could be challenged on the basis that it was beyond the powers of the Company (‘ultra vires’);
Commercial Benefit can sometimes be easy to see as can a lack of benefit be easy to spot.
There are typically 6 factors to look out for;
- The consequences of any decision in the long term interest of the company
- The interests of the company’s employees and labour force
- The need to foster business relationships with suppliers, customers and other parties
- The impact of the company’s operations on the community, environment and other parties
- Maintaining a reputation for high standards of business conduct or conduct in line with the brand
- To act fairly to suppliers, customers and the community
For everything that falls outside these 6 factors, it comes down to justification. Bear in mind that the call on whether it is justifiable will come from an impartial third party should dispute arise, then directors should be comfortable that the underlying benefit is for the business, not themselves.
Lenders & Commercial Justification
There is a concern that despite the protection of legislation, security taken for Companies/LLPs to secure borrowing may be open to challenge if Lenders are on notice or suspect that the directors/members were breaching their good faith (fiduciary) duties.
A lender must assess whether there is any reason to believe that the directors or members are acting improperly in granting the security on the basis that there is insufficient justification for the transaction. As a basic guide, to consider whether the Company or LLP granting the security benefits commercially as a direct result of granting the security.
If the justification of the for the transaction is negligible then there is a possible risk of non-enforceability and potential for loss to the lender.
Ultimately the benefit will pass through the shareholders and directors; but, the justification for the company taking on borrowing must cover at least some of these three bases;
- To grow or potentially increase the company’s profits
- To improve the future potential of the business by reducing costs elsewhere
- To otherwise improve the business
The most common reason that Commercial Benefit arises during borrowing is where during an acquisition, director’s borrowings are being refinanced or there is an operating company and proprietary company model (opco/propco) and the directors are looking to release equity in a commercial building or asset. In all of these cases, it is worth clarifying with your accountant as to whether the commercial benefit can be justified.