Legal implications of cash pooling structures

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Cash management
Treasurers Handbook
Dr Jörg Schwerdtfeger

Maxi Wilkowski

PricewaterhouseCoopers, Frankfurt a.M

PricewaterhouseCoopers, Frankfurt a.M


When setting up a cash pool various legal implications have to be taken into consideration. In this article some of the more important aspects such as licensing requirements, insolvency aspects and reporting duties will be addressed. These aspects can also become relevant in connection with related treasury management instruments.

Legal framework

The legal framework for a cash pooling structure is often comprehensive due to various involved entities and – in the case of cross-border cash pools – because of varied jurisdictions. Moreover, complexity depends on the kind of cash pooling structure. Basically, the economic benefit of cash pooling can be achieved in two ways: physical transfer of liquidity (mostly referred to as zero balancing) and virtual transfer of liquidity (mostly structured as notional pooling).

Within a zero balancing structure, between the master account (“header account”) holder (often an ultimate parent entity or a group’s finance company) and the sub-account holders an effective lending and borrowing situation arises and the subordinated accounts will be zeroed at the end of each day. Notional pooling means that between the header account and the cash pool members’ (participants’) subordinated accounts all funds are only pooled virtually, hence no lending or borrowing situation occurs. The interest is calculated by the bank on a virtual basis and will be designated to the master account holder only. The master account holder will compensate the sub-account holders if they are in a credit position with their bank. Alternatively there are techniques in the market, where the bank directly credits interest to the participants’ accounts in the case of a credit situation, but with a margin reflecting the group’s consolidated bank account balance. Cross guarantees are often required within virtual pooling structures, by which the participants guarantee each other’s debts with the operating bank.

In general, the framework governing the cash pool often consists of two major agreements. One agreement will be closed between the master account holder and the bank offering the cash pooling (e.g. so-called “Zero Balancing Agreement”). Such a Zero Balancing Agreement will describe how funds from the cash pool members’ source accounts are swept by the bank to the header account (where the source account is in credit) and funds from the header account swept to the source account (where the source account is in deficit). Participants can enter into that agreement via separate declarations. With zero balancing it is additionally possible to involve external banks in the cash pooling. Notional pooling will only work with participants’ accounts within the same banking group. That is the reason why often prior to a Notional Pooling a Zero Balancing will take place.

Additionally an intra-group cash pooling agreement will be fixed regarding the duties within the group such as interest at arm’s length, termination rights and credit limits. The details of the intra-group relations can also be governed by attachments to the agreement, which can be easily amended if necessary. An intra-group cash pooling agreement may be less comprehensive in cases where a transfer pricing agreement already exists that governs intra-group loans.

The governing law for the intra-group cash pooling agreements is often English law for cross-border pooling. Alternatively the jurisdiction of the parent entity will be stipulated as applicable. For a Zero Balancing Agreement or a Notional Pooling Agreement, the bank will in many cases provide for a standardised agreement, with the bank’s domicile providing the legal jurisdiction. Treasurers should make themselves aware of the implications of using differing jurisdictions.

Licensing requirements

Within zero balancing intercompany loans instead of bank loans arise. In most jurisdictions the granting of loans requires a banking licence. This becomes critical in all forms of physical pooling such as zero balancing since from an economic perspective the participants are providing their liquidity to the header account (and vice versa). This process is regarded as lending from a legal perspective in numerous jurisdictions. In many jurisdictions in Europe intra-group lending is exempt from the licence requirement (group privilege). It is important to check therefore whether the members of the cash pool qualify as a group according to each relevant jurisdiction. On the other hand, there are jurisdictions where the requirement of a licence is restraining cash pooling where the placing of loans on a regular basis is considered a banking activity restricted to banks. Within Notional Pooling where often cross-guarantees are granted a license regarding guaranty business could be mandatory. However, in most European jurisdiction the group privilege will apply.

Corporate and insolvency law

Cash pooling has a considerable impact on the participant’s finance situation. A timely consent of the competent bodies, such as a supervisory board, is therefore highly advisable – or even legally required by the local jurisdiction.

In various jurisdictions provisions for the protection of shareholders and creditors have to be taken into account. Cash pooling can become disadvantageous in cases where participants or header account holders become insolvent. An uncontrolled liquidity outflow can have detrimental effects. Prominent situations which have been covered by the media or which have become subject to court decisions were Bremer Vulkan and Lehmann UK. The risks for the participant’s existence become even more critical, if the participant not only suffers a liquidity outflow but has also issued a guarantee regarding the insolvent participant.

One legal measure to protect a participant’s equity and funds, particularly in favour of a creditor, are capital maintenance requirements, e.g. as in Germany. This means that in cases where a controlling or profit transfer agreement does not exist liquidity may only be transferred as a loan to a parent entity, where the respective corporation’s receivable will be of full value. With private limited liability companies this rule is only applicable to the assets covering the share capital. In English law provisions and doctrines exist which take into account the position of the company’s creditor.

Another measure to protect a participant’s existence can be a legal obligation to provide for adequate risk management. This can involve an early warning system, for example using economic ratios and an obligatory notice to the other cash pool participants if these ratios reach prescribed levels. This gives participants the possibility to leave a cash pool in time, provided there are adequate termination rights.

The participant’s protection has also to be considered when the bank offering the cash pooling demands a guarantee from the participant for a header account’s debit position. The guarantor should consider if a timely revocation of such a guarantee can be effected at least for future debts. Risk management will become even more important, not only for the cash pool, but also where a participant’s receivables are transferred via a sales and transfer agreement.

Moreover, the shareholders (i.e. pool leader) should take insolvency regulations into account as well. In Germany, loans granted by a shareholder are subordinated to other debts. That can make downstream loans to a cash pool less advantageous compared to bank deposits – at least in the light of insolvency regulations.

Furthermore repayments of loans or interest paid to a shareholder can in some jurisdictions be challenged in the event of the subsidiary’s insolvency.

Conflicts of interest within the management board

A conflict of interest might arise when one or more board members of the parent company are at the same time board members of the subsidiary. In times when a participating company in a cash pool is in economic crisis conflicts of interests could arise for the respective board members. This is because the transfer of liquidity from the subsidiary towards the parent company might be economically disadvantageous for the subsidiary, whereas for the parent company the transfer is economically necessary. That means the particular board member must take different decisions regarding the same questions. The management board must be aware of this conflict situation and the resulting higher liability and criminal law risks. Group companies where this situation could occur should deal with these risks within the framework of the cash pooling agreements. For example regularly monitoring rights to identify potential conflicts of interests should be agreed.

Reporting duties

In most jurisdictions there are reporting requirements regarding cross-border payments. When negotiating a cash pool agreement, it should be clarified how these requirements will be fulfilled and which party bears the ultimate responsibility.

Moreover, in some Eastern European jurisdictions loan agreements, even within a group, have to be reported. That means participants generally have to apply for a so-called transaction passport. This involves a number of documents including the loan contract being submitted by the participant to the cash-pooling bank. In other jurisdictions cross-border cash pooling is also difficult due to foreign currency regulations. All in all, this could become a stumbling block for cash pooling since the authorities can argue that each single money transfer at the end of the day forms a separate loan, thus requiring daily documentation. Here, preliminary contact with the relevant authorities (e.g. the local national bank) will be sensible.

Applicability to related treasury management instruments

In order to minimise costs for banking relations payment and collection factories are increasingly becoming best practice. This applies especially to multinational groups operating with different currencies. Payment and collection factories can, inter alia, be constructed and interpreted in a way that outgoing payments result in intercompany claims and incoming payments result in intercompany liabilities of the entity operating the “Factory”. These internal claims and liabilities replace economically previous existing balances of group companies with banks and can be subject to an internal netting procedure.

Similar to cash pooling such a construction has to be scrutinised especially under aspects of capital maintenance and insolvency. An examination is also advisable regarding a possible licence requirement regarding money transfer business – even if in many cases a regulation can be avoided via the so-called group privilege (see above).