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Cash pooling – a legal perspective

Group Reorganisations

Intercompany Agreements

28 March 2022

Thanks very much to everyone who attended our recent interactive webinar on the basics of intercompany agreements for financial transactions. If you missed it, you'll find a recording here.

One of the issues we discussed was cash pooling arrangements, both physical and notional, and in this blog post I'd like to delve a little deeper into the legal aspects of these. Because while cash pooling arrangements often have important transfer pricing implications, the legal implications are arguably more immediate and more significant in terms of personal liability risks for directors.

The reasons for this are not hard to understand. In a ‘physical’ cash pooling arrangement, the participating legal entities give up control over their own cash, through regular (often daily) ‘sweeps’ of account balances to the cash pool leader. This means that cash pool participants are exposed to a credit risk relating to the future ability of the cash pool leader to meet a demand for repayment of cash on demand at short notice.

From a corporate governance perspective, directors of local legal entities are often personally accountable for breaches of duties to consider the interests of third-party creditors and employees. In addition, provisions of local law regarding capital maintenance and banking regulation, as well as the terms of contractual arrangements with third parties (such as lenders or government bodies), may impose legal restrictions on the extent and manner in which local legal entities may properly participate in cash pooling arrangements.

These local law considerations will need to be reflected in a number of aspects:

  • the legal and commercial terms of the cash pooling agreement;
  • documenting the due consideration of liquidity and other risks as part of the corporate approval process on the set-up of the cash pooling arrangements; and
  • periodic, ongoing review by directors of the relevant legal entities of whether it remains appropriate for them to continue to participate.

As with any other intercompany transaction type, the transfer pricing analysis needs to be aligned with the relevant legal terms, and vice versa. This alignment will include, among other things:

  • the interest rates payable on debit and credit balances (with the margin earned by the cash pool leader often constituting its primary compensation;
  • the legal terms regarding repayment dates and provision of information;
  • the presence or absence of parent company guarantees; and
  • the scope of the treasury or cash management functions performed by the cash pool leader.

So-called ‘notional’ cash pooling arrangements are somewhat different. Here, there may be no actual transfers of cash between the participants. Instead, the bank will notionally aggregate and net off balances across the relevant legal entities’ bank accounts. The benefit for participants is often reduced interest and charges.

The legal documentation of notional cash pooling arrangements is often primarily provided by the relevant bank. These arrangements will often involve the provision of cross-guarantees by all of the cash pool participants. This results in similar liquidity risks as for physical cash pooling.

Whatever the form of cash pooling arrangements, the design, implementation and maintenance of the structure should be approached with a risk-based perspective. A primary consideration is to ensure that an appropriate paper trail is maintained, so that if directors are ever challenged they can explain the positions they adopted.

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Article by
Paul Sutton
LCN Legal Co-Founder

Free Guide: Effective Intercompany Agreements for TP Compliance