March 4, 2019

The Issue of Corporate Guarantees to Foreign Entities

In this month’s legal briefing we focus on the issue of corporate guarantees by Tanzanian entities to foreign entities.

The essential elements of a valid and enforceable corporate guarantee

In transactions where the principal debtor is a subsidiary company or part of a group of companies, most creditors would prefer that a corporate guarantee be issued by the parent company or any other related company as part of the security to be furnished by the principal debtor. By issuing a corporate guarantee the parent company or any other related company, otherwise known as the guarantor, is providing assurance to the creditor that should the principal debtor default in its obligations (e.g. under a loan agreement) the guarantor will be called upon to honour the guarantee. 

In Tanzania, a corporate guarantee (or any contract of guarantee), like every other contract, must satisfy all the essential elements of a valid contract, e.g. genuine consent, legality of object, competency of parties, etc. A corporate guarantee should also be supported by some consideration. No direct consideration is needed between the guarantor and the creditor, as the consideration received by the principal debtor is sufficient for the guarantor.

Furthermore, the ability of a Tanzanian company to guarantee the repayment obligations of another company is subject to the following:

  1. the powers of the company as set out in its memorandum and articles of association (that is, whether it has a specific power to guarantee the repayment obligations of other companies or a general power to do business which is broadly enough drafted to cover such an act); and
  2. the requirements for the directors to act in good faith and in the best interest of the company issuing the guarantee (the corporate benefit requirement).

Corporate benefit requirement

Under Tanzanian law, the directors of a company are required to act in the best interest of that company. If a company is granting a guarantee for another company's obligations, each director of the company granting that guarantee must ask himself/herself whether he/she can justify that company guaranteeing the other company's obligations.

The risk of giving a third party guarantee must be balanced against the actual or potential rewards.

Restrictions on the issue of corporate guarantees to foreign entities

The Bank of Tanzania (BOT) exercises regulatory control in the foreign exchange regime through the Foreign Exchange Act of 1992 (the FEA) and the Foreign Exchange Regulations of 1998 as amended by the Foreign Exchange (Amendment) Regulations of 2014 (together the FER). The FEA and the FER impose restrictions on outflow of funds from Tanzania.

Although the foreign exchange regime in Tanzania has been liberalised, some foreign exchange transactions are still subject to restriction and would require approval from the Governor of the BOT (the Governor). The Foreign Exchange Circular No. 6000/DEM/EX.REG/58 dated 24 September 1998 (the Circular) elaborates on the restrictions imposed under the FER.

Paragraph 3.3 of the Circular states as follows:

“It should be noted that outward portfolio investments, foreign lending operations in favour of non-residents, acquisition of real estate, outward direct investments, operation of offshore foreign currency accounts by residents and participation of non-residents in domestic money and capital markets are still subject of restrictions.”

Ultimately, any flow of funds from Tanzania without a corresponding inflow resulting into an economic benefit to Tanzania is a restricted transaction. A restricted transaction is a transaction that would require prior written approval from the Governor. Accordingly, outward capital account payments, other than repatriation of capital and income to foreign shareholders in respect of direct investments and transfers to foreign lenders in respect of debt servicing, are subject to restriction and should be submitted to the Governor through commercial banks for approval.

Therefore, pursuant to the Circular, where a Tanzanian entity issues a guarantee to a foreign entity, but the Tanzanian entity that issued the guarantee (or any other Tanzanian entity) is not receiving any economic benefit as a result of that guarantee, this effectively means there is no direct inflow of funds to a Tanzanian entity in order to economically justify the guarantee being issued by the Tanzanian entity to the foreign entity. This type of transaction is subject to restriction under the Circular because it is deemed to be an outward capital account transaction without a corresponding inflow.

Taking the above into account, if the structure that is being proposed envisages an outward capital account transaction without a corresponding inflow the parties should engage the BOT at an early stage to seek written approval from the Governor.

In 2014 Tanzania moved to liberalise further the foreign exchange controls by amending the FER. The amendments lifted some of the restrictions on remittances of funds for outward direct investment from Tanzania to cover member states of the East African Community.

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