For treasurers of multinational corporations, cross-border cash pooling can be a vital tool for managing cash on a daily basis. And it makes a great deal of sense to have some members of a corporate group offer up their excess cash in order to meet the needs of the enterprise, from repayment of corporate debt to support of business units that need an influx of capital, to investment of aggregated cash balances for optimal returns. However, waters in the cash pool can turn murky when the enterprise is in distress.
Because legal structures and documentation differ between physical cash pools and notional cash pools, the effects of financial distress on an organization’s cash flows depends on which of these structures defines the cash pool. The differences between a physical and a notional cash pool are significant.
Unless it has executed a separate guaranty, contribution agreement, or indemnity agreement, or otherwise benefits from a special legal theory (such as disregard of corporate formalities, fraudulent transfer, or preference), a cash pool participant that is unpaid by an insolvent cash pool leader can look only to the cash pool leader for recovery. Likewise, if a business unit that has received funds from the cash pool becomes distressed, the cash pool leader may proceed only against the particular cash pool participant to which it has advanced those funds.
Notional cash pooling presents very different challenges in the event of insolvency. A notional cash pool involves a credit relationship between the bank and each cash pool participant—albeit a credit relationship that is supported and secured by other entities’ excess cash balances—but it does not, by default, involve legal obligations among the different cash pool participants. In the event of financial distress, and in the absence of separate contracts or special legal theories, participants in a notional cash pool have no rights against any other cash pool participant, even if funds from solvent cash pool participants are used to pay the debts of cash-starved participants.
There are few legal guides for the application of subrogation in the cash pooling context. Nevertheless, notional cash pooling may give rise to circumstances of unsatisfied cash deficiencies that can be remedied by subrogation. Legal tests vary by jurisdiction, but a common one recognizes five elements that should be present to support a subrogation claim:
- payment must have been made to protect the claimant’s interest,
- the claimant must not be a mere volunteer,
- the claimant must not be primarily liable for the debt,
- the entire debt must be paid, and
- subrogation must not work an injustice to others.
The term “claimant” here is the party seeking subrogation rights (known as a “subrogee” in legal parlance).
Varying legal elements surface when considering the choice of law and jurisdiction related to any subrogation claim. Because these claims arise by law or equity, there will be no governing contractual choice of law to look to. One might contend that the governing law of the cash pooling program should apply to subrogation claims. But that case competes with other possibilities, such as the law of organization or headquarters of either the claimant or defendant, and also the location of relevant bank accounts. There does not exist at this time any legal guiding principle—and this presents a major impediment to satisfactory and predictable recovery in the event of insolvency within the enterprise. For this reason, it advisable to ensure that a contribution and indemnity agreement includes (among other things) the selection of applicable law and venue for hearing any disputes.
In a distressed enterprise situation, the rights of cash pool participants against one another also becomes highly relevant under some local corporate laws and other laws. These issues raise generally the question of corporate benefit. A starting point in most jurisdictions revolves around the specific findings of the board of directors (and, in some jurisdictions, the shareholders) that the program confers corporate benefit. This should be made explicit in the relevant resolutions and minutes of meetings. This benefit is easy to see when things are going well—the cash pool participant will experience assurances of liquidity and capital at a competitive cost.