The complete guide to the cash flow agreement: definition, method, examples

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Signature of a cash flow agreement

Agreements: Definition, Method, Examples

Cash agreements formally define the terms and conditions of cash loans and advances that may take place within a group of companies, most often between a parent company and its subsidiaries. This is a vital contract to protect the entity against the legal and tax risks associated with such cash transactions.

What is a cash agreement? What companies does it apply to? Why is it important? How is it written? In this article you will find all the answers to your questions about cash management agreements.

Cash Agreement Defined

A cash agreement is a contract between several entities forming a group. It defines the ways in which these companies (for example a holding company and its subsidiaries) can transfer finances to one another.

When a group comprises several legal entities, some companies or subsidiaries may have financing needs which are then provided by another entity in the group rather than resorting to borrowing funds. In some groups, cash may be widely centralised via a cash pooling system.

The cash management agreement defines the terms and conditions governing these financial transactions. This is the best way to avoid legal risks, as cash flows are subject to specific legal conditions.

In general, a cash management agreement is drafted with the help of a lawyer or legal expert.

What is an intra-group loan?

When a group company has financing needs (e.g. when you open a new subsidiary and need to invest in recruitment, communication, premises, etc.), rather than resorting to a bank loan, the parent company or another group company can provide the necessary cash. This is called an intra-group loan.

But be careful, as these loans (or cash advances) must be provided in compliance with a specific legal and tax framework. In particular, there must be a common economic, social or financial interest between the creditor company and the debtor company. It may be a commercial interest, an interest for the group, for the survival of a subsidiary, or an economic interest via the interest paid on the loan.

It is therefore essential to clarify the scope of such intra-group cash transactions.

What is a Cash Agreement?

The cash management agreement must be in writing (often drafted with the help of a lawyer) and signed by all the companies concerned. And it must contain certain information:

The Parties: clearly indicate all the group entities to which the cash management agreement applies.

The purpose of the agreement: for example, pooling cash requirements and surpluses.

The term: define a validity period for the cash management agreement.

How it works: the text of the agreement must explain how the financial flows will be used within the group: frequency of flows, current accounts involved, repayment terms, etc.

Interest: the cash flow agreement must indicate how interest will be calculated on cash advances, loans and investments.

Dispute resolution: in the event of a disagreement, the cash management agreement must indicate the procedure to follow and the competent court for settling disputes.

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Legal framework of the cash management agreement

Even though it may seem quite natural to have cash movements within the same group and they are very often set up by the directors of a company with multiple entities, they are strictly governed by a certain number of legal provisions.

Cash management Agreement and Monetary and Financial Code in France

Basically, as indicated in Article L. 511-5 of the French Monetary and Financial Code, only credit institutions (banks) or finance companies are authorised to carry out credit transactions on a regular basis, i.e. to lend money to companies. This is the banking monopoly that has existed for many years in France and Europe.

However, there are some exceptions to this rule: Article L. 511-7 3. of the Monetary and Financial Code authorises a company, whatever its nature, to carry out cash transactions with companies that have direct or indirect capital ties with it, giving one of the affiliated companies effective control over the others. The companies in question may be of different legal forms, e.g. limited companies, joint-stock companies, non-trading property partnerships, etc.

The cash management agreement establishes a framework and regulates these cash transactions between entities in the same group, thereby providing protection against potential disputes and lawsuits.

But note that: the normality of a transaction will always be assessed based on the amounts and interest rates charged, whether there is a cash management agreement or not.

Are cash management agreements regulated agreements?

Cash management agreements are usually considered to be current transactions. They are therefore outside the scope of regulated agreements (if they are made on an arm’s-length basis).

Depending on the type of transactions you carry out and the size of your company, it may however be advisable to subject your cash management agreements to the regulated agreements procedure. There are two main reasons for this:

● you avoid the risk of a lawsuit for undue use of majority powers;

● you can prove that there is a contract in the event of a tax audit, by recording your agreement in a special report.

Why set up a cash management agreement?

A cash management agreement aims primarily to limit the legal and tax risks. It allows you to:

● avoid the criminal risk of fraudulent use of corporate property for the directors, resulting from a debit balance on a current account;

● streamline financial flows to avoid any merger of assets or de facto control in the event of insolvency proceedings;

● furnish justification to the Tax Administration, which therefore cannot invoke any unlawful distribution in the context of intra-group loans.

In practice, a cash management agreement is a guarantee that directors will not incur any criminal liability.

The cash management agreement also paves the way to improving the company’s financial management, by centralising cash management.

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Drafting a cash agreement

A cash management agreement is subject to the freedom of contract principle, so there is no standard model, and it must be adapted to your specific requirements. However, it must contain certain vital provisions.

Your cash flow agreement must specify:

● the identity of the parties (the companies concerned);

● recitals indicating the lead company in the group and the role of the hub company (if there is one);

● the capital ties between the different entities, with a reference to the applicable legislation;

● the manner in which the funds advanced to the hub company may be used;

● the frequency of transfers and the terms and period of repayments;

● the interest payable on advances received and loans granted;

● the parties’ signatures.

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Cash management agreement template

Below is a complete list of what you can include in your cash management agreement:

● Parties

● Recitals

● Purpose of the agreement

● Terms and conditions

○ Mandate

○ Provision of funds

○ Loan repayments

○ Payment for the pooling service

○ Interest calculation

● Term of the agreement

● Renewal

● Change of scope

● Merger of assets

● Extension of bankruptcy

● Abnormal act of management - Fraudulent use of corporate property

● Dispute resolution

● Signatures

To draft a cash management agreement, it is advisable to use the services of a legal and business management professional, who will analyse your project from a legal and fiscal perspective.

For feedback from companies that have implemented a cash management agreement, you can join the Cash is King community of company executives, financial managers and experts who exchange daily in a dedicated Slack group on cash flow, investments, financial tools and many other topics.

Intra-group cash agreement methods

Depending on their needs and the type of financial transactions carried out, corporate groups can implement different methods to manage cash flows between entities.

Direct flows

You can transfer cash directly between companies, with inflows and outflows of cash recorded as claims and debts. Legally speaking, this implies direct creditor/debtor relations between the companies concerned.

In this case, each company concerned has a current account (in credit or debit) with the other company.

Hub company

The most widely-used model consists in defining a hub company, which acts as the intermediary and redistributes the cash. In this kind of cash management arrangement (corresponding to a model between a parent company and its subsidiary), all the cash transactions will be managed by the hub.

The hub company manages the current accounts. And takes different actions:

● analysing the cash surpluses and shortages of each company to determine the cash flow requirements of each one;

● collecting and centralising available funds in a current account;

● redistributing cash and acting as borrower and lender to the subsidiaries.

In general, the cash is invested by the parent or holding company, in which case, this activity must be included in its corporate object.

Cash management agreement between sister companies

Sister companies are companies whose shares are held by one and the same director, i.e. a natural person.

As a reminder, for France, the Monetary and Financial Code stipulates that a company "may only carry out cash transactions with companies that have direct or indirect capital ties with it, giving one of the affiliated companies effective control over the others. " (French Mon. and Fin. Code Art. L. 511-7-3).

To meet these conditions, the director must therefore exercise “effective control” over the companies in question. In other words, a cash management agreement is deemed valid when it is formed between two sister companies whose shares are held by one and the same director. From a legal standpoint, the director must be the majority shareholder in one, and hold at least half the shares in the other.

Furthermore, the French Banking Regulation Committee (CRB) accepts an agreement between two sister companies in the same group, without the involvement of the parent company, provided that the condition of effective control is met.

Interest on loans

Loans or cash advances between companies in a group must have a reciprocal economic, social or financial interest for the creditor company and the debtor company. This generally lies in the interest paid on advances and loans.

Does interest have to be paid on loans and cash advances?

Cash transfers from one company to another within a group are closely scrutinised by the tax authorities. Intra-group loans must be remunerated by interest calculated on the basis of market rates determined with regard to the specific conditions of the cash transactions, particularly in terms of guarantees.

In some cases, however, it is possible to make interest-free advances, but it must be possible to justify them.

If no interest has been paid, or if the rate charged does not correspond to the market (too low or too high), the tax authorities may initiate proceedings for an abnormal act of management. The resulting tax adjustments may concern all the companies involved in the cash management agreement.

In some cases, the director may even be accused of fraudulent use of company property, abuse of power or undue use of majority powers. This is why it is crucial to formally define your cash management agreement and to include the terms and conditions of interest.

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Defining interest on advances

To define the interest rate of a loan or advance, different references can be used:

● the market rate (or the rate that the borrowing company could have obtained from a financial institution under similar conditions);

● the rate that corresponds to the amounts actually borrowed by the lending company.

In the second case, the lending company must prove that it has incurred a specific debt, or estimate the interest according to the rate it would have obtained if it had invested this sum. The Euribor 3-month rate may be used as a reference.

Is VAT payable on interest?

In principle, financial transactions are exempt from value added tax.

But note that intra-group transactions corresponding to services rendered or a cash management service are subject to VAT. This applies both to the parent company, which may need to invoice for this type of service, and to the hub company. The VAT applies to management fees.

Cash pooling and cash agreement

When cash pooling is done through a bank, it may also require a cash management agreement to be signed.

This cash management agreement then corresponds to the agreement signed between the pooling company (acting on its own behalf and as agent for the other companies involved) and a credit institution. This optional agreement allows cash management to be automated.

Signing a cash management agreement with a bank does not exempt the company from introducing an internal cash management agreement to officialise the existence of the arrangement and define its terms and conditions.

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