Legacy debts are one of the hidden costs which bedevil companies in transitional situations (mergers, acquisitions, business transitions). Legacy debts refer to debt obligations incurred by a target company and its predecessors in title, which are inherited by the acquiring company. These debts are usually difficult to identify during transactional due diligence, as they are sometimes concealed within obscure transaction documentation.

The concept of odious debt refers to the particular set of equitable considerations that have often been raised to adjust or sever debt obligations in the context of political transitions based on the purported odiousness of the previous regime and the notion that the debt is incurred did not benefit, or was used to repress the objects for which the loan is taken.

It should be noted that the legal obligation to repay a debt has never been accepted as absolute and has been frequently limited or qualified by a range of equitable considerations, some of which may be regrouped under the concept of “odiousness” which may be invoked in order to invalidate debt obligations. In determining whether to assume the legacy debt, regard is often had to the purpose for which the debt was incurred. If the legacy debt was incurred for an illegal purpose or a purpose which is profligate or inconsistent with the objects of the company, the acquiring company may apply to the court to adjust or sever the legal obligations arising from the transaction.

Debts that may be viewed within this spectrum include debts undertaken by a board in order to prevent a takeover attempt, debts undertaken to subsidize personal expenses of managerial staff, as well as debts incurred to finance criminal activities. A problem may however arise where the purported odious debt conferred some tangible benefit in whole or in part upon the corporate entity and its successors in title. This implies balancing the concept of sanctity of contract against the reality of protecting the funds of the company from embezzlement or wastage.

Generally speaking, when corporate succession occurs, whether through dismemberment, acquisition or some other change that alters the nature of the corporate entity itself, legal obligations are not thought to be automatically transferred to the new corporate entity because as a formal matter the identity of the corporate entity has changed and the new company has not expressed its will to be bound by the debts incurred by its predecessors. The question thus arises whether to commence business on a clean slate, thereby reducing the incentives of companies to enter binding contracts or enshrine financial stability by inheriting the debts incurred prior to its existence.

There is a rich case law concerning the limits of contractual freedom, whereby contractual obligations have been found unenforceable or partly enforceable without substantially preventing the growth of sophisticated financial markets. Some scholars are of the view that contracts made by a predecessor that are of no advantage to the company should not be honoured, in particular where the funds have been applied to purposes that are harmful to the company. Other authors suggest that the total repudiation of the debt would cause substantial injustice and in order to equitably invoke this principle the debtor would have to partially repay the debt. This position places emphasis on equitable arguments to do what is right and just in the circumstances.

In general, the law of contract provides ample room for a judge or adjudicator to balance the equities in a case involving illegal or immoral behavior of one or more parties to the transaction. The treatment of odious debt should therefore be based on the equitable considerations underlying the transaction and the after effects of the legacy debt on the affairs of the company. Consequently, a legacy debt which enhances the book value of the firm over the long term is easier inherited than a legacy debt which leads to long run reduction on the book value of the firm. In the event of the former, the principle of promissory estoppels may apply to prevent the successor company from repudiating the debt.

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