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or branches making KPMG able to assess via interviews with the selected companies practical ......
Contract ETD/2006/IM/F2/71
kpmg.com
KPMG Feasibility Study on Capital Maintenance – Annexes Part 1
Kontakt KPMG Deutsche TreuhandGesellschaft Aktiengesellschaft Wirtschaftsprüfungsgesellschaft Klingelhöferstraße 18 10785 Berlin Germany Georg Lanfermann T +49 30 2068-1262 F +49 1802 11991-1262
[email protected]
The information contained herein is of a general nature and is not intended to address the circumstances of any particular individual or entity. Although we endeavor to provide accurate and timely information, there can be no guarantee that such information is accurate as of the date it is received or that it will continue to be accurate in the future. No one should act on such information without appropriate professional advice after a thorough examination of the particular situation.
2008 KPMG Deutsche Treuhand-Gesellschaft Aktiengesellschaft Wirtschaftsprüfungsgesellschaft, a member firm of the KPMG network of independent member firms affiliated with KPMG International, a Swiss Cooperative. Printed in Germany. KPMG and the KPMG logo are registered trademarks of KPMG International.
Contract ETD/ 2006 / IM / F2 / 71 Feasibility study on an alternative to the capital maintenance regime established by the Second Company Law Directive 77/91/EEC of 13 December 1976 and an examination of the impact on profit distribution of the new EU-accounting regime
Annexes – Part 1
Contract ETD/2006/IM/F2/71
kpmg.com
KPMG Feasibility Study on Capital Maintenance – Main Report
Contact KPMG Deutsche TreuhandGesellschaft Aktiengesellschaft Wirtschaftsprüfungsgesellschaft Klingelhöferstraße 18 10785 Berlin Germany Georg Lanfermann T +49 30 2068-1262 F +49 1802 11991-1262
[email protected]
The information contained herein is of a general nature and is not intended to address the circumstances of any particular individual or entity. Although we endeavor to provide accurate and timely information, there can be no guarantee that such information is accurate as of the date it is received or that it will continue to be accurate in the future. No one should act on such information without appropriate professional advice after a thorough examination of the particular situation.
2008 KPMG Deutsche Treuhand-Gesellschaft Aktiengesellschaft Wirtschaftsprüfungsgesellschaft, a member firm of the KPMG network of independent member firms affiliated with KPMG International, a Swiss Cooperative. Printed in Germany. KPMG and the KPMG logo are registered trademarks of KPMG International.
Contract ETD/ 2006 / IM / F2 / 71 Feasibility study on an alternative to the capital maintenance regime established by the Second Company Law Directive 77/91/EEC of 13 December 1976 and an examination of the impact on profit distribution of the new EU-accounting regime
Main Report
KPMG Feasibility Study on Capital Maintenance - Annexes Part 1
Annexes - Part 1 Contents Pages
1
Sample methodology
1-4
2
Key questionnaires
5 - 44
2.1 CFO questionnaire 2.2 IFRS questionnaire
5-7
Legal annexes
45 - 309
3.1 EU legal annexes
45 - 175
3
3.1.1 3.1.2 3.1.3 3.1.4 3.1.5
France Germany Poland Sweden United Kingdom
3.2 Non-EU legal annexes 3.2.1 3.2.2 3.2.3 3.2.4 3.2.5
4
USA Delaware USA California Canada Australia New Zealand
8 - 44
45 – 71 72 - 106 107 - 129 130 - 146 147 - 175 176 - 309 176 - 207 208 - 239 240 - 252 253 – 288 289 - 309
Private companies
310 - 338
4.1 4.2 4.3 4.4 4.5 4.6
310 - 316
France Germany Poland Sweden (not applicable) United Kingdom Summary
317 - 322 323 - 329 330 331 - 336 337 - 338
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KPMG Feasibility Study on Capital Maintenance - Annexes Part 1
1
Sample methodology
1.) Methodology - Sample of Listed Companies to be interviewed The purpose of this sample was to extract 4 to 8 companies per country of different sizes and / or branches making KPMG able to assess via interviews with the selected companies practical implications at the level of individual companies. Consequently, the interviews have made KPMG able to identify the crucial features and aspects of the incremental costs linked to national requirements regarding capital formation and capital maintenance as well as for profit distribution in each of the various jurisdictions. The jurisdictions have been legally analysed before. For meaningful results KPMG interviewed persons at the company at a very senior level, namely the Chief Financial Officer or legal counsels. Therefore KPMG looked at stock listed companies. In a first step KPMG identified the main stock exchanges in each of the different countries that have been part of this study: • • • • • • • • •
Deutsche Börse (Germany) Euronext Paris (France) London Stock Exchange (UK) Stockholmsbörsen – OMX Group (Sweden) Warsaw Stock Exchange (Poland) NYSE, NASDAQ (USA) Toronto Stock Exchange (Canada) Australian Stock Exchange (Australia) New Zealand Stock Exchange (New Zealand)
While looking at the stock exchanges KPMG analysed the indices at each of these stock exchanges and identified the most common indices. Generally, these have been one large cap index, one mid cap and one small cap index per Stock exchange / per country. The exact names of the indices you can take from the tables below.
D DAX MDAX TecDAX SDAX GSI ESI
F CAC 40 CAC Next 20 CAC Mid 100 CAC Small 90 Alternext Allshare
Indices EU UK FTSE 100 FTSE 250 FTSE SmallCap
SWE OMX S 30 OMX S Attract 40
PL WIG 20 Mid WIG WIRR
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KPMG Feasibility Study on Capital Maintenance - Annexes Part 1
Indices Non-EU USA S&P 500 S&P MidCap S&P SmallCap
CAN S&P/TSX 60 S&P/TSX MidCap S&P/TSX SmallCap
AUS S&P/ASX 50 S&P/ASX MidCap S&P/ASX Small Ordinaries
NZ NZX 10 NZX MidCap NZX SmallCap NZAX
Basic consideration was to draw a sample under size aspects to achieve comparability between the countries. Inter alia, KPMG considered possible denominators like revenues, balance sheet total or number of employees. KPMG decided that market capitalisation would be the most practicable indicator as denominator for company size. For a better comparability the market capitalisation of each firm was retrieved for a specific point in time by September 15th 2006 and converted into Euro (Exchange Rates as of 09/15/2006). Exchange Rates (09/15/2006) GBP 0.67536 GBP 1 SEK 9.24253 SEK 1 PLN 3.96572 PLN 1 USD 1.27070 USD 1 CAD 1.42096 CAD 1 AUD 1.68651 AUD 1 NZD 1.93324 NZD 1
€uro 1 €uro 1 €uro 1 €uro 1 €uro 1 €uro 1 €uro 1
€1.48069 €0.10820 €0.25216 €0.78697 €0.70375 €0.59294 €0.51727
To achieve a diversified picture, KPMG determined a number of companies varying in size and if possible in industry to gain a general overview. Thus, KPMG took as a basis all companies listed on the most common indices (Large Cap, Mid Cap and Small Cap Indices and if available an Alternative Index – to catch small and newly founded companies) of the main stock exchanges in each country as the universe under consideration. Detailed figures you can take from the table below. Universe – Companies listed on the selected Indices (09/15/2006) EU Non-EU D F UK SWE PL USA CAN AUS Number of Companies
387
317
685
267
140
1500
281
299
NZ 132
In a further step KPMG put the listed companies into order by market capitalisation and defined different classes to generate companies of different sizes. The class sizes are: < Bn€ 0.4, Bn€ 0.4 to 1, Bn€ 1 to 10, Bn€ 10 to 50 and > Bn€ 50 of market capitalisation. Furthermore, KPMG decided to consider only listed companies of one agglomeration area per country if feasible. For a better practicability and because of the tight time line of this study, the focus on one agglomeration area per country has helped KPMG to avoid inter alia long travel times between the single interviews. The agglomeration has been chosen in a way that it will still ensure an adequate number of companies of different sizes are represented in the sample. As result KPMG had got the following number of companies per agglomeration area to select the companies for the interviews:
2
KPMG Feasibility Study on Capital Maintenance - Annexes Part 1
Market Cap Classes In €Bn > 50 10 – 50 1–5 0,4 – 1 < 0,4
Listed Companies per Agglomeration Area and class EU France Germany Poland Sweden Paris
All
All
8 25 64 32 41
4 22 55 43 54
UK
Stockholm 13 12 9 106
London 9 34 11 80
4 23 94 41 50
Non-EU Market Cap Classes In €Bn
USA
Canada
Australia
New Zealand
California
Toronto / Montreal
Sydney / Melbourne
Wellington / Auckland
8 25 104 55 29
> 50 10 – 50 1 – 10 0,4 – 1 < 0,4
18 51 34 5
1 10 73 37 41
8 6 77
As a result of the extraction process, KPMG finally interviewed the following number of companies: Market Cap Classes In €Bn > 50 10 – 50 1 – 10 0,4 – 1 < 0,4 Market Cap Classes In €Bn > 50 10 – 50 1 – 10 0,4 – 1 < 0,4
EU Germany
France
2 2 1 2
2 1 2
UK 1 1 2 1 1
Sweden
Poland
1 1
1 2
Non-EU USA (Cal inc) 1
USA (Delaware inc) 1 1 2
Canada
Australia
New Zealand
1 1 1 2 2
2.) Methodology – CFO Questionnaire Sample The aim of the CFO questionnaire was to collect the views of CFOs on a wider statistical basis. As such, the CFO questionnaire was directly addressed to the CFO or CEO of each of the companies. To facilitate answers to the questionnaire, the questionnaire was limited to 5 questions. The population of companies is consistent with the starting basis for the sample of listed companies selected for detailed interviews. The universe of all listed companies on the most common indices in each country was reduced by irrelevant listed entities, like trusts, funds, foreign companies and companies which had become insolvent. In total, 3,578 companies
3
KPMG Feasibility Study on Capital Maintenance - Annexes Part 1
have been contacted. Overall, 157 filled-in questionnaires have been returned (4.39 percent). For more details, please refer to the tables below: Sample Size D Number of Companies
EU UK
F
344
287
515
SWE 245
PL
USA
133
1476
Non-EU CAN AUS 201
252
NZ 125
Responses D Number of Companies Percentage
4
EU UK
F
SWE
PL
USA
Non-EU CAN AUS
NZ
27
8
29
21
3
33
8
19
9
7.85
2.79
5.63
8.57
2.26
2.24
3.98
7.54
7.20
KPMG Feasibility Study on Capital Maintenance - Annexes Part 1
2
Questionnaires 2.1 CFO-questionnaire This questionnaire has been sent to 3,578 stock corporations in the nine countries under consideration. Concerning the selection of these companies, please refer to the previous section concerning sample methodology.
5
KPMG Feasibility Study on Capital Maintenance - Annexes Part 1
6
KPMG Feasibility Study on Capital Maintenance - Annexes Part 1
7
KPMG Feasibility Study on Capital Maintenance - Annexes Part 1
2.2 IFRS-questionnaire This questionnaire has been sent to the KPMG firms in the 27 EU member states for due completion. The results to this questionnaire are incorporated in section 4 of book 1.
Introduction KPMG Deutsche Treuhand-Gesellschaft AG (KPMG Germany) is currently conducting a study on the potential modification of the Second Council Directive 77/99/EEC on the formation of public limited liability companies and the maintenance and alteration of their capital. This study was awarded to KPMG Germany by the European Commission. Amongst other issues the Commission seeks to gain information on the potential impact of the application of IFRS on the determination of distributable profits. This is partially caused by the requirement set by IAS Regulation (EC) 1606/2002 which requires companies to prepare consolidated financial statements according to International Financial Reporting Standards (IFRS) from 2005 onwards if their securities are admitted to trading on a regulated market of any Member State. The Regulation also contains a choice for the member states to permit or require companies to prepare their Consolidated Financial Statements according to IFRS if their securities are not publicly traded. The same choice is also available for the Single Financial Statements (annual accounts) of the companies. To satisfy the information needs of the European Commission we have developed a short questionnaire on selected issues in which the EU is interested. Part I of the questionnaire should be filled in by all KPMG DPPs of the EU-Member States. Only a brief description of the local situation is requested. The main focus of the study lies on the companies governed by the second directive. Please indicate in your answers, if other “corporations” are treated differently. Furthermore the questions on accounting treatment refer solely to recognition and measurement rules. Disclosure requirements are not subject of this study. Part II of the questionnaire is only addressed to the KPMG DPPs of the following countries: ¾ France, 8
KPMG Feasibility Study on Capital Maintenance - Annexes Part 1
¾ Germany, ¾ Poland, ¾ Sweden, and ¾ United Kingdom. Selected sample answers for Germany are attached as an example to this questionnaire.
All answers shall be based on the IFRS and national GAAP effective as at December 31, 2006.
Thank you for your support.
9
KPMG Feasibility Study on Capital Maintenance - Annexes Part 1
Part I – All EU-Member States
Field of Study 1 The European Commission is interested in a complete list of Member States containing information on which financial statements are required or permitted to be used in the determination of distributable profits. Therefore we ask the following questions:
Question 1: Are IFRS permitted or required by legislation to be used to prepare consolidated financial statements of companies not required to apply IFRS by Regulation EC (1606)/2002 (non-listed companies) and/or to prepare single financial statements? Please fill in the following matrix and add supplementary comments if necessary:
Consolidated Accounts
Annual Accounts (single financial statements)
National
IFRS
GAAP
National
IFRS
GAAP
Publicly Traded
Required F
Required F
Required F
Required F
Companies 1)
Allowed F
Allowed F
Allowed F
Allowed F
Non-publicly Traded
Required F
Required F
Required F
Required F
Companies
Allowed F
Allowed F
Allowed F
Allowed F
1) see Article 4 and Article 5 of Regulation (EC) 1606/2002 of the European Parliament and of the Council of 19 July 2002 on the application of international accounting standards THE EUROPEAN PARLIAMENT AND THE COUNCIL OF THE EUROPEAN UNION.
Question 2a: Is it permitted/required to determine distributable profits based on financial statements prepared according to IFRS. Yes F
10
No F
KPMG Feasibility Study on Capital Maintenance - Annexes Part 1
Question 2b: In case the answer to question 2a is “yes”: Is the net profit or loss according to IFRS regarded as distributable profit or are modifications of this profit required? In case modifications are required please indicate any guidance on the modification (Who issued the guidance? Is the guidance binding? Title of the document…)
Explanation: ___________________________________________________________________ ___________________________________________________________________ ___________________________________________________________________
Question 3: Please indicate on a scale from 1 (similar) to 5 (not similar) whether you consider that the rules of IFRS compared with local GAAP are similar or not (qualitative assessment). Please only take into account recognition and measurement rules (no presentation and disclosure issues). Please indicate furthermore whether, in the case of a conversion of local financial statements to IFRS, you would generally expect an increase or decrease in equity or no impact from the (practical) application of a standard in your country (quantitative assessment). I. e. take into account the choices made in practice (for example consider whether most companies apply the cost model instead of the fair value model of IAS 40). This means that a theoretical overall assessment of all companies in your country is necessary. ` Standard
1
2
3
4
5
Indication of impact on equity Increa
Decrea
No
se
se
impact
IAS 2 – Inventories
F
F
F
F
F
F
F
F
IAS 8 – Accounting Policies, Changes
F
F
F
F
F
F
F
F
F
F
F
F
F
F
F
F
in Accounting Estimates and Errors IAS 11 – Construction Contracts
11
KPMG Feasibility Study on Capital Maintenance - Annexes Part 1
IAS 12 – Income Taxes
F
F
F
F
F
F
F
F
IAS 16 – Property, Plant and
F
F
F
F
F
F
F
F
IAS 17 – Leases
F
F
F
F
F
F
F
F
IAS 18 – Revenue
F
F
F
F
F
F
F
F
IAS 19 – Employee Benefits
F
F
F
F
F
F
F
F
IAS 20 - Accounting for Government
F
F
F
F
F
F
F
F
F
F
F
F
F
F
F
F
IAS 23 – Borrowing Costs
F
F
F
F
F
F
F
F
IAS 27 – Consolidated and Separate
F
F
F
F
F
F
F
F
IAS 28 – Investments in Associates
F
F
F
F
F
F
F
F
IAS 29 – Reporting in Hyperinflationary
F
F
F
F
F
F
F
F
IAS 31 – Interests in Joint Ventures
F
F
F
F
F
F
F
F
IAS 36 – Impairment of Assets
F
F
F
F
F
F
F
F
IAS 37 – Provisions, Contingent
F
F
F
F
F
F
F
F
IAS 38 – Intangible Assets
F
F
F
F
F
F
F
F
IAS 39 – Financial Instruments:
F
F
F
F
F
F
F
F
IAS 40 – Investment Property
F
F
F
F
F
F
F
F
IFRS 2 - Share-based Payment
F
F
F
F
F
F
F
F
IFRS 3 – Business Combinations
F
F
F
F
F
F
F
F
IFRS 5 – Non-current Assets held for
F
F
F
F
F
F
F
F
Equipment
Grants and Disclosure of Government Assistance IAS 21 – The Effects of Changes in Foreign Exchange Rates
Financial Statements
Economies
Liabilities and Contingent Assets
Recognition and Measurement
12
KPMG Feasibility Study on Capital Maintenance - Annexes Part 1
Sale and Discontinued Operations
Field of Study 2 The Commission is also interested in the progress of convergence of national GAAP towards IFRS. Therefore IFRS are used as a reference model in this study. To get an idea about the progress of convergence the following three areas were selected for comparison: ¾ investment properties, ¾ defined benefit pension plans; and ¾ financial instruments.
Investment Property Reference: IAS 40 “Investment Property”
Question 4: Do local GAAP distinguish between “investment property” and other (owner-occupied) real property? Yes F
No F
Question 5: How is investment property (even if not distinguished from other property) measured: at cost, at fair value or otherwise? In case of a fair valuemeasurement: Are gains and losses recognised immediately in net income or otherwise? At (depreciated) cost F At Fair Value F Otherwise F (if otherwise, please explain) If Investment Property is measured at Fair Value, where are gains and losses recognised? In the income statement (net profit or loss)
F
In equity
F
In a separate statement of (recognised) income and expense (please explain)
F
Otherwise (please explain)
F
N/A
F
13
KPMG Feasibility Study on Capital Maintenance - Annexes Part 1
Explanations:
__________________________________________________________________________ __________________________________________________________________________ __________________________________________________________________________
Defined Benefit Plans Reference: IAS 19 “Employee Benefits”
Question 6: Is a provision for all defined benefit plans according to local GAAP required? Yes F
No F (if the answer is “No”, please explain)
Explanation:
__________________________________________________________________________ __________________________________________________________________________ __________________________________________________________________________
Question 7: Please indicate how the net obligation is determined. Which method is used to determine the obligation? Projected Unit Credit Method F Other Method F (please indicate) ______________________________ Free Choice between specified methods F (please indicate the methods): ___________________________________________________________________ ___________________________________________________________________ Not specified F (please indicate the method generally applied) __________________________________________________________________________
Is it permitted to directly offset categories of “plan assets” from the obligation? Yes F No F 14
KPMG Feasibility Study on Capital Maintenance - Annexes Part 1
How are plan assets measured At Fair Value F At (amortised/depreciated) cost F Otherwise F (please explain) ________________________________________________
Actuarial Assumptions Is a market rate of interest used in discounting? Yes F No F Not specified F (please explain) __________________________________________________________________________ __________________________________________________________________________
Are the following assumptions taken into account? # mortality: Yes F No F Not Specified/Optional F # expected or actual return on plan assets (if any): Yes F No F Not Specified/Optional F # estimated future salary increases: Yes F No F Not Specified/Optional F # future benefit increases: Yes F No F Not Specified/Optional F # labour turnover rates: Yes F No F Not Specified/Optional F
Supplementary Comments (if deemed necessary)
___________________________________________________________________ ___________________________________________________________________ ___________________________________________________________________
Question 8a: How are actuarial gains and losses recognised? (Please choose all options permitted – if various options are permitted, please explain) Immediately in profit or loss
F
Traditional 10%-Corridor-Approach (like IAS 19)
F
Recognition in equity with recycling through profit or loss (like FAS 158)
F
15
KPMG Feasibility Study on Capital Maintenance - Annexes Part 1
Recognition in equity without recycling through F
profit or loss (like IAS 19)
F
Other Methods (please explain)
Explanations:
__________________________________________________________________________ __________________________________________________________________________ __________________________________________________________________________
Question 8b: Is a special “statement of recognised income and expenses” used in presenting the recognition of actuarial gains and losses? Yes F (please explain) No F
Explanations:
__________________________________________________________________________ __________________________________________________________________________ __________________________________________________________________________
Financial Instruments Reference: IAS 39 “Financial Instruments: Recognition and Measurement”
Question 9: Please indicate how (non-derivative) financial assets and financial liabilities may be classified for accounting (measurement) purposes and how they are permitted/required to be measured. If a fair value measurement is applied, please indicate how gains and losses are recognised (in profit / loss or in equity / with or without recycling?).
Category (please explain) 16
Subsequent Measurement
KPMG Feasibility Study on Capital Maintenance - Annexes Part 1
At
At cost
At Fair Value
(amortised) cost Gains and
Gains and
Gains and
Otherwise
losses
losses in
losses in
(please
through net
equity with
equity without
explain)
income
recycling
recycling
F
F
F
F
F
F
F
F
F
F
F
F
F
F
F
F
F
F
F
F
F
F
F
F
F
F
F
F
F
F
Explanations:
__________________________________________________________________________ __________________________________________________________________________ __________________________________________________________________________
Question 10a: Please indicate the general accounting treatment of derivative financial instruments (before settlement). See also question 11. Not recognised at all
F
Only recognised in case of a loss contract (i. e. no assets recognised)
F
Recognised at Fair Value (with a gain or loss impacting net income)
F
Recognised at Fair Value (with a gain or loss impacting equity directly)
F
Otherwise (please explain)
F
Explanations:
__________________________________________________________________________ __________________________________________________________________________ __________________________________________________________________________
17
KPMG Feasibility Study on Capital Maintenance - Annexes Part 1
Question 10b: If derivative financial instruments are recognised at fair value is a special “statement of recognised income and expenses” used in presenting the recognition of these gains and losses? Yes F (please explain) No F N/A F
Explanations:
__________________________________________________________________________ __________________________________________________________________________ __________________________________________________________________________
Question 11: Which hedge accounting models are applicable under local GAAP (multiple answers are permitted)? Fair Value Hedges
F
Cash Flow Hedges
F
Hedges of a Net Investment in a Foreign Entity
F
Other Model (please explain briefly)
F
No Hedge Accounting permitted
F
Explanation:
__________________________________________________________________________ __________________________________________________________________________ __________________________________________________________________________
18
KPMG Feasibility Study on Capital Maintenance - Annexes Part 1
Selected sample answers for Germany: Sample Answer – Question 1:
Consolidated Accounts
Annual Accounts (single financial statements)
National
IFRS
National
GAAP
IFRS
GAAP
Publicly Traded
Required F
Required :
Required :
Required F
Companies
Allowed F
Allowed F
Allowed F
Allowed F
Non-publicly Traded
Required F
Required F
Required :
Required F
Companies
Allowed :
Allowed :
Allowed F
Allowed F
Supplementary Comments: For publication purposes large corporations may opt to issue single financial statements prepared according to IFRS (§ 325 IIa HGB). However, such financial statements do not satisfy the requirement for single financial statements prepared according to local law (for the purpose of taxation and distribution of profits).
Sample Answer – Question 2a: Yes F
No :
Sample answer – Question 2b: N/A
Sample Answer Question 3:
Standard
1
2
3
4
5
Indication of impact on equity Increa
Decrea
No
se
se
impact
IAS 2 – Inventories
F
F
:
F
F
:
F
F
IAS 8 – Accounting Policies, Changes
F
F
F
:
F
F
F
:
19
KPMG Feasibility Study on Capital Maintenance - Annexes Part 1
in Accounting Estimates and Errors IAS 11 – Construction Contracts
F
F
F
:
F
:
F
F
IAS 12 – Income Taxes
F
F
F
:
F
:
F
F
IAS 16 – Property, Plant and
F
F
F
:
F
:
F
F
IAS 17 – Leases
F
F
F
:
F
F
F
:
IAS 18 – Revenue
F
F
:
F
F
F
F
:
IAS 19 – Employee Benefits
F
F
F
F
:
F
:
F
IAS 20 - Accounting for Government
F
:
F
F
F
F
F
:
F
F
:
F
F
:
F
F
IAS 23 – Borrowing Costs
F
:
F
F
F
F
F
:
IAS 27 – Consolidated and Separate
F
F
:
F
F
F
F
:
F
F
F
:
F
F
F
:
IAS 36 – Impairment of Assets
F
F
:
F
F
F
F
:
IAS 37 – Provisions, Contingent
F
F
:
F
F
:
F
F
IAS 38 – Intangible Assets
F
F
F
:
F
:
F
F
IAS 39 – Financial Instruments:
F
F
F
F
:
:
F
F
IAS 40 – Investment Property
F
F
F
:
F
F
F
:
IFRS 2 - Share-based Payment
F
F
F
F
:
F
F
:
IFRS 3 – Business Combinations
F
F
F
:
F
:
F
F
IFRS 5 – Non-current Assets held for
F
F
F
F
:
:
F
F
Equipment
Grants and Disclosure of Government Assistance IAS 21 – The Effects of Changes in Foreign Exchange Rates
Financial Statements IAS 29 – Reporting in Hyperinflationary Economies
Liabilities and Contingent Assets
Recognition and Measurement
Sale and Discontinued Operations 20
KPMG Feasibility Study on Capital Maintenance - Annexes Part 1
Sample Answer – Question 4: Yes F
No :
Sample Answer – Question 5: At (depreciated) cost : At Fair Value F Otherwise F (if otherwise, please explain) In the income statement (net profit or loss)
F
In Equity
F
In a separate statement of (recognised) income and expense (please explain)
F
Otherwise (please explain)
F :
N/A
Sample Answer – Question 6: Yes F
No : (please explain if the answer is “No”)
Explanation:
Under the German Commercial Code (Handelsgesetzbuch) there is generally a requirement to recognise a provision for all defined benefit plans. Nonetheless there are exceptions from that rule (Art. 28 EG-HGB). One exception exists for grants made before 1987. The other exception refers to “indirect” grants where an external fund (e. g. Unterstützungskasse, Pensionskasse) exists. For these kinds of grants a note-disclosure is sufficient.
Sample Answer – Question 7: Which method is used to determine the obligation? Projected Unit Credit Method F Other Method F (please indicate)
Free Choice between specified methods F (please indicate the methods) Not specified : (please indicate method generally applied) generally a method required by tax law (so called “Teilwertverfahren”) is applied
Is it permitted to offset kinds of “plan assets” from the obligation? Yes : No F 21
KPMG Feasibility Study on Capital Maintenance - Annexes Part 1
How are plan assets measured At Fair Value F At (amortised/depreciated) cost : Otherwise F (please indicate) ________________________________________________
Actuarial Assumptions Is a market rate of interest used in discounting? Yes F No F Not specified : (please explain) A market rate of interest may be used. Generally the companies apply a discount rate of 6% which is required by German tax law.
Are the following assumptions taken into account? # mortality: Yes : No F Not Specified/Optional F # expected or actual return on plan assets (if any): Yes : No F Not Specified/Optional F
# estimated future salary increases: Yes F No : Not Specified/Optional F # future benefit increases: Yes F No : Not Specified/Optional F # labour turnover rates: Yes F No F Not Specified/Optional :
Supplementary Comments (if deemed necessary)
In Germany no specific accounting rule for the measurement of the (net) obligation exists. Traditionally, a large number / the majority of companies apply the tax rules in measuring their pension obligations for accounting purposes. Employee turnover (fluctuation) is generally not taken into account in calculating the obligation rather an obligation is only recognised once the beneficiary has reached the age of 28 years. Recent accounting literature also tends to accept the determination of the (net) obligation according to IAS 19 as appropriate.
Sample Answer – Question 8a: Immediately in profit or loss
:
Traditional 10%-Corridor-Approach (like IAS 19)
F
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Recognition in equity with recycling through F
profit or loss (like FAS 158) Recognition in equity without recycling through
F
profit or loss (like IAS 19)
F
Other Methods (please explain)
Sample Answer - Question 8b: Yes F (please explain) No :
Sample Answer – Question 9: Category
Subsequent Measurement
(please explain) At
At cost
At Fair Value
(amortised) cost Gains and
Gains and
Gains and
Otherwise
losses
losses in
losses in
(please
through net
equity with
equity
explain)
income
recycling
without recycling
Fixed Assets
:
F
F
F
F
F
:
F
F
F
F
F
:
F
F
F
F
F
(Anlagevermögen) Current Assets (Umlaufvermögen) Liabilities
Explanations:
For measurement purposes financial assets can be distinguished in fixed assets (“Anlagevermögen”) and current assets (“Umlaufvermögen”). “Anlagevermögen” are assets that are supposed to serve the business operations in the long term. All other assets are “Umlaufvermögen”.
Sample Answer – Question 10a: Not recognised at all
F
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Only recognised in case of a loss contract (i. e. no assets recognised)
:
Recognised at Fair Value (with a gain or loss impacting net income)
F
Recognised at Fair Value (with a gain or loss impacting equity directly
F
Otherwise (please explain)
F
Question 10b: Yes F (please explain) No F N/A :
Sample Answer – Question 11: Fair Value Hedges
F
Cash Flow Hedges
F
Hedges of a Net Investment in a Foreign Entity
F
Other Model (please explain briefly)
:
No Hedge Accounting permitted
F
Explanation: Under the German Commercial Code there are no specific rules on Hedge Accounting. The Fair Value Hedge Model and the Cash Flow Hedge Model of IAS 39 are not options available under the German Commercial Code. In certain circumstances it may be possible to determine so called “units of accounting” (micro hedge accounting is widely accepted as standard practice). For example, if a foreign currency receivable is hedged by a foreign currency forward it may be permitted to measure the receivable at the forward rate. But the prerequisites for this accounting treatment are not clear and precisely described.
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Part II – Selected EU-Member States The Commission also asked us to provide an in-depth comparison for five Member States of the effect on distributable profits under national GAAP and IFRS in three specific areas: ¾ investment properties, ¾ defined benefit pension plans; and ¾ financial instruments. To achieve comparability the respective IFRS-rules have to be regarded as our point of reference. For the analysis it is generally assumed that profit or loss determined under IFRS is immediately distributable. Profits or losses recognised directly in equity should be regarded as not (immediately) distributable. In each section the chapter “Specific rules on determining distributable profits” should be used to describe whether there are (national) rules under which the net income according to IFRS and/or local GAAP is modified in determining distributable profits.
The following outline should be regarded as a guideline for the description of the impact if distributable profits were to be determined according to IFRS rather than based on national GAAP. Since it is not permitted to determine quantitative effects a qualitative evaluation and an indicative description of tendencies is necessary. Your text under Part II should not refer to Part I of the questionnaire.
Please find attached a sample analysis for Germany.
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1. Introduction 2. Investment Property 2.1. Separate identification of Investment Property 2.2. Measurement of Investment Property 2.2.1. Initial Measurement 2.2.2. Comparison of local GAAP with the “Cost Model” 2.2.3. Comparison of local GAAP with the “Fair Value Model” 2.3. Specific rules on determining distributable profits 2.4. Overall impact assessment on distributable profits 3. Defined Benefit Plans (DBP) 3.1. Identification of DBP and need to recognise a provision 3.2. Measurement of the (net) obligation 3.2.1. Valuation of the obligation 3.2.2. Treatment of Plan Assets 3.3. Treatment of Actuarial Gains and Losses 3.4. Specific rules on determining distributable profits 3.5. Overall impact assessment on distributable profits 4. Financial Instruments 4.1. Identification and classification of Financial Instruments 4.2. Financial asset derecognition 4.3. Subsequent measurement of Financial Instruments (excluding derivatives) 4.3.1. Loans and Receivables 4.3.2. Held to Maturity Investments 4.3.3. Financial Instruments at Fair Value Through Profit or Loss (excluding derivatives) 4.3.4. Available for Sale Financial Assets 4.3.5. Financial Liabilities 4.3.6. Investments in subsidiaries, associates and joint ventures 4.4. Accounting treatment of Derivative Financial Instruments 4.5. Hedge Accounting 4.6. Specific rules on determining distributable profits 4.7. Overall impact assessment on distributable profits
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1. Introduction The following analysis is based on the assumption that any difference between an accounting treatment according to local GAAP and IFRS that has a potential impact on net profit or loss for the period does – for a specific point in time – change the distributable profit. In making this assumption the reader has to keep in mind that generally any impact on profit or loss in one period reverses in another period; i. e. over the life of an entity generally the cumulated profit does not change because of different accounting treatments. So any impact assessment can be given only for a specific point in time. Additionally it is assumed that any profit or loss recognised directly in equity is not distributable unless explicitly stated otherwise.
The following analysis does not explicitly take the effects of deferred taxes into account. Deferred taxes can reduce the primary impact effect of an accounting difference. This should also be kept in mind.
Annotation: The assumptions should not be changed for your analysis. In case you see a need to change these assumptions please contact Dr. Markus Fuchs or Dr. Bernd Stibi – KPMG Germany – via email.
In Germany the distributable profit is (generally) determined as the profit that is recognised in the single financial statements prepared according to the German Commercial Code (“Handelsgesetzbuch”/HGB). This profit is modified (reduced) in only a few cases where the company recognises certain items as “assets” which do not fulfil the HGB definition of assets. There is only a limited number of these – explicitly allowed – items and they do not have immediate impact on the areas analysed in this paper. Therefore it can be said that the accounting under HGB is the basis to determine distributable profits.
Since this analysis focuses on distributable profits, note disclosures and presentation issues are not taken into account. Furthermore it is not necessary to analyse all deviations between German GAAP and IFRS in detail. The analysis focuses on major areas of accounting congruence or divergence.
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2. Investment Property 2.1. Separate identification of Investment Property IAS 40 “Investment property” defines investment property as “property (land or a building — or part of a building — or both) held (by the owner or by the lessee under a finance lease) to earn rentals or for capital appreciation or both, rather than for: a) use in the production or supply of goods or services or for administrative purposes [so called “owner-occupied property”]; or b) sale in the ordinary course of business” (IAS 40.5). IAS 40 contains a measurement option for investment property. A company may apply the “fair value model” or the “cost model” for subsequent measurement. The cost model refers to IAS 16 “Property, Plant and Equipment” and to IFRS 5 “NonCurrent Assets Held for Sale and Discontinued Operations” (IAS 40.56). Owneroccupied property is accounted for according to IAS 16.
The German Commercial Code does not distinguish between investment property and owner-occupied property. Therefore the accounting treatment for both does not differ.
2.2. Measurement of Investment Property 2.2.1. Initial measurement According to IFRS investment property is initially measured at cost including transaction cost (IAS 40.20 et. al.). “The cost of a purchased investment property comprises its purchase price and any directly attributable expenditure.…” (IAS 40.21). The cost of a self-constructed asset includes “any costs directly attributable to bringing the asset to the location and condition necessary for it to be capable of operating in the manner intended by management” (IAS 16.16(b)). This means that they also include “a systematic allocation of fixed and variable production overheads” but no general and administration overheads (IAS 40.22/IAS 16.22/IAS 2.12 et. al.). This measurement will be called “full cost” in the following analysis.
Under German Commercial Code all real property is also initially measured at cost. There is generally no major deviation in determining the cost of a 28
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purchased asset (except in cases where “costs of dismantling and removing the item and restoring the site” form part of the cost of an asset under IFRS. In these cases the obligation is generally recognised as an expense rateably over the useful life of the asset without impact on the cost of the asset). For self-constructed buildings there may be a difference. According to § 255 II HGB it is permitted to measure cost at direct material and production cost, i. e. no material or production overhead is allocated to the assets. This overhead may optionally be allocated to the asset. Furthermore it is also permitted to recognise general administration overhead as part of the cost of an asset. This means that on one hand it is possible to measure buildings below “full cost”; on the other hand it is permitted to measure buildings (slightly) above full cost. In those cases where all “overhead” is expensed immediately under the German Commercial Code, it is possible that in the construction periods the profits under IFRS exceed the profits under HGB. With reference to borrowing cost § 255 III HGB has a similar free choice as IAS 23 “Borrowing cost”. It is optionally permitted to capitalise “borrowing cost” for qualifying assets. [A further analysis of this subject appears to be of no further material merit.]
2.2.2. Comparison of local GAAP with the “Cost Model” Not taking into account the rules of IFRS 5, investment property is – according to IAS 16 – carried at cost less accumulated depreciation and accumulated impairment losses, if any (IAS 16.30). For depreciation purposes the depreciation method “shall reflect the pattern in which the asset’s future economic benefits are expected to be consumed by the entity” (IAS 16.60) and the useful life represents “the period over which an asset is expected to be available for use by an entity ” (IAS 16.6). Any impairment loss is determined under IAS 36 “Impairment of Assets”. Under IAS 36 – should a so called “triggering event” arise – the carrying amount of an asset is compared with its recoverable amount, i. e. the higher of the fair value less costs to sell and the value in use (see IAS 36.6 et. al.).
Assets that are used for a longer period of time are classified as fixed assets according to § 247 II HGB. Real property that is classified as fixed asset is carried at cost less depreciation and write downs (§ 253 I + II HGB). The 29
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accounting treatment under German GAAP therefore resembles the cost model under IFRS. In practice there may be a couple of deviations. The depreciation method as well as the useful lives of buildings may be derived from tax rules and used for accounting purposes. This means that depreciation methods and useful lives may be different from the methods and terms which have to be used under IFRS. The impact on profit or loss can not be generally determined.
Furthermore companies have to write fixed assets down to a kind of “market value” (“beizulegender Wert”) in case the impairment is permanent. The German Commercial Code does not give any guidance on how to determine the “market value”. It appears possible that the market value is similar to the fair value used under IAS 36 so that the amount of impairment losses may be similar. In practice there may be differences, e. g. when the “market value” is determined as replacement cost or when the value in use is applied under IAS 36. Additionally the permanency of an impairment is irrelevant under IFRS. No general effect on the profit or loss can be determined in this case. Since the prudence principle is a very essential principle under the German Commercial Code it might be assumed that generally the impairment losses recognised under HGB exceed the losses recognised under IFRS.
2.2.3. Comparison of local GAAP with the “Fair Value Model” As an alternative to the cost model, IAS 40 grants the option to measure all investment property at fair value. The changes in fair value are recognised in profit or loss for the period (IAS 40.33 et. al.).
A measurement at fair value is not on option under the German Commercial Code since assets are not allowed to be measured above (depreciated) cost (§ 253 I HGB). However, if a loss is deemed permanent, the fair value may be an indication of the “market value” as described under 2.2.2. This means that if fair values increase the profits under IFRS exceed the profits determined under the German Commercial Code. If fair values decrease the results under HGB and IFRS may be similar if the loss is permanent, or the losses
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recognised under IFRS may exceed the losses recognised under HGB if the loss is non-permanent.
2.3. Specific rules on determining distributable profits There are no rules in Germany under which net income is modified to determine distributable profits; i. e. net income according to the German Commercial Code represents the distributable profit (there are no similar rules in IFRS either).
2.4. Overall impact assessment on distributable profits The impact on the net profit or loss arising from accounting deviations in the field of investment property depends on several factors. One is the choice of options granted under HGB and IFRS and the second are market and valuation influences. On initial recognition it is permitted to recognise more expense in profit or loss under the German Commercial Code – reducing the distributable profits. The cost model under IFRS resembles the HGB-model. Deviations generally stem from details and a general statement on the effect on distributable profits appears impossible. If the fair value model is chosen under IFRS and it is assumed that all reductions in fair values are permanent, distributable profits under IFRS may be higher than under the German Commercial Code since increases in fair values can only be recognised under IFRS whereas decreases may be recognised under both accounting regimes.
3. Defined Benefit Plans (DBP) 3.1. Identification of DBP and need to recognise a provision Under IAS 19 “Employee benefits” a company has to recognise a “liability” (or an ”asset”) for all defined befit plans1, no matter whether they are funded or unfunded and no matter whether there is a legal or constructive obligation (IAS 19.49 et. al.).
Under the German Commercial Code an entity has generally to provide for any third party obligation (§ 249 I HGB). But there are two “exceptions” for pension benefits. Benefits granted before January 1, 1987 are grandfathered, i. e. there is a free choice to provide for these grants (Art. 28 I EG-HGB). Further the entity 1
For a definition of defined benefit plans see IAS 19.7.
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may opt to recognise any “indirect grant”, i. e. generally a grant where the primary obligor is an external fund and the entity is secondarily liable and other similar direct grants in its financial statements (Art. 28 II EG-HGB). Should entities choose not to recognise a provision (liability) this generally increases cumulated distributable profits in comparison to IFRS. Indirect grants are generally to be accounted for under IAS 19; the assets of the fund may qualify as plan assets.
3.2. Measurement of the (net) obligation 3.2.1. Valuation of the obligation Under IFRS the relevant measure of the obligation is defined as the “present value of a defined benefit obligation” (DBO; IAS 19.6). This obligation is calculated by applying the so called “Projected Unit Credit Method” (IAS 19.64 et. al.). Furthermore several actuarial assumptions – based on the market expectations at the balance sheet date – are needed to calculate the DBO, for example (IAS 19.72 et. al):
demographic assumptions •
mortality
•
rates of employee turnover, disability and early retirement
•
the proportion of plan members with dependants who will be eligible for benefits
financial assumptions, •
the discount rate (by reference to market yields at the balance sheet date on high quality corporate bonds)
•
future salary and benefit levels
(Medical benefits do not play a role in Germany and are therefore not considered).
Under the German Commercial Code there is no guideline on the measurement of the obligation. Traditionally a large number of / the majority of companies applied the guidance of German Tax Law to determine the obligation. Currently a method similar to IAS 19 may be regarded as appropriate as well. The tax model will be used as the point of reference in the following analysis. According to German Tax Law the method to determine the obligation and the current expense is called “Teilwertverfahren”. This method 32
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is different from the Projected Unit Credit Method. Based only on this difference it is not clear whether the IFRS-method or the German methodology lead to a higher calculated obligation. This depends also on the age structure of the workforce.
The mortality rates and relevant dependants are to be considered under both standards similarly. But under German Tax Law employee turnover is not taken into account in determining the liability. This effect may broadly be offset by the fact that under this law the earliest possible age for the recognition of a provision is 28. No such limit exits under IFRS. The discount rate in Germany (tax law) is set at 6% and not adjusted. For accounting purposes different/lower discount rates may be acceptable. The effect of this discount rate on the obligation in comparison to IFRS depends on the discount rate of high quality corporate bonds. In the previous years this discount rate was below 6% thus leading to in increase of the obligation under IFRS with reference to this factor. For tax purposes as well as for accounting purposes in Germany it is generally not deemed acceptable to take into account future salary and benefit increases. Since these increases are taken into account under IFRS this leads to (significantly) higher calculated obligations under IFRS and consequently to a reduction in cumulated distributable profits.
The overall impact of the different methods to determine the obligation cannot be generalised. But especially the analysis of the applied actuarial assumptions tends to lead to higher obligations under IFRS. This could quite likely be underpinned with the experience from several IFRS-conversions.
3.2.2. Treatment of Plan Assets IAS 19.7 defines plan assets. Plan assets are assets that are held by a longterm employee benefit fund or qualifying insurance policies. The main characteristics are that the respective funds can only be used to pay benefits, are not available to the companies’ creditors (even in bankruptcy) and can generally not be returned to the entity. Plan assets are offset with the DBO (IAS 19.54). IAS 19 also refers to reimbursement rights which cannot be offset
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with the DBO but are otherwise treated in the same way (IAS 19.104A et. al.). Plan assets are measured at fair value (IAS 19.54 / IAS 19.102 et. al.).
Under the German Commercial Code there is no definition of plan assets. For the indirect grants described above it is permitted to recognise the net obligation (generally underfunding) as a liability. The assets of the external fund are measured according to German GAAP. This means that losses have to be anticipated whereas unrealised profits cannot be taken into account (§ 252 I No. 4 HGB). This principle is supported by the rule that assets are not allowed to be carried above (depreciated) cost. For fixed assets permanent impairments and for current assets both permanent and temporary impairments result in write downs of the assets (§ 253 HGB). The fair value of the assets may – based on further analysis – be regarded as a basis for the determination of the impairment loss in these cases. This means that where the fair value of plan assets increases a gain is recognised under IFRS which is not recognisable under HGB. Where the fair value of plan assets decreases – i. e. when a loss is recognised under IFRS – it does not appear to be unlikely that a loss will also be recognised under the German Commercial Code. The amount of the recognised loss, however, may differ (slightly). This means that a tendency towards earlier recognition of distributable profits under IFRS may be assumed.
3.3. Treatment of Actuarial Gains and Losses Under IFRS actuarial gains or losses may arise. Actuarial gains or losses comprise “experience adjustments (the effects of differences between the previous actuarial assumptions and what has actually occurred); and … the effects of changes in actuarial assumptions” (IAS 19.7). These gains and losses do not have to be recognised immediately. It is permitted to apply the so called “corridor approach” meaning that the amount of cumulated actuarial gains and losses exceeding the greater of 10% of the DBO and 10% of the fair value of the plan assets has to be spread over the remaining working lives of the employees. Any method leading to a faster recognition of the gains/losses is acceptable as well (IAS 19.92 et. al.). Recently the IASB added an additional option for the recognition of the actuarial gains and losses. Optionally it is allowed to recognise 34
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immediately all actuarial gains and losses directly in equity (retained earnings). No “recycling” of these gains and losses through profit or loss in later periods is required or allowed (IAS 19.93A et. al.).
Under the German Commercial Code it appears inappropriate not to recognise all actuarial gains and losses immediately. This means that at year end the “full (net) obligation” is recognised. Any adjustments made to the provisions have to be recognised in profit or loss for the year, i. e. neither the corridor approach nor the immediate recognition of actuarial gains or losses directly in equity are allowed under IFRS.
The immediate recognition of actuarial gains/losses is also an option under IAS 19. If this option is used no difference arises in this respect. Indeed if we assume that the adjustment of retained earnings according to the new option under IFRS has an impact on distributable profits there is also no difference between the distribution potential according to the German Commercial Code and IFRS in respect of actuarial gains and losses. If any other method (corridor approach) of IAS 19 is applied the general effect on distributable profits in comparison to the German Commercial Code cannot be generalised. The effect depends on the circumstances: Is there a cumulative actuarial gain or a cumulative actuarial loss? A gain means higher distribution potential under the German Commercial Code, a loss means less distributable profits under the German Commercial Code.
3.4. Specific rules on determining distributable profits There are no rules in Germany under which net income is modified to determine distributable profits; i. e. net income according to the German Commercial Code represents the distributable profit (there are no similar rules in IFRS either).
3.5. Overall impact assessment on distributable profits A general statement on the impact on cumulated distributable profits as between the German Commercial Code and IFRS is impossible. There are several – partly contradicting – tendencies. For example the consideration of salary and benefit increases leads on its own to higher liabilities under IFRS; thus decreasing cumulated distributable profits. On the other hand the measurement of plan 35
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assets at fair value tends to increase distributable profits under IFRS compared with HGB. Furthermore in respect of several factors the impact on distributable profits depends on the individual circumstances, e.g., the interest rate applied or the recognition of actuarial gains or losses. Experience from several HGB to IFRS-conversion projects in the past shows that, in general, the provisions for defined benefit plans do increase with a simultaneous decrease in cumulated distributable profits.
4. Financial Instruments 4.1. Identification and classification of Financial Instruments Under IFRS there is a broad definition of financial instruments. They include financial assets and financial liabilities. Financial assets comprise debt as well as equity instruments (of other entities). Financial instruments also include derivative financial instruments (see IAS 32.11). According to IAS 39 financial instruments have to be classified into the following categories with a consequential effect on their accounting treatment (see IAS 39.9): ⇒ Loans and receivables ⇒ Held to Maturity Investments ⇒ Financial Instruments at Fair Value Through Profit or Loss ⇒ Available for Sale Financial Instruments ⇒ Financial Liabilities Amongst other exceptions investments in subsidiaries, associates and joint ventures are not within the scope of IAS 39 (IAS 39.2).
The most relevant distinction with relevance for measurement purposes under the German Commercial Code is the distinction between fixed assets and current assets. Fixed assets are assets that are intended to serve the business operations in the long term. All other assets are current assets (§ 247 I + II HGB). Even though it is not permitted to exactly match the IFRS-financial asset categories with the German distinction the following assumptions are made. Held to Maturity Investments correspond to fixed assets. At Fair Value through Profit or Loss assets correspond to current assets. Loans and receivables as well as available for sale financial assets can be classified as fixed or current assets, based on the individual circumstances. 36
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Under IAS 39 financial instruments are initially recognised at fair value (generally including transactions cost; IAS 39.43). Under the German Commercial Code financial assets are initially recognised at cost and financial liabilities at their settlement amount (§ 253 HGB). In practice this difference is unlikely to cause major deviations in general.
4.2. Financial asset derecognition IAS 39 contains specific rules on financial asset derecognition and financial liability derecognition (IAS 39.15 et. al.). Under the German Commercial Code there is no explicit guidance on this issue. As a result there may be different accounting treatments in practice. The major problem of financial asset derecognition very often boils down to the question as to whether a financial asset should be replaced by liquid funds received or should the financial asset not be derecognised and the receipt of liquid funds instead lead to an increase in liabilities. This is mainly a presentation issue with no major impact on profit or loss (unless for financial institutions). Therefore this area is not analysed further.
4.3. Subsequent measurement of Financial Instruments (excluding derivatives) 4.3.1. Loans and Receivables Loans and receivables are carried at amortised cost according to IAS 39.46. If there is any objective evidence that such a financial asset or group of financial assets is impaired “the amount of the loss is measured as the difference between the asset’s carrying amount and the present value of estimated future cash flows (excluding future credit losses that have not been incurred) discounted at the financial asset’s original effective interest rate (i.e. the effective interest rate computed at initial recognition; IAS 39.58/IAS 39.63 et. al.). Under IAS 39 the assessment of impairments is done first “for financial assets that are individually significant, and individually or collectively for financial assets that are not individually significant”. The grouping is based on credit risk characteristics (IAS 39.64). A subsequent reversal of the impairment may be required (IAS 39.65).
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Under German Commercial Code these assets are also carried at (amortised) cost. However, the rules for impairment may differ. For a fixed asset, an impairment generally has to be recognised if it is permanent. If it is only temporary the company generally has an option to recognise the impairment loss (§ 253 II HGB/§ 279 I HGB). The assets are written down to a kind of “market value” (“beizulegender Wert”). The determination of this value is not clearly defined (§ 253 II HGB). For current assets an impairment loss has to be recognised even for temporary impairments. The benchmark for the determination of an impairment loss is generally also a “market value”; preferably derived from an active market.
In practice especially the impairment rules may result in differences. For example in Germany accounts receivables are often reduced by individual allowances as well as general allowances which may take into account interest effects. The groupings for general allowances may not be based on credit risk and so on. It can be assumed that the German impairments may be more conservative. This is underpinned by the possibility/need to recognise impairment losses even for temporary impairments. This means that distributable (net) profits may arise later under German the Commercial Code.
4.3.2. Held to Maturity Investments Held to Maturity Investments are also carried at cost (IAS 39.46). Held to Maturity Investments are generally fixed assets under the German Commercial Code. The statements made under 4.3.1. covering fixed assets are also true for held to maturity investments.
4.3.3. Financial Instruments at Fair Value Through Profit or Loss (excluding derivatives) There are two possibilities how a financial instrument is classified as at fair value through profit or loss. One possibility is that the instrument is held for trading, i. e. normally short term profit taking, or the instrument is designated into this class of assets at initial recognition (the possibilities of designation are limited; IAS 39.9 et. al.). Financial instruments in this category are measured
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at fair value with fair value changes recognised in profit or loss (IAS 39.46 et. al.). Under German GAAP financial assets are usually current assets. They are carried at the lower of cost and “market value” as described above. It is not permitted to recognise unrealised gains, i. e. it is not possible to measure assets above cost (§ 253 HGB). Therefore if the fair value increases, gains are recognised under IFRS which may not be booked under German GAAP. For losses an impairment loss has to be recognised under the German Commercial Code – where applicable even for temporary losses (§ 253 II + III HGB). The market value according to German law quite likely corresponds to the fair value according to IAS 39. This means that for losses the deviation is quite likely not a major issue.
Liabilities are measured at settlement amount under German GAAP (§ 253 I HGB). They may not be measured at fair value. Accordingly any changes in the fair value of liabilities designated as at fair value through profit or loss according to IFRS are generally not recognised for German GAAP purposes. This is, e. g., also true for losses caused by a decrease in the refinancing interest rate. Therefore the deviation in the area of liabilities depends on the current circumstances.
4.3.4. Available for Sale Financial Assets Available for Sale Financial Assets are carried at fair value. Changes in the fair value are recognised directly in equity. Upon realisation of profits or losses the gain or loss recognised in equity is “recycled” through net profit or loss for the period (IAS 39.46 et. al.). “When a decline in the fair value of an availablefor-sale financial asset has been recognised directly in equity and there is objective evidence that the asset is impaired …, the cumulative loss that had been recognised directly in equity shall be removed from equity and recognised in profit or loss …” (IAS 19.67 / for details see IAS 19.67 et. al.). [It is assumed that the gains and losses recognised in equity have no impact on distributable profits!]
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As described above a measurement above cost is not permitted under German GAAP either for fixed or for current assets. Where the gains recognised directly in equity are not distributable there is no impact on distributable profits. Under German GAAP temporary losses have to be recognised for current assets and may be recognised for fixed assets. For permanent impairments an impairment loss has also to be recognised for fixed assets. To simplify a complex matter it may be assumed that temporary impairments do not lead to the recognition of decreases in fair values in profit or loss whereas permanent impairments do under IFRS. This would mean that impairments are always recognised in profit or loss under German GAAP when they are recognised under IFRS, too. But temporary impairments have to/may be recognised in profit or loss under German GAAP and not under IFRS. This leads to the conclusion that the distribution potential under German GAAP tends to be lower than the cumulated distributable profits under IFRS.
There are specific rules for reversals of impairments losses under IFRS. For debt instruments the reversals impact profit or loss. For equity instruments the increase in fair value impacts equity (IAS 39.69 et. al.). Under the German Commercial Code a reversal of impairments losses is required and impacts profit or loss in all cases (§ 280 I HGB).
4.3.5. Financial Liabilities Financial liabilities are generally recorded at amortised cost under IFRS. The effective interest method is applied (IAS 19.47). German GAAP require liabilities to be recognised at their settlement amount (§ 253 I HGB). Sometimes liabilities are issued at a discount. This discount may be expensed immediately or recognised as prepaid expenses and spread over the term of the liability (§ 250 III HGB). The second option may be identical or at least similar to the effective interest method. If the first option is used this reduces distributable profits under the German Commercial Code at the time of initial recognition.
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4.3.6. Investments in subsidiaries, associates and joint ventures IAS 27 applies to interests in subsidiaries, associates and joint ventures in single financial statements. These may be carried at cost or according to IAS 39 (IAS 27.37). If they are carried according to IAS 39 they are principally to be regarded as available for sale financial assets. In this respect please refer to 4.3.4. These investments may also be carried at cost. This is similar to the accounting treatment under the German Commercial Code. There is an other “class” of financial assets as well which is carried at cost less impairment loss under IAS 39: “investments in equity instruments that do not have a quoted market price in an active market and whose fair value cannot be reliably measured …” (IAS 39.46 et. al./IAS 39.AG80 et. al.). The accounting treatment is similar to the German Commercial Code as described above. But it may be possible – for fixed assets – or required – for current assets – to write the assets down in case of a temporary impairment which may – subject to specific analyses – not be appropriate under IFRS. Furthermore under the German Commercial Code a reversal of write downs is required (§ 280 I HGB). But under IFRS a reversal of write downs for these specific assets is prohibited (IAS 39.66).
4.4. Accounting treatment of Derivative Financial Instruments Derivative financial instruments – as defined in IAS 39.9 – are generally within the scope of IAS 39. They are automatically classified as trading and therewith as “at fair value through profit or loss”. As described above this means that all derivative financial instruments are recognised at fair value in an IFRS balance sheet and any change in the fair value of those assets / liabilities is recognised within profit or loss for the period.
Under the German Commercial Code there is a non-codified rule that executory contracts are generally not recognised in the balance sheet. Normally derivative financial instruments have to be identified as executory contracts. This means that derivatives are generally not recognised according to German GAAP. This is supported by the fact that positive fair values are regarded as unrealised gains which may not be anticipated (§ 252 I No. 4 HGB). Nevertheless onerous contracts have to be recognised according to the German Commercial Code (§ 41
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249 I HGB / § 252 I No. 4 HGB). An onerous derivatives contract usually corresponds with a negative fair value of the derivative. Therefore in cases of negative fair values of a derivative usually a provision is recognised under the German Commercial Code. The measurement of the provision may deviate from time to time (slightly) from the negative fair value, e.g. discounting is generally not allowed under HGB (§ 253 I HGB). This means that losses / negative fair values tend to be recognised under German GAAP as well as under IFRS. Gains may only be “anticipated” under IFRS. This shows a tendency that distributable profits may be recognised earlier under IFRS.
4.5. Hedge Accounting IAS 39 distinguishes three kinds of hedging relationships: cash flow hedges, fair value hedges and hedges of a net investment in a foreign operation2 (IAS 39.86). To be eligible to apply hedge accounting several demanding prerequisites have to be fulfilled (IAS 39.88 et. al.). Cash flow hedges are used to hedge (potential) variations in future cash flows. Any gain or loss on a (derivative) hedging instrument is recognised directly in equity until the hedged item affects profit or loss. Then the gain or loss of the hedging instrument affects profit or loss as well directly or in the form of a basis adjustment of the hedged item (see IAS 39.88 / IAS 39. 95 et. al.). Fair value hedges are used to hedge the risk of changes in the fair value of a recognised asset or liability or a firm commitment. The gain or loss of the (derivative) hedging instrument is recognised in profit or loss. In addition the hedged item is revalued with respect to the hedged risk as well, and any results of this revaluation are also recognised in profit or loss. Ideally the gain/loss of the hedging instrument is (almost) fully offset by the loss/gain from the revaluation of the hedged item (see IAS 39.88 et. al.).
Under the German Commercial Code there is no guidance on hedge accounting. In practice (and in accounting literature) it is possible to establish “units of account”. This means that the hedged item and the hedging instrument are artificially linked to one unit leading to an offset of gains and losses. For example it is permitted to link a foreign currency receivable and foreign currency forward to a “unit of account”. As a result the foreign currency receivable is always translated 2
Since cash flow hedges and fair value hedges are the most relevant kinds of hedging relationships in single financial statements only those will be analysed further.
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at the forward rate. Or it is permitted to link a liability with an interest rate swap. As a result the “cash flows” are recognised as incurred, i. e. neither the liability nor the swap is revalued. The prerequisites for this kind of hedge accounting are also not specified. Therefore it appears to be easier under the German Commercial Code to be eligible for hedge accounting. A full analysis of hedge accounting under the German Commercial Code appears impracticable due to divergence in practice.
The objective of hedge accounting under German GAAP is similar to the objective under IFRS. The profit or loss should not be affected if two items are in substance closely linked but would due to “inappropriate” basic accounting rules be treated differently. In Germany unrealised losses have to be anticipated whereas unrealised gains cannot be recognised. If hedge accounting were not applied the loss of one item would affect net profit before the gain of the other item could be realised; thus potentially impacting the true and fair view of the financial statements. Therefore hedge accounting is applied. Under IFRS the objective is similar. The need for hedge accounting may even be increased by the fact that derivatives – in general hedging items – are always measured at fair value. A detailed analysis of the impact of the hedge accounting rules is almost impracticable. But, since it is perhaps easier to be eligible for hedge accounting under the German Commercial Code and given the analysis of freestanding derivatives according to 4.4, the whole set of rules may tend towards an earlier recognition of distributable profits under IFRS.
4.6. Specific rules on determining distributable profits There are no rules in Germany under which net income is modified to determine distributable profits; i.e. net income according to the German Commercial Code represents the distributable profit (there are no similar rules in IFRS either).
4.7. Overall impact assessment on distributable profits It is difficult to assess the overall impact on distributable profits in the field of financial instruments. Under IFRS fair value measurements are often applied. This is generally not allowed under the German Commercial Code when fair values of assets exceed (amortised) cost. On the other side, a decrease of fair 43
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values below cost leads in most cases to a write down of assets under HGB. Therefore gains may not be “anticipated”, whereas potential losses have to be anticipated. Viewing this conservatism as a general rule we could conclude that German financial statements tend to recognise distributable profits later than IFRS-financial statements.
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3
Legal annexes
3.1 EU Legal annexes 3.1.1 France Section 1:
Capital formation
Sub-section 1:
Formation of the public company
1.
Minimum capital and other means of equity financing
a) Level of minimum subscribed capital According to the French Commercial Code (Code de Commerce = CCOM), the share capital shall be at least €225,000 in stock companies which make a public offering and at least €37,000 in privately held stock companies (Article L. 224-2 § 1 CCOM). Above such a minimum amount, the shareholders are entitled to freely fix the share capital amount. The share capital must be higher than €225,000 or may be lower than €37,000, as regards some regulated activities, such as insurance (Article R.322-5 CCOM) or press publishing activities (Article L.224-2 § 3 CCOM). b) Authorised capital The possibility given to the board of directors to increase the share capital up to a certain amount and with a certain period is not provided for by French law regarding the stage of incorporation of the company. This possibility only exists in case of an increase in share capital. c) Premiums French law provides for the possibility of paying premiums at the stage of formation but this possibility is hardly used in practice (Article 59 of Decree n°67-246 dated March 23, 1967). The premiums must be accounted for under the section: subscribed capital (“capital social”), account 104 (Article 441/10 PCG). However the premiums can be distributed to the shareholders or be used in any other manner (Cass. Com. 09.07.1952, J.C.P. 1953, II, 7742). Premium distribution may be decided by shareholders’ resolution in general meetings. In the event of liquidation of the company, no individual has a right to premiums paid by him; the premiums remain in the liquidation surplus and can be thus distributed to any shareholder without distinction. d) Other forms of equity contributions There are no other forms of equity contributions in France. e) Information to be fixed in the statutes. According to Article L.210-2 of the French Commercial Code, the amount of the share capital must be indicated in the statutes.
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2.
Subscription of the capital
a) Link of stated capital’s injection with subscription of shares In France, the injection of the stated capital is linked to the subscription of shares. When subscribing a share the shareholder has the obligation to pay in the nominal value/accountable par allotted to the share acquired. b) Time Limit According to the French Commercial Code, the share capital must be subscribed in full (Articles L.225-3 and L.223-12 CCOM). Prior to registration of the company and within 8 days, the founding members have to deposit the share capital with a notary, a bank, an authorised investment company or the “Caisse des Dépot et des Consignations” (state-owned public bank). Only after a certificate of deposit is obtained, can the founders apply for registration. Subsequent to the registration of the company, the contributed capital is released upon presentation of the incorporation certificate. (Article L.225-11 § 1 CCOM). The members of the company are not required to pay up their entire subscription at the time of the creation of the company. The statutes may provide for members to pay a minimal fraction of their contribution, the legal minimum being 50% of the nominal value of their shares. The rest is to be paid within 5 years of registration, at the request of the Board (Article L.225-3 CCOM). c) Prohibition that shares may be subscribed by the company itself Under the French Commercial Code, public companies are prohibited from subscribing their own shares, either directly or through a person acting in his own name but on the company’s behalf (Article L.225-206 CCOM). If they are in breach of such provisions, the founders are required to pay up any share subscribed by the company. They may be punished by a fine of €9,000 (Article L.242-24, § 1 CCOM). Furthermore, the company has to sell the shares within one year after their acquisition. After the expiration of that period, the shares have to be redeemed (Article L.225214 CCOM) When the shares have been subscribed by a person acting in his own name but on the company’s behalf, that person is obliged to pay up the shares jointly or severally with the founders and is deemed to have subscribed those shares for his own account. On the other hand, under French law the subscription of the company’s shares by a subsidiary company is allowed. However, the holding of the shares is regulated (Article L.233-29, 23330 CCOM). It is prohibited for a public company to hold the shares of another company, if that company itself has a stake of more than 10% in the first company. d) No issuance of shares at a price lower than the nominal value / accountable par In France, the issue of shares at a price lower than the nominal value / accountable par is prohibited by Article L.225-128 CCOM. It is common opinion that shares may not be issued under this price. According to the French understanding, this follows from the duty to fully subscribe the share capital. e)
Designs of shares
French law offers shares with a nominal value (par value shares) or, alternatively, no-par value shares (Article L.228-8 CCOM in contrario). Under French law, shares with a nominal 46
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value must represent a certain numeric amount which is the amount of the contribution that has been/must be paid. This is not the case for no-par value shares. Under French law, every par value share represents the same fraction of the subscribed capital as all no par value shares participate in the subscribed capital with the same amount. As the no-par value shares are linked to the subscribed capital, they are in fact notional no-par value shares. f) Necessary information to be fixed in the statutes Under French law, the company’s statutes must contain the following information which is linked to the capital and the shares (Article L.225-14 CCOM and Article 55 of Decree no 67237 dated March 23, 1967: - the amount of the share capital. - for each class of shares issued, the number of shares and the nature of the specific rights attached thereto and, as the case may be, the portion of the share capital said class represents or the nominal value of the shares it comprises; - the form of the shares, i.e., whether registered shares only or either registered or bearer shares; - the identity of in-kind contributors, the valuation of each of their contributions and the number of shares attributed in consideration for the contribution. g) Premiums The French law does not provide for explicit rules on the payment of premiums at the time of the company’s formation. Nevertheless, it does not mean that it is forbidden, even if it is hardly used in practice. However, Article 59 of the Decree n°67-237 dated March 23, 1967, implicitly provides for the payment in full of the premium as this information is required for the publication in BALO. (“Bulletin d’Annonces Légales Obligatoires”, legal mandatory announcements publication) 3.
Contributions
a) Contributions in cash / in kind Whereas contributions in cash (different modalities) are contributions the amount of which is paid up in cash, contributions in kind (different forms) refer to any contribution of assets other than cash. Any moveable (tangible or intangible) or immoveable asset the financial value of which can be assessed and the ownership and possession of which are transferable can be contributed to a company. However, only commercially exploitable assets can be contributed, which therefore excludes such assets as a ministerial office. Contributions in kind may be a business, patents, brands, drawings and designs, real estate, right to a lease, receivables etc. With respect to services, industrial contributions are not allowed (Article L.225-3 §4 CCOM). French law does not contain an express prohibition on the founders being relieved from their obligation to pay their contribution. On the other hand, the law provides that the contributions have to be paid up within a maximum period of five years (Article L. 225-3 CCOM). From this it follows that any relief from the obligation to pay-up the contribution is prohibited, and that failure of fully pay-up the contribution within 5 years of incorporation is a criminal offence punished by a €9.000 fine and a one-year prison sentence.
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b) Amount to be paid-up At least 50% of their nominal value of shares subscribed in cash must be paid-up while the remainder must be paid-up within five years (Article L.225-3 § 2 CCOM). Contributions in kind must be fully paid-up at the time of issue (Article L.225-3 § 3 CCOM). c) Valuation of contributions in kind Pursuant to French law, in the event of contributions in kind, one or more Contribution Appraisers must be appointed by order of the President of the Commercial Court at the request of one or more of the founders (Article L.225-8 § 1 CCOM). It should be noted that the following persons shall not be appointed as a Contribution Appraiser (Article L.225-224 CCOM): 1. founders, contributors in kind, holders of special privileges, directors or members of the management or supervisory boards, as the case may be, of the company or its subsidiaries as defined in Article L.233-1 of the French Commercial Code; 2. relatives of the persons referred to in sub-paragraph 1 by blood or marriage up to and including the fourth degree of kinship; 3. directors, members of the management or supervisory board, and, if applicable, spouses of directors or of members of the management or supervisory board holding one tenth of the company's capital or a company of which the company owns one tenth of the capital; 4. persons who, directly or indirectly or through an intermediary, receive from those mentioned in sub-paragraph 1 of this Article, or from the company or any company to which sub-paragraph 3 above applies, any salary, wages or remuneration whatsoever in respect of any activity other than that of an auditor; this provision shall not apply either to complementary professional activities carried on abroad or to specific review missions carried out by the auditor on behalf of the company in companies consolidated or intended to be consolidated therewith. Auditors may receive remuneration from the company for temporary missions with limited objectives, carried out in the course of their duties, provided that the said missions are assigned to them by the company at the request of a public authority; 5. companies or firms of auditors where one of their partners, shareholders or directors is in one of the situations described in sub-paragraph 1, 2, 3 or 4; 6. spouses of persons who receive any salary, wages or remuneration in respect of a permanent activity other than that of auditor either from the company or its directors or members of its management or supervisory boards, or from companies owning one tenth of the company's capital or of which the company owns one tenth of the capital; 7. firms or companies of auditors where the spouse of one of their directors, or of the partner or shareholder acting as auditor on behalf of the company, is in one of the situations described in sub-paragraph 6. The Contribution Appraiser must appraise on his own responsibility the value of the contributions in kind (Article L.225-14 CCOM). In his report, the Contribution Appraiser must describe each contribution, indicate the method of valuation used and state whether the contributions’ values correspond to at least the nominal value of the shares to be issued, which may be increased, where appropriate, by the issuing premium (Article 64-1 of Decree 67-236 dated March 23, 1967). The report must be held at the disposal of the subscribers at the registered office at least three days before the signature of the statutes (Article 73 of Decree 67-236 dated March 23, 1967). 48
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It is not possible to waive the drawing up of this report but the shareholders are not bound by the valuation made by the Contribution Appraiser in his report. On average, the valuation process takes one or two months d) Further national rules linked to the injection of contributions French law provides for further national rules with respect to listed public companies. The founders of such companies have to convene the subscribers to a constitutive general meeting as soon as the certificate of deposit of the (minimum) founding contributions has been issued. The said meeting shall confirm that the capital has been fully subscribed and that the shares have been paid-up in the amount due (Article L.225-7 CCOM). e) Consequences of incorrect financing Except in cases of wilful or fraudulent misrepresentation, an overvaluation of the contribution is not a ground for the nullification of the contribution (T.com.Paris 24-6-1974). Instead, such an overvaluation simply exposes the contributor to liability for the resulting damage. If a contribution has been overvalued, it is possible to subsequently correct the overvaluation by reducing the share capital (Cass.Req. 9-2-1903). However, unless the contributor is willing to bear the entire impact of the capital reduction alone, the reduction must be applied to all the shares; indeed, the overvaluation is enforceable against all the shareholders. If it becomes apparent that a contribution has been undervalued, the decision to re-value the contribution must be agreed to by all the shareholders, since the re-valuation entails a change in the allocation of their shares to the detriment of all shareholders other than the contributor. f) Premiums The French law does not provide for explicit rules regarding the payment of premiums at the time of the company’s formation. However, Article 59 of the Decree n°67-236 dated March 23, 1967, implicitly provides for the payment in full of the premium because this information is required for the publication in BALO. The premiums must be accounted for under the section: subscribed capital (“capital social”), account 104 (Article 441/10 PCG). However, the premiums can be distributed to the shareholders or the company can freely make use of the premium (Cass. Com. 09.07.1952, J.C.P. 1953, II, 7742). g)
Liability
If the contributor does not pay-up his contribution, his co-shareholders or the company’s creditors can compel him to do so by a court order. Non-payment of the contribution is not a ground to annul the company. However, an interested party could sue the contributor personally if the latter has breached commitments contained in a memorandum of understanding or contribution agreement. In addition, any founders, chairman, board members, managing directors or deputy managing directors who issue shares payable in cash, without ensuring that at least one-fourth of their par value was paid-up upon subscription, may be subject to a fine of €9,000 and a one-year prison sentence (Article L.242-1 §1 and 2 CCOM).
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4.
Accounting for formation expenses
In France, there are three accounting methods for formation or capital increase expenses (Article L.232-9 § 2 CCOM; Article 361-1 PCG). Firstly, these costs can be expensed as incurred. Secondly, they can be offset against the amount of the issued share premiums. Thirdly, these expenses may be capitalised. If the company has opted to account these costs for formation expenses, it cannot change the accounting method later on. In principle, all expenses that are external to the enterprise and directly relate to the transaction may be capitalised, e.g. fees for accounting, legal, and tax advice; bank fees relating to advisory services (financial engineering of the transaction), placement fees, guarantee of proper execution of the transaction; associated costs like the prospectus and printing costs, fees to regulatory authorities, market undertakings, legal formalities; communication and advertising expenses like cost of the campaign (television, newspapers, radio), holding of informational meetings, financial communication agency fees, and cost of advertising space. Under French law, capitalised formation or capital increase expenses have to be written off over a period of not more than five years, i.e. at least 20 % each year. The French law provides that the capital formation and capital increase expenses must be amortised before any profits may be distributed. It is not possible to distribute profits as long as the formation expense account has not been fully amortised, unless the amount of available reserves not subject to minimum level requirements is at least equal to the amount of nonamortised expenses (Article R.123-187 al 2 CCOM). French law requires that these expenses are booked as an asset under the title of “formation expenses”. In addition, the following items must be disclosed in the notes to the financial statements: comments on the elements making up these expenses (their nature, amount and treatment); movements to which they have been subject; methods used to calculate the amortisation allowances (Article R.123-187 al 2 CCOM).
Sub-section 2: Capital increases 5.
Increase in subscribed capital and other forms of equity financing
French law differentiates between ordinary capital increases and increases by authorised capital. Furthermore, it provides for special forms of capital increase. a) Ordinary capital increase Under French law, only an extraordinary general meeting may decide an immediate or possible capital increase, on the basis of a report from the board of directors or the management board (Article L.225-129 CCOM). However, it is general practice to convene, when needed, an extraordinary general meeting at the same venue and date as the annual meeting. Moreover, the extraordinary general meeting may delegate this competence to the board of directors or the executive board. Decisions taken in violation of such provisions are null and void (Article L.225-149 CCOM). Furthermore, any decision made on the basis of the statutes granting a general power of decision to the board of directors or the management board, is null and void. 50
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The extraordinary general meeting has a quorum when first convened only if the shareholders present or represented hold at least one quarter of the voting shares and, if reconvened, one fifth of the voting shares. Failing this, the second meeting may be postponed to a date not later than two months after the date originally scheduled. In non-listed public companies, the memorandum and articles of association may require higher quorums. It passes resolutions by a majority of two thirds of the votes held by the shareholders present or represented (Article L.225-96 CCOM). However, a capital increase carried out by increasing the nominal value of the shares may only be passed with the unanimous consent of the shareholders (Article L.225130 CCOM). The ordinary general meeting has a quorum when first convened only if the shareholders present or represented hold at least one fifth of the voting shares. In non-listed public companies, the statutes may require a higher quorum. If it is reconvened, no quorum is required. It passes resolutions by a majority of the votes held by the shareholders present or represented (Article L.225-98 CCOM). Different classes of shares: The share capital is increased either by an issue of ordinary shares or preference shares. (Article L.225-127 CCOM). According to Article L.225-129-6 of the French Commercial Code, when any capital increase by a cash contribution takes place, unless it results from a prior issue of transferable securities giving access to the capital, an extraordinary general meeting shall resolve on a draft resolution to increase the capital as provided for in Article L.443-5 of the Labour Code. An extraordinary general meeting shall also resolve on such a draft resolution when it delegates its power to increase the capital pursuant to Article L.225-129-2 of the French Commercial Code. After completion of tax registration formalities, the decision of increase in share capital shall be published as follows: 1. 2.
3. 4.
legal announcement in a gazette; filing with the Registry of Commerce and Companies of the following documents within one month from the date of the said general meeting: - two copies duly signed and certified by the legal representative, of the general meeting’s minutes deciding or authorising the increase in share capital; - where applicable, two copies of the minutes of the board of directors’ or managing board’s decision to realise the share capital increase; - two copies of the depository’s certificate; - two copies duly signed and certified by the legal representative of the general meeting’s minutes deciding the correlative amendment to the statutes; - two copies of the amended statutes; notice of the amendment to the Companies and Commercial Registry; publication in BODACC.
b) Authorised capital Under French law, the extraordinary general meeting may delegate its competence to decide on a capital increase to the board of directors or the management board. In order to do so, the extraordinary general meeting sets the period during which that authorisation may be used, 51
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with a maximum of twenty-six months, and the overall maximum amount for that increase (Article L.225-129-2 CCOM). The board of directors or the management board must use the authorisation within the twenty-six-month period and implement the increase in share capital within five years from the date on which the authorising decision was passed. c) Other kinds of increases in capital French law provides that the capital can be increased by capitalisation of reserves (see Article 15 (3)): Article L.225-127 CCOM. d) Contribution of premiums The new shares are issued either for their nominal/par value, or for that value plus a share premium (Article L.225-128 CCOM). The share premium must be fully paid-up on subscription. The share premium amount is decided either by the extraordinary general meeting or the director’s board/supervisory board if the extraordinary general meeting has delegated its competence to decide on the terms of the increase in capital. 6.
Subscription of new shares
a) Time limit According to the French Commercial Code, the share capital must be subscribed in full (Articles L.225-3 and L.223-12 CCOM, see Section 1, No. 2). If the company has been registered in spite of the fact that its shares have not been fully subscribed, the founders and the members of the first board can be liable. Moreover, if the subscribed capital is less than the share capital, the company may be annuled. Newly issued shares must be fully paid-up within a 5-year period. b) Prohibition that shares may be subscribed by the stock company itself Under French law, public companies are strictly prohibited from subscribing their own shares, either directly or through a person acting in his/her own name but on the company’s behalf (Article L.225-206, part 1, § 1). If this provision is breached, the chairman, directors or managing directors of a public company who subscribe, in the name of the company, shares issued by the latter, may be punished by a fine of €9,000 (Article L.242-24, § 1). Shares illegally subscribed by the company, or by any person acting on its behalf, must be sold within one year of their subscription or acquisition. Upon expiry of that period, the shares must be cancelled; failing that, the chairman, directors or managing directors of the company may be punished by a fine of €9,000. Public companies are also prohibited from taking pledges of their own shares, either directly or through a person acting in his/her own name but on the company’s behalf. Shares taken in pledge by the company must be returned to their owner within one year; failing this, the pledge agreement is automatically null and void. Furthermore, the chairman, directors or managing directors of a public company who have taken pledge of the company’s shares or have not returned such shares after the one-year deadline, may be punished by a fine of €9,000. c)
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Under French law, new shares are issued either at their nominal/par value, or at this value plus a share premium (Article L.225-128 CCOM). As mentioned above (Section 1, No. 2, d)) it is common opinion that shares may not be issued under this price. According to the French understanding, this follows from the duty to fully subscribe the share capital. Under French law, a considerable freedom prevails when issuing preference shares. This type of shares can be equipped with special rights and, subject to the prohibition of agreements by which a shareholder intends to avoid any risk or liability (“pactes leonin”), the possibilities are virtually endless. For instance, when a company wants to issue par value shares, the mechanism of preference shares becomes useful. d)
Issue of accountable par shares with the same voting and dividend rights as previously issued shares Newly issued shares, belonging to the same class as shares previously issued, have the same par value and must receive the same voting and dividend rights. Nevertheless, in the case of a capital increase, new shares, called preferential shares, may be issued with different rights different from those attached to the shares previously issued. e) Information to be fixed in the statutes In the case of a capital increase, it is necessary to amend the statutes as follows: - contribution (i.e. date of the decision to increase the share capital and the amount of the increase in share capital), and - share capital (i.e. new amount of the capital and new total number of shares). 7.
Contributions
a) Contributions in cash and in kind Under French law, capital increases can be performed by contributions in cash and in kind. Any immoveable or moveable asset (whether tangible or intangible) whose monetary value can be assessed and whose ownership or possession is transferable can become a contribution in kind. Only commercially exploitable assets can be contributed to commercial companies. A contribution can be made in ownership, possession or usufruct (see Section 1, No. 3). b) Paying-up Article L.225-144 of the French Commercial Code provides that at least one-fourth of the nominal value of any shares subscribed in cash must be paid-up upon subscription and, where applicable, the entire amount of any issue premium. The balance must be paid-up, in one or several installments, within the 5 years following the day on which the capital increase becomes final. c) Valuation Article L.225-147 of the French Commercial Code provides that, in the event of a contribution in kind or of the granting of special advantages, one or several Contribution Appraisers (“commissaires aux apports”) must be appointed by court order. Article 169 of the decree of March 23, 1967 provides that the Contribution Appraiser’s report must be kept available to the shareholders, at the registered office, for at least 8 days before the date of the extraordinary general meeting. If the general meeting approves the valuation of the contributions and the granting of special advantages, it then formally acknowledges the completion of the capital increase. If, on the other hand, the general meeting reduces the valuation of the contributions or the benefit of any special advantages granted, then these modifications must be expressly approved by the contributors, the beneficiaries or their duly 53
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authorised representatives, failing which the capital increase cannot be implemented. Also with respect to mergers, French law requires the appointment of an Expert Appraiser (a “commissaire à la fusion” and a “commissaire aux apports” who may be the same person but who nonetheless has two separate assignments and must draw up two separate reports). French law does not allow for non-cash capital increases to be carried out without recourse to an Expert Appraiser, even if all the shareholders of the beneficiary company have waived their right to an Expert Appraiser’s report. However, the shareholders are not bound by the conclusions of said expert (the Contribution Appraiser). They may therefore apply a different valuation of the contributions, against the advice of the Expert Appraiser. In this case, however, they become personally liable for the valuation. Furthermore, it should be noted that the provisions of Article L.225-147 of the French Commercial Code do not apply where a company whose shares are admitted for trading on a regulated market makes a public exchange offer for the securities of a company whose shares are also admitted for trading on a regulated market (Article L.225-148 CCOM). In such a case, the statutory auditors must state their opinion on the conditions and consequences of the issue in the prospectus to be distributed in advance of the issue as well as in their report to the first general meeting following the issue. d) Incorrect financing No legal consequences arise if the contributions are undervalued, except that the shareholders who made the undervalued contribution and who are thus prejudiced by the undervaluation can seek to hold the Contribution Appraiser liable for any loss they suffer. In the event of an overvaluation, the approval made by the general meeting is not nullified, but the company’s managing executives as well as the Contribution Appraiser may be held liable for the resulting loss. Criminal penalties (5-year prison sentence and a €9,000 fine) are also applicable to persons who fraudulently overvalue a contribution. A French court decision (Cass. Crim 12 – 4 – 1976) imposed criminal penalties on contribution appraisers who had deliberately kept shareholders unaware of elements of the valuation that would have led to a significant decrease in the value of the contributions. 8.
Pre-emption rights
a) Content According to French law, shareholders have a preferential right to subscribe to capital increases based on contributions in cash in proportion to the value of their shares (Article L.225-132 CCOM). However, if the company legally holds its own shares, it may not exercise the preferential subscription right itself (Article L.225-210, § 5 CCOM). Shareholders must exercise their subscription right within a period of time which shall not be less than five trading days after the opening date for subscriptions (Article L.225-141 CCOM). This pre-emption right does not exist if the capital increase results from a contribution in kind (Cass. com. 16 déc. 1969 : JCP 1970, II, 16367, note N. Bernard). Nevertheless, it is believed that the European Court of Justice ruling in Siemens AG (CJCE 19 nov 1996, Siemens AG, C-42/95, Rec I p. 6017), which holds that a pre-emption right exists in case of a contribution in kind, will probably influence French law in that regard.
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To enable shareholders to exercise their rights, the company must also comply with certain publication formalities, which may vary depending on whether the company makes public offering or not: - for non-listed public companies: registered letter with acknowledgement of receipt sent to the shareholders 14 days before the planned date for the close of the subscription, - for listed public companies or in case the shares are not all registered: publication at the BALO 14 days before the planned date for the close of the subscription. Pre-emption rights are attached to either ordinary or preference shares. An appreciable contractual freedom prevails in the matter since the establishment of preference shares: those preference shares may provide for: the attribution of reinforced pre-emption rights thus resulting in pre-empting ordinary shareholders in case of an issue of new shares, no attribution pre-emption rights at all (against, for instance, a preference attribution of the liquidation surplus as has been allowed since the creation of preference shares under French law). b)
Withdrawal or reduction of pre-emption rights by the shareholders’ meeting and/or by authorised body According to Article L.225-135 of the French Commercial Code, the general meeting which decides or authorises a capital increase may remove the preferential subscription right for the total capital increase or one or more tranches thereof. To do so, the general meeting must be informed through (i) a report from the board of directors or the management board and (ii) a special report from the statutory auditor The board of director’s report must include the maximum amount of the intended capital increase, the motives of the increase, the name of the beneficiaries of the capital increase and the number of shares allotted to them. It must assess the influence of the intended operation on the situation of each current shareholder. The statutory auditor’s report must assess the capital increase with respect to (i) price determination of shares, (ii) effect on the current shareholders’ situation, and it has to certify the reliability of the information provided. All the shareholders are entitled to vote except those who are the beneficiaries of the planned capital increase. The exclusion of the pre-emption right is only valid for an 18-month period; thus, the issue of new shares must be implemented in this period of time. If the general meeting has merely approved the capital increase, and authorised the board of directors or the management board to implement it, the authorisation also covers the exclusion of the pre-emption right under the same voting and majority conditions. In addition, a complementary report, which includes the aforementioned information, must be issued by the board of directors to the general meeting. A second report from the statutory auditor will be handed over to the board of directors or the management board at the time of the implementation of the increase.
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It is also possible for existing shareholders to voluntarily waive their pre-emption rights, on an individual basis. They can do so either for reward or free of charge and with or without nominating a beneficiary.
c) Securities to be converted into shares Shareholders, who hold transferable securities giving access to the capital, also have a preferential right to subscribe to these securities in proportion to the value of their shares in case of a capital increase. However, the decision to issue transferable securities giving access to the capital entails the waiving of the shareholders’ preferential right to subscribe the capital securities to which the transferable securities issued give entitlement (Article L.225-132, § 6 CCOM). d) Derogations According to Article L.225-138 of the French Commercial Code, the general meeting may resolve on a capital increase restricting the subscription right to employees in the context of an employees’ participation scheme and thereby exclude the pre-emption rights of all other shareholders.
Sub-section 3: 9.
Subsequent formations
Subsequent formations
a) Content According to French law, where, within two years of registration, a company acquires from a shareholder an asset which is worth at least one-tenth of its share capital, a valuer shall be appointed by a Court in order to value the asset in question on his own responsibility/liability (Article L.225-101 CCOM). Pursuant to this provision of the French Commercial Code, persons affected include any shareholder of the company. Furthermore, it follows from this provision that the assets in question are those which represent at least one-tenth of the “share capital” of the company (i.e., the equivalent of the subscribed capital of the company) and that only acquisitions within two years of the company’s registration are concerned. b) Valuation by an expert According to Article L.225-101 of the French Commercial Code, a valuer shall be appointed by a court order to value the asset. The Commercial Court order will appoint the valuer on an application by the chairman of the board of directors or the management, depending on the organisation of the company’s management. It is specified that the appointment of the said valuer shall be subject to the incompatibility rules set out in Article L.225-224 of the French Commercial Code which gives a detailed list of persons who may not be auditors of a public limited company, for example:
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founders, contributors in kind, holders of special privileges, directors or members of the management or supervisory boards, as the case may be, of the company or its subsidiaries;
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directors, members of the management or supervisory board, and, if applicable, spouses of directors or of members of the management or supervisory board holding
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one tenth of the company's capital or a company of which the company owns one tenth of the capital. Those incompatibilities are intended to preserve the independence of the valuation. The valuer bears the entire liability for the valuation of the asset in question. c) Shareholders’ resolution (majority etc.) Pursuant to Article L.225-101 of the French Commercial Code, the valuer's report shall be made available to the shareholders. The ordinary general meeting must approve the valuation of the asset. The ordinary general meeting has a quorum only if the shareholders present or represented hold at least one fifth of the voting shares. (In non-listed public companies, the statutes may require a higher quorum). If the general meeting is reconvened, no quorum is set and only a simple majority of the votes held by the shareholders present or represented is required. The seller has no right to vote either on his own behalf or as a representative. d) Transparency Under French law, there are no further requirements with respect to transparency apart from the approval by the shareholders. e) Exceptions The provisions of this Article shall not apply where the acquisition is effected on the stock exchange, under the supervision of a judicial authority or in connection with the company's ordinary business, or concluded on normal terms and conditions. f) Consequences of incorrect subsequent formations If the ordinary general meeting does not resolve on the valuer’s report, the acquisition of the asset shall be void. g) Subsequent formations in practice In the French legal system, subsequent formations are common in practice. Nevertheless, there is no relevant jurisprudence dealing with the specific provisions of Article L.225-101 of the French Commercial Code. Under French corporate law, there are also general provisions on the agreement entered into between the company and its general manager, one of its assistant general managers, one of its directors, one of its shareholders holding a fraction of the voting rights greater than 10% or, in the case of a corporate shareholder, the company which controls it (Article L.225-28 CCOM). Such agreement must be subject to the prior consent of the board of directors. In this case, Article L.225-40 of the French Commercial Code states a procedure very similar to that required by Article L.225-101: -
the interested party may not participate in the vote on the requested prior approval of the board, and
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the chairman of the board of directors shall advise the auditors of the agreement in question,
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the chairman of the board of directors shall submit the agreement to the general meeting for approval,
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the auditors shall present a special report on the agreements to the meting, which shall vote on this report,
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the interested party may not participate in the vote and his shares shall not be taken into account for the calculation of the quorum and the majority.
Where the agreement is entered into by a shareholder who is also a manager of the company, the question of the aggregation of the formalities of Article L.225-38 and Article L.225-101 of the French Commercial Code could arise. There is no jurisprudence clarifying the necessity of the application of the general provision of Article L.225-38. Nevertheless, most of the French commentators consider that Article L.225-101 of the French Commercial Code is a specific provision, overriding the general provision of Article L.225-38 of the French Commercial Code.
Section 2: Capital Maintenance 10.
Limitation of distributions
a) Principle Under French law, the principle applies that distributions may not affect the subscribed capital and the legal or statutory reserves. As a consequence, Art. L.232-10 of the French Commercial Code determines that, except in case of a reduction in the subscribed capital, no distribution can be made to shareholders when the net equity, after the distribution, is or would be less than the amount of the subscribed capital plus the legal or statutory reserves that are not distributable. Limits to transactions can follow from the company’s corporate purpose (“objet social”) or from the prohibition on misuse of the company’s funds (“abus de biens et du credit“).The misuse of the company's funds is considered as an offence. This is, for example, the case where a manager, in bad faith, uses the company’s funds for a private purpose and not in compliance with the company’s interest. Another case is when a manager performs an act which impoverishes the company, even temporarily. Furthermore, the principle applies that an economic transaction between the company and a shareholder is subject to prior authorisation. Such a transaction is only possible if it is advantageous for the company. If this is not the case, the contract leads to an "abus de bien sociaux", even though it was authorised. b) Sanctions In the event of a decrease in share capital, shareholders must be treated equally. Otherwise, the President or the managers may be subject to a €375,000 fine (Article L.224-205 § 1 CCOM). In the event of a reduction in share capital to below the legal minimum, any interested parties may petition the President of the Commercial Court to dissolve the company (Article L.224-2 § 2 CCOM). Nevertheless, the President of the Commercial Court may not decide to dissolve the company if the amount of the share capital has been replenished by the date on which the case is heard in court. Any dividend distribution / interim dividend distribution decided on in violation of the Articles L.232-11/L.232-12 of the French Commercial Code constitutes a “false dividend
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distribution” that is subject to (i) specific penalties, i.e., a five-year prison term and a €375,000 fine (Article L.242-6 § 1 CCOM) and (ii) civil damages. 11.
Acquisition of own shares
a) Possibility of acquiring own shares French law generally prohibits companies from purchasing or subscribing their own shares, except in the limited cases provided for by law. These exceptional cases cover purchases (Article L.225-206 CCOM): - in the framework of a capital reduction that is not the result of losses. The repurchased shares must in this case be cancelled immediately (cf. Question 14 in this respect, Article L.225-207 CCOM); - in order to grant shares to the company’s employees (Article L.225-208 CCOM), for example under a profit-sharing plan, a stock option plan or a plan to grant free shares. Furthermore, French law provides for a general authorisation of the acquisition by the company of its own shares (Article L.225-209 CCOM). According to this provision, the general meeting of a listed company can authorise the board of directors to acquire 10% of the company’s capital. The general meeting has to resolve on the purpose, terms and conditions of the acquisition. The authorisation can be given for a maximum period of 18 months. This authorisation can be used, for example to improve the financial management of their shareholders’ equity. The relevant information must be notified to the market (general regulations of the Autorités des Marchés Financiers (i.e., the French securities exchange commission, hereinafter the “AMF” and AMF instructions). The details of the redemption programme must be published in one or several newspapers, made available at the issuer’s registered office and posted on the issuer’s website. b) Conditions regarding acquisition of own shares A company’s acquisition of its own shares is, moreover, subject to the following conditions: - the purchase must not be made by a person acting on the company’s behalf (Article L.225-206 § 2 CCOM), - a 10% limit; i.e. the company may not acquire more than 10% of the total number of its shares (Article L.225-210 § 1 CCOM), - the shareholders’ equity must be maintained: the company’s purchase of its own shares must not have the effect of reducing its shareholders’ equity to an amount that is lower than the combined amount of its capital and non-distributable reserves (Article L.225-210 § 2 CCOM). Furthermore, the company’s purchase of its own shares must be authorised by the ordinary general meeting, which must resolve on the purpose of the transaction (e.g. to grant shares to employees), as well as its terms and conditions. It should be noted that the rules governing a company’s purchase of its own shares do not apply to fully paid-up shares that are acquired further to a transfer of all the assets and liabilities of a business (merger, de-merger, partial contribution of assets) or further to a court decision (Article L.225-213 § 1 CCOM). The company may retain such shares indefinitely provided that it does not hold more than 10% of its own capital.
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c) Shares acquired in contravention of the legal rule Any shares held by the company in contravention of the legal provisions must be sold within one year of their acquisition, failing which they must be cancelled. Any corporate officers or executives who, on behalf of the company, have purchased shares issued by it without satisfying the related conditions of purchase, or who have held on to them beyond the deadline for disposing of them, are subject to a €9,000 fine (Articles L.242-24 § 1 and L.2481 CCOM). d) Holding of shares In France, the shares purchased by the company must be registered shares and be paid-up in full. From the acquisition of own shares follows that the voting rights of treasury shares are cancelled. The same applies with respect to the right to dividends and pre-emption rights (Article L.225-210 CCOM). Furthermore, it must be noted in this context that the amount of the company’s reserves, not including its legal reserve, must be at least equal to the value of all the shares it holds (Article L.225-210 § 3 CCOM). In its report to the annual general meeting, the board of directors or executive committee must indicate (Article L.225-111 CCOM): - the number of shares purchased during the financial year; - the average purchase price; - the amount of trading commissions; - the number of shares registered in the company’s name at the financial year-end, their value based on the buying price, as well as their nominal value; - the reasons for the purchases made; and - the fraction of capital they represent. In companies whose shares are admitted for trading on a regulated market, a special report must also be prepared each year in order to, in particular, inform the general meeting of any share purchase transactions it authorised and to specify the purpose in each case (Article L.225-209 § 2 CCOM): - the number and price of the shares thus acquired, - the volume of shares used for said purpose, - any other purposes to which the shares may have been reallocated. French law prescribes that in a specific schedule to the accounts, the following information must be provided if significant: - the number and value of the company’s own shares held at the end of the financial year, as well as, - share transfers during the last financial year, and if need be, - the method chosen for the allocation of the company’s own shares acquired. e) Acceptance by the company of its own shares as security Article L.225-215 of the French Commercial Code prohibits the company from taking a pledge of its own shares, either directly or through persons acting in their own name but on the company’s behalf. f) Application of Article 24a of the 2nd CLD if exceptions have not been availed of by Member State Under French law, Art. 24a of the 2nd CLD is not applicable. g) 60
Resale of the company’s own shares (equal treatment)
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French law does not provide specific regulations regarding the resale of the company’s own shares. 12.
Prohibition of financial assistance
French law provides that a company cannot grant any loans or securities for the purpose of allowing a third party to subscribe or purchase its own shares (Article L.225-116 § 1 CCOM). This prohibition applies not only to subscriptions or purchases by persons unrelated to the company but also to transactions made by the shareholders themselves. However, this prohibition does not apply: -
to the ordinary transactions of credit institutions; to transactions entered into to allow employees to acquire shares in the company, in one of its subsidiaries or in a company that comes within the scope of a group savings plan.
In France, the amendments of the 2nd CLD by Directive 2006/68/EC have not yet been implemented into national law. 13.
Loans from shareholders
In France, it is possible, and, in practice, usual, that shareholders grant loans to the company. According to Article L.225-38 of the French Commercial Code, any agreements entered into, either directly or through an intermediary, between the company and its general manager, one of its deputy general managers, one of its directors, one of its shareholders holding 10% of voting rights or, in the case of a corporate shareholder, the company which controls it, must be subject to the prior consent of the board of directors. Therefore, a shareholder with more than 10% of the voting rights, proposes to grant a loan to the company, he or she must immediately inform the board of directors and may not participate in the vote on the requested prior approval of the board. Any agreements entered into without the prior authorisation of the board of directors may be cancelled only if they have prejudicial consequences for the company. The chairman of the board of directors shall advise the auditors of all agreements authorised and shall submit them to the general meeting for approval. The auditors shall present a special report on the agreements to the general meeting, which shall resolve on this report. The interested shareholder may not participate in the vote and his shares shall not be taken into account for the calculation of the quorum and the majority. Loans from shareholders cannot be treated as share capital when the company is in a financial crisis. Furthermore, any loans granted by the company to one of its board members are strictly prohibited, so that such loans are considered as null and void and the sums borrowed by the shareholder concerned shall be immediately repaid (Article L.225-43 § 1 CCOM).
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14.
Capital decreases
a) General conditions French law distinguishes two cases of capital decrease: one which is motivated due to losses (simplified capital decrease) and one which is not motivated due to losses (ordinary capital decrease). Depending on whether the capital decrease is motivated due to losses or not, the applicable regime shall be slightly different. The reduction in share capital may be implemented either by the reduction of the number of shares or by reduction of their nominal value. According to Article L.224-2, § 2 of the French Commercial Code, it is possible to reduce the share capital to €225,000 for the listed public company and €37,000 for an unlisted public company. A reduction below these amounts is only possible under one of these conditions: an increase in share capital after the reduction in share capital in order to arrive at the minimum share capital required by French law, a transformation into another company form which requires a lower share capital than a public company. The extraordinary general meeting is exclusively competent to decide or authorise the capital decrease. However, the meeting can delegate to the board of directors all its powers to implement the capital reduction (Article L.225-204 (1) CCOM). The general meeting shall be called with fifteen days notice, and in case of a second meeting, six days notice. The extraordinary general meeting has a quorum when first convened only if the shareholders present or represented hold at least one quarter of the voting shares and, if reconvened, one fifth of the voting shares. Failing this, the second meeting may be postponed to a date not later than two months after the date originally scheduled. In non-listed public companies, the statutes may require higher quorums. The extraordinary general meeting resolves on the capital reduction with a majority of two thirds of the votes held by the shareholders present or represented (Article L.225-96 of the French Commercial Code). Moreover, the statutory auditors have to draw up a special report in order to assess the reasons and conditions of the reduction (Article L.224-204, § 2 CCOM). In any case, the capital decrease cannot jeopardise the equal treatment of the shareholders. A copy of the minutes of the extraordinary general meeting which has decided or authorised the capital decrease must be filed with the clerk of the Commercial Court within a month after the said meeting. b) Ordinary capital decrease With respect to the specific procedure applying if the decrease in share capital is not due to losses (ordinary capital reduction), the following applies: The creditors of the company may notify to the company their objection to the reduction, within 20 days after filing with the Commercial Court of the minutes of the general meeting deciding on the reduction. However, a court decision may reject the objection or order either that the debts be repaid or that guarantees be provided if the company offers them and they are deemed to be sufficient. In any case, the capital reduction procedure shall neither commence during the time period for raising an objection, nor, where applicable, before a decision on first hearing has been given on any objection raised. If the judge of the original jurisdiction accepts the objection, the capital reduction procedure is immediately halted until sufficient guarantees are provided or until the debts are repaid. If he rejects it, the reduction 62
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procedure may recommence and distribution or payment of their shares to the shareholders can be made. (Article L.225-205 CCOM). Regarding the reduction of the number of shares French law provides that it may take the form of the repurchase of its own shares by the company. As soon as the capital decrease is implemented and if the statutes of the company are amended, the following legal formalities shall be performed: -
publication in a legal gazette; and filing with the clerk of the Commercial Court of two original decisions of the board of directors to implement the capital reduction and of two original amended versions of the statutes.
c) Prospective implementation of the amendments of the 2nd CLD The amendments of the 2nd CLD with respect to the burden of proof have not yet been implemented into national law. 15.
Redemption of the subscribed capital
The redemption of subscribed capital is allowed by French law and regulated by Article L.225-198 to Article L.225-203 of the French Commercial Code. Therefore, it is possible to fully or partially repay shares by repaying contributions, cancelling shares but without reducing the capital. a) Condition to which the redemption is linked The decision of redeeming the capital shall be taken either by the ordinary general meeting when the redemption is provided by a special provision of the statutes or, if the statutes do not provide expressly the possibility of redemption, by the extraordinary general meeting. The publication of the resolution is not required. French law provides that the general meeting shall, in any case, be convened with fifteen days notice, and in case of a second meeting, six days notice. The extraordinary general meeting has a quorum when first convened only if the shareholders present or represented hold at least one quarter of the voting shares and, if reconvened, one fifth of the voting shares. Failing this, the second meeting may be postponed to a date not later than two months after the date originally scheduled. The extraordinary general meeting resolves with a majority of two thirds of the votes held by the shareholders present or represented (Article L.225-96 CCOM). The ordinary general meeting has a quorum when first convened only if the shareholders present or represented hold at least one fifth of the voting shares. If it is reconvened, no quorum is required. The ordinary general meeting resolves with a majority of the votes held by the shareholders present or represented (Article L.225-98 CCOM). The redemption may be effected by the repayment of an equal sum per share. French law provides that the payments may not be made out of the profits or reserves, with the exception of the legal reserve and, as the case may be, of statutory reserves (Article L.225-198 par. 1 CCOM). No distribution can be made to the shareholders when the net equity is, or would thereby become, less than the amount of the capital plus the legal or statutory reserves (Article L.232-11 par. 3 CCOM). Such write-offs may only be effected through equal redemption of every share within a given category and do not entail any capital reduction. 63
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The redeemed shares have to be converted into bonus shares (“action de jouissance”) with the consequence that the fully or partially redeemed shares lose their entitlement, pro tanto, to the first dividend and to the repayment of the nominal value, but retain all their other rights (e.g. right to vote, right to information). The fully redeemed shares are known as dividend shares. French law provides that when the capital is divided either into capital shares and fully or partially redeemed shares or into unequally redeemed shares, the extraordinary general meeting may decide to convert the fully or partially redeemed shares into capital shares (Article L.225-200 par. 1 CCOM). Under French law the following two possibilities of conversion are provided for: either the company may provide for a compulsory deduction to be made from the portion of the company's profits, for one or more financial years, that relates to those shares in respect of the redeemed amount of the shares to be converted, after payment of the first dividend or any cumulative preferred dividend to which the partially redeemed shares may give entitlement (Article L.225-200 par. 2 CCOM); or the shareholders may be authorised, in the same circumstances, to pay the company the redeemed amount of their shares and, where applicable, the first dividend or the cumulative preferred dividend for the elapsed portion of the then current financial year and, where appropriate, the previous financial year (Article L.225-201 CCOM). b) Rights of shareholders whose shares are redeemed The redemption resolutions are subject to ratification by special meetings of each class of shareholder having the same rights. 16.
Compulsory withdrawal of shares
In principle, each shareholder has the right to stay in a company and he cannot be forced to transfer his shares without his approval. However, French law provides that the statutes of a public company can provide the compulsory withdrawal of shares provided that the withdrawal is included in the original statutes of the company or has been introduced into the statutes of the company with the unanimous approval of the shareholders (CA Paris 27-32001). A special clause entitled “exclusion of a shareholder” can be included in the statutes. A shareholder can be excluded from the company for serious cause. Such a clause reduces trading and working freedom and is onerous for the shareholders. Consequently, it can only be inserted in the statutes with the unanimous approval of the shareholders. a) Conditions to which the withdrawal is linked In case of compulsory withdrawal, the statutes must expressly provide the conditions of the purchase (grounds, competent body, procedure to be followed). These conditions must be objectively determined, and that the value shall be determined, in case of dispute, by an expert (Article 1843-4 of the French Civil Code). Protection for the shareholders is based on the direct application of Article 36 of the 2nd CLD. In case the compulsory withdrawal leads to a capital reduction, the capital reduction shall be implemented in accordance with the provisions stated by French law regarding capital reduction which is not due to losses.
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b)
Redemption of shares acquired by the company itself or by a person acting on behalf of the company The shares which have been acquired by the company can be cancelled by means of a reduction of capital, Article L.225-209 CCOM. The acquisition, assignment or transfer of the said shares may be effected by any means. Shares representing up to 10% of the company's capital may be cancelled every twenty-four months. The company reports to the Financial Markets Council each month on the purchases, assignments, transfers and cancellations thus effected. The Financial Markets Council brings this information to the attention of the public. In the event of shares purchased being cancelled, the capital reduction is authorised or decided by an extraordinary general meeting, which may delegate full powers to effect such cancellation to the board of directors or the executive board, as applicable. A special report on the planned transaction, drawn up by the auditors, is sent to the company's shareholders within a time limit determined in a Conseil d'Etat decree (15 days).
17.
Redeemable shares
The French legislator did not use the possibility of the 2nd CLD to allow public companies to issue redeemable shares.
Section 3: Dividends and distributions 18.
Definition of Distribution
Under French law, there is no formal definition of the term ‘distribution’. However, a distribution to shareholders generally includes a payment of dividends, reserves or interim dividends (see section 2, No. 10, supra). Contrary to what is provided for in Article 15 (1 d) of the 2nd CLD, under French law the term distribution does not include distributions of interests, since: − Article L.232-15 of the French Commercial Code bans any provision in the statutes by which interest would be payable to shareholders, − any contrary clause shall be null and void. Article L.232-16 of the French Commercial Code, however, provides for the distribution, as initial dividend only, of interest calculated on the basis of the amount of the paid-up share capital (and not reimbursed). However, the statutes may specify the allocation, by way of an initial dividend, of interest calculated on the paid-up a redeemed amount of the shares. Unless otherwise specified in the statutes, the reserves shall not be taken into account when calculating the initial dividend. 19.
Distributable amount
a) Balance sheet net assets test and earned surplus test Under French law, the provisions of Article 15 (1) of the 2nd CLD are implemented by Article L.232-11 of the French Commercial Code. Accordingly, the distributable amount is: o the net after-tax profit, o minus any negative retained earnings or allocations to legal or statutory reserves, o plus any positive retained earnings, 65
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o plus distributable reserves if the general meeting so decides (distributable profits are first taken from the profit; if some distributable profits are taken from the distributable reserves, the decision of the general meeting shall expressly mention from which distributable reserves these amounts are taken). Except in case of a reduction in share capital, no distribution can be made to shareholders when the net equity is or would be, after the distribution, less than the amount of the share capital plus legal or statutory reserves that are not distributable. Pursuant to Article L.232-10 al. 1, 3 of the French Commercial Code, every year five percent of the financial year’s earnings less any losses brought forward have to be allocated to a formation of a reserve fund referred to as “the legal reserve” until the legal reserve reaches ten percent of the subscribed capital or a higher percentage if so provided by the company’s statutes. However, the share premium is not part of the legal reserve and therefore can be distributed. French law does not provide for derogation with respect to investment companies with fixed capital (Article 15 (4) of 2nd CLD). b) Interim dividends Article L.232-12 par 2 of the French Commercial Code provides that the distribution of an interim dividend is subject to the following conditions: -
the preparation of interim accounts which show after (i) the recording of depreciation and provisions and (ii) the deduction of prior losses and of sums entered in reserves, an interim net profit, and certification of the interim accounts by the statutory auditor.
The interim dividend shall not exceed the above-mentioned interim net profit. c) Premiums Premiums must be accounted for under subscribed capital (A. capital, II. premiums) as provided by Article 9 of the 4th CLD. d) Incorrect distributions Any dividend distribution/interim dividend distribution in breach of the rules provided by Article L.232-11/L.232-12 of the French Commercial Code constitutes a “false dividend distribution” which is subject to specific penalties i.e., a five-year imprisonment and a fine of €375,000 (Article L.242-6, par. 1 CCOM) and to civil damages. With respect to incorrect distributions, Article L.232-17 CCOM is applicable. It provides that the company may not request from shareholders any repayment of dividends, except when the following two conditions are met: - the distribution has been carried out in breach of the provisions of Articles L.232-11, L.23212 and L.232-15, (which required the approval of the annual accounts, the existence of distributable sums, no illegal fixed or interim interest); - the company establishes that the recipients knew about the irregular nature of this distribution at the time or could not have been unaware of this, given the circumstances. The managers, the directors or the presidents are liable under criminal law in case of distribution of “dividend fictifs” (five year imprisonment and a fine up to €375,000). Furthermore, they, as well as the statutory auditors, may have to pay civil damages, if they were aware of the irregular distribution and if they had not revealed it to the general meeting. 66
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20.
Determination of the distributable amount
a) Proposal by the company’s bodies / authorisation by the shareholders’ meeting A dividend distribution falls within the exclusive competence of the annual general meeting which approves the annual accounts, upon proposal of the company’s governing body (i.e. board of directors, president). The general meeting can only decide on the dividend distribution after having approved the annual accounts of the relevant financial year and having acknowledged the amount the distributable profits. The majority rule required is that for the ordinary general meeting (50%). b) Publication Minutes of the general meeting approving the annual accounts and allocating the result (i.e. dividend distribution) as well as the annual accounts themselves shall be filed with a clerk of the competent Commercial Court. These documents are then publicly available at the clerk of the Commercial Court. No further publication is required. c) Challenge of resolutions Shareholders can challenge improper decisions of general meetings before the competent Commercial Court. It is often the case that majority shareholders systematically vote in a way that the profits of the company are not distributed; they are rather allocated to the reserves. In such cases, minority shareholders may petition the relevant court in order to have such a decision be considered as an abuse of majority. Nevertheless, case law requires proof of such an abuse of majority: for this purpose, it must be proved that such a decision to allocate profit to reserves is contrary to the company’s general interest and only in the majority shareholders’ interest (Cass com. 23-6-1987; Cass Com. 3-6-2003; Cour d’Appel de Versailles 1-2-2001). In some court cases, a court has sanctioned such decisions which were considered as an abuse of majority (Cass. Com.6-6-1990; Cass. Com 1-7-2003). 21.
Accounting reserves that influence the distributable amount
French law has implemented the restriction of Article 34 of the 4th CLD relating to the accounting of formation expenses. Article L.232-9 (1) of the French Commercial Code, imposes the depreciation of the formation expenses before any dividend distribution. According to Décret 83-1020 du 29-11-1983 art. 19, al. 6, the general meeting will only be able to decide on a dividend distribution if the accounts ‘formation expenses’ have been written off or as long as existing distributable reserves are of an amount equal to the amount of “expenses” not yet depreciated. These expenses shall be depreciated over a five-year period (Décret 83-1020 Art. 19, al. 5). These expenses include the registration expenses (registration tax on contributions, fees, expenses from legal publicity). 22.
Serious loss of the subscribed capital
a) Calling of the general meeting Article L.225-248 of the French Commercial Code provides that, in the event that, because of losses of the company, the net equity becomes less than half of the share capital, an extraordinary general meeting must be held in order to decide on whether or not the company should be dissolved. This extraordinary general meeting must be held in the four months following the ordinary shareholders’ meeting that has approved the financial accounts showing the losses.
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b) Consequences If the shareholders decide not to dissolve the company, it is mandatory that the company brings its net equity to an amount that is at least equal to half of the share capital before the end of the second financial year following that during which the shareholders’ meeting was held (i.e., the replenishment needs to be carried out before the end of the third financial year following the financial year showing the losses). If the extraordinary general meeting ruling on the proposed company dissolution is not convened within the period provided by law, the company manager can be held liable (a €4,500 fine and a 6-month jail term). In addition, any person can petition the court to pronounce the company’s dissolution. But the court can grant the shareholders an additional six months to resolve the situation. The decision (whether to dissolve or not) is published in a legal gazette and filed with the clerk of the Commercial Court. In addition, the loss of more than half of the share capital is indicated on the company’s official information sheet (“Extrait Kbis”) kept by the Commercial Court where the company has its seat. 23.
Trigger of insolvency
The French insolvency law has been modified by the law dated July 26, 2005 which entered into effect on January 1, 2006. a) Factors triggering insolvency The insolvency test is to ascertain if the company is in “cessation des paiements” that means that the company is able to meet its financial obligations, to pay its current liabilities with its liquid assets. b) Time frame The board must apply this test when the company encounters difficulties to meet its financial obligations or when the statutory auditors trigger the alert procedure. However, the board can trigger other procedures (“Mandataire ad hoc” and “protection procedure”) to prevent insolvency before the “cessation des paiements”. The board can be caused to apply the insolvency test after an alert procedure (“Procedure d’alerte”). This procedure can be triggered either by the statutory auditors, the workers council, the minority shareholders or the president of the Commercial Court. The main alert procedure concerns the statutory auditors. They must alert the board on facts which, according to them, can compromise the going concern of the company. This alert is given by registered letter addressed to the board and asking for explanations of the situation. If the statutory auditors are of the opinion that the answers given by the board are not sufficient, or if the board does not answer the alert of the statutory auditors, then they convene a board meeting which must deliberate within 15 days after the delivery of the convening letter. The decisions taken by the board must be transferred to the president of the Commercial Court. If the statutory auditors are of the opinion that the explanations given or the decisions taken are not sufficient, they draft a special report for the attention of the shareholders convened for the occasion by the board. The statutory auditors shall also inform the president of the Commercial Court of their intentions with regards to the decisions taken by the shareholders.
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The president of the Commercial Court can decide if he is of the opinion that the situation (such as information given by the statutory auditors or request of a creditor) threatens the survival of the company, to convene the directors to question them about the situation of the company. c) Duties of the board members A board meeting shall decide to file for one of the following procedures according to the situation of the company: If the company is not insolvent but encounters temporary difficulties to pay its creditors, the directors can ask for the nomination by the commercial court of a person mandated to assist the directors in the negotiations with the creditors of the company (“Mandataire ad hoc”). This procedure is confidential and the agreement entered into with the creditors is privately negotiated. If the company encounters persistent difficulties without being insolvent for more than 45 days the directors can file for a conciliation procedure during which the company continues to be managed by the directors. The Commercial Court nominates a conciliator whose role is to negotiate a new repayment schedule with all the creditors of the company. The agreement can be approved by the Commercial Court. If it is not yet insolvent but encounters difficulties which it cannot overcome and which may lead the company into insolvency, the board can file for a protection procedure which is the equivalent to the receivership but takes place before the insolvency of the company. If the company is insolvent i.e. unable to pay its current liabilities with its liquid assets for 45 days at most the following applies: - if the situation of the company can be remedied, the board must file for receivership if a conciliation procedure has not been already filed for. - if the situation of the company cannot be remedied, the board must file for compulsory liquidation. d) Treatment of subscribed capital, premiums, shareholder loans The repayment of creditors shall be made according to the following order: 1. 2. 3. 4. 5.
employees; judicial fees; conciliation privilege, if any; debts secured by legal warrantees on property or other securities; debts subsequent to the date of insolvency.
After these payments, and if there is any remaining liquidity, the shareholders can be refunded. Moreover, the determination of the insolvency date is important because the directors can be prosecuted for having continued the activity of a company which was insolvent. Decisions as the distribution of premiums or reimbursements of shareholders’ loans which were exercised during this period, constitute a fraud.
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Section 5: Contractual self protection of creditors 24.
Contractual self protection
There is no specific rule regarding the contractual protection of the creditors which can guarantee the payment to the creditors, except the texts regarding warrantees (pledge, security, etc.). In practice, banks use this kind of protection when they are financing a company. The contractual provisions usually provide that the reimbursement of the loan shall prevail against any other repayment. Other provisions can provide that no security can be taken on the assets of the company at least unless prior approval of the bank. Those kinds of protections can also be provided for in shareholders’ agreements. The insolvency law also provide that in the conciliation procedure, creditors can give further funds to enable the company to remedy its situation. Financing, allowed by the conciliation plan, gives a super privilege according to which, in case of further liquidation procedure, those creditors are reimbursed before other creditors with the exception of employees’ debts.
Section 6: Equal Treatment 25. Principle of Equal treatment a) Equal treatment concerning the right to vote Under French law, the right to vote is a main characteristic of a share. This principle follows from Article 1844, al. 1 of the French Civil Code according to which “Every member has the right to participate in collective decisions”. It must be noted that the Supreme Court (“Cour de cassation”) distinguishes between the right to vote and the right to participate in collective decisions. Only the shareholders benefit from the right to vote. The right to vote is a matter of public policy (see Article 1844, al. 4, of the French Civil Code); consequently, an agreement or provisions of the statutes can not derogate from this rule even on a temporary basis. The only cases when a shareholder can be deprived of this right are those provided by the law such as preferred shares, in kind contributions, shares owned by an interested shareholder in a regulated agreement, shares owned by the company, and in case of shares not fully paid-up where such payment is required by Article L.228-29 of the French Commercial Code. It must be noted that for corporations (“société anonyme”) the number of voting rights attached to the shares must be proportional to the portion of the capital that they represent. The number of voting rights can be limited in order to protect small shareholders. The law authorises, in the statutes, the limitation of the number of voting rights a shareholder can have (Article L.225125, al.1, CCOM). b) Equal treatment concerning the pre-emption right Provisions regarding pre-emption rights are only provided for with respect to public companies (“société anonyme”). Any shareholder has the right to subscribe a number of new shares determined proportionally to his participation in the company’s capital (Article L.225132, al.1 CCOM). Any cash capital increase grants the shareholders, in proportion to the amount of their shares, a pre-emption right to subscribe for new shares. This pre-emption right may be separated from the shares and is negotiable through out the entire subscription period. Its purpose is to financially compensate the dilution of the monetary rights and voting rights in the event that certain shareholders do not subscribe the capital increase. Pre-emption 70
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right are reserved to the shareholders and to the holders of investment certificates (“certificats d'investissement”) only, but only if the shares are fully paid-up. However, this provision is not applicable as no capital increase can be decided if the shares are not fully paid-up. The shareholders have to exercise their pre-emption right during a period which cannot be shorter than five trading days (Article L.225-141, al.1 CCOM). If that period is not allowed, the capital increase is invalid. However, the subscription period can end earlier, if all the preemption rights have been exercised or if the capital increase has been fully subscribed. Article L.225-135 of the French Commercial Code provides that an extraordinary general meeting may resolve on or authorise a capital increase and exclude the pre-emption right subject to compliance with certain conditions to protect the shareholders. The exclusion of the preemption right can be complete or partial. Generally, the general meeting can exclude the preemption right only in favour of determined persons or class of persons. However, it might be different for listed companies. c) Equal treatment concerning the right to receive dividends The beneficiaries of the dividends are the company’s shareholders. Concerning shares with beneficial ownership the dividends are paid to the beneficial owner. The shareholders rights depend on whether the shares are ordinary, preferred shares or holding shares. In the absence of any specific provision, all the persons who are shareholders at the moment of the meeting which decides on the distribution of the dividends are entitled to this dividend (Paris Court of appeal decision dated November 29, 1996: RJDA 4/97 n° 513). The right to receive dividends is suspended for the owners of shares who have not fully paid-up their shares after formal notice. There are no dividend rights for the shares which are held by the company; for public companies see Article L.225-210 CCOM. d) Equal treatment concerning the right to attend the shareholders’ meeting In principle, any shareholder can participate in general meetings either personally or represented by an agent. However, this right can be reduced when the shares are not fully paid-up. Besides the right to participate in shareholder meetings, the shareholder has the right to vote. This right is essential and a shareholder can be deprived of it only through a legal provision, in particular the provisions of order 2004-604 dated June 24, 2004. Under certain conditions a shareholder can propose resolutions.
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3.1.2
Germany
Section 1:
Capital formation
Sub-section 1:
Formation of the public company
1. Minimum capital and other means of equity financing a) Minimum subscribed capital Under German law, public companies are required to have a minimum subscribed capital of €50,000 (§ 7 German Stock Corporation Act (AktG). Above this minimum amount, the founders are entitled to freely fix a higher capital amount. German law prohibits the distribution of subscribed capital to shareholders (§ 57 AktG, see under question 19). b) Authorised capital The German Stock Corporation Act uses the possibility of fixing authorised capital at the stage of formation (§§ 202 – 206 AktG). The board of directors can be authorised for a maximum period of five years starting with the incorporation of the company to increase the subscribed capital by up to half of the subscribed capital that existed at the time the authorised capital was fixed in the statutes (§ 202 AktG). The decision of the board of directors to make use of the authorised capital is subject to the consent of the supervisory board (§ 204 (1) s. 2 AktG). c) Premiums Under the German Stock Corporation Act, it is permitted to use share premiums during the stage of formation (§ 9 (2) AktG). Under German law, the term “share premiums” is generally understood as the amount the subscriber of new shares has to pay in excess of the nominal value to the company. They do not grant any additional voting rights and/or profit rights. According to the German Commercial Code, share premiums are to be placed in the capital reserve (“Kapitalrücklage”, § 272 (2) No. 1 HGB). The capital reserve and the statutory reserve (“gesetzliche Rücklage”) form a “legal reserve fund” into which, in each financial year, five percent of the financial year’s net earnings less any losses brought forward have to be placed in the statutory reserve until the statutory reserve and the capital reserves reach ten percent of the subscribed capital or a higher percentage if so prescribed by the company’s statutes. The “legal reserve fund” – and thus the share premium – must not be distributed. It serves in the first place to offset losses which otherwise reduce the subscribed capital (§ 150 (3) AktG). If the combined sum of the capital reserve and the statutory reserve exceeds ten percent of the subscribed capital or the higher percentage prescribed by the company’s statutes, it may also be used for an increase of capital according to §§ 207-220 AktG (§ 150 (4) No. 3 AktG). d) Other forms of equity contribution German law allows further forms of equity contributions during the stage of formation. Shareholders may, by contract, be obliged to make, in addition to their capital contribution and the share premium, a further payment into equity which is to be placed in the capital reserve (§ 272 (2) No. 4 HGB). This capital reserve may be dissolved to increase the balance sheet profit and is thus available for distribution. Furthermore, if a company issues option bonds and/or convertible bonds (“Schuldverschreibungen für Wandlungs- und Optionsrechte”), any payment is to be placed into the capital reserve 72
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(§ 272 (2) No. 2 HGB). The same applies to additional payments made by shareholders in return for preferential rights (§ 272 (2) No. 3 HGB). These reserves form part of the “legal reserve fund” and are not, therefore, available for distribution (see above). e) Information to be stated in the statutes The German Stock Corporation Act requires the founders of the company to state in the statutes the subscribed capital paid (§ 23 (2) No. 3 AktG), the amount of the subscribed capital (§ 23 (3) No. 3 AktG) and the authorised capital (§ 202 (1) AktG). Furthermore, German law requires transparency with respect to any premiums paid. According to § 23 (2) No. 2, the statutes have to contain the amount advanced (§ 23 (2) No. 2 AktG) which is composed of the nominal value/attributable amount and the premium. 2. Subscription of the capital a) Link of stated capital’s injection with subscription of shares In Germany, the injection of the stated capital is linked to the subscription of shares. When subscribing a share, the shareholder has the obligation to pay in the nominal value/accountable par allotted to the share acquired. b) Time limit In Germany, formation in stages (“Stufengründungen”) is not allowed. It follows from § 29 AktG that the founders are obliged to subscribe all shares when adopting the company’s statutes (§ 23 (2) AktG). The German Stock Corporation Act does not expressly establish an exact time limit when the shares have to be subscribed. But, as the company is only established when all shares have been subscribed (§§, 23 (2), 29 AktG) and the establishment of the company is a necessary requirement for the company to be registered, the founders of the company will proceed to subscribe shares within a short-time. c) Prohibition of subscription of shares by the company itself It is prohibited to a German public company to subscribe its own shares (§ 56 (1) AktG). A violation of § 56 (1) AktG makes the declaration to subscribe the shares void (§ 134 BGB). Furthermore, it is determined that, for the case that shares were subscribed in violation to the prohibition of § 56 (1) AktG, the management board is liable for the contribution vis-à-vis the company (§ 56 (4) AktG It must noted that the company is, because of § 29 AktG (the principle that all shares must be subscribed before establishment) not able, in practice, to subscribe its own shares as it does not yet exist and § 56 (1) AktG is, therefore, not relevant during the formation stage. § 56 (2) AktG extends the prohibition to subscribe shares to subsidiaries. According to German law, subsidiaries may not subscribe shares of the issuing (parent) company. With respect to the consequences of a violation of this prohibition, Germany has chosen a middle course: it determines that the voting rights attached to the shares are suspended (§§ 71b, 71d s. 2, 4 AktG by analogue) and that the management board is liable for the contribution vis-àvis the company. Furthermore, it is stated that the subsidiary is obliged to dispose of the shares within the period of one year (§§ 71c, 71d s. 2, 4 AktG analogously). German law does not prohibit a third person acting on behalf of the issuing company or on behalf of a subsidiary to subscribe shares of the issuing company, § 56 (3) AktG. It provides in this case for the suspension of the rights attached to the shares. The third person may only exercise the rights attached to the shares if he/she subscribes the shares for his/her own account. 73
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Art. 24a (4) lit. a 2nd CLD, which states that member states may allow subsidiaries to subscribe shares of the issuing company if the subscription is effected on behalf of a person other than the person subscribing the shares, who is neither the issuing company nor another subsidiary of the issuing company, has not been implemented into German law. The German legislator did not make use of the member state option to allow subsidiaries in exceptional cases to subscribe shares of the issuing company, namely where the subsidiary subscribing the shares is a professional dealer in securities or where the subscription took place before the subscribing company actually became a subsidiary of the issuing company. d) Prohibition of share issues at a price lower than the nominal value/accountable par German law prescribes that par value shares must not be issued at a price lower than the nominal value and no-par value shares must not be issued at a price lower than the no-par value share’s attributable amount of the subscribed capital (§ 9 (1) AktG). German law also provides for the minimum amount of the nominal value and, where there are no-par value shares, for the minimum amount of the no-par value share’s attributable amount of the subscribed capital: par value shares must have a minimum nominal value of 1 Euro (§ 8 (2) AktG) and the no-par value share’s attributable amount of the subscribed capital may not be lower than 1 Euro (§ 8 (3) AktG). Under German law, the principle that shares may not be issued at a price lower than their nominal value or their accountable par is binding. The national legislator did not provide for an exception for professional issuers (Art. 8 (2) 2nd CLD). e) Designs of shares Germany offers shares with a nominal value (par value shares) or, alternatively, no-par value shares (§ 8 (1) AktG). Under German law, shares with a nominal value must be of a certain numeric amount which describes the amount of the contribution which has been/ must be paid. This is not the case for no-par value shares. Under German law, every no-par value share represents the same fraction of the subscribed capital as that in which all no-par value shares participate in the subscribed capital. As no-par value shares are still linked to the subscribed capital, they are in fact notional no-par value shares and also often referred to as such. f) Information to be contained in the statutes With respect to the information to be given concerning the shares a company has issued, the German Stock Corporation Act differentiates between information to be stated in the statutes and information to be set down in the statutes. The statutes must contain, if par value shares have been issued, the nominal value of the shares, or, if no-par value shares have been issued, the number of shares, the amount advanced and, where there are several classes of shares, the classes of shares each founder subscribed for (§ 23 (2) No. 2 AktG). The statutes must state the division of the subscribed capital into either par-value shares or no-par value shares; where there are par value shares, their nominal values and the number thereof; where there are no-par value shares their number and where there are several classes of shares the classes of shares and the number of each class (§ 23 (3) No. 4 AktG). g) Premiums The German Stock Corporation Act contains provisions on transparency with respect to premiums or other forms of equity contributions. The Stock Corporation Act requires that the
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amount contributed be also stated in the statutes (§ 23 (2) No. 2 AktG), which includes any premium paid. 3. Contributions a) Contributions in cash and in kind The German legislator allows both contributions in cash and contributions in kind. Where the subscribed capital is contributed in kind, it must be provided for in the statutes (§ 54 (2) AktG). aa) Contribution in cash Under German law, a contribution in cash is a sum of money that the shareholder promises to pay to the company. Pursuant to the Stock Corporation Act, cash contributions may be made by any legal means of payment, that is banknotes and coinage in Euro, or via credit to a company’s or a director’s bank account at a credit institution (§ 54 (3) s. 1 AktG). Not permissible is direct payment to a company’s creditor, even if the board of directors approves the payment (BGHZ 119, 177, 188f.). bb) Contribution in kind Under German law, a contribution in kind is a contribution of any form of property except cash (§ 27 (1) s. 1 AktG). Contributions in kind must be assets capable of economic assessment (§ 27 (2) AktG). Assets capable of economic assessment include real and personal property, rights of usufruct, receivables against third persons and against the company itself (BGHZ 110, 47, 60), rights of use and enjoyment (BGHZ 144, 290, 294) as well as companies. The German Stock Corporation Act prescribes that contributions in kind do not include the supply of services (§ 27 (2) AktG). This applies without doubt to the founder’s supply of services. In Germany, it is, however, controversial whether contributions in kind include rights to the supply of services rendered by third persons. The prevailing opinion in literature assumes that those rights cannot be contributions in kind. Regarding transparency, German law requires that the statutes must contain the nature of the consideration made other than in cash, the name of the person providing the consideration and the nominal value of shares or, where there are no-par value shares, the number of shares issued for a consideration other than cash (§ 27 (1) s. 2 AktG). If the form required by law has not been observed, the contractual provisions on contributions in kind are void (§ 27 (3) s. 1 AktG) and the investor is liable to pay the contribution in cash (§ 27 (3) s. 3 AktG). Apart from the traditional contribution in kind, the German Stock Corporation Act contains special rules for the case that a shareholder or a third person undertakes to transfer assets to the company which, on its part, is obliged to pay a consideration in return (so called “Sachübernahme” [acquisition of assets]). If the assets are provided by a shareholder, the consideration to be paid by the company may be allowed as credit against the shareholder’s obligation to pay-up his contribution. In this case, the transaction is treated as equivalent to contributions in kind. cc) Hidden contributions in kind In order to ensure that the rules on contributions in kind of the 2nd CLD are not circumvented, judicial decisions have developed the principle of ‘hidden contributions in kind’. In practice, the legal provisions on contributions in kind can easily be evaded by splitting the transaction (contribution of the subscribed capital) in two - a contribution in cash and a commercial transaction which is not subject to the legal provisions on contributions in kind where the 75
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company pays as consideration the equivalent amount of the shareholder’s contribution. The commercial transaction can take place during the stage of formation or after the company has been incorporated. In all these cases, the company obtains in effect property instead of cash but the legal provisions on contributions in kind have not been observed. The courts decided that such transactions, the only purpose of which is to evade the strict legal provisions on contributions in kind, are void. The leading case is BGHZ 28, 314, in which a shareholder paid the outstanding sum of his contribution into a company’s bank account, after he had granted the company the exclusive licence for a pending patent. The company paid back the sum received as consideration for having obtained the licence. In this case, it was held that the shareholder is obliged to repay the contribution in cash but can demand the return of the patent. It is doubtful that this judgement will continue to be applicable when the proposed MoMiG becomes law. In May 2007, a bill to reform the private limited liability company (GmbH) was introduced by the German legislator. In this proposal (“Gesetz zur Modernisierung des GmbH-Rechts und zur Bekämpfung von Missbräuchen – MoMiG”), it is provided that hidden contributions do not make the underlying transactions void. On the contrary, the shareholder is liable if the contribution in cash does not reach the agreed value of the contribution in kind. Even though the MoMiG does not provide for similar rules for public companies, it is possible that the jurisprudence will in future interpret “hidden contributions in kind” in a comparable manner as provided for in the MoMiG. dd) No release from the shareholder’s obligation In order to ensure that the subscribed capital is actually raised, under German law the founders cannot be released from their obligation to pay up their contributions except in case of formal reductions of the subscribed capital. This principle is not explicitly stated in the German Stock Corporation Act, but is implicit and can be deduced from § 54 AktG which sets out the shareholder’s obligation to contribute to the subscribed capital and does not provide for exceptions. b) Amount to be paid in The German Stock Corporation Act differentiates between contributions in cash and contributions in kind. aa) Contribution in cash German law provides that shares issued for a consideration in cash must be paid up to an extent of at least 25 percent of their nominal value or, where there are no-par value shares, that 25 percent of their attributable amount of the subscribed capital is available by the time the company is registered (§§ 36a (1), 9 (1) AktG). Furthermore, it is provided that the board of directors must have the sum paid in irrevocably at its free disposal (§§ 36 (2) s. 1, 54 (3) s. 1 AktG). This is not the case if the making of the payment is, in fact, a pretence (RGZ 157, 213, 225) or if a payback is agreed upon (BGHZ 122, 180, 184 et seq.). bb) Contribution in kind With respect to the paying in of contributions in kind, German law, as a general rule, requires that the full consideration must be transferred to the company at the time the company is registered (§ 36a (2) s. 1 AktG). However, where the consideration other than in cash is an obligation to transfer property to the company by a legal transaction in rem, the consideration can be transferred to the company within five years of the time the company is incorporated (§ 36a (2) s. 2 AktG).
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c) Valuation of contributions in kind Where shares are issued for a consideration other than in cash, German law requires that a valuation report by an independent expert must be drawn up. Any person sufficiently skilled and experienced in the field of accounting or companies of which at least one of the legal representatives is skilled and experienced in the field of accounting may be appointed as independent expert to draw up the report (§ 33 (4) AktG). Auditors and auditing companies are, as a rule, sufficiently qualified. A person who is not authorised to act as an independent auditor may not be appointed as independent expert (§§ 33 (5) s. 1, 143 (2) AktG). The same applies to anyone on behalf of whom the founders subscribed shares and on whom they have a considerable influence (§ 33 (5) s. 2 AktG). Furthermore, the Stock Corporation Act requires that the independent expert is to be appointed by the local court (§ 33 (3) s. 2 AktG, § 145 (1) FGG). German law does not prescribe which methods of valuation are allowed. However, under German law, the following principles have emerged: fixed assets are to be valued at the current replacement value and current assets are to be valued at the current market value. Rights of use and enjoyment are to be valued at most at the reduced comparable rent. In case a firm is contributed into the company as a going concern, it may be valued at book value. The German Stock Corporation Act requires the report on consideration other than in cash to be published: the report must be submitted to the register court (§ 34 (3) s. 1 AktG) which retains it (§ 37 (6) AktG). By law, anyone is allowed to inspect the report (§ 34 (3) s. 2 AktG). Furthermore, under German law, the report must also be submitted to the company’s board of directors (§ 34 (3) s. 1 AktG). Germany did not make use of the Member State option laid down in the 2nd CLD to provide for cases in which the requirement to draw up a report on considerations other than in cash can be departed from. The average time of the valuation process depends on the valuation’s complexity. It can take from a few hours in case of valuations of low complexity to up to a maximum of three weeks if firms are incorporated into the company as contributions in kind. The average time of the valuation process is, therefore, approximately 1-2 weeks. d) Further national rules linked to the injection of contributions In addition to the expert report on considerations other than in cash, the founders are required to draw up a special report on the formation of the company (§ 32 AktG). This report shall state the course of events of the formation of the company (§ 32 (1) AktG). Furthermore, for cases of formation by non-cash capital contribution, the German Stock Corporation Act sets out additional information the report must contain. In this case, the report must also state the main circumstances concerning the adequacy of any consideration other than cash (§ 32 (2) s. 1 AktG). These include the preceding legal transactions which aimed at the acquisition by the company (§ 32 (2) No. 1 AktG), the purchase and production costs of the last two years (§ 32 (2) No. 2 AktG) and, where another firm is incorporated into the company, the operating income of the last two financial years (§ 32 (2) No. 3 AktG). In addition to the special report on the formation of the company to be drawn up by the founders of the company, the German Stock Corporation Act requires the members of the management and the supervisory board to draw up a separate report on the formation of the company (§ 33 (1) AktG). This report must state whether the founders’ statements concerning the subscription of shares, the contributions to the subscribed capital and the information with respect to contributions in kind are correct and complete (§ 34 (2) No. 1 AktG). Furthermore, where contributions in kind have been injected, the report must contain a description of each 77
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of the assets comprising the consideration as well as of the valuation methods used (§ 34 (2) s. 2 AktG). The report must further state if the values arrived at correspond at least to the number and the nominal value or, where there are no-par value shares, to the accountable par and, if applicable, to the premium on the shares to be issued for them (§ 34 (1) No. 2 AktG). Once the required reports have been drawn up, the founders and the members of either boards may register the company (§ 36 (1) AktG). The register court examines on the basis of the documents submitted whether the company has been duly formed (§ 38 (1) AktG). e) Consequences of incorrect financing If the value of a consideration other than in cash does not correspond to the nominal value of shares issued for it or, where there are no-par value shares, to the accountable par: the register court is required to reject the application to register the company if it is of the opinion, or if independent experts state in the expert report on considerations other than cash, that the value of the consideration is not immaterially lower than the nominal value of the shares issued for it, or where there are no-par value shares the attributable amount of the subscribed capital (§ 38 (2) s. 2 AktG). However, a minor difference is not sufficient to justify rejecting the application for incorporation. If the company is, nevertheless, registered, it has still been effectively established. On the question of the liability of the founders the German Stock Corporation Act provides that the founders are jointly and severally liable to compensate the company for any damage caused by incorrect or incomplete statements concerning the formation of the company, the subscription of shares and contributions (§ 46 (1) s. 1 AktG). They are, furthermore, liable to pay up any outstanding contributions (§ 46 (1) s. 3 AktG). The same applies if the sums paid in are not at the management board’s free disposal (§ 46 (1) s. 2 AktG). If the company suffers damage as a result of receiving (over-evaluated) contributions from a founder, the founders are jointly and severally liable to compensate the company for the damage caused if the founder in question acted with intent or gross negligence (§ 46 (2) AktG). If the company suffers a shortfall because of a shareholder being unable to pay up his contribution, the founders are liable to compensate the company if they knew of the shareholder’s inability to pay (§ 46 (4) AktG). Furthermore, the company may initiate claims against founders on grounds of breach of contract. Finally, the Stock Corporation Act also provides for criminal sanctions with respect to founders who give incorrect information about contributions (§ 399 (1) No. 1 AktG). The German Stock Corporation Act provides that members of the management board and the supervisory board who have failed to comply with their duties during the stage of formation are jointly and severally liable to compensate the company for any damage caused (§ 48 (1) AktG). This concerns cases in which the contribution has been paid into a bank account at a credit institution not suitable for this purpose and cases in which the sum paid in is not irrevocably at the management board’s free disposal (§ 48 (1) AktG). Apart from that, members of either board are generally liable to compensate the company for any damage caused due to incorrect statements about the formation of the company (§§ 93 (2), 116 AktG). The Stock Corporation Act also provides for criminal sanctions where members of the management and supervisory board make incorrect statements in respect to the subscription of shares, the payment of or on account of contributions, the application of payments and contributions in kind (§ 399 (1) No. 1 AktG).
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f) Premiums If shares are issued at a premium, the premium must be fully paid in by the time the company is registered (§§ 36a (1), 9 (2) AktG). Where this is not the case, any investor or founder (§ 46 AktG) is liable to pay the outstanding sum, including the premium. g) Liability Judging from the case law at hand, in Germany it is not often the case that founders, shareholders or members of the management/supervisory boards are held liable for incorrectly performed contributions, that is cases in which the value of a consideration other than cash does not correspond to the nominal value of shares issued for it or, where there are no-par value shares, to the accountable par. Indeed, a major part of the judicial decisions concern transactions which have been classified by the courts as ‘hidden contributions in kind’ (for example: BGHZ 110, 47; BGH NJW 1996, 524, 525; BGH NJW 2000, 725, 726; OLG Koblenz, AG 1988, 242; LG Mainz, AG 1987, 221; BGHZ 118, 83, 93ff.; OLG Düsseldorf, AG 1988, 242; LG Mainz, AG 1987, 91). h) Prospective implementation of the amendments of the 2nd CLD The amendments of the 2nd CLD by Directive 2006/68/EC have not yet been implemented into national law. Jurisprudence: RGZ 157, 213, 225; BGHZ 28, 314; BGHZ 110, 47; BGHZ 118, 83, 93ff.; BGHZ 119, 177; BGHZ 122, 180, 184f.; BGHZ 132, 41; BGHZ 144, 290, 294; BGH NJW 1996, 524, 525; BGH NJW 2000, 725, 726; OLG Koblenz, AG 1988, 242; OLG Düsseldorf, AG 1988, 242; LG Mainz, AG 1987, 91; LG Mainz, AG 1987, 221. 4. Accounting for formation expenses Under German law, formation expenses may be capitalised (§ 269 s. 1 HGB). Furthermore, German law allows the capitalisation of expenses for the expansion of the business activity. In Germany, the term “formation expenses” is not defined by law. However, a generally accepted definition has emerged. According to this definition, formation expenses are expenses which accrue during the start-up phase of the business due to setting up the company’s organisation and preparing it to effect performance. These expenses do not, however, include expenses which arise with respect to the legal formation of the company. These cannot be capitalised, as § 248 (1) HGB explicitly prescribes. Expenses for the expansion of the business activity, which under German law may also be capitalised, are not defined by law, either. The term is interpreted narrowly in order to prevent misuse of the option to capitalise such expenses. It is, therefore, generally accepted that expenses for the expansion of the business are only those arising from extraordinary measures of crucial importance which do not only serve the rationalisation, restructuring, relocation or intensification of the business activity. Thus, expenses for the expansion of the business activity arise in the first place from the establishment of a new branch, a substantial expansion of the production centre or the establishment of a new place of business. Under German law, formation expenses and expenses for the expansion of the business activity must be written off over a maximum period of five years (§ 282 HGB). The German Commercial Code also provides for restrictions on distributions during the depreciation period. Under German law, during the depreciation period distributions may only 79
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take place if the amount of the reserves available for distribution and any profits brought forward less any losses brought forward is at least equal to the amount of the expenses not yet written off (§ 269 s. 1 HGB). German law requires that formation expenses and expenses for the expansion of the business activity be explained in the notes to the accounts (§ 269 s. 1 HGB). In this respect, the measures which caused the expenses, the nature of the expenses (e.g. labour costs, interest), the composition of the aggregate amount capitalised with respect to the cost categories, whether all or only part of the expenses are capitalised and how the depreciation has been determined, must be stated.
Sub-section 2:
Capital increases
5. Increase in subscribed capital and other forms of equity financing German law differentiates between ordinary capital increases and increases by authorised capital. Furthermore, it provides for special forms of capital increases. a) Ordinary capital increase For an increase in capital, the German Stock Corporation Act requires a shareholders’ resolution. German law requires that this resolution be passed with a double majority: a simple majority of the votes cast (§ 133 AktG) and a majority of ¾ths of the votes attached to the subscribed capital represented in the general meeting (capital majority) (§ 182 (1) AktG). The statutes may determine that the capital majority must be lower or greater than ¾ths of the votes attached to the subscribed capital represented (§ 182 (1) s. 2 AktG), except where preference shares without voting rights are issued. In this case, the statutes may only require a capital majority greater than ¾ths of the votes attached to the subscribed capital represented (§ 182 (1) s. 2 AktG). Where there are several classes of shares, the German Stock Corporation Act prescribes that the shareholders’ resolution to increase the capital only becomes effective if the shareholders of each class of shares consent to the capital increase by a separate vote (§ 182 (2) AktG). As regards the required majority in the special vote, the rules laid down in § 182 (1) AktG apply (see above). It should also be noted that German law provides for further rules that must be observed where a company decides to issue no-par value shares. German law requires that the new shares must be denominated in such a way that the increase in the number of shares corresponds to the increase in the subscribed capital (§182 (1) 5 AktG). This follows the aim that the proportion between the holdings of the existing shareholders in the case of a capital increase is maintained. The German legislator did not make use of the option laid down in Art. 41 (1) of the 2nd CLD which allows member states to depart from the requirement of a shareholders’ resolution and a separate vote of each class of shares to increase the capital, to the extent that it is necessary for the adoption or application of provisions designed to encourage the participation of employees in the capital of undertakings. The German Stock Corporation Act requires the publication of both the shareholders’ resolution to increase the capital and the increase in subscribed capital: the board of directors and the chairman of the supervisory board are firstly required to register the shareholders’ 80
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resolution and the increase in capital at the register court (§§ 184, 188 AktG). The same applies to the amendment of the statutes (§ 181 (1) AktG). The registration of the increase in capital and the amendment of the statutes are then to be published (§§ 181 (2), 39, 190 AktG). b) Authorised capital The German Stock Corporation Act uses the possibility of creating authorised capital at the stage of formation. In this respect, the Act provides that the statutes may authorise the management board for a maximum period of five years, beginning with the incorporation of the company, to increase the capital up to a specific amount (§ 202 (1) AktG). If the authorisation to increase the capital is not already stated in the statutes, German law provides for the possibility to amend the statutes by way of a shareholders’ resolution (§ 202 (2) s. 1 AktG). The Stock Corporation Act requires a simple majority and a qualified capital majority (see above) (§ 202 (2) s. 2 AktG). Furthermore, where there are several classes of shares, the shareholders’ resolution is subject to a separate vote of shareholders of each class of shares (§ 202 (2) s. 4 AktG, see above under a)). Moreover, the shareholders’ resolution on the amendment of the statutes is subject to notarial recording. The amendment of the statutes must be registered at the register court (§ 181 (1) AktG) and then published (§ 181 (2) AktG). Under German law, the authorised capital is restricted to a maximum amount. It must not exceed ½ of the subscribed capital which existed at the time the authorisation to increase the capital was given (§ 202 (3) AktG). The German Stock Corporation Act provides for rules to be observed where a company issued no-par value shares instead of par value shares. In this case, the Act requires that new shares must be denominated in such a way that the increase in the number of shares corresponds to the increase in the subscribed capital (§§ 202 (3) s. 3, 182 (1) 5 AktG). This serves to ensure that previously issued no-par value shares are not disproportionately highly prejudiced by the capital increase (see above). The Stock Corporation Act prescribes that the management board can be empowered for a maximum period of five years after the authorisation to decide to increase the capital (§ 202 (1) AktG). The utilisation of the authorisation requires a decision of the management board. The responsibility to determine the content of the rights attached to the new shares and the conditions for the issue of new shares lies with the management board, unless the statutes provide otherwise (§ 204 (1) AktG). Both decisions must be approved by the supervisory board (§ 202 (3) s. 2 AktG, § 204 (1) AktG). The German Stock Corporation Act requires that the increase in capital be published. Before the increase in capital is published it must be registered at the register court (§§ 203 (1) s. 1, 188 (1), 190 AktG). c) Other kinds of increases in capital The German Stock Corporation Act provides for special kinds of increase in capital, namely the nominal increase in capital (§ 207 AktG) and the conditional increase in capital (§ 192 AktG). (aa) Nominal increase in capital Under German law, companies are allowed to convert reserves (capital reserves and profit reserve) into subscribed capital. This process is referred to as the nominal increase in capital (§ 207 AktG). The nominal increase in capital is subject to a shareholders’ resolution. A simple majority of the votes submitted and a majority of ¾ths of the votes attached to the subscribed capital represented in the general meeting is required (§§ 207 (2) s. 1, 182 (1) 81
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AktG). The statutes may determine that the capital majority must be lower or greater than ¾ths of the votes attached to the subscribed capital represented, except where preference shares without voting rights are issued. In this case, the statutes may only require a capital majority greater than ¾ths of the votes attached to the subscribed capital represented (§§ 207 (2) s. 1, 182 (1) s. 2 AktG). Where the company issued no-par value shares, the Stock Corporation Act furthermore requires that the number of no-par value shares may only be increased in proportion to the increase in subscribed capital (§§ 207 (2) s. 1, 182 (1) s. 5 AktG). (bb) Conditional increase in capital Under the German Stock Corporation Act, companies are also allowed to increase the capital (only) to such an extent that conversion rights or subscription rights which the company grants in respect to new shares, are exercised. This process is referred to as a conditional increase in capital (§ 192 AktG). The Stock Corporation Act lists several purposes the capital increase may serve: the capital increase may serve subscription or conversion rights of convertible bonds (No. 1); it may serve to prepare a company merger (No. 2) and, it may be to grant stock options to employees and members of the management board (No. 3). The introduction of the latter purpose was widely appreciated. In this context, one should also note that according to the leading opinion the pre-emption rights of shareholders are excluded. The conditional increase in capital is subject to several restrictions. Firstly, a shareholders’ resolution is required (§ 192 (1) AktG). In this respect, the Stock Corporation Act requires a simple majority of the votes submitted and a majority of ¾ths of the votes attached to the subscribed capital represented in the general meeting (§§ 193 (1) s. 1 AktG). Where there are several classes of shares, the shareholders’ resolution is, furthermore, subject to a separate vote of shareholders of each class of shares (§§ 193 (1) s. 3, 182 (2) AktG). Moreover, similar to authorised capital, under German law, the conditional capital is restricted to a maximum amount: the nominal value of the conditional capital may not exceed ½ of the subscribed capital that existed at the time the shareholders’ resolution was taken; where the conditional capital serves to grant stock options to employees or members of the management board, the conditional capital may not exceed 10 percent of the subscribed capital that existed at the time the shareholders’ resolution was taken. Where there are no-par value shares, the Stock Corporation Act requires, furthermore, that new shares must be denominated in such a way that the increase in the number of shares corresponds to the increase in the subscribed capital (§§ 192 (3) 1, 182 (1) 5 AktG). cc) Securities convertible into shares or carrying a right to subscribe shares The German Stock Corporation Act extends the rules applicable to ordinary increases in capital to the issue of convertible bonds and profit-sharing bonds (participating debentures) (§ 221 AktG). In Germany, convertible bonds are defined by law as bonds which grant creditors a conversion right or a subscription right. Profit-sharing bonds are defined by law as bonds where the rights to creditors are linked to the shareholders’ shares in the profits. Analogously to the ordinary increase in capital, the German Stock Corporation Act requires, for the issue of convertible bonds and profit-sharing bonds, a shareholders’ resolution (§ 221 (1) s. 1 AktG). A simple majority of the votes submitted and a majority of ¾ths of the votes attached to the subscribed capital represented in the general meeting is required (§ 221 (1) s. 2 AktG). The statutes may determine a different majority and other conditions (§ 221 (1) s. 3 AktG). Where there are several classes of shares, German law requires that the shareholders’ resolution to issue bonds is subject to a separate vote of each class of shares (§§ 221 (1) s. 4, 182 (2) AktG). In addition, the German Stock Corporation requires that the management board may only be authorised to issue convertible bonds or profit-sharing bonds for a 82
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maximum period of five years (§ 221 (2) s. 1 AktG). Moreover, the shareholders’ resolution and the declaration to issue bonds must be published. In this respect, German law requires the management board and the supervisory board to deposit the shareholders’ resolution and the declaration to issue bonds with the register court (§ 221 (2) s. 2 AktG); furthermore, reference to the shareholders’ resolution and the declaration to issue bonds must be published in the Joint Electronic Register Portal of the Federal States (“Gesellschaftsblättern”). e) Premiums German law allows premiums to be used in the context of the increase in capital (§§ 182 (3), 9 (2) AktG). Under German law, if shares are issued at a premium, the shareholders must, in their capital increase resolution, determine the minimum price below which shares may not be issued (§ 182 (3) AktG. Unless the shareholders also determine the maximum price, the management board will fix the maximum price with due regard to the restrictions laid down in the shareholders` resolution. Under German Stock Corporation Law, the premium must be paid in full by the time the increase in capital is registered (§§ 188 (2) 1, 36a (1) AktG). Analogously to share premiums paid during the stage of formation, premiums paid in the context of increases in capital are to be placed in the capital reserve (§ 272 (2) No. 1 HGB) and are not, therefore, available for distribution. 6. Subscription of new shares a) Time limit German Stock Corporation Law is based on the principle that all shares must be subscribed before the capital increase may be registered. Although this principle is not explicitly stated in the Stock Corporation Act, it may be inferred from §§ 185, 188 (2) s. 1 AktG. Furthermore, it can be inferred from §§ 188 (2) s. 1, 36 (2), 36a AktG that an increase in capital may only be registered - and then become effective - once all shares have been subscribed and the required amount has been paid in. As a consequence, shareholders are required to subscribe the shares at short notice. b) Prohibition of subscriptions of shares by the company itself Under the German Stock Corporation Act, a company is prohibited from subscribing its own shares (§ 56 (1) AktG). In this respect, the same provisions apply as in the context of the formation of the company. That means that the prohibition on a company subscribing its own shares is extended to its subsidiaries (§ 56 (2) AktG) and to third persons acting on behalf of the issuing company or on behalf of a subsidiary (§ 56 (3) AktG) [See for details under 2 b)]. As concerns the prohibition on the company subscribing its own shares – which was no effect during the stage of formation - in the context of capital increases, the following should be noted. Pursuant to § 56 (1) AktG, any declaration of the company that it subscribes its own shares, is void. However, if the capital increase is, nonetheless, registered, the defect in the company’s declaration is cured. This is the prevailing opinion in literature, although not explicitly provided for by the provisions concerned with the capital increase. In this case, the voting rights attached to the shares are suspended (§§ 71b, 71d s. 2, 4 AktG analogously) and the company is obliged to dispose of the shares within a period of one year (§§ 71c, 71d s. 2, 4 AktG analogously).
c) Prohibition of share issues at a price lower than the nominal value/ accountable par In the context of capital increases under the German Stock Corporation Act, the principle applies that shares may not be issued at a price below their nominal value / accountable par (§§ 182 (3), 9 (1) AktG). German law also provides for the minimum amount of the nominal 83
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value/accountable par, which is, however, relatively low: 1 Euro (see under 2 c). Further rules are to be observed where the shareholders’ pre-emption rights have been excluded. In this case, shareholders are entitled to bring an action to set aside the shareholders’ resolution to increase the capital if the share issue price was unreasonably low (§ 255 (2) AktG). d) Issue of accountable par shares with the same voting and dividend rights as previously issued shares The German Stock Corporation Act does not contain any provision which explicitly states whether newly issued no-par value shares of the same class must receive the same voting and dividend rights as the shares previously issued. However, it must be noted that, under German law, shares with an accountable par have to participate in the subscribed capital with the same amount (§ 8 (3) AktG). Furthermore, one has to take into account that, under German law, the principle of equal treatment (§ 53 a AktG) is applicable. From the latter principle, it follows that the voting and dividend rights of the shareholder are in proportion to his share ownership, unless the statutes provide otherwise. As, under German law, all shares of the company with an accountable par have the same amount, they must, independently of the time of issue, grant the same voting and dividend rights. e) Information to be stated in the statutes In case the capital is increased, the German Stock Corporation Act requires that the statutes be amended to show the amount of the subscribed capital (§ 23 (3) No. 3 AktG) as well as the nominal values of shares, the number of shares of each nominal value or, where there are nopar value shares, their number, the classes of shares and the number of shares of each class (§ 23 (3) No. 4 AktG). 7. Contributions a) Contributions in cash and in kind Under the German Stock Corporation Act, capital increases can be performed by contributions in cash and in kind. In the latter case, the shareholders’ resolution to increase the capital must state the nominal value of shares or, where there are no-par value shares, the number of shares issued for a consideration other than cash together with the nature of the consideration and the name of the person providing the consideration (§ 183 (1) s. 1 AktG). The resolution may only be voted on if its terms were laid down in the agenda for the general meeting and duly published (§ 183 (1) s. 2 AktG). If these requirements have not been observed, the investor is obliged to pay the contribution again in cash (§ 183 (2) s. 3 AktG). Analogously to the legal situation during formation, contributions in cash may be made by any legal means of payment, that is banknotes and coinage in Euro, or via credit to a company’s or a director’s bank account at a credit institution (§ 54 (3) s. 1 AktG). Where new shares are issued for a consideration other than cash, the German Stock Corporation Act prescribes that the consideration must constitute assets capable of economic assessment (§§ 183 (1) s. 1, 27 (2) AktG) [for details see the comments under 3 a) cc)]. b) Amount to be paid in With respect to the amount required to be paid-up on contributions at the time the capital increase is registered, the German Stock Corporation Act differentiates between contributions in cash and contributions in kind.
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aa) Contributions in cash Where new shares are issued for a consideration in cash, the German Stock Corporation Act prescribes that at least 25 percent of the nominal value/accountable par of the shares must be paid up (§§ 188 (2) s. 1, 36a (1) AktG). The sum paid in must be irrevocably at the management board’s free disposal (§ 188 (2) s. 2, 36 (2) AktG). That means that the management board has to satisfy itself that the amount has been paid in and has not been returned to the investor (BGHZ 150, 197, 201). bb) Contribution in kind With respect to the amount to be paid in on contributions in kind, the German Stock Corporation Act refers to the rules which apply during the stage of formation. Accordingly, consideration other than cash is to be transferred to the company within five years of the time the capital increase is registered, unless the consideration constitutes rights of use and enjoyment which must have been transferred by the time the capital increase is registered (§§ 188 (2) s. 1, 36a (2) AktG). The consideration’s value must correspond to the lowest subscription price of shares issued for the consideration (§ 188 (2) s. 1, § 36a (2) AktG) [for details see 3 b)]. The case law that has developed with respect to transactions referred to as ‘hidden contributions in kind’ (question 3 a)) is also applicable. c) Valuation of contributions in kind Where, during the stage of capital increase, shares are issued for a consideration other than cash, the German Stock Corporation Act requires that a report on the consideration other than cash must be drawn up (§ 183 (3) AktG). With respect to the experts that may be appointed to draw up the report and the reports contents, the Stock Corporation Act refers to the rules applicable to the expert report on considerations other than cash which must be drawn up during formation. The rules are described under 3 c) and may be referred to for details. The German legislator did not make use of the option laid down in Art. 27 (3) of the 2nd CLD which allows member states to waive the expert report on considerations other than cash in the event that the capital is increased to give effect to a merger or a public offer for the purchase or exchange of shares and to pay the shareholders of the company which is being absorbed or which is the object of a public offer for the purchase or exchange of shares. Nor did the national legislator exercise the option stated in Art. 27 (4) of the 2nd CLD which allows member states to waive the expert report on consideration other than cash if all shares issued in the course of an increase in subscribed capital are issued for a consideration other than cash to one or more companies, on condition that all shareholders in the company who receive the consideration have agreed not to have an experts’ report drawn up. d) Incorrect financing The Stock Corporation Act firstly provides for mechanisms to check if the value of a consideration other than cash corresponds to the nominal value/accountable par of shares issued for it. According to German law, the register court is required to reject the company’s application to register the increase in capital if it is of the opinion that the value of the consideration is not immaterially lower than the nominal value/accountable par of the shares issued for it (§ 183 (3) s. 3 AktG). In case the capital increase is nonetheless registered and, therefore, has come into effect, the investor is, by analogy with §§ 9 (1), 56 (2) GmbHG, liable to pay the difference in cash. Regarding the liability of the management board and supervisory board, the Stock Corporation Act provides, on the one hand, for criminal sanctions where a member of either board gives incorrect information about the subscription of shares, payment on contributions 85
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or contributions in kind (§ 399 (1) No. 4 AktG). On the other hand, members of either board are also liable in civil law to compensate the company for any damage caused due to incorrect statements about the capital increase (§§ 93 (2), 116 AktG).
e) Premiums and other forms of equity contributions If shares are issued for a consideration in cash, the German Stock Corporation Act prescribes that the premium must be fully paid in at the time the capital increase is registered (§§ 188 (2) s. 1, 36a (1) AktG). Where this is not the case, the investor is liable to pay the outstanding sum, including the premium. Analogously to share premiums during the stage of formation, premiums paid in the context of capital increases are to be placed in the capital reserve (§ 272 (2) No. 1 HGB) which is not available for distributions [see also under 5 e)]. Jurisprudence: BGHZ 150, 197 et seq.; BGHZ 135, 381, 384; OLG Hamm, GmbHR 1997, 213, 214; OLG Köln, GmbHR 2000, 720. 8. Pre-emption rights a) Content The German Stock Corporation Act provides for pre-emption rights in the context of capital increases. German law prescribes that pre-emption rights are not only to be granted on the condition that the capital is increased by consideration in cash but also if the capital is increased by consideration other than cash. However, in practice, capital increases in kind are in general linked to an exclusion of the pre-emption rights. Under German law, a pre-emption means that a shareholder has the right to have, upon request, shares allocated to him in proportion to the capital represented by the shares held by him (§ 186 (1) s. 1 AktG). Every shareholder has this pre-emptive right. Even preference shareholders who do not have voting rights have a pre-emptive right under the German Stock Corporation Act. The German legislator did not make use of the option laid down in the 2nd CLD, which allows member states to exclude shares which carry a limited right to participate in distributions or company’s assets in the event of liquidation. Nor did the national legislator exercise the option stated in the 2nd CLD, namely to permit, where the capital of a company having several classes of shares carrying different voting rights, or participation in distributions or in assets in the event of liquidation, is increased by issuing new shares in only one of these classes, the pre-emption right of shareholders of other classes to be exercised only after the exercise of this right by the shareholders of the class in which the shares are being issued. The management board is required to fix the period within which the pre-emption right shall be exercised which must not be less than two weeks; it is, furthermore, to be published in the Joint Electronic Register Portal of the Federal States (§186 (1) s. 2, (2) AktG). However, under the German Stock Corporation Act, the management board is also required to fix and publish in the Joint Electronic Register Portal of the Federal States, in addition to the subscription period, the advanced amount or the basis for its determination (§ 186 (2) s. 1 AktG). In case only the basis for determining the advanced amount has been published, the management board is required to publish the issue price at the latest three days before the subscription period expires in either the Joint Electronic Register Portal of the Federal States or via electronic information media (§ 186 (2) s. 2 AktG). One should, furthermore, note that
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the advanced amount to be fixed may not be unreasonably low if pre-emption rights have been excluded (§ 255 (2) AktG) (see under 6 c)). b) Exclusion or reduction of pre-emption rights by the general meeting The German Stock Corporation Act provides for the possibility to exclude pre-emption rights by the decision of the general meeting. Under German law, these requirements are applicable not only where the capital is increased by consideration in cash but also where it is increased by consideration other than in cash (see above a)). Under the German Stock Corporation Act, pre-emption rights may only be excluded by a shareholders’ resolution, in fact the decision may only be made in the resolution to increase the subscribed capital (§ 186 (3) s. 1 AktG). The resolution requires a simple majority of the votes cast and a majority of ¾ths of the votes attached to the subscribed capital represented in the general meeting (§ 186 (3) s. 2 AktG). The German Stock Corporation Act requires that the resolution to exclude pre-emption rights may only be voted on if the intention to exclude pre-emption rights has previously been expressly and duly published in the Joint Electronic Register Portal of the Federal States (§ 186 (4) s. 1 AktG). The management board is required to present to the general meeting a report indicating the reasons for the exclusion and justifying the proposed issue price (§ 186 (4) s. 2 AktG). Because of the severity of the measure and the position of the shareholders protected under constitutional law, the Federal Supreme Court has held that any restriction of pre-emption rights must be justified by facts (BGHZ 71, 40, 43 et seq.). Under German law, therefore, the exclusion of pre-emption rights is justified provided that it serves a purpose which is in the company’s interest, that it is necessary and suitable to achieve the purpose and that it is proportionate (BGHZ 71, 40, 46). In this respect, the Stock Corporation Act explicitly states that a withdrawal is particularly justified if the capital increase by consideration in cash does not exceed 10 percent of the subscribed capital and the issue price is not materially below the market price (§ 186 (3) s. 4 AktG). According to case law, there are several other reasons that justify exclusion of preemption rights: the Federal Supreme Court held that a partial withdrawal of pre-emption rights is considered to be permissible if it serves to avoid free fractional shares (“freie Spitzen”) (BGHZ 83, 319, 323); furthermore, if employee shares are issued to encourage participation of employees, the exclusion of pre-emption rights is deemed to be permissible (BGHZ 144, 290, 292). The exclusion of pre-emption rights may also be justified by reorganisational measures (BGHZ 83, 319, 323). The criteria developed by the Federal Supreme Court to justify the exclusion by facts also apply in the event the capital is increased by consideration other than in cash. Under German law, therefore, the mere fact that new shares are issued for a consideration other than cash is not sufficient to justify the exclusion of pre-emption rights. After the resolution to increase the capital and to exclude pre-emption rights has been voted on, the management board and the chairman of the supervisory board are required to register the shareholders’ resolution at the register court (§ 184 (1) AktG). This ensures that the decision to exclude pre-emption rights is published. c) Exclusion or restriction of pre-emption right by authorised body The German legislator provides for the possibility that the statutes and the general meeting may delegate the power to restrict or exclude pre-emption rights to the management board empowered to decide on the capital increase within the limit of the authorised capital. The German Stock Corporation Act provides on the one hand for the possibility of creating authorised capital in the statutes during the formation where the founders’ decision to authorise the management board to withdraw pre-emption rights may also be included (§ 203 87
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(1) s. 1 AktG). In this case, the procedural and substantive requirements for a withdrawal of pre-emption rights otherwise applicable under German law (see b)) do not apply. As the statutes must be published (§§ 37, 39, 49 AktG, § 9 HGB), the authorisation to exclude preemption rights is also published. The German Stock Corporation Act also permits that pre-emption rights may be excluded in the general meetings' resolution authorising the board to increase the capital (§ 203 (1) AktG). The resolution must be passed by a majority of the votes submitted and a majority of ¾ths of the votes attached to the subscribed capital represented in the general meeting. Furthermore, under German law, the resolution may only be voted on if the intention to authorise the management board to exclude pre-emption rights has previously been expressly and duly published in the company’s gazette (§ 186 (4) s. 1 AktG). Furthermore, the Stock Corporation Act prescribes that the management board has to draw up a report indicating the reasons for the exclusion and justifying the proposed issue price (§186 (4) s. 2 AktG). On the other hand, the substantive requirements developed by the Federal Supreme Court (see b)) do not apply to the full extent: at the time of the shareholders’ resolution, the withdrawal of pre-emption rights need not be fully justified by facts. It is sufficient that the exclusion serves a purpose which is in the company’s interest and that the measure is disclosed in an abstract form (BGHZ 136, 133, 138 et seq). As, under German law, the shareholders’ resolution constitutes at the same time an amendment of the statutes, the amendment must be registered and published (§§ 181 (2), 39 AktG). The German Stock Corporation Act also permits that the general meeting may delegate the power to restrict or exclude pre-emption rights to the management board empowered to decide on the capital increase within the limit of the authorised capital (§ 203 (2) s. 1 AktG). The resolution must be passed by a majority of the votes submitted and a majority of ¾ths of the votes attached to the subscribed capital represented in the general meeting. Furthermore, under German law, the resolution to authorise the management board to exclude pre-emption rights may only be voted on if the intention to authorise the management board to withdraw pre-emption rights has previously been expressly and duly published in the company’s gazette (§§ 203 (2) s. 2, 186 (4) s. 1 AktG). Moreover, the Stock Corporation Act prescribes that the power to exclude pre-emption rights may only be delegated to the management board for a maximum period of five years and that the management board has to draw up a report indicating the reasons for the exclusion and justifying the proposed issue price (§§ 203 (2) s. 2, 186 (4) s. 2 AktG). In this context, the substantive requirements developed by the Federal Supreme Court (see b)) do not apply to the full extent: at the time of the shareholders’ resolution, the exclusion of pre-emption rights need not to be fully justified by facts. It must only be stated that the withdrawal serves a purpose which is in the company’s interest. Whether the withdrawal of pre-emption rights is also necessary and suitable to achieve the purpose and whether it is proportionate does not need to be examined (BGHZ 136, 133, 138 et seq.). This must, however, be examined at the time the management board actually decides to exclude the pre-emption rights. In this context, it is also important to note that the decision of the management board to exclude pre-emption rights is subject to the consent of the supervisory board (§ 204 (1) s. 2 AktG). d) Securities to be converted into shares Under the German Stock Corporation Act, the provisions concerning pre-emption rights in the context of capital increases are also applicable to the issue of convertible bonds and profitsharing bonds. Accordingly, where convertible bonds and profit-sharing bonds are issued, the 88
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bonds must be offered on a pre-emptive basis to shareholders in proportion to the subscribed capital represented by their shares (§§ 221 (4), 186 AktG). e) Derogations The Stock Corporation Act provides for the possibility to depart from the strict requirements concerning the exclusion of pre-emption rights where it serves to encourage the participation of employees in the capital of the company (BGHZ 144, 290, 292, § 204 (4) AktG). Jurisprudence: BGHZ 71, 40; BGHZ 83, 319, 323; BGHZ 144, 290, 292; HRC Munich AG 1991, 210, 211; DC Munich I AG 1993, 195.
Sub-section 3:
Subsequent formations
9. Subsequent formations a) Content Under German law, the term ‘subsequent formation’ refers to instances where a company, within a period of two years since it has been incorporated, contracts to acquire an asset for a consideration of not less than one-tenth of the subscribed capital. Where the partner in the transaction is a founder of the company, the contract only comes into effect once it is approved by the general meeting and registered at the register court (§ 52 (1) s. 1 AktG). Unless the contract is approved and filed with the registrar, it is void and so is any act intended to carry out the contract (§ 52 (1) s. 2 AktG). The German legislator extends the provisions on subsequent formation to contracts concluded between the company and shareholders. However, the provisions are not extended to all shareholders but to those who hold a share of more than 10% in the subscribed capital (§ 52 (1) AkG). b) Valuation by an expert Before the resolution to approve the contract is voted on by shareholders, the German Stock Corporation Act prescribes that the acquisition must be examined. In this respect the Act requires, on the one hand, the supervisory board to examine the contract between the company and founders/shareholders and to draw up a report on the subsequent formation of the company similar to the report on formation to be submitted during the stage of formation (§ 52 (3) AktG). As to the form and contents of this report, the comments under question 3 d) are referred to. The Stock Corporation Act requires, furthermore, that an expert report must be drawn up similar to the expert report required on considerations other than cash (§ 52 (4) AktG). Accordingly, the property which the company contracts to acquire must be valued by independent experts. Once the report is drawn up, it must be submitted to the management board and the register court where it can be inspected by anyone interested (§§ 52 (4) s. 2, 34 (3) AktG). For details of the form and contents of this report, the comments under 3 c) are referred to. c) Shareholders’ resolution Before the resolution to approve the contracts may be voted on by shareholders, the German Stock Corporation Act prescribes further procedural requirements to be observed. These requirements which are intended to guarantee that the shareholders are properly informed, comprise, apart from the time the general meeting is called, for instance the requirement that the contracts must be laid out in the offices of the company for inspection by shareholders (§ 52 (2) s. 2 AktG). On demand, every shareholder is to be furnished with a copy (§ 52 (2) s. 3 AktG). Furthermore, the contracts must be laid out in the general meeting (§ 52 (2) s. 4 AktG) 89
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and the management board is required to explain them at the beginning of the general meeting (§ 52 (2) s. 5 AktG). The resolution to approve the contracts must be passed by a simple majority of the votes cast and a majority of ¾ths of the votes attached to the subscribed capital represented in the general meeting (§ 52 (5) s. 1 AktG). Where the contract is concluded within one year after the company has been incorporated, the Stock Corporation Act requires, furthermore, that the majority approving the contracts must be not less than ¼th of the votes attaching to the entire subscribed capital (§ 52 (5) s. 2 AktG). d) Transparency Apart from the requirement to submit the expert report to the register court once it has been drawn up, under German law the management board is required to file with the registrar the contract approved by the shareholders’ resolution (§ 52 (6) s. 1 AktG). Furthermore, the original contract, an official copy or a copy attested by a notary together with the report on the subsequent formation of the company and the expert report must also be enclosed (§ 52 (6) s. 2 AktG). The publication of registration must state the contract date, the date of the shareholders’ resolution, the asset to be acquired by the company, the person providing the asset and the consideration for the asset (§ 52 (8) s. 2 AktG). e) Exceptions The German Stock Corporation Act provides for exceptional cases in which the provisions on subsequent formation do not apply. The provisions on subsequent formation do not apply to acquisitions effected in the normal course of the company’s business, to stock exchange acquisitions and to acquisitions effected in the course of the execution of a judgement (§ 52 (9) AktG). f) Consequences of incorrect subsequent formations Analogously to the legal situation during the stage of formation, the German Stock Corporation Act contains special provisions which are concerned with the legal consequences of incorrect subsequent formations. Firstly, the register court is required to reject the application for registration if the experts state, or if it is obvious, that the report on subsequent formation is incorrect or incomplete or not in line with the legal provisions, or if the consideration provided for the property to be acquired by the company is unreasonable high (§ 52 (7) AktG). The German Stock Corporation Act, furthermore, provides for the liability of members of the management board and the supervisory board (§ 53 AktG). In this respect, German law refers to the provisions regarding the liability of founders (§ 46 AktG), which are applicable mutatis mutandi. § 48 AktG which is concerned with the liability of the management board and the supervisory board during the stage of formation, also applies (§ 53 AktG). These provisions have been commented on under 3 e) where details may be obtained. f) Subsequent formation in practice The case law on subsequent formations is sparse. In recent years, two judgements have been published which deal with subsequent formation: OLG Oldenburg, LSK 2002, 490314 and LG Hagen, LSK 2002, 520436. Jurisprudence: OLG Oldenburg, LSK 2002, 490314; LG Hagen, LSK 2002, 520436.
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Section 2:
Capital Maintenance
10. Limitation on distributions a) Principle The German Stock Corporation Act prescribes that contributed capital may not be paid back to shareholders (§ 57 (1) AktG). § 57 (1) AktG prohibits any payment to a shareholder out of the company's funds if it is performed not in the context of a distribution of the balance sheet profits and is not allowed by a special statutory regulation. § 57 (1) AktG applies, therefore, if payment is made out of the subscribed capital, the statutory reserve or the optional reserve, if an effective shareholders’ resolution on the distribution does not exist. Furthermore, it should be noted that § 57 (1) AktG covers not only open but also hidden transactions. It is recognised that the company can make transactions with its shareholders in the same manner as with third parties. This is not, however, the case if there is a lack of proportion between the consideration and the consideration in return, i.e. if the company accepts conditions which it would not have accepted from a third party. In this case, the company’s transaction violates § 57 (1) AktG and is, therefore, not admissible. Furthermore, certain transactions of third parties can be covered by § 57 (1) AktG, if they act for the account of the company. b) Sanctions In cases in which the principle that the contributed capital is not to be returned to shareholders has been infringed, the German Stock Corporation Act provides for the liability of shareholders and the liability of the management board. Under the German Stock Corporation Act, shareholders are obliged to return any payment received contrary to the Stock Corporation Act (§ 62 AktG). Shareholders are not only liable to repay dividends received on the basis of a resolution by the general meeting but also any other payment received from the company which, in effect, constitutes a violation of the principle that the contributed capital must not be returned to shareholders. The German Stock Corporation Act provides that the management board is liable to compensate the company for losses caused by unlawful distributions (§ 93 (1), (3) No. 1 and No. 5 AktG). 11. Acquisition by the company of its own shares a) Possibility of acquiring its own shares In Germany a public company may, in certain circumstances, acquire its own shares (§ 71 AktG). One can distinguish between the following cases: b) Authorisation by a general meeting The first case allows acquisition by the company of its own shares on the basis of an authorisation of the general meeting. In Germany, the acquisition by the company of its own shares is subject to several conditions. The German Stock Corporation Act requires a resolution by shareholders which shall determine the duration of the period for which authorisation is given to the management board to acquire the company’s own shares and which may not exceed 18 months, the maximum and minimum consideration for the shares as well as the nominal value of shares to be acquired which may not exceed 10% of the subscribed capital (§ 71 (1) No. 8 AktG). Furthermore, the German Stock Corporation Act 91
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prescribes that the nominal value or the accountable par of acquired shares held by the company, including shares previously acquired by the company and held by it, and shares acquired by a third person acting in his own name but on behalf of the company, may not exceed 10% of the subscribed capital (§§ 71 (2) s. 1, 71d AktG). Also under German law, only fully paid up shares may be acquired (§ 71 (2) s. 3 AktG) and the acquisition may not affect the subscribed capital and the reserves not available for distributions (§ 71 (2) s. 2 AktG). An additional requirement under German law is that, once shareholders have voted to authorise the management board to acquire the company’s own shares, notice of the authorisation must be given to the Federal Financial Supervisory Authority (§ 71 (3) s. 3 AktG). Finally, the management board is required to inform the next general meeting of the reason for and the purpose of the acquisition, the number and nominal value of shares acquired, the proportion of the subscribed capital they represent as well as the consideration for these shares (§ 71 (3) s. 1 AktG). c) Further possibilities The German legislator used various possibilities stipulated in the 2nd CLD to provide for statutory exemptions to some of the requirements applying to share buybacks where the acquisition by the company of its own shares serves specific purposes. According to the German Stock Corporation Act, a company may buy back its shares if it is necessary to prevent serious and imminent harm to the company (§ 71 (1) No. 1 AktG). In this case, a shareholders’ resolution is not required, but the other requirements (10% limit of § 71 (2) s. 1, the capital limit of § 71 (2) s. 2 and the necessity that the shares are fully paid-up (§ 71 (2) s. 3) apply. The management board is required to inform the next general meeting of the reason for and the purpose of the acquisition, the number and nominal value of shares acquired, the proportion of the subscribed capital they represent as well as the consideration for these shares (§ 71 (3) s. 1 AktG). Furthermore, Germany provides for the possibility of a company repurchasing its own shares where the shares acquired are to be distributed to the company’s current or former employees or the current or former employees of an associated company (§ 71 (1) No. 2 AktG). Analogously to the case in which the share repurchase serves to prevent serious and imminent harm, a shareholders’ resolution is not required, but the other requirements are applicable. In such a case, the German Stock Corporation Act requires that the shares must be distributed within one year of their acquisition (§ 71 (3) s. 2 AktG). The Stock Corporation Act also allows a company to repurchase its shares where this is to carry out a decision to withdraw the shares according to the provisions on the reduction of capital (§ 71 (1) No. 6 AktG). In such case, a separate resolution by shareholders is not required, nor do the preconditions otherwise applicable to share buybacks apply. The German Stock Corporation Act allows a company to buy back its own shares where fully paid up shares are acquired free of charge or if a financial institution with the acquisition carries out a purchasing commission (§ 71 (1) No. 4, (2) AktG). In this case, it is necessary that the shares are fully paid up whereas a shareholders’ resolution is not necessary Furthermore, German law provides for the possibility of a company acquiring its own shares to indemnify shareholders in associated companies in the event of a merger or a change in the company’s legal form and in the event a company is integrated into another company (§ 71 (1) No. 3 AktG). Also in these cases, a resolution by shareholders is not required whereas the
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10% limit (§ 71 (2) s. 1) and the requirement that the acquisition may not affect the subscribed capital and the reserves not available for distribution (§ 71 (2) s. 2 AktG), apply. d) Shares acquired in contravention of the legal rule If shares are acquired in contravention of the legal rules laid down in § 71 (1) and (2) AktG, the German Stock Corporation Act stipulates that the transaction in rem, that is the acquisition itself, is valid but the share repurchase contract is void (§ 71 (4) AktG). The shares acquired must be disposed of within one year (§ 71c (1) AktG). In the case of the 10% limit of § 71 (2) s. 1 AktG, the shares must be disposed of within three years. Should they not be disposed of during this period, they are to be redeemed by way of capital reduction (§ 71c (3) AktG). e) Holding of shares In Germany, if a company acquires its own shares, all rights attached to the shares are suspended (§ 71b AktG). Furthermore, the Stock Corporation Act extends the rule that a company is not entitled to any rights attached to the shares to those acquired by a person acting in his own name but on behalf of the company, by a subsidiary of the company and by a person acting in his own name but on behalf of a subsidiary of the company (§ 71d AktG). German law prescribes, furthermore, that when the company’s own shares are included under assets in the balance sheet, a reserve of the same amount must be entered within the equity position of the balance sheet (§ 272 (4) s. 1 HGB). This reserve is not available for distributions: it may only be dissolved if the company’s own shares held are distributed, disposed of or redeemed (§ 272 (4) s. 2 HGB). If a company acquires its own shares, the Stock Corporation Act requires that specific information must be given in the notes to the accounts (§ 160 (1) No. 2 AktG). The company must disclose that it holds the shares acquired by the company, by a subsidiary or by a third person acting in his own name but on behalf of the company. The number and nominal value or, where there are no-par value shares, the accountable par of the shares, the proportion of the subscribed capital which they represent, the date the shares have been acquired and the reasons for the acquisition, must also be stated. Furthermore, where such shares have been acquired or disposed of during the financial year, account must be given of the acquisition and the disposal by stating the number and the nominal value or the accountable par of these shares, the proportion of the subscribed capital they represent, the consideration for the shares and the application of the proceeds. Under German law, the information must be included in the notes to the accounts and the application of the proceeds of the acquisition or the disposal of shares, must also be stated. f) Acceptance of the company’s own shares as security The German Stock Corporation Act prescribes that the acceptance of the company’s own shares as security, either by the company itself or through a third person acting in his own name but on behalf of the company or by a subsidiary, shall be treated as an acquisition by the company of its own shares (§ 71e (1) s. 1 AktG). Thus, in such cases the rules on share repurchases apply, restricting the cases in which the company may accept its own shares as security to a very few. A statutory exemption applies, however, to cases in which financial institutions and financial service institutions accept the company’s own shares as security in the normal course of business. In this case, only the 10% limit applies (§ 71e (1) s. 2 AktG). The German legislator, therefore, used the possibility of the 2nd CLD to allow for exemptions in respect to transactions concluded by financial institutions in the normal course of business yet not to the full extent as, under German law, the 10% limit still applies.
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g) Application of Art. 24a if exceptions have not been chosen by Member State In Germany, the exceptions of Art. 24a (4) – (6) of the 2nd CLD have not been implemented into national law. Under German law, therefore, the acquisition or holding of shares in a company by its subsidiary is regarded as having been effected by the company itself (§ 71d s. 2 AktG). h) Reselling of the company’s own shares (equal treatment) The German Stock Corporation Act prescribes explicitly that the principle of equal treatment must be observed with respect to a company’s own shares which were acquired under a shareholders' resolution (§ 71 (8) s. 3 AktG). It is sufficient that the shares are sold on the stock exchange. i) Prospective implementation of the amendments of the 2nd CLD The amendments of the 2nd CLD by Directive 2006/68/EC have not yet been implemented into national law. 12. Prohibition of financial assistance Under the German Stock Corporation Act, companies are prohibited from providing financial assistance with a view to the acquisition of its shares by a third party. Prospective implementation of the amendments of the 2nd CLD In Germany, the amendments of the 2nd CLD by Directive 2006/68/EC have not yet been implemented into national law. 13. Loans from shareholders Up to now, the jurisprudence applied to public companies the principles developed with respect to private limited companies. According to this jurisprudence, loans from shareholders responsible for financing the company – which is assumed by the courts if the shareholder holds a share of at least 25% in the subscribed capital – granted to the company in a situation in which the company was in a financial crisis were treated as share capital of the company (BGHZ 90, 381, 385 et seq.; BGH NZG 2005, 712, 713) and were subordinated claims in the case of insolvency. In May 2007, the German legislator proposed a new bill to reform the Act on Limited Liability Companies (“Gesetz zur Modernisierung des GmbH-Rechts und zur Bekämpfung von Missbräuchen, MoMiG”). According to this bill, which must be interpreted as also covering public companies, loans granted by a shareholder are subordinated after insolvency arises and can be repaid only after all other creditors are satisfied (§ 135 InsO). Furthermore, if the shareholder’s loan has been repaid by the company in the year before insolvency arose, the repayment can be challenged (§ 6 AnfG). Jurisprudence: BGHZ 90, 381, 385 et seq.; BGH NZG 2005, 712, 713. 14. Capital decreases The German Stock Corporation Act provides for two kinds of capital reductions: the ordinary capital reduction and the simplified capital reduction. 94
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a) Ordinary capital reduction The German Stock Corporation Act provides for the possibility of an ordinary reduction in capital. A reduction in capital is subject to a shareholders’ resolution (§ 222 (1) AktG). A general meeting must, therefore, be called. By the time the meeting is called, the proposal to reduce the capital must be laid down in the agenda of the general meeting and published in the Joint Electronic Register Portal of the Federal States (§ 124 (1), (2) s. 2 AktG). The resolution to reduce the capital must be passed by a simple majority of the votes submitted and 3/4ths of the subscribed capital represented in the general meeting at the taking of the resolution (§ 222 (1) s. 1 AktG). Where there are several classes of shares, the German Stock Corporation Act, furthermore, requires that the shareholders’ resolution to reduce the capital is subject to a separate vote of each class of shareholders (§ 222 (2) AktG). The separate vote is required irrespective of whether the shareholders’ rights of a class are actually affected by the transaction. Regarding the quorum of the separate vote required, the German Stock Corporation Act refers to the rules applicable to the shareholders’ resolution on the reduction in capital. The resolution must specify the purpose of the reduction in capital, that is particularly whether it serves to return capital to shareholders (§ 222 (3) AktG) and, furthermore, the way in which the reduction of capital is carried out (§ 222 (4) s. 3 AktG). In respect of par value shares, that the reduction may only be carried out by way of consolidating the shares if otherwise the nominal value of shares falls below the minimum value of one Euro (§ 222 (4) s. 2 AktG). The German Stock Corporation Act requires the management board and the chairman of the supervisory board to file the shareholders’ resolution with the registrar (§ 223 AktG). The registration of the resolution is to be published in the Joint Electronic Register Portal of the Federal States (§ 10 (1) HGB). The German legislator did not use the possibility of the 2nd CLD to relax the rules on capital reductions where companies are incorporated under a special law and issue both share capital and workers’ capital, the latter being issued to the company’s employees as a body, the employees being represented as a body at general meetings of shareholders by delegates having a right to vote. The German Stock Corporation Act provides for the protection of creditors. Creditors whose claims antedate the publication of the shareholders’ resolution to reduce the capital and which have not fallen due by the date of the publication, have a right to obtain security if they notify their claims within a period of 6 months from when the resolution has been published (§ 225 (1) AktG). Under German law, the creditors have no right to obtain security if, in the event of the company becoming insolvent, they have a claim to preferred satisfaction (§ 225 (1) s. 3 AktG). The Stock Corporation Act, furthermore, prescribes that no payment may be made to shareholders unless the 6 months period, within which creditors are required to notify their claims, has expired and creditors who notified their claims have either been satisfied or given security (§ 225 (2) s. 1 AktG). The actual transaction of the capital reduction is the business of the management board. It is also required that the transaction be filed with the registrar (§ 227 (1) AktG). In addition, German law prescribes that the subscribed capital may not be reduced to an amount below the minimum amount of capital - in Germany €50,000 (§ 7 AktG) – unless the 95
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company provides that the shareholders’ resolution to reduce the capital may take effect only when the subscribed capital is increased to an amount at least equal to the minimum capital (§ 228 (1) AktG). b) Simplified procedure The German Stock Corporation Act provides for the possibility of a simplified capital reduction. The simplified capital reduction allows companies to waive the safeguards for creditors otherwise to be observed in the context of an ordinary capital reduction where the capital reduction serves to offset losses or to include sums of money in the capital reserve (§ 229 (1) s. 1 AktG). The capital reduction may only be carried out if it is necessary to establish sound conditions, that is if losses have been incurred and the profit reserves and the amount by which the statutory reserve and capital reserve exceed 10% of the reduced subscribed capital are not sufficient to offset losses (§ 229 (2) s. 1 AktG). In case there are still profits brought forward, the capital reduction may not be carried out (§ 229 (2) s. 2 AktG). Where the capital reduction serves to place sums of money into the capital reserve, amounts may only be placed into the capital reserve to the extent that the sum of the capital reserve and the statutory reserve does not exceed 10% of the reduced subscribed capital (§ 231 AktG). In case of a simplified reduction in capital, with the exception of the rules on creditor protection, the rules on ordinary capital reductions are applicable. That means that a shareholders’ resolution which authorises the capital reduction is required (§§ 229 (3), 222 (1) AktG). Where there are several classes of shares, the resolution to reduce the capital is, furthermore, subject to a separate vote of each class of shares (§§ 229 (3), 222 (2) AktG). The management board and the chairman of the supervisory board are required to file the resolution to reduce the capital with the registrar (§§ 229 (3), 223 AktG). The transaction of the capital reduction must also be filed with the registrar and published (§§ 229 (3), 227 AktG). The German Stock Corporation Act prescribes that amounts deriving from the reduction of subscribed capital or from dissolving the capital and profit reserves may not be used for making payments to shareholders or discharging shareholders from their obligation to pay-up their contributions (§ 230 s. 1 AktG). These amounts may only be used to compensate for a decline in value, to offset other losses and to place the amounts in the capital reserve or the statutory reserve, provided such application was previously determined in the shareholders’ resolution to reduce the capital (§ 230 s. 2-3 AktG). In addition, the amounts deriving from the reduction of the subscribed capital and from dissolving the capital and profit reserves may not be distributed to shareholders (§ 233 (3) AktG). Furthermore, profits may not be distributed until the statutory reserve and the capital reserve reach ten percent of the reduced subscribed capital (§ 233 (1) AktG). If this quota is reached within two years after the capital reduction has been carried out, any distribution is restricted to 4% of the share in profits (§ 233 (2) s. 1 AktG). This restriction does not apply if shareholders, whose claims antedate the publication of the shareholders’ resolution to reduce the capital and who notified their claims within a period of 6 months after the annual accounts, on the basis of which the distribution is to be made, have been published, have either been satisfied or obtained security (§ 233 (2) s. 2 AktG). c) Prospective implementation of the amendments of the 2nd CLD The amendments of the 2nd CLD with respect to the burden of proof have not yet been implemented into national law.
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15. Redemption of the subscribed capital The German Stock Corporation Act does not provide for the possibility to redeem subscribed capital without reducing the latter. 16. Compulsory withdrawal of shares The German legislator used the member state option in the 2nd CLD and allows the reduction of the subscribed capital by compulsory withdrawal of shares (§ 237 (1) s. 1 AktG). a) Conditions for the withdrawal Under the German Stock Corporation Act, the compulsory withdrawal of shares is only permissible if it is prescribed or authorised by the statutes before the shares to be withdrawn are subscribed (§ 237 (1) s. 2 AktG). Furthermore, the compulsory withdrawal of shares is permissible if the withdrawal is authorised or prescribed by the statutes after the shares have been subscribed, provided the shareholders concerned approve this. Where the compulsory withdrawal of shares is merely authorised by the statutes, i.e. the statutes describe exactly the conditions under which shares may be withdrawn, the withdrawal does not need a shareholders’ resolution. If the statutes allow the withdrawal of shares without determining the conditions under which the redemption is possible, a shareholders’ resolution is necessary. b) Ordinary procedure The Stock Corporation Act distinguishes between an ordinary withdrawal procedure (§ 237 (2) AktG) and a simplified withdrawal procedure (§ 237 (3) AktG). The latter provides for relaxations with respect to procedural and material requirements otherwise to be observed and is applicable only in a few instances, namely in cases in which creditors’ claims are not affected. The ordinary procedure to withdraw shares follows in most instances the rules on the ordinary capital reduction (§ 222 AktG). Therefore, the rules on the shareholders’ resolution applicable to a capital reduction by a withdrawal of shares (§ 222 (1) s. 1, § 237 (2) s. 1 AktG) apply. The provisions on creditor protection provided for in the case of the ordinary capital reduction also apply (§ 225 AktG). The resolution to withdraw shares, which is passed either by the shareholders or by the management board, must, by law be filed by the management board and the chairman of the supervisory board with the registrar (§§ 237 (2) s. 1, (4) s. 5, 223 AktG) and then published in Joint Electronic Register Portal of the Federal States (§ 10 (1) HGB). The transaction of the withdrawal of shares must also be filed with the registrar (§ 239 AktG) and published (§ 10 (1) HGB). The German legislator did not use the possibility of the 2nd CLD to allow for exemptions for companies incorporated under a special law which issue both capital shares and workers’ shares, the latter being issued to the company’s employees as a body, and the employees being represented as a body at general meetings of shareholders by delegates having the right to vote.
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c) Simplified procedure The simplified procedure is applicable in cases in which fully paid-up shares, which are made available to the company free of charge, are withdrawn, cases in which shares are to be withdrawn using funds available for distribution and cases in which the shares to be withdrawn are no-par value shares and the shareholders’ resolution determines that the other shares’ accountable par is increased. The procedure is simplified as the provisions on the ordinary capital reduction (§ 237 (3) AktG) need not be followed. The simplified withdrawal of shares may only be decided by the general meeting. A simple majority of the votes is sufficient. In the simplified procedure, the strict rules on creditor protection do not apply. In the first two instances, the company is required to place an amount equal to the nominal value or accountable par of the shares withdrawn in the capital reserve (§ 237 (5) AktG). d) Redemption of the company's shares acquired by the company itself or by a person on behalf of the company The German Stock Corporation Act also provides for the possibility of reducing the subscribed capital by redeeming shares which have previously been acquired by the company itself (§ 237 (1) s. 1 AktG). Shares acquired by a subsidiary or a third person in his own name but on behalf of the company may not be redeemed under German law. Analogously to the reduction of the subscribed capital by compulsory withdrawal of shares, German law differentiates in the context of the redemption of shares between the ordinary redemption procedure (§ 237 (2) AktG) and the simplified redemption procedure (§ 237 (3) AktG). In this respect, the same rules apply that are also applicable in the context of a compulsory withdrawal of shares. That means that the redemption of shares is subject to a shareholders’ resolution. This resolution requires a simple majority of the votes and a majority of ¾ths of the votes attached to the subscribed capital represented in the general meeting (§§ 237 (2) s. 1, 222 (1) s. 1 AktG). Where there are several classes of shares, the shareholders’ resolution is, furthermore, subject to a separate vote of each class of shares (§§ 237 (2) s. 1, 222 (2) AktG). By contrast, where the redemption of shares follows the simplified procedure, that is in cases in which fully paid-up shares, which are made available to the company free of charge, are redeemed, cases in which shares are to be redeemed using funds available for distribution and cases in which the shares to be redeemed are no-par value shares and the shareholders’ resolution determines that the other shares’ accountable par is increased (§ 237 (3) AktG), a simple majority for the shareholders’ resolution to redeem shares is sufficient (§ 237 (4) s. 1-2 AktG). The provisions for creditor protection are similar to those applicable in cases of the compulsory withdrawal of shares. That means, in principle, that creditors have a right to obtain security and payment to shareholders may not be made unless the 6 months period stipulated for the notification of creditors’ claims has expired and creditors have either been satisfied or obtained security for their claims (§§ 237 (2) s. 1, 225 AktG). In case the redemption of shares follows the simplified procedure (see above), the strict rule on creditor protection does not apply (see above bb)). The German Stock Corporation Act also provides for rules regarding the publication of the reduction of capital by way of redemption of shares acquired by the company itself. Similar to the legal situation in the context of the compulsory withdrawal of shares, the shareholders’ resolution to redeem shares and the transaction of the redemption are to be filed with the
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registrar (§§ 237 (2) s. 1, 223 AktG, § 237 (4) s. 5 AktG) and published in the Joint Electronic Register Portal of the Federal States (§ 10 (1) HGB). 17. Redeemable shares The German legislator did not use the possibility of the 2nd CLD to allow companies to issue redeemable shares.
Section 3:
Dividends and distributions
18. Definition of Distribution Under German Stock Corporation Law, the term ‘distribution’ is not defined, either positively or by way of stating which transactions are not considered as distributions. From the legal provisions concerned with distributions, it may, however, be concluded that distributions include, in particular, dividends (§ 57 (3) AktG) and payment of interest relating to shares (§ 57 (2) AktG). Beyond that, any other payment whereby the shareholder’s contribution is returned to him is considered as a distribution (§ 57 (1) AktG). 19. Distributable amount a) Balance sheet net assets test/ earned surplus test Pursuant to the Stock Corporation Act, only the balance sheet profit duly determined and agreed in the general meeting to be distributed may be distributed to shareholders (§ 57 (3) AktG). The balance sheet profit is the profit for the financial year as shown in the profit and loss account after setting off losses and profits brought forward as well as sums placed into mandatory and optional reserves and sums drawn from reserves (§ 158 (1) AktG). The disclosed reserves comprise the capital reserve into which any premiums paid must be placed (§ 272 (2) No. 1 HGB) and the profit reserves. The profit reserves comprise the statutory reserve (§ 150 AktG), the reserve for its own shares held by the company (§ 272 (4) HGB [see question 11 b) ee)]), statutory reserves (§ 272 (3) s. 2 HGB) and “other profit reserves” (§ 58 AktG). The capital reserve (§ 272 (2) HGB) and the statutory reserve (§ 158 HGB) form a “legal reserve fund” (see question 1 cc)) which is not available for distribution and may, therefore, not be dissolved to this end. As is the case with the subscribed capital and the reserve for the company’s own shares held (§ 272 (4) HGB), therefore, premiums and any part of the financial year's profit placed into the statutory reserve, may not be paid back to shareholders. The statutory reserves (§ 272 (3) s. 2 HGB) and “other profit reserves” (§ 58 AktG) are by contrast distributable. However, an amount equal to these reserves is bound in the company as long as these reserves are not dissolved by the management board and the general meeting has not decided on the distribution. The balance sheet profit is determined by reference to the items set out in the annual accounts which must be drawn up in accordance with national GAAP, the source of which is the 4th Directive. Furthermore, the annual accounts must be audited (§ 316 (1) HGB) except where the company is considered to be small. A company is considered to be small if, on its balance sheet dates, it does not exceed the limit of two of the three following criteria - balance sheet total: EUR 4,015,000 net turnover: EUR 8,030,000, average number of employees during the financial year: 50 (§ 267 (1) HGB). The management board has no discretion to circumvent the rule that only the balance sheet profit may be distributed to shareholders. 99
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The German legislator did not use the possibility of the 2nd CLD to provide for derogations from the balance sheet net assets test in the case of investment companies with fixed capital. b) Interim dividends The German Stock Corporation Act does not provide for interim dividends. It only allows for payments on account (§ 59 AktG). Payments on account are partial payments on account of the balance sheet profit (§ 59 (1) AktG). They must be authorised by the statutes (§ 59 (1) AktG) and may only be made if provisional annual accounts for the previous financial year have been drawn up which show a profit for the financial year (§ 59 (2) s. 1 AktG). The payment is restricted to ½ of the profit for the financial year less any sums placed into mandatory and optional profit reserves (§ 59 (2) s. 2 AktG). Furthermore, the payment on account may not exceed half of the balance sheet profit of the previous financial year (§ 59 (2) s. 3 AktG). If authorised by the statutes, the management board decides upon the payment. Its decision is subject to the consent of the supervisory board (§ 59 (3) AktG). c) Premiums In Germany, any premiums paid must be placed into the capital reserve (§ 272 (2) HGB) [see also under 1 c)] which must be included on the liabilities side of the balance sheet as part of the company’s equity (§ 266 (3) HGB). d) Incorrect distributions Under the German Stock Corporation Act, shareholders are obliged to return to the company any payment received in contravention of the Stock Corporation Act (§ 62 (1) AktG). Where the payments received constitute dividends, the payments must be returned only if the company proves that the shareholders knew of the irregularity of the payment or could not, in view of the circumstances, have been unaware thereof (§ 62 (2) AktG). The German Stock Corporation Act provides that members of the management board and the supervisory board are liable to compensate the company for losses caused by unlawful distributions (§§ 116 s. 1, 93 (1), (3) No. 1 and No. 5 AktG). e) Liability Judging from the case law at hand, in practice it is not often the case that dividend payments must be returned to the company or that members of the management and supervisory boards are held liable because of incorrectly performed dividend payments. The majority of the judicial decisions concern transactions which have been classified by the courts as ‘hidden distributions’ (e.g. BGHZ 81, 311, 318; OLG Düsseldorf AG 1980, 273, 274; KG NZG 1999, 161; OLG Frankfurt, AG 1996, 324, 326). Jurisprudence: BGHZ 81, 311, 318; OLG Düsseldorf AG 1980, 273, 274; KG NZG 1999, 161; OLG Frankfurt, AG 1996, 324, 326. 20. Determination of the distributable amount a) Proposal by the company’s bodies In Germany, the management board makes a proposal for the allocation of the balance sheet profit (§ 170 (2) s. 1 AktG). The proposal must comprise the distribution to shareholders (§ 170 (2) s. 2 No. 1 AktG), namely the dividend to be paid in Euro per share and, if applicable, itemised in ordinary shares and preferential shares. The proposal must, furthermore, state the 100
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amounts to be allocated to other profit reserves (§ 170 (2) No. 2 AktG), the profits brought forward (§ 170 (2) s. 2 No. 3 AktG) and the balance sheet profit (§ 170 (2) s. 2 No. 4 AktG). The management board’s proposal is to be submitted to the supervisory board together with the annual accounts (§ 170 (2) s. 1 AktG). The supervisory board examines the proposal and the accounts (§ 171 (1) s. 1 AktG) and draws up a report on the examination (§ 171 (2), (3) AktG). The report is to be submitted to the management board within one month after the supervisory board has obtained the management board’s submissions (§ 171 (3) AktG). As soon as the management board has obtained the supervisory board’s report, it must call a general meeting (§ 175 (1) AktG). The report and the management board’s proposal for the allocation of the balance sheet profit is to be displayed in the company’s premises for inspection by shareholders (§ 175 (2) AktG). The general meeting then decides upon the allocation of the balance sheet profit by resolution (§§ 119 (1) No. 2, 174 (1) s. 1 AktG). b) Authorisation by the general meeting The German Stock Corporation Act prescribes that the general meeting decides upon the allocation of the balance sheet profit (§§ 174 (1) s. 1, 119 (1) No. 2 AktG). In this connection, the general meeting is bound by the balance sheet profit shown in the annual accounts as they have previously been adopted by the management board and the supervisory board (§ 174 (1) s. 2 AktG). By contrast, the general meeting is not bound by the management board’s proposal for the allocation of the balance sheet profit. Shareholders may vote to use the balance sheet profit for distributions to shareholders, for the allocation to other profit reserves and to carry amounts forward to new accounts (§ 174 (2) AktG). The German Stock Corporation Act also contains a specific provision prescribing the content of the shareholders’ resolution. Accordingly, the shareholders’ resolution on the allocation of the balance sheet profit must fix the balance sheet profit, the amount to be distributed to shareholders, the amounts to be allocated to other profit reserves, the profits carried forward and additional expenses arising from the resolution (§ 174 (2) AktG). The resolution on the allocation of the balance sheet profit must be passed by a simple majority (§ 133 (1) AktG). c) Publication Under German law, the management board is required to file with the registrar the proposal for the allocation of the balance sheet profit and the shareholders’ resolution on the allocation of the balance sheet profit as far as they cannot be inferred from the annual accounts which also have to be filed with the registrar (§ 325 (1) s. 1 HGB). After submitting the records to the register court, the management board is required to publish them in the Joint Electronic Register Portal of the Federal States (§ 325 (1) s. 1 HGB). d) Challenge to resolutions The German Stock Corporation Act firstly allows shareholders to challenge the resolution on the allocation of the balance sheet profit, if the general meeting votes to allocate amounts to profit reserves or to carry them forward to new accounts if this is financially unnecessary to secure the survival of the company and if the amount to be distributed to shareholders does not fall short of 4 percent of the subscribed capital (§ 254 AktG). The general rules allowing challenges to resolutions if the law or the statutes are violated (§ 243 AktG), are also applicable. However, a challenge to a resolution because a distribution is too low, is, in general, only possible under the conditions of § 254 AktG.
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In cases in which the action to set aside the resolution is brought on grounds of a violation of § 254 AktG, shareholders are only entitled to initiate proceedings if their shares (together) represent 5 percent of the subscribed capital or €500,000 (§ 254 (2) s. 3 AktG). The time limit for bringing an action to set aside the resolution is one month from the passing of the resolution (§ 246 (1) AktG). If the resolution is based on the general rule of § 243, any shareholder who attended the general meeting is entitled to bring an action if he had acquired his shares before the agenda of the meeting was published and if, documented in the minutes, he gave notice of opposition (§ 245 No. 1 AktG). A shareholder who did not attend the general meeting is entitled to bring an action if he was wrongfully not allowed to attend the meeting, if the general meeting was not duly called or if the subject-matter of the resolution was not duly published (§ 245 No. 2 AktG). e) Challenge to distributions in practice In practice, it is not often the case that distributions are challenged by shareholders. 21. Accounting reserves that influence the distributable amount a) Revaluation of tangible fixed assets, fair valuation accounting, accounting for formation expenses Under German law, companies are not permitted to use valuation methods other than historical cost accounting when drawing up their annual accounts. Accordingly, valuation by the replacement value method for tangible fixed assets with a limited useful economic life and valuation by other methods taking account of inflation is not allowed. Valuation at fair value for financial instruments is not permitted, either. By contrast, formation expenses and expenses for the expansion of the business activity may be capitalised under German law (§ 269 HGB). If such expenses are included on the asset side of the balance sheet, distributions to shareholders are restricted to the extent that the expenses have not been completely written off (for details see question 4 b)). b) Any other form of accounting reserve Apart from the measures that exist to restrict distributions in case formation expenses and expenses for the expansion of the business activity are capitalised, German law provides for similar measures in other cases. For instance, under the German Commercial Code, deferred tax assets may be included on the asset side of the balance sheet (§ 274 (2) s. 1 HGB). In this case, profits may not be distributed to shareholders unless the amount of the reserves available for distribution and any profits brought forward less any losses brought forward is at least equal to the amount of the deferred tax assets recognised in the balance sheet (§ 274 (2) s. 3 HGB). c) Extension of the fair value concept to other specified categories of assets As mentioned above (see a)), in Germany companies are not permitted to use valuation methods other than historical cost accounting when drawing up their annual accounts. Consequently, fair valuation accounting is not allowed either for financial instruments or for assets of specified categories other than financial instruments.
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Section 4:
Capital related rules in case of crisis and insolvency
22. Serious loss of the subscribed capital a) Calling of general meeting The German Stock Corporation Act requires the management board to immediately call a general meeting if the board, when drawing up the annual accounts or interim financial statements or by due assessment of the circumstances, establishes that there is a loss of half of the subscribed capital (§ 92 (1) AktG). The notification of the loss must be announced in the agenda of the general meeting which is to be published in the Joint Electronic Register Portal of the Federal States (§ 124 (1) AktG). b) Consequences The German Stock Corporation Act does not contain a provision like Art. 17 of the 2nd CLD which explicitly requires the general meeting to consider whether the company should be wound up or whether any other measures should be taken in case of a serious loss. Instead, German law requires the management board merely to notify the general meeting that a loss of half of the subscribed capital has occurred (§ 92 (1) AktG). This serves to enable the shareholders to vote on resolutions proposing measures to be taken. Suitable measures are, particularly, resolutions on corporate action or the resolution to liquidate the company (§ 262 (1) No. 2 AktG). 23. Trigger of insolvency a) Factors triggering insolvency In Germany, three factors trigger insolvency: the inability to pay one’s debts (§ 17 (1) InsO), impending inability to pay one’s debts (§ 18 InsO) and overindebtedness (§ 19 InsO). According to German insolvency law, a company is unable to pay its debts if it is not able to meet its payment obligations due (§ 17 (2) s. 1 InsO). In order to determine whether a company is unable to meet its payment obligations due, a balance sheet showing liquidity must be drawn up. The liquid funds available and those assets that can be converted into cash within a period of three weeks must be set against the debts due and called in at the relevant point in time (BGH wistra 1991, 26). The evidence that a company is unable to pay its debts may also be circumstantial: under German insolvency law, a company is presumed to be unable to pay its debts if the company suspends payments (§ 17 (2) s. 2 InsO). A short-term suspension of payments is not, however, sufficient to establish evidence of the company’s inability to pay. A company is on the verge of insolvency if it is expected that it will be unable to pay its present payment obligations when they fall due (§ 18 (2) InsO). Whether a company is on the verge of insolvency is to be established on the basis of a cash budget (“Liquiditätsplan”) in which, up to the relevant point in time, all changes in the company’s liquidity situation are to be included. The liquid funds that the company is expected to have available at the relevant point in time must be set against the debts that fall due at the relevant point in time, including those that will inevitably still arise in the course of the ordinary business. German insolvency law does not specify how long the forecasting period must be extended. The prevailing opinion in literature requires a period of two to three months. Pursuant to the German Insolvency Act, a company is overindebted if the company’s assets do not cover its present liabilities (§ 19 (2) s. 1 InsO). In order to determine whether the 103
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company’s assets cover its present liabilities, a statement of assets and liabilities must be drawn up (BGH BB 1987, 1006) – annual accounts are, by contrast, not suitable for this purpose (BGHZ 146, 267). Only those assets which could, at the point in time of the commencement of insolvency proceedings, be utilised as part of the bankrupt’s estate are to be included in the statement (BGH NJW 1983, 677). Thus, valueless receivables may not be recognised in the statement (OLG Hamburg BB 1981, 1441). Liabilities to be included in the statement comprise only present obligations which, when insolvency proceedings are commenced, constitute claims against the bankrupt’s estate. By contrast, the subscribed capital and reserves may not be included in the statement. The assets to be included in the statement are to be valued at going concern values (“Fortführungswerte”) provided that it is more likely than not that the company will continue to be a going concern (§ 19 (2) s. 2 InsO). Going concern values are replacement values; capitalised earnings values may not, by contrast, be used for valuation. Where it is more likely than not that the company will not continue to be a going concern, the assets are to be valued at liquidation values (“Auflösungswerte”) (BGH ZIP 1997, 2009). b) Time frame Neither the German Stock Corporation Act nor the Insolvency Act stipulate when the management board is required to apply these tests; beyond that, an explicit duty of the management board to apply these tests does not exist. A duty to apply these tests may at most arise from the general duty of the management board to take due care (§ 93 (1) s. 1 AktG). It will, by analogy with § 92 AktG, arguably be triggered when, by drawing up the annual accounts or interim financial statements or by due assessment of the circumstances, the management board realises that the company is in financial distress. In this context, it should, however, be noted that the management board’s duty to file for insolvency (see below c)) does not depend on whether the management board actually drew up a statement of assets and liabilities in order to determine whether a company is overindebted; decisive is the actual state of affairs of the company (BGHZ 100, 19, 22). c) Duties of the board members When the company is unable to pay its debts (§ 17 InsO) or is overindebted (§ 19 InsO), the management board is required, without undue delay but at the latest three weeks after the company has become unable to pay its debts/is overindebted, to file for insolvency (§ 92 (2) AktG). The time limit is triggered – at least in the case of overindebtedness – when the management board positively knows that the company is overindebted or when the board intentionally ignores the overindebtedness (BGHZ 75, 96, 110). The duty to file for insolvency does not depend on whether the management board actually drew up a statement of assets and liabilities to determine whether the company is overindebted; decisive is the actual state of the affairs of the company (BGHZ 100, 19, 22). It should also be noted that the legal duty to file for insolvency is not triggered when the company is merely on the verge of insolvency (see a)). In this case, the management board is, however, allowed to file for insolvency (§ 18 (1) InsO). When the company is unable to meet its payment obligations due/is overindebted, the management board is, furthermore, required to suspend payments except for those that are necessary to assists efforts to establish sound conditions within the permissible time period of three weeks until the duty to file for insolvency must have been exercised if efforts to establish sound conditions have not been successful (§ 92 (3) AktG).
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d) Treatment of subscribed capital, premiums, shareholder loans Under German insolvency law, a shareholder who granted the company a loan is treated as an ordinary unsecured creditor in insolvency unless he proves otherwise (§ 38 InsO). By contrast, neither the Insolvency Act nor the Stock Corporation Act states whether a shareholder is treated as a subordinated creditor if his loan is - by case law - treated as share capital (see question 13 b)). According to § 39 InsO, shareholders who have granted loans to private limited companies are subordinated creditors in insolvency (§ 32a GmbHG, § 39 (1) No. 5 InsO). According to the prevailing opinion, the same applies to public companies if the shareholder concerned participates in the company in an entrepreneurial manner. In respect to shareholders’ contributions to the subscribed capital and the premium, the shareholder is subordinated to all other creditors, as the subscribed capital and the premium serve as a liability fund for creditors’ claims (§ 272 (1) HGB). Jurisprudence: BGH wistra 1991, 26; BGH BB 1987, 1006; BGHZ 146, 267; OLG Hamburg BB 1981, 1441; BGH NJW 1983, 676, 677; BGHZ 146, 264, 271; BGH ZIP 1997, 2009; BGHZ 75, 96, 110; BGHZ 100, 19, 22.
Section 5:
Contractual self-protection of creditors
24. Contractual self-protection In Germany, there are no specific legal provisions concerned with contractual self-protection of creditors. Under German law it is not possible that creditors negotiate contracts with a company to limit the distributable amount as the general meeting has to decide on the location of the balance sheet profit. Such contracts are rather a side issue. However, credit institutions will usually demand security for lending, such as a guarantee from third persons.
Section 6:
Equal treatment
25. Principle of equal treatment a) Principle of equal treatment The German Stock Corporation Act prescribes that shareholders who are in the same position must be treated equally (§ 53a AktG). In Germany, this principle is understood as a prohibition on treating shareholders unequally unless the unequal treatment is justified by facts. However, a principle of equal treatment of all shareholders does not exist; the statutes can attribute different rights to shares (preference rights). With respect to the design of these preference rights, the principle of equal treatment must be applied, i.e. the possibility to acquire these preference shares must be offered to all shareholders under the same conditions. With respect to “principal rights”, that is e.g. the right to vote, the right to receive dividends and the pre-emption right, the criterion for equal treatment is the proportion of the shareholder’s share ownership. With respect to “auxiliary rights”, e.g. the right to attend the general meeting and the right to speak at the general meeting, there must be absolute equal treatment. Unequal treatment may be justified by law, the statutes or circumstances. b) Right to vote Pursuant to the German Stock Corporation Act, a shareholder may exercise his voting right in proportion to his share ownership (§ 134 (1) s. 1 AktG). In case a shareholder holds more than 105
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one share, the statutes of a non-listed company may restrict the right to vote by stipulating a maximum amount or by stipulating graduations (§ 134 (1) s. 2 AktG). Furthermore, a company may issue non-voting preference shares (§ 139 (1) AktG). c) Pre-emption right Pre-emption rights are also granted to shareholders in proportion to the capital represented by their shares held (§ 186 (1) s. 1 AktG). However, it is permissible to exclude pre-emption rights in accordance with legal provisions and the principles developed by jurisprudence. d) Right to receive dividends In Germany, the shareholder’s right to receive dividends is determined by the proportion of his share ownership (§ 60 (1) AktG). The company’s statutes may stipulate a different formula for distribution (§ 60 (3) AktG). It is also allowed to issue participating preference shares (§ 139 AktG). e) Right to attend the general meeting Under the German Stock Corporation Act, every shareholder has a right to attend the general meeting - irrespective of the proportion of his share ownership. The shareholder’s right to speak at the general meeting may be restricted. Jurisprudence: BGHZ 33, 175, 186.
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3.1.3 Poland Section 1:
Capital formation
Sub-section 1:
Formation of the public company
1. Minimum capital and other means of equity financing a) Minimum subscribed capital Under Polish law, public companies are required to have a minimum subscribed capital of PLN500,000 (approx. €131,000 according to the exchange rate on 6 December 2006). There are no statutory limits as to the maximum amount of the share capital (Art. 308 § 1 CCC). b) Authorised capital Under the Polish Commercial Companies Code, the statutes may provide for a minimum or/and maximum share capital to be subscribed by the initial shareholders. The incorporation of the company is effected with the subscription of the shares up to the minimum share capital (Art. 310 § 2 CCC). The subsequent subscription of shares of a company which was already incorporated in this way has the effect of an increase in the company’s share capital. It is the right and the power of the initial shareholders to subscribe the shares. The Commercial Companies Code also provides the possibility of creating authorised capital in the statutes. The legal institution of authorised capital is provided more as a means of increasing the share capital in a company that has already been registered. It is the right and the power of the management board to decide on the increase in the share capital within the thresholds provided for in the statutes, and, upon specific authorisation provided for therein, granted for the period not exceeding three years (Art. 444 CCC). c) Premiums Under the Polish Commercial Companies Code, premiums may be fixed at the stage of formation. Premiums, if any, must be paid in full before the company is registered. (Art. 309 § 2 CCC). Premiums and their amount/value should be already agreed at the stage of signing the notarial deeds on subscription of the shares and the shareholders’ consent to the wording of the statutes. Premiums are regarded as being associated with the contribution to the share capital, in particular with respect to the rule that they may not be returned to shareholders (Art. 344 § 1 CCC). Under the Polish Commercial Companies Code, the creation of reserves out of the earned profits is compulsory – each year at least 8% of the profits earned must be allocated to the compulsory reserve, until the accumulated reserve capital amounts to 1/3 of the registered share capital. Premiums must also be allocated to the compulsory reserve, as well as the premiums paid by shareholders for the granting of shares (Art. 396 § 1- 3 CCC). No additional payments to the capital are provided. In particular, it is not possible under Polish law that shareholders make, in addition to their capital contribution and the share premium, a further payment into equity which is to be placed in the capital reserve.
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d) Other forms of equity contributions The statutes may also provide for the creation of voluntary reserves to cover specific losses. (Art. 396 § 4 CCC). Compulsory and voluntary reserves may be used in accordance with a resolution of the general meeting (Art. 396 § 5 CCC). The reserves up to an amount of 1/3 of the registered share capital may be used only to cover the losses shown in the annual financial statements (Art. 396 § 5 CCC). e) Information to be stated in the statutes The Polish Commercial Companies Code states that the statutes of a public company must determine (Art. 304 § 1 CCC): 1) the amount of share capital and the amount of share capital paid-up before registration, 2) the nominal value and number of shares and whether the shares are registered shares or bearer shares, 3) the number of shares of a given class and the rights attached to them where shares of different classes are to be introduced, 4) the gazette selected for the publication of the company’s announcements, if the company intends to publish announcements in addition to those published in the Official Journal, the “Court and Business Gazette” (Monitor Sądowy i Gospodarczy). According to the Commercial Companies Code, the statutes may also determine the following issues; if not, they will not be binding on the company (Art. 304 § 1 CCC): 1) the number and types of entitlements to participate in the profits or in the distribution of the company’s assets and the rights attached to such, 2) any obligations attached to the shares to provide any services to the company (save for the obligation to make contributions for shares), 3) the terms and procedures for redemption of shares, 4) limitations concerning the transferability of shares, 5) certain rights attributed to individual shareholders, 6) an approximation of all costs incurred or those to be borne by the company in connection with its formation. 2. Subscription of the capital a) Link of stated capital contribution to subscription of shares In Poland, the contribution of the stated capital is linked to the subscription of shares. When subscribing a share, the shareholder has the obligation to pay in the nominal value allotted to the share acquired. b) Time limit In Poland, the company is incorporated at the moment at which all of its shares are subscribed (Art. 310 § 1 CCC). However, the statutes may provide for a minimum or/and a maximum share capital to be subscribed by the initial shareholders. In such a case, the company is incorporated with the subscription of the minimum capital as set in the statutes and after a declaration of the management board that the company was incorporated. The capital amount cannot be less than the prescribed amount of PLN 500,000 (Art. 310 § 2 CCC). The time and amounts of payments/transfer of in kind contributions may be set in the statutes or in resolutions of the shareholders. The general meeting of shareholders may also authorise the management board to set deadlines in this respect (Art. 330 § 2 CCC).
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c) Prohibition of subscription of shares by the company itself It is prohibited to Polish public companies to subscribe for their own shares. The prohibition applies to the subsidiaries and dependant cooperatives. A subscription of the company’s shares by a person acting on his own behalf but for the account of the company is regarded as a subscription on the person’s own account (Art. 366 §1, §2, §4 CCC). The company is prohibited from financing a subscription of its shares except in the normal course of the business of financial institutions (Art. 345 CCC). d) Prohibition of share issues at a price lower than the nominal value/accountable par Polish law prescribes that the minimum nominal value is 1 grosz (1/100 of PLN 1; Art. 308§2 CCC). Shares may not be subscribed for a price below the nominal value (Art. 309 §1 CCC). Only shares of a specific nominal value may be issued. All shares must be equal with respect to the nominal value (Art. 302 CCC). The national legislator has not provided an exception for professional issuers (Article 8 (2)). e) Designs of shares Under Polish law, only shares with nominal value are allowed (Art. 308 § 2 CCC). f) Information to be stated in the statutes The Commercial Companies Code states that the statutes should provide for the number and the nominal value of the shares issued (Art 304 § 1 point 5). g) Premiums Premiums must be paid in full before registration of the company. This applies to the excess of the amount paid over the nominal value of the shares (Art. 309 § 2 CCC). For the case of in kind contributions (as well as in case of purchases of property or remunerations for services rendered in the setting up of the company), the founders must deliver a written report. This report is then subject to examination by an auditor appointed by the court, who should also deliver a report in this respect, and should submit both reports to the registry court. The fact that the report was submitted to the court must be announced in the Official Journal. As the court registration files may be reviewed by anyone (public accessibility to court registration files), the contributions (in the form of in kind contributions) are, in this sense, transparent. Premiums, as any other contributions, should be agreed in the notarial deeds consenting to the incorporation of the company and subscription of shares. The deeds must then be submitted to the court prior to the registration of the company. As the court registration files may be reviewed by anyone, the premiums and other contributions and their value are transparent. 3. Contributions a) Contributions in cash and in kind The Polish legislator allows both contributions in cash and contributions in kind. The law does not provide a definition of what may constitute contributions. The Commercial Companies Code states merely that untransferable rights, work and services are not capable of becoming contributions for share capital of public companies (Art. 14 § 1 CCC). Services rendered in the course of the incorporation of the company do not qualify to constitute a contribution for the subscribed share capital. The specific rules on contributable assets are the result of judgements and legal theory.
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aa) Contributions in cash Under Polish law, contributions in cash may be transferred, directly or with the intervention of an investment firm, to the bank account of the company in the course of formation (Art. 315 CCC). Bills of exchange are not regarded as a form of cash contribution. bb) Contributions in kind Under Polish law, the admissibility of particular assets should be considered by the registry court in each case. There is general agreement both among scholars and in the judgements that the following assets, in particular, are capable of being contributions in kind: • ownership of movables and immovables, a business or part of a business, co-ownership, the right of perpetual usufruct, • intellectual property, know-how, trademarks, • rights under leases of movables and immovables, when the rights are created for the purpose, as well as debentures, shares, a shareholder’s receivables from third persons. Similarly, there is a general consensus among scholars and in the judgements that certain assets are not capable of becoming contributions. These are as follows: • bills of exchange issued by the shareholder for the benefit of the company, • goodwill, when contributed without the enterprise to which it belongs, • rights under leases of movables and immovables, if the right was first acquired by the shareholder and then transferred to the company, • financing arrangements for the company, e.g. bank loan (as it is a kind of service). Services cannot constitute a contribution to pay-up the subscribed share capital (Art. 14 CCC). cc) No release from the shareholders’ obligation Under Polish law, the shareholders may not be released from their obligation to pay up their contributions (Art. 329 § 1 CCC). This is considered as a major rule on capital contribution and maintenance and is intended to ensure that the subscribed capital is actually raised. b) Amount to be paid in The Polish Commercial Companies Code differentiates between contributions in cash and contributions in kind. aa) Contributions in cash The Commercial Companies Code provides that shares subscribed for cash contributions must be paid up to an extent of at least ¼ of their nominal value before registration (Art. 309 § 3 CCC). bb) Contributions in kind Shares subscribed for in kind contributions should be paid-up in full (the contributions should be transferred to the company) not later than 1 year after the company was registered. If shares are subscribed for in kind contributions or mixed in kind contributions and cash contributions, at least ¼ of the prescribed registered share capital of PLN 500,000 must be paid-up of before the registration of the company (Art. 309 § 5 CCC). c) Valuation of contributions in kind The contributions in kind are firstly subject to a valuation by the company's founders, who must deliver a report in this respect. The report should include in particular: a description of 110
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the assets, the number and types of the shares and other rights to participate in the profits or in the company’s assets after its liquidation, the individuals that make the in kind contributions and the method of valuation adopted (Art. 311 § 1 CCC). In case of a contribution of an enterprise, its financial statements for the last 2 years must be attached to the report (Art. 311 § 3 CCC). The founders report is subject to review by an auditor. Only registered auditors may be appointed for this task (Art. 312 § 1 CCC). More than one auditor may be appointed. The Registry Court competent for the registered office of the company appoints the auditor (Art. § 2 CCC). In practice, the company may propose an individual auditor to the court. The auditor delivers his own report and is obliged to comment on the valuation method adopted by the founders. Market value valuation is considered to be acceptable. The valuation method need not be that according to accountancy regulations (Sołtysiński, Kodeks, t.III, p.132, marginal number 12). The Polish Commercial Companies Code does not require that the auditors report be published. However, the company has to announce in the Official Journal, before the company’s entry into the court register (KRS), that the auditors report has been submitted to the registry court. It is not possible to waive the founders report and the report of the auditor appointed by the court. The entire valuation process including the founders’ valuation, the appointment of the auditor by the court, the performance of the auditor’s valuation, the submission of the report to the court and the publication in the Official Journal usually takes not less than 5-6 weeks. d) Further national rules linked to the injection of contributions Apart from those mentioned above under c), Polish law does not impose any further national rules. e) Consequences of incorrect financing Shareholders whose contributions in kind are found not to have the value required to pay for their shares, must be called upon by the company to pay-up their outstanding contributions. Failure to pay-up their outstanding contributions can result in the suspension of the rights attaching to the unpaid shares. However, the company may not annul the unpaid shares if the payment of the rest of the contribution is not made in the time set in the statutes or by the management board (Art. 331 § 1 CCC, Sołtysiński, Komentarz, t. III, pg. 241, marginal number 11, Warszawa 2003). The statutes may provide for other sanctions for the case in question (Art. 14 § 2 CCC). Shareholders whose contributions in kind are found not to have the value required to pay for their shares, (or no value) have to compensate the company for the difference between the value declared in the statutes and the sale value of the asset in question plus interest (Art. 14 § 2 CCC). In certain cases, further compensation may be claimed by the company (Art. 2 CCC in connection with Art. 481 CCC). Founders (and any other person), who knowingly or with fault cause damage to the company (e.g. by contributing overvalued contributions) are liable to the company for damages (Art. 480 §1 and §2 CCC). The liability may be triggered in particular by inserting false data into the founders’ report.
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f) Premiums Premiums should be paid in full before registration of the company (Art. 309 § 2 CCC). g) Liability In practice, it is not often the case that members of the board or founders are held liable for breach of the rules on contributions, mainly because it must be proved in court that the persons in question have acted knowingly or negligently. The liability of shareholders (for outstanding part-contributions and interest but excluding damages) can be established more easily as it is linked directly to the failure to make the contributions properly. h) Prospective implementation of the amendments of the 2nd CLD The amendments of the 2nd CLD by Directive 2006/68/RL have not yet been implemented. No proposals are known. 4. Accounting for formation expenses Under Polish law, no shares may be granted for services rendered during the formation of the Company (“formation expenses”). However, in exchange for those services, quasi-shares i.e. “formation certificates”, may be issued (Art. 355 § 1 CCC). Formation certificates for services rendered may be issued in particular to founders (even if the founders also become shareholders), the first members of the management board, lawyers drafting statutes, persons preparing the business plan etc. (Sołtysiński, Komentarz Komentrz, t. III pg. 398, Warszawa 2003). The depreciation period for the formation expenses may be set up to 10 years. Formation certificates carry the right to participate in the profits of the company, to the extent determined in the statutes, but a minimum dividend to shareholders determined in the statutes must first be deducted for the benefit of the shareholders. The law provides for no limitations as far as the amount of the minimum dividend is concerned (Art. 355 § 2 CCC). There is, however, a limitation that the entire remuneration for services rendered in the course of the formation of the company cannot exceed remuneration customary for such services. The Commercial Companies Code does not regulate the form of the formation certificates. It is argued among scholars that the rules as to the form of the shares should be applied accordingly (Sołtysiński, Komentarz, t.III, pg. 397, Warszawa 2003).
Sub-section 2:
Capital increases
5. Increase in subscribed capital and other forms of equity financing Polish law differentiates between ordinary capital increases and increases by authorised capital. Furthermore, it provides for special forms of capital increases. a) Ordinary capital increase The Polish legislator requires, for an increase in capital, an amendment to the statutes and in consequence a resolution by the shareholders (Art. 431 CCC). The increase in capital may be performed by either issuing new shares or raising the nominal value of the existing shares. In case of issuing new shares, a “subscription contract” is required. The new shares may either be offered (i) to a particular entity (private subscription), (ii) to shareholders who have preemption rights (closed subscription) or (iii) to the publicpre-emption (open subscription). 112
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Because of the above mentioned requirement of amending the statutes, at least a qualified majority of ¾ of the votes is needed (Art. 415 CCC). If different classes of shares exist within the company and the increase in capital is by the issue of new shares which are privileged in the same manner as those already issued, this may reduce the rights (privileges) of holders of already issued, privileged shares. In that case, each class of shareholders should vote separately on the resolution amending the statutes. Within each class of shares, the resolution requires the majority normally required for this kind of resolution (Art. 419 CCC). Under Polish law, no derogations exist with respect to an ordinary increase in subscribed capital. Since the ordinary capital increase requires an amendment to the statutes, it also requires registration in the court and subsequent publication in the Official Journal. b) Authorised capital The statutes may authorise the management board to increase the capital up to a set amount and the board may do this in one or several increases. The shareholders’ resolution amending the statutes in order to authorise the management board requires a ¾ths majority of the votes with at least half of the capital present. If the company is listed, this resolution requires only 1/3rd of the capital present (Art. 445 §1 CCC). The management board may not issue privileged shares (Art. 444 §6 CCC). The maximum amount of the capital increase may not exceed ¾ of the company’s subscribed capital on the day of the authorisation (Art. 444 §3 CCC). The management board is empowered to decide on the authorised capital increase. The maximum period within which the management board may be authorised to increase the capital is 3 (three) years (Art. 444 §1). After that period, another authorisation is needed. The resolution amending the statutes as well as the increase in capital performed by the management board is required to be published in the Official Journal. The shareholders’ resolution on the amendment of the statutes is subject to a notarial recording and must be registered at the register court and then be published. d) Other kinds of increases in capital The Polish Commercial Companies Code provides for special kinds of increases in capital, namely the increases by capitalisation of the reserves and the “conditional increase of capital”. aa) Increases by capitalisation of reserves (see Article 15 (3)) Under Polish law, the shareholders may adopt a resolution increasing the capital by the capitalisation of the reserves from the company’s reserve fund or other funds created from profits if these may be utilised in this way (Article 442). The shareholders’ resolution may be adopted if the annual financial accounts report net profit and the auditor’s opinion does not reveal any important problems relating to the company’s financial situation. If the last financial accounts were issued 6 months or more before the general meeting at which the resolution is to be adopted, new financial accounts prepared by an auditor are required. The shareholders’ resolution on capitalisation of the reserves is an amendment of the statutes and requires a qualified majority of ¾ of the votes, registration at the register court before the publication in the Official Journal. 113
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bb) Conditional increase of capital Under Polish law, the general meeting may adopt a resolution increasing the capital on the condition that the person granted the right to new shares will exercise that right in the manner indicated in the resolution. The nominal value of the conditional increase in capital may not exceed twice the value of the company’s capital at the moment of adopting the resolution. The shares issued in this way must be paid-up in full (Art. 451 §3 CCC). The shareholders’ resolution requires a qualified majority of ¾ths of the votes, registration at the register court and publication in the Official Journal. d) Securities convertible into shares or carrying the right to subscribe shares The resolution of the general meeting may include provisions for the issue of securities convertible into shares or carrying pre-emption rights to subscribe shares (Art. 415 §1 CCC). The resolution requires a qualified majority of ¾ths of the votes, registration at the register court, and publication in the Official Journal. The Company may, for the purposes of increasing its capital by way of authorised capital, issue registered securities or bearer securities entitling the bearer to subscribe or take up shares, excluding the pre-emption right (subscription warrants; Art. 452). In the case of an authorised or conditional increase in capital, the authorisation may include the possibility of issuing not only shares but also securities that are convertible into shares or that carry the right to subscribe shares (Art. 444 §7 CCC). The rights from securities expire on the day of the expiry of the authorisation, at the latest. In that case, the general rules on qualified majority of ¾ths, registration at the register court and publication apply. e) Premiums The capital obtained from shares paid in at a premium price must be transferred to the reserve capital account. 6. Subscription of new shares a) Time limit The subscription may be effected when: • at least the minimal number of shares has been subscribed, • the shares have been paid in properly, • the deadline for subscription has passed (Art. 449 §1 CCC). The subscription of the shares should be finalised within 2 weeks from the deadline set (Art. 439 §1). b) Prohibition of subscriptions of shares by the company itself Under the Polish Commercial Companies Code, public companies may not subscribe their own shares. The prohibition also applies to subsidiaries and dependant cooperatives, although in these case the subscription is deemed to be valid, but the members of the management board are liable jointly and severally with the subscribing entity, any board member to whom no fault is attributable being, however, relieved of liability. All the self-subscribed shares should be sold by the company within one year after the subscription. If they are not sold the management board redeems the shares immediately after the lapse of the said period. The subscription of the company’s shares by persons acting in their own names but on behalf of the company or its subsidiary (dependant cooperatives included) is regarded as subscription on that person’s own account (Art. 366 §1,§2,§4 CCC). Additionally, the CCC (Article 588) provides that whoever, being a member of the management board or liquidator of a 114
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commercial company, allows the company to acquire its own shares or to create a pledge thereon - shall be liable to a fine, a penalty of restriction of liberty or deprivation of liberty of up to six months. c) Prohibition of share issues at a price lower than the nominal value/accountable par The Polish CCC provides that in case of an increase in capital the newly issued shares may not be issued below their nominal value (Article 431 § 7 by reference to Article 309 § 1 CCC). d) Issuance of accountable par shares with the same voting and dividend rights as previously issued shares Under Polish law only shares with a nominal value are allowed, so that this question cannot arise. e) Information to be stated in the statutes The resolution amending the statutes must include the following: - the amount of the increase in the capital, - a statement whether the newly issued shares are registered or bearer shares, - any special rights or privileges resulting from holding the shares, - the date from which the newly issued shares will participate in dividends, - the opening and closing date of the subscription, - the time during which the newly issued shares may be held, - the issue price or an authorisation for the management board or the supervisory council to determine the issue price, - if the shares are issued for contributions in kind –the object of the contribution as well as the number of shares for such contribution and the method of valuing the contribution, must be defined. 7. Contributions, performance of contributions, process of evaluation a) Contributions in cash and in kind Besides the requirement that the asset must be capable of economic assessment as set out in the Second Directive, the Polish CCC in Article 14 provides that the contribution to the capital of the company may only be an asset that is transferable. Services and work may not be considered as contributions (for details see under question 3 a). b) Amount to be paid in The Polish CCC differentiates between contributions in cash and contributions in kind aa) Contributions in cash The Commercial Companies Code provides that ¼ of the nominal value of shares subscribed for cash must be paid-up before registration (Art. 309 § 3 CCC; see also under 3 b) aa)). bb) Contributions in kind Shares subscribed for in kind contributions should be paid-up in full (the contributions should be transferred to the company) not later than 1 year after the company was registered. If shares are subscribed for in kind contributions or mixed in kind and cash contributions, at least ¼ value of the prescribed registered share capital of PLN 500,000 must be paid-up before registration of the company (Art. 309 § 5 CCC; see also under 3 b) bb)).
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b) Valuation of contributions in kind With respect to the valuation of contributions in kind, the principles set out under 3 c) are applicable. According to Art. 502 § 1 CCC, a merger plan (including the value of shares and ratio of exchange of shares) shall be examined by an expert as to its correctness and reliability. In the case of a merger between companies, one of which already holds more than 90% but less than 100% of the other, the merger plan need not be examined. This exception does not apply when the company is a public listed company. The Polish CCC does not avail of the exception at No. 4 of Article 27, Second Directive. d) Incorrect financing If the value of a contribution in kind which was properly subjected to the above mentioned evaluation procedure is, nevertheless, less than the value required to pay for the shares, the statutes may not release the shareholder from his responsibility for that contribution. The shareholder is obliged to indemnify the company for the damage caused. If the shareholder pays less than the value required the company may redeem the shares (Article 14 § 2). e) Premiums or other forms of equity contributions If shares are taken up at a price exceeding the nominal value (premiums), the surplus shall be paid in full before the registration of the company. 8. Pre-emption rights a) Content The Polish Commercial Companies Code grants current shareholders pre-emption rights in proportion to the number of shares held (Art. 433 CCC). Pre-emption rights apply to shares to be subscribed for cash as well as for contributions in kind. The general meeting may, in the interests of the company, exclude the shareholders' pre-emption rights, in part or in whole, by a resolution adopted by a majority of 4/5ths of the votes. A written opinion stating the grounds for the exclusion of the pre-emption rights and a proposed issuing price of the shares or the manner of fixing the price must be presented by the board. Alternatively, the resolution may stipulate that the shares are all to be taken up by a financial institution subject to the duty to subsequently offer the shares to shareholders so that they may exercise the pre-emption right on the terms stated in the resolution. Additionally, a resolution may provide for the new shares to be taken up by the sub-issuer in the event that the shareholders who enjoy the pre-emption right fail to take up some or all of the shares offered. The management board must publish an offer of the new shares to shareholders with preemption rights. The publication should include (as stated in Article 434 § 2 CCC): • the date on which the resolution was adopted, • the amount of the capital increase, • the number, type and nominal value of shares subject to the pre-emption right, • the share issue price, • the rules governing the distribution of shares, • the date, place and the amount of payments for the shares and possible consequences of any failure of the exercise of the pre-emption rights or any failure of the due payment, • the deadline from which the subscriber is no longer bound by the subscription, • the deadline for exercising the pre-emption right, • the time limit for the announcement of the allotment of the shares. 116
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If all shares are registered, the management board may decide not to publish the offer. Instead, all shareholders should be informed by registered letter of the data normally required for publication. If the shares are not taken up (certain shareholders did not exercise their pre-emption rights) within the first time limit set in the publication (this period may not be shorter than 3 weeks from publication), the management board announces the second period (at least 2 weeks) in which the remaining shares may be taken up by the shareholders. b) Withdrawal or reduction of pre-emption rights by the general meeting The Polish CCC, in Article 433 § 2 CCC, provides for the possibility to exclude pre-emption rights by resolution of the general meeting. The resolution of the general meeting must be adopted by a majority of four-fifths of the votes. The management board is obliged to present a written opinion to the general meeting on the justification for such resolution and the proposed issue price or a manner of fixing a price. Under Polish law, transparency obligations do not exist. c) Exclusion or reduction of pre-emption rights by an authorised body The Polish CCC provides for the possibility that the founders/shareholders may authorise the supervisory board to decide on entering into a sub-emission contract with a financial institution. Shares taken up by a financial institution are to be resold to current shareholders (Article 433 § 3 and 5). The resolution/decision is adopted on the motion of the management board after presentation of a report by the supervisory board. The resolution may also state that shares not subscribed by the shareholders may then be subscribed by the financial institution. Under Polish law, the general meeting may not delegate the power to restrict or exclude preemption rights to the management board empowered to decide on the capital increase. d) Securities converted into shares Under Polish law, the provisions referring to the shares shall be equally applicable to issues of securities convertible into shares or incorporating the right to subscribe for shares (Article 433 § 6 CCC). e) Derogations Polish law does not provide for any derogations.
Sub-section 3:
Subsequent formations
9. Subsequent formations a) Content Under Polish law, a subsequent formation refers to instances where a public company intends to acquire an asset from a promoter or shareholder (or if a dependent company or a cooperative acquires assets from a promoter or shareholder of the company (Art. 394 CCC). The provisions relating to subsequent formation are also applicable to acquisitions between a dominant company and promoters and shareholders of the dependent company. The rules on subsequent formation are applied where assets are purchased for a price higher than one tenth of the paid-up initial capital. Acquisition of such assets must be approved by a shareholders’ 117
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resolution adopted by a two-thirds majority of the votes. The above mentioned requirement applies if the acquisition is effective before the lapse of 2 years from registration of the company in the national register court. b) Valuation by an expert The Polish CCC requires a written report of the board that must be presented to the general meeting. The report must be audited by an auditor, and subsequently published and filed with the registration court. c) Shareholder’s resolution A shareholders’ resolution at the general meeting must be adopted by a two-thirds majority of the votes. d) Transparency The announcement of the valuation performed by the auditor must be published. A report must be filed with the registration court. e) Exceptions The said rules do not apply to the acquisition of assets under regulations protecting public order, or in the course of insolvency/bankruptcy, liquidation and enforcement proceedings and to the acquisition of securities and commodities at the regulated price. The provisions do not apply in the normal course of business. f) Consequences of incorrect subsequent formations According to the Polish Commercial Companies Code, the performance of a legal act which requires a resolution of the shareholders or the general meeting is null and void if it was performed without the required resolution (Art. 17 CCC). The consent may be granted before or retroactively - within 2 months - from the date of performing that action by the management board. g) Subsequent formations in practice Subsequent formations are not particularly common in practice.
Section 2:
Capital Maintenance
10. Limitation of distributions a) Principle The Polish Commercial Companies Code prescribes that, throughout the lifetime of a company, no full or partial refund of any contributions paid for shares may be made to the shareholder (Art. 344 § 1 CCC). The Polish CCC provides further that shareholders may not receive interest on their contributions or their shares held. Jurisprudence considers “interest” to be any form of periodical pecuniary benefits being a percentage of the subscribed capital (Art. 346 CCC). The prohibition on refund of contribution should be understood in a broader sense, so that no payment out of the company’s funds other than dividends (or exceptionally under specific legal regulations) is possible. Shareholders are entitled to participate in the profit shown in the financial statements examined by the auditor and allocated by the general meeting to be paid to shareholders (Art. 347 § 1 CCC). Any economic transaction between the company and the shareholder on terms 118
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the company would not have agreed to when dealing with an unrelated third party, may be regarded as a prohibited repayment of contribution. b) Sanctions Shareholders who received, contrary to the law or provisions of the company’s statues, any benefits from the company must return the same (Art. 350 CCC). Members of the management board and the supervisory board, who have approved the payments are jointly and severally liable with the person who has received the returned capital. 11. Acquisition of the company’s own shares a) Possibility of the company acquiring its own shares In Poland, the principle is that the company shall not acquire shares it has issued (its own shares; Art. 363 § 1 CCC). The Polish CCC provides for the following exceptions: 1) acquisitions of shares with the object of preventing major damage with which the company is directly threatened, 2) acquisitions of shares to be offered to employees or persons who were employed in the company or its related companies for no less than three years, 2a) cases in which public companies acquire shares in order to comply with obligations resulting from warrants convertible into shares, 3) acquisitions of shares by universal succession, 4) cases in which a financial institution which, for a consideration, acquires fully paid-up shares for another's account for re-sale, 5) acquisitions of shares to be redeemed, 6) acquisitions of fully paid-up shares by execution, to satisfy such claims of the company which cannot be otherwise satisfied from the shareholder's estate, 7) gratuitous acquisitions of fully paid-up shares, 8) cases in which a financial institution acquires shares for its own account with the object of reselling them within the limits of an authorisation granted by the general meeting for a period no longer than one year; however, the financial institution may not hold shares so acquired the total nominal value of which exceeds 5 % of the initial capital, 9) acquisitions of shares in other circumstances provided for in the Act. The prohibition on the company acquiring its own shares also applies to the acquisition of a dominant company's shares by its dependent companies or cooperatives. The prohibition also applies to persons acting for the account of a dependent company or cooperative. b) Conditions regarding acquisition of the company’s own shares There are further limitations, as far as the points 1) 2) and 8) above are concerned. In said cases, shares may be acquired only if: - the shares to be acquired are fully paid-up, 119
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the total nominal value does not exceed 10% of the registered capital, the total purchase price and purchase costs are not higher than capital distributable as dividends. Shares acquired against the law should be resold within 1 year. Shares acquired lawfully but in excess of the 10% of the registered capital should be resold within 2 years. If not, the management board should redeem the shares. Polish law provides that the acquisition of the company’s own shares to be offered to employees (case point 2 above) or the authorisation to do so requires a resolution of the general meeting. At least an absolute majority of votes is required. If the management board decides to act without the consent of the general meeting, then this act will be null and void if the general meeting does not retroactively ratify the acquisition within 2 months. In the case of acquisitions of the company’s own shares acquired to prevent major damage, the management board should report the circumstances of the acquisition to the next general meeting. The management board should report the acquisition of the acquired shares (and any such acquisition for the account of the company) to the general meeting . d) Shares acquired in contravention of the legal rule Shares not sold within the provided timeframe must be redeemed by decision of the management board. e) Holding of shares If the company holds its own shares, it is not allowed to exercise the participation and voting rights attached to those shares, except for the power to transfer the same or to perform acts conducive to preserving such rights (Article 364 §2). Furthermore, it is necessary in this case that the shares are shown in the balance sheet as a separate liability. At the same time, the reserve capital shall be reduced and the supplementary capital shall be increased correspondingly (Art. 363 §6 CCC). The annual report to the general meeting should include the following issues (Article 363 §2): • • • •
a statement of the grounds for the acquisition of the company's own shares in the relevant financial year, the number and nominal value of the shares acquired or transferred in the financial year and their percentage share in the subscribed capital, where the acquisition or transfer is for a consideration, the price obtained or the value of other reciprocal benefits, the number and nominal value of the shares acquired and held, and their percentage share in the subscribed capital.
f) Acceptance by the company of its own shares as security The provisions covering the acquisition of the company’s own shares are also applicable to pledges of shares. However, this does not apply with respect to financial institutions, if the creation of the pledge over the shares is in connection with the financial institution’s normal business (Art. 362 §3). g) Application of Article 24a if exceptions have not been availed of by the Member State In Poland, the exceptions in Article 24a of the 2nd CLD have not been implemented.
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h) Reselling of own shares (equal treatment) The general rule that shareholders shall be treated equal in the same circumstances is applicable under Polish law. i) Prospective implementation of the amendments of the 2nd CLD The recent amendments to the second directive have not been implemented into national law. At the present time, no legislative proposals to implement the said amendments are known. 12. Prohibition of financial assistance Currently, the Polish Commercial Companies Code provides that a company may not make loans, provide security, advance payments or in any other manner, directly or indirectly finance the acquisition or taking-up of its own shares (Art. 345 CCC). This does not, however, apply to transactions in the ordinary course of business of financial institutions or share issues to employees of the company or of an associated company provided that a reserve capital was previously created for this purpose. Prospective implementation of the amendments of the 2nd CLD There are currently no proposals for the implementation of the amendments to the second directive. 13. Loans from shareholders Under Polish law, a loan from a shareholder is considered as a contribution to the company’s capital if the company is declared insolvent within 2 years from the date of conclusion of the agreement for the loan (Article 14 §3 CCC). If such a situation occurs, the shareholder’s claim for repayment may only be satisfied after the other creditors are satisfied. A shareholder may not set off any claim against the company against the receivable of the company resulting from non-payment of the share capital. However, this does not preclude a contractual set-off in cases other than the above mentioned. Loans from shareholders are common practice in small companies and wholly owned companies having their parent company abroad. 14. Capital reductions a) Ordinary capital reduction The Polish Commercial Companies Code provides for the possibility of an ordinary reduction in capital. The invitation to the general meeting must state the purpose, amount and the method of the reduction of capital (Art. 455 §2 CCC). Furthermore, every notice shall state the date, time and venue of the general meeting and a detailed agenda. In the event of a proposed amendment of the company's statutes, the provisions applicable shall be cited as well as the content of the proposed amendments. Where the scope of the proposed amendments is extensive, the announcement may include a draft of the entire new text of the company's statutes with an enumeration of new or amended provisions thereof. The minimum required for the resolution is a ¾ths majority of the votes. In certain cases (“automatic” redemption of shares, redemption of shares acquired by the company and not sold within 2 years – see answers to questions 16 and 17 for details), the management board is empowered to adopt such a resolution. If different classes of shares exist within the company, 121
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any resolution on a reduction in capital that may infringe rights of holders of certain classes of shares must be adopted by resolutions of the different classes of shareholders. The management board has to announce the intended capital reduction, requesting the creditors of the company to raise their objections within three months from the date of the announcement in the event that they should be against the reduction.(Art. 456 §1). Creditors of the company that raise their objections within the prescribed time must be satisfied (if the claims are due), or secured. The creditors who fail to raise their objections are deemed to have agreed to the intended capital reduction. Shareholder’s claims raised during the procedure of the reduction in capital shall be satisfied after 6 months from the announcement of registering the capital reduction in the national register. A reduction to an amount less than that prescribed in Article 6 of the Polish Commercial Companies Code is not possible. Article 455 § 4 CCC provides that the maximum reduction of capital is limited by the minimum capital of the company as prescribed in Article 308 (500,000 PLN). b) Exceptions The Polish Commercial Companies Code provides for the following exceptions to the above mentioned procedure (Art. 457 CCC): a) Although the capital is reduced, shareholders’ contributions for shares are not returned to shareholders, and shareholders are not released from the duty to make contributions to the initial capital and at the same time the capital is increased at least to its initial value, or b) the capital reduction is effected with the object of covering losses suffered or transferring certain amounts of capital to the reserve capital, or c) the capital reduction is effected in the case of a redemption of shares which were acquired by the company and not sold within the timeframe provided by the Polish CCC (2 years). c) Prospective implementation of the amendments of the 2nd CLD The provisions laid down in Article 32 have not yet been implemented in the Polish Commercial Companies Code. Article 455 governing this issue does not contain any conditions for the exercise of creditor’s rights. The judgements maintain the position that if the claim is “due and not contentious”, the company should satisfy this claim. Otherwise, it is only obliged to secure the claim. There is no common opinion in the judgements whether an already secured claim should be secured in any additional way. 15. Redemption of the subscribed capital Polish law does not provide for the possibility to redeem subscribed capital without reducing the latter. 16. Compulsory withdrawal of shares The Polish legislator used the member state option in the 2nd CLD. The Polish Commercial Companies Code provides for the compulsory redemption of shares (i.e. without the shareholder's consent; Art. 359 § 1 CCC). Shares may be redeemed in this way only if the company's statutes so provide.
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a) Conditions Under Polish law, the statutes of the company must provide for such an opportunity, as well as for the grounds and the procedure thereof. The redemption of the shares requires a resolution of the general meeting. The resolution has to state, in particular, the legal grounds for the redemption, the compensation and the manner of reducing the initial capital. A compulsory redemption is subject to compensation (Art. 359 §2 CCC). The resolution on the redemption of the shares must be adopted by a majority of 3/4ths of the votes. Where at least half of the capital is represented at the general meeting, a simple majority of votes is sufficient. The company's statutes may set more rigorous requirements. The resolution shall follow the terms and manner previously fixed in the statutes. The resolution on the redemption must be published (Art. 359 §3 CCC). Furthermore, it should be noted that, under Polish law, the derogation from Article 41 (2) of the 2nd CLD has not been implemented. Article 363 §5 CCC stipulates that the company's shares acquired by the company itself and not sold within the timeframe provided in the Commercial Companies Code are subject to redemption by the authority of the management board without the need of a resolution of the general meeting. This method of redemption does not need to be provided for in the statutes. 17. Redeemable shares The Polish legislator did not use the possibility of the 2nd CLD to allow public companies to issue redeemable shares.
Section 3:
Dividends and distributions
18. Definition of Distribution Under Polish company law, the term “distribution” is not defined, either positively or by stating which transactions are not distributions. 19. Distributable amount a) Balance sheet net asset test / earned surplus test aa) Balance sheet net assets test In Poland, the contributions may not be returned to shareholders. Moreover, before any distributions are made, the uncovered losses must be recovered. Distributions may not, therefore, reduce the company’s nominal (registered) share capital. Premiums may not be paid out as dividends. In addition to the above, distributions may not be paid out before the compulsory reserve and other reserves – to be accumulated out of the net profit – are covered as and insofar as provided in the statutes (Art. 347 § 1 CCC, Art. 348 § 1 CCC). General Polish rules on accounting, contained in the Act on Accounting and in conformity with IFRS, must be observed. As a rule, dividends are payable under a decision of the general meeting. The statutes may authorise the management board to pay shareholders advances on account of the expected 123
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end-of-financial-year dividend (see below). The payment of the advances is not at the sole discretion of the board, as advances are subject to the approval of the supervisory board (Art. 349 § 1 CCC). Interim dividends (see below) may be paid under a decision of the management board accepted by the supervisory board. The Polish legislator did not use the possibility of the second CLD to provide for derogations from the balance sheet net asset test in case of investment companies with fixed capital. bb) Earned surplus test In Poland, the amount to be distributed to shareholders shall not exceed profits for the last financial year increased by undistributed profits from previous years and by such amounts transferred from the supplementary capital and reserve capital created out of profit which may be paid as a dividend. This amount shall be reduced by uncovered losses, the company’s own shares held, and sums which, under the Act or under the company’s statutes have to be allocated out of the last financial year’s profit to the supplementary capital or reserve capital (Art. 348 § 1 CCC). General Polish rules on accounting, contained in the Act on Accounting and conforming with IFRS, must be observed b) Interim dividends Should the statutes so provide and if the supervisory board grants its consent, advances on expected dividends may be paid to the shareholders by the management board, if the approved financial statements of the company indicates a profit. The advances may not be higher than ½ of the profit gained since the end of the last financial year plus the reserve capital created from profits. This amount has to be reduced by uncovered losses and the company’s own shares held by it (Art. 349 CCC). c) Premiums Like any other contributions for subscribed shares, premiums may not be distributed to shareholders. c) Incorrect distributions See. aa) and bb) above – discretion of the board. d) Liability According to Article 350 of the Polish CCC, shareholders who have received, in violation of provisions of the law or the company’s statutes, any benefits (including any form of distributions) from the company are obliged to return the same. The exception to this general rule is a case where the shareholder receives a share of profit in good faith. Management and supervisory board members responsible for this unlawful benefit are jointly and severally liable with the recipient of the benefit. This regulation may not be changed by provisions of the company’s statutes or a resolution of the general meeting. The company may demand that the unlawful benefit received by the shareholder is returned to the company. If it is impossible to return the benefit in its natural form, then the company may demand its cash equivalent. In the above context, the term “benefit” should be understood in a broader sense including dividends, payment of interest on contributions or shares held, as well as any other payments or provision of services. This is a change from the former Act on Commercial Companies where only “payments” to shareholders were forbidden.
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Should the shareholder collect dividends or advances on dividends in good faith, then he/she is exempted from liability. Good faith of the shareholder does not change the scope of liability of board members. The liability of board members responsible for the unlawful benefit is not based on fault. The good faith of the shareholder should be assessed in accordance with the state of knowledge/awareness at the moment of dividend distribution. The judgements hold that if the dividend is paid in breach of the provisions of the company’s statutes, then the shareholder should not be regarded as acting in good faith. The management board is responsible for bringing the suit against the recipient of the unlawful distribution. If the suit is filed against a board member as jointly and severally liable for this benefit with its recipient, then the company is represented by the supervisory board or a proxy appointed by the general meeting. Suits relating to the unlawful benefit/incorrect distribution may be filed within 3 years from the day the unlawful benefit was granted or the unlawful distribution took place. Should the recipient receiving the benefit have known that the benefit was unlawful, then the claim may be filed within 10 years. 20. Determination of the distributable amount a) Proposal by the company’s bodies The proposal concerning distributions has to be proposed by the management board. The proposals are subject to the opinion of the supervisory board (Art. 382 § 3 CCC). The general meeting is, in any case, competent to decide on the distribution of profit and may not accept the proposals and resolve solely upon its discretion. The law provides no detailed requirement as to the content of the management board’s proposal. b) Authorisation by the general meeting The decision on distributions must have the form of a resolution, and should be adopted at the annual general meeting (Art. 395 § 2 CCC). The resolution has to state at least the amounts which have to be used to cover the losses, which amounts are allocated and what reserves and what amounts are subject to distribution. Only those shareholders are entitled to receive a dividend who were shareholders of record on the date of the declaration of the distribution. The company statutes may vest in the general meeting the power to fix the day on which the list of shareholders entitled to dividends for a given financial year is established (the dividend day). The dividend day shall be fixed no later than within two months from adopting the resolution referred to in Article 347, paragraph 1. A resolution altering the dividend day shall be adopted at an annual general meeting . The annual general meeting of a public company shall fix the dividend day and the dividend disbursement time. The dividend day may be set as the day on which the resolution was adopted, or as any other day within the consecutive three months thereafter (Art. 348 § 2 and § 3 CCC). The dividend resolution requires more than half of the votes cast and there are no limitations regarding a quorum. c) Publication Annual financial statements and resolutions approving financial statements, auditor’s opinion, resolutions on distribution of profit or coverage of loss, and report of activities of the company have to be submitted to the court within 15 days from the approval of the financial statement (Article 69 point 1 of the Accounting Act). The management board should publish the introduction to the financial statement, balance sheet, profit and loss account, cash flow 125
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report, and report on changes in capital within 15 days from approval of the financial statements (Article 70 point 1 of Accounting Act). d) Challenge to resolution A resolution that is contrary to the company statutes or good practice and prejudicial to interests of the company or intended to harm a shareholder may be appealed by an action to set aside the resolution brought against the company (Art. 422 §1 CCC). Resolutions made contrary to the law may be challenged on the grounds that they are null and void (Art. 425 §1 CCC). Actions setting aside resolutions and for establishing the nullity of resolutions may be brought by: 1) the management board, the supervisory board and individual members of these bodies, 2) any shareholder who voted against the resolution and, upon the resolution being adopted, demanded that his objection be put on record; the voting requirement shall not apply to the shareholder holding a non-voting share, 3) any shareholder who was unduly prevented from participating in the general meeting, 4) any shareholders who were absent from the general meeting, only in the event that the general meeting had been improperly summoned or the resolution was adopted on a matter not included in the agenda (Art. 422 § 2 CCC). e) Challenge to distribution in practice Court cases on distributions are rare and not yet discussed in public in Poland. However, taking into account the rapid development of financial markets in Poland, it is probable that in the near future this situation will change. 21. Accounting reserves that influence the distributable amount Accounting reserves must be set up for: 1. future liabilities the occurrence of which is beyond doubt or very likely to occur, in the amount that may be reliably estimated, in particular in relation to losses from commercial transactions in progress, in particular guarantees given, results of court proceedings , 2. future liabilities in relation to restructuring, subject to separate regulations. (Art. 35d sec.1 of Act on Accountancy.) The reserve amounts count against distributable amounts until they can be regarded as unnecessary. No revaluation accounting reserves can be set up in respect to fixed assets. No reserves can be set up for formation expenses. (However, such reserves may be formed out of the net profit). Specific regulations on reserves are provided for certain categories of companies, such as certain financial institutions (i.e. insurance companies (Art. 38.1 Act on Accounting).
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Section 4:
Capital-related rules in case of crisis and insolvency
22. Serious loss of the subscribed capital a) Calling of general meeting Where the balance sheet prepared by the management board shows a loss in excess of the sum total of the compulsory and voluntary reserves, and one third of the registered capital, the management board shall call a general meeting with the object of adopting a resolution on the continuation of the existence of the company (Art. 397 CCC). A separate notification of the loss does not have to be published. However, the calling of the general meeting should include its agenda i.e. that a resolution on the continuation of the existence of the company is required by the law due to the amount of losses incurred by the company. The invitation to the general meeting (published in the Official Journal/in other medium required by the company’s statutes) is not required if all shares are registered shares. b) Consequences The general meeting must adopt a resolution in respect of the continuation of the company or a resolution winding-up of the company. Failure to call the general meeting can lead to civil liability (Art. 483 § 1 CCC) and/or penal liability of the management board (Art. 549 § 1 and § 4 CCC) and may give grounds for dismissal of the board. 23. Trigger of insolvency a) Factors triggering insolvency According to the Polish Insolvency and Rehabilitation Act (IRL), bankruptcy proceedings are initiated in respect of a debtor (including a legal entity) that has become insolvent, i.e. that is not able to fulfill its current and due liabilities (Art. 10 IRL). This is particularly the case when - liabilities of the company exceed its assets, - while the debtor has reasonable assets, due to inadequate cash flow cannot pay its current debts. A presumption exists that if the liabilities of a company exceed the value of its property, the company is deemed to be insolvent (Art. 11 IRL). In case of minor or temporary difficulties in meeting liabilities or non-material indebtedness (i.e. when the period for which the company is late in payment of debts does not exceed 3 months and the amount of due liabilities does not exceed 10% of net assets), the court may refuse to declare bankruptcy (Art. 12 IRL). There are two kinds of proceedings in case of insolvency: liquidation (when the company is liquidated) or arrangement (when its operation is supervised by the court and creditors and special arrangement with creditors must to be made). The latter may be taken into consideration when the probability of satisfying the creditors is higher than in the case of liquidation. b)Time frame The reasons for insolvency are of an objective nature and shall be evaluated by the person obliged to file a proper petition to the court (the company management, see below) or a person entitled to do so (creditor). The circumstances are examined by the court. c) Duties of the board members The petition may be filed by the debtor or its creditors. When the company becomes insolvent, the duty of each and every member of the management board is to file the petition
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(Art. 20 IRL). The petition for a declaration of bankruptcy shall be filed within two weeks from the moment the company became insolvent (Art. 21 IRL). d) Treatment of subscribed capital, premiums, shareholder loans The judge during the insolvency proceedings draws up a separate list of creditors being the shareholders of the company (Art. 278 IRL). A loan from a shareholder is considered a contribution to the company’s capital if the company is declared insolvent within 2 years from the date of conclusion of the loan agreement (Art. 14 §3 CCC).
Section 5:
Contractual self protection of creditors
24. Contractual self protection Contractual limitations in this respect could be considered as between shareholders and creditors or between the company itself and creditors. As the board represents the company vis-à-vis the creditors, and the meeting of shareholders decides upon the dividend, any of such contractual obligations (limitations) would have to be made by the board as in the competent body. There are no obstacles to a shareholders’ agreement suspending payment of the dividend. In case of such contracts, especially in the case of public companies, it must be considered whether the legitimate rights of minority shareholders are not violated, so that their consent would be required. There is no data as to whether it is common in Poland to conclude such contracts.
Section 6:
Equal treatment
25. Principle of Equal treatment a) Principle of equal treatment The Polish Commercial Companies Code provides for a general rule of equal treatment of shareholders in the same position (Art. 20 CCC). b) Right to vote In general, one share gives the right to one vote. However, the statutes can provide for the issuance of inscribed shares with the right to two votes (Art. 352 CCC). If provided in the statutes, non-voting shares may be issued. Non-voting shares must be privileged in respect of dividends (Art. 353 § 3 CCC). c) Pre-emption right Shareholders have the right of priority to take up new shares in proportion to the number of shares held (pre-emption right). The general meeting may, however, in the interests of the company, deprive shareholders of their pre-emption right, in part or in whole. The resolution of the general meeting in this respect must be adopted by a majority of 4/5ths of the votes. d) Right to receive dividends In general, each share gives the right to equal participation in the dividend. If provided in the statutes, inscribed shares may be granted no more than 1.5 of the regular share participation. Non-voting shares may have a preferential right to dividends and the right to receive arrears of dividends, if not received or not received in full in the past years (Art. 128
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353 § 3 and § 4 CCC). e) Right to attend the general meeting Each shareholder has the right to attend the general meeting . The date of the meeting should be announced three weeks before the scheduled date. Withdrawal of the right to attend the meeting may give grounds to challenge resolutions adopted at the meeting (Art. 422 CCC and Art. 425 CCC).
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3.1.4 Sweden Section 1: Capital formation Sub-section 1:
Formation of the public company
1. Minimum capital and other means of equity financing a) The level of minimum subscribed capital, the possibility of fixing a higher subscribed capital Under the Swedish Companies Act (Aktiebolagslagen, SFS 2005:551 “ABL”), public companies are required to have a minimum subscribed capital of 500,000 SEK (approx 50,000 €) (Ch. 1 Sec. 14 ABL). The founders are entitled to prescribe a higher capital amount. Private companies are required to have a minimum subscribed capital of 100,000 SEK (which equals about €10,000) (Ch. 1 Sec. 5 ABL). The founders are entitled to prescribe a higher capital amount. b) The possibility of fixing authorised capital in the statutes. The statutes shall state the share capital or, where such may be determined at a lower or higher amount without an alteration of the statutes, the minimum share capital and maximum share capital, the minimum share capital being not less than one-fourth of the maximum share capital (Ch. 3 Sec. 1 ABL). c) The possibility of fixing premiums and, if this is permitted, the treatment of premiums. Payment for a share may not be less than the share's quotient value (Ch. 2 Sec. 15). For example, if the founders have decided that the company's share capital shall be 100,000 SEK and there are 1,000 shares in the company, payment for each share must thus be not less than 100 SEK. On the other hand, there is nothing to prevent the shares being issued at a premium, i.e. in exchange for payment which exceeds the shares' quotient value. In such case, the part of the payment for the shares which corresponds to the quotient value will constitute the company's share capital while the premium will be reported as unrestricted equity under the heading Share Premium Reserve (Ch. 3 Sec. 5a of the Annual Reports Act). d) Other forms of equity contribution that exist under national law. Payment for the subscribed shares must take place in cash or through non-cash consideration (Ch. 2 Sec. 16). Set-off is not permitted in conjunction with formation of a company. e) The necessary information that must be laid down in the statutes. The obligatory information in the statutes includes e.g. the share capital. This may be stated either as a fixed share capital or as a range with a minimum and a maximum share capital. The maximum capital may not exceed four times the minimum capital. By indicating a range, the share capital can be increased or decreased within the range without the need to alter the statutes. In addition, the statutes must state the number of shares in the company. If the share capital is stated as a fixed share capital, the number of shares must also be stated as a fixed number. If, for example, the statutes state a share capital of SEK 200,000.00, the number of shares may 130
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be stated as, for example, 2,000. If the share capital is stated as a range, e.g. SEK 100,000 – 400,000, the number of shares can also be stated as a range, e.g. 1,000 – 4,000 shares. When the company is formed, the quotient between the share capital and the number of shares must be identical at both ends of the range. In the example, the quotient is 100 (100,000/1,000 and 400,000/4,000). (Ch. 3 Sec. 1) 2. Subscription of shares a) Link of stated capital’s injection with subscription for shares The company may be registered in the Companies Registry only when full and acceptable payment (the quotient value as well as the premium) has been made for all shares (Ch. 2 Sec. 23 ABL). b) Requirement to subscribe for shares All shares have to be subscribed before the company may be registered (Ch. 2 Sec. 23 ABL). The subscription for shares shall take place in the memorandum of association. c) Prohibition that shares may be subscribed by the company itself. A Swedish company may not subscribe for its own shares. In the case that shares are subscribed for in violation of this prohibition, the board of directors and the managing director shall, as a rule, be deemed to have subscribed for the shares on their own behalf and shall be jointly and severally liable for payment. (Ch. 19 Sec. 1 ABL) Subsidiaries may not subscribe for shares in the parent company (Ch. 19 Sec. 2 ABL). d) The principle that shares may not be issued at a price lower than the nominal value. Shares may not, as a rule, be issued at a price lower than their quotient value (Ch. 2 Sec. 5 ABL). There is no exception for professional issuers. Listed companies may, under certain circumstances, issue shares at a price lower than the shares quotient value. e) Designs of shares possible under your national law. The concept of nominal value was abolished in the Swedish Companies Act that took effect on January 1, 2006. The design of shares is now limited to quotient value, meaning that every share represents the same fraction of the subscribed capital. f) Necessary information to be fixed in the statutes The memorandum of association must contain the amount of the subscribed capital paid-up (subscription price) (Ch. 2 Sec. 5 ABL). Where appropriate, whether the subscription has been paid in cash or in property other than cash shall be stated (Ch. 2 Sec. 5 ABL). The statutes shall state the share capital and the number of shares (Ch. 3 Sec. 1 ABL). g) Rules and principles concerning the injection of premiums in the sense of the Directive. Premiums are disclosed in the financial statements (Ch. 3 Sec. 5a Annual Reports Act).
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3. Contributions, injection of contributions, valuation process a) Contributions in cash, contributions in kind, different modalities and different forms The Swedish Companies Act allows contributions in cash and contributions in kind (Ch. 2 Sec. 19 ABL). Where the subscribed capital is contributed in kind, it must be provided for in the statutes (Ch. 2 Sec. 5 and 16 ABL). aa) Contributions in cash In the event of a cash issue, payment must take place in cash through deposit on a special account opened by the company at a bank, credit market undertaking or equivalent foreign credit institution in a state within the EEA. Amounts deposited on the account may not be withdrawn until the entire amount to be paid in cash has been deposited and the memorandum of association has been signed by all founders (Ch. 2 Sec. 17 ABL). bb) Contributions in kind In the event of non-cash consideration, payment shall take place through the property being separated and included in the company's property (Ch. 2 Sec 18 ABL). Contributions in kind need to be assets capable of economic assessment. Only property which is or may be assumed to be of value for the operations of the company may constitute property other than cash (Ch. 2 Sec. 6 ABL). An undertaking to perform work or services may not be equated with non-cash consideration (Ch. 2 Sec. 6 ABL). Furthermore, the value of non-cash consideration may not be set higher than the actual value to the company (Ch. 2 Sec. 6). The memorandum of association shall state - in respect to contributions in kind - the manner in which the value of the non-cash consideration has been determined and the legal and economic circumstances taken into account in conjunction with the valuation. The name, personal ID number or company number and domicile of the person referred to in a provision shall be stated specifically as well as the value of the non-cash consideration which is expected to be reported in the balance sheet and the number of shares in the company or other compensation to be provided in exchange for the non-cash consideration. (Ch. 2 Sec. 7 ABL). cc) No release from the shareholder’s obligation to contribute to the subscribed capital The founders cannot be released from their obligation to pay up their contributions. b) Amount to be paid in In respect to the amounts to be paid in on contributions at the time the company is incorporated, the Swedish Companies Act does not differentiate between contributions in cash and contributions in kind. A company may be registered only where full and acceptable payment has been made for all subscribed shares. aa) Contributions in cash Swedish law requires that contributions in cash are to be paid to the full quotient value (Ch. 2 Sec. 15 ABL). bb) Contributions in kind Swedish law requires that contributions in kind are to be separated and included in the company’s assets (Ch. 2 Sec. 18 ABL).
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c) Valuation of contributions in kind – valuation process, valuation methods, average time of evaluation. Where shares are issued for a consideration other than in cash, Swedish law requires that a report on the consideration other than in cash is drawn up by an independent expert before the company is incorporated. An auditor shall provide a written, signed statement in respect of the payment (Ch. 2 Sec. 19 ABL). An auditor shall be any authorised public accountant or approved public accountant or a registered accounting firm (Ch. 2 Sec. 19 ABL). The Swedish Companies Act contains provisions prescribing the contents of the statement. The statement should be registered with the Companies Register (Ch. 2 Sec. 23 ABL). The Swedish Companies Act does not prescribe which methods of valuation are allowed. However, the auditor shall describe the non-cash consideration and state the method of valuation and also any special difficulties associated with the estimation of the value of the property. The value of non-cash consideration may not be set higher than the actual value to the company. d) Further national rules linked to the injection of contributions Under Swedish law, the expert report shall state that (Ch. 2 Sec. 19 ABL): • All non-cash consideration has been conveyed to the company, • The non-cash consideration is (may be assumed to be) of benefit for the company’s operations, • The non-cash consideration has not been reported in the memorandum of association at a higher value than the actual value for the company, • Obligations which, pursuant to the terms of the memorandum of association, are to be performed by the company following the formation have been reported and valued in accordance with generally accepted accounting principles, • The non-cash-consideration and the valuation method used. e) Consequences of incorrect financing As a consequence of incorrect financing, the company will not be registered and the formation of the company lapses (Ch. 2 Sec. 24 ABL). The amounts paid for subscribed shares as well as accrued income thereon, less costs incurred as a consequence of measures take, shall be repaid immediately. This shall also apply to non-cash consideration. f) Treatment of premiums under the national law - paying in. Any premium has to be accounted for as share premium reserve and disclosed in financial statements (Ch. 3 Sec. 5a Annual Reports Act). g) Liability The founders and the members of the board of directors shall be jointly and severally liable for such repayment (Ch. 2 Sec. 24 ABL). h) (Prospective) implementation of the amendments of the 2nd CLD The amendments of the 2nd CLD by Directive 2006/68/EC are still in the process of implementation.
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4. Accounting for formation expenses a) The Possibility of capitalising formation expenses Swedish law (Ch. 2 Sec. 8 ABL) only requires that the memorandum of association shall contain information regarding the maximum estimated amount of the costs for the company’s formation which, pursuant to the memorandum of association, are to be paid by the company. Information regarding the costs need not be provided where no costs, other than public fees and customary costs for the preparation of memorandum and similar work, are incurred with respect to the company’s formation. If the company is a public company, all costs regardless of their nature need to be described in the memorandum of association (Ch. 2 Sec. 28 ABL). b) Definition of formation expenses, time period for depreciation, restriction of profit distribution, information in the notes. Swedish law has no regulations other than described regarding formation expenses.
Sub-section 2:
Capital increases
5. Increase in subscribed capital and other forms of equity financing A Swedish limited company can increase its share capital through bonus issues and new issues. With respect to both types of increase in share capital, the share capital may not be increased in a way which violates the statutes. Thus, the Companies Act prescribes that the statutes must be altered before a resolution is adopted regarding an issue, if the resolution is not compatible with the statutes. If the share capital in the statutes is stated as a fixed amount, a resolution to increase the share capital cannot be adopted unless the statutes are altered at the same time. This is also the case if the statutes state a minimum and a maximum share capital and the increase results in the maximum capital being exceeded. If there is more than one class of shares in the company, an issue resolution may not result in the maximum number, or the maximum portion, of shares of a particular class as prescribed in the statutes being exceeded. See Chapter 11, section 2. a) Ordinary capital increase In the event of a new issue against payment in cash or by set-off, the shareholders have preemption rights to new shares pro rata to the number of shares held previously (Ch. 13 Sec. 1). Thus, the shareholders are entitled to subscribe for, and be allotted, shares in the issue pro rata to their previous shareholdings. As a main rule, a resolution regarding a new issue is adopted by the general meeting (Ch. 11 Sec. 2). Where the shareholders have pre-emption rights to subscribe for new shares, a simple majority is normally sufficient to adopt a resolution regarding a new issue. Thus, the resolution must be supported by shareholders with more than half of the votes cast. If the issue resolution requires an alteration of the statutes, the qualified majority requirements applicable to a resolution regarding such alterations must be observed (two thirds of the votes cast and shares represented at the meeting). This is also the case if the general meeting decides to derogate from the shareholders' pre-emption rights and carry out a private 134
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placement; in that case too the resolution must be supported by shareholders representing two thirds of the votes cast and shares represented at the meeting (Ch. 13 Sec. 2). The Swedish legislator has not made use of the option laid down in Art. 41 (1) of the 2nd CLD which allows member states to depart from the requirement of a shareholders’ resolution to increase the capital to the extent that it is necessary for the adoption or application of provisions designed to encourage the participation of employees in the capital of undertakings. b) Authorised capital If the statutes state a minimum and maximum share capital, the board of directors can decide on a new issue based on advance authorisation provided by the general meeting. Such authorisation, which is often granted at the annual general meeting, may not extend for a period of time beyond the next annual general meeting (Ch. 13 Sec. 31 – 34 and 34 – 38). c) Other kinds of capital increase that exist under national law cc) Bonus issue A bonus issue means that the share capital is increased through the contribution of an amount which is taken from the statutory reserve, the revaluation reserve or unrestricted equity in accordance with the most recently adopted balance sheet or through the value of a fixed asset being written-up (Ch. 11 Sec. 1 and Ch. 12 Sec 1). The share capital increases without an external contribution of capital. A bonus issue may take place with or without new shares being issued (Ch. 12 Sec 1 ABL). In the former case, the new shares are allotted between the existing shareholders. In the latter case, the increase gives rise only to an increase in the shares' quotient value. In the event of a bonus issue in which new shares are to be issued, the shareholders have an unconditional right to such shares pro rata to the number of shares previously held (Ch. 12 Sec 2 ABL). A resolution regarding a bonus issue must always be adopted by the general meeting (Ch. 11 Sec 2 ABL). The resolution is adopted by simple majority of the votes cast. d) Contribution of premiums under national law If shares are issued for a sum exceeding the quotient value, the premium must be set aside in a special fund, the share premium reserve. This share premium reserve constitutes nonrestricted equity of the company, i.e. funds allocated to the premium reserve can be distributed to shareholders in the same way as profits. 6. Subscription of new shares a) Requirement for subscribing shares Subscription for new shares takes place on a subscription list which contains the issue resolution. The documents presented to the general meeting and a copy of the statutes must be attached to the subscription list. If all shares are subscribed for by the persons entitled to subscribe at the time when the general meeting decides on the new issue, subscription can take place through a simplified procedure, referred to as simultaneous subscription. This means that share subscription takes place directly in the minutes of the meeting (Ch. 13 Sec 13).
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b) Prohibition that shares may be subscribed by the public company itself A Swedish company may not subscribe its own shares (Ch. 19 Sec. 1 ABL). Where the shares have been subscribed for by a person on behalf of the company, the subscriber shall be deemed to have subscribed for the shares on his or her own behalf (Ch. 19 Sec. 1 ABL). c)
Application of the principle that shares may not be issued at a price lower than the nominal value or their accountable par Payment for a share may not be less than (but may well exceed) the quotient value of the previous shares (Ch. 13 Sec 19). Listed companies may, however, under certain circumstances issue shares at a price lower than the shares quotient value.
d)
Requirement under national law that newly issued shares with an accountable par of the same class must receive the same voting and dividend rights as the shares previously issued. Not applicable.
e) Information to be stated in the statutes Swedish Law explicitly requires that all shares have to be subscribed before the company may be registered (Ch. 2 Sec. 23 ABL). The subscription for shares shall take place in the memorandum of shares which is an act required for the company to be registered. 7. Contributions, performance of contributions, process of evaluation a) Assets capable of economic assessment In the event of non-cash consideration, payment shall take place through the property being separated and included in the company's property (Ch. 13 Sec 22). An auditor must issue a written, signed statement with respect to the payment (Ch. 13 Sec 23) verifying that the noncash consideration has been provided to the company, that it is or may be assumed to be of benefit for the company's operations and that it has not been reported at a higher value than the actual value for the company. b) Amount to be paid in Within six months of the new issue resolution, the board must notify the resolution for registration in the Companies Register, unless the resolution is ineffective due to insufficient subscription (Ch. 13 Sec 27). As a general rule, registration is conditional, among other things, on full payment having been made for all subscribed and allotted shares (Ch. 13 Sec 28). In this respect, the Act does not differentiate between payment in cash or contributions in kind. aa) Contributions in cash See b) above. bb) Contributions in kind See b) above. c) Valuation of contributions in kind – valuation process, expert report, exceptions In the event of non-cash consideration, payment shall take place through the property being separated and included in the company's property (Ch. 13 Sec 22 ABL). An auditor must issue a written, signed statement with respect to the payment (Ch. 13 Sec 23 ABL) verifying 136
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that the non-cash consideration has been provided to the company, that it is or may be assumed to be of benefit for the company's operations and that it has not been reported at a higher value than the actual value for the company. The statement should be registered with the Companies Register. d) Incorrect financing If the subscription of capital does not comply with the above procedure, the company will not be registered and the formation of the company lapses (Ch. 2 Sec. 24 ABL). The amounts paid for subscribed shares as well as accrued income thereon, less costs incurred as a consequence of measures taken shall be repaid immediately. This shall also apply to non-cash consideration. The founders and the members of the board of directors shall be jointly and severally liable for such repayment (Ch. 2 Sec. 24 ABL). e) Treatment of premiums or other forms of equity contributions under national law The only regulation is that any premium has to be accounted for as share premium reserve and disclosed in financial statements (Ch. 3 Sec. 5a Annual Reports Act). 8. Pre-emption rights a) Right of pre-emption – content, exceptions, offer of pre-emption rights, publication of offer/time frame In the event of a new issue against payment in cash or by set-off, the shareholders have preemption rights to new shares pro rata to the number of shares held previously (Ch. 13 Sec 1 ABL). Thus, the shareholders are entitled to subscribe for, and be allotted, shares in the issue pro rata to their previous shareholdings. b) Withdrawal or reduction of right of pre-emption by the general meeting The main rule regarding pre-emption rights does not apply in the event of a non-cash issue, or if the statutes contain different provisions regarding pre-emption rights. If the company has shares which carry different rights to the company's assets or profits or which carry different voting rights, the issue of pre-emption rights in the event of a cash issue of new shares must be specifically regulated in the statutes. It is also possible to prescribe derogation from the main rule in the actual issue resolution – to decide on a "private placement", for example to an external investor with full coffers (Ch. 13 Sec 2 ABL). c) Withdrawal or reduction of right of pre-emption by authorised body The Swedish legislator provides for the possibility that the board of directors can decide on the exclusion or reduction of pre-emption rights if this decision is authorised or subsequently ratified by the general meeting(Ch. 13 Sec. 35 and 31 ABL). The general meeting’s resolution regarding the authorisation shall be notified immediately for registration in the Company’s Register (Ch. 13 Sec. 37 ABL). Furthermore, an auditor’s review takes place and shall apply with respect to the content of the board’s resolution (Ch. 13 Sec. 31 and 38 ABL).
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d) Treatment of securities to be converted into shares In general under Swedish Law, the treatment of securities to be converted into shares is the same as for shares. e) Derogations The Swedish Companies Act does not provide for derogations.
Sub-section 3:
Subsequent formations
9. Subsequent formations a) Content The rules regarding subsequent formation (or deferred non-cash consideration) entail, in brief, that if the company, within two years from registration in the Companies Register, acquires property from founders or shareholders for an amount corresponding to at least one tenth of the share capital, the acquisition must be submitted to the general meeting for approval within six months. (Ch. 2 Sec 29 – 31 ABL). b) Valuation by an expert An auditor must provide a statement. c) Shareholders’ resolution Shareholders’ resolutions in this regard are taken with a simple majority. d) Transparency The shareholders’ resolution must be registered with the Companies House. e) Exceptions Resolutions are not required for transactions that take place on a Swedish or foreign exchange, an authorised marketplace or any other regulated marked or as a part of the company’s day-to-day business operations. f) Consequences of incorrect subsequent formations The board of directors may be liable for any loss caused. g) Subsequent formations in practice. The rules apply to public companies which make up about 10% of all companies limited by shares.
Section 2: Capital Maintenance 10. Limitation of distributions a) Principle aa) No reflux of the subscribed capital to shareholders if none of the exceptions apply The Swedish Companies Act prescribes that contributed capital may not be paid back to shareholders. Under Swedish law, therefore, the principle of the 2nd CLD that the subscribed capital is not available for distribution, applies.
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In accordance with the 2nd CLD, Swedish law also provides for exceptional cases in which the capital maintenance rules do not apply. These comprise the return of capital to shareholders in cases in which the subscribed capital has previously been reduced in accordance with legal provisions (Capital reduction Ch. 20 ABL / Acquisition of own shares Ch. 19 ABL) and cases in which the payment to shareholders is made in the context of the reduction of the subscribed capital by redemption of shares (Ch. 19 Sec. 5 Point 3 in accordance with Ch. 25 Sec. 22 ABL). Moreover, cases in which the company acquires its own shares are, by law, not treated as returnn of the contributed capital to shareholders (Ch. 19 Sec. 5 ABL). bb) No reflux of other funds of the company to shareholders if not via a distribution In the new Swedish Companies Act, rules concerning the way and extent to which assets can be transferred from the company to shareholders or other parties have been assembled under the term "value transfers". Value transfers are prohibited for sums so large as to leave the restricted equity without full coverage after the transfer (“monetary barrier”). When the scope for a value transfer is decided, an examination must also be made of whether the planned value transfer is justifiable bearing in mind the amount of equity required by the type and size of the business and the risks involved (“the prudence rule”). The concept of value transfer refers to: • dividends • acquisition by the company of its own shares • reduction of the share capital or statutory reserve fund for repayment to shareholders, and • other business transactions of a non-commercial nature that entail a reduction in the company’s assets. b) Sanctions Under Swedish law, the recipient of the distribution must repay it – if repayment in full is not obtained, anyone that participated in the decision may be liable for the deficiency (Chapter 17, sections 6-7). 11. Acquisition by the company of its own shares a) Possibility of the company acquiring its own shares A Swedish company may not, as a rule, acquire its own shares (Ch. 19 Sec. 4 ABL). A company may, however (Ch. 19 Sec. 5 ABL): • Acquire its own shares for which it is not obliged to pay, • Acquire its own shares which are included in business operations which are acquired by the company, where the shares represent a small portion of the company’s share capital, • Redeem its own shares in accordance with Ch. 25 Sec. 22 ABL, • Purchase at auction its own shares if the auction is held in the course of the execution of the company’s claims. Shares which have been acquired pursuant to this section and which have not been withdrawn through a capital reduction shall be divested as soon as that may occur without loss, not later, however, than three years from the date of the acquisition. Shares which have not been divested within this time frame shall be declared void by the company (Ch. 19 Sec. 6 ABL). For listed companies, the following provisions apply:
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b) Conditions regarding acquisition by the company of its own shares - shareholders’ resolution, amount of shares that can be acquired, guarantee that net assets are not affected, fully paid up shares A company listed on a Swedish or foreign exchange, authorised market or any other regulated market may acquire its own shares if the acquisition takes place on an exchange etc. and the company does not acquire more than one tenth of all shares in the company (Ch. 19 Sec. 13 et sqq. ABL). A resolution regarding the acquisition shall be adopted by 2/3rds of the votes cast and the shares represented at the general meeting (Ch. 19 Sec13 and 18 ABL). In this respect, a proposal is necessary which states the period of time within which the resolution must be executed, the number of shares, the consideration to be given for the shares and other conditions and terms (Ch. 19 Sec 20 ABL). As provided for by the 2nd CLD – Swedish Law determines the maximum and minimum consideration for the shares as well as the value of shares to be acquired which may not exceed 10% of the subscribed capital (Ch. 19 Sec. 15 ABL). After the acquisition, there must be full coverage for the company’s restricted equity. Shares acquired in breach of these provisions shall be disposed of within six months from the date of the acquisition (Ch. 19, Sec. 16 ABL). In general, all shares must be paid-up (increase of the subscribed capital) in order to be registered with the Companies House, so there should be no unpaid shares existing. This is not subject to any regulation. c) Exceptions possible for Member States - serious and imminent harm, employees, others, duty to dispose of shares and consequences of not selling The exceptions for serious and imminent harm (Article 19 (2) of the 2nd CLD) and employees (Article 19 (3) of the 2nd CLD) are not implemented into Swedish law. Concerning the other exceptions of Articles 20 (1) and 41 (1 and 2) of the 2nd CLD, Ch. 19 Sec. 5 ABL foresees that a private or public company may acquire its own shares (Chapter 19, section 5): • • • •
if no payment shall be made for the shares, if included in acquired business operations (to a small portion), if decided by court (fraud on a minority), via purchase at auction if the auction is held in the course of the execution of the company’s claims.
Furthermore, there are duties to dispose of shares (Article 20 (2)) and consequences for not selling shares (Article 20 (3)). Shares must be disposed of within three years, otherwise they will be declared void (Ch. 19 Sec. 6 ABL). d) Shares acquired in contravention of the legal rule Shares which have been acquired in accordance with the applicable provisions and which have not been withdrawn through a reduction of the share capital shall be disposed of as soon as this may occur without loss and not later than three years from the date of the acquisition. Shares which have not been disposed of within this time period shall be declared void by the company – in accordance with the 2nd CLD (Ch. 19 Sec. 6 ABL). 140
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e) Holding of shares - voting rights, inclusion of a reserve in the liabilities’ side of the balance sheet, information in the annual accounts The voting rights attached to a company’s own shares may not be exercised at a general meeting (Ch. 7 Sec. 7 ABL). From an accounting perspective, the company’s own shares cannot be assigned any value, i.e. the shares are accounted for with a zero asset value in the accounts. When the company’s own shares are acquired, the non-distributable part of owner's equity is reduced by the cost of the shares (Ch. 4 Sec. 14 Swedish Annual Accounts Act). The company must publish information in the annual report concerning its own shares held. The holding by the company of its own shares (number of shares and quotient value) has to be disclosed in the administration report section of the statutory annual report. Information must also be disclosed regarding all the company’s shares acquired and sold t by during the financial year (number of shares and quotient value) as well as the reason for the transactions (Ch. 6 Sec. 1 (disclosures) and Ch. 5 (accounting for acquisition of the company’s own shares) Swedish Annual Accounts Act). f) Acceptance by the company of its own shares as security A company may not accept its own shares as security. Any agreements in violation of this provision are void (Ch. 19 Sec. 3 ABL). g) Application of Article 24a if exceptions have not been chosen by Member State In Sweden generally, the sale by a public company of its own shares is allowed. The sale shall take place either on an exchange, an authorised market or other regulated market or in another manner (Ch. 19 Sec. 31 ABL). Therefore, the board or another party shall prepare a proposal and a proposed resolution. A resolution shall be adopted by the general meeting. (Ch. 19 Sec. 33 et sqq. ABL). h) Conditions regarding the reselling of the company’s own shares (equal treatment) If the shares are not on the market, the sale must take place in a procedure equivalent to the issuance of new shares where shareholders have pre-emption rights (Ch. 19 Sec. 31 et sqq. ABL. i) (Prospective) implementation of the amendments of the 2nd CLD The amendments of the 2nd CLD by Directive 2006/68/EC are still in the process of implementation. 12. Prohibition of financial assistance Prospective implementation of the amendments of the 2nd CLD regarding the prohibition of financial assistance In Sweden, the amendments of the 2nd CLD (Directive 2006/68/EC) have not been implemented into national law. However, a parent company may provide financial assistance to a third party buying shares in a subsidiary (Ch. 21 Sec. 5 ABL).
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13. Loans from shareholders In Sweden, there is no direct regulation dealing with loans from shareholders. 14. Capital reduction a) Capital reduction The Swedish Companies Act provides for the possibility of a reduction of the share capital. A reduction is subject to a shareholders’ resolution (Ch. 20 Sec. 5 ABL). A general meeting must therefore be called (Chapter 20, Section 3). A proposal to reduce the capital must be set down in the agenda for the general meeting (Ch. 20 Sec. 7 et sqq. ABL). The resolution must be passed with a majority of at least 2/3 of the votes cast and shares represented at the general meeting (Ch. 20 Sec. 5 ABL) – the same majority requirement applies within classes of shares. The resolution must specify the purpose of the reduction in capital, particularly whether it serves to return capital to shareholders (Ch. 20 Sec. 1 No. 3 ABL) or to cover losses where unrestricted shareholders’ equity equal to the loss is not available (Ch. 20 Sec. 1 No.1 ABL) or for transfer to a fund to be used pursuant to a resolution adopted by the general meeting (Ch. 20 Sec. 1 No. 1 ABL) and, furthermore, the way in which the capital reduction is to be effected (Ch. 20 Sec. 2 ABL) – with or without withdrawal of shares. The capital reduction is also subject to the “prudence rule”, whereby the board of directors has to examine whether the planned value transfer is justifiable bearing in mind the amount of equity required by the type and size of the company. The Swedish Companies Act requires the board to register the resolution with the Companies House within 4 months (Ch. 20 Sec. 19 ABL). The amendments of the 2nd CLD by Directive 2006/68/EC are still in the process of implementation 15. Redemption of the subscribed capital The Swedish Companies Act does not provide for the possibility to redeem subscribed capital without reducing the latter. Under Swedish law, the subscribed capital may be redeemed, but the redemption involves a reduction of the subscribed capital (Ch. 20 Sec. 31 et sqq. ABL). 16. Compulsory withdrawal of shares In Sweden, there is no general regulation on compulsory withdrawal, but the statutes may provide a redemption clause (see the following question for further details). However, a court may order the company to buy-out the shares of a shareholder (Ch. 25 Sec. 22 ABL). This is a remedy available to the court following fraud on minority shareholders. 17. Redeemable shares Under Swedish law it is allowed to issue redeemable shares. To this end, the statutes must include a redemption clause. The shareholders have to decide on the redemption by a simple majority. The decision must be approved and/or registered with the Companies House.
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Section 3: Dividends and distributions 18. Definition of Distribution The dividend is determined based on the concept of a value transfer. A value transfer may not take place where, after the transfer, there is insufficient coverage for the company’s restricted equity. The calculation shall be based on the most recent balance sheet taking into consideration changes in the restricted shareholders’ equity which have occurred subsequent to the balance sheet date. Notwithstanding this, under the “prudence rule” the company may effect a value transfer to shareholders or another party only provided such appears to be justified taking into consideration 1. The demands with respect to size of shareholders’ equity which are imposed by the nature, scope and risks associated with the operations, and 2 the companies need to strengthen its balance sheet, liquidity and financial position in general. Items 1 and 2 are subject to a written statement from the board confirming compliance to be presented to the general meeting when deciding upon distribution. 19. Distributable amount a) Balance sheet net assets test/ earned surplus test The amount that can be distributed consists of two parts. Firstly, the reported net profit for the financial year less obligatory reserves. Secondly, the non-restricted reserves or retained profits which can serve for distributions. For a group of companies, the distributable amount for dividend payment is determined as the lesser of distributable amounts available at the parent company’s level or the distributable amount according to the group accounts. In this context, the above mentioned “prudence rule” also plays a decisive factor in determining the actual distribution. This requires specific considerations concerning the company’s/group’s financial position, especially in view of cash flows. b) Interim dividends Interim dividends are allowed. However, these can only be paid from amounts available for distribution as adopted in the annual accounts. c) Premiums Premiums are accounted as share premium reserve (non-restricted equity). d) Incorrect distributions Swedish law provides for different ways of challenging the distribution resolution. If the distribution is based on a resolution which is subject to unanimous consent of all shareholders, the challenge must be commenced within three months from the date of resolution. Otherwise there is no time limitation.
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Under the “prudence rule”, the board of directors must present a written statement confirming compliance of the dividend distribution with the concept of value transfer. In this regard, there would be an obligation to return dividends or, if the dividend is not returned, the individuals involved in the decision to cover the loss are liable. 20. Determination of the distributable amount a) Proposal by the company’s bodies The board proposes a resolution to the general meeting. If the distribution is to be decided on by the annual meeting the proposal is included in the annual report. The general meeting may resolve upon the distribution of a larger amount than proposed or approved by the board only where such an obligation exists in accordance with the statutes or where the distribution was resolved upon at the request of a minority of shareholders If the decision of the shareholders is to be taken at a meeting other then the annual general meeting (extraordinary general meeting), additional information is to be prepared/distributed. The decision is nevertheless to be based on available capital according to the most recent adopted balance sheet. The auditor of the company provides a statement to be presented to the general meeting b) Authorisation by general meeting The resolution by the general meeting must be taken with a simple majority at the annual general meeting. The basis for this resolution is the profit and loss account, the balance sheet and allocation of profits or losses as adopted by the general meeting. If taken at an extraordinary general meeting, the resolution on the proposal comes from the board. c) Publication If the resolution has been adopted at the annual general meeting, the annual report shall be sent to the Companies Register including an attestation on the resolution regarding profit or loss. If the resolution has been adopted at an extraordinary general meeting, the resolution shall be notified to the Companies Register. d) Challenge to resolution Swedish law provides for different ways of challenging the distribution resolution. If the challenge to the distribution resolution refers to an error that can be adopted with unanimous consent of all shareholders, the challenge must be commenced within three months from the date of resolution (Ch. 7 Sec 50 and 51 ABL). If the challenge refers to an error that can not be adopted this way, there is no time limitation (Ch. 7 Sec. 51 ABL). 21. Accounting reserves that influence the distributable amount a) Revaluation of tangible fixed assets, fair valuation accounting, accounting for formation expenses Companies in Sweden are not yet allowed to value tangible assets at fair value. There is a proposal that Swedish companies which are subsidiaries or the parent company of a group which prepares the financial statements in accordance with International Financial Reporting Standards (IFRS) may do this from 2009. The revaluation will be accounted for in a special reserve within equity. This reserve will not be restricted equity.
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Swedish companies have the possibility to value financial instruments at fair value. In some cases, the revaluation will be accounted for in a special reserve within equity. This reserve is not restricted equity. According to the Swedish Annual Accounts Act, Swedish companies are not allowed to set up formation expenses as an asset. b) Any other form of accounting reserve Not applicable. c) Extension of the fair value concept to other specified categories of assets For the time being, Sweden has not extended the fair value concept to other specified categories of assets. There is a proposal to give the Swedish companies which are subsidiaries or the parent company of a group which prepares the consolidated financial statements in accordance with International Financial Reporting Standards (IFRS) the possibility from 2009 to value biological assets, intangible assets, fixed tangible assets and buildings held for investment purposes at fair value. The revaluation of biological assets and investment properties will be recognised in the income statement but the other revaluations will be accounted for in a special reserve within equity. This reserve will not be restricted equity.
Section 4: Capital related rules in case of crisis and insolvency 22. Serious loss of the subscribed capital a) Calling of general meeting If there is reason to believe that more than 50% of the capital has been lost, the board must prepare a special balance sheet for liquidation purposes. If the balance sheet shows that there is less than 50% of the share capital remaining, the board has 8 months to restore the capital (chapter 25, section 13). b) Consequences In case of failure to establish a special balance sheet, to call a general meeting or to apply for liquidation, the board is jointly and severally liable for the debts of the company (chapter 25, section 18). 23. Trigger of insolvency a) Factors triggering insolvency The issue of insolvency is not regulated in the Companies Act, but in the Insolvency Act. A company is generally insolvent when it is not in a position to pay it debts when due and when this incapacity is not temporary. b) Time frame There is no specific time frame stipulated in Swedish insolvency law. c) Duties of the board members There is no duty for directors to file for insolvency. However, failure to act in the best interests of the creditors in an insolvency situation is an offence.
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Section 5: Contractual self protection of creditors 24. Contractual self protection In Sweden, there are no specific legal provisions concerned with contractual self-protection of creditors.
Section 6: Equal treatment 25. Principle of Equal treatment Sweden has implemented the 2nd CLD requirements regarding equal treatment. This includes rights of shares (Ch. 4 Sec. 1 ABL) and decisions at general meetings (Ch. 7 Sec. 47 ABL). Furthermore, the shareholders may, for example, agree to have different voting rights or receive dividends. However, such agreement must be included in the statutes (Ch. 4 Sec. 1 ABL).
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3.1.4 United Kingdom Section 1:
Capital formation
Sub-section 1:
Formation of the public company
1. Minimum capital and other means of equity financing a) Minimum subscribed capital Under the UK Companies Acts, a public company is required to have a authorised minimum share capital of £50,000 (ss11, 117, 118 (1985); ss761, 763 (2006)), . The authorised share capital, to which this minimum applies, is an upper limit, set out in the articles, as to the aggregate nominal value of shares which the company may have. It need not allot all of this capital at incorporation (formation). The founders are entitled, as it is provided for in the 2nd CLD, to freely fix a higher capital amount. The called-up share capital is, as it is required by the 2nd CLD, not available for distributions to shareholders (s263, s264 (1985); s830, s831 (2006), see question 19)). b) Authorised capital Under the Companies Act 1985 founders of a public limited company are required to state in the memorandum of association the amount of the share capital with which the company proposes to be registered and the nominal amount of each of its shares (s2 (1985)). This is known in the UK as the "authorised share capital" and acts as a ceiling on the amount of capital which can be issued - although the limit may be subsequently raised by members’ ordinary resolution (s121 (1985)). Under the Companies Act 2006 the requirement for a company to have an authorised share capital is abolished. However, the founders of the company are free to limit the maximum share capital in the articles. UK law requires that in order to allot any part of the "authorised share capital" that is not yet allotted that directors must also be authorised to do so In order to allot shares a separate authorisation is required - either by a shareholders' resolution or in the articles (ss80 CA (1985); s551 (2006)). An authorisation can be given at the time of the company's original incorporation (ie, by inclusion of directors’ authority in the articles) and must specify the maximum amount of share capital that can be allotted and the maximum time period the authorisation is valid (s80 CA (1985); s551 (2006)). Such possibility corresponds to the possibility under the 2nd CLD to fix authorised capital during the stage of formation to facilitate the issuance of additional shares. Therefore, also British law provides for the possibility to fix authorised capital during the stage of formation as it is provided for by the 2nd CLD. c) Premiums The British Companies Acts do not require the possibility of fixing premiums, yet such possibility is implicit in national law (see ss130-133 (1985); ss610-613 (2006)). Hence, the terms of a company’s articles could require that its shares be allotted only at specified premium. The amount of the premium is the real value (eg, not accounting values) of the assets’ contributed in excess of the nominal value of shares (Shearer vs Bercain Ltd [1980] 3 All ER 295).
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If the company decides to issue shares at a premium, the premium must be added to the “share premium account” (the same reserve as for increases under art 26) (s130 (1985); s610 (2006)). Exceptions are for share-for-share transactions and subscription of non-cash assets intra-group (provided the subscriber and the issuer are within a wholly owned (portion of the) group) (ss131-133 (1985); ss611-613, 615 (2006). The share premium account is treated in virtually all respects as if it were subscribed capital (1985, s130; 2006, s610). Thus, the share premium account is not available for distributions); if however it is dissolved in accordance with the rules on a formal reduction in capital than the amount may be used to offset a deficit of distributable reserves (S135, 263 of 1982; S610, 850 of 2006) or, unless the court specifies otherwise in the course of the reduction process, to create a surplus available for distribution; this latter is currently a matter of legal analysis (see TECH 7/03) but is expected to be codified in secondary legislation under powers set out in the 2006 Act (S654, 2006). Moreover, British law requires that premiums on formation must be in cash (s106 1985, s584 2006). d) Other forms of equity contribution The British Companies Acts do not contain provisions dealing with other forms of equity contributions. However, shareholders are free to gift money/ assets to the company, which (per accounting practice) is credited directly to capital and reserves and called, typically, a “capital contribution”. It has no standing in legislation as capital and is therefore could, subject to conditions, be available for distribution. The main condition is that the contributed assets meet the test of being “realised”, in the same way that a profit must be realised before it may be available for distribution. The test for realisation is described at question 19. It should also be borne in mind that another condition is that of linkage: if, say, cash contribution is received as one step in a series if linked transactions that ultimately result in the cash being paid out to acquire, say, a property, that it is considered to be a contribution of cash a property (not realised) rather then a contribution of cash. e) Information to be stated in the statutes The British Companies Act 1985 requires that the memorandum of association must contain the amount of the share capital with which the company proposes to be registered and the nominal amount of each of its shares (the "authorised share capital", see above bb)); and the number of shares taken by each subscriber(s2 (1985). The provisions of the 2nd CLD have, therefore, been fully implemented into national law. Due to the fact that the requirement for a company to have an "authorised share capital" is abolished under the Companies Act 2006, the information about the shares subscribed for by the subscribers of the memorandum is not to be stated in the memorandum of association but in the statement of capital and initial shareholdings which is to be delivered to the registrar together with an application of registration (ss9, 10 (2006)). The statement must contain the total number of shares of the company to be taken on formation by the subscribers to the memorandum, the aggregate nominal value of those shares, for each class of shares prescribed particulars of the rights attached to the shares, the total number of shares of that class, and the aggregate nominal value of shares of that class, and the amount to be paid up and the amount to be unpaid on each shares (whether on account of the nominal value of the shares or by way of premium) (s10 (2006)). Therefore, beyond the provisions of the 2nd CLD the British Companies Act 2006 also requires transparency with respect to any premiums paid.
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2. Subscription of the capital a) Link of stated capital’s injection with subscription of shares In accordance with the 2nd CLD, in the UK the injection of the nominal capital is linked to the subscription of shares. When a company is incorporated, those persons who subscribed to its memorandum become members of the company in respect of the shares in relation to which they subscribed. As result those shareholders are liable to pay to the company the nominal value of those shares as and when the company calls for payment; payment arrangements are effected separately from subscription to the memorandum, but the legislation provides that at least 25% must be paid up immediately (S101, 1985; S586, 2006) together with the whole of any premium. b) Time limit The British Companies Act requires that every public company must have a nominal capital with which it is registered (s2 (1985); s542 (2006)). ) Whereas the Companies Act 1985 requires a minimum of at least two subscribers (s (1) (1985)), under the Companies Act 2006 a single person is enabled to form a public limited company (s7 (2006)). No subscriber may take less than one share s2 (5)(b) (1985) / s8(1)(b) (2006). Unless the registrar is satisfied that the nominal value of the company's allotted share capital is not less than the required minimum share capital, the company is not allowed to commence business (s117 (2) (1985); s761 (2) (2006)). UK law is, therefore, not strictly based on the principle that all shares must be subscribed for and allotted before the company may be incorporated. Instead the subscription of the minimum capital may be done in stages: some figure of allotted capital of less than £50,000 will suffice to be incorporated, but total subscriptions/allotments must be subsequently brought up to £50,000 nominal value in order for the company to commence business. c) Prohibition of subscription of shares by the company itself Although there is the general rule, described below, against subscription by the company itself, this provision is unnecessary in relation to the incorporation of the company: at the time of persons’ subscribing to the memorandum of a company intended to be formed, the company does not exist and ipso facto could not subscribe to the memorandum. In what follows the term “subscription” refers to the subscription for shares in a company after it has been incorporated. In accordance with the 2nd CLD a company is prohibited from acquiring its own shares via subscription (s143 (1) (1985) / s658 (1) (2006)). In case of contravention of this rule, the company is liable to a fine, and every officer of the company who is in default is liable to imprisonment or a fine, or both; the purported acquisition is void (s143 (2) (1985); s658 (2) (2006)). S23 (1985) / s136 (2006) extends the prohibition to acquire shares of the issuing company by subscription to its subsidiaries (but an exception is made for subscriptions before the subscriber became a subsidiary – s23(1985)/s137(2006)). In case shares are allotted to the subsidiary in contravention of this section, the allotment or transfer of shares is void (s23(1985); s136 (1) (b)). S144 (1985)/S660 (2006) implements art 18 (2), treating the company’s nominee subscriber as a person subscribing in his own name. However, this untested provision may be irrelevant
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as the company’s nominee’s acts would normally be attributed to the company with the result that the purported acquisition is void as described before (s143, 1985; S658, 2006). The British legislator used the possibility under the 2nd CLD to relax the prohibition that shares may not be subscribed by the subsidiary, thus allowing subsidiaries in exceptional cases to subscribe shares of the holding company, namely where the subsidiary subscribing the shares acts as authorised dealer in securities (s23(1985); s141 (2006)) and where the subsidiary is concerned only as personal representative or trustee, unless, in the latter case, the holding company or a subsidiary of it has a beneficial interest under the trust (s231985); s138 (1) (2006)). d) Prohibition of share issues at a price lower than the nominal value/accountable par s100 (1985) / s580 (2006) prohibits - in line with the 2nd CLD - that shares are issued at a discount to their nominal amount. Unlike other jurisdictions, UK law does, however, not provide for a minimum nominal value of shares. In light of the statutory prohibition to issue shares at a discount it should be noted that a company is permitted to pay commission to any person, subject to having that power in its articles, up to a maximum of 10% of the price the shares are issued (s97 (1985) / s553 (2006)). This permission has narrow application practise, eg the payment of fees to underwriters (which would be otherwise frustrated). e) Designs of shares Under UK law shares must have a nominal value. The possibility of the 2nd CLD to allow the issuance of shares with an accountable par has, therefore, not been included in national law. f) Information to be contained in the statutes The British Companies Act 1985 requires that the memorandum of association must contain the amount of the share capital with which the company proposes to be registered and the nominal amount of each of its shares (the "authorised share capital"); and the number of shares taken by each subscriber (s2 (1985)). The provisions of the 2nd CLD have, therefore, been fully implemented into national law. According to the Companies Act 2006 the necessary information must be laid down in the statement of capital which is to be delivered to the registrar together with an application of registration (ss9, 10 (2006)). The statement must contain the total number of shares of the company to be taken on formation by the subscribers to the memorandum, the aggregate nominal value of those shares, for each class of shares prescribed particulars of the rights attached to the shares, the total number of shares of that class, and the aggregate nominal value of shares of that class, and the amount to be paid up and the amount to be unpaid on each shares (whether on account of the nominal value of the shares or by way of premium) (s10 (2006)). Therefore, the provisions of the 2nd CLD UK law have been fully implemented into national law. g) Premiums Under UK law, there is no restriction on issuing shares at a premium over their nominal value. The treatment of any issue premium, subject to exceptions, it that it must be added to the “share premium account” which is then treated in virtually all respects as if it were subscribed capital (s130 (1985) / s610 (2006)). Thus, the share premium account is not available for distributions (see question 1) b) cc)). It is also required that premiums on formation must be
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in cash (s106 (1985) / s584 (2006)) and that they must be fully paid in s101(1) (1985) / s586(1) (2006). 3. Contributions a) Contributions in cash and in kind Under the British Companies Act, during the stage of formation, contributions may only be made in cash: s106 (1985) / s584 (2006) dictates that shares taken by a subscriber to the memorandum (ie, on formation) in pursuance of an undertaking of theirs in the memorandum and any premium on the shares, shall be paid up in cash. The British legislator, therefore, did not use the possibility of the 2nd CLD to allow contributions in kind during the stage of formation. A cash consideration means cash received by the company, a cheque received by the company in good faith that the directors have no reason for suspecting will not be paid, a release of a liability of the company for a liquidated sum, an undertaking to pay cash to the company at a future date (s738(2)(1985), s583(3)(2006); or payment by other means giving rise to a present or future entitlement to a payment, or credit equivalent to payment, in cash s583 (3) (2006)). The provisions of the 2nd CLD have, therefore, been fully implemented into national law. Also under UK law, shareholders cannot be released from the obligation to make a contribution by virtue of s98 (1985), s552 (2006), according to which a company may not permit the allottee any allowance against the amount he agreed to subscribe. b) Amount to be paid in In accordance with the 2nd CLD, the British Companies Act provides that shares allotted for a cash consideration need only be paid up to an extent of 25% of their nominal value (s101 (1) (1985) / s586(1) (2006)). c) Valuation of contributions in kind As under the British Companies Act shares must not be allotted for a consideration other than in cash during the stage of formation, the legislative provisions concerning valuation of contributions in kind are not applicable. d) Further national rules linked to the injection of contributions There are no further national rules linked to the injection of contributions. e) Consequences of incorrect financing The British Companies Act provides for a comprehensive system of sanctions in case the legal provisions concerning the raising of capital are violated which include the personal liability of the allottee and the directors of the company: If shares are allotted at a discount, the allottee is liable to pay the company an amount equal to the discount with interest at the appropriate rate s100 (2) (1985) / s580(2) (2006). If at least one quarter of the nominal value and the whole premium has not been paid on allotment, the allottee is liable to pay the company the minimum amount that would have been received (i.e. a quarter of the nominal value and the whole premium) less the valuation of any consideration actually applied in payment up of the amount, with interest at the appropriate rate s101(3),(4) (1985) / s586(3) (2006).
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If a company contravenes any of the provisions of sections 99 to 104 and 106 in respect of the allotment of shares (see above), the company and any officer of it who is in default is liable to a fine (s114 (1985)). f) Premiums Under UK law there is no restriction on issuing shares at a premium over their nominal value. If shares are issued at a premium, the premium, , subject to exceptions, must be added to the “share premium account” which is then treated in virtually all respects as if it were subscribed capital (s130 (1985) / s610 (2006)). Thus, the share premium account is not available for distributions (s264 (4) (1985); s831 (4) (2006)); if however it is dissolved in accordance with the rules on a formal reduction in capital than the amount may be used to offset a deficit of distributable reserves (S135, 263 of 1982; S610, 850 of 2006) or, unless the court specifies otherwise in the course of the reduction process, to create a surplus available for distribution; this latter is currently a matter of legal analysis (see TECH 7/03) but is expected to be codified in secondary legislation under powers set out in the 2006 Act (S654, 2006). Premiums on formation must be in cash s106 (1985) / s584 (2006) and must be fully paid s101 (1) (1985) / s586(1) (2006). g) Liability Generally it is allottee (shareholder) that is held liable. h) Prospective implementation of the amendments of the 2nd CLD These amendments are not being implemented in the UK at present. 4. Accounting for formation expenses a) The Possibility of capitalising formation expenses Under UK legislation, formation expenses are not permitted to be capitalised. The British legislator, therefore, did not use the possibility of the 4th Directive to allow the capitalisation of formation expenses. Instead where share premium has been recorded under section 130 (1985), it is permitted under that section for the company’s preliminary expenses (i.e. expenses incurred in connection with the company's formation) to be offset against that share premium account; however any offset of any preliminary expenses is limited to the amount recorded in the share premium account at that time. However, under the 2006 Act, the equivalent section 610 will no longer allow such preliminary expenses to be offset against the share premium account. b) Definition of formation expenses, time period for depreciation, restriction of profit distribution, information in the notes In respect of current treatment as offsetting against the share premium account, there is no legal definition of formation expenses that can be so treated. Where preliminary expenses are written off other than against share premium accounts (eg, under the 2006 Act) distributions are automatically thereby restricted. There are no specific disclosure requirements for preliminary expenses under national law.
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Sub-section 2:
Capital increases
5. Increase in subscribed capital and other forms of equity financing a) Authorised share capital Under the 1985 Act the initial authorised share capital is established in the memorandum of association required on the formation of the company (section 2 (1985). Subsection 5 of section 2 requires that the memorandum must state the amount of share capital with which the company purposes to be registered and the different classes of the share capital into shares of fixed amount (ie the nominal amount of each class of each share). This authorised share capital is a limit upon the capacity of the company itself, it is the company’s maximum possible share capital. If is differenct from the question (under s80 (1985)) as to the authorisation of the directors to allot of such of its authorised share capital that is not yet allotted; this authorisation corresponds with that set out in article 25 of 2nd CLD. Under the 2006 Act there is no authorised share capital. Under the 1985 Act following the initial establishment of the authorised share capital, a company can increase its authorised share capital by passing an ordinary resolution (unless its articles of association require a special resolution) in a general meeting of its members (section 121 (1985). In respect of this increase in authorised share capital, a copy of the resolution and a notice of the increase must be filed on the public registry within 15 days of the resolution being passed by the members of the company (section 123, 1985). There is no maximum amount of share capital established by UK law nor is there any period for which the increase occurs – the increase is (absent reduction – see question 14) permanent. There are however time limits on the actual allotment of share capital as discussed below. Under the 1985 Act even though a company will have authorised share capital, the directors of the company do not have complete power to issue additional shares up the amount of the authorised share capital. Section 80 (1985) requires that in order for the directors to have such powers they need either consent of the shareholders (by the passing of an ordinary resolution by its members or general meeting – at which the different classes of shares have such voting rights as are set out in the articles) or being so authorised within the articles of the association of the company. The powers granted under section 80 are limited as the resolution is required to contain the maximum of shares that can be issued under that resolution and that the period of authority cannot exceed five years from the date of the resolution. The exception under Article 41 under the 1985 Act is provided within section 80(2)(a). Under the 2006 Act, the directors of the company do not have complete power to issue additional shares. Section 549 and 551 (2006) requires that in order for the directors to have such powers they need either consent of the shareholders (by the passing of an ordinary resolution by its members or general meeting – at which the different classes of shares have such voting rights
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as are set out in the articles) or being so authorised within the articles of the association of the company. The powers granted under section 551 are limited as the resolution is required to contain the maximum of shares that can be issued under that resolution and that the period of authority cannot exceed five years from the date of the resolution. Under the 2006 Act the requirement for authority from the members under section 549 does not apply to shares to be allotted pursuant to an employee’s share scheme. When shares are actually allotted notification must be filed on the public registry within a month of the allotment (under section 88 (1985) or section 555 (2006)). Under section 99 (1985) and 582 (2006) the company is able to allot bonus shares to its existing shareholders applying amounts previously credited to the share premium account (s130, 1985; s610, 2006), the capital redemption reserve (sections 170(4) (1985) and 733 (5) (2006)), a revaluation reserve (para 34 Sch 4, 1985) or, subject to the articles of association, out of its unrealised or realised profits. The allotment is in essence a form of distribution. Thus the procedures not only involve the need for an authority to allot (see above) and are subject to the upper limit of the company’s authorised share capital, but regulations would be laid down in the articles as to entitlements on such occasion and to the procedure for effecting the distribution of shares (a directors resolution is typically required). 2nd CLD Article 25 (4) requirement that the rules do not only apply to the issuance of shares but also to the issuance of securities that are convertible into shares or that carry the right to subscribe shares are covered in the 1985 Act by the section 80 authority which covers not only shares but also any right to subscribe for, or convert any security into, shares of the company. Similarly this exists in the 2006 Act through section 549 (1). These provisions do not go further then required by the 2nd CLD. The requirement under Article 26 of the 2nd CLD that shares issued for a consideration, in the course of an increase in issued capital, must be paid up to at least 25 % of their nominal value and in full for any share premium is a requirement of sections 101 (1985) and 586 (2006). The share premium account is treated in virtually all respects as it were subscribed share capital (S130, 1985; S610,2006). Thus the share premium account is not available for distribution; if however it is dissolved in accordance the rules on a formal reduction of capital then the amount may be used to offset a deficit of distributable reserves (S135, 263 of 1985; S610, 830 of 2006) or, unless the court specifies otherwise in the course of the reduction process, to create a surplus available for distribution. This latter is currently a matter of legal analysis (see TECH 7/03) but is separated to be codified in secondary legislation under powers set out in the 2006 Act (S654, 2006). 6. Subscription of new shares a) Requirement for subscribing shares (time limit) S84 (1985) / s578 (2006) prohibits shares being allotted by a public company pursuant to an offer for subscription unless all shares issued are subscribed for or the terms of the offer state otherwise. If the shares are not fully subscribed, the company has to return the monies received to the applicants.
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Only a quarter of the nominal value needs to be paid up when allotted s101(1) (1985) / s586(1) (2006). . Whilst the shares may be paid up by an undertaking, such an undertaking must be performed within 5 years after the date of the allotment s 102(1) (1985) / s587(1) (2006). b) Prohibition of subscriptions of shares by the company itself s143(1) (1985) / s658(1) (2006) prohibits a company from acquiring its own shares via subscription and s23 (1985) / s136 (2006) extends this prohibition to its subsidiaries. However, as permitted by the 2nd CLD exceptions are made for cases where the company or its subsidiary subscribes as part of its business as a securities dealer or as acting on behalf of third parties (S23(2), (3), 1985; S138,141 of 2006). In addition s144 (1985)/s660 (2006) implements art 18 (2), treating the company’s nominee subscriber as a person subscribing in his own name. However, this untested provision may be irrelevant as the company’s nominee’s acts would normally be attributed to the company with the result that the purported acquisition is void as described before (s143, 1985; S658, 2006). c) Prohibition of share issues at a price lower than the nominal value/ accountable par s100 (1985) / s580 (2006) prohibits shares being issued at a discount to their nominal amount. Consistent with article 8(2) of the 2 CLD, s97 (1985) / s553 (2006) permits a company to pay commission to any person, subject to certain conditions, up to a maximum of 10% of the price the shares are issued. d) Issue of accountable par shares with the same voting and dividend rights as previously issued shares This is not applicable. e) Information to be stated in the statutes A subscription of new shares does not require any change to the memorandum and articles unless, under the 1985 Act, it is necessary to increase the authorised share capital (statement of the total maximum capital and the classes and numbers of shares into which it is divided) needs to be increased to facilitate the subscription. Under the 2006 Act there is no concept of authorised share capital. Under both Acts it is, however, necessary to furnish a return of allotment to the registrar of companies (S88, 1985; S555, 2006), detailing the number and nominal value of shares allotted, the allotees and the consideration paid or payable. (These are the details required under the 1985 Act, but those under the 2006 Act, not yet fully in force, will be set out in secondary legislation yet to be made). The 2006 Act also requires a statement of capital to be furnished to the registrar, detailing the post-allotment share capital of the company (number, nominal value, amounts paid-up including premium and share rights). Jurisprudence: Note that where shares are paid up by an undertaking to pay cash at a future date, the value of the payment-up is the value of the undertaking and not of the ultimate cash sum, on the principle in Shearer vs Bercain Ltd is [1980] 3 All ER 295, and it is the value of the undertaking that must meet the called up amount of the nominal value.
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7. Contributions a) Assets capable of economic assessment s99(1) (1985) / s582(1) (2006) requires shares that are allotted by a company may be paid up in money or money’s worth (including goodwill and know-how). s99(2) (1985) / s585 (2006) prohibits a public company in accepting an undertaking given by any person that they should do work or perform services for the company or any other person. s102 (1985) / s587 (2006) prohibits a public company from allotting shares from any other undertaking that may be performed after more than five years. This includes cases where the undertaking is to be performed within five years, but the alottee fails to perform within that time. b) Amount to be paid in Only a quarter of the nominal value, along with the whole of any premium, needs to be paid up when allotted (ss101(1) (1985) / ss586(1) (2006)). c) Valuation of contributions in kind If shares are to be paid in amounts other than cash (as required by the 2nd CLD), then generally a valuation report is required by s103(1) (1985) / s593(1) (2006) before the shares are allotted. There are two principal exceptions to this rule – firstly where there is a bonus issue s103(2) (1985) / s593(2) (2006), or when then is a share for share exchange in respect of an acquisition of one company by another or when one company proposes to acquires all the assets and liabilities of another in exchange for the issue of shares s103(3)(4)(5) (1985) / s593(3)(4)(5) (2006). The format of the report is detailed in s108 (1985) / s1150 (2006). The report should be made by person (appointed by the company) who is qualified to be appointed as auditor to the company, although that person may himself accept a report from another person (not an officer of the company) who has the requisite knowledge and experience to value the consideration. There are no mandatory valuation standards. The report must state the nominal value of the shares to be wholly or partly paid by the consideration in question, the amount of any premium payable on the shares, the description of the consideration ,the method used to value it, the date of valuation and whether the value covers the nominal value of the shares and any premium proposed to be treated as paid up by the consideration. The report must be made during the 6 months immediately preceding the allotment of the shares s103(1)(b) (1985) / s593(1)(b) (2006). A copy of the report has to be filed with the registrar and, beyond the requirements of the 2nd CLD, another has to be given to the allotee s111 (1985)/ s597 (2006). It should be noted the valuation report does not determine the value of the consideration at the time of the allotment but at an earlier date. The questions of whether the allotment price is, on the day, actually satisfied by the consideration tendered and if so how much premium has been tendered are ones of fact as to the actual value that day. The report required earlier on is, in effect, acting as a control on the directors otherwise proposing a non-cash allotment that is likely to be unlawful. Of course, if the report is as at a recent date and the asset is one for which prices are not volatile, it may well be that the actual allotment day value is the same as the report date value.
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d) Incorrect financing If a share is allotted at a discount to nominal value, the allottee is liable to pay up the discount in cash with interest at the appropriate rate, (s100(2), 1985; s580(2), 2006) In the same way the allottee of a share allotted for less then one quarter paid or less then the whole of any premium, must pay the shortfall in cash with interest (s101(3), (4), 1985; s586(3), 2006). If shares are allotted in exchange for the performing of services per s99(3) (1985) / s585 (2006) the holder of the shares is liable to pay the amount of the nominal value and any premium, or the appropriate part of it if the shares were partly paid up in cash, together with interest at the appropriate rate. Similarly, if shares are allotted for an undertaking to be performed after more then 5 years or from the date of allotment or within 5 years but it is not so performed, the holder is liable to pay the consideration in cash with interest at the appropriate rate s102(2) (1985) / s587(2) (2006). If the valuation report requirements (for non-cash consideration) are not complied with, the allottee is liable to pay the subscription price in cash (s103(6), 1985; s593, 2006). The company and any officer in default of incorrect financing are liable to a fine s114 (1985) / s590 (2006). However, even if the company is found to be in default, unless relief is given under s113 (1985) / s589 (2006), the company can still enforce any undertakings given by any person to transfer any consideration other than cash to the company provided that they would be enforceable apart from the provision of the Act. e) Premiums and other forms of equity contributions There is no restriction on issuing shares at a premium over their nominal value. The treatment of any issue premium, subject to exceptions, it that it must be added to the “share premium account” which is then treated in virtually all respects as if it were subscribed capital (s130 (1985) / s610 (2006). Premiums must be fully paid s101(1) (1985) / s586(1) (2006). 8. Pre-emption rights The right of pre-emption is given to shareholders through section 89 to 95 of the 1985 Act and 560 to 577 of the 2006 Act, in particular S89(1)-(3)(1985) and S561,568 (2006). The rights relate only in relation to the allotment for cash of equity shares (shares carry unrestricted rights both as to income and capital) or of securities that are convertible into such shares or that carry the right to subscribe for such shares. As mentioned before in relation to question 5, there is an exemption from these general preexemption rights in respect of shares to be held or issued under an employee’s share scheme. Where the company allots new shares following the pre-emption rules, (ie make a rights issue) section 90 (1985) and 562 (2006) sets out the rules to be followed for such an offer to existing shareholders. It must be in writing (1985) or in electronic (2006 – and note that this does not include communication by website) and be open for 21 days. In addition the Act provides that the pre-emption rights may be disapplied. The law governing such dis-application are in section 95 (1985) and 571 (2006). These sections provide that when the directors have authority under section 80 (1985) or 551 (2006) to allot
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additional shares, then the directors are able to seek authority from the shareholders also disapply the pre-emption rules. In order to be granted such powers, the shareholders of the company are required to pass a special resolution (75% majority) at a general meeting as required by the 2nd CLD. Alternatively, as permitted by the 2nd CLD, the articles might provide that pre-emption rights are automatically disapplied where an allotment authority is granted (almost unheard of in practice). Note that the articles cannot be changed without a special resolution (S9, 1985; S21, 2006). Section 95 (1985) and 571 (2006) have the requirement that any permission can be given with a limited life (it cannot be longer than the outstanding period of the section 80/ 551 authority – itself limited to five years) and hence the permission will cease if permission if revoked or if it expires (without being renewed). As part of the parts of the papers sent to the members of the company in respect of the proposed special resolution, there is a requirement that there is included a written statement setting the directors’ their reasons for making the recommendation, the amount to be paid to the company in respect of the equity securities to be allotted, and the directors' justification of that amount. It is also the case that the directors must also recommend to the members of the company that this special resolution be approved. A withdrawal of the exemption from pre-emption rights will occur if it is not renewed by the shareholders when the previous one ceases or if the members by special resolution at a general meeting. There is no ability in UK law otherwise to withdraw or reduce pre-emption rights.
Sub-section 3:
Subsequent formations
9. Subsequent formations a) - f) Subsequent formation - Concerned persons, 10 percent of the subscribed capital, shareholders’ resolution, delay of two years, valuation by an expert The legislation concerning the transfer of a non-cash asset to a public company and the remedies for breaching the legislation are detailed in s104 (1985) / s598 (2006) and s105 (1985) / s607 (2006) respectively. A company can not enter into an agreement to acquire a non-cash asset if that person is a subscriber to the company’s memorandum and the consideration for the transfer is equal to one tenth or more of the company’s nominal capital that has been issued, during the first two years from the issue of the certificate of subscription of the minimum capital (see question 1) unless certain conditions are met. The conditions are: 1) the consideration to be received by the company and any payment made by the company (other than cash) must be independently valued and a report produced (see s109 (1985) / s600 (2006)) 158
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2) the report must be made to the company during the six months preceding the agreement, and to the members prior to voting 3) the terms of the agreement must have been approved by an ordinary (majority) resolution of the company 4) a copy of the resolution and the report must have been circulated to the members of the company and the person with whom the agreement in question is proposed to be made (if not then a member of the company) by the time the notice of the meeting at which the resolution is proposed is given (s104(4) (1985) / s601(3) (2006).). g) Transparency A copy of the valuation report and the resolution passed by the company must be filed with the registrar no later than 15 days after the resolution s111(2) (1985) / s602(1) (2006). This goes beyond the requirements of the 2nd CLD. h) Exceptions There are two principal exceptions, firstly where it is part of the company’s ordinary business to acquire or arrange for other person’s to acquire some non-cash assets, and secondly where the acquisition has been sanctioned by a court. i) Consequences of incorrect subsequent formations If the person with whom the company has agreed to transact has not received a copy of the valuation report, or the report is defective then the company can recover any consideration it has paid and the transaction is void, these penalties are beyond the penalties set out by the 2nd CLD. If the agreement is for the allotment of shares in the company, then the allottee is liable to the pay the company an amount equal to the aggregate of the nominal value of the shares and the premium (to the extent paid up) with interest at the appropriate rate s105 (1985) / s604 (2006). j) Please state if subsequent formations are common in practice Whilst we can’t be definitive, we think that subsequent formations are uncommon.
Section 2:
Capital Maintenance
10. Limitation on distributions a) Principle There is no statutory facility to return funds to shareholders other than by way of one of the 2nd CLD exceptions or by way of distribution (eg, as reflected in UK legislation in s263(2) (1985) / s830 (2006). As discussed at Q18, the concept of a distribution is very wide and is a matter of common law. The principle is that there should be no distribution otherwise than in implementation of article 15 is given in sections 263-265 (1985) and 830-832 (2006). A public company may not make a distribution if, at the time of the distribution or to the extent that immediately after the distribution, its net assets are less than the aggregate of its called-up share capital and (defined) undistributable reserves. See s264 (1) (1985); s831(1) (2006). A company’s undistributable reserves are i) the share premium account (i.e. that pursuant to article 26, ii) the capital redemption reserve (i.e. that pursuant to article 39(e)), iii) the excess 159
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amount of unrealised profits over unrealised losses, iv) any other reserve which is prohibited from being distributed by another enactment or by its memorandum or articles. The redenomination reserve (which exists only under the 2006 Act s628, is also undistributable). Special rules apply for investment companies. See s265 (1985); s843 (2006). Net assets means a company’s total assets (not including uncalled share capital) less its total liabilities (including provisions) as shown in usually the last annual accounts under the 4th CLD. See ss264(2), 264(4) (1985); ss831(2), 831(5) (2006). These rules become very difficult to implement in relation to share capital shown to some extent as a liability or other similar cases (eg, forward contract to purchase own shares), under EU adopted IFRS. The Board has no discretion to circumvent this rule. b) Sanctions If an illegal distribution has been made this would give rise to a claim by the company against the recipients of the dividend (sections 277 (1985) and 847 (2006)) as the amount was illegally paid. There is also the possibility under case law for recovery to be sought from the directors, see jurisprudence below for an example Jurisprudence: Recovery for an illegal distribution to be sought from the directors - Bairstow vs Queens Moat Houses Plc [2001] 2 BCLC 531 11. Acquisition by the company of its own shares a) Possibility of acquiring its own shares The general rule is that a company may not acquire its own shares (s143(1), 1985; s658, 2006). There are, however, a number of exceptions to this (s143(3), 1985; s659, 2006) as follows: - acquisition and holding of shares (treasury shares) (ss162-162F, 1985, ss724-732, 2006), for which see the next part of this response; - acquisition and cancellation without reduction, for which see questions 15 and 17; and - various other cases, for which see the response in relation to exemptions below. b) Conditions regarding acquisition of own shares - Shareholders’ resolution (majority, time frame, content) - Amount of own shares that can be acquired - Guarantee that net assets are not affected - Fully paid up shares The response to this part of the question deals with the acquisition and holding of own shares (treasury shares). The shares that may be acquired, known as “qualifying shares”, are equity shares (s744, 1985; s548, 2006) traded on certain specified markets (s162, 1985; s724, 2006). The rules and procedures for their acquisition are essentially the same as those for acquisition and cancellation (more fully explored at questions 15 and 17), save that the acquisition must always be out of distributable profits. Under the 1985 Companies Act, a company with share capital limited by shares or limited by guarantee and having a share capital may requires authorisation in its articles of association in order to be permitted to purchase its own shares (s162). Under the 2006 Companies Act the 160
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company’s articles must not prohibit the purchase of its own shares (s690(1)(b)). This requirement for authorisation is beyond the requirements of the 2nd CLD. A maximum of 10% of each class of qualifying shares may be held by the company at any one time. Purchases via a recognised investment exchange (“market purchases”) must be authorised by a shareholder resolution (simple majority). Such a resolution may relate to a specific purchase or be general but must specify the maximum number of shares that can be acquired, a maximum and minimum price that may be paid, and contain an expiry date (not more than 18 months after the date of the resolution) (s166, 1985; s701, 2006). Different rules apply for purchases of shares otherwise than via a recognised investment exchange (“offmarket purchases”). In overview, the terms need to be authorised by a special resolution (75% majority) and the resolution must state a date by which the authority will expire, such date not to exceed 18 months from the date of the resolution (s164, 1985; ss694-699, 2006). The ability of a company to purchase treasury shares (or make any other type of distribution of profits) is also controlled by the “net assets test” (see s264, 1985; s831, 2006). This allows a distribution (or purchase of treasury shares) to be made only if the amount of the company’s net assets is not less than the aggregate of its called-up share capital and undistributable reserves (a company’s undistributable reserves are i) the share premium account (i.e. that pursuant to article 26, ii) the capital redemption reserve (i.e. that pursuant to article 39(e)), iii) the excess amount of unrealised profits over unrealised losses, iv) any other reserve which is prohibited from being distributed by another enactment or by its memorandum or articles and the redenomination reserve (which exists only under the 2006 Act s628), is also undistributable), and provided that the distribution (or purchase of treasury shares) would not reduce the company’s net assets below this amount. There is ordinarily no requirement to dispose of treasury shares. The exception to this is if the shares cease to be qualifying shares, eg because they are delisted, in which case they must be cancelled. The company must deliver to the registrar of companies a prescribed form stating each class of share purchased as well as the number and nominal value of those shares and the date on which they were delivered to the company. The form must be delivered to the registrar Within the period of 28 days beginning with the date on which any shares purchased by a company are delivered to it. This applies whether the shares are cancelled or held as treasury shares. In addition public companies shall also state the aggregate amount paid by the company for the shares; and the maximum and minimum prices paid in respect of shares of each class purchased (s169, 1985, s707 2006). This requirement goes beyond the requirements of the 2nd CLD. c) Exceptions possible for Member States - Serious and imminent harm - Employees - Others - Duty to dispose of shares and consequences of not selling Other, general exemptions from the prohibition of a company acquiring its own shares are as follows (s143(3), 1985; ss659(1)(2), 2006). - acquisition otherwise than for valuable consideration (no restrictions); - acquisition as part of a reduction in capital (no restrictions);
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- acquisition as a result of a court order as a result of alteration of the company’s objects (1985 Act only), or relief to members unfairly prejudiced (as the court may order); and - acquisition as a result of forfeiture by a shareholder for failure to pay an amount due on the shares. The legislation does not contain provisions relating to acquisition of own shares explicitly on the grounds of avoiding harm to the company. There are no exemptions on the rules to facilitate the benefit of employees. For this reason many companies set up a special purpose entity, separate from the company, often as an employee benefit trust to acquire shares for the benefit of employees. Shares acquired for this purpose will often be used to settle share-based payment arrangements. d) Shares acquired in contravention of the legal rule If a company acquires its own shares when this does not fall within one of the permitted exceptions above, the company is liable to a fine and the directors responsible are liable to a fine, imprisonment or both and (other than for purchases of treasury shares) the transaction is void (s143(2), 1985; s658(2)&(3), 2006). In the event that the rules governing the maximum holdings of treasury shares are contravened, the company must dispose of or cancel the excess shares within 12 months of the date that contravention occurs (s162B(3), 1985; s725(3), 2006). In the event of contravention of the rules in respect of treasury shares, including failure to dispose of or cancel excess treasury shares, every officer of the company who is in default is liable to a fine. e) Holding of shares - Voting rights - Inclusion of a reserve in the liabilities - Information in the annual report Where shares are held (i.e. acquired without cancellation), the company may not exercise voting rights in respect of such shares. Provided such shares are not cancelled, the existing balances in share capital and share premium in respect of these shares remain unchanged. The cost of acquiring the shares must be met from distributable profits and is thus a reduction in distributable profits, and not capital. Where a company acquires shares in itself and those shares are shown in the balance sheet (albeit that this is no longer permitted under UK GAAP or EU adopted IFRS), an amount equal to the value of those shares is transferred out of profits to a non-distributable reserve (see s148(4), 1985; s669, 2006). Where the amount received from sale of the treasury shares is greater than the cost of their acquisition, the excess must be credited to share premium account (s162F, 1985; s731, 2006). Companies accounting under UK GAAP that hold treasury shares must disclose the number and aggregate nominal value of such shares held (schedule 4, part B, s38(2), 1985). In addition the directors’ report must contain details of the number, nominal value and percentage of shares acquired, consideration paid and reason for the purchase; the maximum number, nominal value and percentage of shares held; and the number, nominal value and
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percentage of shares that are disposed of or cancelled during the year and the value of any consideration received (schedule 7, Part II, s8, 1985). f) Acceptance of the company’s own shares as security A company may not accept its own shares as security except where the shares are not fully paid and the security is in respect of the unpaid amount; where the company is a money lending company and the security is taken in the normal course of business; or where the charge was in existence before the company became a public company, and for certain old public companies (s150, 1985; s670, 2006). If a company does accept shares as security where the exceptions do not apply, the transaction is void (s150(1), 1985; s670(1), 2006). g) Application of Art. 24a if exceptions have not been chosen by Member State Not applicable. As per question 6 s143(1) (1985) / s658(1) (2006) prohibits a company from acquiring its own shares via subscription or purchase and s23 (1985) / s136 (2006) extends this prohibition to its subsidiaries. This prohibition does not apply where the subsidiary only acts as personal representative or trustee unless, in the latter case, the holding company or a subsidiary of it is beneficially interested under the trust (s23(2) (1985); s138 (2006)) or in cases in which the subsidiary acts as authorised dealers in securities (s23(3) (1985); s141 (2006)). h) Reselling of the company’s own shares (equal treatment) The resale of treasury shares is subject to the same rules regarding pre-emption rights as for the issue of new shares. These require that existing shareholders are first offered the chance to purchase the shares of terms at least as favourable as any external offer (see ss89-96, 1985; ss561-577, 2006). i) Prospective implementation of the amendments of the 2nd CLD This has not been implemented in UK law. 12. Prohibition of financial assistance Financial assistance by a company for the acquisition of its own shares is generally prohibited (s151, 1985; s678, 2006). There are however some exceptions, principally in respect of lending of money in the ordinary course of business and assisting employees to acquire shares in the company (s153, 1985, s682, 2006). The recent amendments to the 2nd CLD have not been implemented in the UK, nor is there any current, published proposal to do so. Jurisprudence: There is a great deal of common law in this difficult area, involving a great many cases. The common law here is generally thought to be very difficult and complex. 13. Loans from shareholders In the UK, there is no legislative provision in this area.
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14. Capital decreases a) Ordinary capital reduction In the UK, the conditions for an ordinary capital decrease are the calling a shareholders’ meeting, a shareholders’ resolution, a publication of the resolution, the consideration of the derogation of Art. 41 (2), the right to obtain security, and that there is no reduction to an amount less than laid down in accordance with Art. 6. The rules governing capital reduction are set out in sections 135 to 141 (1985) and 641 to 654 (2006). Put briefly, all public company capital reductions must be permitted by the articles of the company (1985 Act only) and resolved upon by the members (75% majority) and be confirmed by the court prior to the reduction being undertaken. The court has power in all cases to ensure that creditors have consulted, been paid off or been secured. These require at the first stage that the shareholders of the company need to consider and approve a special resolution which may reduce its share capital in any way. The form of reductions can include (but are not limited to): 1. extinguish or reducing the liability on any of its shares in respect of share capital not yet paid up; or 2. either with or without doing 1. above, cancel any paid-up share capital which is lost or unrepresented by available assets; or 3. either with or without doing 1. above, pay off any paid-up share capital which is in excess of the company’s wants; and the company may, if and so far as is necessary, alter its memorandum by reducing the amount of its share capital and of its shares accordingly. A special resolution needs be approved by 75% of shareholders voting and the notice for the meeting considering such a special resolution requires 14 days. However the passing reduction is not effective on the of the special resolution by the shareholders, as the resolution needs to be confirmed by the court (and records thereof filed on the public registry). As part of the court process, legislation provides that where the proposed reduction of share capital involves either diminution of liability in respect of unpaid share capital, the payment to a shareholder of any paid-up share capital, or in any other case if the court thinks it fit, every creditor of the company who at the date fixed by the court is entitled to any debt or claim which, if that date were the commencement of the winding up of the company, would be admissible in proof against the company is entitled to object to the reduction of capital. In order to allow this to occur, notice of the proposed reduction is advertised in the London Gazette. The law requires that the court shall be provided with a list of creditors entitled to object and the nature and amount of their debts or claims and also it may publish notices fixing a day or days within which creditors not entered on the list are able to claim to be so entered The court needs to be if satisfied with respect to every creditor of the company ultimately included on the list who are entitled to object to the reduction that either his consent to the reduction has been obtained, his debt or claim has been discharged or his debt or claim has been secured. 164
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The convert/discharge procedures described in the previous three paragraphs may, however, be dispensed with if, having regard to the circumstances, the court thinks it proper to do so. In practice companies always seek to have the court dispense with the procedures by demonstrating to the court that the creditors’ positions are adequately safeguarded. For example, a guarantee of payment, in favour of the creditors, might be purchased by the company from a financial guarantor (eg, a bank); or, where the reduction creates a reserve, the company might undertake not to distribute the reserve so arising until the creditors are paid off (which can be particularly limiting on the usefulness of the reduction where there are long-term creditors such as lessors). It should be noted that the securing of creditors rule (which cannot be relaxed due to art 32(1)) can sometimes have the inequitable effect of putting creditors in abetter position after the reduction than they would have been absent the reduction. If the court has been satisfied as to the consent / safeguarding of the creditors it may make an order confirming the reduction in capital on such terms and conditions as it thinks fit. The company is then required to file on the public registry, a copy of the court order and of a minute (approved by the court) showing the company's share capital as altered by the order. It is the case that only when the registration of the order and minute take place, and not before, that the resolution for reducing share capital as confirmed by the court order becomes effective. Sections 139 (1985) and 650 (2006) cover the position where the reduction of a public company's capital has the effect of bringing the nominal value of its allotted share capital below the authorised minimum (which is £50,000). The law requires that the Registrar of Companies shall not register the court order of the reduction of capital unless the court otherwise directs, or the company is first re-registered as a private limited company. b) Exceptions – condition: offsetting losses or including sums of money in a reserve, use of the amount derived from the capital decrease Neither the Derogation of Article 41 (2) nor the “simplified” procedure under Article 33 (1)) have been included into UK law. c) Prospective implementation of the amendments of the 2nd CLD The recently amended text of the 2nd Company Law Directive which must be implemented by 15 April 2008, to changes Article 32 with respect to the burden of proof has not already been implemented into national law nor if there is there currently any proposal in this context. Jurisprudence: Subject to any statutory facility providing otherwise, the common law requires that a company cannot return capital to its members except by a reduction of capital sanctioned by the court. See Trevor v. Whitworth [1887] 12 App.Cas. 409. 15. Redemption of the subscribed capital Existence of redemption of subscribed capital under national law (Member State option) The redemption of shares is effected under the legislation as an acquisition of own shares with cancellation thereof. An acquisition pursuant to the terms of the shares (i.e. that the shares are 165
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liable to such acquisition, laid down in the articles) is referred to as redemption and the shares as redeemable shares (s159, 1985; s684, 2006) Where the terms of the shares (in the articles) do not make them liable to such acquisition, they may nevertheless be so acquired and cancelled if the articles provide a general power to do so or (2006) do not prohibit it. This is referred to as a purchase of own shares (s162, 1985; s690, 2006). A ‘redemption’ is dealt with in question 17, whereas this response addresses a ‘purchase’. Condition to which the redemption is linked - Statutes - Shareholders’ resolution if applicable (majority, separate vote etc.) - Publication of the resolution - Sums that are available for distribution Shares may not be purchased unless they are fully paid (s159(3), s162(2), 1985; s691, 2006). Purchases via a recognised investment exchange (“market purchases”) must be authorised by a shareholder resolution (simple majority). Such a resolution may relate to a specific purchase or be general but must specify the maximum number of shares that can be acquired, a maximum and minimum price that may be paid, and contain an expiry date (not more than 18 months after the date of the resolution) (s166, 1985; s701, 2006). Different rules apply for purchases of shares otherwise than via a recognised investment exchange (“off-market purchases”). In overview, the terms need to be authorised by a special resolution (75% majority) and the resolution must state a date by which the authority will expire, such date not to exceed 18 months from the date of the resolution (s164, 1985; ss694-700, 2006). When a company purchases its own shares, the company must make a return to the registrar of companies stating the number and nominal value of each class of share purchased and the date they were delivered to the company. The company must also state the total amount paid for the shares and the maximum and minimum prices paid in respect of shares in each class (s169, 1985; ss707-708, 2006). A purchase may only be out of distributable profits (including by reference to the net asset test) or the proceeds of a fresh issue of shares made for the purposes of the redemption (s160(1), 1985; s692, 2006). The shares redeemed are treated as cancelled and share capital must be reduced by the nominal value of the shares (s160(4), 1985; s706, 2006). Other than where the share capital has been replaced by new share capital from a fresh issue of shares, the diminution in capital must be replaced by a corresponding increase in the capital redemption reserve (s170, 1985; s733, 2006). Any premium payable on purchase must be met out of distributable profits (s160(1), 1985; s692(3), 2006). If the shares were issued at a premium, any premium payable on purchase may be paid out of the proceeds of a fresh issue of shares made for the purposes of this purchase, up to an amount equal to the lower of (i) the premiums received by the company on the issue of the shares purchased; and (ii) the current amount of the share premium account including amounts arising from the fresh issue of shares (s160(2), 1985; s687(4), 2006).
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Rights of shareholders whose shares are purchased Once the shares have been purchased, the shares are cancelled (s160(4), 1985; s706, 2006), and the former shareholders have no further shareholder rights. Jurisprudence: Subject to any statutory facility providing otherwise, the common law requires that a company cannot return capital to its members except by a reduction of capital sanctioned by the court. See Trevor v. Whitworth [1887] 12 App.Cas. 409. 16. Compulsory withdrawal of shares This part of the directive has not been implemented into UK law. 17. Redeemable shares Existence of redeemable shares under national law (Member State option) A company may, if authorised to do so by its articles, issue shares which, according to their terms (in the articles), are liable to be acquired and cancelled, either mandatorily or at the option of the company or the shareholder (s159, 1985; s684, 2006). These are referred to as redeemable shares. The company may also have a general power in its articles to acquire and cancel shares even though the shares in question are not so liable according to their terms. This is referred to as a purchase of shares. The procedures for a purchase, as explained in question 15, are the same as for redemption of redeemable shares (except that the paragraphs referring to market purchases and off-market purchases are not relevant to the redemption of redeemable shares). Conditions to which the redemption are linked are the statutes, the fixing of terms and manner of withdrawal, the fully paying in the shares, and sums available for distribution or proceeds of a new issue. The issue of redeemable shares must be authorised by the company’s articles (s159(1), 1985; s684(3), 2006). Redeemable shares may not be redeemed unless they are fully paid (s159(3), 1985; s686(1), 2006). Redemption may only be out of distributable profits or the proceeds of a fresh issue of shares made for the purposes of the redemption (s160(1), 1985; s687(2), 2006). Inclusion of an amount in the reserves The shares redeemed are treated as cancelled and share capital must be reduced by the nominal value of the shares (s160(4), 1985; s688, 2006). Other than where the share capital has been replaced by new share capital from a fresh issue of shares, the diminution in capital must be replaced by a corresponding increase in the capital redemption reserve (s170, 1985; s733, 2006), which may not be reduced (other than in the like manner to share capital – for which see question 14). Provision for the payment of a premium
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Any premium payable on redemption must be met out of distributable profits (s160(1), 1985; s687(3), 2006). If the redeemable shares were issued at a premium, any premium payable on redemption may be paid out of the proceeds of a fresh issue of shares made for the purposes of this redemption, up to an amount equal to the lower of (i) the premiums received by the company on the issue of the shares redeemed; and (ii) the current amount of the share premium account including amounts arising from the fresh issue of shares (s160(2), 1985; s687(4), 2006). Publication When a company redeems its shares, the company must make a return of specified particulars to the public register (s122, 1985; s689, 2006). Jurisprudence: Subject to any statutory facility providing otherwise, the common law requires that a company cannot return capital to its members except by a reduction of capital sanctioned by the court. See Trevor v. Whitworth [1887] 12 App.Cas. 409.
Section 3:
Dividends and distributions
18. Definition of Distribution A comprehensive definition of distribution is not attempted. Instead the legislation implementing Article 15 is expressed to apply, subject to exceptions, to every description of distribution of a company’s assets to its members, whether in cash or otherwise. See s263 (1985); s829 (2006). The exceptions are distributions by way of i) an issue of shares as bonus shares, ii) the redemption or purchase of the company’s own shares out of capital or unrealised profits, iii) the reduction of share capital by reducing the liability of members in respect of share capital that is not fully paid up or repaying paid up share capital, or iv) a distribution of assets on a wind up. Jurisprudence: Whether a transaction amounts to a distribution is a matter of common law. There have been numerous cases, but a leading case is that of Aveling Barford Ltd vs Perion Ltd and others [1989] BCLC 626. This provides that a sale at undervalue from one company to a sister company is a distribution. Eg, the gratuity element therefore need not flow to the company’s members directly. 19. Distributable amount a) Balance sheet net assets test A public company may not make a distribution if, at the time of the distribution or to the extent that immediately after the distribution, its net assets are less than the aggregate of its called-up share capital and undistributable reserves. See s264 (1) (1985); s831(1) (2006). A company’s undistributable reserves are i) the share premium account (i.e. that pursuant to article 26, ii) the capital redemption reserve (i.e. that pursuant to article 39(e)), iii) the excess amount of unrealised profits over unrealised losses, iv) any other reserve which is prohibited from being distributed by another enactment or by its memorandum or articles. The redenomination reserve (which exists only under the 2006 Act s628), is also undistributable. 168
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Special rules apply for investment companies. See s265 (1985); s843 (2006). Net assets means a company’s total assets (not including uncalled share capital) less its total liabilities (including provisions) as shown in usually the last annual accounts under the 4th CLD. See ss264(2), 264(4) (1985); ss831(2), 831(5) (2006). The Board has no discretion to circumvent this rule. b) Earned surplus test A company can only make distributions out of its accumulated, realised profits, so far as not previously distributed or capitalised, less accumulated, realised losses, so far as not previously written off in a reduction or reorganisation of capital. See s263 (1985); s830 (2006). See below for ‘realised’, the source of which is the 4th CLD. Special rules apply for investment companies. See s265 (1985); s843 (2006) The maximum amount that can be distributed under this principle (and under (aa)) is determined by reference to the profits, losses, assets, liabilities and share capital and reserves as stated in (usually) the company’s annual accounts, under the 4th CLD, laid before members in general meeting. A profit is a realised one if it is generally accepted as so for accounting purposes per s262 (1985), s853 (2006). Pursuant to that section there are various pieces of authoritative accounting guidance in relation to determining what profits are realised, issued by the Institute of Chartered Accountants in England and Wales (ICAEW) jointly with Institute of Chartered Accountants of Scotland (ICAS). These are listed in the general information section of this document. See s275 (1985), s841 (2006) for guidance on realised profits and losses for revalued fixed assets. See s268 (1985); s843 (2006) for guidance on realised profits for insurance companies with long term business. Put simply, whilst the starting point for determining realised profits is the accounts profits, this is far from the end of the matter. First of all not all accounts profits may be realised. Second, some accounting losses may not be losses for the purposes of company law (eg, accrual of capital repayment, on liability classified preference shares, presented as an interest charge on a liability). Third, some items are profits as a matter of law but not for accounting purposes (eg, contribution of capital otherwise than for share capital). Thus the accounting profits must first be adjusted to add in some items and take others out; and then what is left must be further narrowed down to leave only the realised items. Put briefly, and subject to the question of fair value accounting, something is realised if is in the form of cash, an asset readily convertible to cash, a debtor meeting certain conditions or elimination of a liability (collectively, called Qualifying Consideration). In relation to fair value accounting, the key is whether the asset or liability that is so accounted is itself readily convertible to cash: This requires that an asset can be immediately cashed-in, eg by being able to close out the position; that observable market data for this are available; and that the company can actually dispose of/ close out the position, eg without needing to curtail its business or accept adverse terms. Directors have no discretion to circumvent this rule. Taking the net assets and earned surplus tests together, the effects of accounting under IAS 32 (and its UK equivalent – FRS 25 – applied in annual accounts of companies that do not adopt IFRS) are complex and a source of difficulty in application. The ICAEW guidance in this 169
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area (TECH 2/07) devotes considerable material to this topic. The effect of IAS 32 is in some cases to recognise a liability in relation to a share (typically a preference share) or in relation to a written option to acquire own shares in the future. The first complicates the operation of the net assets test but does not necessarily change its result: since share capital and net assets are to be determined according to the accounts, then both are reduced equally. On the other hand, the latter case restricts distributions. This is because when the liability to purchase the share is recognised, net assets are reduced and a debit is taken directly to reserves. The debit does not fall to be included (as a deduction from) share capital and undistributable reserves and thus distributions are restricted (net assets are reduced but share capital etc is not). This is so notwithstanding that the debit is not, as a matter of law, a loss and thus cannot be a realised loss. (It is not a loss because as a matter of law the amount is the advance recognition of a future capital repayment or distribution.) Thus not only are the rules difficult to comprehend and apply in the context of modern accounting practice, but are having an adverse effect on companies’ distributable reserves. Modern accounting practice is also having the effect of including ever more fair values in the accounts. This has the effect of straining or creating a disconnect between accounting profits and distributable profits on the realised earned surpluses test. As a result, there is a strong climate of opinion in the UK (eg, it is the position of the ICAEW that the usefulness and operability of a distribution test based upon accounting measures (including pursuant to IAS 32) calls for a fundamental re-appraisal of the distribution regime with the aim of breaking that link. TECH 2/07 also states “Directors are subject to fiduciary duties in the exercise of the powers conferred on them. For example, directors must consider whether the company will still be solvent following a proposed distribution, having regard to both the immediate cash flow implications of a distribution and the continuing ability of the company to pay its debts as they fall due (see paragraphs 9 and B3 of TECH 7/03). In the context of fair value accounting, volatility is an aspect where directors will need to consider their fiduciary duties. The fair value of financial instruments may be volatile even though such fair value is properly determined in accordance with IAS 39. Directors should consider, as a result of their fiduciary duties, whether it is prudent to distribute profits arising from changes in the fair values of financial instruments considered to be volatile, even though they may otherwise be realised profits in accordance with this guidance.” For the purposes of determining the lawfulness of a distribution, where a company makes a distribution in kind of a non-cash asset, any amount at which the asset is stated that is an unrealised profit for the purposes of a distribution is treated as a realised profit. See s276 (1985); s846 (2006). c) Interim dividends Where the last annual accounts under the 4th CLD, laid in general meeting, do not show sufficient net assets or profits to cover a distribution, interim accounts must be drawn up. See s270 (1985); s836 (2006). The accounts must be properly prepared and filed with the registrar. See s272 (1985); s838 (2006). In this way UK law implements the substance of Article 15(2) of the 2nd CLD but does not make formal distinctions as to interim or other dividends (and in any event, Article 15(2) does not define ‘interim dividend’).
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d) Premiums Any premium on the issue of shares will, as a matter of law, be added to the “share premium account” (same reserve as for increase under art 26). Exceptions are for share-for-share transactions and subscription of non-cash assets intra-group (provided all wholly owned). See ss130-133 (1985); ss 610-613, 615 (2006). Where the capital is, under accounting standards, (IAS 32 or its UK equivalent) presented in line with the substance of the arrangement and treated as if it were debt, it will be presented in the accounts as a liability. See Schedule 4, paragraph 5A Companies Act 1985 for legal requirement for accounts prepared under UK GAAP (Article 4 4th CLD). For accounts prepared under IFRSs, there is no specific legal provision other than to be prepared in accordance with relevant IFRSs. e) Incorrect distributions Where a member receives an unlawful distribution and at the time of the distribution he knew or had reasonable grounds to know that the distribution had been unlawfully made, he is liable to repay it. See s277(1985); s847 (2006). f) Liability A number of listed companies have made unlawful distributions. However, this is usually as a result of procedural issues which can be rectified by repeating the procedures in the correct manner and passing a resolution in general meeting to waive any rights of recovery in relation to the unlawful distribution, thereby remaking the distribution. Without being able to cite specific cases we are also aware of cases where intra-group dividends have been returned as unlawful. We are not aware, within our client base, of directors being pursued. However this does happen occasionally. (See below) Jurisprudence: As a matter of common law, the directors must consider whether there has been a fall in the distributable reserves of the company subsequent to the date of the relevant accounts. This may limit the maximum amount of distribution that can be legally made. Re Exchange Banking Co [1882] 21 Ch. D. 519. In certain situations the common law would consider directors liable to compensate the company for the losses caused by the unlawful dividend. Also, Bairstow v Queens Moat Houses Plc [2001] 2 BCLC 531,. The argument that directors who knowingly recommend an unlawful divided may be personally liable only where the company was insolvent was rejected by the Court of Appeal. One of the authoritative publications on company law, Buckley on the Companies Act, notes ‘There is no specific requirement in CA 1985, Part VIII that a company should not make a distribution if to do would render it unable to meet its liabilities actual and foreseeable, but it is considered that there is probably a rule of law to this effect.’ It cites Peter Buchanan Ltd v McVey [1955] A.C. 516 as authority for this proposition.
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20. Determination of the distributable amount a) Proposal by the company’s bodies Under the standard Table A articles (the default articles of a company unless it adopts something different), a distribution can be decided on by the directors or be declared by the members in general meeting by a simple majority. In the latter case the amount must not exceed that recommended by the directors. b) Authorisation by the general meeting Content of the resolution – No specific national provision. In the case of a dividend to be approved by shareholders, typically the amount of the proposed dividend per share, the date on which the dividend will be paid and the date on which the shareholder must be included on the company’s register of shareholders to be entitled to the dividend, will be given. The distribution would be considered unlawful unless it is supported by the accounts. There is no specific procedural requirement to check the accounts, but sanctions apply if the distribution is unlawful. See Question 19. But note that if the accounts relied upon are the annual accounts (4th CLD) they must first be laid in general meeting, if they are interim accounts, they must be filed on the public registry. c) Publication There is no national provision to publish the results of an ordinary resolution. The resolution will be documented in the minutes of the board or general meeting (as appropriate). d) Challenge to resolutions It is usually thought that, as with a proposed unlawful payment out of capital at common law, a proposed dividend payment contrary to the Act may be restrained by injunction at the suit of an individual shareholder. See, eg, Gore-Browne on Companies 25[14] which cites Hoole v Great Western Railway Co [(1867) 3 Ch App 262] as authority for this proposition. e) Challenge to distributions in practice In practice, it is not, however, common for such a challenge to be made. Jurisprudence: Hoole v Great Western Railway Co [(1867) 3 Ch App 262] 21. Accounting reserves that influence the distributable amount a) Revaluation of tangible fixed assets, fair valuation accounting, accounting for formation expenses A separate reserve is required by Schedule 4 paragraph 34, 1985; under the 2006 Act it will be included within the regulations which are yet to be issued. Article 33(2)(cc) provides that the revaluation reserve must not be distributed unless it represents gains actually realised. There is no specific national provision on this as it is instead covered by the general provision (s263 (1985); s830 (2006)) that only realised profits may be distributed.
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Formation expenses must not be treated as an asset of the company, therefore written off immediately. See Schedule 4, paragraph 3(2)(a); under the 2006 Act it will be included within the regulations which are yet to be issued. Fair valuing financial instruments – Separate reserve required for the cases stated in Art 42c of the 4th CLD. See Schedule 4 paragraphs 34E, 34F (1985); 2006, will be included within the regulations which are yet to be issued. Draft guidance on whether these profits and losses are realised is contained within TECH 21/05. Fair valuing of other assets through profit and loss account – The fair value concept has been extended to other specified categories of assets, ie, investment properties and living animals and plants. See Schedule 4 paragraph 34 (1985); 2006 will be included within the regulations which are yet to be issued. Changes in fair value are recorded in the profit and loss account unless they meet certain criteria in which case they are recorded in a separate reserve. See Schedule 4 paragraph 34E/34F (1985); 2006, will be included within the regulations which are yet to be published. Draft guidance on whether these profits and losses are realised is contained within TECH 21/05. b) Redenomination reserve Under the 2006 Act a company may redenominate its shares and, subject to limitations, reduce its share capital to obtain a more suitable value. The difference is recorded in a separate redenomination reserve that is treated as if it were share capital. See s626, 628 (2006).
Section 4:
Capital related rules in case of crisis and insolvency
22. Serious loss of the subscribed capital a) Condition linked to the calling of the general meeting A serious loss of capital arises where the net assets of a public company are half or less of its called-up share capital. See s142 (1985); s656 (2006). If a company suffers a serious loss of capital, the directors of the company shall call an ordinary general meeting not later than 28 days from the earliest day on which that fact is known to a director. Furthermore, the meeting must be convened for a date not later than 56 days from that day (s142(1) (1985); s656(1)-(3) (2006)). b) Consequences The purpose of the general meeting is to consider whether any, and if so what, steps should be taken to deal with the situation (s142(1) (1985); s656(1) (2006)). Since the steps that may be taken are not restricted in any way, it thus covers the possibility of wind-up.
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23. Trigger of insolvency There are several different types of insolvency process ranging from those to promote rescue of the company to winding up and dissolution. These are described in the Insolvency Act 1986. There is also one process contained in the Companies Acts: the Scheme of Arrangement (s425), which may be used to compromise the claims of creditors outside an insolvency process. a) Factors triggering insolvency Tests which trigger formal insolvency are contained in s123 Insolvency Act 1986 (see response to Q44 for details). The test is the same for each type of insolvency (administration, liquidation, provisional liquidation) except receiverships (enforcement by a creditor holding a security right, where enforcement depends on the terms of the security). S123 of the Insolvency Act 1986 state a company is unable to pay its debts if: • a statutory demand (a formal demand that a debt be paid) is served on the company for a sum exceeding £750 and remains unpaid for 21 days thereafter; • the execution of a court order to enforce a debt could not satisfy the whole of the debt due; • it is proved to the satisfaction of the court that the company cannot pay its debts as they fall due (cash flow test); • it is proved to the satisfaction of the court that the value of the company’s assets is less than the amount of its liabilities, taking into account prospective and contingent liabilities (balance sheet test). The inclusion of prospective and contingent liabilities makes this a difficult test to apply. However, the test is not a strict one but one for the court’s discretion. b) Time frame There is no formal timeframe for applying these tests, as they are occurrences instigated by creditors which the directors cannot predict. In practice, responsible directors will take advice if these events occur on anything more than a one-off basis. The exact point at which insolvency is inevitable (by which time the directors must act in the creditors’ interests and enter insolvency proceedings) is dependent on the specific facts of each case and is not set down by statute. There is a general common law test of “a director having reasonable knowledge, skill and care”. The courts will thus look at what a director ought to have done in that light. Again, there is substantial case law, but see Re Produce Marketing Consortium [1989] 5 B.C.C. 569. c) Duties of the board members After insolvency has been entered the insolvency officeholder will review the conduct of the directors to see whether they entered insolvency proceedings as soon as they knew, or should have known, that there was no reasonable prospect of avoiding insolvent liquidation (s214 Insolvency Act) If they did not, there is a further test of their duty in s214 which is whether they took every step to minimise the potential loss to creditors as soon as they knew, or should have known, that there was no reasonable prospect of avoiding insolvent liquidation. There is no statutory obligation for the directors to commence insolvency proceedings. However the directors are open to statutory liability under s214 once they know that there is no prospect of avoiding insolvent liquidation. 174
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d) Treatment of subscribed capital, premiums, shareholder loans Shareholder loans – treated as an ordinary unsecured creditor unless specific loan documentation exists to prove otherwise (either to subordinate the loans or to grant them security); Subscribed capital and share premiums –a shareholder is subordinated to all creditors. If creditors are not paid in full there will be no payment in respect of capital. Jurisprudence: aa) There is a huge body of case law on various aspects of the insolvency test. bb) There is substantial case law, but see Re Produce Marketing Consortium [1989] 5 B.C.C. 569 cc) Case law surrounding this area is extensive but without reviewing each case’s specific facts it is difficult to ascertain which cases are most relevant to the point.
Section 5:
Contractual self-protection of creditors
24. Contractual self-protection Under UK law it is entirely usual for certain creditors to negotiate the terms of contractual protections with companies. As long as these are not illegal under any statutory provision any such terms are permitted. There are no standard contracts mandated, though banks and similar financial institutions will normally try to impose their institution’s standard terms. However each case is negotiated on its own facts. The most common contractual protections are security for lending (fixed or floating charges); financial covenants in relation to lending (eg ratio based); retention of title over stock; invoice discounting (factoring) of debts; and guarantees from other parties.
Section 6:
Equal treatment
25. Principle of equal treatment The 2nd CLD does not require equality generally, but only in the case of the application of the 2nd CLD’s provisions (which do not appear to us to include any right to receive a dividend). UK legislation does not have any single provision that corresponds with article 42. Rather, wherever a provision implements a directive provision, the principle of equality is taken into account in so far as the members in question are in the same position. For example, the general rule, insofar as the articles of the company do not make other provision (s370(1) (1985); s284(4) (2006)) is that , in respect of a company having a share capital, every shareholder has one vote in respect of each share or each £10 of stock held (s370(6) (1985); s284 (1) – (3) (2006)) or in cases in which equity shares are allotted for cash consideration pre-emption rights are, subject to certain exceptions, granted to shareholders equal to the proportion of the nominal value held by him of the share capital (s89 (1) (1985); s561 (1) (2006)). It is permissible to disapply pre-emption rights in accordance with legal provisions (s95 (1980); s564-571 (2006)).
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3.2 Non-EU legal annexes 3.2.1 USA Delaware Delaware is the most important source of state corporation law in the United States at least for publicly traded corporations. More than half of the corporations listed for trading on the New York Stock Exchange and nearly 60 % of the Fortune 500 corporations are incorporated in Delaware.
Section 1:
Capital formation
Sub-section 1:
Formation of the stock corporation
1. Stated capital and other means of equity financing Delaware continues to follow with respect to the equity financing for stock corporations traditional legal capital rules, but with several important twists. a) Minimum subscribed capital The Delaware General Corporation Law (DGCL) does not prescribe a minimum stated capital; instead stated capital (stock with par value) can be fixed in the certificate of incorporation. b) Composition of capital: stated capital and other forms of equity financing (premiums) In Delaware every corporation may issue classes of stock with par value or stock without par value as shall be stated and expressed in the certificate of incorporation, or in the resolution providing for the issue of such stock adopted by the board of directors pursuant to authority expressly vested in it by the provisions of its certificate of incorporation (§ 151(a) DGCL). In the case stock is issued without par-value the corporation has to specify this in certificate of incorporation (see Section 1, No. 1d), infra). According to Delaware law any corporation may, by resolution of its board of directors, determine that only a part of the consideration which shall be received by the corporation for any of the shares of its capital stock which it shall issue shall be capital (§ 154 DGCL). But, in case any of the shares issued shall be shares having a par value, the amount of the part of such consideration so determined to be capital shall be in excess of the aggregate par value of the shares issued for such consideration having a par value, unless all the shares issued shall be shares having a par value, in which case the amount of the part of such consideration so determined to be capital need be only equal to the aggregate par value of such shares. In each such case the board of directors shall specify in dollars the part of such consideration which shall be capital. If the board of directors shall not have determined (1) at the time of issue of any shares of the capital stock of the corporation issued for cash or (2) within 60 days after the issue of any shares of the capital stock of the corporation issued for consideration other than cash what part of the consideration for such shares shall be capital, the capital of the corporation in respect of such shares shall be an amount equal to the aggregate par value of such shares having a par value, plus the amount of the consideration for such shares without par value.
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The amount of the consideration so determined to be capital in respect of any shares without par value shall be the stated capital of such shares. The capital of the corporation may be increased by resolution of the board of directors directing that a portion of the net assets of the corporation in excess of the amount so determined to be capital be transferred to the capital account. The board of directors may direct that the portion of such net assets so transferred shall be treated as capital in respect of any shares of the corporation of any designated class or classes. The excess, if any, at any given time, of the net assets of the corporation over the amount so determined to be capital shall be surplus. “Net assets” means the amount by which total assets exceed total liabilities. Capital and surplus are not liabilities for this purpose. The determination of the amount that is to be “capital” and the amount that is to be “surplus” is one that essentially is within the control and discretion of the board of directors with one exception: an amount equal to the par value of all shares with par value must be allocated to capital. The Delaware General Corporation Law contains no prescriptions as to the form or manner of preparing and maintaining books of account and financial statements nor of the manner in which the corporation values its assets for such purposes (for further information on accounting methods see Section 3, No. 18bb2), infra). c) Authorised capital Delaware law allows authorised capital. § 161 DGCL provides that the directors may, at any time and from time to time, if all of the shares of capital stock which the corporation is authorised by its certificate of incorporation to issue have not been issued, subscribed for, or otherwise committed to be issued, issue or take subscriptions for additional shares of its capital stock up to the amount authorised in its certificate of incorporation. d) Information to be made public The Delaware General Corporation Law requires that if the corporation will have the authority to issue only a single class of stock, the certificate of incorporation must recite the total number of shares authorised for issue and the par value of such shares or a statement that there is no par value (§ 102(a)(4) DGCL). If the corporation will have the authority to issue more than one class of shares, then the certificate of incorporation must set forth the number of shares of all classes which the corporation has the authority to issue and the number of shares of each class and the par value of such shares or the certificate of incorporation must contain a statement that there is no par value. However, the amount of surplus does not have to be disclosed in this manner. e) Consideration for stock § 152 of the Delaware General Corporation Law states that the consideration, as determined pursuant to subsections (a) and (b) of § 153 DGCL, for subscriptions to, or the purchase of, the capital stock to be issued by a corporation shall be paid in such form and in such manner as the board of directors shall determine. The board of directors may authorise capital stock to be issued for consideration consisting of cash, any tangible or intangible property or any benefit to the corporation, or any combination thereof. In the absence of actual fraud in the transaction, the judgment of the directors as to the value of such consideration shall be conclusive. Therefore, the DGCL grants a board of directors considerable discretion in determining the consideration for the issuance of non-par value shares. Future profits or services to a company are not valid or lawful consideration. In addition, while the board of directors may employ non-directors to assist them in arriving at 177
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value to be placed on the property to be received in exchange for the corporation’s stock, directors do not have the power to delegate the duty of determining consideration for stock. The capital stock so issued shall be deemed to be fully paid and nonassessable stock upon receipt by the corporation of such consideration; provided, however, nothing contained in § 152 DGCL shall prevent the board of directors from issuing partly paid shares under § 156 DGCL. 2. Subscription of capital Delaware law contains rules which deal with the subscription of shares. a) Link of subscribed capital’s injection with subscription of shares In the case par values have been chosen, under Delaware law the formation of the subscribed capital is technically linked to the issuance of shares because a person subscribing a share is to pay a certain part of the subscribed capital. b) Time limit Under Delaware law there is no time limit within which the shares must be subscribed. c) Prohibition of subscription of shares by the corporation itself In Delaware there is no prohibition that shares may be subscribed by the corporation itself. In practice, however, it does not seem to be realistic that a corporation would issue shares to itself. d) Setting of the price of the shares The board of directors may authorise capital stock to be issued by a corporation which shall be paid in such form and in such manner as the board of directors shall determine (with respect to the principle of issuances of shares at a price lower than the par value see Section 1, No. 1e), infra). Only in the case the certificate of incorporation so provides, the stockholders decide on the amount of the consideration. The consideration may consist of cash, any tangible or intangible property or any benefit to the corporation, or any combination thereof. In the absence of actual fraud in the transaction, the judgment of the directors as to the value of such consideration shall be conclusive. The principle in evaluating the directors’ determination of consideration is the absence of fraud (see also Section 1, No. 3d, infra). e) Prohibition of share issues at a price lower than the nominal value/accountable par Under Delaware law shares of stock with par value may be issued for such consideration, having a value not less than the par value thereof, as determined by the board of directors, or by the stockholders if the certificate of incorporation so provides (§ 153(a) DGCL). There is no minimum par value prescribed by Delaware law. Shares of stock without par value may be issued for such consideration as is determined by the board of directors, or by the stockholders if the certificate of incorporation so provides. If the certificate of incorporation reserves to the stockholders the right to determine the consideration for the issue of any shares, the stockholders shall, unless the certificate requires a greater vote, do so by a majority vote. f) Consequences of share issues at a price lower than the nominal value/accountable par § 152 of the Delaware General Corporation Law provides that capital stock so issued shall be deemed fully paid and non-assessable stock upon receipt of the consideration due and, 178
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pursuant to § 153(a) DGCL, shares of stock with par value may not be issued for consideration having a value less than the par value thereof. Pursuant to § 152 DGCL, in the absence of actual fraud in the transaction, the judgment of the directors as to the value of the consideration shall be conclusive. Stockholders may bring a claim for fraud through a derivative action. However, in an action by a stockholder to cancel stock issued by a corporation on the grounds of improper motive where the defendants are not deemed to be on both sides of the transaction, the defendants are entitled to start with a presumption of good faith (Benett v. Breuil Petroleum Corp., 34 Del. Ch. 6, 99 A.2d 236 (1953)). Although “good faith” is not defined and is a subjective standard, it generally means in this case that the directors acted with honesty of intention, openness and fair dealing. § 145(a) and (b) DGCL give corporations the right (but not the obligation) to indemnify directors for costs incurred in actions brought against them by reason of the fact that they are directors; provided that the director acted in good faith, among other requirements. Most corporations (particularly public ones) have a provision in their certificate of incorporation or bylaws which require the corporation to indemnify directors (and, in most but not all cases, officers, at the option of the corporation). Even if the claim is for fraud, § 145(e) DGCL permits the corporation to advance expenses pending an adjudication on the issue, provided that the director undertakes to repay the corporation in the event that it is ultimately determined that the director’s conduct did not permit indemnification. Most public companies also include a provision in their certificate of incorporation or bylaws incorporating this requirement. § 145(c) DGCL provides that if the director successfully defends any action, claim or proceeding referred to in § 145(a) and (b) DGCL on the merits, the director shall be indemnified for expenses (including attorneys’ fees) actually and reasonably incurred therewith. g) Design of shares As discussed above (see Section 1, No. 1b), supra), the Delaware General Corporation law provides that every corporation may issue one or more classes of stock or one or more series of stock within any class thereof, any or all of which class may be of stock with par value or stock without par value and which classes or series may have such voting powers, full or limited, or no voting powers, and such designations, preferences and relative, participating, optional or other special rights, and qualifications, limitations or restrictions thereof (§ 151(a)). h) Information to be fixed in the statutes As stated above (see Section 1, No. 1d), supra), the Delaware General Corporation Law states that issuance of stock with par or no par value shall be stated and expressed in the certificate of incorporation or in any amendment thereto, or in the resolution or resolutions providing for the issue of such stock adopted by the board of directors pursuant to authority expressly vested in it by the provisions of its certificate of incorporation (§ 151(a) DGCL)). 3. Contributions Under Delaware law provisions exist concerning the question what can be injected as capital /funds and of how it can be injected into the corporation. a) Contributions in cash and in kind The Delaware law allows both contributions in cash and contributions in kind (§ 152 DGCL). 179
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aa) Contribution in cash The Delaware General Corporation Law provides that the board of directors may authorise capital stock to be issued for consideration consisting of cash (§ 152 DGCL). bb) Contribution in kind Under Delaware law contributions in kind include any tangible or intangible property or any benefit to the corporation, or any combination thereof (§ 152 DGCL). Future services to a corporation are not lawful consideration. cc) Stockholder’s obligation In Delaware the rights of stockholders are contractual rights. According to § 152 DGCL, the stock issued is deemed fully paid and non-assessable if: (1) the par value or stated value of the stock is paid in full by consideration in the form of cash, any tangible or intangible property or any benefit to the corporation, or any combination thereof; (2) the corporation has received a binding obligation from the purchaser for any balance of the consideration; and (3) the board of directors had decided that the stock was not issued as partly paid shares pursuant to § 156 DGCL. b) Amount to be paid in Delaware law allows for any corporation to issue the whole or any part of its shares as partly paid and subject to call for the remainder of the consideration to be paid therefore (§ 156 DGCL). The section requires that the amount of consideration outstanding shall be documented on the face or back of each stock certificate issued to represent any such partly paid shares, or upon the books and records of the corporation in the case of uncertificated partly paid shares, the total amount of the consideration to be paid therefor and the amount paid thereon shall be stated. c) Valuation of contributions in kind Under Delaware law shares of stock with par value shall be issued for such consideration as determined (having a value not less than par value thereof for par value shares) by the board of directors, or by the stockholders if the certificate of incorporation so provides (§ 153(a) DGCL). § 153(b) DGCL states that shares of stock without par value shall be issued for such consideration as determined by the board of directors, or by the stockholders if the certificate of incorporation so provides. The discretion of the board of directors in the sale of its no-par value stock shall not be interfered with, except in the case of improper motive, personal gain, arbitrary action, conscious disregard of the interests of the corporation and the rights of its stockholders, or clear abuse. Under § 152 DGCL, the board of directors may employ non-directors to assist them in arriving at value to be placed on property to be received in exchange for the corporation’s stock, but directors do not have the power to delegate this duty of determining consideration for stock. Ultimate responsibility for valuing contributions in kind lies with the board of directors. 180
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Case-law suggests that directors, when selling stock to themselves, should seek independent evidence of the market value of the consideration (heightened scrutiny because it is an insider transaction). For example, in Union Illinois v. Korte, C.A. No. 17392, slip-op. at 16 (Del. Ch. Nov. 28, 2001), the court found the directors’ conduct with respect to the selling stock price was not entirely fair when the directors “failed to establish the value of the stock they sold to themselves.” In determining the price to pay for each share, the board of directors did not seek any independent evidence of the market value of the stock, but instead, relied solely on information provided to them by the chief financial officer, which did not include the basis for the price in this offering or in the two previous offerings that the chief financial officer relied on for guidance, and did not contain any indication that the prior stock sales were for market value. The court noted that while a corporation in financial distress issues stock as a means to raise needed capital, its directors are given considerable latitude in fixing the price for issuance; provided, however, directors must employ or establish a reliable method to set a sale price for the stock of the corporation. If the certificate of incorporation reserves to the stockholders the right to determine the consideration for the issue of any shares, the stockholders shall, unless the certificate requires a greater vote, do so by a vote of a majority of the outstanding stock entitled to vote thereon (§ 153(d) DGCL). d) Consequences of incorrect financing Delaware law differentiates between the following consequences of incorrect financing: aa) Voidability of the stock Although the Delaware General Corporation Law does not provide a definitive answer as to the remedy for stock that has been issued illegally because it was issued without consideration or without proper or adequate consideration, the case-law has held that the stock is voidable, not void, and the stockholder’s acceptance of the stock raises an implied agreement and equitable obligation to pay lawful consideration for it. Case-law has held that the issuance of stock as fully paid for a consideration never delivered to, nor acquired by, the corporation constitutes “actual fraud” within the meaning of § 152 DGCL. In Diamond State Brewery, 17 A.2d 313 (1941) the plaintiff corporation filed a lawsuit against defendant stockholders alleging that the shares they held were illegally issued, without sufficient consideration and should therefore be cancelled. The court found that the corporation had issued shares of stock to an individual as payment for a beverage formula and equipment. However the corporation never received the equipment. Partial consideration was also attributed to a secret formula, but the court found that the formula did not have substantial value. Therefore, the court concluded that the corporation was entitled to cancellation of the shares of stock. Furthermore the issuance of the shares may be invalidated on equitable grounds in instances of gross overvaluation, although the Delaware General Corporation Law grants the board of directors a great deal of discretion. In order to establish actual fraud, the courts require two things. First, there must be a showing of gross overvaluation that would establish constructive fraud (as opposed to actual fraud). Second, there must be allegations of other facts sufficient in combination with the fact of overvaluation that may provide a basis to infer actual fraud. In Fidanque v. American Maracaibo Co., 92 A.2d 311 (1952), stockholders filed suit to enjoin a corporation from carrying out an agreement for an exchange of shares with another 181
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company, claiming that a director, who was also a director of the other company, had committed fraud and that the agreement effected a merger without complying with statutory requirements. They also alleged that an employment agreement with a corporate official, the former president who was over 70 years of age and in poor health, lacked adequate consideration. A majority of the corporation’s stockholders ratified both agreements. Although typically the burden of proof lies with the party bringing the claim, in cases involving two interlocking directorates (where the director is on both sides of the transaction), the burden is upon the directors to prove the validity of their actions and their good faith. However, a stockholder ratification shifts the burden of proof back to the objector. In Fidanque, the court held that although one director was acting in a dual capacity, the record did not disclose overreaching or fraud. Because the exchange agreement was not ultra vires or illegal, its ratification by the stockholders cured any defect. However, the court did find that the compensation to be paid to the former president was so out of proportion to the services he could be expected to render that the employment agreement constituted an illegal gift of corporate funds and was null and void. The court stated that mere inadequacy of price, unless so gross as to lead the court to conclude that it was due not to an honest error of judgment but rather to bad faith or to a reckless indifference to the rights of others interested, will not reveal fraud. bb) Claims of stockholders and creditors Stockholders, receivers in the case of an insolvent corporation, or creditors may make claims concerning unpaid or partially paid stock. The party bringing the claim generally has the burden of proof. Furthermore, as stated above, § 145(a) and (b) DGCL give corporations the right (but not the obligation) to indemnify directors for costs incurred in actions brought against them by reason of the fact that they are directors provided that the director acted in good faith (i.e., absent fraud), among other requirements. cc) Liability of stockholders vis - à - vis creditors § 162(a) DGCL states that when the whole of the consideration payable for shares of a corporation has not been paid in, and the assets shall be insufficient to satisfy the claims of its creditors, each holder of or subscriber for such shares shall be bound to pay on each share held or subscribed for by such holder or subscriber the sum necessary to complete the amount of the unpaid balance of the consideration for which such shares were issued or are to be issued by the corporation. All who hold stock not paid for are liable to creditors for the amount so unpaid (Scully v. Automobile. Fin. Co., 12 Del. Ch. 174 (1920)). dd) Return of dividends There is no particular case law regarding the consequences if a stockholder receives dividends or profits on partially paid shares which are higher than those received by stockholders of fully paid shares. However, when directors, as trustees for the stockholders, issue capital stock to themselves for services within the scope of their duty, the court has found that dividends or profits distributed on unpaid stock certificates must be returned. For example, in Lofland v. Cahall, 13 Del. Ch. 384 (1922), appellee receiver filed a complaint against appellant directors to compel the return of dividends or profits and the cancellation of certain stock certificates that were fraudulently and unlawfully issued. The court found that, in the circumstances, the shares they issued to themselves were unlawful and constructively fraudulent and that the profits derived therefrom must be returned to the corporation.
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ee) Correction of failure by stockholder If the equities favour the stockholder, he can correct his or her failure to pay proper consideration for the stock at the time of issue and retain his proprietary interest in the corporation (MacLary v. Pleasant Hills, Inc., 35 Del. Ch. 39 (Del. Ch. 1954)). 4. Accounting for formation expenses Although Delaware law does not require the use of US generally accepted accounting principles (US-GAAP), many corporations follow these rules. According to Statement of Position No. 98-5 (Reporting on the Costs of Start-Up Activities), costs of start-up activities and organisation costs must not be capitalised. Instead, these costs have to be expensed as incurred.
Sub-section 2:
Capital increases
5. Issuance of new shares Delaware law disposes of different rules regarding the issuance of new shares. a) Increase of capital by use of authorised capital Under Delaware law the authority of the corporation to issue new shares is set forth in the certificate of incorporation. The issuance of new shares must use authorised capital according to § 161 DGCL. § 102(a)(4) DGCL requires that if the corporation will have only a single class of stock, the certificate must recite the number of shares authorised for the issue and whether they are par or no-par. If the corporation will have authority to issue more than one class of shares, then the certificate must set forth the number of shares authorised of all classes and of each class and whether the shares are par or no-par. The board of directors must authorise any issuance of stock by the corporation. There is no maximum amount the authorised shares may cover set by law. In the case all shares that are covered by the certificate of incorporation have already been issued the corporation may amend its certificate of incorporation to increase its authorised capital stock (§ 242(a) DGCL). The amendment first must be proposed by the board of directors in a resolution setting forth the proposed amendment and declaring its advisability. After the proposed amendment has been duly approved by the board of directors it must then be submitted to the stockholders at the next annual meeting, or at a special meeting called for the purpose of considering the amendment, or it may be submitted to the stockholders entitled to vote thereon for adoption by written consent if the certificate so allows. If a majority of the outstanding stock entitled to vote thereon, and a majority of the outstanding stock of each class entitled to vote thereon as a class, has been voted in favour of the amendment, a certificate setting forth the amendment and certifying that such amendment has been duly adopted in accordance with § 242 DGCL shall be executed, acknowledged and filed and shall become effective in accordance with § 103 DGCL. As an alternative, § 151(g) DGCL provides that if the shares are not authorised in the certificate of incorporation or an amendment thereto, a resolution or resolutions adopted by the board of directors pursuant to authority expressly vested in it by the certificate of incorporation or any amendment thereto, a certificate of designations setting forth a copy of such resolution or resolutions and the number of shares of stock of such class or series as to which the resolution or resolutions apply shall be executed, acknowledged, filed and shall become effective, in accordance with § 103 DGCL. 183
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b) Rules of stock exchanges concerning stockholder approval for issuing shares In addition to the rules of the Delaware General Corporation Law there are rules of US stock exchanges that require stockholder approval for issuing shares. aa) New York Stock Exchange (NYSE) The NYSE, pursuant to § 312.03 of the Listed Company Manual, states that stockholder approval is required for the issuance of securities in the following situations: (a) equity compensation plans; (b) in any related transactions to (1) a director, officer or substantial security holder of the corporation (each a “Related Party”), (2) a subsidiary, affiliate or other closely-related person of a Related Party, or (3) any company or entity in which a Related Party has a substantial direct or indirect interest, if the number of shares of common stock to be issued, or if the number of shares of common stock into which the securities may be convertible or exercisable, exceeds either 1% of the number of shares of common stock or 1% of the voting power outstanding before the issuance; (c) prior to the issuance of common stock, or of securities convertible into or exercisable for common stock, in any transactions or series of related transactions if (1) the common stock has, or will have upon issuance, voting power, equal to or in excess of 20 % of the voting power outstanding before the issuance of such stock or of securities convertible into or exercisable for common stock, or (2) the number of shares of common stock to be issued is, or will be upon issuance, equal to or in excess of 20 % of the number of shares of common stock outstanding before the issuance of the common stock or of securities convertible into or exercisable for common stock. bb) National Association of Securities Dealers Automated Quotation-System (NASDAQ) NASDAQ, pursuant to Market Place Rule 4350(i), requires stockholder approval prior to the issuance of securities: (a) when a stock option or purchase plan is to be established or materially amended or other equity compensation arrangement made or materially amended, pursuant to which stock may be acquired by officers, directors, employees, or consultants (with respect to the exceptions from this rule see Market Place Rule 4350(i)); (b) when the issuance or potential issuance will result in a change of control of the issuer; (c) in connection with the acquisition of the stock or assets of another company if (i) any director, officer or 5 % or greater stockholder has a 5 % or greater interest (or such persons collectively have a 10 % or greater interest), directly or indirectly, in the corporation or assets to be acquired or in the consideration to be paid in the transaction(s) and the present or potential issuance of common stock, or securities convertible into or exercisable for common stock, could result in an increase in outstanding common stock or voting power of 5 % or more or (ii) where, due to the present or potential issuance of common stock, or securities convertible into or exercisable for common stock, other than a public offering for cash (a) the common stock has or will have upon issuance voting power equal to or in excess of 20 % of the voting power outstanding before the issuance of stock or securities convertible into or exercisable for common stock, or (b) the number of shares of common stock to be issued is or
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will be equal to or in excess of 20 % of the number of shares of common stock outstanding before the issuance of the stock or securities; or (d) in connection with a transaction other than a public offering involving (i) the sale, issuance or potential issuance by the issuer of common stock (or securities convertible into or exercisable for common stock) at a price less than the greater of book or market value which together with sales by officers, directors or substantial stockholders of the corporation equals 20 % or more of common stock or 20 % or more of the voting power outstanding before the issuance, or (ii) the sale, issuance or potential issuance by the corporation of common stock (or securities convertible into or exercisable common stock) equal to 20% or more of the common stock or 20 % or more of the voting power outstanding before the issuance for less than the greater of book or market value of the stock. cc) American Stock Exchange (AMEX) § 711 of the Amex Company Guide states that approval of stockholders is required in accordance with § 705 with respect to the establishment of (or material amendment to) a stock option or purchase plan or other equity compensation arrangement pursuant to which options or may be acquired by officers, directors, employees, or consultants, regardless of whether or not such authorisation is required by law or the corporation’s charter (with respect to the exceptions from this rule see § 711 of the Amex Company Guide). § 713 of the Amex Company Guide states that AMEX will require shareholder approval in accordance with § 705 as a prerequisite to approval of applications to list additional shares to be issued in connection with: (a) a transaction involving (i) the sale, issuance, or potential issuance by the corporation of common stock (or securities convertible into common stock) at a price less than the greater of book or market value which together with sales by officers, directors or principal stockholders of the corporation equals 20 % or more of presently outstanding common stock, or (ii) the sale, issuance, or potential issuance by the corporation of common stock (or securities convertible in common stock) equal to 20 % or more of presently outstanding stock for less than the greater of book or market value of the stock; or (b) a transaction which would involve the application of AMEX’s original listing standards as described in § 341. § 713 does not apply to public offerings. 6. Subscription of new shares With respect to the subscription of new shares which were issued during a capital increase the same rules apply which Delaware law provides for the subscription of shares during the formation of the corporation. This applies for the time frame (see Section 1, No. 2b), supra), the prohibition of subscriptions of shares by the company itself (see Section 1, No. 2c), supra) the setting of the price of the shares (see Section 1, No. 3d), supra) and the prohibition of share issues at a price lower than the nominal value/ accountable par (see Section 1, No. 2e) and f), supra). With respect to the information to be made public, it should be noted that Delaware law requires in case the capital is increased that the owners of the shares should be added to the records of the corporation.
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7. Contributions Regarding capital contributions and their payment at the stage of a capital increase the same regulations apply as those at the stage of formation. As in the stage of formation the Delaware General Corporation Law allows both contributions in cash and contributions in kind (§ 152 DGCL, see Section 1, No. 2a), supra). Furthermore with respect to the amount to be paid in (see Section 1, No. 2b), supra), the valuation of contributions of kind (see Section 1, No. 2c), supra) and the consequences of incorrect financing (see Section 1, No. 2d), supra) the same rules are applicable as in the stage of formation. 8. Pre-emption rights Delaware law recognises pre-emptive rights. They are understood as rights that safeguard a stockholder’s right to maintain ownership of his proportionate share of the assets and protect a proportion of the voting control. In Delaware the law does not explicitly provide for pre-emption rights but allows such a right in the certificate of incorporation. § 102(b)(3) of the Delaware General Corporation Law states that no stockholder shall have any pre-emptive right to subscribe to an additional issue of stock or to any security convertible into such stock unless, and except to the extent that, such right is expressly granted to such stockholder in the certificate of incorporation. All such rights in existence on July 3, 1967 shall remain in existence unaffected by this paragraph unless and until changed or terminated by appropriate action which expressly provides for the change or termination. Delaware law does not provide for any rules specifying the time frame in which the pre-emption rights must be executed.
Section 2:
Capital Maintenance
9. Limitation of profit distributions – fraudulent transactions Delaware has a statute prohibiting fraudulent transfers. a) Conditions of fraudulent transfers Pursuant to Title 6, Chapter 13, § 1304,1304(a) of the Delaware Statutory Law a transfer made or obligation incurred by a debtor is fraudulent as to a creditor, whether the creditor’s claim arose before or after the transfer was made or the obligation was incurred, if the debtor made the transfer or incurred the obligation: (1) with actual intent to hinder, delay or defraud any creditor of the debtor; or (2) without receiving a reasonably equivalent value in exchange for the transfer or obligation, and the debtor: (a) was engaged or was about to engage in a business or a transaction for which the remaining assets of the debtor were unreasonably small in relation to the business or transaction; or (b) intended to incur, or believed or reasonably should have believed that the debtor would incur, debts beyond the debtor’s ability to pay as they became due. § 1304(b) of the Delaware Statutory Law sets forth a non-exclusive list of factors in determining actual intent under subsection (a)(1), consideration may be given, among other factors, to whether:
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(1) The transfer or obligation was to an insider; (2) The debtor retained possession or control of the property transferred after the transfer; (3) The transfer or obligation was disclosed or concealed; (4) Before the transfer was made or obligation was incurred, the debtor had been sued or threatened with suit; (5) The transfer was of substantially all the debtor's assets; (6) The debtor absconded; (7) The debtor removed or concealed assets; (8) The value of the consideration received by the debtor was reasonably equivalent to the value of the asset transferred or the amount of the obligation incurred; (9) The debtor was insolvent or became insolvent shortly after the transfer was made or the obligation was incurred; (10) The transfer occurred shortly before or shortly after a substantial debt was incurred; and (11) The debtor transferred the essential assets of the business to a lienor who transferred the assets to an insider of the debtor. b) Case law Courts generally use reasonably equivalent value and fair consideration interchangeably. Wilmington Savings Fund Soc., FSB v. Kaczmarczyk, 2007 WL 704937, *4 (Del.Ch. 2007) (citing In re Key3Media Group, Inc., 336 B.R. 87, 93-94 (D.Del.2005) (“Courts typically use these terms interchangeably, and do not usually make a distinction between the standard required for reasonably equivalent value, on the one hand, and fair consideration on the other.”) An analysis of what constitutes an unreasonably small amount of assets is a question of fact. See In re Thunderdome Houston Ltd. Prtnsp., 2000 WL 889846 (Bankr. N.D. Ill. 2000) (Analysis of unreasonably small capital is forward looking. Court must look at liabilities the debtor was planning on incurring in the future to determine if the remaining assets were unreasonably small). Courts have determined that one is left with an unreasonably small amount of capital where the remaining assets are unreasonably small compared to historical levels (In re Dayton Title Agency, Inc., 262 B.R. 719 (Bankr. S.D. Ohio 2001)), or there are insufficient assets to generate enough cash to operate the business. In re WCC Holding Corp., 171 B.R. 972 (Bankr. N.D. Tex. 1994). Only the trustee in bankruptcy may bring a fraudulent conveyance action. 11 U.S.C. § 548. However, if the trustee unjustifiably fails to bring suit or relinquishes that right to the creditors’ committee, then the committee may bring the action. In re STN Enterprises, 779 F.2d 901, 904 (2d Cir. 1985). However, Delaware case law is clear that directors owe a duty of care and loyalties to their shareholders in the performance of their duties. Malone v. Brincat, 722 A.2d 5, 10 (Del. 1998). Shareholders may bring derivative claims and may also bring direct actions, both as individuals and as a class, for injuries done to them in their individual capacities by corporate fiduciaries. Kramer v. Western Pacific Industries, Inc., 546 A.2d 348, 351 (Del. 1988). However, the business judgment rule protects directors. In Aronson v. Lewis, the Delaware Supreme Court held that “[The business judgment rule] is a presumption that in making a business decision the directors of a corporation acted on an informed basis, in good faith and in the honest belief that the action taken was in the best interests of the company.” Aronson v. Lewis, 473 A.2d 805 (Del. 1984). “The business judgment rule, thus, prevents a substantive review of the merits of a business decision made by directors acting, without self-dealing, and 187
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in good faith and with due care.” In re J.P. Stevens & Co., Inc. Shareholders Litigation, 542 A.2d 770, 780–781 (Del.Ch. 1988). In Cede & Co. v. Technicolor, Inc., the Delaware Supreme Court stated: “To rebut the [business judgment] rule, a shareholder plaintiff assumes the burden of providing evidence that directors, in reaching their challenged decision, breached any one of the triads of their fiduciary duty – good faith, loyalty or due care . . . If the rule is rebutted, the burden shifts to the defendant directors, the proponents of the challenged transaction, to prove to the trier of fact the ‘entire fairness’ of the transaction to the plaintiff shareholder.” Cede & Co. v. Technicolor, Inc., 634 A.2d 345 (Del. 1993). In Moody v. Security Pacific Business Credit Inc., 127 Bankr. 958 (W. D. Pa. 19919, aff’d, 971 F. 2d 1056 (3d Cir. 1992)), a Pennsylvania case, the corporation, prior to its bankruptcy, was purchased by bottler. Bottler then sold the corporation to investor group, which obtained financing for the purchase from credit company using the assets of the corporation as collateral. Under the investor group’s management, the corporation converted an involuntary bankruptcy petition filed against it to a voluntary petition. The trustee then filed an action against bottler, investor group and credit company, claiming the transaction from bottler to investor group was a fraudulent conveyance and that unlawful dividends and distributions of the corporation’s assets violated federal and state bankruptcy laws. The court denied the trustee’s claims and held that the trustee failed to establish that the transaction involved fraudulent conveyances or that any unlawful dividend or distribution of the corporation's assets were authorised, that the transaction was without fair consideration to the corporation, but that the corporation was not rendered insolvent by the transaction, and that bottler, investor group, and credit company did not know the corporation’s creditors could not be paid, and did not intentionally hinder, defraud, or delay creditors. Under Pennsylvania law, an intent to hinder, delay, or defraud creditors may be inferred from transfers in which consideration is lacking and where the transferor and transferee have knowledge of the claims of creditors. Fair consideration is given for property or obligations: (a) when, in exchange for such property or obligation, as a fair equivalent therefore and in good faith, property is conveyed or an antecedent debt is satisfied; or (b) when such property or obligation is received in good faith to secure a present advance or antecedent debt in an amount not disproportionately small as compared with the value of the property or obligation obtained. The court held that fraudulent conveyance laws apply to a leveraged buyout such as the one here. This conclusion is mandated by the decision in United States v. Tabor Court Realty, 803 F.2d 1288 (3d Cir. 1986). However, although the fraudulent transaction laws have become an important safeguard in leveraged buyout activities, the fraudulent conveyance laws were not designed to insure creditors against all possible consequences of a corporation’s postleveraged buyout errors in judgment or poor business practices. c) Challenge of fraudulent transfers Pursuant to Title 6, Chapter 13, § 1307 of the Delaware Statutory Law, subject to the limitations of § 1308, the creditor may obtain: (1) avoidance of the transfer or obligation to the extent necessary to satisfy the creditor’s claim; (2) an attachment or other provisional remedy against the asset transferred or other property of the transferee in accordance with the procedure prescribed by applicable law;
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(3) an injunction or appointment of receiver. Under § 1308 of Title 6, Chapter 13, a transfer or obligation is not voidable under § 1304(a)(1) against a person who took it in good faith and for a reasonably equivalent value or against any subsequent transferee or obligee. Creditors or the trustee may pursue the avoidance remedy, but must do so through the court. § 1309, §§ 1304(a) and 1305 provide for a statute of limitations of either four years after a fraudulent transfer was made, or, if later, one year after the transfer or obligation was or could reasonably have been discovered, subject to certain limitations. 10. Disclosure of related transactions Delaware corporations have to disclose related transactions. a) Requirements of the US securities laws Pursuant to Item 404(a) of Regulation S-K, promulgated under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), a registrant must describe any transaction with a related person, since the beginning of the registrant’s last fiscal year, or any currently proposed transaction, in which the registrant was or is to be a participant and the amount involved exceeds $120,000, and in which any related person had or will have a direct or indirect material interest. The registrant must disclose the following information regarding the transaction: (1) the name of the related person and the basis on which the person is a related person; (2) the related person’s interest in the transaction with the registrant, including the person’s position(s), relationship(s) with, or ownership in, a firm, corporation, or other entity that is a party to, or has an interest in, the transaction; (3) the approximate dollar value of the amount of the transaction; (4) the approximate dollar value of the amount of the related person’s interest in the transaction, which shall be computed without regard to the amount of profit or loss; (5) in the case of indebtedness, disclosure of the amount involved in the transaction shall include the largest aggregate amount of principal outstanding during the period for which disclosure is provided, the amount of interest paid during the period for which disclosure is provided, and the rate or amount of interest payable on the indebtedness; (6) any other information regarding the transaction or the related person in the context of the transaction that is material to investors in light of the circumstances of the particular transaction. b) Rules regarding a corporation acquiring an asset owned by founder/stockholder Under the Delaware General Corporation Law there is no rule regarding a corporation acquiring an asset that is owned by a founder/stockholder. However, if a founder/stockholder is a director, § 144 DGCL may apply. § 144(a) DGCL provides that no contract or transaction between a corporation and one or more of its directors or officers, or between a corporation and any other corporation, partnership, association, or other organisation in which one or more of its directors or officers, are directors or officers, or 189
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have a financial interest, shall be void or voidable solely for this reason, or solely because the director or officer is present at or participates in the meeting of the board or committee which authorises the contract or transaction, or solely because any such director’s or officer’s votes are counted for such purpose, if: (1) the material facts as to the director’s or officer’s relationship or interest and as to the contract or transaction are disclosed or are known to the board of directors or the committee, and the board or committee in good faith authorises the contract or transaction by the affirmative votes of a majority of the disinterested directors, even though the disinterested directors be less than a quorum; or (2) the material facts as to the director’s or officer’s relationship or interest and as to the contract or transaction are disclosed or are known to the stockholders entitled to vote thereon, and the contract or transaction is specifically approved in good faith by vote of the stockholders; or (3) the contract of transaction is fair as to the corporation as of the time it is authorised, approved or ratified, by the board of directors, a committee or the stockholders. 11. Loans to directors With respect to the question if loans to directors are restricted by law different approaches exist under the Delaware General Corporation law and the Sarbanes Oxley Act. a) Requirements of the Delaware General Corporation Law A Delaware corporation is permitted to lend money to, guarantee an obligation of or otherwise assist an officer or employee, including one who acts as a director, if the loan, guaranty or other assistance is reasonably expected to benefit the corporation (§ 143 DGCL). The Delaware General Corporation Law does not require that stockholders approve loans or guaranties to or for the benefit of directors or officers, provided the loan or guaranty, in the judgment of the board of directors, may reasonably be expected to benefit the corporation. If board approval is sought, the contract of transaction must be approved by a majority vote of a quorum of the directors, without counting the vote of any interested directors (except that interested directors may be counted for purposes of establishing a quorum). b) Requirements of the Sarbanes-Oxley Act of 2002 Notwithstanding the foregoing, the Sarbanes-Oxley Act of 2002 prohibits personal loans to any executive officer or director of a corporation. § 402 of the Sarbanes-Oxley Act of 2002 states that issuers are prohibited from, directly or indirectly, through a subsidiary or otherwise, extending, modifying, maintaining or arranging extensions of credit, in the form of a personal loan, to or for their directors or executive officers. c) Sanctions Violation of § 402 of the Sarbanes-Oxley Act of 2002 may lead to both criminal and other civil sanctions that arise in the case of violations of the Exchange Act, including imprisonment, censure, cease and desist orders, revocation of registering with Securities and Exchange Commission (SEC) and fines.
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12. Acquisition of own shares When a corporation purchases own shares, corporate assets flow out to shareholders. The Delaware law generally allows share repurchases provided the corporation adheres to certain statutory restrictions. With specified exceptions, the financial limitations on repurchases are the same as those for dividends (see Section 3, No. 18, infra). a) Requirements for legal share repurchases The Delaware General Corporation Law contains one main test for determining the legality of a share repurchase: A corporation must satisfy the surplus test/capital impairment test. There is no explicit solvency test in the Delaware General Corporation Law. While the dividend statute permits dividends out of recent net profits (nimble dividends), there is no comparable authorisation for repurchases. aa) Surplus test/Capital impairment test In Delaware, § 160(a) DGCL provides that every corporation may purchase its own stock, provided that it may not do so if its capital is impaired or if the repurchase would cause its capital to be impaired. A corporation may also purchase preferred or, if there are no preferred shares outstanding, common shares out of capital, so long as the shares are retired, and the corporations’ capital reduced (§ 160(a)(1) DGCL). The procedure for reducing capital is set forth at §§ 243-244 DGCL (see Section 2, No. 14, infra). If the shares are acquired out of surplus, the corporation may retire them (§ 243(a) DGCL) or retain them as treasury shares (§ 160(b) DGCL). The accepted definition of capital impairment emerged from the case In re International Radiator Co., 10 Del. Ch. 358, 92 A. 255 (1914). In that case, a stockholder sought to enforce the corporation’s obligation to purchase his shares pursuant to a contract made at a time when the corporation’s capital stock was valued at $400,000 and its assets were valued at only $13,000. The court denied relief because payment of the stockholder’s claim from assets would have depleted or impaired its capital. The court said that impairment of capital “means the reduction of the amount of the assets of the company below the amount represented by the aggregate outstanding shares of the capital stock of the company.” The court found that use by a corporation of its assets to purchase shares of its own capital stock under such conditions impairs the capital of the company. Directors are not restricted in the way that they calculate surplus, and may revalue assets to show a surplus, so long as they “evaluate assets and liabilities in good faith, on the basis of acceptable data, by methods that they reasonably believe reflect present values, and arrive at a determination of surplus that is not so far off the mark as to constitute actual or constructive fraud.” Klang v. Smith’s Food & Drug Centers, Inc., 702 A.2d 150, 154 (Del. 1997). In Klang v. Smith’s Food & Drug Centers, Inc., 702 A.2d 150, 156n.12 (Del. 1997) the court reinforced that § 154 DGCL does not require any particular method of calculating surplus, but simply prescribes factors that any such calculation must include. The court stated that “in cases alleging impairment of capital under § 160 DGCL, the trial court may defer to the board’s measurement of surplus unless a plaintiff can show that the directors ‘failed to fulfill their duty to evaluate the assets on the basis of accepted data and by standards which they are entitled to believe reasonably reflect present values.’” However, in Pereira v. Cogan, 294 B.R. 449, 540 (S.D.N.Y. 2003), rev’d on other grounds, Nos. 03-5035 (CON), slip op. (2d Cir. June 30, 2005), the court held that § 172 DGCL did not 191
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insulate directors from liability where reliance on a purported “report” amounted to mere “blind reliance” on an alleged surplus calculation that had no analysis to support it. For a more complete discussion of the surplus test/capital impairment test under the Delaware law, see Section 3, No. 18bb), infra. bb) Solvency Test Like Delaware’s dividend statute, the rules authorising repurchases do not contain an insolvency prohibition. However, directors violate their fiduciary duties to creditors if they make a distribution when the corporation is insolvent. LaSalle Nat. Bank v. Perelman, 82 F. Supp. 2d 279 (D. Del.2000). In addition, a solvency test applies as a matter of the Delaware fraudulent transfer law (see Section 2, No. 9, supra). For further information concerning Delaware common law dealing with the solvency test see Section 3, No. 18a) bb), infra. cc) Maximum amount of own shares that can be acquired Under Delaware law, so long as the above mentioned restrictions are met there is no specific maximum amount of own shares that can be acquired. Practically, a corporation will not acquire all shares; at least one shareholder is needed. b) Directors’ and shareholders’ liability for illegal share repurchases In Delaware directors are jointly and severally liable for any wilful or negligent violation of the statute (§ 174 DGCL). Liability runs to the corporation and, in the event of its dissolution or insolvency, to its creditors. A director is specifically protected against liability if he relies in good faith on the books of the corporation or on reports of officers or outside experts selected with reasonable care in determining whether there are sufficient funds legally available for the purchase of stock (§ 172 DGCL). A director who has been found liable and who has paid back moneys to the corporation is entitled to be subrogated to the rights of the corporation against shareholders who received assets with knowledge of facts indicating that the transaction was unlawful (§ 174(c) DGCL). For a more detailed discussion of the liability of directors and shareholders under the Delaware statute, see Section 3, No. 18b) and c), infra. c) Treasury shares In Delaware, treasury stock is possible. Generally, treasury stock is listed on the balance sheet under stockholders’ equity as a negative number. § 160(c) DGCL provides that shares of its own capital stock belonging to the corporation or to another corporation, if a majority of the shares entitled to vote in the election of directors of such other corporation is held, directly or indirectly, by the corporation, shall neither be entitled to vote nor be counted for quorum purposes. Nothing in this section shall be construed as limiting the right of any corporation to vote stock, including but not limited to its own stock, held by it in a fiduciary capacity. d) Cancelling own shares Cancelling the stock means that the retired stock is not listed as treasury stock on the corporation’s financial statements. § 160 DGCL provides that every Delaware corporation may hold, sell, lend, exchange, transfer, or otherwise dispose of, pledge, use and otherwise 192
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deal in its own shares. Thus, a corporation may retire or cancel stock that it acquires from stockholders, or hold such stock as treasury stock. e) Reselling of own shares (equal treatment) The Delaware General Corporation Law gives the corporation broad power in allowing the corporation to sell its own shares. § 160(b) DGCL provides that nothing in this section limits or affects a corporation’s right to resell any of its shares theretofore purchased or redeemed out of surplus and which have not been retired, for such consideration as decided by the board. Therefore, it is possible that the corporation sells its own shares to only one designated person. f) Sanctions In case the Delaware corporation is publicly traded and therefore has to obey the rules of the Securities and Exchange Commission (SEC), there are a number of sanctions if shares were acquired in contradiction of the law and SEC rules respectively. The SEC has the ability to bring a wide variety of enforcement actions, which include censure, cease and desist orders, revocation of registration with the SEC and fines up to $500,000. The SEC’s fundamental enforcement tool is a civil action in federal court seeking an injunction against future violations of certain provisions of the federal securities laws. The SEC brings these actions against both corporations and individuals. The SEC often brings enforcement actions against senior corporate executives. The SEC can also ask a court to order defendants to disgorge unjust enrichment and to impose monetary penalties on defendants. In addition, the SEC has become more aggressive in seeking to bar individuals from serving as officers or directors of public companies. However, absent egregious behaviour from the directors, this scenario is less likely. The SEC can also bring an enforcement proceeding before an administrative law judge. In such proceedings, the SEC can seek an order that the respondent cease and desist from certain violations of the federal securities laws and take corrective action. If the corporation is selling securities pursuant to a registration statement, the SEC can seek an order suspending the effectiveness of the registration statement. The SEC also has the ability to obtain orders suspending for ten days trading in the securities of a public traded corporation. However, the SEC does not have the power to bring criminal actions. The SEC refers appropriate cases to the Department of Justice or to state and local authorities for prosecution. The SEC considers a number of factors in deciding whether to make a criminal referral, including its view on: (1) the quality of the evidence; (2) whether the witness lied during testimony, destroyed documents or otherwise obstructed justice; (3) the perceived egregiousness of the defendant's conduct; (4) whether the prospective defendant has previously violated the federal securities laws; and (5) the loss to the investing public and the profits reaped by the prospective defendant. g) Disclosure A Delaware corporation registered with the SEC as a publicly traded corporation has to follow certain disclosure obligations. In accordance with the Exchange Act, in each quarterly report on Form 10-Q and in the annual report on Form 10-K the corporation must provide a table showing, on a month-to-month basis the following: the total number of shares purchased, the average price paid per share, the total number of shares purchased under publicly announced repurchase programs, and the maximum number of shares that may be 193
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repurchased under these programs (or maximum dollar amount if the limit is stated in those terms). 13. Financial assistance Delaware law does not deal directly with transactions such as leveraged buy-outs (LBOs). However, Delaware law does restrict certain business combinations between a Delaware corporation and an “interested stockholder” (in general, a stockholder owning 15 % or more of the outstanding voting stock of such corporation). Specifically, § 203(a) DGCL provides that, notwithstanding any other provisions of such chapter and subject to certain exceptions, a corporation shall not engage in any business combination with any interested stockholder for a period of three years following the time that such stockholder became an interested stockholder unless: (1) prior to such time the board of directors of the corporation approved either the business combination or the transaction which resulted in the stockholder becoming an interested stockholder; (2) upon the consummation of the transaction which resulted in the stockholder becoming an interested stockholder, the interested stockholder owned at least 85% of the voting stock of the corporation outstanding at the time the transaction commenced, excluding for the purposes of determining the voting stock outstanding (but not the outstanding voting stock owned by the interested stockholder) those shares owned (i) by persons who are directors and also officers and (ii) employee stock plans in which employee participants do not have the right to determine confidentially whether shares held subject to the plan will be tendered in a tender or exchange offer; or (3) at or subsequent to such time the business combination is approved by the board of directors and authorised at an annual or special meeting of stockholders, and not by written consent, by the affirmative vote of at least two-thirds of the outstanding voting stock which is not owned by the interested stockholder. A corporation has the right to opt-out of the provisions of § 203(a) DGCL, pursuant to certain procedures set forth in § 203(b) DGCL. 14. Loans from shareholders Delaware law neither prohibits loans from stockholders, nor does it treat these loans in a specific way. Loans from stockholders are not specifically prohibited by the Delaware General Corporation Law. In the case of a dissolution of the corporation where a loan has been made from a stockholder, a dissolved corporation or successor entity which has followed the procedures described in § 280 DGCL: (1) shall pay the claims made and not rejected in accordance with § 280(a) DGCL, (2) shall post the security offered and not rejected pursuant to § 280(b)(2) DGCL,
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(3) shall post any security ordered by the Court of Chancery in any proceeding under § 280(c) DGCL, and (4) shall pay or make provision for all other claims that are mature, known and uncontested or that have been finally determined to be owing by the corporation or such successor entity. Such claims or obligations shall be paid in full and any such provision for payment shall be made in full if there are sufficient assets. If there are insufficient assets, such claims and obligations shall be paid or provided for according to their priority, and, among claims of equal priority, ratably to the extent of assets legally available therefor. Any remaining assets shall be distributed to the stockholders of the dissolved corporation; provided, however, that such distribution shall not be made before the expiration of 150 days from the date of the last notice of rejections given pursuant to § 280(a)(3) DGCL. In the absence of actual fraud, the judgment of the directors of the dissolved corporation or the governing persons of such successor entity as to the provision made for the payment of all obligations under paragraph (4) above shall be conclusive. 15. Capital decreases In a Delaware corporation, capital decreases may be performed in different ways. § 244(a) DGCL provides that a corporation, by resolution of its board of directors, may reduce its capital in any of the following ways: (1) by reducing or eliminating the capital represented by shares of capital stock which have been retired; (2) by applying to an otherwise authorised purchase or redemption of outstanding shares of its capital stock some or all of the capital represented by the shares being purchased or redeemed, or any capital that has not been allocated to any particular class of its capital stock; (3) by applying to an otherwise authorised conversion or exchange of outstanding shares of its capital stock some or all of the capital represented by the shares being converted or exchanged, or some or all of any capital that has not been allocated to any particular class of its capital stock, or both, to the extent that such capital in the aggregate exceeds the total aggregate par value or the stated capital of any previously unissued shares issuable upon such conversion or exchange; or (4) by transferring to surplus (i) some or all of the capital not represented by any particular class of its capital stock, or (ii) some or all of the capital represented by issued shares of its par value capital stock, which capital is in excess of the aggregate par value of such shares, (iii) some of the capital represented by issued shares of its capital stock without par value. Under § 244 DGCL, board resolutions are sufficient in order to decrease capital of a corporation. The previous requirements of supplemental stockholder approval and public filing of a certificate with the Secretary of State have been eliminated. Board resolutions are considered corporate documents and are available to the corporation’s stockholders. § 244(b) DGCL provides that notwithstanding the other provisions of this section, no reduction of capital shall be made or effected unless the assets of the corporation remaining 195
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after such reduction shall be sufficient to pay any debts of the corporation remaining after such reduction for which payment has not been otherwise provided. No reduction of capital shall release any liability of any stockholder whose shares have not been fully paid. Few Delaware cases have construed current § 244 DGCL or its predecessor statutes. Although it has been noted that § 244 DGCL continues to offer protection to creditors, there is no discussion as to which accounting or valuation method to use in order to satisfy the sufficiency-of-assets requirement. 16. Redeemable shares A Delaware corporation can distribute assets to stockholders by acquiring outstanding shares through redemption or repurchase. While a repurchase is a voluntary buy-sell transaction between the corporation and a stockholder (see Section 2, No. 12, supra), redemption refers to a forced sale initiated by the corporation, in accordance with a contract or the articles of incorporation. a) Possibility of redeeming shares In Delaware shares may be redeemed pursuant to § 151 DGCL. b) Conditions of share redemptions § 151(b) DGCL provides that any stock of any class or series may be made subject to redemption by the corporation at its option or at the option of the holders of such stock or upon the happening of a specified event; provided however, that immediately following any such redemption the corporation shall have outstanding one or more shares of one or more classes or series of stock, which share, or shares together, shall have full voting powers. Shares may be made redeemable at such price or prices or at such “rate or rates, and with such adjustments” as are stated in the certificate of incorporation or appropriate board resolution. The redemption of stock pursuant to § 151 DGCL cannot, however, be used as a technique to maintain management in control of the corporation. In Petty v. Penntech Papers, Inc., 347 A.2d 140 (Del. Ch. 1975) the court issued a temporary restraining order against a planned selective redemption designed to give two directors control of the corporation. If the shares are redeemed, the corporation may reduce its capital if it chooses according to § 244(a) DGCL by applying to an otherwise authorised purchase or redemption of outstanding shares of its capital stock some or all of the capital represented by the shares being purchased or redeemed, or any capital that has not been allocated to any particular class of its capital stock. Any stock which may be made redeemable under § 151 DGCL may be redeemed for cash, property or rights, including securities of the same or another corporation, at such time or times, price or prices, or rate or rates, and with such adjustments, as shall be stated in the certificate of incorporation or in the resolution or resolutions providing for the issue of such stock adopted by the board of directors pursuant to subsection (a) of this section. c) Challenge of redemption price If the stockholders do not believe that the price they receive for their shares redeemed is appropriate, they have the possibility to challenge this, but it is essentially a contractual claim because the redemption terms are set out in the certificate of incorporation or board resolutions. In construing the complaint, all inferences are drawn in favour of the non-moving 196
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party. If the certificate makes shares redeemable at book value, the courts will not compel the directors to pay more than book value for the shares even if the book value is disproportionately low, otherwise the courts would improperly usurp the directors’ discretion. Corbett v. McClintic-Marshall Corp., 151 A. 218, 221 (Del. Ch. 1990). Principles of good faith and fair dealing may be implicated in the setting of a redemption price. In Gale v. Bershad, C.A. No. 15714 (Del. Ch. Mar. 3, revised, Mar. 4, 1998) the Court of Chancery found that a complaint stated a claim for breach of implied covenant of good faith and fair dealing when an allegedly interested board set a below-market redemption price. The basis for the claim for breach of implied covenant of good faith and fair dealing was the certificate language mandating the “Fair Value Per Share shall mean the fair value per share of the Exchangeable Preferred Stock as determined by the Board of Directors of the Company.” The court found that the impact of that language was that, regardless of the method the board used, the resulting valuation must represent a “fair value” for the preferred stock. The plaintiff also alleged a breach of fiduciary duty claim based on the same facts. The court dismissed the fiduciary duty claim because “[t]o allow a fiduciary duty claim to coexist in parallel with an implied contractual claim would undermine the primacy of contract law over fiduciary law in matters involving the essentially contractual rights and obligations of preferred stockholders.” As stated before, §145(a) and (b) DGCL give corporations the right (but not the obligation) to indemnify directors for costs incurred in actions brought against them by reason of the fact that they are directors provided that the director acted in good faith (i.e., absent fraud), among other requirements. Most corporations (particularly public ones) have a provision in the certificate of incorporation or bylaws which require the corporation to indemnify directors (and, in most but not all cases, officers, at the option of the corporation). Even if the claim is for fraud, § 145(e) DGCL permits the corporation to advance expenses pending an adjudication on the issue, provided that the director undertakes to repay the corporation in the event that it is ultimately determined that the director’s conduct did not permit indemnification. Most public companies also include a provision in the certificate of incorporation or bylaws incorporating that requirement. § 145(c) DGCL provides that if the director successfully defends on the merits, the director must be indemnified for expenses incurred.
Section 3:
Dividends and distributions
17. Definition of Distribution The Delaware General Corporation Law does not define “distribution”. However, court decisions give some guidelines. Pursuant to Pennington v. Commonwealth Hotel Const. Corp., 155 A. 514, 517 (Del. 1931) a dividend is a payment to the stockholders as a return upon their investment. Under § 173 DGCL “dividends may be paid in cash, in property, or in shares of the corporation’s capital stock.” From the legal provisions in Delaware concerning distributions it may be concluded that in addition to dividends (cash or other property) distributions include in particular payments in the form of a repurchase or redemption. As mentioned above, in Delaware repurchases and redemptions of shares are limited by § 160 DGCL (see Section 2, No. 12 and No. 16, supra). Statutory restrictions upon dividends are imposed in § 170 DGCL. Further restrictions concerning dividends may be contained in 197
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the certificate of incorporation (§ 170(a) DGCL). These rules are described in depth in the following (see Section 3, No. 18, infra). 18. Distributable amount a) Requirements for legal distributions The Delaware General Corporation Law contains two alternative tests for determining the legality of dividends. A corporation may pay dividends out of any surplus (surplus test/capital impairment test). If the corporation has no surplus, it may pay dividends out of net profits for the fiscal year in which the dividend is declared and/or the preceding fiscal year (so-called nimble dividends; net profits test). “Wasting asset corporations” may determine the net profits derived from the exploitation, or the net proceeds derived from the liquidation, of the wasting assets without regard to depletion. There is no explicit solvency test in the Delaware General Corporation Law. aa) Surplus test/capital impairment test aa1) Design of the surplus test/capital impairment test In Delaware dividends may be paid out of the corporation’s surplus (§ 170(a) DGCL). According to the Delaware Supreme Court, the purpose of the surplus test is “to prevent boards from draining corporations of assets to the detriment of creditors and the long-term health of the corporation”. Klang v. Smith’s Food & Drug Centers, Inc., 702 A.2d 150, 154 (Del. 1997). The terms “surplus” and “net assets” are defined in § 154 DGCL as follows: “The excess, if any, at any given time, of the net assets of the corporation over the amount so determined to be capital shall be surplus. Net assets means the amount by which total assets exceed total liabilities. Capital and surplus are not liabilities for this purpose.” Capital, as used in § 154 DGCL, is generally the sum of the aggregate par value of all issued shares with par value and at least some part of the consideration received for all issued shares without par value. Thus, under Delaware law a dividend cannot be paid if, before or after payment of the dividend the capital is or would be impaired. That is why courts frequently refer to this test as a capital impairment test. aa2) Determination of surplus The Delaware General Corporation Law does not specify particular accounting methods. Thus, Delaware corporations do not have to adhere to US generally accepted accounting principles (US-GAAP) in determining whether a dividend lawfully may be paid. Because of the lack of a specified standard, it was a controversial matter for a long time whether a Delaware corporation may revalue assets at current value or fair market value for purposes of calculating net assets even though US-GAAP generally requires historical costs. In Klang v. Smith’s Food & Drug Centers, the Delaware Supreme Court makes it clear that directors may revalue the corporate assets to reflect current value. As part of a recapitalisation, the corporation repurchased fifty per cent of its common shares. The board authorised the transaction based on an investment firm’s solvency opinion that the transaction would not impair the corporation’s capital. Plaintiff relied on a pro-forma balance sheet that showed a deficit of more than US-$ 100 million in statutory surplus (net assets in excess of the par value of issued shares) would result 198
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from a proposed repurchase of shares and argued that “balance-sheet net worth” should be conclusive for purposes of determining the validity of the repurchase under § 160 DGCL. The test for the legality of a repurchase pursuant to § 160 DGCL is substantially the same as the test for the legality of a dividend under § 170(a) DGCL. Accordingly, Klang v. Smith’s Food & Drug Centers, Inc., governs the payment of dividends under the Delaware statute, as well as the repurchase of stock. In upholding the transaction, the court rejected plaintiff’s first argument the negative surplus shown on the corporation’s balance sheet after the repurchase established a violation of § 160 DGCL. “Regardless of what a balance sheet that has not been updated may show, an actual, though unrealised, appreciation reflects real economic value that the corporation may borrow against or that creditors may claim or levy upon.” Klang v. Smith’s Food & Drug Centers, Inc., 702 A.2d 150, 154 (Del. 1997). It then rejected plaintiff’s second argument that, even if the board was permitted to calculate surplus off the balance sheet, the method used did not adequately calculate the available surplus, since it did not separately calculate “total assets” and “total liabilities” as those terms are defined in § 154 DGCL. “No corporation may repurchase or redeem its own shares except out of ‘surplus,’ as statutorily defined… Corporations may revalue assets to show surplus, but perfection in that process is nor required. Directors have reasonable latitude to depart from the balance sheet to calculate surplus, so long as they evaluate assets and liabilities in good faith, on the basis of acceptable data, by methods that they reasonably believe reflect present values, and arrive at a determination of the surplus that is not so far off the mark as to constitute actual or constructive fraud.” Klang v. Smith’s Food & Drug Centers, Inc., 702 A.2d 150, 152 (Del. 1997). The statute provides that directors, in making dividend decisions, are entitled to rely in good faith upon reports made by employees or outside experts “as to matters the director reasonably believes are within such other person’s professional or expert competence and who has been selected with reasonable care...” (§ 172 DGCL). The experts may properly advise the directors “as to the value and amount of surplus or other facts pertinent to the existence and amount of surplus or other funds from which dividends might properly be declared or paid…” (§ 172 DGCL). The board’s calculation of surplus is determinative unless plaintiff can show that the directors “failed to fulfil their duty to evaluate the assets on the basis of acceptable data and by standards which they are entitled to believe reasonably reflect present values.” Klang v. Smith’s Food & Drug Centers, Inc., 702 A.2d 150, 155-156 (Del. 1997). Thus, directors who rely on a balance sheet surplus, as determined from the audited financial statements, should be protected against a charge that the assets should have been written down to reflect depreciation in value. Conversely, directors who rely on a current value surplus, as determined by an outside expert like an appraiser or investment banker, should be protected against a charge that the assets should not have been written up to reflect unrealised appreciation. There is no requirement in Delaware law that the corporation adhere to US-GAAP or any other specific accounting method. However, many corporations use US-GAAP. Although USGAAP is not written in law, the SEC requires that US-GAAP be followed in financial reporting by publicly-traded companies.
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Although non-public companies are not required to use US-GAAP, many do for several reasons. Because financial statements prepared under US-GAAP are intended to reflect an economic reality, US-GAAP makes a corporation’s financials comparable and understandable so that investors, creditors and others can make rational investment, credit and other financial decisions. Therefore, there are certain situations, such as obtaining credit or seeking investors, which require, by contract, these corporations to also follow US-GAAP when preparing their financial statements. Compliance with US-GAAP also helps maintain credibility with stockholders because it reassures outsiders that a corporation’s financial reports accurately portray its financial position. However, the debate does exist as to whether separate accounting and reporting standards should be set for small and medium-sized corporations. To limit compliance costs and to simplify accounting, some corporations choose to depart from US-GAAP. As an alternative to US-GAAP, some corporations prepare statements using other comprehensive basis of accounting (OCBOA). Tax-basis and cash-basis, including modified-cash-basis, financial statements are the most widely used OCBOA statements. Although not a statutory requirement, the accounts are typically audited. aa) Reduction of capital The board of directors may increase surplus by reducing the corporation’s capital (§ 244 DGCL). The additionally created surplus can then be used for a distribution of assets. Neither stockholder approval nor publication of a notice of reduction is required. Pursuant to § 244(a)(1)-(4) DGCL there are several possible ways (see Section 2, No. 15, supra). Moreover, the aggregate par value of the outstanding stock is not an immutable barrier below which the corporation cannot reduce its capital. The directors and stockholders can vote to amend the corporation’s articles to lower par value or change the stock into no-par shares (§ 242(a)(3) DGCL). The amendment of the articles, in itself, might not lower capital; but it clears the way for a board resolution which does. bb) Solvency test Unlike the dividend statutes of most other states, the Delaware General Corporation Law contains no explicit prohibition against dividends when the corporation is, or would be rendered, insolvent. However, directors violate their fiduciary duties to creditors if they make a distribution when the corporation is insolvent. LaSalle Nat. Bank v. Perelman, 82 F. Supp. 2d 279 (D. Del.2000). The court defined “insolvent” alternatively under the equitable and the balance sheet tests. LaSalle Nat. Bank v. Perelman, 82 F. Supp. 2d 279, 290 (D. Del.2000). In addition, a solvency test applies as a matter of the Delaware fraudulent transfer law (see Section 2, No. 9, supra). Under Delaware common law, insolvency occurs at the moment when the entity “has liabilities in excess of a reasonable market value of assets held.” Trenwick Am. Litig. Trust v. Ernst & Young, L.L.P., 906 A.2d 168, 195 (Del. Ch. 2006) (citing Blackmore Partners, L.P. v. Link Energy LLC, 2005 Del. Ch. LEXIS 155, 2005 WL 2709639, at * 6 (Del. Ch. Oct. 14, 2005) (quoting Geyer v. Ingersoll Publ'ns, 621 A.2d 784, 789 (Del. Ch. 1992)). An entity is also insolvent when it is unable to pay its debts when they have come due. Prod. Res. Group, L.L.C. v. NCT Group, Inc., 863 A.2d 772, 776 (Del. Ch. 2004) (citing Siple v. S & K Plumbing and Heating, Inc., 1982 Del. Ch. LEXIS 566, 1982 WL 8789, at *2 (Del. Ch. Apr. 13, 1982).
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Neither the Delaware law nor Delaware case law specifically details a “solvency test”. However, In re: PWS Holding Corp., 228 F.3d 224 (2000), the court explained that the test of solvency was whether, at the time of the recapitalisation discussed in the case, the corporation’s assets exceeded its liabilities. The court stated that there are two basic approaches to this evaluation: asset by asset evaluation, which ascribes value to each asset and determines solvency by comparing the sum of those assets to total liabilities, and enterprise valuation, which values the business as a going concern and includes intangibles such as relationships with customers and suppliers, and the name, profile, and reputation of the business. In In re PWS Holding Corp., the court appointed examiner, in assessing liabilities, considered the bank loans, subordinated notes, capital lease obligations, deferred stock liability, and contingent and other off-balance sheet liabilities. In In re PWS Holding Corp., 2000 U.S. App. 23393, the court was dealing with a recapitalisation by the corporation, thus the court stated that the solvency test was to be done at the time of the event (in this case recapitalisation) in determining whether the corporation is solvent. Thus, the period of time used to determine solvency is at the time of occurrence of the transaction in question. The statutes and the case law do not suggest that the test must be examined by an accountant. If the corporation’s action is challenged, the test is examined by an examiner or a trustee as in In re PWS Holding Corp. cc) Net profits test (nimble dividends) Under § 170(a) DGCL, a Delaware corporation may pay dividends “in case there shall be no such surplus, out of its net profits for the fiscal year in which the dividend is declared and/or the preceding fiscal year.” These dividends are called nimble dividends, because they can only be paid if directors are sufficiently nimble to declare the dividends before the close of the relevant period. The corporation, however, may not pay a dividend from net profits if “the capital of the corporation, computed in accordance with §§ 154 and 244 of this title, shall have been diminished by depreciation in the value of its property, or by losses, or otherwise, to an amount less than the aggregate amount of the capital represented by the issued and outstanding stock of all classes having a preference upon the distribution of assets” (§ 170(a) DGCL). Therefore, the corporation cannot pay nimble dividends unless the current value of the corporation’s net assets at least equals the aggregate amount of the par value of the outstanding preferred shares. This test should be satisfied after taking account of the dividend, but, in fact, the statute provides that the test must only be satisfied prior to payment: The “directors of such corporation shall not declare and pay out (…) any dividends (…) until the deficiency (…) shall have been repaired” (§ 170(a) DGCL). dd) Special rules for wasting asset corporations In Delaware, § 170(b) DGCL provides that in the case of a wasting asset corporation, net profits can be calculated for dividend purposes without regard to depletion (depreciation) resulting from passage of time, consumption, liquidation or exploitation of wasting assets. Generally, a wasting asset corporation is a corporation that is in the business of exploiting a non-replenishable asset, like a mine, an oil well, or a rock quarry. 201
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The justification sometimes given for the wasting asset corporation exception is that all concerned parties expect that the corporation’s lifetime will be limited to the lifetime of the wasting asset, so that there is no reason to preserve the corporation’s capital. However, a corporation, which purpose of business is a continuing one, because it has several wasting assets that are continually replaced or has both wasting and non wasting assets, may use this rule, too. Furthermore, in Delaware wasting assets include not only natural resources but also “other wasting assets, including patents” (§ 170(b) DGCL). b) Directors’ liability for illegal distributions Under § 174(a) DGCL, directors are jointly and severally liable for any illegal dividends resulting from wilful misconduct or negligence, at any time within six years after paying such unlawful dividend. Liability for unlawful dividends cannot be limited by the corporation in its certificate of incorporation (§ 102(b)(7)(iii) DGCL). Liability runs to the corporation and to its creditors in the event of its dissolution or insolvency, to the full amount of the dividend unlawfully paid (§ 174(a) DGCL). In order to avoid liability an individual director who does not vote in favour of an illegal dividend must make sure that his dissent is recorded in the minutes at the time of the resolution. A director who is absent from the meeting at which the dividend was declared must cause his dissent to be recorded in the minutes immediately after he has notice of the declaration (§ 174(a) DGCL). Even if a director voted for an illegal dividend, he is not liable if he relied in good faith on the corporation’s records, or other kinds of information presented to the corporation by an officer, employee, a committee of the board of directors or by any other expert who has been selected with reasonable care by or on behalf of the corporation. They may provide the board with information as to the value and amount of the assets, liabilities and/or net profits of the corporation, or any other facts pertinent to the amount of surplus or other funds from which dividends might properly be paid (§ 172 DGCL). Any director against whom a claim is successfully asserted is entitled to contribution from the other directors who voted for or concurred in the unlawful dividend (§ 174(b) DGCL). Furthermore, a director is entitled to be subrogated to the right of the corporation against stockholders who received the dividend with knowledge of facts indicating that the dividend was illegal (§ 174(c) DGCL). For example, in In re Sheffield Steel Corp., 320 B.R. 405 (Bankr. D. Okla. 2004) plaintiff alleged that defendants were personally, jointly and severally, liable under Delaware law for authorising, as directors of the corporation, the payment of dividends to stockholders, notwithstanding the absence of a “surplus” or “net profits” at the time of payment, rendering such payments unlawful under Delaware law. The court held that the debtor sufficiently stated a claim for improper dividends against the directors where the directors allegedly declared dividends even though the debtor corporation lacked a surplus or net profits from which the dividends could be paid under § 170 DGCL, which would establish a violation of § 174(a) DGCL. For the claim of improper dividends against the stockholders, the debtor sufficiently stated a claim under Delaware common law that the stockholders knew or should have known that the negative financial position precluded the lawful payment of dividends. For the breach of fiduciary duty claim, the debtor sufficiently alleged that the directors were grossly negligent in authorising dividends and that the other stockholders assisted in the breach of fiduciary duty. 202
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c) Stockholders’ liability for illegal distributions The Delaware statute provides that recipients of illegal dividends may be required, in some circumstances, to return them. As mentioned above, a director who has been found liable for an unlawful dividend and who has paid back moneys to the corporation is entitled to be subrogated to the rights of the corporation against stockholders who received the dividend with knowledge of facts indicating its illegality (§ 174(c) DGCL). Stated another way, stockholder liability requires bad faith. d) Challenge of illegal distributions by creditors The Delaware General Corporation Law does not provide that anyone, apart from the director, can assert the rights of the corporation. There is no modern Delaware decision considering the issue. A number of earlier cases suggest that creditors of an insolvent corporation, or one in dissolution, may only enforce § 174 DGCL in a representative, rather than an individual action. In John a. Roebling’s Sons Co. v. Mode, 43 A. 480, 482 (Del. Super. Ct. 1899), the Delaware Superior Court found that liability was enforceable only in equity by a general creditors’ bill. The language of both present § 174 DGCL and its predecessors appears to give a solvent corporation the right to sue. However, there are no recent cases addressing the question of whether, after insolvency, the corporation, as opposed to its creditors, retains its right of action under § 174 DGCL. 19. Determination of the distributable amount a) Decision of the board of directors In Delaware, the declaration of dividends generally is within the discretion of the board of directors and protected by the business judgement rule. However, directors have to obey any restrictions in the certificate of incorporation and the applicable statutory provisions (§ 170 DGCL), see Section 3, No. 18a), supra. b) Disclosure Under the Delaware General Corporation Law, there is no requirement for corporations to disclose the amount of dividends. If the corporation is public, applicable SEC rules apply. Under Regulation S-X of the SEC, which applies to registration statements under the Securities Act of 1933, annual or other reports under §§ 13 and 15(d), and proxy and information statements under § 14 of the Securities Exchange Act of 1934, dividends must be disclosed stating the amount per share in the aggregate for each class of shares. c) Challenge of resolutions As mentioned above, in Delaware the business judgment rule applies. A plaintiff must show the dividend payment resulted from improper motives and amounted to waste. Where a dividend complies with § 170 DGCL, the alleged excessiveness of the amount alone does not state a cause of action. d) Mandatory distributions In Delaware, the Court of Chancery has discretionary power to compel directors to declare a dividend. However, just because assets exist from which a dividend may be declared is 203
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insufficient to invoke the forcing of a declared dividend. A plaintiff must show gross abuse of discretion, oppression or bad faith. In Gabelli & Co. v. Liggett Group, Inc., 479 A.2d 276 (Del. 1984) the plaintiff minority stockholders filed suit against defendant corporations to compel the payment of a dividend, claiming that the corporations owed a fiduciary duty to the stockholders and that the first corporation breached that fiduciary duty by causing the second corporation to eliminate its regular dividend to enable the first corporation to obtain the money for itself upon the merger of the two corporations. The trial court held that in order for the stockholders to show that they were entitled to the dividend, the stockholders were obliged to plead and prove that the dividend was withheld as a result of an oppressive abuse of discretion in the context of an unfair merger. On appeal, the court concluded that there was no error in the trial court’s grant of summary judgment in favour of the corporations and that there was no showing that the board of directors of the second corporation abused its discretion by not declaring the third quarter dividend. In order to state a cause of action, plaintiff must show plaintiff’s right to the dividend in question. Courts act to compel the declaration of a dividend only upon a demonstration “that the withholding of it is explicable only on the theory of an oppressive or fraudulent abuse of discretion.” In Baron v. Allied Artists Pictures Corp., 337 A.2d 653 (Del. Ch. 1975), plaintiff stockholder brought within his actions, an action in the Court of Chancery of Delaware against defendant corporation to have the elections of the board of directors declared invalid, and charging that the board fraudulently perpetuated itself in office by refusing to pay the accumulated dividend arrearages on preferred stock issued, which, in turn, permitted the preferred stockholders to elect a majority of the board of directors at each annual election. The court held that, considering the yearly hit-and-miss financial history of the corporation, the board did not engage in fraud or grossly abuse its discretion in its refusal to pay the dividends even though there was a legal source from which payment could have been made. However, the board could not be permitted indefinitely to plough back all profits in future commitments so as to avoid full satisfaction of the rights of the preferred to their dividends and the otherwise normal right of the common stockholders to elect corporate management. The basic question is whether or not the board has wrongfully refused to pay dividends even if funds exist which could have been used for such purpose. The mere existence of a legal source from which payment could be made, standing alone, does not prove this. 20. Accounting reserves that influence the distributable amount Nothing in Delaware law requires obligatory accounting reserves. However, § 171 DGCL does provide that the directors of a corporation may set apart out of any of the funds of the corporation available for dividends a reserve or reserves for any proper purpose and may abolish any such reserve.
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Section 4:
Capital related rules in case of crisis and insolvency
21. Trigger of insolvency Delaware law does not discuss filing for insolvency. Federal bankruptcy law neither requires an insolvent company to file for bankruptcy, nor is insolvency a requirement to commence a bankruptcy proceeding. Corporations may seek to accomplish an out of court restructuring. a) Factors triggering insolvency Under § 1-201(23) of the Delaware Uniform Commercial Code, “insolvent” means: (a) having generally ceased to pay debts in the ordinary course of business other than as a result of bona fide dispute; (b) being unable to pay debts as they become due; or (c) being insolvent within the meaning of federal bankruptcy law. Under § 101(32) of the federal bankruptcy law, the term “insolvent” means with reference to an entity other than a partnership and a municipality, financial condition such that the sum of such entity’s debts is greater than all of such entity’s property, at a fair valuation, exclusive of (i) property transferred, concealed, or removed with intent to hinder, delay, or defraud such entity’s creditors; and (ii) property that may be exempted from property of the estate under § 522 of the federal bankruptcy law. Further, insolvency is defined under § 1302 of the Delaware Fraudulent Conveyance Law as follows: (a) A debtor is insolvent if the sum of the debtor’s debts is greater than all of the debtor’s assets, at a fair valuation; (b) A debtor who is generally not paying debts as they become due is presumed to be insolvent; (c) Assets under this section do not include property that has been transferred, concealed or removed with intent to hinder, delay or defraud creditors or that has been transferred in a manner making the transfer voidable under this chapter; (d) Debts under this section do not include an obligation to the extent it is secured by a valid lien on property of the debtor not included as an asset. b) Time frame There is no requirement that a board of directors conduct a solvency analysis. c) Duties of the board members A board of directors of a solvent company always owes duties of care and loyalty to the shareholders. Malone v. Brincat, 722 A.2d 5, 10 (Del. 1998). However, when a company moves toward the “zone of insolvency” those duties may broaden to include a duty to creditors. Credit Lyonnais Bank Nederland, N.V. v. Pathe Comm. Corp., 1991 WL 277613 (Del. Ch. 1991).
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d) Subordination of claims Nothing in Delaware law discusses priority or subordination of claims. Some cases recognise a court’s power to recharacterise debt as equity. Generally, recharacterisation requires the court to determine that the money advanced to a debtor is equity – not debt – and results in a determination that the “creditor” is illegitimate because the advance of money is not a claim to begin with. Whether a debt will be recharacterised is a fact based inquiry. The more a transaction appears to reflect the characteristics of an arm’s length negotiation, the more likely such a transaction is to be treated as debt. Subordination of a creditor’s claim to the claim of another creditor, or an equity holder’s equity to the equity of another equity holder is authorised by § 510(c) of the federal bankruptcy code. One widely followed test provides that a claim will be equitably subordinated if there is a showing by a preponderance of the evidence that (i) the claim holder engaged in some type of inequitable conduct, (ii) which injured the creditors of the debtor or conferred an unfair advantage on the claimant, and (iii) equitable subordination of the claim is not inconsistent with the provisions of the federal bankruptcy code.
Section 5:
Contractual self protection of creditors
22. Contractual self protection In Delaware, many long-term creditors (particularly bank lenders and bondholders) and preferred stockholders demand contractual limits on dividends and other forms of distribution, contained in a trust indenture agreement or sometimes incorporated into the articles of incorporation. Typical negative covenants in loan/credit agreements and bonds include the following: restricting payment of dividends or repurchase of company stock unless company income exceeds certain amount; requiring company to meet certain financial tests/ratios; limiting new indebtedness and liens that can be incurred; limiting amount of capital expenditures; and limiting investments in new businesses. Under the law, creditors have relatively few control rights (in terms of the actions of the corporation) until a company has defaulted on its obligations. Thus, creditors use contractual agreements to assert additional control over a corporation in order to protect their own interests by including contractual restrictions, such as those mentioned above, in their contractual agreements.
Section 6:
Equal treatment
23. Principle of Equal treatment a) Principle of equal treatment Delaware law provides for equal treatment of stockholders who hold the same series of stock of a corporation. A corporation may freely resell the shares that it has acquired. § 160 DGCL empowers a corporation to “hold, sell, lend, exchange, transfer or otherwise dispose of, pledge, use and otherwise deal in” treasury stock. A corporation enjoys virtually all the incidents of ownership of its own stock that accrue to other owners, except the power to vote them. Thus, a corporation may freely resell the shares that it has acquired. Bronson v. Bagdad Copper Corp., 206
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151 A.2d 677 (Del. 1959) recognised the breadth of a corporation’s power to dispose of its treasury stock. In the absence of fraud, the courts deferred to the discretion of the directors in fixing the price at which treasury stock was sold, even holding that treasury stock is freed from the requirement that par-value stock must be sold at not less than par value. b) Right to vote In Delaware, § 151(a) DGCL provides that every corporation may issue one or more classes of stock or one or more series of stock within any class thereof, which classes or series may have such voting powers, full or limited, or no voting powers. § 212(a) DGCL states that unless otherwise provided in the certificate of incorporation and subject to § 213 of the DGCL, each stockholder shall be entitled to one vote for each share of capital stock held by such stockholder. If the certificate of incorporation provides for more or less than one vote for any share, on any matter, every reference in this chapter to a majority or other proportion of stock, voting stock or shares shall refer to such majority or other proportion of the votes of such stock, voting stock or shares. c) Pre-emption right Delaware law provides that no stockholder shall have any preemptive right to subscribe to an additional issue of stock or to any security convertible into such stock unless, and except to the extent that, such right is expressly granted to such stockholder in the certificate of incorporation (§ 102(b)(3) DGCL). d) Right to receive dividends Under § 151(c) of the Delaware General Corporation Law holders of preferred or special stock of any class or of any series thereof shall be entitled to receive dividends at such rates, on such conditions and at such times as shall be stated in the certificate of incorporation or in the resolution or resolutions providing for the issue of such stock adopted by the board of directors as hereinabove provided therein, payable in preference to, or in such relation to, the dividends payable on any other class or classes or of any other series of stock, and cumulative or non-cumulative as shall be so stated and expressed. When dividends upon the preferred and special stocks, if any, to the extent of the preference to which such stocks are entitled, shall have been paid or declared and set apart for payment, a dividend on the remaining class or classes or series of stock may then be paid out of the remaining assets of the corporation available for dividends as elsewhere in this chapter provided. e) Right to attend the shareholders’ meeting Nothing in Delaware law hinders a stockholder’s right to attend a stockholders’ meeting.
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3.2.2 USA California California is one of the major states of incorporation in the United States. In 1977, California was the first jurisdiction to eliminate the traditional concept of legal capital. Further significant and innovative features of the California Corporations Code are the explicit adoption of US generally accepted accounting principles (US-GAAP) and limitations on distributions which recognise practicalities of corporate finance.
Section 1:
Capital formation
Sub-section 1:
Formation of the stock corporation
1. Capital and other means of equity financing a) Subscribed capital The California Corporations Code (CCC) relating to legal capital was thoroughly revised in the mid-1970ies. The concepts of par value and subscribed capital were abolished by the new law, which became effective on January 1, 1977. § 202 CCC does not require that the par value of shares be stated in the articles. The concept of par value originally was intended to correspond to the total capital of the corporation, essentially to serve as a fund to satisfy creditors. That obligation and practice has been abandoned and par value is meaningless except to the extent that there are other statutes that make calculations based upon par value. For example, the California Insurance Code contains such references that are applicable to insurance companies. § 205 CCC states that for purposes of tax or fee calculations based upon capitalisation, par value shall be determined at $1 per share and for other statutes that refer to par value, the board can determine par value by resolution (therefore, no amendment to the articles is required). Nonetheless, the California Corporations Code permits a corporation to state a par value in its articles if it wishes to do so. Pursuant to § 409(a)(1) CCC, the board of directors, or the shareholders if the articles of incorporation so provide, determines the consideration for the shares being issued. Notwithstanding the foregoing, the Supreme Court of California has held that a corporation needs to be adequately capitalised and has found that a corporation is inadequately capitalised if (a) the corporation is likely to have insufficient assets to meet its debts or (b) if the capital is “illusory” or “trifling” compared with the business to be done and the risk of loss. Automotriz del Golfo de California S. A. de C. V. v. Resnick, 47 Cal. 2d 792, 796-97 (Cal. 1957). Inadequate capitalisation is not a question of corporate law, but rather an issue that can be raised by creditors of the corporation. In some circumstances, pursuant to the “alter ego doctrine,” directors and shareholders may also have personal liability, on a joint and several basis, to the corporation for the benefit of creditors for illegal distributions or for the debt of the corporation if the corporation is inadequately capitalised. Although undercapitalisation is not conclusive evidence that the individuals should be treated as the corporation’s alter ego, it is a very important factor. Under the alter ego doctrine, the 208
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burden is on the claimant to show that the director or officer breached the standard of care under the business judgment rule. State Farm Mutual Automobile Ins. Co. v. Superior Court, 114 Cal. App. 4th 434, 451 (Cal. Ct. App. 2003). b) Composition of capital California requires the use of US generally accepted accounting principles (US-GAAP) in the preparation of financial statements (§ 114 CCC; for details concerning the accounting requirements of the California Corporations Code see Section 3, No. 18a), infra). Accounting principles and terminology generally divide the shareholder equity section of the balance sheet into two parts: contributed capital and retained earnings. US-GAAP requires that contributed capital be divided only to comply with the legal requirements of par value or stated value. The California law eliminates “stated capital” and thereby eliminates the necessity for dividing contributed capital under US-GAAP. c) Authorised capital California law allows authorised capital. Each corporation must have at least one class of shares. The articles of incorporation are required to state the authorised number of each class of shares that (or series within a class) the corporation is permitted to issue (§ 202 CCC). The number of issued shares of each class cannot exceed the number authorised under the articles. § 202(d) CCC requires that if the corporation is authorised to issue only a single class of shares, the articles of incorporation must recite the total number of shares authorised to issue. If the corporation will have authority to issue more than one class of shares, or if any class of shares is to have two or more series, § 202(e) CCC requires that the articles set forth the following: (a) the total number of shares of each class the corporation is authorised to issue, and the total number of shares of each series which the corporation is authorised to issue or that the board is authorised to fix the number of shares of any such series; (b) the designation of each class, and the designation of each series or that the board may determine the designation of any such series; and (c) the relative rights, preferences, privileges and restrictions of such shares or series. d) Information to be made public The California Corporations Code does not require disclosure of (contributed) capital and additional paid-in capital. However, publicly traded corporations will be required to disclose very detailed financial information in their public filings with the Securities and Exchange Commission (SEC). e) Consideration for stock As already mentioned, in California the consideration of the shares issued is determined by the board of directors, or by the shareholders if the articles so provide (§ 409(a)(1) CCC). The consideration may consist of any or all of the following: money paid; labour done; services actually rendered to the corporation or for its benefit or in its formation or reorganisation; debts or securities cancelled; and tangible or intangible property actually received either by the issuing corporation or by a wholly owned subsidiary.
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Neither promissory notes of the purchaser (unless adequately secured by collateral other than the shares acquired or unless permitted by § 408 CCC) nor future services shall constitute payment or part payment for shares of the corporation (§ 409(a)(1) CCC). § 409 CCC provides the board of directors with broad discretion in determining the fair value of monetary and non-monetary consideration. Pursuant to § 409(b) CCC, the judgment of the board of directors as to the value of such consideration shall be conclusive in the absence of fraud in the transaction. § 409(e) CCC specifically addresses the board’s fair valuation of non-monetary consideration: “The board shall state by resolution its determination of the fair value to the corporation in monetary terms of any consideration other than money for which shares are issued.” In Andrews v. Panama Oil Co., 50 Cal. App. 764, 767, 195 P. 963, 964 (1920), the court said, that a board’s decision is protected if there was an honest mistake as to the value of property and in the absence of proof that their over-valuation was not the result of an innocent mistake. However, excessive valuations may be invalidated on equitable grounds taking into consideration whether the attending circumstances cast grave suspicions or affirmed the board’s honest and intelligent belief. Hasson v. Koeberle, 180 Cal. 359, 181 P. 387 (1919). Shares issued for consideration or pursuant to an employee stock plan or exchange or conversion of shares shall be declared and taken to be fully paid stock. However, § 409(d) CCC provides that a corporation may issue the whole or any part of its shares as partly paid and subject to call for the remainder of the consideration to be paid therefore. On the certificate issued to represent any such partly paid shares or, for uncertificated securities, on the initial transaction statement for such partly paid shares, the total amount of consideration to be paid therefore and the amount paid thereon shall be stated. The burden of proof to show any wrongdoing on the part of the board members is on the corporation and/or the shareholder to plead and prove facts rebutting the presumptions supplied by the business judgment rule. The cost of a trial to the board members can usually be advanced or reimbursed by the corporation pursuant to typical indemnification provisions set forth in the corporation’s bylaws or as permitted by § 317 CCC, subject to the restrictions set forth in § 317(c) and (h) CCC in the event the board member is adjudged to be liable or such provisions are inconsistent with the articles, bylaws, shareholder resolutions or other agreement then in effect. In addition, pursuant to § 317(i) CCC, the corporation has the power, and usually does, purchase and maintain insurance on behalf of its board members against any liability asserted against or incurred by the board member in that capacity. Based on case law, one can conclude that it would seem that a conservative approach to the question of valuation is the more prudent one. 2. Subscription of capital California law contains rules which deal with the subscription of shares. a) Link of subscribed capital’s injection with subscription of shares In the case par values have been chosen, under California law the formation of the subscribed capital is technically linked to the issuance of shares because a person subscribing a share is to pay in a certain part of the subscribed capital. b) Time limit Under California law there is no time limit within which the shares must be subscribed. 210
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c) Prohibition of subscription of shares by the corporation itself § 510(a) of the California Corporations Code states that any shares reacquired by the corporation (whether by redemption, purchase or other acquisition) are restored to the status of authorised but unissued shares unless reissuance is prohibited by the articles of incorporation. If reissuance is so prohibited, § 510 CCC sets forth a mechanism to adjust the authorised number of shares. d) Setting of the price of the shares California law does not require any minimum amount the corporation must receive for its shares. The valuation of shares issued for consideration is determined from time to time by the board of directors or by the shareholders if so authorised by the articles (§ 409(a)(1) CCC). For further details concerning the consideration of shares see Section 1, No. 1e), supra. e) Amount of consideration Since the abolition of all references to the par value concept there is no legal requirement as to the amount of consideration that must be received for the shares. It must be determined by the board of directors. However, directors violate their fiduciary duties if, for example, shares were to be issued to different parties at different prices contemporaneously. f) Consequences of insufficient consideration If the consideration to be paid to a California corporation is insufficient or fails to comply with the requirements set by the board, § 409(d) CCC permits the corporation to accept partial payment and to issue the whole or any part of its shares as partly paid and subject to call for the remainder of the consideration to be paid therefore. However, upon the declaration of any dividend on fully paid shares, the corporation shall declare a dividend upon partly paid shares of the same class, but only for the consideration actually paid thereon. According to § 410 CCC, every subscriber to shares is liable to the corporation for the full consideration agreed to be paid for the shares. For shares issued as partly paid, the consideration shall be paid in accordance with the agreement of subscription or purchase. Transferees who acquired partly paid shares (a) under a certificate or initial transaction statement showing that the shares were partially paid or (b) with actual knowledge that the full agreed consideration had not been fully paid, are personally liable to the corporation under § 412 CCC for the unpaid instalments. The transferor may be personally liable as well if so provided on the stock certificate, initial transaction statement, written statement, or as agreed upon in writing. According to § 414 CCC, a creditor may sue to enforce the payment obligations of the shareholder in respect of partially paid shares if the creditor has obtained a final judgment either against the corporation and the execution of the judgment is unsatisfactory in whole or in part, or where a proceeding against the corporation would be useless. g) Design of shares § 400(a) CCC provides that a corporation may issue one or more classes of stock or one or more series of stock or both, with full, limited or no voting rights and other rights, preferences, privileges and restrictions as set forth in the articles of incorporation. In order to have limited or no voting rights, there must be one or more classes or series of outstanding shares or debt securities, singly or in the aggregate, that are entitled to full voting rights. In 211
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order to have limited or no dividend or liquidation rights, there must be one or more classes or series of outstanding shares, singly or in the aggregate, that are entitled to unlimited dividend and liquidation rights. h) Information to be fixed in the statutes As stated above (see Section 1, No. 1b), supra), § 202(d) and § 202(e) of the California Corporations Code eliminated any references to “par value” and the concept of “par value stock” and “no par value stock.” § 202(d) CCC simply requires the articles to recite the total number of shares authorised for issuance if the corporation is authorised to issue only a single class of shares. § 202(e) CCC has the same requirement but in reference to each class or series the corporation is authorised to issue. Although the current California Corporations Code removed references to “par value stock” and “no par value stock,” it does not prohibit the inclusion of a “par value.” Consequently, if a corporation would like its shares to have a par value, it can do so by disclosing such par value in its articles of incorporation. 3. Contributions Under California law there are provisions concerning the question what can be injected as capital/funds and of how it can be injected into the corporation. a) Contributions in cash and in kind The California law allows both contributions in cash and contributions in kind (§ 409(a)(1) CCC). aa) Contribution in cash The California Corporations Code provides that the board of directors, or the shareholders if the articles so provide, may authorise capital stock to be issued for consideration consisting of cash (§ 409(a)(1) CCC). bb) Contribution in kind Under California law, the board of directors, or the shareholders if the articles so provide, may authorise capital stock to be issued for in-kind consideration such as labor done; services actually rendered to the corporation or for its benefit or in its formation or reorganisation; debts or securities cancelled; and tangible or intangible property actually received either by the issuing corporation or by a wholly owned subsidiary. However, consideration may not consist of promissory notes of the purchaser (unless adequately secured by collateral other than the shares acquired or unless permitted as part of an employee stock purchase plan) nor future services (§ 409(a)(1) CCC). cc) Stockholder’s obligation In California, the rights of shareholders are contractual rights. Typically, there is a written agreement, which may be a contribution or subscription agreement, which sets forth the conditions and requirements for the sale of the shares. The stock subsequently issued is deemed fully paid and not liable to any further call nor shall the holder thereof be liable for any further payments if shares are issued for valid consideration under § 409 CCC. In turn, § 410 CCC provides that every subscriber to shares or holder of the originally issued shares is liable to the corporation for the full consideration agreed to be paid for the shares. The full agreed consideration for the shares shall be paid 212
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prior to or concurrently with the issuance of the shares unless the shares are issued as partly paid shares under § 409(d) CCC. b) Amount to be paid in As mentioned above (see Section 1, No. 1e), supra), a California corporation may issue the whole or part of its shares as partly paid and subject to call for the remainder of the consideration to be paid therefore (§ 409 CCC). On the certificate issued to represent such partly paid shares or, for uncertificated securities, on the initial transaction statement for such partly paid shares, the total amount of the consideration to be paid therefore and the amount paid thereon shall be stated. Upon the declaration of any dividend on fully paid shares, the corporation shall declare a dividend upon partly paid shares of the same class, but only upon the basis of the percentage of the consideration actually paid thereon. Under § 411 CCC, a transferee who acquires partly paid shares in good faith, without knowledge that they are not fully paid or without knowledge that they have not been paid to the extent stated on the certificate, is liable only for the amount shown by the certificate, if any, to be unpaid on the shares. § 412 CCC, however, states that a transferee of partly paid shares becomes liable for the unpaid balance of the subscription price if the shares have been properly legended to show that they are not fully paid and the amount unpaid thereon, or if the transferee has actual knowledge of those facts. Any prior transferee ceases to be liable when he transfers to one who becomes liable as described in the previous sentence, unless it is provided on the certificate or by a written agreement that the prior holder will remain liable. c) Valuation of contributions in kind As stated before, under § 409 of the California Corporations Code valuation of stock issued for consideration is determined by the board of directors, or by the shareholders if the articles of incorporation so provide. If the articles grant the shareholders this right, such determination shall be made by approval of the majority of the outstanding shares entitled to vote thereon as provided in § 409(c) CCC. If the articles do not grant the shareholders this right, then only the board is empowered to decide whether and what in-kind contributions the corporation will accept. § 309(b) CCC permits a director to rely on information, opinions, reports or statements, including financial statements and other financial data prepared by (1) one or more officers or employees of the corporation whom the director believes to be reliable and competent in the matters presented; (2) counsel, independent accountants or other persons as to matters which the director believes to be within such person’s professional or expert competence; (3) a committee of the board upon which the director does not serve, as to matters within its designated authority, which committee the director believes to merit confidence, provided that, in any such case, the director acts in good faith, after reasonable inquiry when the need therefore is indicated by the circumstances and without knowledge that would cause such reliance to be unwarranted. Although the California Corporations Code provides directors with broad discretion in the issuance and valuation of shares, the directors are constrained by their fiduciary duty as 213
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directors of the corporation to act in the best interests of all the shareholders of the corporation, and not for the purpose of personal profit or gain. If the board attempts to manipulate the issuance of shares where the shares are issued at an unreasonably low price or in favour of certain persons without a legitimate corporate purpose, then the transaction may be enjoined by the courts or the persons responsible may be held liable in damages. Shaw v. Empire Savings and Loan Association, 186 Cal. App. 2d 401 (1960), Schwab v. SchwabWilson Machine Corp., Ltd., 13 Cal. App. 2d 1 (1936). If, however, as provided in § 310(a) CCC, the director exercised due care or reasonable diligence in good faith and in what the director believes to be the best interests of the corporation and where no conflict of interests interferes with his judgment, then the director is protected from personal liability under the business judgment rule. More than a “good faith” effort, § 310 CCC provides that a contract or transaction between a corporation and interested directors (directors who have access to confidential information or can use their position of authority to financially benefit themselves) if the material facts as to the director’s interest in the transaction are fully disclosed or known to the (a) shareholders but the contract or transaction is approved by the shareholders (excluding any votes from the interested director) in good faith, or (b) the board or committee, and they subsequently authorise, approve or ratify the contract or ratification in good faith by a sufficient vote (not counting the interested director’s votes) and the contract or transaction is just and reasonable to the corporation at the time of the board or committee’s decision. If not fulfilled under (a) or (b), the person asserting the validity of the contract or transaction sustains the burden of proving that the contract or transaction was just and reasonable to the corporation at the time of the decision. The corporation, or a shareholder who has suffered losses due to the improper or illegal distribution, can bring an action directly against the board members for an alleged improper valuation. A shareholder of the corporation can also bring a derivative suit on behalf of the corporation against the board members. The burden of proof to show any wrongdoing on the part of the board members is on the corporation and/or the shareholder to plead and prove facts rebutting the presumptions supplied by the business judgment rule. As mentioned before, the cost of a trial to the board members can usually be advanced or reimbursed by the corporation pursuant to typical indemnification provisions set forth in the corporation’s bylaws or as permitted by § 317 CCC, subject to the restrictions set forth in § 317(c) and (h) CCC in the event the board member is adjudged to be liable or such provisions are inconsistent with the articles, bylaws, shareholder resolutions or other agreement then in effect. In addition, pursuant to § 317(i) CCC, the corporation has the power, and usually does, purchase and maintain insurance on behalf of its board members against any liability asserted against or incurred by the board member in that capacity. d) Consequences of incorrect financing If there was an agreement for partly paid shares pursuant to § 409(d) of the California Corporations Code, then there are no consequences so long as the payment arrangement is being honored. Otherwise, § 410 CCC provides that every subscriber is liable to the corporation for the full consideration agreed to be paid for the shares. Failure of full payment does not lead to automatic cancellation of the shares. Rather, as this is a contractual obligation, the corporation may sue in a contract action against the subscriber for the collection of the unpaid amount. 214
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Under § 414 CCC, any creditor of the corporation may apply unpaid subscriptions and any or all shareholders who hold partly paid shares to their final judgment claim. For example, in Hunt v. Sharkey (20 Cal. App. 690), the Superior Court of California, as affirmed by the California Court of Appeal, found the bankruptcy of the corporation did not completely relieve a subscriber from his obligation to pay the unpaid amounts. In fact, the subscriber was liable to the corporation to the extent required to pay its creditors even after exhausting the assets of its estate. 4. Accounting for formation expenses As mentioned before, a California corporation is required to prepare financial statements in conformity with US-GAAP (§ 114 CCC) unless it has fewer than 100 shareholders (§ 1501(a) CCC). According to Statement of Position No. 98-5 (Reporting on the Costs of Start-Up Activities), costs of start-up activities and organisation costs must not be capitalised. Instead, these costs have to be expensed as incurred.
Sub-section 2:
Capital increases
5. Issuance of new shares a) Authorised capital A California corporation, through the board of directors (or the shareholders if the articles of incorporation so provide), has the statutory power to create, value and issue authorised shares. The number of shares authorised for issuance must be stated in the articles. If there are not enough authorised shares, the articles need to be amended for new issuances to occur. If a new class or series of shares are being issued, an amendment to the articles or other certificate of determination must be filed with the California Secretary of State that describes the characteristics of such new class or series of shares. Typically, before the board actually issues the shares, the shareholder and corporation enter into a contractual agreement, such as a “stock purchase agreement” or subscription agreement that describes the terms of the transaction such as number and class or series of shares, price/consideration, effective date of sale and closing conditions, representations and warranties, covenants and voting, pre-emptive, buyback and other agreements relating to the transaction. Pursuant to §§ 404, 405, 406 and 409(a)(2) CCC, shares may also be created by the exercise of an option or warrant to purchase or subscribe to shares of any class or series, the exercise of a conversion right, stock split or share divided, reverse stock split, reclassification of outstanding shares into shares of another class, conversion of outstanding shares into shares of another class, exchange of outstanding shares for shares of another class or other change affecting outstanding shares. b) Amendment to the articles In California, an amendment to the articles must be submitted to increase the number of authorised shares. § 900 CCC states that a corporation may amend its articles from time to time, in any and as many respects as may be desired, so long as its articles, as amended, contain only such provisions as would be lawful to insert in original articles filed at the timing of the filing of the amendment and, if a change in shares or the rights or shareholders or an exchange, reclassification or cancellation of shares or rights of shareholders is to be made, such 215
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provision as may be necessary to effect such change, exchange, reclassification or cancellation. § 902 CCC provides that with respect to any amendments issued after shares have been issued, amendments to the articles may be adopted if approved by the board and approved by the outstanding shares entitled to vote. § 903(a) CCC requires majority approval of a class if the amendment would increase or decrease the aggregate number of authorised shares of such class, unless it is an increase (a) where the corporation has obtained majority approval of voting shareholders for the issue of options to purchase shares or of securities convertible into shares or (b) for a stock split. § 903(a) CCC also permits the creation of a new class of shares having rights, preference or privileges and in the case of preferred shares, divide the shares of any class into series having different rights, preferences, privileges or restrictions or authorise the board to do so. The foregoing must be approved by the outstanding shares of a class and also by the outstanding voting shares. In the case of amendments adopted by the board of directors, § 905 CCC prescribes the process of amending the articles. First, the corporation shall file a certificate of amendment with the California Secretary of State, which shall consist of an officers’ certificate stating: (a) the wording of the amendment in accordance with § 905 CCC; (b) that the amendment has been approved by the board; (c) that the amendment was in accordance with shareholder approval (§§ 902, 903 and 904 CCC) if the approval of the outstanding voting shares is required; (d) if the amendment is one which may be adopted with approval by the board alone to adopt the amendment. The required wording in an amendment to the articles is described in § 907 CCC. The amendment should state that the articles are being amended or that certain named provisions are eliminated from the articles or by stating that certain provisions are added to the articles. Also, the amended articles should state the effect thereof on outstanding shares if the purpose of the amendment is to effect a stock split or reverse stock split or to reclassify, cancel, exchange or otherwise change outstanding shares unless the amendment is adding or eliminating a stated par value or changing the state par value and does not state the effect of the amendment on outstanding shares. Furthermore, § 405 CCC specifically deals with the authorisation of additional shares for options and conversion rights. § 405(a) CCC states that if at the time of granting option or conversion rights, the corporation is not authorised by its articles to issue all the shares required for the satisfaction of the rights, if and when exercised, the additional number of shares required to be issued upon the exercise of such option or conversion rights shall be authorised by an amendment to the articles. In addition, § 405(b) CCC provides that if a corporation has obtained approval of the holders of outstanding shares who are entitled to vote for the issue of options to purchase shares or of securities convertible into shares of the corporation, the board of directors may, without 216
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further approval of the holders of the outstanding shares, amend the articles to increase the authorised shares of any class or series to such number as will be sufficient from time to time, when added to the previously authorised but unissued shares of such class or series, to satisfy any such option or conversion rights. c) Disclosure requirements As mentioned above, the certificate of amendment must be filed with the California Secretary of State. Any documents filed with the Secretary of State are accessible by the public. In addition, public coorporations are subject to the 1934 Securities and Exchange Act and Regulation S-X of the Securities Exchange Commission (SEC), which require the description and disclosure of all material agreements of the corporation, including the articles of incorporation and bylaws. d) Rules of stock exchanges concerning stockholder approval for issuing shares In addition to the rules of the California Corporations Code there are rules of US stock exchanges that require stockholder approval for issuing shares. aa) New York Stock Exchange (NYSE) The NYSE, pursuant to § 312.03 of the Listed Company Manual, states that stockholder approval is required for the issuance of securities in the following situations: (a) equity compensation plans; (b) in any related transactions to (1) a director, officer or substantial security holder of the corporation (each a “Related Party”), (2) a subsidiary, affiliate or other closely-related person of a Related Party, or (3) any company or entity in which a Related Party has a substantial direct or indirect interest, if the number of shares of common stock to be issued, or if the number of shares of common stock into which the securities may be convertible or exercisable, exceeds either 1% of the number of shares of common stock or 1% of the voting power outstanding before the issuance; (c) prior to the issuance of common stock, or of securities convertible into or exercisable for common stock, in any transactions or series of related transactions if (1) the common stock has, or will have upon issuance, voting power, equal to or in excess of 20 % of the voting power outstanding before the issuance of such stock or of securities convertible into or exercisable for common stock, or (2) the number of shares of common stock to be issued is, or will be upon issuance, equal to or in excess of 20 % of the number of shares of common stock outstanding before the issuance of the common stock or of securities convertible into or exercisable for common stock. bb) National Association of Securities Dealers Automated Quotation-System (NASDAQ) NASDAQ, pursuant to Market Place Rule 4350(i), requires stockholder approval prior to the issuance of securities: (a) when a stock option or purchase plan is to be established or materially amended or other equity compensation arrangement made or materially amended, pursuant to which stock may be acquired by officers, directors, employees, or consultants (with respect to the exceptions from this rule see Market Place Rule 4350(i)); (b) when the issuance or potential issuance will result in a change of control of the issuer; 217
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(c) in connection with the acquisition of the stock or assets of another company if (i) any director, officer or 5 % or greater stockholder has a 5 % or greater interest (or such persons collectively have a 10 % or greater interest), directly or indirectly, in the corporation or assets to be acquired or in the consideration to be paid in the transaction(s) and the present or potential issuance of common stock, or securities convertible into or exercisable for common stock, could result in an increase in outstanding common stock or voting power of 5 % or more or (ii) where, due to the present or potential issuance of common stock, or securities convertible into or exercisable for common stock, other than a public offering for cash (a) the common stock has or will have upon issuance voting power equal to or in excess of 20 % of the voting power outstanding before the issuance of stock or securities convertible into or exercisable for common stock, or (b) the number of shares of common stock to be issued is or will be equal to or in excess of 20 % of the number of shares of common stock outstanding before the issuance of the stock or securities; or (d) in connection with a transaction other than a public offering involving (i) the sale, issuance or potential issuance by the issuer of common stock (or securities convertible into or exercisable for common stock) at a price less than the greater of book or market value which together with sales by officers, directors or substantial stockholders of the corporation equals 20 % or more of common stock or 20 % or more of the voting power outstanding before the issuance, or (ii) the sale, issuance or potential issuance by the corporation of common stock (or securities convertible into or exercisable common stock) equal to 20% or more of the common stock or 20 % or more of the voting power outstanding before the issuance for less than the greater of book or market value of the stock. cc) American Stock Exchange (AMEX) § 711 of the Amex Company Guide states that approval of stockholders is required in accordance with § 705 with respect to the establishment of (or material amendment to) a stock option or purchase plan or other equity compensation arrangement pursuant to which options or may be acquired by officers, directors, employees, or consultants, regardless of whether or not such authorisation is required by law or the corporation’s charter (with respect to the exceptions from this rule see § 711 of the Amex Company Guide). § 713 of the Amex Company Guide states that AMEX will require shareholder approval in accordance with § 705 as a prerequisite to approval of applications to list additional shares to be issued in connection with: (a) a transaction involving (i) the sale, issuance, or potential issuance by the corporation of common stock (or securities convertible into common stock) at a price less than the greater of book or market value which together with sales by officers, directors or principal stockholders of the corporation equals 20 % or more of presently outstanding common stock, or (ii) the sale, issuance, or potential issuance by the corporation of common stock (or securities convertible in common stock) equal to 20 % or more of presently outstanding stock for less than the greater of book or market value of the stock; or (b) a transaction which would involve the application of AMEX’s original listing standards as described in § 341. § 713 does not apply to public offerings.
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6. Subscription of new shares With respect to the subscription of new shares which were issued during a capital increase the same rules apply which California law provides for the subscription of shares during the formation of the corporation. This applies for the time frame (see Section 1, No. 2b), supra), the prohibition of subscriptions of shares by the company itself (see Section 1, No. 2c), supra) the setting of the price of the shares (see Section 1, No. 2d), supra), the amount of the consideration (see Section 1, No. 2e), supra) and the consequences of insufficient consideration (see Section 1, No. 2f), supra). Concerning the information to be made public, it should be noted that under California law an amendment to the articles of incorporation needs to be filed with the California Secretary of State and therefore is accessible to the public. 7. Contributions Regarding capital contributions and their payment at the stage of a capital increase the same regulations apply as those at the stage of formation. As at the stage of formation the California Corporations Code allows both contributions in cash and contributions in kind (§ 409(a)(1) CCC, see Section 1, No. 3a), supra). Furthermore with respect to the amount to be paid in (see Section 1, No. 3b), supra), the valuation of contributions in kind (see Section 1, No. 3c), supra) and the consequences of incorrect financing (see Section 1, No. 3d), supra) the same rules are applicable as at the stage of formation. 8. Pre-emption rights When a corporation issues new shares, the proportional financial interests and voting rights of existing shareholders are reduced. Pre-emptive rights were developed to provide a mechanism for preserving the proportional interests of existing shareholders. Pre-emptive rights give the shareholders the right to purchase a pro rata share of any new issues, prior to any sale of such shares to third parties. Under the California Corporations Code, shareholders of a corporation are entitled to preemptive rights only if the articles of incorporation explicitly provide for them (“opt in” approach). § 406 CCC states: “Unless the articles provide otherwise, the board may issue shares, options or securities having conversion or option rights without first offering them to shareholders of any class.” Pursuant to § 204(a)(2) CCC, pre-emptive rights can be part of the optional provisions in the articles of incorporation. Virtually all public corporations in the US have chosen to eliminate pre-emptive rights.
Section 2:
Capital Maintenance
9. Limitation of profit distributions – fraudulent transactions The subject of fraudulent transactions by a debtor has been codified in California by the enactment of the Uniform Fraudulent Transfer Act (UFTA), which is contained in §§ 3439 through 3439.12 of the California Civil Code. This statute replaced the prior Uniform Fraudulent Conveyance Act (UFCA) as of January 1, 1987, and in general follows the provisions of a revised version of the Uniform Act promulgated by the Commissioners of Uniform State Laws, although with significant changes in the version of the new Uniform Act which was enacted in California.
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This statute applies in connection with any debtor and, in general, its application is not affected by the fact that the debtor is a corporation. However, the UFTA does have a particular application in connection with any distributions by a corporation to its shareholders (see Section 3, No. 18g), infra). a) Conditions of fraudulent transfers § 3439.04 of the California Civil Code provides that a transfer made or obligation incurred by a debtor is fraudulent as to a creditor, whether the creditor’s claim arose before or after the transfer was made or the obligation was incurred, if the debtor made the transfer or incurred the obligation: (1) with actual intent to hinder, delay or defraud any creditor of the debtor; or (2) without receiving a reasonably equivalent value in exchange for the transfer or obligation, and the debtor: (a) was engaged or was about to engage in a business or a transaction for which the remaining assets of the debtor were unreasonably small in relation to the business or transaction; or (b) intended to incur, or believed or reasonably should have believed that the debtor would incur, debts beyond the debtor’s ability to pay as they became due. b) Challenge of fraudulent transfers Pursuant to § 3439.07 of the California Civil Code, subject to the limitations in § 3439.08, the creditor may obtain: (1) avoidance of the transfer or obligation to the extent necessary to satisfy the creditor’s claim; (2) an attachment or other provisional remedy against the asset transferred or other property of the transferee in accordance with the procedure prescribed by applicable law; or (3) an injunction or appointment of receiver. Under § 3439.08, a transfer or obligation is not voidable under § 3439.04(a)(1) against a person who took it in good faith and for a reasonably equivalent value or against any subsequent transferee or obligee. c) Hidden contributions According to the California Corporations Code, there is no law dealing with “hidden contributions.” Although at first blush § 310(a)(3) CCC seems to address “hidden contributions” or “secret profits,” the provision was not intended to apply to such transactions. Rather, it is intended to cover situations where the approval of the board cannot be obtained because a majority of the directors are interested or the vote of a majority of a quorum cannot be obtained because the interested director’s vote is not counted. In other words, the director can prove the burden of showing that the transaction was just and reasonable to the corporation. Tevis v. Beigel, 174 Cal. App. 2d 90, 98, 344 P.2d 360, 365 (1959). “Secret profits” are dealt more frequently through common law. If a director engages in “secret profit” transactions, the courts have considered the director’s actions as wilful and 220
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deliberate misappropriation of funds and rendered the directors jointly and severally liable for the misappropriation of such funds. Dean v. Shingle, 198 Cal. 652, 246 P 1049 (1926). In other cases, courts have held the director liable to the corporation and required to return any secret profits gained in the transaction or held the transaction itself voidable. Angelus Securities Corporation v. Ball, 20 Cal. App. 2d 436, 67 P.2d 158 (1937); Western States Life Insurance Co. v. Lockwood, 166 Cal. 185, 135 P. 496 (1913); 173 Cal. 734, 161 P. 498 (1916). 10. Disclosure of related transactions California corporations have to disclose related transactions. a) Requirements of the US securities laws Pursuant to Item 404(a) of Regulation S-K, promulgated under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), a registrant must describe any transaction with a related person, since the beginning of the registrant’s last fiscal year, or any currently proposed transaction, in which the registrant was or is to be a participant and the amount involved exceeds $120,000, and in which any related person had or will have a direct or indirect material interest. The registrant must disclose the following information regarding the transaction: (1) the name of the related person and the basis on which the person is a related person; (2) the related person’s interest in the transaction with the registrant, including the person’s position(s), relationship(s) with, or ownership in, a firm, corporation, or other entity that is a party to, or has an interest in, the transaction; (3) the approximate dollar value of the amount of the transaction; (4) the approximate dollar value of the amount of the related person’s interest in the transaction, which shall be computed without regard to the amount of profit or loss; (5) in the case of indebtedness, disclosure of the amount involved in the transaction shall include the largest aggregate amount of principal outstanding during the period for which disclosure is provided, the amount of interest paid during the period for which disclosure is provided, and the rate or amount of interest payable on the indebtedness; (6) any other information regarding the transaction or the related person in the context of the transaction that is material to investors in light of the circumstances of the particular transaction. b) Rules regarding a corporation acquiring an asset owned by founder/stockholder Under the California Corporations Code, there is no specific rule regarding a corporation acquiring an asset that is owned by a founder/shareholder. There are a number of general rules that are applicable, however. According to § 309(a) CCC, a director shall perform his duties as director in good faith and in what the director believes to be in the best interests of the corporation and its shareholders and with such care, including reasonable inquiry, as an ordinarily prudent person in a like position
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would use under similar circumstances. The general duties of care, good faith and fair dealing are implied covenants in all California contracts. If a founder/shareholder is a director, § 310 CCC may apply. § 310(a) CCC provides that no contract or transaction between a corporation and one or more of its directors or officers, or between a corporation and any other corporation, partnership, association, or other organisation in which one or more of its directors or officers, are directors or officers, or have a financial interest, shall be void or voidable solely for this reason, or solely because the director or officer is present at the meeting of the board or committee which authorises the contract or transaction, or solely because any such director’s or officer’s votes are counted for such purpose, if: (1) the material facts as to the director’s or officer’s relationship or interest and as to the contract or transaction are disclosed or are known to the board of directors or the committee, and the board or committee in good faith authorises the contract or transaction by the affirmative votes of a majority of the disinterested directors even though the disinterested directors be less than a quorum; or (2) the material facts as to the director’s or officer’s relationship or interest and as to the contract or transaction are disclosed or are known to the shareholders entitled to vote thereon, and the contract or transaction is specifically approved in good faith by vote of the shareholders; or (3) the contract or transaction is fair as to the corporation as of the time it is authorised, approved or ratified, by the board of directors, a committee or the shareholders. 11. Loans to directors With respect to the question if loans to directors are restricted by law different approaches exist under the California Corporations Code and the Sarbanes Oxley Act. a) Requirements of the California Corporations Code § 315 of the California Corporations Code states that a corporation shall not make any loan of money or property to, or guarantee the obligation of, any director or officer of the corporation or of its parent, unless the transaction, or an employee benefit plan authorising the loans or guaranties after disclosure of the right under such a plan to include officers or directors, is approved by a majority of the shareholders entitled to act thereon. However, there are several exceptions to § 315 CCC: (1) § 315(b) CCC – any loan or guaranty to an officer of a “public company” (having at least 100 shareholders on record) if the bylaws permit the board alone to authorise such loans or guaranties; (2) § 315(c) CCC – the loan or guaranty is adequately secured or approved by a majority of the shareholders entitled to vote; (3) § 315(d) CCC – advances of expenses reasonably anticipated to be incurred in performance of the director’s or officer’s duties;
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(4) § 315(e) CCC – payment of premiums in whole or in part by a corporation on a life insurance policy of a director or officer and such payment is secured by the proceeds of the policy and its cash surrender value; (5) § 315(f)(1) CCC – any transaction, plan, or agreement pursuant to an employee stock purchase plan; (6) § 315(f)(2) CCC – depository institutions; and (7) § 315(f)(3) CCC – any loan or guaranty in the ordinary course of business where applicable statutes regulate the corporation providing or underwriting loans to its officers or directors. b) Requirements of the Sarbanes-Oxley Act of 2002 Notwithstanding the foregoing, the Sarbanes-Oxley Act of 2002 prohibits personal loans to any executive officer or director of a corporation. § 402 of the Sarbanes-Oxley Act of 2002 states that issuers are prohibited from, directly or indirectly, through a subsidiary or otherwise, extending, modifying, maintaining or arranging extensions of credit, in the form of a personal loan, to or for their directors or executive officers. c) Sanctions Subject to the standard of due care required of a director under § 309 CCC, directors who violate statutory provisions on distributions, loans and guaranties or approve of improper distributions, loans and guaranties shall be jointly and severally liable to the corporation under § 316 CCC for the benefit of all creditors (whose claims must have arisen before the time of the loan was made) or shareholders who file suit in the name of the corporation. Violation of § 402 of the Sarbanes-Oxley Act of 2002 may lead to both criminal and other civil sanctions that arise in the case of violations of the Exchange Act, including imprisonment, censure, cease and desist orders, revocation of registering with Securities and Exchange Commission (SEC) and fines. 12. Acquisition of own shares California law generally allows share repurchases. § 207(d) CCC authorises the corporation to have the power to issue, purchase, redeem, receive, take or otherwise dispose of, pledge, use and otherwise deal in and with its own shares, bonds, debentures and other securities, subject to the provisions of § 510 CCC and any limitations contained in the articles and any other applicable laws, including, importantly, the California Corporations Code restrictions on distributions. The California law applies identical restrictions to cash and property dividends, redemptions and share repurchases. However, the definition of a distribution in § 166 CCC excludes certain rescissions and repurchases of employees’ shares (for further details on the definition of a distribution in California see Section 3, No. 17, infra). The restrictions of distributions are described in-depth in Section 3, No. 18 and 19, infra. Therefore, in this Section 12 there will only be a brief overview of the statutory limitations of share repurchases.
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a) Requirements for legal share repurchases The California Corporations Code contains the following tests for determining the legality of a share repurchase. A corporation cannot acquire own shares if the corporation is, or as a result of the repurchase would likely be unable to meet its liabilities (equity insolvency test). If the proposed distribution meets the equity insolvency test, additional tests must be satisfied as well. The corporation may make purchases out of its retained earnings (retained earnings test). Alternatively, a corporation may purchase own shares if two balance sheet tests are satisfied (also referred to as remaining assets test). The first compares total assets to total liabilities (quantitative solvency test), and the second compares current assets to current liabilities (liquidity test). Furthermore, there are additional restrictions imposed on repurchases of the junior securities if a corporation has preferred stock outstanding. Finally, § 505 CCC expressly authorises additional restrictions upon repurchases under the articles of incorporation or the bylaws, or under an indenture or other agreement. For a complete description of these requirements, see Section 3, No. 18, infra. aa) Retained earnings test If a California corporation meets the equity insolvency test (see section 2, No. 12cc), infra), a “distribution may be made if the amount of the retained earnings of the corporation immediately prior thereto equals or exceeds the amount of the proposed distribution” (§ 500(a) CCC). “Retained earnings” represents the earned capital of a corporation. It consists of all undistributed income that remains invested in the corporation. As indicated before, the determination of the retained earnings is, in general, to be made in accordance with USGAAP (for a complete description of the accounting requirements in California see Section 3, No. 18a), infra; for further details on the retained earnings test see Section 3, No. 18b) aa), infra). bb) Balance sheet tests/remaining assets test In the event that sufficient retained earnings under § 500(a) CCC are not available for the proposed distribution, only one alternative – § 500(b) CCC – is provided (remaining asset test). Under this section, the corporation must meet two balance sheet tests. bb1) Quantitative solvency test First, the quantitative solvency test requires that, immediately after the repurchase, total assets are no less than one and one-quarter times total liabilities, i.e. the equity ratio must be at least 20 %. According to § 500(b)(1) CCC, certain assets and liabilities have to subtracted before applying this test (see Section 3, No. 18b) bb1), infra). bb2) Liquidity test In general, once the quantitative solvency test has been met (see section 2, No. 12b) bb1), supra), the liquidity test must also be satisfied. The liquidity test requires that immediately after the repurchase, current assets equal or exceed current liabilities. However, if the average earnings of the corporation before income taxes and interest expense were less than the average interest expense for the preceding two fiscal years, the current assets are required to be at least one and one-quarter times current liabilities after distribution (for details see Section 3, No. 18b) bb2), infra). cc) Equity insolvency test In California, repurchases are prohibited which would cause the corporation to be rendered insolvent in the equity sense. § 501 CCC provides: “Neither a corporation nor any of its subsidiaries shall make any distribution to the corporation’s shareholders (Section 166) if the corporation or the subsidiary making the distribution is, or as a result thereof would be, likely 224
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to be unable to meet its liabilities (except those whose payment is otherwise adequately provided for) as they mature.” The specific characteristics of the California equity insolvency test are explained in Section 3, No. 18b) cc), infra. dd) Additional restrictions on repurchases of junior securities Where there are two or more classes of stock, additional restrictions are imposed under California law on repurchases of junior securities. A corporation with outstanding shares entitled to liquidation preferences cannot make a distribution to shareholders on junior shares if, after the distribution, the excess of its assets (exclusive certain assets) over its liabilities (exclusive certain liabilities) would be less than the liquidation preference of the senior shares (§ 502 CCC). Pursuant to § 503 CCC, a corporation with outstanding shares with dividend preferences may not make a repurchase unless, after the distribution, there would be sufficient retained earnings to cover all dividends in arrears on such preferred shares (see Section 3, No. 18b) dd), infra). ee) Additional restrictions on permitted repurachases In California, additional restrictions upon repurchases under the articles of incorporation (§ 204(d) CCC), or under the bylaws (§ 212(b)(1) CCC), or under an indenture or other agreement are allowed (§ 505 CCC). ff) Maximum amount of own shares that can be acquired Under California law, so long as the above mentioned restrictions are adhered to there is no specific maximum amount of own shares that can be acquired. c) Determination of time of repurchase and application of restrictions The California law specifies the time at which the tests are to be applied. § 166 CCC provides that the time of any purchase is the date when the corporation transfers cash or property, even if made pursuant to a contract of earlier date. If, however, a negotiable debt security is issued in exchange for the shares, the time of the distribution is the date when the corporation acquires the shares (§ 166 CCC). d) Directors’ liability for illegal repurchases Directors who approve a repurchase which violates §§ 500-503 CCC are jointly and severally liable to the corporation for the benefit of non-consenting creditors or shareholders (§ 316(a)(1) CCC). A director who is present and abstains from voting is considered to have approved the action (§ 316(b) CCC). However, a director is not liable if he lived up to the director’s duty of care (§ 316(a) CCC). For a more complete discussion of the liability of directors under the California Corporations Code, see Section 3, No. 18e), infra. e) Shareholders’ liability for illegal repurchases Pursuant to § 506(a) CCC, shareholders who received the distribution with knowledge of facts indicating its impropriety are liable to the corporation for the benefit of all creditors or shareholders entitled to institute an action (see Section 3, No. 18f), infra). f) Challenge of illegal repurchases by creditors In case of an illegal share repurchase because the California corporation is insolvent or because the amount of the distribution exceeds the retained earnings or does not satisfy the remaining assets test, suit may be brought in the name of the corporation against any or all shareholders liable by any non-consenting creditor whose debts arose before the time of the unlawful distribution (§ 506(b)(1) CCC).
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In California, a creditor may also challenge a corporate debtor’s repurchase as a fraudulent transfer pursuant to § 506(d) CCC and §§ 3439-3439.12 California Civil Code (see Section 2, No. 9, supra). Under the fraudulent transfer law, a creditor has a variety of remedies, including avoidance of the fraudulent transfer, so long as the property has not been transferred to a good faith purchaser for value (for further details see Section 3, No. 18g), infra). g) Treasury shares In California, the concept of treasury shares has been abolished. A corporation does not have the independent right to own and hold its own shares. However, § 703 CCC provides that shares held by the issuing corporation in a fiduciary capacity shall be entitled to vote on any matter only in the following circumstances: (1) to the extent that the settlor or beneficial owner possesses and exercises a right to vote or to give the corporation binding instructions as to how to vote such shares; or (2) where there are one or more co-trustees who are not affected by the prohibition of this subdivision, in which case the shares may be voted by the co-trustees as if it or they are the sole trustee. h) Status of reacquired shares § 510(a) of the California Corporations Code provides that when a corporation reacquires its own shares, those shares are automatically restored to the status of authorised but unissued shares, unless the articles prohibit such reissuance. If the articles prohibit the reissuance of reacquired shares, the remainder of § 510 CCC sets forth detailed rules regarding how the corporation’s capital stock is affected by the reacquisition: If the articles generally prohibit the reissuance of the class or series of the reacquired shares then: (1) When all of the authorised shares of that class or series have been reacquired, (a) that class or series is automatically eliminated, (b) if the reacquisition affects all of the authorised shares of a series, the authorised number of shares of the class to which the shares belonged is reduced by the number of shares so reacquired and (c) the articles shall be amended to eliminate the rights, preferences and restrictions relating solely to that class or series. (2) When less than all of the authorised shares but all of the outstanding shares of that class or series have been reacquired, the authorised number of shares is automatically reduced by the number of shares so reacquired and the board is required to either (a) eliminate that class or series or (b) not to eliminate that class or series, in which case the articles must be amended to reflect the reduction in the number of authorised shares of that class or series by the number of shares so reacquired. (3) When less than all of the authorised shares and less than all of the outstanding shares of a class or series are reacquired, the authorised number of shares are automatically reduced by the number of shares reacquired and the articles must be amended to reflect this. If the articles only prohibit the reissuance of those shares as the shares of the same series then: (1) When all of the authorised shares of that series are reacquired, (a) that series is automatically eliminated (and the articles must be amended to reflect this) and (b) the board is required (1) to return those shares to the status of authorised but undesignated shares of the class to which they belong or (2) to eliminate those shares entirely, in which case the articles must be amended to reflect the reduction of the total authorised shares of that series and class.
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(2) When all of the outstanding shares of the series (but less than all of the authorised shares of that series) are reacquired, the board is required to determine either (a) eliminate the series (and the articles must be amended to reflect this), or (b) not to eliminate the series, in which case the articles shall be amended to reflect the return of the reacquired shares to the status of authorised but undesignated shares of the class to which they belong. (3) When less than all of the outstanding shares of the series are reacquired, the authorised number of shares of that series shall be automatically reduced by the number of shares reacquired (and the articles must be amended to reflect this), and the board is required either (a) to return those shares to the status of authorised but undesignated shares of the class to which they belong or (b) to eliminate those shares entirely, in which case the articles must be amended to reflect the reduction of the total authorised shares of that series and class. i) Reselling of own shares (equal treatment) As mentioned above (see Section 2, No. 12h), supra), shares reacquired by a corporation are considered authorised but unissued shares per § 510(a) CCC unless reissuance is prohibited by the articles. A corporation may reduce its authorised but unissued shares by amending its articles. j) Sanctions If the California corporation is publicly traded and therefore has to obey the rules of the Securities and Exchange Commission (SEC), there are a number of sanctions if shares were acquired in contradiction of the law and SEC rules, respectively. The SEC has the ability to bring a wide variety of enforcement actions, which include censure, cease and desist orders, revocation of registration with the SEC and fines up to $500,000. The SEC’s fundamental enforcement tool is a civil action in federal court seeking an injunction against future violations of certain provisions of the federal securities laws. The SEC brings these actions against both corporations and individuals. The SEC often brings enforcement actions against senior corporate executives. The SEC can also ask a court to order defendants to disgorge unjust enrichment and to impose monetary penalties on defendants. In addition, the SEC has become more aggressive in seeking to bar individuals from serving as officers or directors of public companies. However, absent egregious behaviour from the officers or directors, this scenario is less likely. The SEC can also bring an enforcement proceeding before an administrative law judge. In such proceedings, the SEC can seek an order that the respondent cease and desist from certain violations of the federal securities laws and take corrective action. If the corporation is selling securities pursuant to a registration statement, the SEC can seek an order suspending the effectiveness of the registration statement. The SEC also has the ability to obtain orders suspending for ten days trading in the securities of a public traded corporation. However, the SEC does not have the power to bring criminal actions. The SEC refers appropriate cases to the United States Department of Justice or to state and local authorities for prosecution. The SEC considers a number of factors in deciding whether to make a criminal referral, including its view on: (1) the quality of the evidence; (2) whether the witness lied during testimony, destroyed documents or otherwise obstructed justice; (3) the perceived egregiousness of the defendant's conduct; (4) whether the prospective defendant has previously violated the federal securities laws; and (5) the loss to the investing public and the profits reaped by the prospective defendant. 227
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k) Disclosure A California corporation registered with the SEC as a publicly traded corporation has to follow certain disclosure obligations. In accordance with the Exchange Act, in each quarterly report on Form 10-Q and in the annual report on Form 10-K the corporation must provide a table showing, on a month-to-month basis the following: the total number of shares purchased, the average price paid per share, the total number of shares purchased under publicly announced repurchase programs, and the maximum number of shares that may be repurchased under these programs (or maximum dollar amount if the limit is stated in those terms). § 1501(a) CCC and § 1501(b) CCC require corporations having 100 or more shareholders to provide annual reports to their shareholders. § 1501(a) CCC requires an annual report to be sent no later than 120 days after the close of the fiscal year or at least 15 days prior to the shareholder’s annual meeting, unless this requirement is expressly waived in the bylaws. The annual report may be sent electronically if permitted in the articles or bylaws. The annual report shall contain a balance sheet, income statement, cashflow statement as of the end of that fiscal year accompanied by a report by independent accountants. Otherwise, if no report is provided, the certificate of an authorised officer of the corporation that the statements were prepared without audit form the books and records of the corporation. In addition to the financial statements required above, § 1501(b) CCC requires annual reports to accompany financial statements if the corporation has less than 100 shareholders and is not subject to the reporting requirements of Section 13 of the Securities Exchange Act of 1934 or otherwise exempt from such filing. The report shall briefly describe (1) any transactions (excluding officer and director compensation) during the previous fiscal year in excess of forty thousand dollars ($40,000) or (2) the amount and circumstances of any indemnification or advances aggregating more than ten thousand dollars ($10,000) paid during the fiscal year to any officer or director. 13. Financial assistance The California Corporations Code does not deal directly with transactions such as leveraged buy-outs (LBOs). 14. Loans from shareholders California law does not prohibit loans from stockholders nor does it treat these loans in a specific way. § 510 of the Bankruptcy Code addresses subordination of certain claims and, in concert with other sections of the Bankruptcy Code, furthers the policy of ensuring a fair allocation of estate assets among various creditors who may have a claim to such assets in a liquidation or reorganisation. Pursuant to § 510 of the Bankruptcy Code, claims may be subordinated by contractual agreement, under equitable principles, or when the claim is one arising from the purchase or sale of a debtor’s debt or equity security. § 726 of the Bankruptcy Code governs the distribution of the property of the estate. Under § 726, there are six classes of claims; and each class must be paid in full before the next lower class is paid anything. The debtor is only paid if all other classes of claims have been paid in full.
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15. Capital decreases The California Corporations Code does not specifically address capital decreases. As previously stated, the California Corporations Code does not prescribe a minimum stated capital (see Section 1, No. 1a), supra). § 409 CCC governs the issuance of stock and the consideration to be paid with respect thereto. As provided in § 409(a)(1) CCC, the valuation of consideration is determined from time to time by the board of directors or in § 409(c) CCC, by majority approval of voting shareholders if so required by the articles of incorporation. 16. Redeemable shares A California corporation can distribute assets to stockholders by acquiring outstanding shares through redemption or repurchase. While a repurchase is a voluntary buy-sell transaction between the corporation and a stockholder (see Sub-section 2, No. 12, supra), redemption refers to a forced sale initiated by the corporation, in accordance with a contract or the articles of incorporation. a) Possibility of redeeming shares In California, shares may be redeemed pursuant to § 509 CCC. § 509 CCC provides that a corporation may redeem any or all shares which are redeemable at its option by (a) giving notice of redemption, and (b) payment or deposit of the redemption price of the shares as provided in its articles or deposit of the redemption price pursuant to a trust fund. The trust fund shall be set up by the corporation with any bank or trust company in the state of California if, on or prior to any date fixed for redemption of redeemable shares, the corporation deposits (a) a sum sufficient to redeem, on the date fixed for redemption thereof, the shares called for redemption, (b) in the case of redemption of any uncertificated securities, an officer’s certificate setting forth the holders thereof registered on the books of the corporation and the number of shares held by each, and (c) irrevocable instructions and authority to the bank or trust company to publish the notice of redemption thereof (or to complete publication if theretofore commenced) and to pay, on and after the date fixed for redemption or prior thereto, the redemption price of the shares to their respective holders upon the surrender of their share certificates, in the case of certificated securities, or the delivery of the officer’s certificate in the case of uncertificated securities, then from and after the date of the deposit (although prior to the date fixed for redemption) the shares called shall be redeemed and the dividends on those shares shall cease to accrue after the date fixed for redemption. The deposit shall continue full payment of the shares to their holders and from and after the date of the deposit the shares shall no longer be outstanding and the holders thereof shall cease to be shareholders with respect to the shares and shall have no rights with respect thereto except the right to receive from the bank or trust company payment of the redemption price of the shares without interest, upon surrender of their certificates therefore, in the case of certificated securities, and any right to convert the shares which may exist and then continue for any period fixed by its terms. b) Conditions of share redemptions § 402 of the California Corporations Code permits a corporation to establish one or more classes or series of shares which are redeemable, in whole or in part, (a) at the option of the corporation or (b) to the extent and upon the happening of one or more specified events.
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Subject to special exceptions for investment companies and professional or other corporations whose ability to conduct business is contingent upon certain shareholders continuing to hold shares, no redeemable common shares shall be issued or redeemed unless the corporation at the time has outstanding a class of common shares that is not subject to redemption provided with a few limited exceptions (§ 402(c) CCC). The circumstances under which the corporation may reacquire its own shares also may be established by contract. c) Notice of redemption of shares Pursuant to § 509(b) of the California Corporations Code, the corporation may give notice of the redemption of any or all shares subject to redemption by causing a notice or redemption to be published in a newspaper of general circulation in the county in which the principal executive office of the corporation is located at least once a week for two successive weeks, in each instance on any day of the week, commencing not earlier than 60 nor later than 20 days before the date fixed for redemption. The notice of redemption shall set forth: (1) the class or series of shares or portion thereof to be redeemed; (2) the date fixed for redemption; (3) the redemption price; and (4) if the shares are certificated securities, the place at which the shareholders may obtain payment of the redemption price upon surrender of their share certificates. Notice also should be provided to the holder of books and records for the corporation. d) Restrictions on legal share redemptions, liability and challenge of illegal redemptions A corporation’s redemption is one of the transactions within the meaning of “distribution to its shareholders” by a corporation (§ 166 CCC, for details see Section 3, No. 17, infra). Such redemption, therefore, is subject to the same restrictions imposed on all such distributions, like for example the equity solvency test and the retained earnings test (for details see Section 2, No. 12, supra, and Section 3, No. 18, infra, respectively).
Section 3:
Dividends and distributions
17. Definition of Distribution In California, the phrase “distribution to its shareholders” is defiend in § 166 CCC. This definition is then used throughout Chapter 5 (“Dividends and reacquisitions of shares”) of the California Corporations Code (§§ 500-511 CCC) in specifying the restrictions imposed upon such a distribution. § 166 CCC provides: “‘Distribution to its shareholders’ means the transfer of cash or property by a corporation to its shareholders without consideration, whether by way of dividend or otherwise, except a dividend in shares of the corporation, or the purchase or redemption of its shares for cash or property, including the transfer, purchase, or redemption by a subsidiary of the corporation.” Certain rescission transactions of share issuances by a corporation and certain repurchases by a corporation of its shares are excluded from the definition of “distribution to its shareholders” in § 166 CCC. These transactions are excluded from the provisions of Chapter 5 CCC. The sentence in § 166 CCC dealing with these exclusions reads as follows: “’Distribution to its shareholders’ shall not include (a) satisfaction of a final judgment of a court or tribunal of appropriate jurisdiction ordering the rescission of the issuance of shares, (b) the rescission by 230
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a corporation of the issuance of its shares, if the board determines (with any director who is, or would be, a party to the transaction not being entitled to vote) that (1) it is reasonably likely that the holder or holders of the shares in question could legally enforce a claim for the rescission, (2) that the rescission is in the best interests of the corporation, and (3) the corporation is likely to be able to meet its liabilities (except those for which payment is otherwise adequately provided) as they mature, or (c) the repurchase by a corporation of its shares issued by it pursuant to Section 408, if the board determines (with any director who is, or would be, a party to the transaction not being entitled to vote) that (1) the repurchase is in the best interests of the corporation and that (2) the corporation is likely to be able to meet its liabilities (except those for which payment is otherwise adequately provided) as they mature.” Unlike the prior California law, payment of dividends and share repurchases are treated the same. The statutory restrictions on distributions of a California corporation are discussed in depth in the following (see Section 3, No. 18, infra). 18. Distributable amount The revision of the California Corporations Code in the mid-1970ies led to major changes in the treatment of distributions to shareholders by a corporation. The California law prescribes the circumstances under which a “distribution to its shareholders” may be made. Whether a corporation can do so generally depends on the ability to pay its debts as they become due and upon its retained earnings or its financial position, determined almost entirely in accordance with generally accepted accounting principles. a) Reliance on US-GAAP (consolidated) financial statements California is the only state in the US which explicitly states what accounting rules have to be the basis of the distribution requirements. Wherever the California Corporations Code refers to “financial statements, balance sheets, income statements, and statements of cashflows, and all references to assets, liabilities, earnings, retained earnings, and similar accounting items of a corporation” it means that those items are prepared “in conformity with generally accepted accounting principles then applicable” (§ 114 CCC). California also is the only state that requires the use of consolidated financial statements in determining the amount available for distributions (§ 114 CCC). The purpose of consolidated financial statements is to present the financial position of the parent and its subsidiaries as if the group were a single company. The term “subsidiary” is defined in § 189(a) CCC as “a corporation shares of which possessing more than 50 percent of the voting power are owned directly or indirectly through one or more subsidiaries by the specified corporation.” Pursuant to § 194.5 CCC, “voting power” means the power to vote for the election of directors. The mere fact that a parent-subsidiary relationship exists does not always mean that a consolidated statement is required under US-GAAP, and in case of doubt, attention will have to be given to US-GAAP to determine where it is required or permitted. § 166 CCC requires that the restrictions on distributions be applied to each corporation in the group. A separate determination has to be made for each corporation and its subsidiaries. Therefore, in a three-tier corporate group, for example, the ultimate parent must satisfy the tests based on the consolidated group financial statements (consolidation of the parent and both subsidiaries). The middle corporation must meet these tests based on the consolidated financial statements of the sub-group (consolidation of the middle corporation and its one subsidiary). The bottom level subsidiary must satisfy the tests on the basis of its single financial statements. 231
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The California Corporations Code contains a limited number of special modifications of the US-GAAP accounts. Contrary to US-GAAP, the profits derived from an exchange of assets shall not be included unless the assets received are currently realisable in cash (§ 500(b)(2) CCC). In conjunction with the application of the quantitative solvency and liquidity tests, the California law specifies several accounting practices. Even though such practices may contravene US-GAAP, adherence to them is mandatory (for details see section 3, No. 18bb), infra). Notwithstanding § 114 CCC, the financial statements of any corporation with fewer than 100 holders of record of its shares are not required to be prepared in conformity with US-GAAP, if they reasonably set forth the assets and liabilities and the income and expense of the corporation and disclose the accounting basis used in their preparation (§§ 1501(a), 605 CCC). In addition, a corporation may be required to maintain other books and accounts of financial transactions, such as a stock ledger if dictated by other applicable state and federal laws, such as the Securities Exchange Act of 1934 (for public corporations) and Regulation S-X of the Securities and Exchange Commission (specifies the format, content of required financial statements under the Securities Act of 1933 and Securities Exchange Act of 1934), and the requirements of any securities exchange on which the corporation may have an outstanding class of securities listed. b) Requirements for legal distributions The California Corporations Code contains the following tests for determining the legality of distributions. A corporation cannot make a distribution if the corporation is, or as a result of the distribution would be, likely to be unable to meet its liabilities (equity insolvency test). If the equity insolvency test is met, additional tests must be satisfied as well. Dividends are permitted out of a corporation’s retained earnings (retained earnings test). Alternatively, a corporation may pay a dividend if two balance sheet tests are satisfied (also referred to as remaining assets test). The first compares total assets to total liabilities (quantitative solvency test), and the second compares current assets to current liabilities (liquidity test). Furthermore, there are additional restrictions imposed on dividends on junior shares if a corporation has preferred stock outstanding. Finally, the California Corporation Code expressly authorises additional restrictions upon distributions under the articles of incorporation or the bylaws, or under an indenture or other agreement (§ 505 CCC). aa) Retained earnings test If a California corporation meets the equity insolvency test (see section 3, No. 18b) cc), infra), a “distribution may be made if the amount of the retained earnings of the corporation immediately prior thereto equals or exceeds the amount of the proposed distribution” (§ 500(a) CCC). Under this test, the only determination that needs to be made is the amount of the retained earnings of the corporation. “Retained earnings” represents the earned capital of a corporation. It consists of all undistributed income that remains invested in the corporation. As indicated before, the determination of the retained earnings is to be made in accordance with generally accepted accounting principles (US-GAAP). Once that number is ascertained, the corporation may legally pay a dividend or repurchase shares in an amount up to but not to 232
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exceed that figure (unless it is permitted to do so under the remaining assets test pursuant to § 500(b) CCC; see section 3, No. 18b) bb), infra). If the corporation declares a dividend in property, the amount of the dividend shall be determined on the basis of the value at which the property is carried on the financial statements in accordance with US-GAAP (§ 500(c) CCC). If the corporation, for example, was distributing property with a fair market value of US-$ 1,000,000, which was shown on the financial statements with a value of US-$ 200,000, then only US-$ 200,000 in retained earnings would be necessary to permit the distribution. Provisions relating to nimble dividends and wasting assets corporations, contained in the prior California law, were abolished. bb) Balance sheet tests/remaining assets test In the event that sufficient retained earnings under § 500(a) CCC are not available for the proposed distribution, consideration must be given to the alternative requirements of § 500(b) CCC. Under this section, the corporation must meet two balance sheet tests (remaining asset test). bb1) Quantitative solvency test First, the quantitative solvency test requires that, immediately after the distribution, total assets are no less than one and one-quarter times total liabilities, i.e. the equity ratio must be at least 20 %. According to § 500(b)(1) CCC goodwill, capitalised research and development expenses and deferred charges have to be subtracted from the assets. It should be noted, however, that generally under US-GAAP research and development expenses have to be expensed as incurred anyway (Statement of Financial Accounting Standard (SFAS) 2.12). Deferred taxes, deferred income, and other deferred credits have to be subtracted from the liabilities. bb2) Liquidity test Once the quantitative solvency test has been met (see section 3, No. 18b) bb1), supra), the liquidity test must also be satisfied by those corporations which classify their assets as current or fixed under US-GAAP (§ 500(b)(2) CCC). Corporations which do not classify their assets are nor required to satisfy the liquidity test. The liquidity test requires that immediately after the distribution, current assets equal or exceed current liabilities. However, if the average earnings of the corporation before income taxes and interest expense were less than the average interest expense for the preceding two fiscal years, the current assets are required to be at least one and one-quarter times current liabilities after distribution. The statute goes on to detail specific rules in computing assets and current assets in certain situations. Profits derived from an exchange of assets should not be included unless the assets received are currently realisable in cash. Contrary to US-GAAP, § 500(b)(2) CCC permits that “‘current assets’ may include net amounts which the board has determined in good faith may reasonably be expected to be received from customers during the 12-month period used in calculating current liabilities pursuant to existing contractual relationships obligating those customers to make fixed or periodic payments during the term of the contract.” Furthermore, public utilities may do the same “pursuant to service connections with customers, after in each case giving effect to future costs not then included in current liabilities but reasonably
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expected to be incurred by the corporation in performing those contracts or providing service to utility customers.” cc) Equity insolvency test In California, distributions are prohibited which would cause the corporation to be rendered insolvent in the equity sense. § 501 CCC provides: “Neither a corporation nor any of its subsidiaries shall make any distribution to the corporation’s shareholders (Section 166) if the corporation or the subsidiary making the distribution is, or as a result thereof would be, likely to be unable to meet its liabilities (except those whose payment is otherwise adequately provided for) as they mature.” In performing the equity insolvency test, a corporation and its subsidiaries are considered as a unit. For example, where the parent corporation is or would be insolvent, its subsidiaries are prohibited from making distributions to shareholders of the parent by purchasing their shares. Even if the parent corporation meets the solvency test, the subsidiary must still meet the solvency limitation with respect to distributions on its own. § 501 CCC contains one exception: Even though a corporation would be rendered insolvent, a distribution is allowed if the liabilities which it would not be able to meet as they fall due as a result of the distributions are “otherwise adequately provided for.” The distribution provisions of the California Corporations Code do not define what is meant by “adequately provided for.” § 2005 CCC, one of the general provisions relating to dissolution of corporations, however, does deal with the meaning of this term. It states that payment is “adequately provided for” if (a) it has been assumed or guaranteed in good faith by one or more financially responsible corporations or other persons or by the United States government or any agency thereof, and the provision (including the financial responsibility of such corporations or other persons) was determined in good faith and with reasonable care by the board to be adequate at the time of the liquidating distribution, or (b) the amount of the debt or liability has been deposited with the California State Treasurer or with a bank or trust company in California in trust for the benefit of those lawfully entitled to it. These provisions should be applicable to a provision for payment pursuant to § 501 CCC. The exception permits a distribution if a financially responsible controlling shareholder guaranteed the corporation’s liabilities. In other jurisdictions, distributions are prohibited if the corporation “is or would be unable” to pay its debts as they become due (for example, see § 6.40(c)(1) MBCA). § 501 CCC, prohibiting distributions if the corporation is or would be “likely to be unable” to pay, bans distributions even if the corporation is not actually insolvent. dd) Additional restrictions on distributions to junior shares Where there are two or more classes of stock, additional restrictions are imposed under California law on distributions to the junior shares. A corporation with outstanding shares entitled to liquidation preferences cannot make a distribution to shareholders on junior shares if, after the distribution, the excess of its assets (exclusive of goodwill, capitalised research and development expenses, and deferred charges) over its liabilities (exclusive of deferred taxes, deferred income, and other deferred credits) would be less than the liquidation preference of the senior shares (§ 502 CCC). Therefore, this provision may prohibit a distribution to common shareholders where there are retained earnings. This would occur if there are preferred shares outstanding and the write-off of intangibles required by § 502 CCC were in excess of that required by US-GAAP.
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A corporation with outstanding shares with dividend preferences may not make a distribution on junior shares unless, after the distribution, there would be sufficient retained earnings to cover all dividends in arrears on such preferred shares (§ 503 CCC). ee) Additional restrictions on permitted distributions In California, additional restrictions upon distributions under the articles of incorporation (§ 204(d) CCC), or under the bylaws (§ 212(b)(1) CCC), or under an indenture or other agreement are allowed (§ 505 CCC). c) Determination of time of distribution and application of restrictions The California law specifies the time at which the tests are to be applied. § 166 CCC provides that the time of any distribution by way of dividend shall be the date of declaration thereof. Therefore, the directors must act upon the latest financial statements available and on the basis of their general knowledge of the affairs of the corporation to the effect that its financial condition has not substantially deteriorated in the interim between the date of that balance sheet and the time when they take the action. d) Notice to shareholders Shareholders must be notified if a dividend is not chargeable to retained earnings (§ 507 CCC). The notice must state the accounting treatment of the dividend. It must accompany the dividend or be given within three months after the end of the fiscal year in which it was paid. e) Directors’ liability for illegal distributions Directors who approve a distribution which violates §§ 500-503 CCC are jointly and severally liable to the corporation for the benefit of non-consenting creditors or shareholders (§ 316(a)(1) CCC). In order to avoid liability an individual director has to vote against the illegal distribution; a director who is present at the meeting of the board and abstains from voting shall be considered to have approved the action (§ 316(b) CCC). Even if a director voted for an illegal distribution, he is not liable if he complies with the statutory standard of care specified in §§ 309(a)-(b) CCC. § 309(a) CCC provides that a director is required to perform the duties of a director: (1) in good faith; (2) in a manner a director believes to be in the best interests of the corporation and its shareholders; and (3) with such care, including reasonable inquiry, as an ordinarily prudent person in a like position would use under similar circumstances. As mentioned before, pursuant to § 309(b) CCC, a director is entitled to rely on information prepared or presented by internal or external experts (for details see Section 1, No. 3c), supra). Since the directors must determine the legality of a distribution in part by reference to financial statements prepared in accordance with US-GAAP, they will be protected by their reliance on the reports of independent accountants, so long as they satisfy their duty of inquiry and so long as they have no knowledge that would cause their reliance to be unwarranted.
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If a director fails to perform the duties pursuant to §§ 309(a)-(b) CCC and approves an improper distribution to shareholders, the damages recoverable will be the amount of the illegal distribution plus interest thereon from the date of the distribution at the legal rate on judgments until paid, not exceeding the sum of the liabilities owed to non-consenting creditors or shareholders (§ 316(d) CCC). Any director who is sued for recovery of an unlawful distribution may implead all other directors liable and may compel contribution (§ 316(e) CCC). If a director is liable for such improper distribution, he shall also be subrogated to the rights of the corporation against shareholders who received the distribution. The director may cross-complain in the action in which the director’s liability is asserted, or the director may file an independent action (§ 316(f)(3) CCC). As mentioned before, the cost of a trial to the directors can usually be advanced or reimbursed by the corporation pursuant to typical indemnification provisions set forth in the corporation’s bylaws or as permitted by § 317 CCC, subject to the restrictions set forth in § 317(c) and (h) CCC in the event the director is adjudged to be liable or such provisions are inconsistent with the articles, bylaws, shareholder resolutions or other agreement then in effect. In addition, pursuant to § 317(i) CCC, the corporation has the power, and usually does, purchase and maintain insurance on behalf of its board members against any liability asserted against or incurred by the directors in that capacity. f) Shareholders’ liability for illegal distributions Shareholders who received the distribution with knowledge of facts indicating its impropriety are liable to the corporation for the benefit of all creditors or shareholders entitled to institute an action (§ 506(a) CCC). The measure of liability is the amount of the unlawful distribution received plus interest thereon at the legal rate on judgments until paid, but not exceeding the liabilities of the corporation owed to non-consenting creditors or shareholders. A shareholder who is sued for recovery of an illegal distribution may implead other shareholders who may be liable in order to compel their contribution (§ 506(c) CCC). In addition, § 506(d) CCC explicitly provides that shareholder’s liability under this provision is not exclusive and shareholders may be liable under the fraudulent transfer law (see Section 3, No. 18g), infra). g) Challenge of illegal distributions by creditors In case of an illegal distribution because the California corporation is insolvent or because the amount of the distribution exceeds the retained earnings or does not satisfy the remaining assets test, suit may be brought in the name of the corporation against any or all shareholders liable by any creditor whose debts arose before the time of the unlawful distribution (§ 506(b)(1) CCC). Creditors who have consented to an illegal dividend are precluded from bringing suit. In California, a creditor may also challenge a corporate debtor’s payment of dividends as a fraudulent transfer pursuant to § 506(d) CCC and §§ 3439-3439.12 California Civil Code (see Section 2, No. 9, supra). Under the fraudulent transfer law, a creditor has a variety of remedies, including avoidance of the fraudulent transfer, so long as the property has not been transferred to a good faith purchaser for value.
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The creditors’ statute may differ from the California distribution rules in four respects: who can challenge the transfer; who can be required to pay back the transferred assets; what is the standard of illegality; and who bears the burden of proof: (1) Under the California Civil Code, present and future creditors of a corporation can attack a distribution as fraudulent in three circumstances: actual intent; unreasonably small remaining assets; and intent to incur debts beyond its ability to pay. The California Corporations Code denies standing to anyone who was not a creditor at the time of the distribution. (2) Under the fraudulent transfer law, the shareholder who received the distribution, and not the directors who declared the distribution, are the appropriate defendants. If the distribution was a fraudulent transfer, then innocent shareholders could also be required to turn over the amounts received. Only a good faith purchaser for value is protected against avoidance of the transfer, and shareholders do not pay value for distributions. (3) There are four circumstances in the fraudulent transfer law where creditors can attack distributions (actual intent, unreasonably small remaining assets, intent to incur debts beyond its ability to pay, insolvency). One of them – unreasonably small remaining assets – could provide creditors with greater protection than they have under the California Corporations Code. If the courts apply this standard in a meaningful way, it imposes a requirement of some minimal adequacy of capital, the original purpose of the dividend surplus statutes which vanished in the era of low- and no-par shares. Therefore, the fraudulent transfer law could impose a greater restriction on distributions than the balance sheet or the equity insolvency tests do. “Unreasonably small capital” denotes a financial condition short of insolvency. (4) In challenging the legality of a distribution under the California Corporations Code, the plaintiff bears the burden of proof that the distribution is illegal. Under the fraudulent transfer law there are circumstances where it is easier for a creditor to establish illegality. 19. Determination of the distributable amount a) Decision of the board of directors In California, §§ 500-503 CCC provide that the declaration of distributions is left to the corporation subject to any restrictions in the articles of incorporation and by the applicable statutory provisions. In practice, the declaration of distributions generally is within the discretion of the board of directors and protected by the business judgement rule. However, directors have to obey any restrictions in the articles or bylaws or any other agreement and the applicable statutory provisions (see Sub-section 3, No. 18), supra). b) Disclosure Under California law, the board must disclose any distributions made during the fiscal year in the financial statements contained in the annual report the corporation must provide to the shareholders within 120 days after the end of the fiscal year, as required by § 1501 CCC. As mentioned before, the automatic requirement to provide an annual report can be waived in the corporation’s bylaws if the corporation has less than 100 shareholders of record but any shareholder can nonetheless request annual financial statements and 5% shareholders also can request quarterly income statements and balance sheets. If the corporation has more than 100 shareholders, the corporation is required to deliver an annual report. If the corporation is public, applicable SEC rules apply. Under Regulation S-X of the SEC, which applies to registration statements under the Securities Act of 1933, annual or other 237
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reports under §§ 13 and 15(d), and proxy and information statements under § 14 of the Securities Exchange Act of 1934, dividends must be disclosed stating the amount per share in the aggregate for each class of shares . c) Challenge of resolutions If a shareholder believes that the board has made an incorrect distribution, the shareholder must first bring his complaint to the board and request that the board provide an explanation and/or correct the alleged wrongdoing. If the shareholder does not notify the board of its complaint prior to filing an action, he will need to explain to the court why he did not do so. If the board does not provide a satisfactory answer or remedy, the shareholder can bring a direct suit if he has suffered losses as a result of such incorrect distributions, or a derivative suit on behalf of the corporation pursuant to § 800 CCC, against the board. The business judgment rule applies. Plaintiff must show the dividend payment resulted from improper motives and amounted to waste. Where a distribution complies with §§ 500-503 CCC, the alleged excessiveness of the amount alone does not state a cause of action. d) Mandatory distributions The fact that assets exist from which a dividend may be declared is insufficient to invoke the forcing of a declared dividend. A plaintiff effectively must show gross abuse of discretion, oppression, or bad faith. 20. Accounting reserves that influence the distributable amount In general, the California Corporations Code relies upon US-GAAP (consolidated) financial statements when determining the distributable amount. As mentioned above, a distribution may be made if the amount of the retained earnings of the corporation immediately prior thereto equals or exceeds the amount of the proposed distribution (see Section 3, No. 18b) aa), supra). However, if the corporation decides to distribute an amount in excess of retained earnings the corporation must retain an equity ratio of at least 20 % and current assets must at least equal current liabilities of the corporation. In calculating these ratios specific modifications of assets and liabilities have to be made (see Section 3, No. 18b) bb), supra).
Section 4:
Capital related rules in case of crisis and insolvency
21. Trigger of insolvency California law does not discuss filing for insolvency. Federal bankruptcy law neither requires an insolvent company to file for bankruptcy, nor is insolvency a requirement to commence a bankruptcy proceeding. Corporations may seek to accomplish an out of court restructuring. In the United States, under the Bankruptcy Code, an entity is insolvent if its debts are greater than its assets, at a fair valuation, exclusive of property exempted or fraudulently transferred.
Section 5:
Contractual self protection of creditors
22. Contractual self protection In California, creditors and preferred stockholders rarely rely on legal capital rules when extending credit or investing their money. Instead, many long-term creditors (particularly bank lenders and bondholders) and preferred stockholders demand contractual limits on 238
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dividends and other forms of distribution, contained in a trust indenture agreement or sometimes incorporated into the articles of incorporation. Typical negative covenants in loan/credit agreements and bonds, include the following: restricting payment of dividends or repurchase of company stock unless company income exceeds certain amount; requiring company to meet certain financial tests/ratios; limiting new indebtedness and liens that can be incurred; limiting amount of capital expenditures; and limiting investments in new businesses. Under the law, creditors have relatively few control rights (in terms of the actions of the corporation) until a company has defaulted on its obligations. Thus, creditors use contractual agreements to assert additional control over a corporation in order to protect their own interests by including contractual restrictions, such as those mentioned above, in their contractual agreements.
Section 6:
Equal treatment
23. Principle of Equal treatment a) Principle of equal treatment In California, all shares of any one class shall have the same voting, conversion and redemption rights and other rights, preferences, privileges and restrictions, unless the class is divided into series. If a class is divided into series, all the shares of any one series shall have the same voting, conversion and redemption rights and other rights, preferences, privileges and restrictions. b) Right to vote § 400 of the California Corporations Code provides that every corporation may issue one or more classes of stock or one or more series of stock within any class thereof, which classes or series may have such voting powers, full or limited, or no voting powers. c) Pre-emption right § 204(a)(2) CCC allows for pre-emptive rights in the articles of incorporation. However, these rights must be explicitly stated in the articles of incorporation to be effective. These rights may also be provided by contract such as in a “stock purchase agreement” (which is more common than doing so in the articles). d) Right to receive dividends As mentioned before, §§ 502-503 impose restrictions for the protection of preferred shareholders in connection with distributions made to common shareholders or to other preferred shareholders who rank in a junior position to the particular class of preferred shareholders (see Section 3, No. 18b) dd), supra). § 502 CCC deals with the protection of liquidation preference in favour of preferred shares and basically requires that the corporation maintain a net worth of at least equal to that liquidation preference after making any distribution to any junior class of shares. § 503 CCC deals with the protection of the dividend preference of a class of preferred shares and basically requires that the corporation maintain retained earnings in an amount equal to all accrued and unpaid dividends on the preferred shares after making any distribution to any junior class of shares. e) Right to attend the shareholders’ meeting Nothing in California law hinders a stockholder’s right to attend a stockholders’ meeting. 239
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3.1.1 Canada As is the United States, Canada is a federal jurisdiction subdivided into ten provinces and three territories. Unlike the US, however, both the federal government and the provincial governments regulate in the area of corporate law. Accordingly, there are fourteen corporate law statutes. For purposes of the study, only the federal Canada Business Corporations Act (CBCA), R.S.C. 1985, c. C-44, as amended (CBCA) will be examined. Further, also unlike the United States, securities law is a matter of provincial regulation. Accordingly, there is securities regulation in thirteen jurisdictions. The most important one is the Securities Act Ontario (Securities Act, R.S.O. 1990, c. S.5, as amended, (OSA)). While the statutes are generally similar, one has to bear in mind that there may be differences from jurisdiction to jurisdiction.
Section 1:
Capital formation
Sub-section 1:
Formation of the stock corporation
1. Stated capital and other means of equity financing Canada does not follow the traditional system of legal capital rules. The CBCA includes provisions on Corporate Finance in Part V (sections 24 and the following) starting with the rule that shares shall be without nominal or par value. a) Minimum subscribed capital There is no minimum capital requirement. b) Composition of capital/authorised capital Generally, a company will choose to have unlimited authorised capital. It may, however, in its articles, provide for a limit on capital. The more usual practice is to have no limit on authorised capital. In either case, this capital is referred to as authorised capital – not stated capital. The board of directors establishes the price for which shares are issued, including the value of any non-cash consideration. This consideration must represent the fair value of the goods or services provided – a matter to be determined by the board, which is entitled to rely on the assistance of experts. The articles deal only with authorised capital – not with issued capital. Because there is no concept of par value securities, there is no premium or contributed surplus. A company shall maintain a separate stated capital account for each class and series of shares it issues and shall add the appropriate stated capital account the full amount of any consideration it receives for the shares it issues. In the financial statements, stated capital (the consideration received for the issuance of shares) is usually described under the heading “shareholders equity” as “share capital“. Unless the company is a reporting issuer, its statements are generally not available to the public – that is, there is no public disclosure of stated capital. d) Information to be made public Unless the company is a reporting issuer, its statements are generally not available to the public – that is, there is no public disclosure of stated capital. Nevertheless the articles are a public document.
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2. Subscription of capital The prospective shareholder’s obligation to buy shares arises when the shareholder’s subscription to buy shares is accepted by the company and a contract is thereby formed. a) Capital and share issue on incorporation According to s 6 CBCA the articles of incorporation shall set out the classes and any maximum number of shares that the corporation is authorised to issue, if there will be two or more classes of shares, the rights, privileges, restrictions and conditions attaching to each class of shares and if a class of shares may be issued in series, the authority given to the directors to fix the number of shares in, and to determine the designation of, and the rights, privileges, restrictions and conditions attaching to, the shares of each series. A corporation comes into existence on the date shown in the certificate of incorporation. b) Prohibition of subscription of shares by the company itself Sections 30-36 CBCA constrain the corporation from holding its own shares. The exceptional authorisation by legislation to purchase own shares applies to repurchase and is then possible only under limited circumstances. It is not possible to subscribe for own shares at the time of issuance. c) Setting of the price of the shares As mentioned above, the directors determine the consideration for shares. A share shall not be issued until the consideration is fully paid. Principles applicable to the purchase price on share issuance are as follows: (i) shares may be issued at such times and to such persons and for such consideration as the directors determine; (ii) shares may only be issued as fully-paid and non-assessable (iii) if the consideration is property or past services, the directors must determine that payment in kind is not less in value than the equivalent of the money that the company would have received if the shares had been issued for money (iv) none of a promise to pay, a promissory note or an obligation to provide future services is acceptable property for the payment of shares. d) Design of shares There is a presumption that the shares of the company carry the same rights. However, the articles may provide for more than one class of shares carrying different rights, privileges, restrictions and conditions. Except that there must be one class of shares which is characterised as (but need not be called) common shares, these being shares which carry the right to elect directors, the right to dividends and the right to distribution of any remaining assets after obligations to all creditors and all other classes of shares have been satisfied, there are no limitations on the classes of shares which may be issued and the rights attaching to them. Since authorised capital may be unlimited, there is no requirement to subscribe for all authorised shares in either the articles or the CBCA nor is there any time limit by which shares must be subscribed. Only non-par value shares may be issued. Most companies have only one class of shares (common) but a company may issue shares of as many classes with as many preferences and/or restrictions as the articles provide. Further, Canadian corporate and securities law permit multiple-voting and subordinate-voting shares. Shares of a class may be issuable in 241
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series with each series having certain common rights (for example, voting rights) but varying other rights (for example, the right to, or the amount of, a preferential dividend). If the company has more than one class of shares, one class is usually designated as common shares with the attributes described above and the other class or classes are generally entitled to a preference on dividends and distributions and either entitled to special voting rights or restricted from voting except in limited circumstances. However, the common share rights may be in one or more classes of shares and need not be in a single class. e) Information linked to the share to be fixed The share conditions must be fully set out in the articles, which are a public document. 3. Contributions Under the Canadian Corporate Law section 25 CBCA deals with contributions. a) Contributions in cash and other forms Generally, payment of shares can be made in cash or through contribution of property or past services. Since shares may be issued only as fully-paid and non-assessable, the promise to perform future services is not good consideration. Again, because shares must be fully-paid at the time of issue, a promissory note is not proper consideration. No shareholder has any obligation to make future contributions unless the shareholder agrees to do so through a shareholders agreement or, in theory, by subscribing for shares in a company in which the articles require future contributions. In Canada, this would be most unusual. The stated capital does not appear on the company’s share certificates or in its corporate records. It appears only in its financial statements. b) Amount to be paid in Shares must be fully-paid at the time of issue. c) Valuation of contributions in kind It is the responsibility of the directors to value contributions in kind at fair value. In doing so, they may retain the services of an expert and, if they do so, in a situation which could otherwise be controversial, they are entitled to rely on the opinion of the expert. Except to the extent that shareholders of a closely-held corporation may remove the power of the directors to issue shares in an unanimous shareholders agreement, they have no right to require that shares be paid for by contribution in kind. d) Consequences of incorrect financing If shares are issued for inadequate consideration, the directors are jointly and severally liable to the company for the amount of the deficiency, s 118(1) CBCA. There is conflicting case law as to whether the issue of shares in the circumstances is a nullity or is a rectifiable error but the better view is that it is rectifiable error. Pearson Finance Group v. Takla Star Resources [2002] A.J. 422 (C.A. Alta) Javelin v. Hillier [1988] Q.J. 928 (Que S.C.) 4. Accounting for formation expenses This is essentially an accounting, not a corporate law, question. The capitalisation of anything other than nominal incorporation and organisation expenses would be highly unusual in Canada. The more common practice is to have them borne by the incorporators or expensed. 242
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Dividends are normally paid out of earnings. If incorporation and organisation expenses are amortised, the amortisation will affect earning available for distribution. Dividends are, however, payable only if the company meets the applicable solvency test (see questions 17 and 18). Since these expenses would normally have no realisable value, their inclusion on the balance sheet would not assist on this branch of the solvency test.
Sub-section 2:
Capital increases
5. Issuance of new shares The number of shares which a company can issue is unlimited unless a company chooses to limit the number of shares authorised by its articles. a) The usual way to issue new shares Shares will, subject to any stock exchange or securities regulatory authority restrictions, be issued by resolution of the directors. No statutory authorisation is required and, except as required by stock exchange or securities regulatory authorities, no shareholders’ resolution is necessary. Except in these situations, the directors need no further authority. As it is unusual for a company to limit the number of shares authorised in its articles, we will not deal with this process in detail but, if that were to be the situation, the company would need to amend its articles to issue shares beyond its authorised capital. This would entail shareholder approval by an extraordinary resolution – that is, by two-thirds of those voting - and filing of the articles of amendment with the governmental authority. The usual procedure for authorised shares is: Step 1: Check articles, by-laws and unanimous shareholders agreement to see if any restrictions on the issue of shares Step 2: The board of directors determines the number of shares to be issued, the prospective subscribers and the consideration for each share Step 3: If the shares are to be offered for property or past services, the directors determine that the consideration is the fair equivalent of the monetary consideration for its shares. If they desire, they may use a third party expert to assist in this process Step 4: The company receives the consideration and the shares are issued as fully paid and non-assessable. A proposal by a company to capitalise retained earnings (reserves) would be extremely rare as there are tax disincentives to a step of this nature but, to effect this step, a company must obtain the approval of two-thirds of the shareholders voting on the resolution. b) Special procedures If a listed company sets aside shares for stock option plans, it must comply with applicable stock exchange rules (under the rules of the Toronto Stock Exchange (TSX), a shareholder vote is required). Under TSX rules, the strike price for stock options must not be less than the formula market price at the time of grant. In addition to the above TSX rules, the most important securities regulatory rule relates to related party transactions. In this situation, if, as a result of the transaction, the number of new shares (together with, in some cases, shares already held by the related party) cannot exceed 25% of the issued capital at the time of the transaction, on a undiluted basis, without the approval by the requisite majority of all shareholders (for many transactions, two-thirds of those voting) together with the favourable vote of a “majority of the minority” – that is, a majority of the shareholders who do not have an interest in the transaction. See question 10
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for further details. See also Ontario Securities Commission (OSC) Rule 61-501 and Companion Policy 61-501 CP. If a class of shares is issuable in series (cf s 27 CBCA), the directors may authorise a new series complying with the class conditions and, in doing so, must file articles of amendment to authorise the series. c) Shareholders’ rights The shareholders have no right to set any aspect of share consideration except where this right has been removed from the directors under an unanimous shareholders agreement. In connection with certain related party transactions in a public company context, shareholders may have the right to review and approve the decision of the directors to issue shares to a related party. This issue is discussed briefly above. 6. Subscription of new shares Generally, the issue of additional capital is subject to the same considerations as set out for the formation. There is no requirement that all authorised or offered shares be subscribed for. Except for any time limitation imposed by an applicable shareholders agreement or by securities authorities relating to the timeliness of disclosure, there is no minimum or maximum timeframe relating to the offer of additional shares. As Canada has only no par value shares, aspects of the question relating to par value shares are inapplicable. 7. Contributions The requirements in respect of contributions on formation of the company are equally relevant to the issue of new shares. 8. Pre-emption rights The issue of pre-emptive rights is governed by s 28 CBCA. a) No general pre-emptive right The legislation specifically allows a company to include pre-emptive rights in its articles but provides that no pre-emptive right exists if shares are to be issued for a non-cash consideration, as a share dividend or on the exercise of a conversion, option or similar right. For a closely-held corporation, an unanimous shareholders’ agreement could prohibit the issue of shares pursuant to one or more of these exceptions without specific shareholder approval. b) “Minority oppression” Generally, shareholders do not have a fiduciary duty to other shareholders and may act in their own self-interest. Directors, who are responsible for the issuance of shares, do have a fiduciary duty. Further, if there is a unanimous shareholders’ agreement removing the power of the directors to the majority shareholder(s), the fiduciary duty would extend to it/them. While there is no fiduciary obligation on shareholders as such, the court is given broad power under s 241 CBCA if a company (or an affiliate) or its directors have acted in a manner “that is oppressive or unfairly prejudicial to or that unfairly disregards the interest of any” complainant. In a complaint of this nature, the legislation specifically provides that
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shareholder approval of the act in question does not overcome the court’s right to scrutinise the transaction but the court may take this approval into account when deciding the matter.
Section 2:
Capital Maintenance
9. Limitation of profit distributions – fraudulent transactions Because Canada’s corporate legislation contains an extensive oppression remedy (s 241 CBCA), a complainant would be much more likely to move under the oppression remedy than attempt to exercise rights under federal bankruptcy legislation or provincial fraudulent conveyance legislation (eg Fraudulent Conveyances Act Ontario). A trustee-in-bankruptcy might possibly pursue an action under the Bankruptcy and Insolvency Act (Canada) because the limitation period is theoretically longer but this is a highly unlikely scenario. 10. Disclosure of related transactions As noted elsewhere, Canada does not have national securities legislation. Accordingly, each province has its own securities legislation but, in many substantive areas (including related party transactions), the rules across the country are generally similar. One set of rules is governed by the Ontario Securities Commission Rule 61-501 and Companion Policy 61-501 CP. The rules described here apply only to reporting issuers. In addition to related party transactions, it covers insider bids, issuer bids and certain business combinations. It applies to transactions between a company and its significant shareholders and/or their affiliates. The Ontario Securities Commission requires the issuer to file a material change report describing the proposed transaction in detail – generally, not less than 21 days before the proposed closing date of the transaction. Often, corporate law will require shareholder approval (again, often by a two-thirds vote, including shares owned by the related party) of the shareholders. In these circumstances, unless there is a specific exemption, the policy will also require the approval of a “majority of the minority” – that is, a majority of those voting who are not related parties or insiders or affiliates of the related parties and insiders. Further, in certain circumstances, the policy will also require a formal valuation by an independent valuer as well as disclosure any other valuation obtained by the company within the previous two years. Finally, the transaction must be negotiated by directors independent of the related party and their recommendation in favour of the transaction (based, in part, on the formal valuation or a fairness opinion from a financial adviser) is a pre-requisite to taking the transaction to the shareholders. 11. Loans to directors At one time, most Canadian corporate statutes contained limitations on financial allowance to shareholders and directors. These constraints have been eased over the years and have now been eliminated in both the federal legislation and its Ontario counterpart. Likewise, Canadian securities legislation does not inhibit loans to shareholders, directors and officers except to the extent that these loans are either covered by the related party rules referred to in question 10 (see also OSC Rule 61-501 and 61-501 CP) or covered by rules applicable to stock purchase plans. In all cases, however, loans must be fully disclosed directly in the management proxy circular and indirectly elsewhere and, in the case of a stock purchase or option plan, set out in the plan itself, which is subject to shareholder approval.
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As a practical matter, large reporting issuers in Canada will generally not provide these loans because the issuers are either governed by SEC rules or may contemplate becoming SEC registrants. Further, good corporate governance practice tends to enhance this practical prohibition. 12. Acquisition of own shares The general principle is a prohibition on the acquisition of own shares but there are exceptions. a) General rule The general rule (s 30(1) CBCA) is that, except as permitted in the legislation (summarised below), a company may neither: (a) hold its own shares or the shares of its controlling shareholder; nor (b) permit any subsidiary to acquire its shares. If, however, a subsidiary does hold shares of the parent (for example, it was a shareholder before it became a subsidiary), it must dispose of the shares within five years. b) Exceptions There are some specific exceptions (sections 31 et seqq CBCA) – for example, a corporation can hold its own shares in a representative capacity (a trustee for a third party beneficial owner) or by way a security for a loan made in the ordinary course of business. There is also an exception if the shareholding is necessary to enable the company to meet a minimum Canadian content share ownership requirement of regulatory legislation - for example, telecom legislation. Most importantly, shares may be purchased or redeemed under a provision in the articles and according to s 34 CBCA (or according to s 35 of the Act acquired to settle or compromise a debt, to eliminate fractional shares, to meet a contractual obligation, to satisfy the claim of a dissenting shareholder or to comply with a court order) if, after paying for the acquired shares, the company meets the applicable solvency test. For example, s 34(2) CBCA includes this two-limb solvency test. In all of these cases, the shares must be cancelled (except, in the case of a company with limited authorised capital, in which case the shares can be restored to treasury). Further, in all cases, the stated capital account of the applicable class of shares will be reduced by the pro rata stated capital of the cancelled shares and the balance of the payment will be made from retained earnings. A reporting issuer may make either an issuer bid or a normal course issuer bid in accordance with applicable securities legislation. An issuer bid must comply, to the extent applicable, with the same regime as is applicable to related party transactions (see question 10) and takeover bid rules. These include timely disclosure, a formal valuation unless an exemption exists and pro rata treatment of all shareholders except for those who agree before the bid not to tender. A normal course issuer bid is a process by which a company can acquire up to 5% of its shares in any twelve-month period provided that no more than 2% of the shares is acquired in any thirty-day period. It is preceded by a timely disclosure (material change) report in a form required by securities legislation. Generally, the issuer is not active in the market in periods when insiders are free to trade and an issuer under a normal course issuer bid cannot make the market – that is, it can only respond at the market price from time to time by buying at market.
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If shares have been improperly purchased or redeemed, the company may apply for a court order requiring the shareholder to return the improperly paid money and the directors are also jointly and severally liable for any improper payment, subject to their ability to recover from the shareholder. In both cases, the action must be brought within two years. As noted above, repurchased shares are cancelled. As a result, they have no voting rights. In addition to the corporate law regulation, there are provisions in eg: OSA, Part XX OSC Rule 61-501 and Companion Policy 61-501 CP 13. Financial assistance As noted in Questions 10-11, restrictions on financial assistance to shareholders are gradually being eliminated in Canada and have been eliminated in the federal legislation. Accordingly, the only rules that apply are where the target is a reporting issuer and the transaction is a takeover bid, an insider bid, an issuer bid, a business combination or a related party transaction. There are no specific rules applicable to LBOs. 14. Loans from shareholders Because Canada has an oppression remedy (s 241 CBCA) which is quite unique and which is quite flexible in dealing with matters such as this, the courts have not found it necessary to create solutions under insolvency law. Therefore, if a security holder, creditor, director or officer determines that an action of the company on an affiliate or its directors is oppressive or unfairly prejudicial to or unfairly disregards his or her interests, the complainant may bring an action under section 241 within two years of the alleged improper act. 15. Capital decreases Of importance are sections 34-40 and sections 190 and 241 CBCA. See generally question 12 as to purchase or redemption of shares. Regarding the reduction of capital ss 38 and 39 CBCA are relevant. A company may/must reduce its stated capital (the consideration received for the issuance of shares) by the pro rata stated capital of the class of any shares acquired by the company on: (a) a purchase or redemption made by agreement or tender; (b) a purchase to compromise a debt, eliminate fractional shares or cash out a director, officer or employee; (c) a purchase under a shareholders’ right of dissent and appraisal where a shareholder is opposed to a fundamental corporate action (for example, an amalgamation) and the holders of a majority of the shares have approved the transaction; and (c) a purchase to satisfy an oppression remedy court order. In addition (cf s 38 CBCA), a company may reduce its capital by a special resolution (that is, the favourable vote of two-thirds of the shares voting on the resolution) for any purpose. Unless the purpose is, however, to reduce its capital to an amount represented by realisable assets, it may not do so unless it meets the applicable solvency test.
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16. Redeemable shares The Corporations Act deals with the issue in sections 24(4), 27 and 36. Redeemable shares are expressly permitted under the legislation. Generally, the articles of a company will set out the terms of redemption of a class of shares and, if shares are issuable in series, the articles will set out what terms are common to the class and what terms may be set for each series issued within the class. If the shares are issuable in a series, the directors must approve an appropriate amendment to the articles to designate the terms of the series. The articles will, therefore, set out a complete code for the redemption of shares including matters such as notice and, on a partial redemption, the manner in which the shares to be redeemed are to be selected (pro rata, by lot, etc.). The one provision stipulated by the legislation is that shares may be redeemed only if the company can meet the applicable solvency test. If a company is a reporting issuer, the main features of its redeemable shares must be set out in its financial statements and accompanying notes as must any financial condition (for example, breach of a covenant in a loan document) which might impair redemption in accordance with the share conditions.
Section 3:
Dividends and distributions
17. Definition of Distribution “Distribution” is not a legal term in Canadian corporate law. A company is entitled to declare and pay dividends on its shares, subject to meeting the applicable solvency test. It is required to distribute its remaining property to shareholders after satisfaction of all liabilities on dissolution or liquidation. The board of directors has the sole right to declare dividends. A dividend becomes a debt owing by the company only after it has been declared and not paid when due. Directors have the right to pay dividends in cash or in specie and to permit shareholders to elect to receive stock dividends in lieu of cash. If they do, the company, in effect, buys the stock and distributes it to the shareholders. If a company is a reporting issuer, there are requirements relating to the setting of record dates for the payment of dividends so that the stock can trade ex-dividend after the appropriate date and publication requirements of these dates established by the stock exchanges. A dividend (even a fixed dividend on preferred shares) may be declared and paid only if the company can meet the applicable solvency test after the payment of the dividend. 18. Distributable amount The only Canadian condition applicable to payment of a dividend is a solvency test. The Canadian test for the declaration of dividends is quite simple. A company is not entitled to declare or pay dividends if there are reasonable grounds for believing that: (a) the company is, or would be after the payment is made, unable to pay its liabilities as they fall due; or (b) after payment of the dividend, the realisable value of its assets will be less than the total of its liabilities and its stated capital.
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This is not a GAAP test nor is there any requirement as to the accounting method to be used. There is no direction as to the method of valuation but it must be appropriate in the circumstances; accordingly, the going concern assumption is usually most appropriate. In the ordinary course, a company which has earnings in excess of its dividend requirements generally is not concerned with the solvency test. The test only becomes an issue when there is a concern as to whether the company can meet the test. The decision is ultimately that of the board but, for its own protection (it is entitled to rely on the advice of experts if it has a reasonable belief in their credibility), it will engage financial advisors for this purpose. As directors will be personally, jointly and severally liable for repayment of an improper dividend, they generally take care in this area. As noted in question 17, a company may pay a dividend in specie or through the issue of its own fully paid shares. If it does the latter, the stated capital account will be adjusted accordingly. See CBCA, sections 42, 43 and 118. 19. Determination of the distributable amount Except as noted in the next paragraph, the directors have the sole responsibility for determining whether a dividend is to be declared and paid. See question 18 as to the amount that can be declared and paid. The only exceptions to the statement in the first sentence of the preceding paragraph are: (a) if there are preferred shares with a preferential dividend entitlement, the directors must declare and pay the dividend if the company can meet the solvency test; (b) in theory, the right to declare the dividends can be reserved to the shareholders under the articles but, to our knowledge, this is never done; (c) in a closely-held company, the power of the directors to declare and pay dividends can be reserved to the majority shareholder(s) through the use of a unanimous shareholders agreement. Each shareholder will know about the dividend when he or she receives his or her pro rata payment. Further, the financial statements of the company will show what dividends have been paid in the preceding year. Finally, if the company is a reporting issuer, the company will have an obligation to publish a dividend notice in advance setting out the amount and timing of dividends to allow trading pre- and ex-dividend. Shareholders are entitled to challenge a dividend which has been made in violation of the solvency test. Otherwise, the board is free to declare a dividend in whatever amount it thinks fit. The only other remedy available to the shareholders is the oppression remedy. Because dividends are paid pro rata, it is difficult to see how this would be effective unless the company is closely held and there is an argument that the money is being siphoned out through wages or consulting contracts to the benefit of certain shareholders and the detriment of others. 20. Accounting reserves that influence the distributable amount As the solvency test is set out by the legislation for the payment of dividends, accounting reserves are not meaningful in this context. As noted in question 18, one branch of the solvency test involves the realisable value of the company’s assets over the total of its liabilities and stated capital.
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Section 4:
Capital related rules in case of crisis and insolvency
21. Trigger of insolvency a) Definition of Insolvency A company is insolvent for insolvency legislation purposes if it is unable to meet its liabilities as they fall due (the going concern test) or if the realisable value of its assets is less than the amount of its liabilities. In theory, both of these tests are maintenances test which must be met at all times. In practice, however, the board is concerned with the tests only if the company is financially troubled. b) Overview of procedures The duty of the directors is to the company and not to the creditors or even the shareholders, although some aspects of the U.S. concept of the “zone of insolvency” are beginning to be discussed in Canada. The directors must apply their business judgment as to whether and when a company files for protection under the Bankruptcy and Insolvency Act (BIA) or the Companies Creditors Arrangement Act (CCAA). The latter statute is a somewhat novel alternative to a standard bankruptcy proceeding. In general terms, it affords the company and its board greater time to effect a workout. Some companies (for example, such well-known Canadian companies as Stelco and Air Canada) have been under CCAA protection for up to two years. In other words, CCCA affords a U.S.-style debtor-friendly opportunity to negotiate a workout from insolvency. Under the bankruptcy and insolvency legislation, however, unless a workout proposal receives speedy creditor approval, a trustee-in-bankruptcy is appointed and control of the company is then effectively removed from the board. Because Canada does not have par value shares, there are no share premiums. Stated capital ranks as the last priority on an insolvency. Subject to any claim made under the oppression remedy (see previous questions), shareholder loans are treated in the same manner as any other debt and are afforded whatever contractual rights they enjoy. If there is a going concern issue, the board monitors both the financial pressures on the company and its ability to meet the solvency test. If the company is not forced into insolvency, the board determines whether to assign the company into bankruptcy under the BIA or to seek protection under the CCAA. Generally, if the board believes the company is viable, it will pre-emptively move under the CCAA to avoid being forced into bankruptcy and to retain control of the situation.
Section 5:
Contractual self protection of creditors
22. Contractual self protection Both traditional lenders (banks) and corporate bondholders negotiate both negative and positive covenants in their loan and bond purchase agreements, as applicable. In recent years, these covenants have grown increasingly lax. The effect of this trend has been particularly noticed in private equity transactions (where investment grade corporate bonds are often reduced to junk bonds) as a result of the additional leverage employed by the private equity firms and in the recent period of economic uncertainty. The most common of these provisions do not deal with distributions; rather they impose a limit on leverage and an interest coverage test. Accordingly, dividends and other distributions to shareholders are often only impacted if their payment would lead to the company failing to meet these tests. On default, further 250
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distributions to shareholders are normally prohibited. In addition, if there is subordinated shareholder debt, repayment of this will be restricted as will payment of interest if the senior loan is in jeopardy. In times of economic uncertainty, covenants tend to be more tightly negotiated. There are no standard forms. If a company fails, small creditors will generally be unprotected – primarily because they are unsecured and, in these situations, there is usually only money available for secured creditors. In a CCAA-style workout, unsecured creditors may not be treated as well as bondholders but there are some protections available to them. To the extent that they extend credit to the company while it is under the CCAA protection (“rescue money”), this credit is generally a priority. Further, there are priority protections available in bankruptcy to employees and, to a much lesser extent, landlords. Finally, they may enjoy a class vote on the restructuring proposal, which may give them some negotiating leverage. The main reasons why lenders typically negotiate these contractual arrangements are: (a) on default, their debt chrystallises and they can demand repayment, subject to the ability of the company to repay and to whatever CCAA protection it negotiates; (b) these protections give them a leverage in negotiating favourable terms on bankruptcy or a workout, as applicable; (c) these provisions give them some control over the operations of the company during the period of negotiation; and (d) in the case of operating lenders (for example, banks), they can withhold further advances if it is in their best interests to do so.
Section 6:
Equal treatment
23. Principle of Equal treatment a) Principle of equal treatment The general principle of equal treatment within one class of shares is laid down in s 24(3) CBCA. As noted in question 2, if there is only one class of shares, each shareholder must have a right to vote and a right to receive dividends and the remaining property of the company and dissolution on a pro rata basis. As noted in question 8, there can be a pre-emptive right relating to any particular class of shares but there are exceptions. As noted below, only shareholders entitled to vote are entitled to receive notice and attend a shareholders meeting. b) Classes of shares If there is only one class of shares, all shareholders are equal and each has the right to one vote per share and a pro rata right to receive dividends and to share in any remaining property on the dissolution of the company. If there is more than one class of shares the three common share rights described in the preceding sentence must exist but they need not exist in the same class of shares, s 24(4) of the Act. Each class is entitled to the rights, privileges, restrictions and conditions attaching to it as set out in the articles. Section 176 CBCA sets out provisions regarding class votes (see below). c) Voting rights Accordingly, both Canadian corporate law and Canadian securities law recognise subordinate-and-multiple-voting shares so that a shareholder of a reporting issuer with a 251
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relatively small proportion of the equity can own a controlling voting interest. A classic example in Canada has been Magna, a large auto parts manufacturer, where, until very recently, the founding shareholder had less than 1% of the equity but approximately 75% of the votes. Otherwise, s 140(1) expresses the principle of “one share – one vote”. d) Pre-emption rights The legislation (see s 28 CBCA) recognises the right of a company to include pre-emptive rights in its articles on a class-by-class basis but, as noted in question 8, there are no preemptive rights for shares issued for other than cash, as a stock dividend or to satisfy any conversion or option right. In a closely-held company, however, the shareholders could prohibit issue of shares in these circumstances through an unanimous shareholders agreement. e) Shareholders’ meeting Only shareholders entitled to vote at a meeting (and directors and the auditors) are entitled to notice of, and to attend at, shareholders meetings, s 135(1)(a) CBCA. All shareholders of a class (even one which does not otherwise have voting rights) are, however, entitled to notice of, to attend and to vote seperately as a class at any meeting which involves a proposed amendment to the articles which would have any impact on the shares of that class, whether by amending the conditions applicable to that class or creating new shares (or new rights in any existing class of shares) ranking equal or superior, to the rights attaching to the shares of that class.
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3.2.4 Australia Section 1:
Capital formation
Sub-section 1:
Formation of the stock corporation
1. Stated capital and other means of equity financing Australia does not follow the traditional system of stated capital rules. The Corporations Act 2001 specifically requires that share capital does not have a stated value and therefore shares don’t have a par value. When a company is registered under the Corporations Act 2001 it is automatically registered as an Australian company. This means that it can conduct business throughout Australia without needing to register in individual State and Territory jurisdictions. A company has the legal capacity and powers of an individual both in and outside this jurisdiction. It also has all the powers of a body corporate, including the power to issue and cancel shares in the company, to issue debentures, to issue grant options over unissued shares in the company, to distribute any of the company’s property among the members, in kind or otherwise, etc. (s 124 CA). A company's internal management may be governed by provisions of the Corporations Act that apply to the company as replaceable rules, by a constitution, or by a combination of both. There are additional requirements concerning internal management contained in ordinary provisions of this Act and also in common law. A company may modify some or all of the replaceable rules by adopting a constitution. If a company has a constitution, it may define legal rights, duties and restrictions of the company. Furthermore, the constitution will define the types and amounts of share capital and any limits on capital that can be issued. The following table sets out the provisions of this Act that apply as replaceable rules. Provisions that apply as replaceable rules 1 2 3 4 5 6 7 8 9 10 11 12
Officers and Employees Voting and completion of transactions—directors of proprietary companies Powers of directors Negotiable instruments Managing director Company may appoint a director Directors may appoint other directors Appointment of managing directors Alternate directors Remuneration of directors Director may resign by giving written notice to company Removal by members—proprietary company Termination of appointment of managing director
194 198A 198B 198C 201G 201H 201J 201K 202A 203A 203C 203F 253
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Provisions that apply as replaceable rules 13 14 15 16 17 18 19 20 21 22 22A 23 24 25 26 27 28 29 30 31 32 33 33A 33B 34 35 36 37 38 39
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Terms and conditions of office for secretaries Inspection of books Company or directors may allow member to inspect books Director’s Meetings Circulating resolutions of companies with more than 1 director Calling directors’ meetings Chairing directors’ meetings Quorum at directors’ meetings Passing of directors’ resolutions Meetings of members Calling of meetings of members by a director Notice to joint members When notice by post or fax is given When notice under paragraph 249J(3)(cb) is given Notice of adjourned meetings Quorum Chairing meetings of members Business at adjourned meetings Who can appoint a proxy [replaceable rule for proprietary companies only] Proxy vote valid even if member dies, revokes appointment etc. How many votes a member has Jointly held shares Objections to right to vote How voting is carried out When and how polls must be taken Shares Pre-emption for existing shareholders on issue of shares in proprietary company Other provisions about paying dividends Dividend rights for shares in proprietary companies Transfer of shares Transmission of shares on death Transmission of shares on bankruptcy Transmission of shares on mental incapacity Registration of transfers Additional general discretion for directors of proprietary companies to refuse to register transfers
204F 247D 248A 248C 248E 248F 248G 249C 249J(2) 249J(4) 249J(5) 249M 249T 249U 249W(2) 249X 250C(2) 250E 250F 250G 250J 250M 254D 254U 254W(2) 1072A 1072B 1072D 1072F 1072G
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a) Minimum subscribed capital Effective from 1 July 1998, shares in all companies have no par value: s 254 C Corporation Act 2001 (“CA”). Former sec 1444 made it clear that the no par value regime was to apply to all shares issued before 1 July 1998, as well as to those issued after that date. The concept of having a par value (also termed a ”notional value'') was abolished as, amongst other things, it was considered that par values could mislead unsophisticated investors as to the value of a particular share. The Explanatory Memorandum (para 11.22) to the Company Law Review Bill 1997 notes the par value was simply an arbitrary monetary denomination which was attributed to shares and gave no indication of the value of a share at any particular time. There is no stated capital amount provided in the statutes although limits on capital can be specified in the constitution of the company and companies may have a numerical limit on shares in their constitution. For various (tax and practical) reasons, the minimum number of shares issued is generally at least 2 shares although these can be of any dollar value. Different share types can be issued which may be issued at various prices as determined by the Board of the Company. b) Composition of capital: share capital When an Australian corporation is built up, different classes of shares may be issued where particular rights apply to the different classes of shares. A company’s power to issue shares includes the power to issue bonus shares (shares for whose issue no consideration is payable to the issuing company), preference shares (including redeemable preference shares) and partly-paid shares (whether or not on the same terms for the amount of calls to be paid or the time for paying calls). Under the no par value regime, each share within a given class has the same value and rights. Each holder has the same entitlement to a share in the shareholders' funds of the company, irrespective of the amount paid. Prior to the abolition of par values, it was common for companies to make a new issue of shares for the par value plus a premium, yet those who were required to pay the premium did not enjoy any greater rights than existing shareholders who may not have paid a premium. The abolition of par values ended the distinction between the par value and any premium and combined both into one the single notion of “share capital''. This combination was reflected in former s 1446 which provides that the amount standing to the credit of the share premium account and the capital redemption reserve became part of the company's share capital on 1 July 1998. Classes of shares are distinguished only by differences in rights and obligations attaching to the shares in question rather than by differences in how particular persons can use the rights when the shares come into their hands. Differences in the rights exercisable by particular shareholders are not differences between classes of shares, even if, for some purposes, they distinguish classes of shareholders. Shares are accounted for in accordance with the amount received since the concept of par value does not exist under current corporation legislation. All money received will be credited to the company’s share capital account with no distinction between “par value” and “share premiums”. Australian Accounting Standard AASB 101: Presentation of Financial Statements prescribes the basis for preparation of general purpose financial reports for reporting entities - Clause 76 requires disclosures in the financial statements details in respect of share capital.
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c) Information to be made public aa) Application for registration s 117 CA states which information has to be delivered for registration a corporation in Australia. To register a company, a person must lodge an application with ASIC. The application must state (1) the type of company that is proposed to be registered under the Corporations Act, (2) the company’s proposed name, (3) the name and address of each person who consents to become a member, (4) the name of each person who consents in writing to become a director, (5) the name of each person who consents in writing to become a company secretary, (6) for a company limited by shares or an unlimited company the number and class of shares each member agrees in writing to take up and the amount each member agrees in writing to pay for each share; whether the shares each member agrees in writing to take up will be fully paid on registration; if that amount is not to be paid in full on registration—the amount each member agrees in writing to be unpaid on each share; whether or not the shares each member agrees in writing to take up will be beneficially owned by the member on registration; and (7) for a public company that is limited by shares or is an unlimited company, if shares will be issued for non-cash consideration—the prescribed particulars about the issue of the shares, unless the shares will be issued under a written contract and a copy of the contract is lodged with the application. If the company is to be a public company and is to have a constitution on registration, a copy of the constitution must be lodged with the application. Furthermore, a company must send a copy of its constitution to a member of the company within 7 days if the member asks the company for the copy. The ASIC may register the company and issue a certificate that state that the company is registered as a company under this Act, if the application is lodged in the prescribed way. A public company must lodge with ASIC a copy of a special resolution adopting, modifying or repealing its constitution within 14 days after it is passed. The company must also lodge with ASIC within that period if the company adopts a constitution—a copy of that constitution; or if the company modifies its constitution—a copy of that modification. This also applies to a proprietary company to change to a public company, while its application has not yet been determined. bb) Registers A company must set up and maintain a register of members (see s 169 CA), if the company grants options over unissued shares or interests—a register of option holders and copies of options documents (see s 170 CA) and if the company issues debentures—a register of debenture holders (see s 171 CA). The register of members must contain the member’s name and address of each member and the date on which the entry of the member’s name in the register is made. If the company has a share capital, the register must generally also show the date on which every allotment of shares takes place, the number of shares in each allotment, the shares held by each member, as well as the class of shares, the amount paid on the shares; and whether or not the shares are fully paid and as the case may be the amount unpaid on the shares. A company must allow anyone to inspect such a register and the company must give a person a copy of the register (or a part of the register) within 7 days if the person asks for it.
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2. Subscription of capital Australia does not have specific regulations with respect to subscription of capital in the case of formation of a company. When issuing shares the rules for allotment or issue of shares apply as per Chapter 2H – Shares of Corporations Act. Basically this allows shares to be issued in accordance with the constitution of the Company. A Company itself may determine the terms on which its shares are issued (s 254B CA). A company is restricted in purchasing shares itself (see question 12). 3. Contributions Under Australian law provisions exist concerning the question what can be injected as capital/funds and of how it can be injected into the company. a) Contributions in cash and in kind In Australia contributions in cash and in kind are possible. Non cash consideration is permissible under the Corporations Law (see s 254X) subject to certain notices and requirements being satisfied. However, the parties must genuinely believe that the value placed upon the assets sold is a fair one. This intent is reflected in para 11.50 of the Explanatory Memo to the Company Law Review Bill 1997 which notes that s 254X is “not intended to permit the directors to deem an amount to have been paid which exceeds the value of the cash and non-cash consideration actually received for the share.'' This intent is consistent with judicial decisions made prior to the removal of par values on 1 July 1998 and with that the removal of the previous embargo on a company issuing shares at a discount (except with Court approval). Knox CJ and Dixon J stated that “The liability upon shares cannot be discharged unless the company obtains in funds or assets that which is, or is supposed to be, a real equivalent to the capital represented by the shares'': Commr of Stamp Duties v Perpetual Trustee Co Ltd (1929) 43 CLR 247. Payment in kind is effective if the consideration flowing from the allottee is something which is bona fide regarded by the parties as fairly representing the sum which the payment is to discharge. If, on the other hand, the consideration is a mere blind or is clearly colourable or illusory the so-called payment is ineffectual: Re White Star Line Ltd [1938] 1 All ER 607. Whether or not the consideration is colourable is one of fact in each case. If what is taken by the company instead of money is not a proper consideration for the amount of the call then the full payment has not been made, and the unpaid amount is still outstanding on the shares, a matter which becomes highly relevant in the event of an insolvent winding up. The bona fide purchaser of such shares for valuable consideration and without notice of the deficiency of payment who acts on the strength of the share certificate is not at risk in this regard and his shares are deemed to be fully paid up: Re British Farmers; Re Building Estates Brickfields Co [1896] 1 Ch 100. Australian case law shows that not only the general adequacy but also the particular value of non-cash consideration for the issue of shares has traditionally been regarded as a question for the directors' judgment. In case law following (exemplary) principles has been developed: Non-existent consideration: A contract was executed between a company and its shareholders by which it was agreed that shares would be allotted to the directors and shareholders in 257
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consideration of their past services and expenses. Held, that as no payment in money or money's worth had been made for the shares, the directors and shareholders must be liable for the full nominal value of the shares. Re Eddystone Marine Insurance Co [1893] 3 Ch 9. Shares in exchange for land: The promoters of a company sold land to the company in exchange for shares. Held, by the Court of Appeal, the company can buy the property at any price it thinks, and can pay for such property in fully paid up shares; and the transaction will be valid and binding upon its creditors if the company has acted honestly and not colourably, and has not been so imposed upon by the vendor as to be entitled to be relieved from its bargain. The value received by the company is measured by the price at which the company agreed to buy the property it sought to acquire; and when the transaction is impeached that is the only value which the Court can take into consideration. Re Wragg Ltd [1897] 1 Ch 796. Set off: Shareholder subscribed for contributing shares, and owed the company the whole of the subscription money (which he could be sued for). On the other hand, the company, by an independent agreement bought this shareholder's property and owed him the price for it as a debt. The Court allowed to stand the setting off against each other of the two pecuniary debts and regarded each debt as being paid in cash without the actual form of money passing backwards and forwards. Spargo's case (1873) LR 8 Ch 407. b) Amount to be paid in Australian law permits partly paid shares. Rules about liability on partly paid shares generally can be found in sec 254M. Except in the case of a no liability company, a shareholder holding partly-paid shares is liable to pay calls on those shares in accordance with the terms on which the shares are on issue: sec 254M(1). Such a shareholder may be liable as a contributory if the company is wound up under sec 514 — 529. Under the no par value regime applying from 1 July 1998, the amount unpaid on a share, and hence the amount of the liability to pay calls, is the difference between the issue price and the amount already paid (on issue and by way of previous calls). Where this liability is not honoured, the Company will have legal power to recover the required amounts through the Courts. c) Disclosures to be made If shares will be issued for a non-cash consideration, public companies must lodge a Form 208 (details of shares issued other than for cash). If some or all of those shares will be issued under a written contract, public companies must also lodge a Form 207Z (certification of compliance with stamp duty law) and either Form 208 or a copy of the contract. 4. Accounting for formation expenses The expenses associated with the formation of a company do not meet the definition of an asset under Australian International Financial Reporting Standards. Further the formation expenses do not meet the identifiably criteria in the Australian Accounting Standard AASB 138 Intangible Assets and thus will be expensed as incurred. AASB 132 Financial Instruments: Presentation provides that “transaction costs of an equity transaction shall be accounted for as a deduction from equity, net of any related income tax benefit” (clause 35). Thus formation costs pertaining to the transaction costs of issuance of equity will be accounted for as a deduction from equity.
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Sub-section 2:
Capital increases
5. Issuance of new shares Australia law disposes of different rules regarding the issuance of new shares. a) Increase of shares When issuing securities including the issue of new shares, the process to be followed is prescribed by the Corporations Act 2001. The issuance of shares can be to existing shareholders (notice pre-emption rights, section 1, No. 8., supra) or the general public (which will include existing shareholders) and needs generally a shareholder approval. As noted above, there is no concept of par value in the Australian regulatory environment. However, the Australian regulatory environment allows shares to be issued from time to time (subject to the internal company constitution) at whatever price is sought. Where the share capital of a corporation is restricted in some way by the constitution of the company, then it will be necessary to alter the constitution in order to provide for additional capital. This process will be defined to some extent by the specific provisions of the constitution. Division 2 of Part 6D.2 of Chapter 6D - Fundraising, specifies when a disclosure document for the offer of securities is required. Divisions 3 and 4 specify the type and content of the disclosure document. Where a disclosure document is required, the relevant section requires that the disclosure document (commonly a Prospectus or Information Statement) specify an expiry date which has a similar definition for each type of disclosure document. The expiry date must not be later than 13 months after the date of the prospectus. b) ASX Listing Rules There are certain rules relating to the listing requirements of the Australian Stock Exchange. Key features of the rules are as follows: • Shares can be issued without the approval of the holders of the ordinary shares (commonly referred to as a share placement) where the issue and any other issues in the last 12 months, is less than 15 percent of the shares outstanding at the beginning of the 12 month period; otherwise • Approval of the issue is required by the shareholders at a general meeting The company often uses the money it raises in a placement to take over a new business or to significantly expand the company's activities. In the past, companies have sometimes struggled to raise money through the traditional offer of rights to subscribe for more shares, called a 'rights issue'. They often had to pay underwriters sizeable fees to make up for any shortfall in the money raised this way. As the Australian market has grown, companies have found institutional and sophisticated investors willing to come up with extra capital, often in large amounts, within 24 hours. Generally, institutional and sophisticated investors invest at least $500,000.
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6. Subscription of new shares With respect to the subscription of new shares which were issued during a share increase the same rules apply which Australian law provides for the subscription of shares during the formation of the corporation. 7. Contributions Regarding share contributions and their payment at the stage of a share increase the same regulations generally apply as those at the stage of formation. As in the stage of formation the Australia corporation law allows both contributions in cash and contributions in kind. Furthermore with respect to the amount to be paid in and the valuation of contributions of kind the same rules are applicable as in the stage of formation. 8. Pre-emption rights Australia law knows pre-emptive rights. The Corporations Act 2001 provides pre-emption rights for existing shareholders. Before issuing shares of a particular class, the directors of a proprietary company must offer them to the existing holders of shares of that class. As far as practicable, the number of shares offered to each shareholder must be in proportion to the number of shares of that class that they already hold. To make the offer, the directors must give the shareholders a statement setting out the terms of the offer, including the number of shares offered and the period for which it will remain open. The directors may issue any shares not taken up under the offer as they see fit. The company may by resolution passed at a general meeting authorise the directors to make a particular issue of shares without an offer to the existing shareholders. Section 254D regards (proprietary) company shareholder's pre-emption rights. When a company decides to issue shares in a particular class it is required (where s 254D applies as a replaceable rule) to offer those shares on a pro-rata basis to existing holders of shares of that class. That offer is to be made in a statement to shareholders which sets out the terms of the offer, including the number of shares offered and the period of time that the offer will remain open. Where the pre-emption right is not exercised by the existing shareholders, any shares not taken up may be issued by the directors in any manner they see fit. As an alternative to complying with the foregoing, the company may, in general meeting, pass a resolution authorising the directors to make a particular issue of shares. Section 254D is a replaceable rule and therefore applies subject to the operation of Pt 2B.4.
Section 2:
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9. Limitation of profit distributions – fraudulent transactions Australia has a statute prohibiting fraudulent transfers. a) General conditions of fraudulent transfers s 181(1) of the Corporations Act requires directors and other officers to exercise their powers and discharge their duties in good faith in the best interests of the corporation and for a proper purpose.
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In Chew v R (1991) 5 ACSR 473, Malcolm CJ (at 499) summarised the requirements of the duty to act in good faith as including that directors: (1) must exercise their powers in the interests of the company, and must not misuse or abuse their power (2) must avoid conflict between their personal interests and those of the company (3) must not take advantage of their position to make secret profits, and (4) must not misappropriate the company's assets for themselves. The words "in the best interests of the corporation" emphasise the significance of the relevant constituencies — in particular, the shareholders as a whole, and the creditors in the case of impending insolvency. This duty is imposed not to secure compliance with the various requirements of the Corporations Act, but, as it was at general law, to prevent abuses of directors' powers for their own or collateral purposes. aa) Objective test There is some difference of judicial opinion as to whether contravention of s 181 CA requires the officer to engage deliberately in conduct, knowing that it is not in the interests of the company, or whether the section may be contravened even when the officer has acted in what he or she believes are the company's best interests. In the Adler and Williams cases, it was said that the assessment as to whether an officer has complied with s 181(1) CA is objective. Therefore, it is not necessarily sufficient that the officer has acted in what he or she subjectively believes to be in the best interests of the company. An officer will contravene s 181(1) CA if the officer exercises the powers for a purpose which he or she thinks is proper but which the court considers to be improper: see ASIC v Adler (No 3) (2002) 20 ACLC 576 at 705; upheld by the NSW Court of Appeal in Adler v ASIC; Williams v ASIC (2003) 21 ACLC 1,810 at 1,908. On the other hand, in ASIC v Maxwell (2006) 24 ACLC 1,308, Brereton J referred to the discussion of one of the predecessor provisions of s 181 CA by Gowans J in Marchesi v Barnes [1970] VR 434 in terms which emphasise that the section is not concerned with the conduct of a director in relation to creditors, other persons dealing with or concerned with the company, or anybody else but the company itself; and that a breach of the obligation to act bona fide in the interests of the company involves a consciousness that what is being done is not in the interests of the company, and deliberate conduct in disregard of that knowledge. Brereton J went on to say that while the words "act honestly" have not been retained in the current section (see further below), the historical origins of the duty, as explained by Gowans J, which led his Honour to equate "acting honestly" with "acting bona fide in the interests of the company" are equally applicable to the current section. In this context, absence of good faith requires much more than negligence. On this view, s 181 CA is contravened only where a director engages deliberately in conduct, knowing that it is not in the interests of the company. If the officer's conduct is to be measured against objective standards, it is likely that the courts will allow limited subjective factors to be taken into account; namely, the officer's position and responsibilities and the corporation's circumstances. This is clear from the court's approach to statutory provisions regarding misuse of position and company information (ss 182 and 183). These provisions have been interpreted as requiring an objective standard where limited subjective factors can be taken into account: see Grove v Flavel (1986) 4 ACLC 654. Other provisions requiring an objective standard specify that the standard is to be formulated with regard to the officer's position and the corporation's circumstances (see ss 180(1) and 588G CA). As a practical matter, failure to take these type of factors into account would involve the court analysing the director's conduct in a vacuum.
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The duty of good faith under s 181(1) CA mirrors the common law duty of good faith. Therefore, the cases which have considered this common law duty will be relevant to the courts' interpretation of s 181(1) CA. bb) Consequences of failing to act in company's best interests and for a proper purpose S 181(1) CA is a civil penalty provision: s 1317E CA. If the court makes a declaration under s 1317E CA that an officer has contravened s 181(1) CA, the officer may be ordered to pay a pecuniary penalty of up to $200,000: 1317G. Before imposing such a penalty, the court must be satisfied that the contravention: (i) materially prejudices the interests of the corporation or its members (ii) materially prejudices the corporation's ability to pay its creditors, or (iii) is serious. Where the corporation has suffered damage as a result of the contravention, the person may be ordered to pay compensation to the corporation: s 1317H CA. This compensation includes profits made by the person as a result of the contravention: s 1317H(2) CA. In ASIC v Adler (No 3) (2002) 20 ACLC 576 at 710, Santow J made compensation orders pursuant to s 1317H CA based on the losses suffered by HIH, without deciding whether the equitable test applicable to fiduciaries or the common law test was applicable, deciding instead on the basis that the loss identified had resulted from the identified contraventions. As stated above, an officer commits an offence if they dishonestly or recklessly fail to exercise their powers in good faith in the interests of the corporation or for a proper purpose: s 184(1) CA. The maximum penalty that can be imposed for contravention of s 184 CA is a fine of up to $20,000 and/or five years' imprisonment (s 1311, Sch 3 CA). b) Trading whilst insolvent s 588G of the Corporations Act imposes liability on a director of a company who allows the company to incur a debt at a time when the company is insolvent and at the time that the debt was incurred there existed reasonable grounds for suspecting that the company was, or may become as a result of incurring the debt, insolvent. A director will be liable if at the time the debt was incurred he or she was actually aware of the existence of reasonable grounds to suspect insolvency or a reasonable person in a similar position within a similar company would have been aware. In ASIC v Plymin, Elliott and Harrison, Justice Mandie of the Victorian Supreme Court found that John Elliott as a non-executive director had failed to prevent a company from incurring debts at a time when it was insolvent and had contravened the civil penalty provision, s 588G of the Corporations Act. The Water Wheel companies (the Company) were placed into voluntary administration in February 2000. ASIC commenced civil proceedings against the Managing Director, Chairman of the Board and Elliott (as a non-executive director) for orders that they had contravened the insolvent trading provisions. Justice Mandie confirmed that the test of whether or not a company is insolvent is the 'cash flow test' (i.e., whether the company can pay its debts as and when they fall due for payment; for detailed information concerning the cash flow test see section 3, No 18), supra) rather than a simple 'balance of assets over liabilities' test. This follows a long line of cases that establish that insolvency is to be considered as a 'moving picture' rather than a snapshot of the company's finances taken at a particular point in time. Whether there are reasonable grounds for suspecting insolvency is to be judged according to the (objective) standard of reasonableness appropriate to a director or non-executive director, as the case may be, of reasonable competence and diligence.
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10. Disclosure of related transactions Who and what are “related parties” for purposes of Ch 2E are defined wholly within sec 228. Whether or not parties are related for purposes of Ch 2E depends wholly on the definition of “related party'” in sec 228. Some of the relationships described in sec 228 in turn depend on a new definition of “control” in sec 50AA. The term “related party” covers a wide range of persons and entities related to a public company and directors of the public company. One important exception is entities controlled by the public company; these are not related parties for purposes of Ch 2E. The definition depends in turn upon a number of other important terms that are defined elsewhere in the Corporations Law. See in particular: • “entity“ • “control”: sec 50AA The definition of “control” is based on accounting standards (see AASB 1017 and AASB 1024), and is incorporated into the Corporations Act, and applies for all purposes of the Law, not just those of Ch 2E. “Control” — the central concept Under the definition, the central concept of “control” operates as follows: Entity A controls Entity B if Entity A has the capacity to determine the outcome of decisions about Entity B's financial and operating policies: sec 50AA(1). Note that it is not enough for Entity A to be able to influence Entity B; it must be able to determine the outcome of decisions about Entity B's financial and operating policies (although that capacity may arise out of practical influence, rather than legal capacity). Controlling entities An entity which controls the public company is a related party of that company: sec 228(1). Directors and their spouses and relatives Under sec 228(2), the following natural persons are treated as related parties of a public company: • directors of the company; • directors of an entity that controls the company; • all of the persons who make up an entity that controls the company, but which is not itself a body corporate; • spouses, de facto spouses, parents and children of any of the persons listed above. Entities controlled by other related parties If any of the persons or entities listed above also controls another entity, that other entity is also a related party of the public company, unless it, too, is controlled by the public company. Deeming provisions The following persons are also deemed to be related parties of a public company: • an entity that has been a related party in any of the categories listed above at any time within the last six months: sec 228(5); • an entity which believes or which has reasonable grounds to believe that it is likely, at any time in future, to become a related party of any of the kinds listed above: sec 228(6) (the former sec 243F included a provision which explained that if an entity in this category was not a body corporate, and was comprised of two or more persons, it was enough if only one of those persons had the necessary belief or reasonable grounds for belief; this provision has been omitted from the current section); 263
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• an entity which acts in concert with a related party of the public company on the understanding that, if the public company gives the first entity a financial benefit, the related party will also receive a financial benefit as a result: sec 228(7). Persons acting in concert Section 228(7) deals with the case where a public company (or controlled entity) proposes to give a benefit to a party which would otherwise be unrelated, on the basis that another, related, party will also receive a benefit. To take a simple example, public company A intends to give a financial benefit to an unrelated person, C, and, as part of or as a consequence of the arrangement, a related party, B, will also receive a benefit from A, perhaps for acting as intermediary. In this case, C is also deemed to be a related party of A, and the benefit flowing to C will be subject to Ch 2E. There can be more than one reason for such a transaction. This widens the reach of the related party provisions to cover schemes involving more than two persons. Financial benefit “Financial benefit” is not specifically defined in the Corporations Act, however it is clear that it “is to be given the broadest of interpretation”: ASIC v Adler (No 3) (2002) 20 ACLC 576 at 618; sec 229(1)(a). The economic and commercial substance of the conduct or transaction is to prevail over legal form. A financial benefit will be conferred upon a related party even though the related party is holding the alleged financial benefit as trustee for the entity giving the financial benefit: Adler (No 3) per Santow J at 619: The broad scope of the meaning of “financial benefit” would capture: • any kind of benefits to directors and their families, including remuneration, loans, guarantees, indemnities and reimbursements; • loans, guarantees and indemnities between members of corporate groups; • trading contracts between public companies and entities controlled by their directors; • transfers of assets between members of corporate groups; • releases and other transactions entered into as part of settlement of litigation (but not where pursuant to a court order); • loan schemes, staff discount schemes and employee share schemes, where directors are entitled to participate; • management and consultancy contracts, and professional retainer agreements, with entities controlled by directors: see sec 229(3) for a further list of indicative examples. Chapter 2E of the Corporations Act places strict controls on public companies, and entities controlled by public companies, giving financial benefits to entities or persons related to or associated with the public companies. There is no prohibition, as such, on financial benefits flowing to related parties. Rather, Ch 2E regulates the circumstances in which benefits may flow (it being clear that these are the only circumstances in which such transactions may occur) and provides penalties for breach of the rules laid down in the Chapter. In practice, when a company gives a financial benefit to a related party it is almost invariably at the behest of a director or directors of the company. The rules in Ch 2E should therefore be read in the broader context of the legal relationship between directors and their companies. Indeed, Ch 2E makes it clear that the rules contained in it are subject to the duties imposed on directors by other provisions of the Corporations Act and the general rules of common law and equity. The fact that a contravention of Ch 2E incurs a penalty under a specific provision of that Chapter does not prevent a director, or other officer of the company, involved in the contravention being exposed to sanctions under other provisions of the Act (such as the civil penalty provisions in Pt 9.4B), or court action for damages or equitable remedies. 264
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The directors of a company stand in a fiduciary relationship to their company. There is a considerable body of case law dealing with fiduciary relationships generally, and with the relationship between directors and their companies in particular, especially in the context of company officers causing their companies to confer benefits on, or using their position to elicit benefits for, themselves or parties associated with them. To a large extent, the incidents of that relationship, what they mean in legal terms to the director and to the company, have been codified in various provisions of the Act: cf the statutory duties in Pt 2D.1. For present purposes, it is enough to emphasise that the enforcement rules in Ch 2E do not stand alone, but may be supplemented or reinforced in appropriate cases by other available sanctions. The purpose of Ch 2E is “to protect the interests of a public company's members as a whole, by requiring member approval for giving financial benefits to related parties that could endanger those interests'': sec 207. The rules are designed to protect “the interests of a public company's members as a whole''. This must mean as opposed to the interests of any member, or group or category of members, where their interests are not the same as the interests of the entire body of members considered as a whole. “Purpose'' or “object'' clauses are relatively rare in the Corporations Act. Where present, such a clause functions as “an overt statement of the legislative intention'': Bennion, Statutory Interpretation (Butterworths, London, 1984 at 580). In Re Credit Tribunal; ex parte General Motors Acceptance Corp, Australia (1977) 137 CLR 545 Barwick CJ said that such a statement of legislative intent: “... will not, of course, be definitive. But the Courts can resort to it in case of uncertainty or ambiguity when the operation of the Act of the Parliament, according to its other terms, has been ascertained and applied. Thus, the statutory expression of Parliament is not invalid nor inoperative. Without being definitive, it may assist in the determination of the operative effect of the Act.” A purpose clause is unlikely to be held to override the clear words of a detailed provision: see Bennion at 580, citing the English Court of Appeal in Page (Inspector of Taxes) v Lowther (1983) The Times, 27 October. In that sense, sec 207 is to be read subject to the operative provisions of Ch 2E. The primary rule of Ch 2E is that a public company, or an entity controlled by the public company, may give a financial benefit to a related party of the public company only if. (a) the benefit is in one of seven specified categories of financial benefit (see Div 2 of Pt 2E.1); or (b) if the benefit is of any other kind, the company has obtained the approval of the members to give the benefit, or to enter into a contract to give the benefit (see sec 208). Listed companies contemplating related party transactions must consider the operation of both Ch 2E of the Corporations Act and Ch 10 of the ASX Listing Rules. Chapter 10 of the ASXLRs governs “transactions with persons in a position of influence'' and contains provisions which supplement the operation of Ch 2E of the Act. There are three important points of distinction between Ch 10 of the ASXLRs and Ch 2E of the Act. First, the ASXLR rules which regulate related party transactions are confined to “substantial assets'' (effectively transactions carrying a value of 5% or more of the equity interests of the listed entity): see LR 10.2. The Ch 2E provisions are not so limited. Secondly, the exceptions to the need for member approval are different: compare Pt 2E.1 Div 2 of the Act and LR 10.3. Thirdly, notices of meeting under the ASXLRs (seeking member approval to give benefits to related parties) must be accompanied by an independent expert's report on the proposed transaction and a voting exclusion statement: see LR 10.10. The corresponding rules for “explanatory statements'' under Ch 2E contain no directly equivalent requirements: see sec 219 — 222.
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11. Loans to directors There is no law/regulation specifically dealing with loans to directors. The principle that each director occupies a fiduciary position in relation to the company is given effect by well-established rules requiring the director to avoid unauthorised conflict of his duty to the company with his interest as well as unauthorised conflict of his duty to the company with a duty owed by him to a third person. The requirements under the Corporations Act are additional and complementary to any other laws to which the actions of directors may apply. The Companies Act contains no detailed statement of those rules apart from the very generally expressed requirement in the provision of s 180 that prescribe the general duties around Care and Diligence (s 180), Good Faith (s 181), Use of Position (s 182) and Use of Information (s 183). These provisions are based, in whole or in part, on the principle of avoidance of conflict. 12. Acquisition of own shares The acquisition of own shares is an issue that is generally discussed under the principle of capital maintenance. A prohibition of the self-acquisition of shares (or units in shares) reflects the concerns expressed in the House of Lords in Trevor v Whitworth (1887) 12 App Cas 409. Lord Watson made clear (at p 423) that persons who deal with a company “are entitled to assume that no part of the capital which has been paid into the coffers of the company has been subsequently paid out, except in the legitimate course of its business.” According to s 259A CA 2001 a company must not acquire shares in itself except: (a) in buying back shares under s 257A CA; or (b) in acquiring an interest (other than a legal interest) in fully-paid shares in the company if no consideration is given for the acquisition by the company or an entity it controls; or (c) under a court order; or (d) in circumstances covered by s 259B(2) or (3) CA, i.e. taking security over own shares under an employee share scheme or by a financial institution. Share buy-backs are governed by ss 257A – 257J CA, and, if the company has one, by the constitution. a) Requirements for share repurchase First, it is required that buy-backs do not materially prejudice the company’s ability to pay its creditors and secondly, the company must follow procedures laid down by the CA 2001. aa) Solvency test The Solvency test only refers to the ability to pay the creditors and is confined to a material impact. Under ss 588G, 1317H CA the directors may have to compensate the company if the company is, or becomes, insolvent when the company enters into the buy-back agreement (for detailed information concerning the cash flow test see section 3, No 18), supra). bb) Procedures A table in s 257B CA specifies the steps required for, and the sections that apply to, the different types of buy-back. An ordinary resolution is required if the buy-back exceeds 10% of the voting rights during a period of 12 month (10/12 limit), a selective buy-back requires a special or unanimous resolution.
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b) Maximum amount of own shares that can be held and cancelling of own shares The amount of shares that are bought-back is relevant in respect of the question whether a shareholders’ resolution is necessary. Immediately after the registration of the transfer to the company of the shares bought back, the shares are cancelled. c) Reselling of own shares A company must not dispose of shares it buys back. An agreement entered into in contravention of this subsection is void. d) Disclosure In cases of a selective buy-back or a share buy-back under an equal access scheme the offer documents must be lodged with ASIC and the company must include with the offer to buy back shares a statement setting out all information known to the company that is material to the decision whether to accept the offer. 13. Financial assistance The Australian CA 2001 deals directly with assistance by a company in the purchase of its own shares. Requirements for financial assistance (regulated in ss 260A-260D CA 2001). A company may financially assist a person to acquire shares (or units of shares) in the company or a holding company of the company only if: (a) giving the assistance does not materially prejudice: (i) the interests of the company or its shareholders; or (ii) the company’s ability to pay its creditors; or (b) shareholders’ approval is given by special resolution or a resolution agreed to by all ordinary shareholders (see s 260B CA; that section also requires advance notice to ASIC and gives further provisions in respect of shareholders’ approval in other companies than the target); or (c) the assistance is exempted under s 260C CA. The provision includes in particular an exemption for financial institutions, for subsidiaries of debenture issuers, and for cases in which other provisions must be complied with, such as capital reduction or share buy-backs. a) What is financial assistance? There is no definition in the Corporations Act of what is meant by “financially assist”. The issue of what constitutes financial assistance only becomes relevant for a transaction which involves a material prejudice to the company, its shareholders or its ability to pay its creditors. If there is no material prejudice it is unnecessary to decide whether the transaction involves the giving of financial assistance. As with “material prejudice”, it would seem that what constitutes financial assistance is a question of fact to be answered in light of the prevailing circumstances. In the absence of legislative guidance to the contrary, the expression would appear to be intended to be given a wide meaning. To that end, the illustrative examples given in the former s 205(2) CA of the Law can be taken as illustrative for the purposes of the present Act, these examples include the making of a loan, the giving of a guarantee, the provision of security, the release of an obligation and the forgiving of a debt. It is further submitted that in assessing whether a transaction constitutes financial assistance, the economic and commercial substance and effect of the transaction should prevail over its legal form. Accordingly, a transaction may have the effect of providing financial assistance for the acquisition of shares (or units of shares) in a 267
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company, notwithstanding the existence of an alternate intent. The use of the expression “on ordinary commercial terms” in s 260C(5)(d) CA may indicate that the whole of a transaction could be viewed as providing financial assistance where it is made other than on ordinary commercial terms. Consistent with the Law applying prior to 1 July 1998, the person to whom the financial assistance is given need not be the person who acquires the shares or unit of shares. The section is directed to the provision of financial assistance to whomsoever given (including the vendor), provided that it be for the purpose of, or in connection with, the acquisition of shares or units of shares: Ryan & Anor v Independent Steels Pty Ltd (1988) 6 ACLC 754 (Appeal on different grounds allowed). b) The “impoverishment test” It would appear that “financial assistance” does not require that the company's financial resources be diminished. Relevant is the so-called “impoverishment test” developed from a statement of Hutley JA (with whom Samuels JA generally agreed) in Burton v Palmer (1980) CLC. The test was described by Kirby P in Darvall v North Sydney Brick & Tile Co Ltd & Ors (No 2) (1989) 7 ACLC 659 at 687 as follows: “This Court has held that a transaction by a company cannot constitute the giving of financial assistance unless the transaction involves some diminution of the financial resources of the company.” However, Kirby P disagreed with this proposition (at p 688), as have subsequent courts: see Re an application by National Mutual Royal Bank Ltd (1990) 8 ACLC 1,057 (Qld Sup Ct); Dempster v NCSC (1993) 11 ACLC 576 (Full WA Sup Ct); Milburn & Ors v Pivot Ltd (1997) 15 ACLC 1,520. In Dempster v NCSC, Malcolm CJ (with whom Walsh and Anderson JJ agreed) concluded (at p 589) that the most which could be said about the impoverishment test was that it may provide some assistance in determining whether a transaction was a genuine commercial transaction and that it may be relevant, but not decisive, of the question of financial assistance. The impoverishment test was held to be inapplicable on the facts in Dempster v NCSC because the alleged benefit to the company arose not at the time of the transaction but as a result of subsequent and independent transactions. c) Case examples The NSW Court of Appeal has held that the mere agreement by a company to pay a debt, which was presently payable in any case, did not amount to financial assistance: Burton v Palmer (supra). The Court in that case also had to consider whether certain warranties, which the company had given to the purchaser of the shares, constituted financial assistance. One was a warranty that the books and registers, which the company was required by law to keep, were properly kept. Hutley JA, with whom Samuels JA generally agreed, was unable to see this as giving any more than a right of action against the company for nominal damages. His Honour continued: “A creation of a right of action for nominal damages is not, in my opinion, the giving of financial assistance. It is to be contrasted with an action on a worthless guarantee which results in a real but valueless debt.” In Armour Hick Northern Ltd v Armour Trust Ltd (1980) 3 All ER 833 Judge Mervyn Davies QC, sitting as a judge of the High Court of England, accepted that the due discharge of a debt would not be financial assistance. However, in the case before him, the debt had been paid, not by the company that owed the debt, but by its subsidiary. Accordingly his Honour held that the payment, being a voluntary payment, was capable in law of constituting financial assistance.
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In Wall Street (Holding) Pty Ltd v Wambo Mining Corporation Pty Ltd; Micabil Pty Ltd v Wambo Mining Corporation Pty Ltd (1996) 14 ACLC 1, the Federal Court held that there was no breach of former s 205 (now s 260A) where a mining company had entered into agreements with other miners under which those miners undertook not to compete with the company in return for the payment of royalties by the company. This agreement was the result of a demand by an investor which was being courted by the company. Some time after the investor had acquired a major stake in the company, the company stopped paying the royalties. In the subsequent action by the former miners, the company had argued, unsuccessfully, that the royalty agreements were unenforceable because they breached the former s 205 (now s 260A) (the argument being that they constituted the giving of financial assistance in connection with its acquisition of shares in the company). d) Disclosure The notice of a shareholders’ meeting must include a statement setting out all the information known to the company or body that is material to the decision on how to vote on the resolution under s 260B CA. The company must lodge with ASIC a copy of the notice of the meeting and any document relating to the financial assistance that will accompany the notice of the meeting sent to the members. Furthermore, the company must lodge with ASIC, at least 14 days before giving the financial assistance, a notice in the prescribed form stating that the assistance has been approved. e) Consequences of failing to comply with the law If a company fails to comply with the requirements, neither the financial assistance nor any transaction or contract connected to it is not void or voidable. The company is not guilty of an offence. A person involved in the company’s contravention is liable according to civil penalty provisions, and commits an offence if the involvement is dishonest. 14. Loans from shareholders The Australian law does not deal specifically with loans from shareholders. Loans from shareholders in the case of insolvency rank equally with loans from nonshareholders. For example, if the debt is unsecured, it will rank equally with other unsecured debt of the company. Except as otherwise provided by the Act, all debts and claims proved in a winding up rank equally and, if the property of the company is insufficient to meet them in full, they must be paid proportionately (s 555 CA). 15. Capital decreases Australian Law applies the alternative model for capital in that no par value applies. Nonetheless there are various means by which capital can be returned to the company. Part 2J.1 of the Corporations Act - Share capital reductions and share buy-backs, defines the means and requirements for reductions in capital and share buy-backs. The rules are designed to protect the interests of shareholders and creditors by: (a) addressing the risk of these transactions leading to the company`s insolvency (b) seeking to ensure fairness between the company’s shareholders (c) requiring the company to disclose all material information.
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a) Capital Reductions Subject to a company’s constitution, a company may reduce its share capital in a way that is not otherwise authorised by law if the reduction is fair and reasonable to the company’s shareholders as a whole and does not materially prejudice the company’s ability to pay its debts. It is to be noted that the requirement in s 256B(1)(a) that the reduction be fair and reasonable to the shareholders as a whole is not limited to ordinary shareholders, however only ordinary shareholders may be included in an equal reduction pursuant to s 256B(2)(a). Accordingly, with all reductions, fairness and reasonableness needs to be considered in respect of all shareholders, not just those entitled to vote on a resolution to approve the reduction. The Law does not provide assistance as to what is meant by “fair and reasonable”. The Explanatory Memorandum (para 12.24) to the Company Law Review Bill 1997 states that “fair and reasonable'' is intended to be a composite requirement, presumably meaning that a reduction will be either fair and reasonable or not fair and reasonable. As such, a reduction would not meet the requirement if it was fair but unreasonable. The Explanatory Memorandum lists some factors which might be relevant in determining whether a capital reduction is fair and reasonable to shareholders as a whole, these are: • the adequacy of any consideration paid to shareholders; • whether the reduction would have the practical effect of depriving some shareholders of their rights (eg, by stripping the company of funds that would otherwise be available for distribution to preference shareholders); • whether the reduction is being used to effect a takeover and avoid the takeover provisions; and • whether the reduction involves an arrangement that should more properly proceed as a scheme of arrangement. The Explanatory Memorandum also notes, at para 12.25, that the issue of whether a reduction is fair and reasonable focuses on the effect and not the purpose of the reduction. Accordingly, the principles set out by the High Court in Gambotto v WCP Ltd (1995) 13 ACLC 342 do not apply to the expropriation of rights under the mechanism in sec 256B: Winpar Holdings Ltd v Goldfields Kalgoorlie Ltd (2000) 18 ACLC 665 and Nicron Resources v Catto & Ors (1992) 10 ACLC 1,186. They may however be relevant if, as the Explanatory Memorandum contemplates could arise, the expropriation is challenged as oppressive conduct under s 232. A cancellation of a share for no consideration is generally a reduction of share capital. One of the ways in which a company might reduce its share capital is cancelling uncalled capital. The company must not make the reduction unless it complies with these requirements. If the company contravenes the requirements, the contravention does not affect the validity of the reduction or of any contract or transaction connected with it and the company is not guilty of an offence. Any person who is involved in such a company’s contravention and the involvement is dishonest, commits an offence. Reductions in capital are either an equal reduction or a selective reduction. aa) Equal reduction The reduction is an equal reduction if it relates only to ordinary shares, it applies to each holder of ordinary shares in proportion to the number of ordinary shares they hold and the terms of the reduction are the same for each holder or ordinary shares. Otherwise, the reduction is a selective reduction. S 256C CA requires that if the reduction is an equal reduction, it must be approved by a resolution passed at a general meeting of the company.
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bb) Selective reduction If the reduction is a selective reduction, it must be approved by either: (a) a special resolution passed at a general meeting of the company, with no votes being cast in favour of the resolution by any person who is to receive consideration as part of the reduction or whose liability to pay amounts unpaid on shares is to be reduced, or by their associates; or (b) a resolution agreed to, at a general meeting, by all ordinary shareholders. If the reduction involves the cancellation of shares, the reduction must also be approved by a special resolution passed at a meeting of the shareholders whose shares are to be cancelled. The company must lodge with ASIC a copy of any resolution concerning a selective reduction within 14 days after it is passed. The company must not make the reduction until 14 days after the lodgement. cc) Solvency test Furthermore, the company has to pass the solvency test (see section 3, No. 18., supra), otherwise the directors may have to compensate the company if the company is, or becomes, insolvent when the company reduces its share capital (see ss 588G, 1317H CA). dd) Other situations of capital reduction S 258A-258F CA deal with some of the other situations in which reductions of share capital are authorised. Please refer to the rules for an accurate description of the application of the rules which is too long to describe here. Subsection 254K(2) CA authorises capital reductions involved in the redemption of redeemable preference shares, therefore see section 2, No. 16., supra. b) Share Buy-backs Division 2 of the Corporations Act deals with Share buy-backs. If a company has a constitution, it may include provisions in the constitution that preclude the company buying back its own shares or impose restrictions on the exercise of the company’s power to buy back its own shares. s 257A of the Corporations Act allow a company to buy back its own shares. A company may buy back its own shares if: (a) the buy-back does not materially prejudice the company’s ability to pay its creditors; and (b) the company follows the procedures laid down in this Division.
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The following table specifies the steps required for, and the sections that apply to, the different types of buy-back: Procedures
minimum employee on-market holding share scheme
equal access scheme
selective buy-back
[and sections applied] within over within over within over 10/12 10/12 10/12 10/12 10/12 10/12 limit limit limit limit limit limit ordinary resolution [257C] special/unanimous resolution [257D] lodge offer documents with ASIC [257E] 14 days notice [257F] disclose relevant information when offer made [257G] cancel shares [257H] notify cancellation to ASIC [254Y]
—
—
yes
—
yes
—
yes
—
—
—
—
—
—
—
—
yes
—
—
—
—
—
yes
yes
yes
—
yes
yes
yes
yes
yes
yes
yes
—
—
—
—
—
yes
yes
yes
yes
yes
yes
yes
yes
yes
yes
yes
yes
yes
yes
yes
yes
yes
yes
yes
Note: The 10/12 limit is the 10% in 12 months limit laid down in subsections (4) and (5) of s 257 B CA. Subsections (6) and (7) of this section explain what an on-market buy-back is. See s 9 CA for definitions of minimum holding buy-back, employee share scheme buy-back and selective buy-back. An equal access scheme is a scheme that satisfies all the following conditions: (a) the offers under the scheme relate only to ordinary shares; (b) the offers are to be made to every person who holds ordinary shares to buy back the same percentage of their ordinary shares; (c) all of those persons have a reasonable opportunity to accept the offers made to them; (d) buy-back agreements are not entered into until a specified time for acceptances of offers has closed; (e) the terms of all the offers are the same. A buy-back is an on-market buy-back if it results from an offer made by a listed corporation on a prescribed financial market in the ordinary course of trading on that market. A buy-back by a company (whether listed or not) is also an on-market buy-back if it results from an offer made in the ordinary course of trading in a financial market outside Australia which ASIC declares in writing to be an approved overseas financial market. A buy-back by a listed company is an on-market buy-back only if an offer to buy-back those shares is also made on a prescribed financial market at the same time. 272
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A selective buy-back requires special or unanimous resolution. In the case of a buy-back, the company must include with the offer to buy back shares a statement setting out all information known to the company that is material to the decision whether to accept the offer. Once a company has entered into an agreement to buy back shares, all rights attaching to the shares are suspended. The suspension is lifted if the agreement is terminated. A company must not dispose of shares it buys back. An agreement entered into in contravention is void. Immediately after the registration of the transfer to the company of the shares bought back, the shares are cancelled. Furthermore, the company has to pass the solvency test (see section 3, No. 18., supra), otherwise the directors may have to compensate the company if the company is, or becomes, insolvent when the company reduces its share capital (see ss 588G, 1317H CA). 16. Redeemable shares An Australian company may issue redeemable preference shares. a) Possibility of redeeming shares A company’s power under s 124 CA to issue shares includes the power to issue preference shares including redeemable preference shares. The power to issue redeemable shares is also determined by the constitution of the company, and follows the approval process as set out in the constitution (including the Articles of Association) or by approval of the shareholders by special resolution. b) Conditions of share redemptions (regulated in ss 254J – 254L CA) The conditions under which the redeemable shares can be redeemed are prescribed by the terms of issue (included in any offering document such as a Prospectus or Information Statement). On redemption, the shares are cancelled. A company may only redeem redeemable preference shares if the shares are fully paid-up and out of profits or the proceeds of a new issue of shares made for the purpose of the redemption. Furthermore, the company has to pass the solvency test (see section 3, No. 18., supra), otherwise the directors may have to compensate the company if the company is, or becomes, insolvent when the company reduces its share capital (see ss 588G, 1317H CA). If a company redeems shares in contravention of ss 254J or 254K CA, the contravention does not affect the validity of the redemption or of any contract or transaction connected with it; and the company is not guilty of an offence. Any person who is involved in a company’s contravention of ss 254J or 254K CA and the involvement is dishonest, commits an offence.
Section 3:
Dividends and distributions
17. Definition of Distribution The Australia Corporations Act does not define “distributions”. However, pursuant to the prevailing opinion, distributions include distributions of profits, being dividends and distributions of capital. In addition, the directors may fix the method of payment of a dividend (s 254U(1)(c)). The methods of payment include the payment of cash, the issue of shares, the grant of options and the transfer of assets.
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18. Distributable amount In Australia, the rules around distributions of profits are straight forward: any amount can be distributed as long as they are paid out of profits (s 254T) and do not render the corporation insolvent (s 588G). The Australian equivalents of International Financial Reporting Standards (AIFRS) apply for reporting periods on or after 1 January 2005. ASIC has clarified that its interpretation of the impact of the AIFRS is that retained profits reported on a pre-AIFRS basis will not be relevant for the payment of dividends. Thus, for the purposes of determining whether or not companies are able to pay dividends, only retained profits and current year profits recorded under AIFRS will be relevant from that time going forward: This will include unrealised gains under A-IFRS. Distributions of capital are more complex since they arise in situations when the company is solvent (such as in share buy-backs) and when the company is insolvent (when a company may be wound up). The rules applying to distributions of capital through a reduction of capital are included in Part 2J.1 (Share capital reductions and share buy-backs). In addition to the statutory requirements there are court decisions on distributions. Therefore, the principles established by case law have to be taken into consideration, too, when an Australian corporation determines the amount of a legal distribution. a) Requirements for legal distributions The principles enunciated in Lee v Neuchatel Asphalte Co (1889) 41 Ch D 1; 61 LT 11 were applied, extended, qualified and commented upon in a number of cases over the following decades; and from these and the foregoing cases, there have been drawn by various writers a series of rules governing the payment of dividends. It is proposed now to examine some of these “rules” in the light of the authorities and the legal and accounting principles arising from them: (1) dividends must not be paid if the result is that the company is unable to pay its debts; (2) current revenue profits may be distributed without making good revenue losses of previous periods; (3) undistributed profits remain profits which can be distributed in later years. aa) Profits test In Australia, dividends may only be paid out of the corporation’s profits (s 254T). The former s 201(7) stated that a dividend for the purposes of that section included a bonus and a payment by way of bonus. Since the commencement of the Company Law Review Act 1998 there is no express equivalent provision, except to the extent that a similar definition is included in the replaceable rule contained in s 254U. That section provides that a dividend may be payable by way of cash, the issue of shares, the grant of options and the transfer of assets. Being a replaceable rule, technically, the company could amend that definition by adopting an alternate rule as part of its constitution. In the absence of any alternate indicator of legislative intent, it would appear that a dividend for the purposes of Pt 2H.5 should be construed having regard to the wording of the 274
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replaceable rule in s 254U. Taken at the widest meaning apparent in s 254T, a dividend would be any distribution made by the company to shareholders out of the profits of the company. The nexus to profits is of importance since a company may issue bonus shares without the need to increase the share capital of the company (see note 3 to s 254A). Arguably, the issue of bonus shares unsupported by a capitalisation of profits (s 254S) is substantially the same as the conversion of shares into a larger number pursuant to s 254G, and would not be a dividend. Conversely, an issue of shares supported by the capitalisation of an amount of profits would appear to be a dividend, with potential taxation consequences for shareholders. aa1) Losses of fixed assets In Australia, there is case law on the treatment of losses of fixed assets when determining the distributable amount. Therefore, the following principles should now be read subject to s 254T which says that a dividend may only be paid out of profits. Losses of fixed assets need not be made good before treating a revenue profit as available for dividend. Lindley LJ said in Lee v Neuchatel Asphalte Co (1889) 41 Ch D 1 that, “... the Companies Acts do not require the capital to be made up if lost. They contain no provision of the kind... I cannot find anything in them which precludes payment of dividends so long as the assets are of less value than the original capital”. His Lordship concluded that since the Acts were silent on the question, and since to decide otherwise would “paralyse the trade of the country”, it should be held that “so long as they pay their creditors there is no reason why they should not go on and divide profits, so far as I can see, although every shilling of the capital may be lost.” The Court of Appeal confirmed this decision in Verner v General and Commercial Investment Trust Ltd. In a joint judgment with Smith LJ, Lindley LJ commented as follows: “The broad question raised by this appeal is whether a limited company which has lost part of its capital can lawfully declare or pay a dividend without first making good the capital which has been lost. I have no doubt that it can — that is to say, there is no law which prevents it in all cases and under all circumstances.” His Lordship went on to say: “The law is much more accurately expressed by saying that dividends cannot be paid out of capital than by saying that they can only be paid out of profits. The latter expression leads to the inference that the capital must be kept up and represented by assets which, if sold, would produce it: and this is more than is required by law...” aa2) Losses of circulating assets in the current accounting period Losses in circulating assets in the current accounting period must be taken into account in calculating divisible profit. If the phrase “circulating assets” means stock-in-trade, this seems so obvious as hardly to need stating. In Bond v Barrow Haematite Steel Co (1902) 1 Ch 353, Farwell J held that money invested by a large smelting company in surrendered mining leases should be regarded as circulating capital, seeing no difference in principle between ore bought in advance and ore in situ. It followed, he thought, that losses caused by flooding of the mines first had to be made good before available profits were computed. But quaere whether the mining leases (and the blast furnaces and mine cottages connected therewith) were really circulating assets as Farwell J thought. In Ammonia Soda Co v Chamberlain (1918) 1 Ch 266, Swinfen Eady LJ at p 286 gave this explanation of circulating capital: “It is a portion of the subscribed capital of the company intended to be used by being temporarily parted with and circulated in business, in the form of money, goods or other 275
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assets, and which, or the proceeds of which, are intended to return to the company with an increment, and are intended to be used again and again, and to always return with some accretion. Thus the capital with which a trader buys goods circulates; he parts with it, and with the goods bought by it, intending to receive it back again with profits arising from the resale of the goods. A banker lending money to a customer parts with his money, and thus circulates it, hoping and intending to receive it back with interest.” bb) Solvency tests In Australia, there is a need for an overriding condition of solvency. s 588G(1A) makes it clear that the payment of a dividend may be an act of insolvent trading for the purposes of s 588G. While it is well established that a company may borrow in order to obtain the cash necessary to pay the dividend (Stringer's case (1869) LR 4 Ch App 475; Mills v Northern Railway of Buenos Ayres Co (1870) LR 5 Ch App 621) it appears that the moneys borrowed together with funds in hand must be sufficient to cover not only the dividend but also liabilities presently due and payable: see QBE Insurance Group Ltd & Ors v Australian Securities Commission & Anor (1992) 10 ACLC 1,490. The relevant principles were summarised by Tipping J, of the NZ High Court, in Hilton International Ltd (in liq) v Hilton & Anor (1988) 4 NZCLC 64,721 at p 64,750: “(1) Dividends including capital dividends may be paid only out of profits, or putting the matter conversely, may not be paid out of paid up capital without the Court’s approval of a reduction of capital. (2) The payment of a dividend out of paid up capital will occur if the payment has the effect of reducing the company’s net assets (often referred to as shareholders’ funds) below the amount of its paid up capital. The expression net assets for present purposes means the amount which remains after deducting all the company’s liabilities both actual and contingent prudently assessed from the sum of all its assets prudently valued. Accounts should be taken to demonstrate the company’s position overall. A capital or income transaction should ordinarily not be viewed in isolation. (3) Whether there are profits and if so how much thereof should be paid out as dividend is essentially a matter of commercial assessment and judgment but that assessment and judgment must be made and exercised with these and the following propositions in mind. (4) No dividend may be paid, whether out of capital or income profits, if the company is in a state of trading insolvency. (5) No dividend may be paid, whether out of capital or income profits, if the company is in a state of balance sheet insolvency, or will enter that state as a result of the payment. (6) No dividend may be paid, whether out of capital or income profits, if the company is in a state of doubtful trading or balance sheet solvency [sic] unless the directors can demonstrate, if later challenged, that they believed in good faith and on reasonable grounds that the payment of the dividend would not jeopardise the company’s ability promptly to satisfy its creditors present and future and whether secured or unsecured. (7) Even if the company is fully solvent in both the trading and balance sheet senses no dividend may be paid whether out of capital or income profits if the directors ought to have 276
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appreciated that such payment was likely to jeopardise the company’s balance sheet or trading solvency.” cc) Nimble dividends In Australia, there are court decisions concerning the question whether or not current revenue profits may be distributed without making good revenue losses of previous periods. In Ammonia Soda Co v Chamberlain (1918) 1 Ch 266, the English Court of Appeal held that losses in prior years need not be made good before ascertaining available profit for the current year. After referring to Lee v Neuchatel Asphalte Co (1889) 41 Ch D 1, Verner v General and Commercial Investment Trust Ltd (1894) 2 Ch 239, and Re National Bank of Wales (1899) 81 LT 363, Scrutton LJ continued: “Therefore I come to the conclusion which was come to in the three cases I have mentioned — that it is inaccurate to say that if in subsequent years you pay dividends, having lost capital in previous years, you are paying the dividends out of the capital that you lost in the previous years. It is only possible to support that suggestion by treating the profit when made in a subsequent year as in some way automatically turned into capital, and as replacing the capital which has been lost, and by saying that what was made as profit has in some way automatically become capital and must be treated as capital. I can find no foundation for that in the statutes or in the decisions.” It was argued that the decisions on which Scrutton LJ placed reliance were no longer good law in view of the doubts cast upon their correctness by the House of Lords in Dovey v Corey (1901) AC 477. To this Scrutton LJ replied: “I desire to say only respectfully to the House of Lords that if the Court of Appeal decisions are to be over-ruled it must be done in a clearer way than has been done by the noble Lords in Dovey v Corey...” b) Determination of time of distribution and application of restrictions The Australian case law specifies the time at which the distribution requirements have to be satisfied. The question arose in Marra Developments Ltd v BW Rofe Pty Ltd (1977-1978) CLC (1977) 2 NSWLR 616. A dividend was declared at a general meeting of Marra at a time when there were profits available to meet it. The dividend was in fact not paid and by the time six months had elapsed the company was showing accumulated losses of some $20 million in its books. One of the shareholders sought an order from the court that he was entitled to receive the dividend. Marra argued that to pay it would involve the company and its directors in a breach of the statutory prohibition against payment of dividends except from profits, because there was no longer a fund from which the dividend could be paid. The court rejected Marra’s argument, holding that a dividend is validly declared so long as there are profits to meet it at the time the declaration is made. Once validly declared, the dividend becomes a debt owing to the shareholder. On this point Hutley JA cited with approval the following passage from Pennington's Company Law 3rd ed: “An important difference between final and interim dividends is that once a final dividend has been declared, it is a debt payable to the shareholders and cannot be revoked or reduced by any subsequent action of the company; but where directors have power to pay interim dividends, their decision to do so is not a declaration of a dividend, and so can be rescinded or varied at any time before the dividend is paid.”
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A corollary of the principle in the Marra Developments case is the rule that a holding company cannot declare a dividend out of profits which it expects to receive from its subsidiary by the time the dividend is to be paid: Industrial Equity Ltd v Blackburn (19771978) CLC 137 CLR 567. The rule applies even if the subsidiary is wholly owned by the holding company. S 254T appears to overcome the effect of the decision in the Marra Developments case by providing that a dividend may only be “paid” (rather than being “payable”) out of profits, implying that those profits must continue to exist at the time that the payment is made. c) Liability for illegal distributions A dividend that is “paid” other than out of profits would result in a reduction of capital. The directors may be liable to the creditors or liquidator of a company for the amount of a dividend paid which exceeds available profits Auditors may be liable in negligence for acts or omissions which result in a payment of dividends out of capital: Segenhoe Ltd v Akins & Ors (1990) 8 ACLC 263. It would also appear that a right of action may exist against shareholders who receive wrongly paid dividends. This right of action may depend on the shareholders’ state of mind when the payment was received. At least in the case of a knowing recipient who was aware of the wrongfulness of the payment, liability is fairly settled: Moxham v Grant [1900] 1 QB 88. The position of innocent recipients is less clear. Their liability may turn on the nature of the action. For a comprehensive review of the authorities and the various forms of action see the judgment of Giles J in Segenhoe Ltd v Akins & Ors. d) Publication duties/solvency declaration by directors Chapter 2M of the Corporations Law contains the financial reporting provisions of the Corporations Act. Disclosing entities, public companies, registered schemes, large proprietary companies and some small proprietary companies are required by the Act to prepare, lodge with ASIC and provide to members: • the financial statements • a directors' declaration about the financial statements • a directors' report • an auditor's report. Every company, registered scheme and disclosing entity required to prepare a financial report in accordance with the requirements set out in Ch 2M, must appoint an auditor. Auditors are under a statutory duty to form an opinion on the financial report and an opinion on whether proper financial records and registers have been kept. These statutory duties exist concurrently with the auditor's duties at common law. Auditors must also comply with the Auditing and Assurance Standards Board (AuASB) series of auditing standards. Directors' declaration: s 295(4), (5): All companies, registered schemes and disclosing entities required to prepare annual financial statements must also prepare a directors' declaration about the financial statements. The directors' declaration must state: • whether, in the directors' opinion, there are reasonable grounds to believe that the company, scheme or entity will be able to pay its debts as and when they become due and payable (known as the "solvency declaration) • whether, in the directors' opinion, the financial statements and notes have been prepared in accordance with the Act including s 296 (accounting standards) and s 297 (present a true and fair view): s 295(4). 278
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While not specifically stated in the Act, because the directors' declaration on the financial statements forms part of the financial report, an auditor is under a duty form an opinion about the solvency declaration made by the directors. Both ASIC and the AuASB hold the view that the directors' declaration forms part of the financial statements and should be audited: PN 22.13 and AUS 702: The Audit Report on a General Purpose Financial Report (Appendix 3, para 8-10). The auditor's duty is to form an opinion as to whether the directors' declaration is in accordance with the Act. This means that the auditor must consider the solvency declaration and, if of the opinion that there is a defect or irregularity in relation to it, provide a description of the defect or irregularity. The auditor's opinion on the solvency declaration made by the directors is obviously linked to going concern considerations. The auditor must give consideration on the appropriateness of the going concern basis adopted in the financial statements: AUS 708. The two concepts — solvency and going concern — are not necessarily identical. A company may be solvent but not be a going concern because of an intention to liquidate or significantly curtail its operations during the financial period. Conversely, the going concern basis may be appropriate where the company intends to maintain the scale of operations in the short term, but there may be significant uncertainty as to whether it can pay its debts as and when they become due and payable in the long term. The audit engagement letter is the primary document setting out the terms of the audit contract between the auditor and the audit client: see AUS 204: Terms of Audit Engagements. The auditor is also under a statutory duty to conduct the audit in accordance with the auditing standards issued by the Auditing and Assurance Standards Board (AuASB): s 307A, 336. This statutory duty applies to financial years starting on or after 1 July 2004. Compliance with the AuASB auditing standards is mandatory with respect to all audits under the Corporations Act, irrespective of whether the auditor is a member of the Institute of Chartered Accountants in Australia (ICAA) and CPA Australia (CPAA). This means that compliance with the AuASB auditing standards can be enforced by ASIC against the auditor under the Act. Section 307A is stated to be an offence of strict liability, carrying a maximum penalty of 50 penalty units. The criminal nature of failing to comply with the auditing standards does not have immediate application; a contravention of an auditing standard does not give rise to criminal consequences if the contravention occurs before 1 July 2006: s 1455(5). The relevant AuASB auditing standards and other professional guidance statements govern the conduct of the audit (see 108-090). 19. Determination of the distributable amount a) Decision of the board of directors In Australia, the declaration of dividends generally is within the discretion of the board of directors. Pursuant to s 254U(1) the directors may determine that a dividend is payable and fix the amount, the time for payment and the method of payment. However, directors have to obey any restrictions in the articles of association and the applicable statutory provisions as well as the principles derived from case law (see Section 3, No. 18). b) Disclosure S 292 of Division 1 of the Corporations Act (Annual financial reports and directors’ reports) requires that a financial report and a directors’ report must be prepared for each financial year by (a) all disclosing entities; (b) all public companies; (c) all large proprietary companies; and (d) all registered schemes.
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The financial report referred to in s 292 includes the financial statements which are further defined as those complying with applicable Australian accounting standards (s 295). The relevant standard for the presentation of dividends is AASB 101 Presentation of Financial Statements. c) Dividend rights Unless a public company has a constitution which provides for shares in a class to have different dividend rights or different dividend rights are provided for by special resolution, each share comprised in that class has the same dividend rights: s 254W(1). The provisions of s 254U operate as a replaceable rule. S 254U states that the directors may determine that a dividend is payable and fix the amount, the time for payment and the method of payment. This changes what has been the usual practice of the directors declaring interim dividends, with members declaring any final dividend in general meeting. Where the replaceable rule applies to a company, the directors will now have authority to determine both interim and final dividends. The Explanatory Memorandum to the Company Law Review Bill 1997 (at para 11.41) notes this replaceable rule means that the directors no longer need constitutional authorisation to pay a dividend, as was required by the decision in Oakbank Oil v Crum (1882) 8 App Cas 65 at 71. In relation to listed companies, the holders of partly-paid securities are entitled to a dividend no greater than the proportion paid up (ignoring amounts being paid in advance of calls): LR 6.11. 20. Accounting reserves that influence the distributable amount There are no obligatory accounting reserves which prevent a company distributing profits. In the normal course of business distributions to shareholders are conducted through the payment of dividends. The primary rule in this regard is that dividends are paid out of the company’s after tax profits (s 254T).
Section 4:
Capital related rules in case of crisis and insolvency
21. Trigger of insolvency The legislative basis for identifying and managing insolvent companies is the Corporations Act 2001. Under the Act, there are a number of mechanisms that trigger the laws in relation to insolvency. a) Overview legislation As regards insolvency the following provisions may be important: S 459P Who may apply for order under section 459A (1) Any one or more of the following may apply to the Court for a company to be wound up in insolvency: (a) the company; (b) a creditor (even if the creditor is a secured creditor or is only a contingent or prospective creditor; (c) a contributory; 280
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(d) a director (e) a liquidator or provisional liquidator of the company; (f) ASIC (g) a prescribed agency. (2) An application by any of the following, or by persons including any of the following, may only be made with the leave of the Court: (a) a person who is a creditor only because of a contingent or prospective debt; (b) a contributory (c) a director (d) ASIC (3) The Court may give leave if satisfied that there is a prima facie case that the company is insolvent, but not otherwise. (4) The Court may give leave subject to conditions. (5) Except as permitted by this section, a person cannot apply for a company to be wound up in insolvency. S 95A Solvency and insolvency (1) A person is solvent if, and only if, the person is able to pay all the person’s debts, as and when they become due and payable. (2) A person who is not solvent is insolvent. S 347A Directors must pass a solvency resolution after each review date (1) The directors of a company must pass a solvency resolution within 2 months after each review date for the company. (2)... S 459D Contingent or prospective liability relevant to whether company solvent (1) In determining, for the purposes of an application of a kind referred to in subsection 459C(1), whether or not the company is solvent, the Court may take into account a contingent or prospective liability of the company. (2) Subsection (1) does not limit the matters that may be taken into account in determining, for a particular purpose, whether or not a company is solvent. Shareholders (equity) rank last in the order of priority in the liquidation of the company. Members of the company who are also creditors of the company rank before equity but after any other creditors. In respect of the priorities s 563A is to be regarded: S 563A Member’s debts to be postponed until other debts and claims satisfied Payment of a debt owed by a company to a person in the person’s capacity as a member of the company, whether by way of dividends, profits or otherwise, is to be postponed until all debts owed to, or claims made by, persons otherwise than as members of the company have been satisfied. b) Test of insolvency, various approaches to protection and factors of triggering insolvency The legislative basis for identifying and managing insolvent companies is the Corporations Act 2001.
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aa) Test of insolvency and applicants A company is solvent if it is able to pay its debts as and when they fall due – otherwise the company is insolvent. The directors of a company must attest to the solvency of a company each year in accordance with the Act. S 459P(1) provides that any one or more of the following may apply to the court for a company to be wound up in insolvency: • the company itslef • a creditor (even if the creditor is a secured creditor or is only a contingent or prospective creditor) • a contributory • a director • a liquidator or a provisional liquidator of the company • ASIC, or • a prescribed agency (such as the Australian Prudential Regulation Authority). This list of categories of eligible applicants in s 459P(1) is exhaustive: Western Interstate Pty Ltd v DFC of T (1996) 14 ACLC 216 (cf Re Kalblue Pty Ltd (1994) 12 ACLC 1,057). Of the list of applicants referred to in s 459P(1), several of those applicants may only make an application with the leave of the court. The applicants who require leave are: • a person who is a creditor of the company only by reason of a contingent or prospective debt • a contributory • a director • ASIC: s 459P(2). The court may only grant leave to any such applicant if the court is satisfied that there is a prima facie case that the company is insolvent: s 459P(3). The word "may" in s 459P(3) indicates that the court has a residual discretion whether to grant leave, even if it is satisfied that there is a prima facie case of insolvency: Bingham v Iona Corporation Pty Ltd (1995) 13 ACLC 560; Melbase Corporation Pty Ltd v Segenhoe Ltd (1995) 13 ACLC 823; Re Daintree Rain Forest Resort Pty Ltd (1999) 17 ACLC 585. The applicant bears the onus of satisfying the court that prima facie the company is not able to pay all its debts as and when they become due: Bingham v Iona Corporation Pty Ltd (supra); Melbase Corporation Pty Ltd v Segenhoe Ltd (supra); Graf v Auscan Timber Marketing Pty Ltd (1995) 13 ACLC 952; Re Daintree Rain Forest Resort Pty Ltd (supra). The applicant is required to make out a prima facie case in the sense that if the evidence remains as it is, there is a probability that at the trial of the action the plaintiff will be held entitled to relief: Bingham v Iona Corporation Pty Ltd (supra); Melbase Corporation Pty Ltd v Segenhoe Ltd (supra); Graf v Auscan Timber Marketing Pty Ltd (supra); Re Daintree Rain Forest Resort Pty Ltd (supra). Leave may be granted subject to conditions: s 459P(4). It may be granted nunc pro tunc (ie retrospectively): Emanuele & Emanuele v Australian Securities Commission (1997) 15 ACLC 763; Masri Apartments Pty Ltd v Perpetual Nominees Ltd (2005) 23 ACLC 165. An order that the company be wound up in insolvency is made by the court pursuant to s 459A. The court may also make an order under s 459A even if the company is being wound up voluntarily: s 467. A company may be ordered to be wound up in insolvency where application is made to the court under Pt 2F.1, s 462 or s 464 and the court is satisfied that the company is insolvent: s 459B.
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bb) Discretion of the court The decision whether a company should be wound up by the court is a matter for the discretion of the relevant court. The matters that the court might take into account have been discussed in various cases. In Re JD Swain Ltd [1965] 2 All ER 761, there was a choice between liquidation of the company by order of the court, or continuation of the voluntary liquidation which was already in progress. The majority of the creditors opposed the application for compulsory liquidation, and in the court of first instance the application was dismissed. The Court of Appeal dismissed the appeal and held that the decision whether or not a winding up order will be made is a matter entirely within the discretion of the judge whose decision cannot be interfered with unless the judge is wrong in law. Further, the court held that where there is a voluntary liquidation in progress and the majority of the creditors oppose the making of a winding up order the court would require the applicant to show special reasons or circumstances why an order should be made. In Re Southard & Co Ltd [1979] 1 All ER 582, Brightman J considered an application by a creditor to have a company (which was in voluntary liquidation) wound up by the court. His Honour reviewed the various cases applicable and was of the view that the decision whether the company should be wound up by the court is a matter for the discretion of the judge. While conceding that the petitioning creditor's right to a winding-up order is only a prima facie right, counsel for the petitioning and supporting creditors submitted that if the opposition is in a minority, so that the majority are on the side of the creditor seeking to exercise his prima facie right, the court will not deny a winding-up order save in the most exceptional circumstances. Debts owing to subsidiary companies, and other like debts of an inside or 'domestic' nature, are commonly discounted by the court in evaluating the weight of the opposition to a winding-up order: see, for example, the ABC Coupler case [1961] 1 All ER 354. Counsel submitted that domestic debts should not be discounted where the domestic creditors in question are supporting and not opposing the petition. “It would, I think, be wrong for me to seek to lay down any rules as to how the court should exercise its discretion. My proper course is to have regard to the value of the debts of the creditors supporting and opposing a winding-up order, and the nature of those debts, to the reasons given by the minority for desiring the court to override the wishes of the majority, and, since the majority have given reasons, to examine those reasons.” In Melbase Corporation Pty Ltd v Segenhoe Ltd (1995) 13 ACLC 823, Lindgren J considered the discretion conferred on the court by s 459P(3) to grant leave to a contributory to apply for the winding up of a company on the ground of insolvency. The contributory was a minority shareholder in the company, and there was a prima facie case that the company was insolvent. The contributory was also applying for the winding up of the company on other grounds in s 461. Lindgren J was in favour of granting leave, for the following reasons: • it was not generally in the public interest that an insolvent company continue trading • it was not in the interests of minority shareholders that they should be "locked into" an insolvent company • the proceedings for the winding up of the company would continue in any event, and it was appropriate that the contributory be permitted to rely upon the insolvency ground in addition to other grounds In Re Daintree Rain Forest (supra), the court held that the finding by an independent auditor that the company was "technically insolvent" would ordinarily be sufficient to establish a prima facie case which would justify the grant of leave under s 459P(3). However, in that case, the court declined to grant leave, particularly having regard to the fact that the auditor's report had acknowledged that it had "not addressed the valuation of assets held by the company or its credit resources". 283
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The court may refuse an application for leave to commence winding up proceedings where it is clear that the issue of the originating process is an abuse of process: Australian Beverage Distributors v Evans & Tate Premium Wines Pty Ltd (2006) 24 ACLC 657. In that case, the applicant had a minuscule holding of notes and shares which were acquired when it knew of the financial position of the group of which the company was a member, and which were acquired in order to disrupt the group's affairs. It had already had considerable success in that endeavour. The court concluded that the applicant should not have leave, either retrospectively or prospectively, to commence winding up proceedings against the company as a prospective or contingent creditor or contributory. The court also granted an injunction to restrain the filing of new proceedings for the winding up of the company based on the same debts. c) Directors must pass a solvency resolution after each review date Part 2N.3 imposes a requirement on directors of companies to pass a solvency resolution at least once every year. The Part does not apply to registered schemes. Within two months after each review date, the directors of a company must pass a solvency resolution: s 347A(1). The solvency resolution finds a parallel with the requirement to include a declaration as to solvency in the directors' declaration under s 295(4)(c). The directors' declaration forms part of the annual financial report. This is the reason for the exemption in s 347A(2), which provides that directors of a company are not required to pass a solvency resolution under s 347A(1) if the company has lodged a financial report with ASIC under Ch 2M within the period of 12 months before the review date. The practical effect of this requirement will be that only directors of small proprietary companies that do not prepare and lodge a financial report with ASIC will be under an obligation to make a solvency resolution under s 347A. A solvency resolution could be either a positive or a negative solvency resolution. A positive (negative) solvency resolution means a resolution by the directors of a company that, in their opinion, there are (not) reasonable grounds to believe that the company will be able to pay its debts as and when they become due and payable: s 9. The passing of a positive solvency resolution does not trigger any notification obligations. An obligation to notify (using Form 485) is only triggered where the directors either pass a negative solvency resolution or fail to pass a solvency resolution at all within the required time: s 347B. The notification must be made within seven days of passing the negative solvency resolution or, where the directors have failed to pass a solvency resolution, within 7 days after the end of the two month period following the review date. The obligation to notify is imposed on the company, not the directors. This avoids a self-incrimination problem that would otherwise arise for directors of companies if they were obliged to inform ASIC that they had not passed a solvency resolution within the required time. Failure to comply with any of these requirements is a strict liability offence. d) Presumptions of insolvency: ss 459C, 459D The initial question that the Court must determine before making an order that the company be wound up in insolvency is whether the company is insolvent. aa) Presumptions There are various presumptions which are specified in s 459C that enable the Court to presume that a company is insolvent in certain circumstances: s 459C(2). A presumption is rebuttable upon proof to the contrary: s 459C(3). Once a presumption of insolvency of a company is established, the burden of proving its solvency rests with the company: Commonwealth Bank of Australia v Begonia & Ors (1993) 11 ACLC 1,075.
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The Court must presume that the company is insolvent if, during or after the three months ending on the day when the application for the winding up order was made: (a) the company failed (as defined by s 459F) to comply with a statutory demand. The operation of the presumption of insolvency in the context of a company's failure to comply with a statutory demand was considered in Pinn v Barroleg Pty Ltd (1997) 15 ACLC 757. The Court in this case held that the effect of s 459C(2)(a) was that the statutory presumption of insolvency arose where a company had failed to comply with a demand: • during the three months before a winding up application; or • after the making of the winding up application (but before it was heard). If the failure to comply fell outside these periods (as it did in Pinn's case) then the creditor could not rely on the presumption to support its application for the company to be wound up in insolvency. (b) the execution or other process issued on a judgment, decree or order of an Australian Court in favour of a creditor of the company was returned wholly or partly unsatisfied; (c) a receiver (or receiver and manager) of property of the company was appointed pursuant to the terms of an instrument relating to a floating charge on the property; (d) a receiver (or receiver and manager) was appointed by the Court for the purpose of enforcing such a charge; (e) a person entered into possession, or assumed control, of such property for the purpose of enforcing a floating charge on such property; or (f) a person was appointed so to enter into possession or assume control (whether as agent for the chargee or for the company): s 459C(2). bb) Authorities governing the operation of sec 459C The authorities governing the operation of s 459C were clearly expounded by Weinberg J in Ace Contractors & Staff Pty Ltd v Westgarth Development Pty Ltd [1999] FCA 728 at para 44: • The respondent is presumed to be insolvent and as such bears the onus of proving its solvency: s 459C(2) and (3); Elite Motor Campers Australia v Leisureport Pty Ltd ; Leisureport Pty Ltd v Bremer Pty Ltd (1996) 14 ACLC 1,759; (1996) 22 ACSR 235 per Spender J; FC of T v Simionato Holdings Pty Ltd (1997) 15 ACLC 477 per Mansfield J. • In order to discharge that onus the Court should ordinarily be presented with the `fullest and best' evidence of the financial position of the respondent: Commonwealth Bank of Australia v Begonia (1993) 11 ACLC 1,075 at 1,081 per Hayne J. • Unaudited accounts and unverified claims of ownership or valuation are not ordinarily probative of solvency. Nor are bald assertions of solvency arising from a general review of the accounts, even if made by qualified accountants who have detailed knowledge of how those accounts were prepared: Simionato Holdings Pty Ltd (supra); Citic Commodity Trading Pty Ltd v JBL Enterprises (WA) Pty Ltd [1998] FCA 232 per Heerey J; Leslie v Howship Holdings Pty Ltd (1997) 15 ACLC 459 at 463 per Sackville J. • There is a distinction between solvency and a surplus of assets. A company may be at the same time insolvent and wealthy. The nature of a company's assets, and its ability to convert those assets into cash within a relatively short time, at least to the extent of meeting all its debts as and when they fall due, must be considered in determining solvency: Rees v Bank of New South Wales (1964) 111 CLR 210; Re Tweeds Garages Ltd [1962] Ch 406 at 410 per Plowman J; Simionato Holdings Pty Ltd (supra); Melbase Corporation Pty Ltd v Segenhoe Ltd (1995) 13 ACLC 823 at 832 per Lindgren J; Leslie v Howship Holdings Pty Ltd (supra) at 465-466. • The adoption of a cash flow test for solvency does not mean that the extent of the company's assets is irrelevant to the inquiry. The credit resources available to the company must also be taken into account: Sandell v Porter (1966) 115 CLR 666 at 671 per Barwick CJ (with whom 285
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McTiernan and Windeyer JJ agreed); Leslie v Howship Holdings Pty Ltd (supra) at 466; Taylor v Australia and New Zealand Banking Group Limited (1988) 6 ACLC 808 at 812 per McGarvie J. • The question of solvency must be assessed at the date of the hearing. However, this does not mean that future events are to be ignored: Leslie v Howship Holdings Pty Ltd (supra) at 466467. cc) Contingent and prospective liabilities: sec 459D Other factors which the Court may take into account for the purposes of determining the solvency of a company are the contingent and prospective liabilities of the company: s 459D(1). However, this provision in no way limits the matters that the Court may take into account in determining a question of solvency: s 459D(2). The expression “contingent and prospective liabilities” relates to possible liabilities which may be incurred as a result of contracts or activities entered into prior to or at the time the issue of insolvency is being raised: Community Developments Pty Ltd v Engwirda Construction Co (1969) 43 ALJR 365. It does not, therefore apply to liabilities that will be incurred under a future contract, under which the company will also derive benefits: Leslie v Howship Holdings Pty Ltd (1997) 15 ACLC 459. A more “liberal” view is to be found in Commissioner of Taxation v Simionato Holdings Pty Ltd (1997) 15 ACLC 477. There, Mansfield J held that “contingent and prospective liability” in s 459D had the same meaning, mutatis mutandis, as “contingent or prospective creditor” in s 459P(1)(b). On that basis, his Honour held that Court proceedings against a company for unliquidated damages could be taken into consideration under s 459D. (His Honour was careful to make it clear that such a finding would not automatically entitle the contingent or prospective creditor to a winding up order).
Section 5:
Contractual self protection of creditors
22. Contractual self protection Debt arrangements and supplier or other creditor arrangements are negotiated between the lender and an authorised person in the company. Such authorisations are generally delegated to various persons in the Company depending upon the size of the commitment and their area of accountability. For example, supplier arrangements wull be negotiated with the procurement division. Large debt will be negotiated with the Treasurer or the Chief Financial Officer etc. The documentation in relation to debt is not a prescribed uniform contract, although many contracts contain similar provisions and content as practices have developed over time. a) Supplieres and other creditors Smaller creditors and suppliers do not generally have the means for mitigation of the credit exposure described for the debt providers below. Rather, such suppliers are reliant upon strict billing and collection procedures to ensure amounts are collected within a reasonable time of the goods and services being provided. b) Debt providers Banks and other financial institutions that provide debt to corporations negotiate the terms and conditions of the debt directly with the Corporation. Debt providers conduct assessments of the borrower before providing funds and this influences the amount of security or other credit mitigation they will seek to obtain before providing the funds. Broadly speaking, the
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less confidence the lender has in the ability of the company to meet the debt repayments, the more terms and conditions associated with the debt will be sought. In order to protect themselves against losses from the lending to the corporate it is usual to negotiate certain terms and conditions. The terms and conditions negotiated reflect the type of lending provided. The two broad categories of lending and common terms and conditions are: aa) Cash flow lending Cash flow lending is lending where recovery is based on the profitability and cash flows of the business in order to meet repayments of the debt. Accordingly, terms and conditions focus on the cash flows of the business such as: - Negative pledge clauses - Financial covenants (capital ratio, debt –equity ratios, limitations on dividends) - Directors’ guarantees - Requirement to produce regular financial information such as Quarterly financial reports and reporting of certain management information such as aged debtors and creditors bb) Asset lending This type of lending is where the funds are provided for the purposes associated with a particular asset (such as property and plant). Accordingly the debt is generally secured by a charge over the asset. A mortgage over the title to the property is a common example.
Section 6:
Equal treatment
23. Principle of Equal treatment a) Principle of equal treatment Generally shares of a class carry the same rights and benefits. b) Voting rights and right to attend the shareholders’ meeting The Corporations Act 2001 requires certain actions to be taken to ensure that members have equal voting rights. These include the notice provided to members of the meeting and the location and/or means to participate. Subject to any rights or restrictions attached to any class of shares, at a meeting of members of a company with a share capital (a) on a show of hands, each member has 1 vote and (b) on a poll, each member has 1 vote for each share they hold (s 250E). The Corporations Act 2001 requires certain actions to be taken to ensure that members have equal rights to attend meetings. These include the notice provided to members of the meeting and the location and/or means to participate. Relevant extracts of the Corporations Act are provided below: According to s 249H(1) at least 21 days notice must be given of a meeting of a company’s members. However, if a company has a constitution, it may specify a longer minimum period of notice. Written notice of a meeting of a company’s members must be given individually to each member entitled to vote at the meeting and to each director. The meeting itself must be helf for a proper purpose and at a reasonable time and place. A company may hold a meeting of its members at 2 or more venues using any technology that gives the members as a whole a reasonable opportunity to participate (s 249S). c) Right to receive dividends All classes of shares have equal rights within that class in relation to dividends. The relevant provision in the Act is s 254W. 287
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Each share in a public company in a class of shares in a public company has the same dividend rights unless (a) the company has a constitution and it provides for the shares to have different dividend rights or (b) different dividend rights are provided for by special resolution of the company. Subject to the terms on which shares in a proprietary company are on issue, the directors may pay dividends as they see fit. In a no liability company a person is not entitled to a dividend on a share in a no liability company if a call (a) has been made on the share and (b) is due and unpaid. Dividends are payable to the shareholders in a no liability company in proportion to the number of shares held by them, irrespective of the amount paid up, or credited as paid up, on the shares. The subsection has effect subject to any provisions in the company’s constitution relating to shares that are not ordinary shares. d) Pre-emption right The Corporations Act specifies the rights of shareholders when issuing and converting shares such that all shareholders are treated equally. S 254D Pre-emption for existing shareholders on issue of shares in proprietary company (1) Before issuing shares of a particular class, the directors of a proprietary company must offer them to the existing holders of shares of that class. As far as practicable, the number of shares offered to each shareholder must be in proportion to the number of shares of that class that they already hold. (2) To make the offer, the directors must give the shareholders a statement setting out the terms of the offer, including (a) the number of shares offered; and (b) the period for which it will remain open. (3) The directors may issue any shares not taken up under the offer under subsection (1) as they see fit. (4) The company may by resolution passed at a general meeting authorise the directors to make a particular issue of shares without complying with subsection (1). e) Rights in a takeover situation In a takeover situation the equal treatment of all shareholders plays an important role. The ASIC Policy Statement [PS 163] Takeovers: minimum bid price principle s 621 says [PS 163.5] that “The minimum bid price principle is an application of the “equality principle” underpinning Chapter 6: s 602(c). Section 602(c) says that as far as practicable, all holders must have a reasonable and equal opportunity to participate in any benefits accruing to the holders through any proposal under which a person would acquire a substantial interest in a company, body or scheme to which Chapter 6 applies”. The ASIC Practice Note 32 on Classes of shares mentions [PN 32.10] that “One of the aims of the regulation of takeovers, set out in s731(d), is to ensure that: “as far as practicable, all shareholders of a company have equal opportunities to participate in any benefits accruing to shareholders under any proposal under which a person would acquire a substantial interest in the company”.
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3.2.3 New Zealand The today New Zealand corporation law is regulated in the Companies Act 1993 and the Financial Reporting Act 1993. It sets out the general administrative requirements. The Securities Act 1978 will apply when an entity issues securities (equity, debt, etc) to the public. Central norm for all considerable capital measures is the, in the general part standardised, solvency test. The requirements compiled there have to be complied with in respect of a distribution of dividends, an acquisition of own shares or a reduction of the corporate capital.
Section 1:
Capital formation
Sub-section 1:
Formation of the stock corporation
1. Stated capital and other means of equity financing New Zealand does not follow the traditional system of stated capital rules. The Companies Act 1993 specifically requires that share capital must not have a nominal or par value and therefore shares do not have a stated value. a) Minimum subscribed capital § 38(1) CA 1993 clarifies that a share must not have a nominal or par value. However, nothing would prohibit the company from stating that a share will be redeemed at a specified value. b) Composition of capital: stated capital and other forms of equity financing (premiums) With the introduction of the Companies Act 1993, the legal concept of capital maintenance distributions has been discarded in favour of the solvency test. Therefore a distinction between components of equity is no longer needed unless an accounting standard requires separate disclosure in the financial statements (e.g. retained earnings, fixed asset revaluation reserves). While there is no necessity for a distinction to be made between the components of equity, a company may choose to maintain records of (and report) those components of equity which it deems relevant. Generally entities that take this option would present consideration received from shareholders as “share capital”. Share capital does not serve as a limit on corporate distributions. Instead, so long as the trading solvency test is met, a corporation can declare a distribution up to the amount by which its assets exceed its liabilities (balance sheet solvency test). Theoretically, $1 of equity will satisfy that test (for details on the requirements for legal distributions see Section 3, No. 18, infra). In addition, where equity is componentised, there is no requirement that any component of equity must have a credit balance. That is, a component (e.g. retained earnings) may be negative. Contributed capital can be repurchased or redeemed for a greater amount than was originally subscribed. Subject to the constitution of the company, different classes of shares may be issued. These shares may be redeemable, confer preferential rights to distributions of capital or income, confer special, limited, or conditional voting rights or don’t confer voting rights. The Board of Directors determines the consideration payable for a share issue. However, unless the constitution or another contract calls for it, no amount is actually payable in respect of the shares issued. The shares will be presented as unpaid, partly paid up or paid up share capital depending on the case. 289
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c) Authorised capital The Board of a company may issue shares at any time, to any person, and in any number it thinks fit, as long as the Companies Act 1993 and the constitution of the company don’t state otherwise. If shares cannot be issued by reason of any limitation or restriction in the company’s constitution, the Board may issue shares if it obtains the approval for the issue in the same manner as approval for an alteration of the constitution that would permit such an issue. d) Information to be made public In New Zealand the constitution of a company has to be sent to the Registrar, if the company has one. § 26 CA 1993 states that a company may have but does not have to have a constitution. For a company’s registration an application for registration must be delivered to the Registrar, which contains a document signed by every person named as a director, a consent signed by every shareholder stating the shareholders and their class and number of shares specified, a notice reserving a name for the company. The application for registration must be signed by each applicant and the applicants have to state their full name and address. Also the directors and shareholders have to state their full names and their residential address, as well as the number of shares to be issued to every shareholder. e) Consideration for share In New Zealand the Companies Act 1993 states in § 46 that the consideration for which a share is issued may take any form and may be cash, promissory notes, contracts for future services, real or personal property, or other securities of the company. The Board determines the consideration and the terms on which the shares will be issued. Where consideration is other than cash, the Companies Act requires the directors to determine the reasonable present cash value of the consideration, to sign a certificate to this effect, and to file such certificate which must be handed in to the Registrar of Companies. There are no further disclosure requirements in respect of the value at which shares are issued. 2. Subscription of capital The New Zealand company law follows a model without stated capital (alternative model). The Board determines the consideration to be paid to the corporation in an adequate way. a) Issue to any person or persons named in the application for registration Forthwith after the registration of the company it has to issue to any person or persons named in the application for registration as a shareholder or shareholders, the number of shares specified in the application as being the number of shares to be issued to that person or those persons. There is no requirement that the shareholders actually have to pay up the amounts payable on each share unless the constitution or another pre-incorporation contract requires otherwise. In certain instances, and at the company’s option, where securities are offered to the public, the prospectus could state a minimum amount that should be raised. If such minimum amount is not received within 4 months of the date of the prospectus, the securities cannot be issued and any consideration received must be repaid. An allotment could also be voidable if the securities are allotted more than 6 months (or in some instances 9 months) after the prospectus date or where the maximum amount specified in the prospectus is exceeded. 290
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b) Prohibition of subscription of shares by the company itself An entity is allowed to hold its own shares provided its constitution allows this. The Board resolves that the shares are not cancelled upon acquisition and the number of share is not more than 5% of the number previously issued. c) Setting of the price of the shares As mentioned above, the directors determine a reasonable value at which shares will be issued. Where the consideration is other than for cash, the directors will place a reasonable present value on such consideration which would not be inquired into unless fraud is considered. d) Design of shares There is a presumption that the shares of the company carry the same rights and obligations. However, this presumption may be rebutted either by the company’s constitution or by the particular terms on which the shares are issued. Therefore a company may issue shares with differing rights and obligations. Generally the following classes of shares exist: • Ordinary shares • Redeemable shares • Preference shares (income or capital) • Special, limited, or conditional voting shares • Non-voting shares • Convertible shares. e) Information linked to the share to be fixed Constitutional documentation and the financial statements of the entity will generally provide detail in respect of the terms of issue of each class of shares. 3. Contributions Under New Zealand law provisions exist concerning the questions what can be injected as capital /funds and how it can be injected into the company. a) Contributions in cash and other forms The consideration for which a share is issued may take any form and may be cash, promissory notes, contracts for future services, real or personal property or other securities of the company (§ 46 CA 1993). b) Amount to be paid in Unless the constitution so requires or the shareholders have entered a contract that stipulates payment, the shareholder has no obligation to pay for shares issued on registration of the company. Disclosure is required in the financial statements in respect of the extent to which the shares are paid up e.g. they are presented as unpaid, partly paid up or paid up. c) Valuation of contributions in kind As mentioned above, contributions in kind are valued by the directors at the present cash value of the consideration. The method for determining present cash value is not defined in legislation, but generally is expected to be the value that could be obtained from a third party (i.e. a fair value) for the goods or services. There is also no requirement that the value should be determined by an accountant or expert. However, depending on the nature of the asset and the level of public information available around the value of the asset, in practice, valuations 291
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would normally be obtained from valuers with sufficient experience in valuing a particular type of asset. According to § 47 CA 1993 the Board has to certify the reasonableness of the valuation, including the basis used for determining the value and deliver a copy of a certificate to the Registrar. Shareholders do not have the right to determine the value of contributions in kind. d) Consequences of incorrect financing Where the valuation process is not undertaken appropriately – the directors do not certify the reasonableness of the valuation and the certification is not delivered to the Registrar, they commit an offence and on conviction could be penalised. A shareholder that considers the affairs to be conducted in a manner that will prejudice the shareholder, could apply to the Court for an order which could include: • Requiring the company or any other person to acquire the shareholder's shares; or • Requiring the company or any other person to pay compensation to a person; or • Regulating the future conduct of the company's affairs; or • Altering or adding to the company's constitution; orAppointing a receiver of the company; orDirecting the rectification of the records of the company; orPutting the company into liquidation; or • Setting aside action taken by the company or the board in breach of this Act or the constitution of the company. 4. Accounting for formation expenses The New Zealand accounting standards do not allow the capitalisation of formation expenses.
Sub-section 2:
Capital increases
5. Issuance of new shares New Zealand law allows a company issuing additional shares, as long as the requirements of the constitution are adhered to. a) The usual way to issue new shares If the constitution allows, the board is responsible for issuing new shares. § 42 CA 1993 states that subject to the Companies Act and the constitution of the company, the board of a company may issue shares at any time, to any person, and in any number it thinks fit. The board must deliver a notice of the issue of the new shares by the company to the Registrar for registration within 10 working days. If the board of a company fails to comply with those requirements, every director of the company commits an offence and is liable on conviction to the penalty set out in the Companies Act. In case of a prohibition or limitation in the constitution regarding the issue of new shares, the shareholders can, by special resolution, authorise the share issue, i.e. the board may issue shares if it obtains the approval for the issue in the same manner as approval is required for an alteration of the constitution that would permit such an issue. The board must ensure that notice of that approval, being given by the shareholders, is delivered to the Registrar for registration within 10 working days. The same applies to liability of the board. However, a failure to comply with these requirements does not affect the validity of an issue of shares.
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In some instances there could be a limitation or a restriction in the company’s constitution to issue new shares. The general way to issue new shares, provided that the requirements of the constitution are adhered, is: • • • • • •
Proposal of the board to issue new shares Invitation to shareholders’ meeting Resolution by shareholders on capital (share) increase Registration of decision with Registrar Issue of shares and update of share register Lodgement of necessary documentation with Registrar
b) Exceptions A decision regarding the consideration needs not to be made when the issued shares are fully paid up from the reserves of the company and made to all shareholders of the same class in proportion to the number of shares held by each shareholder. The same applies to the consolidation or division of shares or any class of shares in the company in proportion to preexisting number and the subdivision in proportion to those shares. c) Disclosures The company has to register a certificate in respect of reasonableness of consideration for shares with the Registrar within 10 working days of the decision. After issuing shares and updating the share register, the board of the company must deliver a notice of the issue by the company in the prescribed form to the Registrar for registration within 10 working days of the issue of shares in case of an amalgamation or an issue of other shares (means not during the formation). If the board of a company fails to comply these requirements, every director of the company commits an offence and is liable on conviction to a penalty. 6. Subscription of new shares With respect to the subscription of new shares which were issued generally the same rules apply which New Zealand law provides for the subscription of shares during the formation of the corporation. This applies to the prohibition of subscriptions of shares by the company itself (see section 1, No. 2b), supra) the setting of the price of the shares (see section 1, No. 2c), supra), the design of shares (see section 1, No. 2d), supra) and the information linked to the share to be fixed (see section 1, No. 2e), supra). A difference between the subscription of new shares and the subscription of shares during the formation is that the board may issue new shares to any person it thinks fit (barring pre-emptive rights and other rules stated in the company’s constitution) while the shares on registration have to be issued to the person or persons named in the application for registration. 7. Contributions The requirements on formation of the company are equally relevant to the issue of new shares. There is no requirement to pay any consideration in respect of shares allocated as set out in the application for registration of the company unless the constitution or another contract so requires. Regarding share contributions and their payment at the stage of a share increase the same regulations generally apply as those at the stage of formation. As in the stage of formation the 293
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New Zealand Companies Act permits contributions in cash or other forms like promissory notes, contracts for future services, real or personal property or other securities of the company (§ 46 CA 1993, see section 1, No. 3a), supra). Otherwise there is no requirement to pay any consideration in respect of shares allocated as set out in the application for registration of the company unless the constitution or another contract so requires (see section 1, No. 3b), supra). Furthermore with respect to the valuation of contributions in kind (see section 1, No. 3c), supra) and the consequences of incorrect financing (see section 1, No. 3d), supra) the same rules are applicable as in the stage of formation. 8. Pre-emption rights New Zealand law acknowledges pre-emptive rights. According to § 45 CA 1993 shares issued or proposed to be issued by a company that rank or would rank as to voting or distribution rights, or both, equally with or prior to shares already issued by the company must be offered for acquisition to the holders of the shares already issued in a manner and on terms that would, if accepted, maintain the existing voting or distribution rights, or both, of the those holders. The constitution of the company may negate, limit, or modify these requirements. There are no specific time limits on these offers, but the Act requires a “reasonable time” for acceptance.
Section 2:
Capital Maintenance
9. Limitation of profit distributions – fraudulent transactions In respect of distributions, every director who votes in favour of a distribution must sign a certificate stating that in his opinion the company will immediately after the distribution satisfy the solvency test and the grounds for that opinion (§ 52 CA 1993). Every director who fails to comply commits an offence and is liable on conviction to penalties. In addition, if there were no reasonable grounds to believe that the company will satisfy the solvency test at the time the certificate is signed, every director that signed the certificate is personally liable to the company to repay so much of the distribution as is not able to be recovered from shareholders (§ 56(2) CA 1993). When a company is placed in liquidation, certain transactions might be set aside. The Companies Act sets out certain provisions that deals with voidable transactions and charges, transactions at an undervalue, and transactions which appear to give an advantage to persons who have a special relationship with the company and that will ensure that persons who have received some advantage at the expense of the company and its creditors in general be made to account for that advantage. Transactions which are set aside under this Part of the Act are for the benefit of creditors generally and not for the benefit of any single creditor and generally relate to a period of up to two years before the company is placed in liquidation. New Zealand law also includes a specific Act (the Corporations (Investigation and Management) Act 1989) that applies to any corporation that is, or may be, operating fraudulently or recklessly or to which it is desirable that this Act applies: • for the purpose of preserving the interests of the corporation's members or creditors; 294
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•
for the purpose of protecting any beneficiary under any trust administered by the corporation; or
•
for any other reason in the public interest;
if those members, creditors or beneficiaries or the public interest cannot be adequately protected under the Companies Act 1993 or in any other lawful way. This Act confers powers on the Registrar of Companies to obtain information and investigate the affairs of corporations and to limit or prevent further action and also to enable the Registrar or its agent (called a “statutory manager“) to take over the operation of the corporation. 10. Disclosure of related transactions In New Zealand a director must disclose to the Board and record in the interests register any interest that he/she has in a transaction or proposed transaction. In addition, the accounting standards demand disclosure of all material transactions between directors and shareholders and the company. a) Interdicted related transactions A director is prohibited from causing the company to enter into transactions in which he or she has an interest. A director may be interested in a transaction either by having a personal stake in the outcome (the so-called duty-interest conflict) or owning duties to the other party to the transaction with the company (the so-called duty-duty conflict). The prohibition on acting where the director has an interest is designed to ensure that the director acts in the company’s interests and in the company’s interests alone. However, the prohibition is not absolute. Rather the duty is to avoid acting where he or she is interested unless that interest has first been fully disclosed to the company. It is thus not inaccurate to describe the duty as giving rise to a disability to act. Once disclosure has been made and acknowledged by the company, the disability is removed. b) Disclosure Accounting standards would require disclosure of all material transactions between directors and shareholders and the company such as details remuneration, nature of transactions, outstanding balances and bad/doubtful debts. 11. Loans to directors There is no law/regulation specifically dealing with loans to directors. Generally such transactions are disclosed in the financial statements and ratified by the shareholders accepting the financial statements. 12. Acquisition of own shares When a corporation purchases own shares, corporate assets flow out to shareholders. In New Zealand a company is generally allowed to purchase its own shares, hold those shares and resell the shares.
a) Requirements for share repurchase
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In New Zealand the requirements for the repurchase of own shares are regulated in §§ 58 to 67C CA 1993. aa) Solvency test For an acquisition of own shares, the directors of the company must certify that the solvency test is met (for further details on the solvency certificate see Section 3, No. 18b), infra). First, that means, that they have to confirm that the company is able to pay its debts as they become due in the normal course of business, and secondly, the value of the company's assets is greater than the value of its liabilities including its contingent liabilities (for further detailed information according to the New Zealand solvency test see section 3, No. 18, infra). bb) Additional requirements In addition, certain other procedures set out in law must be followed, i.e. the directors have to certify the reasonableness and fairness of the offer and that the acquisition is in the interest of the company. They have to send a disclosure document to the shareholders, which complies with the detail requirements of the Act. The offer of repurchase of shares, which must be made not less than 10 working days and not more than 12 months after the disclosure document is set out, could be made to all shareholders in proportion to their existing holdings or selectively to one or more shareholders, if all shareholders consented to this in writing or it is expressly permitted by the constitution. Where an offer is made to all shareholders, the offer may also permit the company to acquire additional shares from a shareholder to the extent that another shareholder does not accept the offer or accepts the offer only in part. A shareholder or the company may apply to the Court for an order restraining the proposed acquisition on the grounds that it is not in the best interests of the company and for the benefit of remaining shareholders or the terms of the offer and the consideration offered for the shares are not fair and reasonable to the company and remaining shareholders. Finally, the board has to deliver a notice of acquisition or repurchase to the Registrar within 10 working days. Shares listed on the stock exchange may in certain instances be acquired without prior notice to shareholders. That is possible, when the board resolved that the acquisition is in best interest of company and shareholders, the terms of and consideration for the acquisition are fair and reasonable, the board isn’t aware of any information that is not available to shareholders and the number of shares are acquired in the preceding 12 months does not exceed 5 % of the shares in the same class as at the beginning of that period. Subject to the provisions of the company’s constitution, the Companies Act 1993 and a resolution by directors, own shares acquired could be held by the company. All rights and benefits relating to the shares held by the company are suspended, i.e. the shares will have no voting rights and the company cannot pay dividends in respect of those shares. The normal rules (as set out above) apply when the company so resolves to re-issue such shares unless it is transferred by means of a system that is approved under section 7 of the Securities Transfer Act 1991 (a scripless trading system). b) Maximum amount of own shares that can be held For listed companies the number of shares acquired, with out prior notice to shareholders and when aggregated with shares of the same class held by the company must not exceed 5 % of the shares in the same class previously issued by the company.
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Shares acquired not in accordance with all the requirements mentioned before are deemed to be immediately cancelled on acquisition. As set out under section 3(d) above, a shareholder that considers itself prejudiced in the process of acquisition of the companies own shares could apply to the court and the court could issue various orders, including who bears the costs of the proceedings. A share that a company holds may be cancelled by the board of the company resolving that the share is cancelled. On reacquisition of the company’s shares, the required shares will be presented as a “debit” in equity, i.e. treasury shares, at the amount the shares were reacquired. When the shares are cancelled (in practice), the amount is simply netted against contributed capital if the entity where the entity componentise its equity. d) Reselling of own shares In New Zealand it is generally possible to resell own shares (in the way it is described in section 1, No. 5, supra). e) Disclosure Accounting requirements would result in treasury shares being separately disclosed in the financial statements as a component of equity. As mentioned above, on reacquisition of the shares, the amount paid to shareholders is presented as a debit in equity and the line item would be named “treasury shares”. There is no prescriptive format for the disclosure. 13. Financial assistance New Zealand law deals directly with assistance by a company in the purchase of its own shares: Requirements for financial assistance (regulated in §§ 76 to 81 CA 1993). A company may give financial assistance (which includes loans, guarantees or the provisions of a security) to a person for the purpose of the purchase of a share issued by the company, or by its holding company, whether directly or indirectly, only if the board has previously resolved that the company should provide the assistance, giving the assistance is in the best interests of the company; and the terms and conditions under which the assistance is given are fair and reasonable to the company. In other words, the financial assistance should not disadvantage the ongoing operations or business conduct of the company and should be on terms that would benefit or at least leave the company in the same position that it would have been if the assistance was not provided (i.e. a neutral position). Moreover, the company must, immediately after giving the assistance, satisfy the solvency test (cp. Section 3, No. 18., infra). The directors who vote in favour of the giving of the financial assistance must sign a certificate stating that, in their opinion, the company will, immediately after the financial assistance is given, satisfy the solvency test and the grounds for that opinion. In applying the solvency test for financial assistance, “assets” excludes amounts of financial assistance given by the company in the form of loans and “liabilities” includes the face value of all outstanding liabilities, whether contingent or otherwise, incurred by the company at any time in connection with the giving of financial assistance. In addition, one of the following circumstances should apply: 297
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a) All shareholders consent Financial assistance is possible, if all shareholders have consented to giving the assistance; or b) The board resolves benefit (special financial assistance) If the board has previously resolved that giving the assistance in question is of benefit for those shareholders not receiving the assistance and that the terms and conditions under which the assistance is given are fair and reasonable to them. Before the financial assistance is given the company must send to each shareholder a disclosure document that sets out the nature and terms of the financial assistance to be given, and to whom it will be given as well as the text of the resolution together with such further information and explanation as may be necessary to enable a reasonable shareholder to understand the nature and implications for the company and its shareholders of the proposed transaction. The assistance may be given not less than 10 working days and not more than 12 month after the disclosure document has been sent to the shareholders. A shareholder or the company may apply to the Court for an order restraining the proposed assistance being given on the ground that it is not in the best interests of the company and of benefit to those shareholders not receiving the assistance or the terms and conditions under which the assistance is to be given are not fair and reasonable to the company and to those shareholders not receiving the assistance; or c) Financial assistance not exceeding 5 % of shareholders' funds If the amount of the financial assistance, together with any other financial assistance given by the company pursuant to this paragraph, repayment of which remains outstanding, would not exceed 5 % of the aggregate of amounts received by the company in respect of the issue of shares and reserves as disclosed in the most recent financial statements of the company, the company receives fair value in connection with the assistance and within 10 working days of providing the financial assistance, the company sends to each shareholder a notice containing the following particulars: • The class and number of shares in respect of which the financial assistance has been provided, • the consideration paid or payable for the shares in respect of which the financial assistance has been provided, • the identity of the person receiving the financial assistance and, if that person is not the beneficial owner of the shares in respect of which the financial assistance has been provided, the identity of that beneficial owner, • the nature and, if quantifiable, the amount of the financial assistance. The directors who vote in favour of a resolution on financial assistance must sign a certificate which contains that the legal requirements are complied with. If a company fails to comply with those requirements, it commits an offence and is liable to a penalty. Furthermore, every director commits an offence and is liable to a penalty. 14. Loans from shareholders The New Zealand law does not deal specifically with loans from shareholders. But if a transaction falls within the parameters of “voidable” or “undervalued” transactions, the liquidator would be able to take action under the provisions of the Companies Act.
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In practice, loans from shareholders are generally subordinated and therefore they will rank subordinated to creditors claims. 15. Capital decreases In a New Zealand corporation, capital decreases may be performed in different ways. The process of decreasing share capital is the same as noted under acquisition of own shares (section 2, No. 12, supra), under distributions (section 3, No. 17 and 18, infra) and redeemable shares (section 2, No. 16, infra). Depending on the way in which the transaction is effected, the following need to be satisfied: • Constitution must allow the transaction to take place; • Board must resolve that the solvency test is met; • Board must resolve that it is in the best interest of the company and on terms that are fair and reasonable; • Proper/detailed disclosures to the shareholders, including the information required by the law. 16. Redeemable shares In New Zealand redemption refers to a forced sale initiated by the corporation, the shareholders or a fixed date in accordance with the terms of issue or/and the constitution of the company. a) Possibility of redeeming shares In New Zealand shares may be redeemed pursuant to § 68 ff CA 1993. b) Conditions of share redemptions Subject to an entity’s constitution, it may issue redeemable shares and redeem those shares as provided in the terms of issue. Generally the shares would be redeemable by either, the company, the shareholder or both and the consideration would be specified or calculated using a formula or fixed by an independent suitable qualified person. aa) Redemption at option of the company An option by the company to redeem shares should only be exercised if it is in relation to all shareholders in a class and affecting all equally, or in relation to one or more shareholders where all shareholders consented in writing or the option is expressly permitted by the constitution. If the option is exercised in relation to one or more shareholders and permitted by the constitution, the directors need to forward a disclosure document to the shareholders before exercising the option and shareholders should have a period of between 10 and 30 working days after the document has been sent to consider the option. A shareholder or the company may apply to the Court for an order restraining the proposed exercise of the option on the grounds that it is not in the best interests of the company or of benefit to remaining shareholders, or the consideration for the redemption is not fair or reasonable to the company or remaining shareholders. The directors must also resolve and certify that the redemption is in the best interests of the company, the consideration is fair and reasonable to the company and the solvency test is satisfied.
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Depending on which requirement is not fulfilled, either the company or the directors commits an offence and is liable on conviction to a penalty is set out in the Companies Act. When shares are redeemed, they are deemed to be cancelled immediately although they could be reissued in future. bb) Redemption at option of the shareholders If a share is redeemable at the option of the holder of the share, and the holder gives proper notice to the company requiring the company to redeem the share, the company must redeem the share on the date specified in the notice, or if no date is specified, on the date of receipt of the notice, the share is deemed to be cancelled on the date of redemption and from the date of redemption the former shareholder ranks as an unsecured creditor of the company for the consideration payable on redemption. cc) Redemption on fixed date If a share is redeemable on a specified date the company must redeem the share on that date and the share is deemed to be cancelled on that date as well as from that date the former shareholder ranks as an unsecured creditor of the company.
Section 3:
Dividends and distributions
17. Definition of Distribution The New Zealand Corporation Law does define “distribution” in § 2 CA 1993. A Distribution, in relation to a distribution by a company to a shareholder, is defined to mean: (a) the direct or indirect transfer of money or property, other than the company's own shares, to or for the benefit of a shareholder; or (b)
the incurring of a debt to or for the benefit of a shareholder;
in relation to shares held by that shareholder, and whether by means of a purchase of property, the redemption or other acquisition of shares, a distribution of indebtedness, or by some other means. Furthermore, § 53 CA 1993 states, that a dividend is a distribution other than an acquisition of own shares (cp. section 2, No. 12) or financial assistance (cp. section 2, No. 13). The section appoints, that the board of a company must not authorise a dividend in respect of some but not all the shares in a class, or that is of a greater value per share in respect of some shares of a class than it is in respect of other shares of that class unless the amount of the dividend in respect of a share of that class is in proportion to the amount paid to the company in satisfaction of the liability of the shareholder under the constitution of the company or under the terms of issue of the share. Subject to the constitution of the company, the board of a company may issue shares to any shareholders who have agreed to accept the issue of shares in lieu of a proposed dividend or proposed future dividends if the right to receive shares in lieu of the proposed dividend has been offered to all shareholders of the same class on the same terms, if all shareholders elected to receive the shares in lieu of the proposed dividend, relative voting or distribution rights, or both, would be maintained and the shareholders to whom the right is offered are 300
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afforded a reasonable opportunity of accepting it as well as the shares issued to each shareholder are issued on the same terms and subject to the same rights as the shares issued to all shareholders in that class who agree to receive the shares. Furthermore, the board may resolve that the company offers shareholders discounts of the goods or services provided by the company only if it has resolved that the proposed discounts are fair und reasonable to the company and to all shareholders and to be available to all shareholders (of the same class) on the same terms. However, the solvency test has to be satisfied. Reduction of shareholder liability has to be treated as if it is a distribution and in some cases as if it is a dividend. The issue of the company’s own shares is not a distribution. Share issues are excluded because the requirement of fair value ensures that the company’s position is not prejudiced and raising capital when the company is in difficulty should not be discouraged. (Potential investors will be protected by other legislation and the general law if misled in such circumstances.) A payment to a shareholder that does not relate to shares held by that shareholder (for example, wages) is not a distribution. In Re DML Resources Ltd (in liq), Vague v McCarthy ; Re DML Resources (Asia) Ltd (in liq), DML Resources Ltd (in liq) v Bolton (2003) 9 NZCLC 263,310 the High Court held that a distribution does not occur if the shareholder receives benefits from the company as part of a genuine arms’ length transaction for which valuable consideration is given. The court also said that transactions involving broadly equal consideration are not intended to fall within the distribution provisions and that a distinction should be drawn between the transfer of wealth to a shareholder in its capacity as a shareholder and a bona fide transfer of wealth to that shareholder in some other capacity. The various distributions which may be made, including dividends, shares instead of dividends, shareholder discounts, reduction of shareholder liability, etc, are subject to a body of rules set out in the constitution of a company and the Companies Act. The most important of these is the requirement that the solvency test be satisfied before the distribution is made. This is a novel concept borrowed from North American corporate law. It is based on the premise that creditors and shareholders are protected if a distribution can only be made if it leaves the company solvent. For further detailed information according to the New Zealand solvency test see section 3, No. 18., infra. 18. Distributable amount a) Requirements for legal distributions In New Zealand, the board of a company that is satisfied on reasonable grounds that the company will, immediately after the distribution, satisfy the solvency test may, subject to the constitution of the company, authorise a distribution at a time, and of an amount, and to any shareholders it thinks fit (§ 52(1) CA 1993). Therefore, the benchmark for making a distribution is whether the solvency test is met. The content of the test is set out in § 4(1) CA 1993. There are two limbs to the test, and a company must satisfy both. First, the company must be able to pay its debts as they become due in the normal course of business. This aspect of solvency is frequently referred to as trading solvency. Secondly, the value of the company’s assets must be greater than the value of its liabilities including its contingent liabilities, i.e. the company must demonstrate balance sheet solvency. 301
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In the context of distributions to shareholders, the terms debts and liabilities as used in the formulation of the solvency test have particular meanings (§ 52(4) CA 1993). Debts include fixed preferential returns on shares which rank ahead of those shares in respect of which a distribution is made (§ 52(4)(a) CA 1993). This is designed to protect shareholders with fixed entitlements against prejudice through distributions to shares which rank after them. An exception is made where the constitution provides that the fixed preferential return is subject to the power of the directors to make distributions. This excludes the possibility that a fixed preferential dividend which is subject to the discretion of the board could be considered a contingent liability. Debts do not include debts arising by reason of the authorisation of the distribution itself. Liabilities include the amount which would be required, if the company were removed from the New Zealand register after the distribution, to repay all fixed preferential amounts payable by the company to shareholders at that time, or on earlier redemption (§ 52(4)(b) CA 1993). Again, this definition is subject to an exception where the constitution provides that the fixed preferential amounts are subject to the power of the directors to make distributions. Subject to § 52(4)(a) CA 1993, “liabilities” do not include dividends payable in the future. In determining the value of a contingent liability the directors may take account of the likelihood of the contingency occurring; and any claim the company is entitled to make and can reasonably expect to be met to reduce or extinguish the contingent liability (§ 4(4) CA 1993). aa) Trading solvency (cash flow solvency) test To satisfy the solvency test the company must be able to pay its debts as they become due in the normal course of business. The phrase “able to pay its debts as they become due” has to be interpreted in the way as revealed by case law concerning § 309 CA 1955, which contained an equal phrase. The jurisprudence established five requirements that have to be fulfilled: •
The ability to pay its debts must be fulfilled at the present time in consideration of the recent past, especially the company’s position in recent weeks
•
Outstanding debts have to be considered
•
The liabilities have to become due in the legal sense
•
Non-cash assets may be taken into account if there is a substantial element of immediacy about the ability to obtain cash from non-cash assts; debts which mature while non-cash assets are converted must be considered; and
•
The test of solvency is an objective one.
This includes in the case of a distribution, for example, fixed preferential dividends as to which the directors have no discretion. Before the due date the dividend is only a future debt, but nonetheless it is submitted that the company could not make a distribution where this would leave the company unable to pay the dividend when it falls due. On the other hand, the dividend before the due date is not a liability, because liabilities do not include dividends payable in the future. Where the dividend must still be declared or authorised by the board, it is neither a debt nor a liability until this occurs. 302
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§ 4 CA 1993 does not expressly require a company to use its own money to pay debts as they become due. That raises the issue of whether a director can consider support expected from another party, for example from a parent company. In literature discussions this possibility was rejected, whereas Australian jurisprudence (in cases dealing with applications for winding up) in general is well disposed to this idea. The New Zealand Courts have not had to discuss that problem yet. The other ambiguous element of the trading solvency test is the meaning of the phrase ”in the ordinary course of business”; that means the directors need not consider extraordinary or unusual circumstances, which would possibly found new debts. “The transaction must fall into place as part of the undistinguished common flow of business done, that it should form part of the ordinary course of business as carried on, calling for no remark and arising out of special or particular situation” (Down Distributing Company Ltd v Associated Blue Star Stores Ltd, (1948) 76 CLR, 463, 477; affirmed in Julius Harper Ltd v FW Hagedon & Sons Ltd, (1991) 1 NZLR, 530, 543). However, appropriateness of the cash flows is not unproblematic, because the directors have to consider future business development, which always contain incertitude. If the company is unable to accomplish the requirements of the trading solvency, it contravenes the solvency test. bb) Balance sheet solvency test bb1) Design of the balance sheet solvency test The directors are directed to two mandatory factors for the purposes of determining whether the value of a company’s assets is greater than the value of its liabilities. The directors must have regard to (§ 4(2)(a) CA 1993): •
the most recent financial statements of the company that comply with § 10 of the Financial Reporting Act 1993 (section 10 refers to entity accounts, i.e. not consolidated accounts); and • all other circumstances which the directors know or ought to know affect, or may affect, the value of the company’s assets and the value of its liabilities, including its contingent liabilities. In addition, the directors may rely on valuations of assets or estimates of liabilities that are reasonable in the circumstances (§ 4(2)(b) CA 1993). (Similar provisions apply specifically in relation to amalgamations pursuant to § 4(3) CA 1993.) Broadly, the test which the directors must satisfy in determining the value of assets over liabilities is one of acting reasonably. The directors will not act reasonably in relying upon the company’s most recent financial statements if there exist circumstances suggesting that those statements are not an accurate guide to valuation. The wording of § 4(2)(a)(ii) CA 1993 does not require the directors to have regard to adverse valuations which do not appear in the company’s most recent financial statements. That provision refers to circumstances which “affect, or may affect, the value of the company’s assets and the value of its liabilities”: a valuation does not affect the value of the property or liability which it values. Nonetheless, an adverse valuation will generally point to factors affecting valuation which the directors may not ignore. 303
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§ 4(2)(a)(ii) CA 1993 was amended on the third reading of the Bill to make it clear that the directors must have regard only to those factors affecting value of which they know or ought to know. The directors have to accomplish the following examinations: They have to analyse the financial statements for evaluating a possible adjustment of those. In the case of an adjustment the directors can fall back on an appropriate valuation. There are only three situations were a reference to the financial statements is not adequate: First, the solvency of the company is questionable (financial statements are prepared on a going concern basis); second, the financial statements are doubtful; or company assets/debts have to be included, which are not part of the financial statements. The valuation of assets and liabilities for the purpose of the balance sheet test can be difficult. Whether assets are valued as part of a business, as a going concern, or individually, at their liquidation value, markedly affects their value. In one case it is possible that the company passes the test whereas in the other case it does not. Not all companies’ financial statements are required to be audited (e.g. a New Zealand, nonIssuer, company where all the shareholders have unanimously agreed that they do not require an audit). Therefore, the accounts/numbers taken into account in determining whether the solvency test has been met might not be audited. However, where the company’s financial statements are subject to audit, the auditor will have to verify that the directors have complied with the requirements of the Companies Act with regard to distributions. There is no concrete guidance for auditors in New Zealand how to audit the solvency test; it is part of the general test of compliance with legislation (enquiry and inspection of records and resolutions/minutes of meetings). bb2) Accounting methods As mentioned above, when performing the balance sheet solvency test, directors must have regard to the most recent single financial statements of the company that comply with § 10 of the Financial Reporting Act 1993. Therefore, financial statements prepared under New Zealand GAAP are the basis for the test. New Zealand GAAP is already similar to the International Financial Reporting Standards (IFRS). From periods beginning on or after 1 January 2007 all companies will be preparing single and group financial statements under IFRS. In New Zealand, there are only minor modifications of the IFRS as approved by the International Accounting Standards Board (IASB). Those modifications mainly concern specific disclosure requirements. There are limited modifications for differential reporting entities with regard to measurement (essentially they are only exempted from including deferred taxes in their financial statements). Listed entities, however, cannot qualify for differential reporting. b) Solvency certificate The board of a company that is satisfied on reasonable grounds that the company will, immediately after the distribution, satisfy the solvency test may, subject to § 53 CA 1993 and the constitution of the company, authorise a distribution by the company at a time, and of an amount, and to any shareholders it thinks fit. The directors who vote in favour of a distribution must sign a certificate stating that, in their opinion, the company will, 304
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immediately after the distribution, satisfy the solvency test and the grounds for that opinion (§ 52(2) CA 1993). The certificate must be available for inspection by any shareholder of the company (§ 216(1)(c) CA 1993) c) Determination of time of distribution and application of restrictions It is not necessary for the solvency test to be satisfied at the time of authorisation, but at the time of distribution. During the interval between authorisation and making the distribution, the board may cease to be satisfied on reasonable grounds that the company will pass the solvency test immediately after the distribution, whereupon the distribution is deemed unauthorised and will incur the same consequences as an unauthorised distribution (§ 52(3) CA 1993). d) Shareholders’ liability for illegal distribution The company may recover a distribution made to a shareholder where immediately after the distribution the company does not satisfy the solvency test. However, a shareholder has a good defence to recovery if three conditions are met. These are: •
the shareholder received the distribution in good faith and without knowledge of the company’s failure to satisfy the solvency test
•
the shareholder has altered his or her position in reliance on the validity of the distribution, and
•
that it would be unfair to require repayment in full or at all.
e) Directors’ liability for illegal distributions A director may be personally liable to the company to make good any shortfall in a distribution which cannot be recovered from a shareholder (§ 56 CA 1993). A director will be personally liable in four circumstances. The first relates to procedural irregularity through failure to follow the procedure set out in law. A director who failed to take reasonable steps to ensure the requisite procedure was followed is personally liable to repay the company that amount of the distribution as is not recoverable from shareholders (§ 56(2)(a) CA 1993). Second, personal liability may follow where there were no reasonable grounds for believing that the company would satisfy the solvency test at the time of execution by the directors of the solvency certificate. A director who signed the certificate in those circumstances is personally liable to repay the company so much of the distribution as is not recoverable from shareholders (§ 56(2)(b) CA 1993). Third, § 56(3) CA 1993 deals with the situation where a distribution is deemed not to have been authorised because after authorisation the board ceased to be satisfied on reasonable grounds that the company would satisfy the solvency test at the time the distribution was made. In this case, a director who ceased so to be satisfied and who failed to take reasonable steps to prevent the distribution being made is personally liable to repay the company so much of the distribution as is not recoverable from shareholders. Fourth, under § 56(4) CA 1993 a discount paid to a shareholder is recoverable from a director who failed to take reasonable steps to prevent the discount being paid where the discount is deemed in terms of § 55(5) CA 1993 not to have been authorised. § 55(5) CA 1993 applies 305
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where the board ceased to be satisfied on reasonable grounds that the company would satisfy the solvency test. In some instances, a distribution of a lesser amount would not have caused the company to fail the solvency test. In an action against a shareholder or director in such a case, the court may in effect give the defendant “credit” for the amount which could legitimately have been distributed. Thus, a defendant shareholder may be permitted to retain an amount equal to the value of any distribution that could properly have been made (§ 56(5)(a) CA 1993) and a defendant director may be relieved from liability to the same extent: § 56(5)(b) CA 1993. § 56(5) CA 1993 creates a discretion. A court is not required to apply a strict arithmetical approach to the distribution: National Trade Manuals Ltd (in liq) v Watson (2006) 9 NZCLC 264,163. At common law a dividend improperly paid out of capital is recoverable from shareholders who knew or ought reasonably to have known of the impropriety of the payment: Hilton International Ltd (in liq) v Hilton (1988) 4 NZCLC 64,721 at p 64,754; [1989] 1 NZLR 442 at p 479. It is likely that the common law rule applies even where the company is not insolvent and there is no immediate prejudice to creditors in the payment of the dividend: cf Segenhoe Ltd v Atkins (1990) 8 ACLC 263. In this respect the common law rules (which are superseded by the 1993 Act) are more stringent and permit recovery where the Companies Act does not: recovery under the Act is dependent upon breach of the solvency test. § 56(2), (3) and (4) CA 1993 deal with recovery from a director where a dividend improperly paid under the Act cannot be recovered from a shareholder to whom it was paid. But this does not mean that a company can only recover compensation from a director for a dividend paid in breach the solvency test. A dividend can be paid without technically infringing the solvency test, for example, in circumstances where the solvency of the company is jeopardised by the payment. At common law, a director may be liable in negligence where a dividend payment merely jeopardises the solvency of the company without actually infringing the rule that dividends may not be paid out of capital: see Hilton International Ltd (in liq) at NZCLC p 64,750; NZLR p 475. Similarly, it is submitted that a director who authorises a dividend which jeopardises solvency, while not technically infringing the solvency test, does not act with the care, diligence and skill of a reasonable director as required by § 137 Companies Act 1993. 19. Determination of the distributable amount a) Decision of the board of directors The directors generally have discretion as to the amount to be distributed. The company might have a dividend policy in place, however, this normally only acts as a guideline / target for the directors. b)Disclosure Dividends paid and proposed are presented in the financial statements. Otherwise under the New Zealand law, there is no requirement for corporations to disclose the amount of dividends. The same applies with respect to the solvency certificate which must be available for inspection by any shareholder of the company (§ 216(1)(c) CA 1993), but does not have to be disclosed in the notes to the financial statements.
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20. Accounting reserves that influence the distributable amount Certain assets and liabilities (investment property, biological assets, derivatives, and share investments) are required to be measured at fair value and in some cases the entity has the choice to fair value assets (fixed assets). The movement in fair value might go to the income statement or be included directly in equity. However, there is no limitation on the amount that would be allowed to be distributed, provided the solvency test is met, i.e. there is no distinction between distributable and non-distributable reserves.
Section 4:
Capital related rules in case of crisis and insolvency
21. Trigger of insolvency a) Treatment of companies which are insolvent or in a crisis A company which is unable to pay its due debts is insolvent for the purposes of the Act. For determining insolvency the objective “test of insolvency” has to be executed. If a company passes the test of insolvency various avenues of approach exist for creditors or shareholders to protect themselves. These can broadly be described as follows and each avenue would have its own requirements to be followed by the third party acting as receiver, liquidator, trustee, etc. aa) Compromise The creditors of a company which is unable to pay its debts as they fall due may be induced to compromise their claims in the belief that by forgoing their full entitlement and therefore avoiding the liquidation of the company, they will recover more from the company as a going concern than as a company in liquidation. Compromise may be achieved by agreement between the company and some or all of its creditors. Lenders to the company, for example, may agree to postpone or partially forgo repayment of capital, waive interest, or take shares in the company in lieu of repayment of debt. Compromise by agreement binds only those creditors who have agreed to compromise, and there is nothing to prevent a creditor who is not a party to the compromise from applying for liquidation. bb) Receivership In the company law context, receivership may be seen as one of the remedies available to a creditor where a company is in financial difficulties. It enables secured creditors to protect their interests in the assets which constitute the security and, if necessary, to realise those assets in order to satisfy the debt owing to them. The remedy does not necessarily involve the liquidation of the company. In some cases, companies are able to survive as a result of the appointment of a receiver, and to continue trading when the receivership comes to an end. The function of the receiver depends on the terms of the instrument authorising appointment. It may be to take control of the assets charged, to collect income in respect of them, and to dispose of them, accounting for the proceeds. Where the receiver is also appointed as a manager, the business may be carried on by the receiver with the intention of restoring it to profitability if possible. Whether the receiver is able to be appointed as a receiver and manager will depend on the terms of the instrument authorising appointment. Under the Receiverships Act 1993, all receivers are empowered to manage the property in receivership unless there is a provision to the contrary: § 14(2). Where the instrument charging assets 307
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contains no powers authorising the appointment of a receiver, it is still possible to apply to the court for a receiver to be appointed, although this rarely happens. cc) Liquidation Liquidation is the process which the law provides for bringing a company to an end as a legal entity. Generally once a company is incorporated it has an independent existence which can be terminated only by liquidation. However, in certain situations a company may be removed from the register without first being placed in liquidation. The major purposes of liquidation are the collection and realisation of assets and out of the proceeds of such realisation, first, paying creditors in a fixed order of priority and, secondly, adjusting the rights of members inter se according to the constitution of the company, if it has one, or according to the Act. dd) test of insolvency The test of insolvency is an objective test. The belief or state of mind of the company is irrelevant. In each case it will be a question of fact to be determined by all the relevant circumstances: Sandell v Porter (1966) 115 CLR 666. The observations of Richardson J in Re Northridge Properties Ltd at p 26 remain relevant: "It is a matter of striking a balance. On the one hand the test is not one of measuring assets against liabilities. It is not whether if given sufficient time, assets could be realised and existing debts and accruing debts paid. On the other, the section is concerned with solvency, not with liquidity.” As it was put in Sandell v Porter (1966) 115 CLR 666 per Barwick CJ at p 670: 'But the debtor's own moneys are not limited to his cash resources immediately available. They extend to moneys which he can procure by realisation by sale or by mortgage or pledge of his assets within a relatively short time — relative to the nature and amounts of the debts and to the circumstances, including the nature of the business, of the debtor. The conclusion of insolvency ought to be clear from a consideration of the debtor's financial position in its entirety and generally speaking ought not to be drawn simply from evidence of a temporary lack of liquidity. It is the debtor's inability, utilising such cash resources as he has or can command through use of his assets, to meet his debts as they fall due which indicates insolvency.' " Consideration may normally be taken of money that the company is able to borrow: Re Armour; Official Receiver v Commonwealth Trading Bank of Australia (1956) 18 ABC 69, though this depends on the nature of the company's business; Re Australian Co-operative Development Society Ltd (1977–1978). The liquidator in some cases may be able to rely on the company's own records to establish insolvency: Re Action Waste Collections Pty Ltd (in liq), Crawford v O'Brien (1981) 5 ACLR 673. b) Time frame for the board There is no requirement that a board of directors conduct a solvency analysis. But anyone, including the company, directors and creditors could apply to the Courts for the appointment of a liquidator. c) Subordination of claims Where the assets of a company in liquidation are insufficient to satisfy all proper claims, the question arises as to the order in which creditors should be paid.
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Claims fall into three categories: secured, preferential and ordinary. Preferential claims which must be paid by the liquidator out of the assets of the company are listed and defined in Schedule 7. After paying the claims referred to before, the liquidator must distribute the company's surplus assets— (a) In accordance with the provisions contained in the company's constitution; or (b) If the company's constitution does not contain provisions for the distribution of surplus assets or, if the company does not have a constitution, in accordance with this Act. Shareholders’ loans would either rank with unsecured claims or would be subordinated and therefore rank just ahead of share capital. This would generally mean repayment of shares would be the last item to consider (shareholders last principle).
Section 5:
Contractual self protection of creditors
22. Contractual self protection In New Zealand contractually negotiated self protection such as the limitation on payment of dividends would only generally be incorporated where a large amount of finance is provided or where another class of shares are issued that rank behind other creditors. Normal trade terms would apply for smaller creditors.
Section 6:
Equal treatment
23. Principle of Equal treatment a) Principle of equal treatment Generally shares of a class carry the same rights and benefits. However different classes of shares could have different rights and benefits attached. Subject to the constitution, a share in a company generally confers on the holder the right to one vote on a poll at a meeting of the company on any resolution, including any resolution to appoint or remove a director or auditor, adopt a constitution, alter the company's constitution, if it has one, approve a major transaction, approve an amalgamation of the company, put the company into liquidation, the right to an equal share in dividends authorised by the board and the right to an equal share in the distribution of the surplus assets of the company. b) Pre-emption right New Zealand law provides, subject to the constitution, that shares issued or proposed to be issued by a company that rank as to voting or distribution rights, equally with or prior to shares already issued by the company must be offered for acquisition to the holders of the shares already issued in a manner and on terms that would, if accepted, maintain the existing voting or distribution rights of those holders. e) Right to attend the shareholders’ meeting Nothing in New Zealand law hinders a shareholder’s right to attend a shareholders’ meeting.
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4 4.1
Private companies France
Private Limited Liability Companies The French private limited liability company is the “Société à responsabilité limitée (SARL)”.
Sub-section 1:
Capital formation – injection of contributions
1. Minimum capital and other means of equity financing a) Minimum subscribed capital Under French law, since the Act 2003-721 of August 1, 2003, private limited companies (SARL) are no longer obliged to have a minimum share capital of €7,500. On the contrary, it is sufficient that the amount of the share capital is determined in the company’s statutes pursuant to Article L. 223-2, al.1, of the French Commercial Code (= CCOM). Accordingly, the share capital of such companies can be symbolic, e.g., even one Euro. It is, however, impossible to create an SARL with no share capital. Even though the share capital is symbolic, the founders must pay attention to the fact that all the shares constituting the share capital must be equal. b) Other forms of equity financing Under French law, it is possible to inject capital by premiums even during the formation of the company. The premium, in accordance with Article 441/10 of the Plan Comptable Général (general accounting plan), is credited to account number 104 entitled « Primes liées au capital social » (i.e. premiums linked to the share capital) (subdivision 1041 « Primes d'émission ») (i.e. issue premiums). The first losses can be offset against the premiums, which enables the avoidance of the provisions dealing with the recapitalisation of the company, as the share capital will not, if there are sufficient premiums, fall to less than one half of the net equity. c) Authorised Capital Under French law, in general, authorised capital or registered capital is not provided for with respect to SARL’s. However, authorised capital is a notion that can be found with respect to SARL’s with variable capital. In this case, the SARL must be constituted with a variable capital. The share capital of these companies can be increased or reduced at any time (Articles L.231-1 to L.231-8 CCOM). The stipulation providing the variability of the share capital must be included in the statutes either from the formation of the company or during the company’s corporate life. In considering companies with variable capital, the following concepts must be understood: (i) Subscribed capital (“capital souscrit”): represents the shareholders’ contribution commitments. It is the capital which during the company’s life will vary depending on the shareholders’ arrival and departure. The subscribed capital cannot be higher than the authorised capital or lower than the minimum capital.
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(ii) The minimum capital (“capital plancher”): must be determined in the statutes. It represents the limit below which the subscribed capital must never go. It cannot be lower than one tenth of the original subscribed capital (Article L. 231-5 CCOM). (iii) The authorised capital (“capital autorisé”): is the upper limit above which an increase in the subscribed capital can be carried out only in accordance with the ordinary rules, i.e., meaning an extraordinary general meeting that amends the company’s statutes. (iv) The paid-up capital (“capital libéré”): is the capital which has actually been paidup by the shareholders. It can be lower than the minimum capital during the company’s first five years but cannot be higher than the subscribed capital. The subscribed capital can vary without restriction within the limits determined by the minimum capital and the authorised capital, either through the shareholders’ buyback of their contributions or through the increase in the payments made by the shareholders or the acceptance of new shareholders. When the subscribed capital reaches the authorised capital, an extraordinary general meeting must be held in order to amend the statutes and to increase the authorised capital. If the shareholders’ withdrawals are so significant that the subscribed capital is equal to the minimum capital, however, an extraordinary general meeting must be held in order to reduce the minimum capital. d) Information to be made public French law requires that the subscription and the full payment of the shares must be included in the statutes in accordance with Article 22 al. 2 of the March 23, 1967 Decree. The statutes are filed with the Commercial Court and anyone can obtain a copy of them on request. Furthermore, the official excerpt from the companies and trade registry includes the indication of the share capital; such document can be obtained by anyone. Finally, in accordance with Article L.233-1 of the French Commercial Code and Article 28 of the March 23, 1967 Decree, the share capital must be indicated in any document issued by the company and intended for third parties, such as letters, invoices, publications etc. 2.
Subscription of shares/nominal value
Under French law, all the shares must be subscribed by the shareholders. A minimum nominal value is no longer required since Act No. 94-126 of February 11, 1994. This nominal value is now determined by the shareholders without restriction. When the nominal value of the shares is not indicated in the statutes, they merely represent a portion of the share capital (the par) which is obtained by dividing the share capital by the number of shares. 3.
Injection of contributions
a) Contributions in cash and in kind The French legislator allows both contributions in cash and in kind. In kind contributions are any contributions that are not in cash. Any tangible or intangible goods or buildings that can be valued and of which the property or holding may be transferred, can be contributed to a company. Only a business that can be commercially operated can be contributed to a commercial company, however, which excludes ministerial offices “office ministériel”. Contributions of professional businesses or of services are not in kind contribution; they are industrial contributions.
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Contributions to a SARL must represent a value that can be used as security for the creditors. Accordingly, services provided during the formation of the company are not contributions. b) Paying-up of the contribution French law differentiates between contributions in kind and in cash. Contributions in kind must be completely paid-up. At least one fifth of the amount of the shares representing cash contributions must be paid-up. They must be completely paid-up within five years from the incorporation of the company with the companies and trade registry (Article L. 223-7 al.1 CCOM). The indication that the shares have been subscribed and paid-up must be included in the statutes. In accordance with Article L. 223-7, al. 1 of the French Commercial Code, contributions made when the company is created must be at the company’s disposal when the statutes are signed. In this context, it should be noted that if a contribution is not paid-up by a shareholder, the company may not be annulled. A SARL’s shareholder who omits to declare the allocation of the shares to the shareholders, the payment in full of the shares or the deposit of the funds may be sentenced to up to six months in prison and/or a fine of €9,000. c) Valuation of contributions in kind In France, the statutes include the valuation of each in kind contribution, this is provided in a report appended to the statutes under the liability of an appraiser appointed by either the future shareholders unanimously or a court decision. The future shareholders can decide, however, that the appointment of an in kind appraiser is not necessary when the value of none of the in kind contributions is higher than €7,500 and if the overall value of all the in kind contributions is not higher than one half of the share capital (refer to Article L. 223-9, al.1 to 3 CCOM). When there is no in kind appraiser or when the retained value is different from that proposed by the in kind appraiser, the shareholders are, for five years, jointly liable to third parties for the value granted to the in kind contributions at the moment of the company’s formation (Article L.223-9, al.4 CCOM). 4. Capital increases a) Resolution Under French law, only the shareholders can decide to increase the share capital. The majority conditions for this decision depend on the conditions of the capital increase. When the increase in capital is in cash or through in kind contributions, the majority required is that required for amendments to the statutes, i.e. a majority of the shareholders representing at least three fourths of the shares is needed. As all the shares must be equal, if the decision to increase the capital is made by increasing the shares’ nominal value, consequently it increases the shareholders’ commitments and accordingly it must be approved by all the shareholders. In case of an increase in capital without any payment by the shareholders – the capital increase is paid by money which is already recorded in the company's accounts - by incorporation of the reserves or of the profits, no special majority to amend the statutes is specified. It must be noted that when the new shares are subscribed by persons who are not already shareholders of the company, these persons must be agreed as new shareholders by the other shareholders, under the same conditions as for a share purchase. New shares are issued at the nominal value mentioned in the statutes. However, if the nominal value of the shares is lower than their accounting value, an issue premium can be required. This premium represents the difference between the issue price and the nominal value of the 312
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shares allocated to the shareholders. The amount of the premium must be justified by the company’s situation. b) Pre-emption rights French law does not provide for the concept of pre-emption rights. However, the statutes of a SARL can provide for such a right or the shareholders can decide that for a specific capital increase such a right be provided for. 5.
Subsequent formation
In France, the acquisition by the company of an asset which is owned by a founder/ shareholder is regulated by the provisions related to in kind contributions in case of an acquisition paid for by the issue of shares (either during the company’s formation or later, in case of capital increases) please refer to question No. 3. In case of an acquisition by the company of an asset which is owned by a shareholder, such acquisition is considered as a regulated agreement, unless the acquisition can be considered as a common agreement entered into under normal conditions. If that is not the case, the procedure provided by Article L.223-19 of the French Commercial Code, must be followed: the manager of the company must inform the company’s statutory auditor (if there is one) of the regulated agreements entered into a month after their execution at the latest, the manager or the statutory auditor (if there is one) must draft a report on these agreements that includes, among other things, the list of the regulated agreements, the identity of the interested shareholders, the purpose of any such agreement and the main conditions of any such agreement, the presentation of the above report to the general meeting: all the shareholders, except the interested shareholder, must approve the executed regulated agreements, and the shares of the interested shareholder are not taken into account to establish the quorum and the majority. If the regulated agreement is not approved by the shareholders, the sole consequence is that any harmful consequences of the agreement will be the shareholder’s liability; on the other hand, the company cannot be liable. If the above procedure is not complied with, the consequence is the same as if the agreement was not approved by the shareholders.
Sub-section 2: Capital maintenance 6.
Fraudulent distributions
A company’s share capital constitutes the security for its creditors. It cannot, therefore, be distributed to shareholders. If capital is paid back to a shareholder in violation of the rules, French law does not provide for any specific sanctions. However, managers can be liable under the general rules of civil law. If the amount of share capital appears to be too high in relation to the company’s business needs, a capital reduction can be carried out, either through a repurchase of shares or a reduction of their nominal value. In such a case, the repurchase price, or the portion corresponding to the reduction in the shares’ nominal value, is paid out to the shareholders. But such operations are subject to a strict procedure which involves, in particular, giving the company’s creditors the possibility to object to this capital reduction during the 30 days following the general meeting decision on the said capital reduction. If the
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company has a statutory auditor, he must, in particular, draw up a report on the causes and conditions of the capital reduction. 7.
Acquisition by the company of its own shares
Under French law, a commercial company cannot hold its own shares (Cf. Article 223-34, § 4 CCOM which provides that “companies are forbidden to purchase their own shares”). However, if a shareholder wishes to withdraw from the company, aside from the possibility of selling his shares to co-shareholders or to a third party, it may also be possible for the company to repurchase his shares. In this case, the company must then carry out a capital reduction by cancelling the repurchased shares (cf. the above-described procedure). 8.
Financial Assistance
In France, in respect of financial assistance the same principles which apply to public companies are applicable. For details please refer to question 12. 9.
Loans from shareholders
In France, in respect of loans from shareholders the same principles which apply to public companies are applicable. For details please refer to question 13. 10.
Capital reduction
Under French law, Article 223-34 of the Commercial Code provides for the conditions and means by which a SARL’s capital may be reduced. The reduction must be authorised by the general meeting. If the company has a statutory auditor, the capital reduction plan must be submitted to him at least 45 days before the scheduled date of the general meeting. The statutory auditor then drafts a report in which he states his assessment of the causes and terms of the capital reduction. In cases where the capital reduction is not justified by losses, the company’s creditors may then object to the capital reduction during a 30 day period, which starts from the date on which the minutes of the general meeting deciding on the capital reduction are filed with the Commercial Court. Capital reduction operations (i.e., distributions to shareholders) cannot begin until the end of this 30 day period. 11.
Redemption of subscribed capital
French law does not provide for the possibility for SARL’s to repay subscribed capital, whereas it does provide for this possibility for Sociétés Anonymes (cf. question No. 15 in this respect). Accordingly, in the absence of any legal basis, it is not possible, in our opinion, for SARLs to carry out such operations.
12.
Compulsory withdrawal of shares
Under French law on limited liabilities companies, the compulsory withdrawal of shares is possible. The company’s statutes can authorize a compulsory repurchase of a shareholder’s shares. Such statutes must also precisely set forth the conditions of the repurchase (procedure to be followed, reasons for the repurchase, competent body). If not agreed between the parties, the repurchase price must be determined by an expert appraiser.
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A court judgement of September 26, 1989, by the Orléans Court of Appeals, holds that the extraordinary general meeting of a SARL may validly decide, in accordance with its statutes, to oust a shareholder who had committed serious violations by not following various provisions of the statutes. Case law has also confirmed the validity of clauses that provide for a compulsory sale of shares held by a company in the event that said company were to fall under the control of a third party who is not approved by the other shareholders (Cass. Com. 13-12-1994). 13.
Redeemable shares
French law on private limited companies does not provide for the possibility of redeemable shares (compare question 17).
Sub-Section 3: Distribution 14.
Definition of distribution
According to Article L. 232-11 of the French Commercial Code, distributable profits include the profit of the current financial year, reduced by previous losses and sums recorded in the legal or statutory reserves, and increased by any profits carried forward ("report à nouveau"). 15.
Distributable amount
Under French law on private limited companies, various distribution procedures exist. a) Distributions of dividends (§ 1 of Article L.232-11 CCOM): The distributable profit available to pay a dividend includes the profit of the current financial year, reduced by previous losses and sums recorded in the legal or statutory reserves, and increased by any profits carried forward ("report à nouveau"). b) Exceptional distributions of reserves (§ 2 of Article L.232-11 CCOM): The reserves that may legally be distributed are (a) the part of the legal reserve that exceeds 10% of the amount of share capital, (b) contractual reserves and (c) reserves provided by the statutes. c) Payments of interim dividends (§ 2 of Article L.232-12 CCOM): The distribution of an interim dividend is subject to the preparation of interim financial statements that show a net profit after (a) the recording of depreciation and provisions and (b) the deduction of any prior losses and sums entered in reserves. Any net profit may be distributed. Any dividend distribution/interim dividend distribution decided on in breach of the rules provided by Article L.232-11/L.232-12 of the French Commercial Code constitutes a “false dividend distribution” that is subject to (i) specific penalties, i.e., a five-year prison term and a €375,000 fine (Paragraph 1 of Article L.242-6) and (ii) civil damages. 16.
Process of distribution
Each distribution procedure requires different steps:
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a) Dividend distribution: • Preparation of the Annual Financial Statements (AFS), • Certification of the AFS by the company’s statutory auditor (if the company has a statutory auditor), • Management report, annual general meeting: approval of the AFS and the dividend distribution, • Payment of the dividend within a maximum of 9 months after the closing of the FY. b) Exceptional distribution of reserves: • Management report, • General meeting deciding on the distribution of reserves, • Payment of the distribution. c) Distribution of an interim dividend: • Preparation of an interim balance sheet closed at a date near that on which the decision to distribute is made. • that interim balance sheet must be certified by the company’s statutory auditor (if the company has a statutory auditor), • the manager decides on the distribution, • the interim dividend is paid. Sub-section 4:
Crisis and Insolvency
17. Serious loss of subscribed capital In France, with respect to a serious loss of subscribed capital, the same principles which apply to public companies are applicable. For details please refer to question 22. 18.
Trigger of insolvency
In France, with respect to the trigger of insolvency, the same principles which apply to public companies are applicable. For details please refer to question 23.
Sub-section 5: Equal treatment 19.
Equal treatment
Under French law, the principle of equal treatment is applicable with respect to the shareholders of limited liability companies. The same principles apply as with respect to the pubic company. For details please refer to question 25.
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4.2 Germany Private Limited Liability Companies The German private limited company is referred to as the "Gesellschaft mit beschränkter Haftung (GmbH)".
Sub-section 1:
Capital formation – injection of contributions
1. Minimum capital and other means of equity financing a) Minimum subscribed capital Under German law, private limited companies are currently required to have a minimum subscribed capital of 25,000 Euro (§ 5 (1) GmbHG), although the founders are entitled to freely fix a higher capital amount in the statutes (§ 3 (1) No. 3 GmbHG). The German legislator, in May 2007, presented a bill to reform the limited liability company. In this bill (Gesetz zur Modernisierung des GmbH-Rechts und zur Bekämpfung von Missbräuchen – MoMiG), a minimum subscribed capital of 10,000 Euro is provided for. Furthermore, the bill introduces a new form of limited liability company, the Unternehmergesellschaft (UG). This form of limited liability company requires a subscribed capital of 1 Euro (§ 5a of the draft bill) and has to establish a legal reserve of 25% of the profits every year. b) Other forms of equity financing Under German law, it is permitted to oblige founders to inject additional amounts (premiums). Under the German Commercial Code, premiums are to be placed into the capital reserve (§ 266 (3) A No. 11 HGB). c) Authorised capital German law on limited liabilities companies does not provide for authorised capital. d) Information to be made public German law requires that the amount of the subscribed capital must be fixed in the statutes (§ 3 (1) No. 3 GmbHG) and be made public via the commercial register (§ 10 GmbHG). Premiums and other kinds of equity financing need not be made public in this manner, if they are not part of the statutes. 2. Subscription of shares / nominal value Under German law, the sum of the contributions must be equal to the subscribed capital (§ 5 (3) s. 3 GmbHG). Up to now, each shareholder can only acquire one shareholding at the stage of the formation of the company (§ 5 (1) GmbHG). The minimum contribution is €100; the amount of the original contribution must be divisible by 50 (§ 5 (3) s. 2 GmbHG). The amounts of the original contributions can vary as between the shareholders (§ 50 (3) s. 1 GmbHG). The amount of the original contribution constitutes the contribution obligation of the shareholder concerned. Analogue to § 9 (1) AktG, the principle applies that the shares must not be issued at a price lower than the nominal value. 317
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The new bill mentioned above provides that every shareholder can subscribe for more than one share. 3. Injection of contributions a) Contributions in cash and in kind The German legislator allows both contributions in cash and in kind. Where the subscribed capital is contributed in kind, it must be provided for in the statutes (§ 5 (4) GmbHG). Analogue to § 27 (2) AktG all assets capable of economic assessment can be contributed (see Section 1, No. 3 a) bb)). b) Paying in of the contribution German law differentiates between contributions in cash and contributions in kind. 25% of the original contribution must be paid-up before registration of the company is applied for (§ 7 (2) s. 1 GmbHG). In contrast to this, non-cash contributions must be made available completely to the company before the registration of the company is requested (§ 7 (3) GmbHG). Furthermore, it should be noted that it is necessary for the registration of the company that at least half of the minimum subscribed capital has been paid in (§ 7 (2) s. 2 GmbHG). d) Valuation of contributions in kind German law does not prescribe a valuation of contributions in kind by an expert. However, the founders are required to draw up a report on contributions in kind (Sachgründungsbericht) in which they have to describe the main circumstances with respect to the adequacy of any contribution in kind (§ 5 (4) s. 2 GmbHG). The register court, on the basis of the document, examines whether the company was duly formed. If this is not the case, the register court can refuse the registration of the company. The same applies if contributions in kind have been over-valued. 4. Capital increases a) Resolution For an increase in capital, German law requires a resolution by shareholders with a qualified majority of ¾ths of the votes cast (§ 53 (2) GmbHG). Furthermore, the acceptance declaration of each accepting shareholder has to be notarised (§ 55 (1) GmbHG). On the contrary, German law on private limited companies does not contain provisions on authorized capital in the context of capital increases. b) Pre-emption rights The provisions of German law do not expressly provide for the concept of pre-emption rights. According to § 55 (2) GmbHG, a simple majority of the shareholders can decide who should be authorized to subscribe the increased capital. However, it is recognized that the principle of equal treatment applies with respect to the allocation of shares to shareholders and that the minority must be protected against an allocation of shares to third parties. According to the leading opinion, the character of the relationship and the necessity to protect it argue for the acceptance of pre-emption rights with respect to private limited companies also (BGH 71, 40 Kali & Salz). Furthermore, it should be noted that it is possible to stipulate pre-emption rights in the statutes.
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5. Subsequent formation German law on private limited companies does not provide for rules on subsequent formation.
Sub-section 2: Capital maintenance 6. Fraudulent distributions German law prescribes that the subscribed capital may not be paid back to shareholders (§ 30 (1) GmbHG). In cases in which the principle that the subscribed capital is not to be paid out to shareholders has been infringed, § 31 GmbHG provides that these payments have to be returned to the company (§ 31 (1) GmbHG). If the shareholder was in good faith, the return of the payment can only be demanded if it is necessary to satisfy the creditors of the company (§ 31(2) GmbHG). Furthermore, the shareholders are liable for the payment if the return of the payment is necessary to satisfy the creditors of the company and if it cannot be obtained from the recipient (§ 31 (3) GmbHG). Beyond this, the management can be liable vis-à-vis the shareholders if the shareholders are liable according to § 31 (3) GmbHG. 7. Acquisition of own shares German law allows the acquisition of their own shares by private limited companies under certain conditions which are linked to the protection of the company’s capital. Whereas an acquisition by the company of its own shares is not allowed with respect to shares which are not fully paid up, an acquisition of such fully paid up shares is possible if the acquisition will not affect the company’s subscribed capital (§ 30 (1) GmbHG). Furthermore, if the company’s own shares are included on the asset side of the balance sheet, the limited liability company has to set up a reserve of the same amount on the liabilities side of the balance sheet (§ 33 (2) GmbHG, § 272 (4) HGB). 8. Financial Assistance The German law on private limited companies does not contain a prohibition of financial assistance. 9. Loans from shareholders Up to now, the jurisprudence classifies loans from shareholders granted in a financial crisis as share capital if the amount of the loan covers losses of the subscribed capital or an amount exceeding these losses (BGHZ 90, 381, 385 et seq.; BGH NZG 2005, 712, 713). In the case of insolvency, these loans are classified in full as subordinated claims. In both cases, shareholders other than the company’s managing director and those holding 10% or less in the subscribed capital, are not affected by this provision. Under the bill referred to above, loans granted by a shareholder to a limited liability company are subordinated after insolvency is triggered unless the shareholder is not managing director of the company and holds 10% or less of the subscribed capital (§ 39 (1) No. 5 InsO). Furthermore, if such a shareholder loan was repaid by the company in the year before the insolvency application was made, the company’s repayment of the loan can be challenged (§ 135 (1) InsO, § 6 AnfG).
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10. Capital decrease The German law on private limited companies provides for two kinds of capital reductions: the ordinary capital reduction and the simplified capital reduction. a) Ordinary capital decrease An ordinary reduction in capital is subject to a shareholders’ resolution (§ 58 (1) No. 1 GmbHG). The resolution to reduce the capital which leads to an amendment of the statutes must be passed by a majority of ¾ths of the votes cast (§ 53 (2) GmbHG). Furthermore, the resolution must be notarized. The resolution on the capital reduction must be made public three times at different times in the Joint Electronic Register Portal of the Federal States. This public announcement must be connected with the demand to the creditors of the company to contact the company. Known creditors must be contacted directly (§ 58 (1) No. 2 GmbHG). Creditors who have contacted the company and declared that they are not willing to accept the capital reduction must be satisfied or must be provided with security for their claims. The right of the creditors to object to the capital reduction must be pointed out in this announcement. To those creditors who have accepted the capital reduction, only the reduced subscribed capital is liable for their claims. The registration of the capital reduction in the commercial register cannot take place until one year after the third announcement of the capital reduction in the Joint Electronic Register Portal of the Federal States. In the course of registration, the directors must affirm that the three announcements have been published and that objecting creditors have been paid or been provided with security. The capital reduction has to be registered in the commercial register (§ 54 GmbHG). b) Simplified procedure The simplified capital reduction allows limited liability companies to waive the safeguards for creditors otherwise to be observed in the context of an ordinary capital reduction where the capital reduction serves to offset losses (§ 58a (1) GmbHG). The capital reduction may only be carried out if it is necessary to establish sound conditions, that is if the part of the capital and profit reserves, which together exceeds 10% of the reduced subscribed capital have already been dissolved (§ 58a (2) GmbHG). Furthermore, a shareholders’ resolution which authorizes the capital reduction is required; the resolution requires a qualified majority of ¾ths of the votes cast. The capital reduction has to be registered in the commercial register (§ 54 GmbHG). 11. Redemption of subscribed capital The German law on private limited companies does not provide for the redemption of subscribed capital without reducing the latter. 12. Compulsory withdrawal of shares Under German law on limited liabilities companies, the compulsory withdrawal of shares is, in principle, possible. According to § 34 GmbHG, such a withdrawal is subject to the following conditions: the withdrawal must be allowed by the statutes with adequate certainty; a shareholders’ resolution was passed with a simple majority of the votes cast; only fully paid
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up shares are concerned in the withdrawal and the subscribed capital is not affected by the compensation the shareholder receives because of the withdrawal. 13. Redeemable shares The German law on private limited companies does not provide for the possibility of redeemable shares.
Sub-Section 3: Distribution 14. Definition of distribution German law on private companies does not contain an express definition of the term “distribution". 15. Distributable amount: In Germany, shareholders of limited liability companies are generally allowed to distribute the annual net profits (“Jahresüberschuss”) as shown in the annual financial statements (§ 29(1) s. 1 GmbHG). If applicable, the distributable net profits have to be adjusted by profit brought forward (which are added to net profits) and losses carried forward (which are subtracted). In addition, there might be certain amounts which are excluded from a distribution due to legal provisions, the statutes or a resolution of the shareholders. In case the annual accounts provide for a part profit distribution (e.g. a certain percentage of net profits has already been added to the retained earnings because the statutes so provide) or reserves have been liquidated, the shareholders are allowed to distribute the balance sheet profit (“Bilanzgewinn”) (§ 29(1) s. 2 GmbHG). The basis for net profits or balance sheet profit are the financial statements prepared in conformity with German GAAP. The annual accounts of companies, which are not small companies, must be audited (§ 316(1) HGB). According to § 267(1) HGB, a company is small if it does not exceed more than one of the following three criteria: (1) total assets of EUR 4,015,000; (2) sales of EUR 8,030,000; (3) 50 employees. According to § 46 GmbHG, the approval of the annual accounts as well as the distribution of the annual result require a shareholders’ resolution. A simple majority of the votes is needed for both resolutions. According to § 29 (3) GmbHG, the distribution of the annual result follows the ratio of the shares held by the shareholders. Decisive is the nominal value of the shares. However, the statutes can offer a different allocation basis. If parts of the protected subscribed capital (§ 30 (1) GmbHG) have been distributed, the payments have to be reimbursed to the company (§ 31 (1) GmbHG). If the shareholder acted in good faith, the return of the payment can only be demanded if it is necessary to satisfy the creditors (see No. 31). Furthermore, the resolution on the distribution can be challenged by shareholders analogously to § 243 AktG, for example when the fiduciary duty has been violated by the resolution of the shareholders. 16. Process of distribution The German law on limited liability companies prescribes that the general meeting decides by simple majority upon the allocation of the profit (§ 46 No. 1 GmbHG). In this respect, the 321
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general meeting is bound by the balance sheet profit shown in the annual accounts as they have previously been adopted by it (§ 46 No. 1 GmbHG). Pursuant to § 42a(2) GmbH, both approval of the annual accounts and the decision on the allocation of the profit must be taken within the first eight months of the following accounting year; small companies in terms of § 267(1) HGB have to do this within eleven months.
Sub-section 4: Crisis and Insolvency 17. Serious loss of subscribed capital German law prescribes that the management has to immediately call a general meeting if it follows from the annual accounts or interim financial statements that there is a loss of half of the subscribed capital (§ 49 (3) GmbHG. 18. Trigger of insolvency In Germany, three factors trigger the insolvency of a limited liability company: its inability to pay its debts (§ 17 (1) InsO), its impending inability to pay its debts (§ 18 InsO) and overindebtedness (§ 19 InsO). The same principles apply as to the public limited company (for details see Section 4, No. 23).
Sub-section 5: Equal treatment 19. Equal treatment Under German law, the principle of equal treatment is applicable with respect to the shareholders of limited liability companies. The same principles apply as to the stock corporation (see Section 6, No. 25).
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4.3 Poland Private Limited Liability Companies The Polish legal title for a private limited company is ”spółka z ograniczoną odpowiedzialnością (Sp. z o. o.)”.
Sub-section 1:
Capital formation – injection of contributions
1. Minimum Capital and other means of equity financing a) Minimum subscribed capital Under Polish law, private limited companies are currently required to have a minimum subscribed capital of 50,000 PLN (about 13,157 Euro, Art. 154 of the Commercial Companies Code = CCC). There are no restrictions on the founders providing for a higher amount of subscribed capital during the formation of the company, by amendments to the company’s statutes or without such amendment within the threshold set out in the statutes. b) Other forms of equity financing Under Polish law, shareholders (or founders during the incorporation of the company) may decide to take up shares at a premium above their nominal value. The additional amount above the nominal value is transferred to the capital reserve it is permitted to oblige founders to inject additional amounts (premiums). If the shares are taken up at their premium value the amount which is above the nominal value must be transferred to the capital reserve (Art. 154 §3 CCC). c) Authorised Capital Under Polish law on limited liability companies, it is possible to include in the statutes an authorisation allowing shareholders to increase the capital within a set limit without amending the company’s statutes. See section 4. Capital increases for details (Art. 257 CCC). d) Information to be made public Polish law requires that the information dealing with the incorporation of the company and subsequent changes in its functioning (including the information concerning its capital) are subject to the obligation of registration in the national register court and publication in the official gazette. Information from the national register court is available to the general public. Additional resolutions concerning the modification of capital must be registered and published. 2. Subscription of shares / nominal value Under Polish law, the sum of the contributions must be at least equal to the subscribed capital. With respect to increases in share capital, the present shareholders have priority to subscribe for the new shares in proportion to their existing shares. The company’s statutes or shareholders' resolutions may provide otherwise. The present shareholders should exercise their pre-emption right within 1 month from the moment they are called upon to do so. As a rule, the declaration of subscription for shares should be a notarial deed (Art. 258 CCC). The company may not, with certain exceptions, itself subscribe for the shares (Art. 200 CCC). 323
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The nominal value of any share may not be lower than 50 PLN. The shares may not be subscribed below their nominal value. If the shares are taken up at their premium value, the amount which is above the nominal value must be transferred to the capital reserve (Art. 154 §3 CCC). 3. Injection of contributions a) Contributions in cash and in kind The Polish legislator allows contributions in cash and in kind. However, the Commercial Companies Code states that untransferable rights, work and services are not capable of becoming contributions for share capital of private limited liability companies or public limited liability companies (14 § 1 CCC). Services rendered in course of the incorporation of the company do not qualify to constitute a contribution for the subscribed share capital. b) Paying in of the contribution Polish law requires that the shares and the premiums must be fully paid before the registration of the company. c) Valuation of contributions in kind Polish law (the Commercial Companies Code) does not provide for an obligation to perform an evaluation of contributions in kind by an independent expert. As a general rule, in kind contributions must be equal to the par value or above. The management board is obliged to submit a written declaration that the shareholders have fulfilled their obligation concerning the contribution. A submission of a false declaration is considered to be an offence penalised by criminal law (Art. 587 CCC). The shareholders and the members of the management board are liable to the company for damages caused to the company if in kind contributions are not of the declared value (Art. 292 CCC). In such a situation, members of the management board may be held liable jointly and severally together with the company to the creditors of the company (Art. 291 CCC). The shareholder whose contribution did not have the value as claimed (or no value) is obliged to pay the company the difference between the value declared in the statutes and the sale value of the asset in question plus interest (Art. 14 § 2 CCC). The statutes may provide for other sanctions for the case in question (Art. 14 § 2 CCC). 4. Capital increases a) Resolution Capital increases in a private limited liability company may take place either by: i) shareholders' resolution amending the company’ statutes by the increase of the company’s share capital. This is the basic but most formalised way of increasing the share capital since it must be notarized and adopted with at least a 2/3rds majority of the votes. If the capital increase occurs before the registration of the company in the national register a unanimous vote is required. ii) ordinary shareholders’ resolution. The company’s statutes may provide the highest allowable amount of share capital increase and a set time limit for making that increase by an ordinary shareholders' resolution - without the need to amend the 324
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statutes by a notary deed. There is no requirement to notarize the resolution on the increase of subscribed capital adopted in accordance with the provisions of the company’s statutes. In either case, the capital increase may take place by issuing new shares or by increasing the nominal value of shares. A capital increase by resolution amending the company’s statutes, may be either for cash or in kind contributions or by capitalisation of reserves. Shares issued on the basis of capitalisation of reserves are attributable to shareholders in proportion to their existing shares and they need not be taken up. b) Pre-emption rights Under Polish law, if the statutes or the resolution adopted in order to increase the capital do not provide otherwise, the current shareholders are granted pre-emption rights in proportion to the shares held. The management board is obliged to send notifications about this right to all shareholders at the same moment. The pre-emption right must be exercised within a month from the day of sending the notification by the board. Any shareholder’s declaration exercising new shares requires the form of a notary deed (Art. 258 CCC). This form is not required if the capital increase takes place by a capitalisation of reserves. Similarly if the capital increase takes place as a consequence of an “informal” decision (without amending the statutes) the declaration on subscription for new shares requires only a written form (jurisprudence notices that in such case current shareholders have already given their consent in a form of a notary act during the formation of the company or amending of the statutes). 5. Subsequent formation Polish law on private limited companies does not provide for rules on subsequent formation.
Sub-section 2:
Capital maintenance
6. Fraudulent distributions Polish law prescribes that throughout the existence of the company, shareholders may not be refunded their contributions unless the Commercial Companies Code states otherwise (acquisition of own shares by the company, reduction of capital, Article 189). Article 198 of the Commercial Companies Code provides that shareholders who received a reimbursement contrary to the law or provisions of the statutes are obliged to return that amount. Members of company bodies which are responsible for this reimbursement are liable for the refund jointly and severally with the recipient. 7. Acquisition of own shares Polish law especially Article 200 of the Commercial Companies Code sets forth that the company or its dependant company may not take up, acquire or accept as pledge its own shares, except for the situation where the shares are acquired for the purpose of redemption or in satisfaction of claims of the company as a creditor of a shareholder. Own shares shall be alienated within one year from their acquisition or redeemed (Art. 200 CCC).
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8. Financial Assistance Polish law does not prohibit granting financial assistance by the company to its shareholders for the purpose of obtaining funding for shares. 9. Loans from shareholders The Polish Commercial Companies Code regulates loans from a shareholder in general i.e. not only arranged during in the crisis of the company. A loan from a shareholder is considered as a contribution to the company’s capital if the company is declared insolvent within 2 years from the date of conclusion of the loan agreement (Article 14 §3 CCC). If such situation occurs the shareholder ‘s claim may only be satisfied after the other creditors have been satisfied. Tax restrictions on thin capitalisation are also applicable under Polish law. 10. Capital reduction The Polish Commercial Companies Code provides the following three options for reducing the subscribed capital: - liquidation (redemption) of certain shares without changing the nominal value of other shares - reduction in the value of all shares without changing the general number of shares - it is also possible to mix the above mentioned options i.e. reduce the number and the value of shares. It is possible to reduce the capital proportionally to all shareholders or to execute a reduction which affects the shareholders in an unequal manner (this is only possible if the affected shareholders grant their consent to this – Article 246 §3). The process involving the reduction in capital requires the following steps: a) adoption of a resolution by shareholders on the reduction in capital (the resolution must be in the form of a notarized protocol and at least a 2/3rds majority is required. If the reduction in capital occurs as the effect of an “automatic” redemption of shares – (article 199 §4 and 5) this resolution is adopted by the management board). b) announcement of the capital reduction - the management board is obliged to announce the shareholders’ intention to reduce the share capital. The reduction in order to take effect must be registered in the commercial register. The Commercial Companies Code provides that the reduction may be registered after the creditors of the company are informed (by a public announcement in the official court and economic journal – Monitor Sądowy i Gospodarczy”) that the shareholders have adopted a resolution on the reduction and calling creditors to raise objections within 3 months from the date of the announcement (Art 264 §1 CCC). Creditors that raised objections should be either satisfied or granted security. These rules do not apply in the case mentioned in Article 264 § 2 – if along with the resolution on the reduction in of capital another resolution is adopted - increasing the capital at least to the previous amount, and in case of a split-off division of a new company if the newly established company is financed from the capital from the capital reduction. c) entering the changes into the national register court and publication.
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11. Redemption of subscribed capital Polish law does not provide for the redemption of subscribed capital. 12. Compulsory withdrawal of shares The Polish Commercial Companies Code provides in Article 199 that shares may be subject to compulsory withdrawal only after the company is registered and only if this is allowed by the company’s statutes. In consequence of the withdrawal, shares are obtained by the company and redeemed. As a general rule, shares are purchased by the company for consideration. The shareholder may agree to waive his right to consideration for the withdrawn shares. It is required that the statutes provide grounds and the description of procedure related to the withdrawal. The general meeting is authorized to adopt a resolution on the withdrawal which must specify legal grounds for this procedure and consideration for the shares to be withdrawn. This consideration may not be lower than the book value of withdrawn shares. The shareholders’ resolution must include a justification as to why the shares were subject to compulsory withdrawal. Withdrawal of shares may take place without the need to reduce the share capital if it is covered by the net capital profit of the company. 13. Redeemable shares Polish law does not provide a possibility to issue redeemable shares – i.e. specified shares that, contrary to ordinary (non-redeemable) shares, may be purchased either at the option of the company or the shareholder. However, the Polish CCC provides that the statutes may allow “automatic” withdrawal of shares. This might be considered as being similar to the idea of redeemable shares. The statutes may provide that, upon a specified (certain or uncertain) event, specified shares are to be redeemed without the need of a shareholders’ resolution. In such case, the management board decides to redeem shares either from net profit or by reducing the share capital. Provisions of the CCC relating to compulsory withdrawal of shares should be applied accordingly.
Sub-section 3:
Distributions
14. Definition of distribution Polish law on private limited companies provides that the shareholder is entitled to participate in the profits declared in financial statements and allocated to distribution under a resolution of the shareholders. (Article 191 CCC) The statutes may provide a different manner of distribution of the profits as long as it is in accordance with the imperative provisions of Polish Commercial Companies Code in this matter. 15. Distributable amount The amount of capital designated for distribution may not exceed the profit for the last financial year increased by the undistributed profits of previous years and by distributable amounts transferred from the supplementary capital and reserve capital created from the profits. This amount is reduced by uncovered losses, own shares, and by amounts which, as 327
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required by the Polish Commercial Companies Code or statues should be transferred from the profits into the supplementary or reserve capital. With respect to the distributable amounts, the Polish Accounting Act is in accordance with the International Financial Reporting Standards. In case of illicit distributions, Article 198 CCC provides that shareholders who received a reimbursement contrary to law or provisions of the statues are obliged to return that amount. Members of company bodies which are responsible for this reimbursement are liable for the refund jointly and severally with the recipient. 16. Process of distribution The Polish law on limited liability companies prescribes that the general meeting is entitled to decide on the distribution. Article 193 of the Commercial Companies Code provides that the holders of shares who were entitled to the shares on the date of the resolution dealing with the distribution of the profits have the right to the dividends. Unless the statutes provide otherwise, the net profit is distributed in proportion to the shares held. The statutes may authorise the shareholders to determine the dividend day, i.e. the date on which the list of shareholders entitled to dividends for a given financial year is prepared. The dividend day may not be fixed later than within two months from the adoption of the resolution deciding on distribution of profit. If the approved financial statements of the company indicate a profit, an advance on the dividends is possible. The advance may not be higher than ½ of the profits gained since the end of the last financial year plus the reserve capital created from the profits. This amount is reduced by uncovered losses and own shares.
Sub-section 4:
Crisis and Insolvency
17. Serious loss of subscribed capital Polish law prescribes that if the balance sheet prepared by the management board shows a loss exceeding the sum of the reserve and supplementary capital and half of the initial capital, the management board is immediately obliged to summon shareholders to an extraordinary meeting to decide on the further existence of the company (Art. 233 CCC). 18. Trigger of insolvency Insolvency is defined under Polish law as the inability to discharge obligations to the creditors. A legal entity may also be considered insolvent if its liabilities exceed its assets even though it still is discharging certain obligations to its creditors (Art 10 and 11 of the Polish Insolvency and Rehabilitation Law). In respect to factors which trigger insolvency according to Polish Insolvency and Rehabilitation Law , bankruptcy proceedings are initiated in respect of a debtor that has become insolvent, i.e. that is not able to fulfil its current and due liabilities. In case of minor or temporary difficulties in meeting liabilities or non-material indebtedness (i.e. when the period for which the company is late in payment of debts does not exceed 3 months and the
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amount of due liabilities does not exceed 10% of net assets) the court may refuse to declare bankruptcy.
Subsection 5:
Equal treatment
19. Equal treatment Under Polish law the principle of equal treatment is applicable. The general rule of equal treatment may be limited by issuing privileged shares. Certain shares may be granted, for example, additional voting power, additional amounts of dividends, or a higher share in the assets resulting from liquidation of the company (Article 174 CCC). The shareholders may agree to grant additional privileges. For example, it might include the power to appoint members of the management board. Shares carrying privileges must be properly marked. The Polish CCC provides restrictions on the scope of privileges that may be linked to certain shares. Additional voting power may only be carried by shares of equal nominal value and the maximum amount of votes is 3 per privileged share. The privilege concerning the additional dividend may not exceed more than half of the dividend attributable to non-privileged shares. Besides privileges connected with holding certain shares, the company may grant personal privileges to a specified shareholder. These are not transferable with the transfer of the shares; the personal privileges expire upon transfer of all shares.
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4.4 Sweden (not applicable) In Sweden, there is only one legal form for limited liability company: the Aktiebolag (AB). Therefore, there is no separate description for private companies. Please refer to the general discussion of the Aktiebolag (AB) within this study report.
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4.5 United Kingdom Private Limited Liability Companies UK law disposes as private limited company of the “private limited company by shares (Ltd.)".
Sub-section 1:
Capital formation – injection of contributions
1. Minimum capital and other means of equity financing a) Minimum subscribed capital Under UK law, it is not mandatory for the private limited company to have a minimum subscribed capital comparable to the one fixed in the 2nd CLD b) Other forms of equity financing The arrangements concerning the different kinds of funds/capital, which can be raised by the private limited company, are the same as for a public company (save for the absence of minimum capital). Authorised capital – This is stated in the company’s memorandum. It is the maximum amount of capital that the directors can issue without having to seek approval from the shareholders. It is a memorandum item and does not in itself generate any value for the business. Allotted capital – Arises where a person has obtained the unconditional right to be included in the register of members in respect of the share. Issued capital – Arises where an investor is actually entered into the company’s register of members. The private limited company could of course in addition raise loans from banks etc. but these would not be classed as ‘capital’. Private companies are not required to offer their funds/capital to the public. c) Information to be made public Private companies must file details of their capital with the registrar as a result of filing their memorandum and articles, returns of allotments and annual accounts as required by various sections of the Act. See ss10, 88, 242 (1985); ss18, 555, 441 (2006). 2. Subscription of shares / nominal value The provisions that regulate the subscription of shares for a private limited company are broadly similar to those for a public company as described in the response to questions 2 and 6, except that there is no minimum nominal capital needed to register a company (save for one share),only one member is required to form a company.
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3. Injection of contributions UK law prescribes dictates that shares taken by a subscriber to the memorandum(ie, on formation) in pursuance of an undertaking of theirs in the memorandum and any premium on the shares, shall be paid up in cash. The rules are the same as for a public company as described in question 3 and 7, except that there is no prohibition for a private company in accepting an undertaking given by any person that they should do work or perform services for the company or any other person or accepting any other undertaking to be performed after more than five years. The rules in respect to what dregree contributions have to be paid in are the same as for a public company as described in question 2 and 6, except that there is no requirement for at least a quarter of the nominal value to have be paid up. A statutory valuation of non-cash consideration or of a non cash asset transferred subsequent to formation, is not required. 4. Capital increases a) Resolution Save in two regards there are no differences in the rules applicable to public limited company and those applicable to private limited companies in relation to capital increases including areas such as authorisation in the statutes, shareholders’ resolution, majority, principle of nominal value, subscription of new shares etc. The first difference is that under the 1985 Act the authority to allot may, however, be longer than for five years. The second difference is that under the 2006 Act the allotment authority is, if the company has only a single class of shares, entirely a matter for the articles. b) Pre-emption rights In respect of pre-emption rules, private companies are permitted by section 91 (1985) and 567 (2006) to exclude themselves from much of the requirements of the pre-emption rules in the Companies Act, if their Memorandum or Articles of Association contains a provision excluding them. In the absence of any such provision there will be no difference in the rules applicable to public limited company and those applicable to private limited companies. 5. Subsequent formation There are no rules for private limited companies that are equivalent to those public limited companies in respect of articles 10 and 11 of 2nd CLD.
Sub-section 2: Capital maintenance 6. Fraudulent distributions The position is the same as described at question 10. 7. Acquisition of own shares In addition to the circumstances whereby to a public company may acquire its own shares, a private company may also acquire and cancel its own shares by making a payment out of 332
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capital (there is no facility to acquire shares out of capital and hold them). The procedure for this requires the directors to make a solvency statement that is also reported on by the company’s auditors. (See ss171-177, 1985; ss709-723, 2006.) 8. Financial Assistance Under the 1985 Act, the general prohibition on offering financial assistance is relaxed for private companies. To be able to take advantage of this also requires a solvency statement by the directors that is also reported on by the company’s auditors. The company must have net assets that are not reduced, or, if reduced, the reduction is out of distributable profits. (See ss155-158, 1985.) Under the 2006 Act, a private company will no longer be prohibited at all from giving financial assistance for the purchase of own shares. 9. Loans from shareholders In the UK, there are no special provisions or case law dealing with loans from shareholders that are given in a crisis situation. 10. Capital decrease The current law (under the 1985 Act) for the reduction of capital is the same as for public limited companies as covered in question 14. However the 2006 Act will introduce a simplified method for private limited companies. These are contained in sections 642 to 644. This will allow a private company to reduce its capital without the need to go to court. These procedures still require that the shareholders of the company need to consider and approve a special resolution which may reduce its share capital in any way. However instead of a court approval route, there is the need for the resolution to be supported by a solvency statement. A solvency statement is a statement that each of the directors: (a) has formed the opinion, as regards the company’s situation at the date of the statement, that there is no ground on which the company could then be found to be unable to pay (or otherwise discharge) its debts; and (b) has also formed the opinion: (i) if it is intended to commence the winding up of the company within twelve months of that date, that the company will be able to pay (or otherwise discharge) its debts in full within twelve months of the commencement of the winding up; or (ii) in any other case, that the company will be able to pay (or otherwise discharge) its debts as they fall due during the year immediately following that date. The date of the solvency statement may not be more than 15 days before the date on which the resolution is passed. After the shareholders resolution has been approved by the shareholders within 15 days a copy of it, the solvency statement and a statement of capital (its contents are set out in section 644) must be filed on the public registry. It is the case that only when these documents have registered will the resolution for reducing share capital be effective.
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11. Redemption of subscribed capital The rules in respect of the purchase and cancellation / redemption of shares are the same for private companies as for public companies, with the addition that (as set out at question 33) purchase / redemption may be out of capital. 12. Compulsory withdrawal of shares UK law does not allow the withdrawal of shares. 13. Redeemable shares The rules in respect of redeemable shares are the same for private companies as for public companies, with the addition that (as set out at question 33) redemption may be out of capital.
Sub-Section 3: Distribution 14. Definition of distribution A comprehensive definition of distribution is not attempted. Instead the legislation implementing Article 15 is expressed to apply subject to exceptions, to every description of distribution of a company’s assets to its members, whether in cash or otherwise. See s263 (1985); s829 (2006). The exceptions are distributions by way of i) an issue of shares as bonus shares, ii) the redemption or purchase of the company’s own shares out of capital or unrealised profits, iii) the reduction of share capital by reducing the liability of members in respect of share capital that is not fully paid up or repaying paid up share capital, or iv) a distribution of assets on a wind up. 15. Distributable amount: A company can only make distributions out of its accumulated, realised profits, so far as not previously distributed or capitalised, less accumulated, realised losses, so far as not previously written off in a reduction or reorganisation of capital. See s263 (1985); s830 (2006). Simply put, the rules are the same as for public companies save that the net assets test does not apply. A profit is a realised one if it is generally accepted as so for accounting purposes per s262 (1985), s853 (2006). Pursuant to that section there are various pieces of authoritative guidance in relation to determining what profits are realised, issued by the Institute of Chartered Accountants in England and Wales (ICAEW) jointly with Institute of Chartered Accountants of Scotland (ICAS). These are listed in the general information section of this document. See s275 (1985), s841 (2006) for guidance on realised profits and losses for revalued fixed assets. See s268 (1985); s843 (2006) for guidance on realised profits for insurance companies with long term business. In addition please refer to the text in Question 19bb with regard to the complexity in this area and draft TECH 21/05.
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The maximum amount that can be distributed under the principle of s263 (1985), s830 (2006) as described above is determined by reference to the profits, losses, assets, liabilities, and share capital and reserves as stated in the company’s relevant accounts (see below). For the purposes of determining the lawfulness of a distribution, where a company makes a distribution in kind of a non-cash asset, any amount at which the asset is stated that is an unrealised profit for the purposes of a distribution is treated as a realised profit. See s276 (1985); s846 (2006) As a matter of common law, the directors must consider whether there has been a fall in the distributable reserves of the company subsequent to the date of the relevant accounts. This may limit the maximum amount of distribution that can be legally made Subject to exceptions, it is the last 4th CLD annual accounts (those laid in respect of the last preceding accounting reference period) that are relevant for assessing the maximum legal amount of a distribution. The exceptions are where the proposed distribution would exceed the amount available for distribution by reference to these accounts, or where the distribution is proposed in the company’s first accounting reference period. In these cases interim accounts or in the latter case initial accounts must be drawn up. See s 270 (1985); s836 (2006). Unlike a public company, the interim accounts are not filed. Where a member receives an unlawful distribution and at the time of the distribution he knew or had reasonable grounds to know that the distribution had been unlawfully made, he is liable to repay it. See s277(1985); s847 (2006). In certain situations the common law would consider directors liable to compensate the company for the losses caused by the illegal dividend. 16. Process of distribution Under the standard Table A articles (the default articles of a company unless it adopts something different), a distribution can be decided on by the directors or be declared by the members in general meeting by a simple majority. In the latter case the amount must not exceed that recommended by the directors.
Sub-section 4: Crisis and Insolvency 17. Serious loss of subscribed capital UK law does not contain provisions for the case of a serious loss of the subscribed capital. 18. Trigger of insolvency Insolvency is triggered by any of the factors in s123 of the Insolvency Act 1986 (Inability to pay debts). Briefly, these are where: a statutory demand (a formal demand that a debt be paid) is served on the company for a sum exceeding £750 and remains unpaid for 21 days thereafter; execution of a court order to enforce a debt could not satisfy the whole of the debt due;
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it is proved to the satisfaction of the court that the company cannot pay its debts as they fall due (requires a court hearing); and it is proved to the satisfaction of the court that the value of the company’s assets is less than the amount of its liabilities, taking into account prospective and contingent liabilities. The inclusion of prospective and contingent liabilities makes this a difficult test to apply, and arguably an unfair one. However, as a matter of insolvency practice this isn’t a practical issue as the test isn’t a strict one but one for the court’s discretion; moreover, in practice this is not often used by creditors – the failure to pay debts when due is the common test. There is extensive case law on this point. Companies may also be wound up (put into insolvency) by order of a Government official if it is proved that there is a public interest in it being wound up. This is unusual.
Subsection 5: Equal treatment 19. Equal treatment As with the case of public companies, there is no single provision of legislation specifying equal treatment. Individual provisions in particular areas make such provisions as the legislature has thought necessary.
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4.6 Summary The analysis of the legal framework for private companies in the four EU Member States (France, Germany, Poland, the United Kingdom; Sweden has no specific legal form) resulted into the following main findings: • • • • • • •
• • • • • • • • •
Subscribed capital cannot be distributed to shareholders in France, Germany and Poland. In the UK, this restriction can be fixed in the statutes. Minimum capital is to varying degrees necessary in France (€1), Germany (€25,000), Poland (€13,750) and in the UK (GBP 1). Premiums exist in all four Member States. The concept of the nominal value of shares exists in Germany and Poland. In the UK and France, it has not been laid down in legislation, but in France it can be freely determined by shareholders. Contributions in cash and in kind are allowed in all four Member States; however, in the UK, contributions in kind are prohibited in the stage of formation. Expert valuations for in kind contributions are only mandatory in France. A shareholder resolution regarding capital increases is mandatory in all four Member States. In Germany, ¾ of the votes cast are necessary. In Poland, the resolution must represent ¾ of the shares. In the UK, an authorisation in the company’s statutes is sufficient. Pre-emption rights are not legally foreseen in France and Germany; Poland and basically the UK have established such rights. The distributable amount is in all four Member States defined as the annual net profits as shown in the annual financial statement. Provisions with respect to the acquisition of own shares only exist in the UK. Provisions prohibiting financial assistance only exist in France and the UK; however in the UK exist certain exceptions. Capital decreases are possible in all Member States. Redemption of subscribed capital is only allowed in the UK. Compulsory withdrawal of shares is permitted in all Member States except for the UK. Redeemable shares can only be issued in the UK. Subsequent formation rules are not provided for in any of the four Member States.
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The following table intends to present an overview on basic features of the capital regimes for private companies in France, Germany, Poland and the United Kingdom: Subscribed capital which cannot be distributed to shareholders Minimum capital Premiums Nominal value
Contributions in cash and in kind (only assets of economic value) Valuation of contributions in kind by an expert Resolution by shareholder meeting for capital increase Pre-emption rights
Distributable amount: annual net profits as shown in the annual financial statements Prohibition of acquisition of own shares Prohibition of Financial assistance Capital decrease Redemption of subscribed capital Compulsory withdrawal Redeemable shares Subsequent formation
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France
Germany
Poland
UK
Yes
Yes
Yes
Fixed in the statutes
€1
€25,000 Law proposal: €10,000 Yes Yes
PLN 50,000 (€13,750)
GBP 1
Yes Yes
Yes Not by law
Yes
Yes
Yes (Not in stage of foundation)
Yes, appointed by court
No
No
No
Yes
Yes – ¾ of votes cast
Yes – representing ¾ of the shares
Yes or an authorisation by the company`s statutes
No
Not by law; however, most commentators in literature argue for pre-emption rights
Yes
Yes
Yes
Yes
Basically yes; Possibility of excluding these legal requirements by a provision in the statutes Yes
No
No
No
Yes (same rules as for public companies)
Yes
No
No
Yes (exceptions exist)
Yes No
Yes No
Yes No
Yes Yes
Yes
Yes
Yes (if allowed by company`s statutes
No
No No
No No
No No
Yes No
Yes Not by law; can be determined by shareholders without restriction Yes
