Restoration of a company’s net worth

Cause of dissolution.

This situation occurs when the net worth of a company – the difference between assets and liabilities – is less than half of the share capital figure (for example, if a limited company that was incorporated with a share capital figure of 10,000 euros, at a certain point in time the company’s balance sheet indicates that there have been losses or expenses of 6,000 euros and its net worth is 4,000 euros).

In these cases, corporate law considers that there is a real risk that the company will not be able to meet all its payment obligations, and therefore obliges its partners and administrators to dissolve the company, unless a series of measures are adopted to rebalance this negative equity situation. That is to say, what can be done to avoid having to dissolve the company, as the Law states, due to the accumulated losses.

Before starting with the description of these alternatives, it is important to point out the risk that exists in the event that this situation of imbalance is prolonged in time without having taken any action to solve it or even the dissolution of the company, since there is a possible direct liability of the administrator for the corporate debts subsequent to the occurrence of the legal cause of dissolution, which means that the administrator may have to respond with his own personal assets for the corporate debts.

In particular, the regulations provide that such liability begins after two (2) months have elapsed without the directors having complied with the obligation to call a General Meeting to adopt, as the case may be, a resolution to dissolve the company or any of the following options that allow the company’s economic situation to be reestablished.

Thus, the most common alternatives for restoring a company’s equity balance, which can be adopted either individually or in combination, are as follows:

 1. Capital stock increase with or without premium.

The increase in capital stock, understood as the direct investment of the shareholders in the capital stock, thereby increasing the company’s equity. This increase can be carried out by creating new shares or participations or by increasing the nominal value of the existing ones (e.g. if they were worth 1 euro before, now they are worth 10 euros).

Note that there are also different types of magnifications:

i) direct monetary contributions of the partners in the bank account of the company;

(ii) non-monetary contribution to the company’s assets such as real estate, land, etc… any economically assessable element that is contributed to the company and in this case becomes the property of the company, in these cases it will be necessary to give them a quantifiable value in shares or participations;

(iii) It is also possible to contribute claims against the company, in this way the creditors become partners of the company, as their claims are transformed into capital;

(iv) or the increase charged against profits or reserves already included in the last approved balance sheet, when the company’s balance sheet allows for such offsets for accounting purposes. 

In any of the above cases, the increase should be made in an amount sufficient to restore the company’s equity situation.

It should be borne in mind that as another variant within the capital increase, this can be done through the creation of shares or stockholdings with a premium, which would allow the company to increase the amount of the capital stock by a smaller amount and, nevertheless, increase the net equity by a sufficient amount to reestablish the equity balance. The premium, let us say, is the extra price paid for the participation in the company, so there can be shares worth 5 euros and a premium of 200 euros, for example.

This alternative involves going to the notary and registration in the Commercial Registry.

2. Reduction of capital stock due to losses.

The operation of reducing the capital stock can be carried out provided that the company has sufficient capital to do so, and consists of reducing all the equity accounts in order to offset the losses. The normal procedure will be to reduce the nominal value of the shares or participations; another possibility is the amortization of some of them or their grouping.

Like the previous one, this alternative involves going to the notary and registration in the Mercantile Registry and in this case the partners do not have to make any disbursement.

3. The direct equity contribution of partners to compensate losses.

Another alternative can be the direct contribution of the partners in the amount necessary to cover the losses to the account of the company, or if desired in other higher amounts. This is a simple operation that does not require a modification of the bylaws, unlike the two previous ones.
The partners deposit money in the society a specific account that is called to lost fund, in fact it is not necessary that it is realized by all the partners in the same proportion. In this case, it must be taken into account that the contributions are made without any idea of direct return, but nevertheless it is a fast option and without cost for the society. As far as formalities are concerned, it is cheaper than the two previous ones – capital increase or reduction – since it only needs to be agreed at the shareholders’ meeting.

4. Participating loans from members

In this case, these are loans from the shareholders to the company with the special characteristic that the interest to be received by the shareholders is linked to the evolution of the company’s activity, in addition to the possibility of having an additional fixed amount. The regulations consider that the amount of these participating loans is considered as equity for the sole purpose of capital reduction and liquidation.

This option is also convenient and fast because these loans are usually made in a private contract although they can also be made before a notary to avoid problems with third parties or their distinction from normal loans that do not have these characteristics. This type of loan must be detailed in the annual accounts of the company. It should be noted that in the event of bankruptcy of the company the amount of these loans would be the last to be received.

5. Simultaneous reduction and increase of capital stock (Operation Accordion)

Finally, another option is the possibility of carrying out an agreement to reduce the capital stock to zero or below the minimum legal figure – so that the balance sheet is clean by eliminating the negative results – but provided that simultaneously it is agreed to increase its capital up to an amount equal to or greater than the minimum legal figure. It should be noted that this option mainly affects minority shareholders who may see their shareholding cancelled by the reduction. This alternative involves going to a notary public to execute a public deed and register it in the Registry.

However, we remind you that these alternatives are only available when the company, either by direct contribution of its partners or by its internal resources, has sufficient economic strength to be able to refloat its equity situation, but this could not be done when it is necessary to file for insolvency proceedings.