July 27 2012
In a recent decision (4A_288/2011), the Federal Supreme Court specified the prerequisites for a restructuring measure that is often termed the 'restructuring harmonica'.
Within this framework, a corporation reduces its share capital to zero and then re-increases its share capital for the purpose of restructuring. Upon the reduction to zero, the previous rights of shareholders are extinguished and the previously issued shares and share certificates, respectively, must be cancelled. In connection with the re-increase, the previous shareholders have pro-rata pre-emptive rights that may not be withdrawn. If the share capital is re-increased up to at least the previous amount by newly issued, fully paid-up shares, a simplified procedure applies. In such case neither an auditor's report confirming the continued full coverage of the creditors' claims nor a creditor's call is required, and the creditors do not have the right to request payment of, or security for, their claims, all in contrast to the ordinary procedure that applies to capital reductions.
In this case, the company's board of directors convened an extraordinary shareholders' meeting in early January 2008. The company was over-indebted, but had not notified the court because its main shareholder – who was also serving as chairman of the board of directors – had subordinated a loan granted to the company in an amount exceeding the over-indebtedness. The agenda of the extraordinary shareholders' meeting included the proposal for a harmonica, with a reduction of the share capital to zero and a re-increase of the share capital to the previous amount of Sfr500,000. Before the extraordinary shareholders' meeting, the board of directors invited the company's shareholders to exercise their pre-emptive rights and subscribe for their pro-rata share of the capital re-increase. The respective letter set the deadline for the exercise of the pre-emptive rights well ahead of the extraordinary shareholders' meeting.
Before the extraordinary shareholders' meeting, a minority shareholder – previously a member of the board of directors and the controller of the company, and as such in charge of the implementation of the business plan – submitted various questions to the chairman regarding the need for restructuring and requested insight into company records. The chairman answered by referring to the company's annual report for the financial year 2007 (which was unavailable at that time) and the subordination of the loan, as well as the minority shareholder's position as the company's controller and his concomitant knowledge of the company's financial situation.
The extraordinary shareholders' meeting took place with all shareholders either present or represented. As a basis for its resolutions, the board of directors had made available preliminary financial statements for the previous financial year (2007), which showed an over-indebtedness of over Sfr4 million. The definitive financial statements for 2007, the annual report for 2007 and the auditor's report were unavailable. A motion of the minority shareholder requesting a response to his questions submitted to the chairman was rejected, again by making reference to his position as controller. No information on further restructuring measures was presented at the meeting.
Against the votes of the minority shareholder, the extraordinary shareholders' meeting approved all agenda items, including the proposed harmonica. The entire capital re-increase was thereafter subscribed by a single shareholder – the chairman and main shareholder, who was able to offset part of his loan in connection therewith. Subsequently, the chairman also submitted a waiver of claims, which eliminated the over-indebtedness.
The minority shareholder challenged the resolutions of the extraordinary shareholders' meeting and thereafter appealed the respective lower court decisions.
In its decision, the Supreme Court specified certain prerequisites for a harmonica.
First, the permissibility of a harmonica with a reduction of the share capital to zero is limited to cases where the combination of a capital reduction and a capital (re-)increase serves "the purpose of restructuring", in accordance with the wording of the respective provision of the Code of Obligations. Only a company which is effectively in need of restructuring may be restructured using the harmonica procedure. As such, it must – "from an objective point of view" – have lost its entire share capital. Hence, the company must be over-indebted. A partial capital loss is insufficient basis for a harmonica.
Second, if the company is effectively in need of restructuring, a harmonica with a reduction of the share capital to zero must in fact result in a restructuring, which means that it must eliminate the over-indebtedness in its entirety, without giving credit to any subordination of claims by creditors. If it does not entirely eliminate the over-indebtedness, it may still be permissible, but only if implemented together with other restructuring measures that together eliminate the over-indebtedness and afford a reasonable prospect of a sustainable restructuring. In such case, the board of directors must have a restructuring plan that involves various restructuring measures, only one of which is the harmonica, and that must be presented in its entirety to the shareholders' meeting. If the plan is not presented to the meeting, the shareholders will not be in a position to make an informed decision on the proposed harmonica, whether it serves "the purpose of restructuring" and whether it is favourable for them to continue to participate in the company as shareholders. Under such circumstances, the resolution of the shareholders' meeting approving the harmonica is deemed to restrict unlawfully the shareholders' pre-emptive rights.
Since in this case the proposed harmonica did not eliminate entirely the over-indebtedness, and no further restructuring measures were proposed or presented at the extraordinary shareholders' meeting – not even information on the planned waiver of claims by the main shareholder – the prerequisites for a harmonica were not met and the respective resolutions of the extraordinary shareholders' meeting were thus unlawful. In essence, the Supreme Court ruled that if a harmonica by itself – and without giving credit to any subordination of claims by creditors – eliminates the over-indebtedness of a company, it is a permissible restructuring measure, even without a proposal or presentation by the board of directors of further restructuring measures.
With that outcome, it was not necessary for the Supreme Court to rule on other aspects of the case.
The Supreme Court emphasised in its decision that the shareholders must be put in a position to make an informed decision on the exercise of their pre-emptive rights. This is not possible as long as basic information that is necessary for the understanding of the proposed restructuring measures has not been made available and the shareholders' respective questions have not been answered satisfactorily. It therefore appears extremely unwise and hardly defensible to force dissenting shareholders to exercise their pre-emptive rights ahead of the respective shareholders' meeting and before they have received all relevant information – which, according to the Supreme Court, was the case here. The lower courts had not objected to the procedure and deadline set by the board of directors for the exercise of the shareholders' pre-emptive rights. However, unlike the Supreme Court, both lower courts had found no information deficits ahead of the extraordinary shareholders' meeting.
The financial statements presented at the extraordinary shareholders' meeting were preliminary financial statements for the preceding financial year. However, for the purpose of determining over-indebtedness, the Code of Obligations requires an audited (interim) balance sheet. It would have been interesting to hear from the Supreme Court whether this also applies for the purpose of a shareholders' meeting resolving on restructuring measures of an over-indebted company, including a harmonica, or whether preliminary unaudited financial statements would have been a sufficient basis for this purpose. In a previous decision (121 III 420 and following), the Supreme Court had rejected the requirement of audited interim financial statements for a shareholders' meeting resolving on restructuring measures. However, it is not entirely clear from the respective decision whether the defending company's financial situation had been comparable to this case. Also, the timing of the respective shareholders' meeting had been different, with the ordinary shareholders' meeting resolving on restructuring measures in August, presumably on the basis of audited year-end financial statements for the preceding financial year.
The court decisions give no indication as to whether the capital reduction and re-increase were registered in the Commercial Register. The decisions mention only that the minority shareholder had obtained an injunction on entries in the Commercial Register (which, however, was subsequently lifted by the first instance court). This is an important aspect of the case, since once registered in the Commercial Register, capital measures can in principle no longer be undone, mainly to protect third-party interests.
For further information on this topic please contact Micha Fankhauser at Homburger AG by telephone (+41 43 222 1000), fax (+41 43 222 1500) or email (firstname.lastname@example.org). The Homburger website can be accessed at www.homburger.ch.
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