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18 April 2011
Company's business purpose
Principle of adequate risk diversification
Principle of diligent liquidity management
Prohibition on repayment of capital to shareholders
Prohibition on hidden pay-out dividends
Directors' and officers' duty of care
Companies commonly enter into loan agreements with their shareholders. The reasons for this vary. One common instance in which a company may consider making a loan is when a shareholder wishes to obtain a cash advance for private purposes. Such loans are quite common, especially in small companies where the shares are held by one or several individuals. However, whenever directors of a Swiss company are contemplating granting loans to shareholders, they must be mindful of the specific restrictions and conditions imposed by general principles of Swiss corporate law. This update examines the corporate law implications of loans to shareholders and takes a practical look at the risks involved in such activity.
As a general rule, a Swiss company may enter into any agreement to the extent that the commitment is within the company's business purpose, as set forth in the articles of association. The company's business purpose rarely precludes the granting of loans to shareholders. However, it is questionable whether loans to shareholders which are not entirely made on an arm's-length basis (eg, loans to parent companies, known as 'upstream' loans) are within a company's business purpose. Where affiliated companies are granting each other loans which are not entirely at arm's length, it is common pratice to extend the company's purpose clause to provide explicitly for the granting of financial assistance to group companies.
When granting a loan to shareholders, the board of directors of a Swiss company must comply with the principle of adequate risk diversification. Bulk risks should be avoided.
The principle of diligent management liquidity must be complied with when making loans to shareholders. When carrying out such actions, directors of Swiss companies must look at the company's solvency, in particular its cash-flow position and the anticipated liquidity needs during the term of the loan agreement.
Pursuant to Article 680(2) of the Code of Obligations, Swiss companies may not return to shareholders their paid-in capital contributions. This capital protection norm is a central creditor protection provision. Creditor protection is achieved through a prohibition against the pay-out of company assets which are necessary for the maintenance of the protected minimum capital reserve to cover liabilities.
The question of whether loans to shareholders may be granted for an amount exceeding the company's free equity (non-committed assets) is controversial in Swiss legal literature. Some legal scholars advocate a general prohibition on the granting of loans to shareholders from the committed company assets. Others argue that loans may be made for an amount exceeding the lender's free equity, provided that the repayment claim is a full-value one and the loan conditions withstand a third-party comparison. However, all scholars agree that a loan which exceeds the free equity constitutes an unlawful return of the shareholder's contributions if the loan is fictitious or where it was clear from the outset that the shareholder will not be in a position to repay the loan when due.
A loan to a shareholder which infringes Article 680(2) of the code is null and void and may be challenged by any party as being null and void from the outset. As a consequence of the nullity and invalidity of the loan, the claim to repay the loan (irrespective of the term of the loan agreement) becomes due immediately and the shareholder cannot be released from such claim by way of a waiver; nor can such claim be deferred.
For the sake of transparency, Article 663a(4) of the code provides that Swiss companies must state the total value of outstanding claims against shareholders separately in the balance sheet.
Under Swiss corporate law, shareholders and members of the board of directors are obliged to return any benefits that they received from a Swiss company to the extent that such benefits are obviously disproportionate to the consideration received by the company and to its economic situation (Article 678(2) of the code). This is known as the hidden distribution of profits, or constructive dividends.
The benefits of the shareholder receiving a loan must be adequately proportionate to the consideration received by the company. Loans granted to shareholders under conditions which differ from market prices and which the company would not have considered when dealing with independent third parties may be deemed to be constructive dividends. In order to avoid being deemed constructive dividends, loans to shareholders should have arm's-length terms. In order to withstand a third-party comparison, loans to shareholders should have customary terms of duration, termination and amortisation. In addition, the loan should provide for adequate (market) interest to be paid on a regular basis, and not just accrued.
In practice, loans to shareholders which potentially qualify as constructive dividends are often approved by the shareholders' general meeting. However, legal scholars are divided as to whether such formal step can prevent the loan from being deemed a constructive dividend.
The board of directors and the senior management of Swiss companies may become personally liable to the company, as well as to its shareholders, for any damage caused by an intentional or negligent breach of their duties. When making loans to shareholders, directors should comply with the above-mentioned principles and respect the prohibitions on the repayment of capital to shareholders and hidden pay-out dividends. When granting loans to shareholders, directors have an ongoing duty to verify the creditworthiness of the shareholder during the term of the loan and to take measures if the creditworthiness ceases. This duty does not apply if the repayment of the loan is fully guaranteed through intrinsically valuable securities.
When granting loans to shareholders, the boards of directors of Swiss companies must be mindful of the specific restrictions and conditions imposed by general principles of Swiss corporate law. The principles of adequate risk diversification and diligent liquidity management must be observed. Loans should not be granted from the company's committed assets and loans to shareholders should meet arm's-length conditions.
For further information on this topic please contact Markus Dörig or Olivier Bauer at BADERTSCHER Rechtsanwälte AG by telephone (+41 44 266 20 66), fax (+41 44 266 20 70) or email (firstname.lastname@example.org and email@example.com).
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