—–For general audience—-–
An important item, relevant to Corporate Treasury, is to gauge cautiously the corporate interests of subsidiaries and the associated risk, before joining a group’s Cash Pool. Also, subsidiaries should not simply follow instructions form the head office, but take responsibility in verifying whether or not participation in Cash Pools is possible. Why? Because failing to do so may have unexpected adverse consequences for all parties involved. Especially during times of economic downturn.
Previously (strongly recommended you read this first):
- Part 1; Consider Corporate Benefit at subsidiary level (click here)
By Shining Lin (l) and Jiaxin Huang (r)
Visit the blog-page for this and more articles (click here).
What are Capital Maintenance Rules? (Part 2)
The Facts
Capital Maintenance Rules[i] are one of the fundamental elements of corporate law in many jurisdictions. In general, it means that the (core) capital of a company must be protected on an ongoing basis. Distributions to shareholders can be made only in accordance with statutory requirements (dividend is one of the explicit circumstances). When entering into a transaction with its shareholders, the management and the shareholders of a company must question themselves whether the company will conclude the same transaction with a third party under arm’s length principle. If this question is answered in the negative or it is not possible to answer them due to the lack of arm’s length comparison suitability, and there is no operational justification for the transaction as such, capital maintenance law has been violated.[ii]
The Potential Consequences
Any transaction violating the rules will have legal consequences such as the nullification of the relevant transaction, an obligation for the recipient to repay received payments to the company etc. The parties involved in such transactions, mainly shareholders, managing directors, supervisory board members, will be personally held liable and may also face criminal charges.
A case study as illustrative example (continued from part 1).
In order to discuss the essential elements to be considered before joining a Cash Pool the recent court case from Part 1 is used as illustration.
The Claim
Due to that fact that set-off (as discussed in Part 1) led to insolvency of the Austrian subsidiary, the bankruptcy trustee deemed that the set-off weakened the position of other creditors to claim the debts from the Austrian subsidiary. The trustee therefore challenged the validity of the contract and enforceability of the set-off.
The Verdict
Both the lower courts and the Supreme Court held the view that the cash management service provider could not be held liable for an infringement of the Capital Maintenance Rules. There is no explicit case law on Cash Pooling from the point of view of Capital Maintenance Law, as such, the court applied the general principle of Capital Maintenance Law to intra group loans and collateral provided by the group.
During the examination, the Supreme Court stated that the violation of capital maintenance rule was due to internal instructions from the parent company to the subsidiary to make the surplus liquidity available to the Cash Pool, which took the opportunity from the subsidiary to dispose its own liquid assets. Very similar to arrangement in intra group loans, the internal instruction of the parent company also makes it impossible for the subsidiary to withdraw its right to terminate the contract.
The cash management service provider, as a third party, is in general not the addressee of the Capital Maintenance Rules, but only the company and its shareholders or representatives. A third party however will be affected if the suspicion of a violation is “practically obvious” to the third party. Or the third party doesn’t recognize the infringement through gross negligence.
In the present case, the trustee proclaimed that the cash management service provider should have investigated to ensure that subsidiary maintained sufficient and robust capital when the cash management service provider executed the set-off (seizure of the credit balance of Austrian subsidiary).
The Supreme court opined that it is quite right to assume that the Cash Pool generally is in the interest of the participants. The economic significance addressed the operational justification. Thus, the Cash Pool doesn’t constitute a case of suspicion. The duty of a third party to inquiry and investigate doesn’t exist unless when it is blatantly obvious that a transaction will breach the rule.
Interim Conclusion
A third party, is in principle not responsible for ensuring that the Capital Maintenance Rules are respected. Except in cases where the suspicion of a violation is obvious to the third party.
Next (essential elements to be considered before joining a Cash Pool)
Is set-off enforcement legitimate? (click here)
Featured image: Top of the world. The Alps, seen from Austria (near Sölden) towards Italy. The Alps are the highest and most extensive mountain range system that lies entirely in Europe. Sölden (popular ski resort) is a municipality in the Ötztal valley of Tyrol, Austria. (Foto: Norbert Braspenning).
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In the posts the author(s) express(es) personal insights, expert views, and opinions with respect to the topic(s) discussed. Due to differences in interpretation, insights may (and will) differ.
Editor: Norbert Braspenning
[i] Capital maintenance rule: See Sections 82 et seq of the Companies with Limited Liability Act and Sections 52 and 65 et seq of the Stock Corporation Act. One of the fundamental elements of Austrian corporate law is the principle of capital maintenance. The cornerstone of the Austrian capital maintenance rules is that all the assets of an Austrian corporation, even those exceeding its stated capital, are protected. Distributions to shareholders may be made only in accordance with statutory exceptions; the most important of these explicitly specified circumstances is that shareholders have the right to receive dividend payments out of the annual distributable profits of the company. Any transaction qualifying as a violation of such rules will generally result in a prohibited repayment of equity, leading to the nullification of the relevant transaction. Pursuant to case law and unanimous doctrine, activities such as taking out loans and forwarding the proceeds to shareholders and providing up-stream and cross-stream guarantees or other security interests will – unless certain strict precautions are applied – violate the Austrian capital maintenance rules. In addition, the parties involved in such transactions (eg, shareholders, managing directors, supervisory board members and – in certain scenarios – third parties) are personally liable to repay the amounts paid by the corporation under such transactions and may also face criminal charges.
[ii] Capital maintenance and (notional) Cash Pooling article – Vedran Obradovic/Andrei Demian – ZFR 2019/198 – ZFR 2019, 451 – Issue 9 26.9.2019
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