|Till Spillmann||Luca Jagmetti|
Further, the court raised the question of whether Swiss companies are allowed to participate in zero balancing cash pools at all.
On a more positive note, the court gave the long awaited confirmation that paid-in surplus capital (agio), including capital contribution reserves, need not be treated in the same way as nominal share capital but may be distributed to shareholders.
The case before the Supreme Court related to a Swiss subsidiary of the former Swissair group, which participated in a zero balance cash pooling arrangement. The subsidiary had a positive outstanding balance against the cash pool leader (a sister company) and a loan against its grandparent company when it resolved to distribute a dividend. The dividend was paid via the cash pool, and the subsidiary's auditors confirmed that the payment of the dividend complied with the law and the company's articles of association. In the aftermath of the Swissair grounding in 2001, the administrator of the subsidiary sued the auditors for providing this confirmation on the basis that the two loans should have been deducted from the subsidiary's freely distributable reserves as at the relevant balance sheet date.
What the Swiss Federal Supreme Court decided
High standards for up-stream and cross-stream loans to pass the at arm's length test
In its decision, the court held that, in light of mandatory Swiss capital maintenance provisions, the ability to grant loans between companies belonging to the same group is limited. It ruled that an intragroup loan granted by a subsidiary to its shareholder or a sister company may constitute a de facto distribution rather than a loan. It also seems to suggest that such loan may only be granted for an amount not exceeding the subsidiary's freely distributable reserves. Until now, the majority of legal doctrine has only imposed this requirement on fictitious loans and similar financing arrangements under which repayment is unlikely or not even intended. While it was generally recognised that non-market term interests could constitute a hidden distribution, the absence of market terms did not necessarily result in a requalification of the entire loan. In addition, the Swiss Federal Supreme Court's decision suggests that surprisingly high standards will be imposed for up-stream loans to pass the arm's length test. The court did not specify what constituted arm's length terms in the context of the case at hand. However it held that none of the loans entered into were at arm's length because they were unsecured and the creditor allegedly did not analyse the debtors' credit-worthiness at the time it entered into the loan.
Intragroup loans that are not at arm's length restrict the ability to pay future dividends
Further, the Swiss Federal Supreme Court introduced a new requirement for up-stream and cross-stream loans that are not at arm's length terms. For these loans, the creditor has to set aside a corresponding amount of freely distributable reserves and ensure that it is not distributed to shareholders. In combination with the exacerbated standards for such loans, this may constitute a challenging new requirement for Swiss companies; it seems to require them to closely monitor freely distributable reserves in light of their intragroup financing arrangements, and to assess whether these may have been entered into at market terms.
Permissibility of (zero balancing) cash pool arrangements left open
The court also raised the question of whether a Swiss company's participation in a cash pooling arrangement according to which the participant disposes over its liquidity is at all capable of constituting an arm's length transaction. However, it held that the question could remain unanswered in this particular case because the loans that had been granted as part of the cash pooling arrangement were not on market terms in any event.
Paid-in surplus capital (Agio) may be distributed to shareholders
The Swiss Federal Supreme Court conclusively decided that paid-in surplus capital (agio) may be distributed as dividends. While companies have distributed billions of Swiss francs out of capital contribution reserves that were accumulated from surplus capital in recent years, a minority of legal scholars criticised this practice. Therefore, a clear Supreme Court ruling on this has been much anticipated. The court decided that paid-in surplus capital is not subject to the strict rules protecting the paid-in nominal share capital, but that it is governed by the rules applicable to general reserves. It follows that agio may be distributed if and to the extent that such general reserves exceed half of the nominal share capital (or 20% for holding companies).
What the decision means for Swiss companies
It is recommended that Swiss companies review their intragroup financing arrangements. The review should focus on, inter alia, the following key topics:
- up-stream and cross-stream loans should only be granted at arm's length terms;
- if there is any doubt as to whether the loan constitutes an arm's length transaction, cautionary measures should be taken; and
- cash pooling arrangements involving Swiss companies should generally be assessed in light of the recent decision.
The practical impact of the decision will partly depend on how auditors implement the ruling. Given the complexity of the legal and financial issues involved with intragroup financing and in view of the paramount importance of efficient liquidity management for Swiss companies, further clarification in case law would be welcome.
By Till Spillmann and Luca Jagmetti of Bär & Karrer in Zurich