|Diana Dimova||Atanas Mihaylov|
In times of economic crisis, many companies undertake restructuring while others seek alternative sources of financing to improve cashflow. While the company is attempting to improve its financial position, its shareholders might be experiencing their own cashflow problems and could be interested in extracting resources from the company. This leads to a conflict between the shareholders' interests and the management's duties to secure the company's solvency and creditors' interests.
Bulgarian legislation gives priority to creditors' interests and protects them consistently through a system of measures known as the capital maintenance regime. The regime imposes special restrictions on operations between a joint-stock company and its shareholders in order to protect the company's capital.
Dividend distributions in a Bulgarian joint-stock company should comply with the following requirements:
- Subject to dividend distribution is the profit for the respective year, as shown in the audited and approved annual financial statements, reduced by (i) any losses transferred from previous years and (ii) any sums placed to reserves in accordance with the law or Articles of Association, and increased by (i) any undistributed profits transferred from previous years and (ii) any sums placed to reserves which are exceeding the legally-required minimum amount of the reserves; and
- Following the payment of dividends, the net assets of the company (the difference between the value of the assets and the liabilities as per the balance sheet), as set out in the company's audited and approved annual financial statements for the respective year, should not be lower than the amount of the company's registered capital plus any sums placed to reserves.
It is important that some specific features of applicable accounting standards, on the basis of which the company's annual financial statements are prepared, may influence the amount of the distributable profit. Thus, under the International Accounting Standards, some categories of assets, for example investment properties or some types of financial assets, can be accounted for at their fair value, where every subsequent change of their fair value would have to be accounted for as a loss or a profit in the company's income statement without any disposal of the asset. As a result, the distributable profit of the company may be increased with unrealised profits from subsequent revaluations.
Special attention must be paid to the issue of financial assistance. Under Bulgarian law, a joint-stock company is prohibited from extending loans or providing collaterals for the acquisition of its own shares by third persons. A violation of this prohibition would trigger invalidity of the loan agreement or the collateral agreement.
Decrease of the registered capital in a joint-stock company should also account for the rights of the company's creditors. In case of violation of the requirements for notifying and satisfying creditors, the members of the company's managing body can be held jointly and severally liable by the creditors for any damages incurred.
The capital maintenance regime also includes restrictions on the acquisitions by the company of its own shares (such as buy-back of shares, preferred shares with privilege for buy-back, decrease of capital by cancellation of shares, and so on).
The company may acquire its own shares only with amounts eligible for distribution (amounts distributable as dividends, for example). The company may not hold its own shares with a total nominal value exceeding 10% of its registered capital. If this rule is violated, the company has to transfer excessive shares within a specified period, otherwise such shares should be cancelled and the registered capital of the company should be reduced. The company's managing body must disclose in the annual activity reports what own shares the company holds.
Some restructuring alternatives could lead to an outcome similar to that of an acquisition of own shares – for example, if shares in a company which is a shareholder in a joint-stock company are contributed to the same joint-stock company; then the contributed shares would be considered own shares of joint-stock company, with all restrictions applicable to it.
Acquisition of own shares, however, should be carefully considered from an accounting and tax point of view. Depending on the particular circumstances, it can be treated as payment of dividends or liquidation proceeds and some types of preferred shares with buy-back privilege can be treated by the applicable accounting standards not as equity instruments, but as financial liabilities of the company, with all the consequent complications arising from that fact.
If, despite the capital maintenance restrictions, the net assets of the company fall below the figure of its registered capital and the shareholders do not take a decision to decrease the registered capital, restructure or liquidate voluntarily the company within a period of a year, the company could be compulsorily liquidated upon request of a prosecutor.
There are several legal ways to avoid the negative consequences of capital erosion. One of them is to carry out a simultaneous capital decrease and increase: the company's capital is decreased in order to cover losses and to reach the level of the net assets of the company, but then is increased back to the same level or higher, often through an equity injection by a new investor. Restructuring (such as merger or spin off) also creates opportunities to optimise capital structure.
Diana Dimova and Atanas Mihaylov
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