The Council Directive no. 77/91/CEE, of the 13th  of December 1976, known as the  «Second Directive», established a regime applicable to the constitution of public  companies and to the conservation and maintenance of its share capital. In order to  protect the creditors’ interests, this Directive implemented at the Community level the  so called legal capital doctrine.

In general terms, this doctrine is characterized by a set of rules that regulate the contribution of certain assets, preferably money, from the shareholders to the company and also the preservation of these assets in the company during its activity.

Said legal capital doctrine has several corollaries that range from the establishment of a minimum capital, the attribution of a nominal value to the shares and the prohibition of the issue of new shares with a price lower than that nominal value, the evaluation of the contributions that do not consist in money, the prohibition of the performance of services as a contribution, to the establishment of limitations to the distribution of dividends and to the acquisition and redemption of own shares, and the regulation of the reductions of capital, loss of capital and financial assistance.

However, practice and several studies have been showing that creditors do not give great importance to share capital as a guarantee of their credits and that many of the legal capital doctrine corollaries impose excessive restrictions and additional costs to the management of the companies.

Several voices have been raised against the application of the legal capital doctrine to the public companies constituted in the European Union and several Member -States have opted for alternative legal solutions regarding the companies not included in the scope of the Second Directive.

In Portugal, for example, the rule that required a minimum capital in the constitution of private companies was repealed and it is now permitted that the shares of those companies have different nominal values, provided that any of those shares ha s a nominal value of less of 1 EUR.

Regarding public companies the limitations resulting from the legal capital doctrine established by the Second Directive impede further changes.

The most controversial rule of the Second Directive is its article 15º, which establishe s the so called balance sheet test. According with this balance sheet test: (i) no distribution to shareholders may be made when on the closing date of the last financial year the net assets as set out in the company's annual accounts are, or following such a distribution would become, lower than the amount of the subscribed capital plus those reserves which may not be distributed under the law or the statutes; and (ii) the amount of a distribution to shareholders may not exceed the amount of the profits at the end of the last financial year plus any profits brought forward and sums drawn from reserves available for this purpose, less any losses brought forward and sums placed to reserve in accordance with the law or the statutes.

It is said that the link established by this balance sheet test between the distribution of dividends and the accounts is misleading and generates a divorce between the company’s real capacity to pay dividends and the result obtained by this balance sheet test. The balance sheet is a mere snapshot of a reality in constant change, being unable to assess the company’s prospects and future cash flows, in other words to determine the solvency of a certain company and its capability to distribute or not dividends.

To this structural struggle of the balance sheet to determine the real capacity of a certain company to distribute or not dividends was added a new difficulty: the implementation of the International Financial Reporting Standards (“IFRS”) at the Community level with the approval of the Regulation (EC) no. 1606/2002 of the European Parliament and of the Council, of the 19th of July 2002. As it is recognized by the International Accounting Standards Board (“IASB”), the IFRS were designed to serve the interests of the current and potential investors and not the interests of the company’s creditors. In addition to that, the fact that the application of the IFRS is not mandatory to all types of public companies leads to the simultaneous application of different accounting rules and that creates unacceptable distortions among companies that operate in the same market.

It should be noted that these criticisms can also be drawn against the acquisition and redemption of own shares regime established by the Second Directive, a s they also rely on the balance sheet test.

With this background and practical difficulties, the number of critics of the balanced sheet test increased dramatically and the application of the so called solvency test to the distribution of dividends gained many supporters.

The so called balance sheet test is a typical mechanism of Anglo-Saxon countries and has different versions and legal transpositions. In broad terms, it can be said that it is a test that gives the directors of a certain company the responsibility to propose or not the distribution of dividends. In case the directors are of the opinion that the company is in conditions to distribute dividends they shall attest and justify their belief in a declaration addressed to the shareholders, being subject to disqualification and personally liable for the content of such declaration. 

This mechanism has been successfully used in common law countries, but also in civil law countries that opted for this legal solution in the distribution of dividends, such as New Zealand.

In the first decade of the XXI century various academics and working groups warned about the weaknesses and inefficiencies of the legal capital doctrine, mainly the ones of the dividends distribution regime, and pointed out the need for change, suggesting the solvency test as a way forward.

In this context, in 2006, the European Commission decided to hire the accounting company KPMG to conduct a study on the feasibility of an alternative regime to the one established by the Second Directive.

The findings of that extensive study were released two years later. It was concluded that the current regime do not constitute a major obstacle to dividend distribution and that various Member-States have implemented or permitted the implementation of the IFRS without apparent difficulties for the distribution of dividends.

Regardless of the criticisms drawn against the methodology used in this study, the truth is that the European Commission accepted its conclusions and issued a press release announcing that no follow-up measures or changes to the Second Directive would be implemented in the near future.

Since that moment no initiatives were taken by the European Commission to re - introduce the issue of the implementation of the so called solvency test. This issue and the remaining issues raised by the legal capital doctrine were not even mentioned in the report on the future of the EU company law that, on the 5th of April 2011, was presented by the reflection group that was created by the European Commission for that purpose.

It was then with surprise that, on the 9th of April of 2014, it was found that the Proposal for a Directive on single-member private limited liability companies suggested, for the very first time at the Community level, the implementation of a solvency test.

Such surprise was even bigger when the explanatory memorandum of this Proposal for a Directive affirms that:The Directive also contains rules regarding distributions (e.g. dividends) to the single - member of the SUP (Societas Unius Personae). A distribution may take place if the SUP satisfies a balance-sheet test, demonstrating that after the distribution the remaining assets of the SUP will be sufficient to fully cover its liabilities. In addition, a solvency statement must be provided to the single-member by the management body before any distribution is made. The inclusion of the two requirements in the Directive ensures a high level of protection of creditors, which should help the label «SUP» to develop a good reputation.” 

Even though this Proposal for a Directive established a version of the solvency test that only includes a prevision about the ability to pay the debts that will fall due in the year following the date of the proposed distribution and that the solvency test is still coupled with the balance sheet test, it is remarkable that the European Co mmission finally recognizes the merits of the solvency test and the weaknesses and inefficiencies of the legal capital doctrine implemented by the Second Directive.

Not only does this Proposal for a Directive introduce a solvency test, but it also re peals the minimum capital requirement and obliges Member-States not to approve rules that require companies to build up additional reserves.

This Proposal for a Directive and the arguments used in its explanatory memorandum indicate that the European Commission has changed its mind regarding this topic, being nowadays convinced that the legal capital doctrine is not a decisive element in the protection of creditors and that in many cases it imposes unjustified restrictions and costs to the companies. This Proposal for a Directive will inevitably reintroduce the debate about the legal capital doctrine and about the change of the balance sheet test for a solvency test in the distribution of dividends of public companies.