In the course of business, companies may not always report profits; if the losses are either recurrent or of a significant size, this situation can have a negative impact on the shareholders’ equity. The shareholders’ equity (or a company’s net assets) is the residual value of the assets after paying off all the company’s debts. The shareholders expect a high valuation of their company’s net assets, but there are other stakeholders in the company for whom the value of the company’s assets is also important. To this end, Romanian Companies’ Law imposes certain rules on a minimum threshold of the net assets that must be observed by all companies.
Framework: The provisions of the Romanian Companies Law (the ”Company Law”) specify the steps to be taken when dealing with losses within the net assets position.
Threshold: Whenever the shareholders’ equity of a company is less than half of the value of its share capital, the Company Law requires the Board of Directors to call an Extraordinary Shareholders Meeting to inform them about the financial position, so that they can decide whether the company remains a going concern or whether it must be liquidated.
Timing: Should the shareholders decide that the company continues its activity, then the company is required, as per the dispositions of the Company Law, to correct the negative shareholders’ equity before the end of the financial year following the year when this issue was identified. The wording of the legal provisions is misleading, as it offers two possible interpretations of the reference year: either the financial year when the situation has occurred or the financial year when the situation has been identified. In the absence of clear interpretation rules and other guidelines, we argue that the wording speaks in favour of the second interpretation.
- the Extraordinary Shareholders Meeting is not held, or
- the Extraordinary Shareholders Meeting does not vote on a course of action, or
- the company fails to correct the shareholders’ equity situation within the term allowed by the Company Law,
there is a risk that any third party justifying an interest may approach the court and request the dissolution of the company. The court can then grant the company a six-month grace period to mitigate the situation.
Recently, the National Agency for Fiscal Administration (“ANAF”) initiated a law project which should allow the tax authorities to start the liquidation procedures of companies which have reported net assets below the legal threshold for at least two consecutive years.
Available options to correct negative shareholders’ equity: Companies which report a loss at the end of a financial year, following the approval of the financial statements, have to undertake, as a first step, the covering of the losses by using the available cumulated profits, share premiums, reserves and share capital. If, following such process, there is a residual loss, the share capital should be increased.
To bring the shareholders’ equity up to the limit requested by the Company Law, increasing the share capital should result in an increase of total assets (see a) below) or a decrease of the company’s debts (see b below). Consequently the share capital may be increased by:
a.Contribution in kind or cash contribution from shareholders
Shareholders decide the form of contribution and the new weight in the increased share capital, based on the company’s Articles of Incorporation.
b.Conversion of the overdue debt into shares
The provisions of the Company Law allow companies to increase the share capital by converting overdue liabilities into shares. One option, usually preferred by companies in such situations, is the conversion of loan debts towards shareholders into share capital. This conversion can be used only for loans which are due, and within the terms allowed by the company’s Articles of Incorporation.
Following this increase, the share capital should be subsequently decreased with the purpose of covering the accounting losses, therefore lowering the minimum threshold to be met by net assets.
Registration procedure: All increases and decreases of the share capital of a company must be recorded at the Romanian Commercial Register.
Companies recording net assets below the 50% mark of their share capital for at least two consecutive years are likely to receive notification from the tax authorities about remediation steps required. If not satisfied with the proposed actions or progress, the tax administration can initiate the liquidation procedure. If in the past there were few cases when third parties requested the court to order the dissolution of a company, now this risk is significantly higher.
The correction of a company’s net assets must be approached by covering first the reported net losses from the company’s reserves and share capital and, if such equity elements are not enough, to increase the share capital by means of shareholders’ contribution (increase of assets) or conversion of shareholders’ loans or other forms of debt to shareholder into shares (decrease of liabilities) and subsequently use such share capital to cover residual losses and reduce the required threshold.