The Swiss Federal Supreme Court ruled in a recent decision that up-stream and cross-stream loans must  be entered into at arm's length terms. If not at arm's length, the decision seems to suggest that such loans  constitute de facto distributions and may only be granted for an amount that does not exceed the lender's  freely distributable reserves. The court also imposed stringent requirements on satisfying the arm's length  test. In addition, the court held that an up-stream or cross-stream loan that is not entered into at market terms  reduces the lender's ability for future dividend distributions by the amount corresponding to the loan.

Further, the Swiss Federal Supreme Court raised the question whether Swiss companies are allowed to  participate in zero balancing cash pools at all.

On a more positive note, the Swiss Federal Supreme Court used the decision to give 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, instead, may be distributed to shareholders in accordance with  the general rules applicable to the distribution of dividends.


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 on a distribution of 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 giving such 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 Swiss Federal Supreme 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. In particular, in the case at hand it ruled  that an intra-group loan granted by a subsidiary to  its shareholder or a sister company may constitute a  de facto distribution rather than a loan, and it 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 recognized that  non-market term interests could under certain  circumstances 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. While the Swiss Federal Supreme  Court did not specify what constituted arm's length  terms in the context of the case at hand, it held  that none of the loans entered into were at arm's  length because the loans were unsecured and  the creditor allegedly did not analyze the debtors'  credit-worthiness at the time it entered into the  loan. The court made its finding without taking  into consideration the particular circumstances of  the case or the indirect benefits of the intra-group  financing arrangement (or indeed the fact that the  relevant loans had already been repaid). 

Intra-group 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 according to  which 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 as it suggests to  require them to closely monitor freely distributable  reserves in light of their intra-group 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 Swiss Federal Supreme Court also raised the  question of whether the participation by a Swiss  company 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, the court 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 for the reasons indicated  above.

Paid-in Surplus Capital (Agio) May  Be Distributed to Shareholders

On a more positive note, the Swiss Federal  Supreme Court further decided conclusively 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 this practice was criticized by  a minority of legal scholars. Therefore, a clear ruling  on this by the Swiss Federal Supreme Court 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 (Allgemeine Reserve). 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% in the case of holding companies).

What the Decision Means  for Swiss Companies

In light of this recent decision we recommend that  Swiss companies review their intra-group financing  arrangements, in particular, up-stream and cross-stream loans, cash pooling arrangements and  also any up-stream and cross-stream security. 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 decision raises a number of legal questions  and certain of its parts appear to deviate from past  precedents and established legal doctrine without  discussing this in depth. In our view this may suggest  that, although the court does not explicitly mention  it, some of the rulings of the court may rather have  to be seen in the context of the particular case  and less in more general terms. In any event, the  practical impact of the decision on Swiss companies  remains to be seen. This will in part depend on how  auditors implement the Swiss Federal Supreme  Court's decision because it is the auditors who will  have to give confirmation that dividends comply  with the law and with the companies' articles of  association. Given the complexity of the legal and  financial issues involved with intra-group financing  and in view of the paramount importance of efficient  liquidity management for Swiss companies, further  clarification in case law would be welcome. We  can only hope that courts will take into account  the crucial need for efficient financing and liquidity  management within groups of companies.