Suspension of Compulsory Capital Reduction and Liquidation in the event of Capital Loss

The Solidarity Law declared a public emergency in economic, financial, tax, administrative, pension, tariff, energy, health and social matters. In the referred law and pursuant to section 76 of the Argentine Constitution, important legislative powers were delegated to the Argentine Executive. As has occurred on previous occasions, section 59 of the Solidarity Law established the suspension of the effectiveness of sections 206 and 94, subsection 5 of Argentine Companies Law No. 19,550 (the “Companies Law”) until December 31, 2020.

 

1. Preliminary considerations

The Argentine economy is in the middle of a deep recession. This has been  compounded by the Argentine peso devaluing nearly 100% in 2019, the impact of the adjustment for inflation effective as of the end of 2018, and the losses generally associated with business risk per se. All these issues have impacted negatively on  local companies, many of which are  at risk of requiring compulsory capital reduction (Section 206 of the Companies Law) or even compulsory liquidation (Section 94 subsection 5 of the Companies Law).

This is not the first time that such a measure has been taken. From September 1989 until September 1991   and from July 2002 until December 2005, due to economic emergency situations, the effectiveness of Sections 206 and 94 subsection 5 of the Companies Law were also suspended.

 

2. Compulsory capital reduction 

Section 206 of Companies Law provides that the capital “[r]eduction is compulsory when losses absorb reserves and fifty per cent of the share capital.”

According to section 316 of the General Resolution 7/2015 of the Public Registry of Commerce (the “IGJ” after its acronym in Spanish), companies recording losses on their balance sheets must absorb them impacting on: (i) legal, statutory and voluntary reserves, according to  the order approved by the shareholders´ meeting, following, as the case may be, the provisions of the by-laws; (ii) premium share account; (iii) capital adjustment account; and (iv) corporate capital account (for non-listed companies in the city of Buenos Aires). For listed companies, the Argentine Securities and Exchange Commission (the “CNV” after its acronym in Spanish) follows similar criteria, but goes into more detail regarding the order to be considered. In that sense the CNV provided that the negative balance of the “Retained Earnings Account”, at the end of the tax year must be absorbed as follows: i) to retained earnings (voluntary, statutory, and legal, in that order); (ii) capital contributions; (iii) premium share account and other premium accounts; (iv) other instruments of the net worth (provided that it is legally possible); (v) capital adjustment account; and (vi) corporate capital account.

Once the existence of losses in the conditions referred to above have been verified, either when preparing the tax year balance sheet or from other accounting documentation, the board of directors must summon an extraordinary shareholders’ meeting to approve the compulsory capital reduction. The Companies Law does not set any limit on the reduction, even though there are certain theories regarding the amount of the capital reduction above the necessary values to allow the company not being encompassed in said situation. However, since the Companies Law does not set any special provisions in this regard,  the shareholders will set the terms of the reduction as they deem appropriate.

The Companies Law does not provide any penalty if the company should fail to make the compulsory reduction, but it does consider directors, statutory auditors and members of the supervisory board as liable, authorizing legal actions to be brought against them.

 

3. Winding up due to losses

Section 94, subsection 5 of the Companies Law provides that “The company is to be dissolved (...) following loss of share capital ...”.

As to the interpretation of the concept of “share capital”, there are those who consider that in spite of the terminology used, the Companies Law refers to “corporate assets”. It seems reasonable to consider that the law is referring to situations of companies in which there is a negative net worth situation.

The ideal instrument for determining the existence of a total loss of share capital is also an issue to consider. The majority of legal scholars’ opinions leans towards the use of the financial statements for the tax year as the appropriate document for evaluating this matter. It is important to underline that the loss should be definitive in nature and not merely circumstantial.

Once the existence of the compulsory capital reduction situation has been determined, the board members are obliged to confirm it and notify the situation to the shareholders, under penalty of being considered liable. However, winding up and liquidation may only occur upon a resolution of the shareholders, and not automatically. Shareholders may choose alternatives other than liquidation, such as restoring the capital or increasing it. Even though the Companies Law does not provide a term for shareholders to remedy the situation, it is generally considered that they should act immediately upon determination of the loss, adopting any of the alternatives provided by the Companies Law.

Directors and statutory auditors of companies that are considered to be under liquidation for the reasons described above must adopt the measures required to initiate the winding up and liquidation and cease corporate activities unless the shareholders approve either a capital refund or increase. If this does not occur, and the company continues to operate, the directors and statutory auditors would be considered severally liable, without limit, to third parties and shareholders, notwithstanding the responsibility of the latter (Section 99 of the Companies Law).

 

4. Conclusions

The Solidarity Law eliminates (or at least defers) the risk of compulsory capital reduction or even liquidation faced by companies with negative net worth.

The Solidarity Law allows companies’ balance sheets to be approved and filed even when they have negative net worth or are in situations of compulsory capital reduction. It also allows companies to continue operating without generating any responsibility for directors and statutory auditors for adopting those actions. This is a temporary remedy based on the extreme urgency of the situation.