When a company is in distress, the most certain way to get financing required to avoid its bankruptcy is to ask its shareholders.

Financing a limited liability company by its shareholders

Any company may at some point face financial difficulties, which, if not mitigated, may quickly turn into insolvency.

According to the Polish Bankruptcy and Reorganisation Law1, a company is considered to be insolvent when (i) it does not timely perform its financial obligations (regular insolvency) or (ii) the value of its obligations exceeds the value of its assets, even if it continues to perform its financial obligations on time (balance sheet insolvency). If a company is insolvent, its directors (called in Poland "company's management board members") should file for bankruptcy and the court should initiate the relevant proceedings aimed at protecting the company's creditors.

To prevent the company from becoming bankrupt, the company itself may try to get the external financing, which may be difficult for a distressed entity. The company may also try to obtain internal financing, such as from the company's shareholders, which seems the most certain way of getting the funds required to avoid bankruptcy.

Funding scenarios

Generally shareholders may fund the company by: (i) additional payments (in Polish: "dopłaty"), (ii) shareholders' loan, or (iii) increasing the company's share capital. Depending on the type of financing, it may improve the cash flow and prevent regular insolvency or decrease the company's debts and mitigate balance sheet insolvency.

Additional payments and shareholders' loan

To finance the entity by way of "additional payments", the shareholders' meeting should adopt a resolution imposing the relevant obligation on all shareholders; such an obligation may not be imposed only on selected shareholders. Furthermore, "additional payments" must be imposed on all shareholders equally, pro rata to their shares. The shareholders' meeting can adopt the resolution on additional payments only when the company's Articles of Association (i) clearly state that shareholders may be obliged by the shareholders' resolution to make "additional payments" and (ii) indicate the maximum amount of such "additional payments". If after obtaining "additional payments", the company at some point has excess funds, then it may return "additional payments" to the shareholders.

At first glance it seems that "additional payments" are similar to the shareholders' loan. The main difference is that "additional payments" can be imposed compulsorily (ie, when the majority shareholders decide to impose such payments, the minority shareholders must make them). Shareholders' loan, by contrast, can be granted only at the sole discretion of each shareholder, and each shareholder can refuse to participate in this kind of financing.

Another difference between the "additional payments" and a shareholders' loan is that in the case of a loan, the company's debts are increased by the amount of the loan. In contrast, "additional payments" received by the company do not increase its debts. This means that "additional payments", unlike shareholders' loan, may mitigate the balance sheet insolvency.

"Additional payments" and shareholders' loan are subject to a 0.5% tax on civil law transactions, and the tax basis is the total amount of the loan or of the "additional payments".

Share capital increase

Shareholders may also provide additional funds to the company by (i) increasing its share capital or (ii) increasing the share capital and the reserve capital. The second option is when the shareholders take up new shares at a value higher than the nominal and the surplus (agio) is transferred to reserve capital.

The main difference between the above two options is that the amount of agio does not create new shares, so some part of the funds contributed to the company (agio) is not exchanged for the newly created shares. Furthermore, with respect to these options, the tax implications are different. The increase of the share capital triggers an obligation to pay the tax on civil law transactions (0.5% of the amount of the increase), but the amount intended for the reserve capital (agio) is free of such tax.

An increase of the share capital generally requires amending the Articles of Association and the court filing. Taking into consideration these formalities, such way of financing seems more complex and time-consuming than "additional payments". But this scenario has a significant advantage: If the shareholders do not want to engage their own funds, they may decide to admit the third party as the company's shareholder; that is, the third party may take up new shares and cover them by the relevant contribution.

Quote: When shareholders are considering the best way to fund their company, they should weigh the expected outcome of the process (ie, whether the aim is to improve cash flow or decrease debts) and the tax implications.

Footnote

1. Consolidated text published on 9 October 2012 (Journal of Laws 2012, pos. 1112).

This article was originally published in the schoenherr roadmap`14 - if you would like to receive a complimentary copy of this publication, please visit: pr.schoenherr.eu/roadmap.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.