The Legal Capital Rule

Redbridge

The structure of business models of many companies, (those which engaged in the implementation of long-term investment projects, service) are such when at the initial stage of activity companies face conditions of negative capital before receiving so-called deferred profits. In this situation many countries have adopted different approaches regarding the protection of creditors․

In the United States, corporate law provides maximum flexibility to the owners of the company, and creditors protect their interests by contract, while in Europe, the main purpose of corporate law is to protect creditors. 

One of the instruments of protection creditors by law is the rule of legal capital and its aftereffect rule recapitalize or liquidate (ROL), which means if the value of net assets falls below the minimum amount of the authorized capital, the company must be liquidated or recapitalized.        

In Armenia, generally, there is no established minimum amount of the authorized capital for companies. However, if the value of net assets is negative some consequences can be expected:

    • In the case of limited liability companies (LLC) if the value of net assets is negative the company is subject to liquidation.
    • In the case of joint stock companies (JSC), negative net asset value is admissible under certain conditions.

If the value of the company’s net assets is negative, or if the minimum amount of the authorized capital is established, the value of the company’s net assets is less than the established amount then:

    • The executive body of the company is obliged to submit to the Board of directors a request to convene an extraordinary meeting of shareholders,
    • An extraordinary meeting decides whether liquidate or continue the activities of the company,
    • A decision on continuing operations may be made if the board or the executive body has submitted a written opinion on the expediency and justification of continuing the company’s activities taking as a basis:     
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        • the directions of the company’s activities,       
        • scope of the company’s activities,       
        • its features,       
        • activity programs and other circumstances.

If such a decision is not taken, the company is subject to liquidation․

It is also should be noted, that according to the balance sheet insolvency rules, the debtor is insolvent where the liabilities of the debtor in two thousand times or more, the amount of the minimum wage established by law, exceeds the value of the debtor’s assets. Accordingly, in Armenia, the top limit of permissible negative equity is two million Armenian drams (approx. 4,170 USD).

However, some experts have suggested that legal capital rules are an ineffective and unnecessary form of creditor protection in developed economies, since the rules themselves are incapable of delivering the desired protection, and other strategies are available to provide what is necessary.