Mandatory regulations in Spain when the equity of the company is lower than one half (or two-thirds) of the share capital

The Drunkard (Le saoul) - Marc Chagall
Spanish companies are regulated by Royal Decree 1/2010, of July 2, whereby it is approved the condensed text of the Companies Law (hereinafter referred as “Companies Act”).

According to article 363.1 e) of the Companies Act: “A company shall be dissolved: e) due to losses that reduce its equity to an amount lower than one half of the share capital, except where the capital is increased or decreased as required and application for insolvency protection is not warranted.”

In consequence, if the accounts of a Spanish company reveal that the equity is below one half of the share capital, there is an obligation to restore the equity of such company. However, if the company is under state of insolvency, Spanish Insvency Act prevails over Companies Act.

Regarding the insolvency situation it is important to note, that the Spanish Insolvency Act uses a concept quite different from the used by the UK Insolvency Act and the US Bankruptcy Code, as we seen on previous entries published in this blog as “Concepto de insolvencia en Estados Unidos (y mención al régimen español e inglés)” or “Situación de insolvencia España-Inglaterra”.

Another important point regarding the obligation to restore the equity of a Spanish company, is to distinguish a private limited company (in Spanish “Sociedad Limitada” or “S.L.”) from a limited company by shares, also called joint stock company (in Spanish “Sociedad Anónima” or “S.A.”). That is due to an special rule applicable to S.A., which is laid down in article 327 of the Companies Act: “Joint stock companies shall be bound to reduce their capital when their losses lower their equity to under two-thirds of their capital and no recovery in equity is forthcoming for one full year.”

As we have seen, a S.L. can choose to reduce its share capital or other options (for example increase its share capital, take out a profit participating loan, etc.). However, a S.A. is allowed to decide between the existing options during one year and, if during such year the equity is under two-thirds of its share capital, the share capital reduction shall be mandatory.

This regulations are relevant to be met, because article 367 of the Companies Act establishes that directors who fail to convene the mandatory general meeting within two months shall be jointly and severally accountable for the company obligations incurred after the legal cause emerged. In consequence, if directors do not comply with articles 363.1 e) and 327 of the Companies Act, an insolvency proceeding will terminate with a resolution stating its liability for company debts (debts not covered by the assets of such company).