Minimum legal capital – trivial and irrelevant

One of the basic requirements of the legal capital regime as established the by the Second Directive is that before a company takes its first ‘breath’ as a legal vehicle with limited liability, it must raise a certain amount of minimum capital. According to the Second Directive, this amount is 25.000 Euro (Art. 6 Para. 1). The minimum capital required by the Directive has been criticised for being trivial and meaningless.³⁰⁰ It is trivial because the amount of 25.000 Euro is too low of an amount to provide any realistic protection to creditors against the risk of insolvency caused by exogenous shocks to the company.³⁰¹ The principle of proportionality of own (equity) capital to the risk/loss potential of the company cannot be guaranteed even for the small companies, the loss potential of which is normally much higher than the minimum legal capital.³⁰² Additionally, the requirement of the Second Directive that at least one quarter of capital, namely 6.250 Euro, is paid in before a company starts operations adds more to the woes of the minimum capital requirement. Considering that the Second Directive applies only to public limited liability companies (Art. 6 Para. 3), it becomes obvious that the amount of minimum capital cannot provide any significant protection to creditors of the company.³⁰³ The legal capital does not provide a ‘buffer capital’ or a pool of capital, which the company can avail herself of when facing difficulties, because the legal capital is a business capital that can be consumed in the course of business and not a regulatory capital.³⁰⁴ Therefore, the

298 High Level Group Report.

299 Ibid., p. 13.

300 Enriques/Macey, Cornell Law Review, 2001, 1165, p. 1185; Miola, European Company and Financial Law Review, 2005, 413, p. 426; Interdisciplinary Group on Capital Maintenance, European Business Law Review, 2004, 921, p. 931; Hirte, Kapitalgesellschaftsrecht, p. 304; Schall, Zeitschrift für Unternehmens- und Gesellschaftsrecht, 2009, p. 138.

301 Mülbert/Birke, European Business Organization Law Review, 2002, 695, p. 718. “At best, this may reduce the probability of insolvency of rather small ventures in the start-up phase. However, knowing that the public company is usually the typical legal form for large scale undertakings this amount will hardly reduce the probability of insolvency caused by exogenous shocks by more than a trivial percentage.” See also Boschma et al., Alternative Systems, p. 6.

302 Grigoleit, Gesellschafterhaftung, p. 461.

303 See also Ewang, 2007, p. 9 “Despite its triviality, the capital maintenance doctrine on which the minimum capital doctrine is based is an unnecessary abstraction and provides illusory protection.”

304 Cf. with regulatory capital held by banks as a ratio of weighted assets.

test function, assumed to be performed by the legal capital could be strongly questioned. ³⁰⁵ Further, the amount of capital stipulated by the Directive is completely disconnected to the type of business activity, and thus also to the size of risk a company choses to undertake.³⁰⁶ Considering the ‘one-quarter-of-paid-up-capital’ rule, it is possible that also small-scale enterprises avail themselves of the possibility of being established as public limited liability companies to perform large scale business activities. Thus the ‘filter effect’ of the minimum capital to prevent ‘bogus’ or ‘sham’ companies from gaining limited liability and performing large size business activities loses its strength.³⁰⁷ Certainly, increasing the minimum capital would not be a solution either, because it could constitute too high a burden for successful projects to materialise. Additionally, the difficulties of quantifying an amount of minimum capital that reduces significantly the risk of insolvency and that would make a balanced barrier neither too high to prevent successful business initiatives to materialise nor too low to make it easy for ‘sham’ companies to exploit the status of a public limited liability company are almost insuperable. Any chosen amount would be arbitrary and inappropriate, and economically doubtful³⁰⁸ because it is difficult to determine ex-ante the amount of capital necessary to cover a firm’s future liabilities.³⁰⁹

It is certainly better, one has to concede, that little capital is better that no capital. But it is open to doubt whether the level of protection provided to creditors and the effectiveness of the seriousness signals given by the minimum capital justify the current complex system of rules.

As a matter of fact, there is a growing trend³¹⁰ in relying more on stronger company law rules regarding managers and shareholders (also of shareholders-managers) liability towards company’s creditors for actions that endanger the existence of the company by causing³¹¹ its

305 For a critical perspective on the seriousness-test function of the legal capital see Hirte, in:

Verhandlungen des Sechsundsechzigsten Deutschen Juristentages. Sitzungberichte - Referate und Beschlüsse, 2006, p. P 27. See also Mülbert/Birke, European Business Organization Law Review, 2002, 695, pp. 717-8.

306 See Vetter, Zeitschrift für Unternehmens- und Gesellschaftsrecht, 2005, 788, p. 799. However, certain types of business activities, such as banks, require a substantially higher amount of minimum capital.

307 Hirte, Kapitalgesellschaftsrecht, p. 304. The minimum capital is simply a “Einstrittskarte”, an entry card into the privilege of limited liability.

308 Mülbert/Birke, European Business Organization Law Review, 2002, 695, pp. 718-9. See also Schön, European Business Organization Law Review, 2004, 429, p. 437 stating that there is no meaningful link between the financial needs of an individual enterprise and the amount of legal capital prescribed by statutory law.

309 Ewang, 2007, p. 18.

310 For example the 2008 German Act to Modernise the Law on Private Limited Companies and Combat Abuses.

311 Such acts include for example undercapitalization or deviation from the rules of appropriate financial

insolvency or its inability to serve its debts. This refocusing in the mechanisms of statutory creditor protection is seen as a complementary response to the weakness of the legal capital maintenance mechanisms of creditor protection.³¹² The privilege of limited liability is no longer justified when those persons enjoying this privilege misuse it for personal benefit and to the disadvantage of the company or of the company’s creditors. Under this stricter liability regime, the statutory requirements would demand a two-steps model³¹³ for ensuring a better protection of the creditors of a company experiencing a crisis: first, the duty of the management of the company experiencing the crisis are to be focused on maintaining the interests of the company’s creditors and not of the shareholders. This includes also the prohibition to use company’s assets for the payment of debts other than of those pertaining to creditors. As a second step, the company’s management is obliged to stop trading and file for insolvency in order to avoid incurring more debts and cause more harm to the company’s creditors (see for example the English concept of wrongful trading³¹⁴). This trend moves the focus of creditor protection away from the “entry requirements” into the limited liability regime through minimum legal capital to the “exit liability”³¹⁵ by holding company’s management liable under stricter rules combined with added requirements regarding publicity of company’s information. The strengthening of the liability rules for company’s management tightens also the liability of company’s shareholders, who might be held liable in the same way as the company’s manager where the controlling shareholder exerts undue influence on the manager as to cause the later to act according to the instructions of the former,³¹⁶ or where the manager is also the sole shareholder of the company, as it typically is the case in private companies.

planning, deprivation or withdrawal of assets from the company (and putting the company in danger of insolvency or at disability to pursue its statutory goals) or the treating of the company’s assets as it were of the shareholders (or differently put, when the non-separation of the company’s assets from those of the shareholders). For a more thorough discussion on these situations triggering personal liability for the shareholders see Grigoleit, Gesellschafterhaftung), p. 394 ff. and Schall, Kapitalgesellschaftsrechtlicher Gläubigerschutz, p. 332 ff.

312 See also Kroh, Der existenzvernichtende Eingriff, 2013, p. 111 – 2.

313 See the work of Schall, Kapitalgesellschaftsrechtlicher Gläubigerschutz, p. 324 ff. for a longer elaboration of this model under German law.

314 See for example the concept of wrongful trading in English company law.

315 Schall, Kapitalgesellschaftsrechtlicher Gläubigerschutz, p. 333 and Kroh, Der existenzvernichtende Eingriff, 2013, p. 112.

316 An example of such a situation is when the company’s manager fails to run the company for the benefit of the company as a whole rather for the benefit of a particular shareholder, with other words failing to commit to the so called “decentralized pursue of profit” (in German language „dezentrale Gewinnverfolgung“). The so called “decentralized pursue of profit” leads to the neutralisation of diverging individual interests of the company’s shareholders, guaranteeing in this way their equal participation in the company’s success. Also the company’s management is bound by the company purpose to act in the interest of the company as a whole and to commit to the “decentralized pursue of