Update on the Future of Control Balance Sheet

Current Regime

In accordance with Chapter 25 of the Swedish Companies Act (Sw. Aktiebolagslagen (2005:551)) (the “Swedish Companies Act”) currently in force if there is a reason to believe that a limited liability company’s shareholders’ equity (Sw. egna kapital) is less than one-half of its registered share capital the board of directors must immediately prepare a control balance sheet. If the control balance sheet consequently shows that the company’s shareholders’ equity is less than half of the registered share capital, the company must take the steps described in Chapter 25 of the Swedish Companies Act and convene a general meeting. The first general meeting shall then contemplate whether the company shall commence liquidation proceedings or whether shortage of own capital can be remedied to full amount and the company may continue to exist. If the first general meeting opts to continue, then the company has eight months to remedy the shortage of own capital. Shortage of own capital can be remedied for example by lowering the registered share capital, by converting shareholder loans into equity, by receiving new equity investments from shareholders or by the shareholders’ issuance of a capital adequacy guarantee (Sw. kapitaltäckningsgaranti). Following the eight-month period, a new general meeting shall be convened, and a second control balance sheet prepared. If the second control balance sheet does not show that the shareholders’ equity equals at least registered share capital of the company, the second general meeting shall resolve to liquidate the company. If no liquidation proceedings are commenced within two weeks after the second general meeting or no second general meeting was held timely a relevant district court shall resolve on a compulsory liquidation. If, however, the second control balance sheet shows that the registered share capital is recovered in full the company may continue its business.

Background for the New Proposal

Historically, the requirement to have a registered minimum capital and liability to act upon shortage of own capital derives from the tradition wherein such minimum capital is deemed to provide creditor protection. On an EU level such requirements regulate only public companies, and for example Finland has repealed minimum share capital requirement in respect of private limited liability companies. In Sweden the current minimum share capital for a private limited liability company is SEK 25,000 and for a public limited liability company SEK 500,000. In practice the minimum share capital required for private limited liability companies does not provide robust creditor protection in case of insolvency. Therefore, it has been questioned whether the Swedish Companies Act should include clauses that are not required on EU level, and which do not seem to serve the initial purpose of such clauses. Further, shortage of share capital coverage often arises late in the process and in practice if a company experiences financial difficulties in its operational business, such company typically becomes insolvent (i.e., unable to pay its debts when they fall due and such inability is not merely temporary) before the share capital coverage falls short.

New Proposal

The Report proposes, inter alia, sections 13 - 20(a) of Chapter 25 of the Swedish Companies Act regulating the compulsory liquidation due to shortage of own capital to be removed. Instead, it is proposed that under Chapter 8 section 4 regarding the duties of a board, the board’s duty to continuously assess the financial situation is further elaborated to include assessment that the company's equity and liquidity corresponds to what the nature, scope and risks of the business requires. Further, a requirement to deal with the matter immediately and convene a general meeting if the company's equity capital or liquidity does not correspond to what the nature, scope and risks of the business requires is incorporated under Chapter 8 section 6.

Certain requirements regarding minimum coverage of registered share capital for public companies are incorporated on EU level. Therefore, a new section 46(a) is proposed to be added to Chapter 8 setting out a requirement to convene a general meeting if a public limited liability company's shareholders’ equity corresponds to less than half of the share capital. The general meeting is to contemplate whether the company is to go into liquidation or if other measures are to be taken. The aim is to alert shareholders of the situation, but there is no requirement for the shareholders to decide to act, and thus, the shareholders may decide to continue operations without remedying the capital shortfall.

As a conclusion the Report proposes to replace the current share capital coverage requirements by a more general duty of the board to monitor equity and liquidity of the company. The suggestion is to shift focus of creditor protection from capital sufficiency to liquidity and solvency, and thus, connect the liquidity and solvency requirements to the existing precautionary rule (Sw. försiktighetsprincip) of Chapter 17 section 3 applicable upon distribution of dividends and other value transfers from a limited liability company.

In accordance with Chapter 17 Section 3 of the Swedish Companies Act a company may not carry out a value transfer (e.g., distribution of profit), unless there is a full coverage for the restricted equity (Sw. bundet eget kapital) immediately after the transfer (so called amount restriction rule (Sw. beloppsspärren)). In addition, according to the so-called the precautionary rule regardless of the result of an application of the amount restriction rule, a value transfer may only take place if it appears to be justifiable taken into account (i) the requirements that the nature, scope and risks of the business set on the size of the equity capital, and (ii) the company's consolidation needs, liquidity and position in general. Thus, in practice companies never make distributions in the full value permitted by the amount restriction rule, but the operation of the precautionary rule further restricts the distributable amount on a case-by-case basis and considering the special circumstances in which the company operates.

Liability of the Board

In accordance with the current regime (Chapter 25, section 18) if the board does not fulfil its obligations to prepare and have the company's auditor review a control balance sheet, convene a first general meeting (i.e., first control meeting) or apply to the district court for the company to go into liquidation the members of the board are jointly and severally liable for the obligations that arise during the time that an omission is continuing. A board member can be exempted from liability provided that that board member can evidence that she/he has not been negligent. As the Report proposes the relevant sections 13 – 20(a) of Chapter 25 to be repealed, the assumption of personal payment liability for new debts upon a failure to follow the statutory steps upon shortage of own capital would no longer apply.

According to the Report, the proposed new regulation aims to clarify the board’s liability to continuously monitor company’s financial position, thus the regulation primarily provides protection for the company (i.e., shareholders). Therefore, a sanction for any breach of such obligations should in the first place be liability for damages towards the company (i.e., internal damages) in accordance with Chapter 29. Therefore, the Report does not deem it necessary to connect any specific sanctions to the proposed new regulation as the sanctions would be those set out in Chapter 29.

According to the general rule set out in Chapter 29 section 1, a board member who intentionally or negligently causes damage to the company must compensate for the damage. The board’s general liability for damages towards the company provides protection also for the creditors of the company. In practice such protection would be obtained by a bankruptcy trustee raising a claim for damages on behalf of the company’s bankruptcy estate against the former board of directors, if as a result of the board's failure to act in accordance with the new regulation, the company has become insolvent and has been declared bankrupt.

Responses

Several referral bodies provided their responses to the Report to the Department of Justice by the deadline 15 December 2023, however, not all referral bodies commented on the new proposal regarding the shortage of own capital. Amongst those referral bodies who commented on the new proposal regarding the shortage of own capital, the majority welcomed a throughout perusal of the existing regulation, potential amendments to the existing regulation, and expressed generally positive response on the new proposal. However, several referral bodies expressed the need to amend, clarify and emphasise several wordings and aspects of the proposal. A few respondents expressed negative views on repealing of the current regime on the control balance sheet and expressed a concern whether the proposed new regulation would achieve its objective of strengthening the creditor protection under the Swedish Companies Act. Further, concerns were raised as to whether sanctions provided in Chapter 29 are sufficient, if in practice in bankruptcy situations creditors would receive protection only if the bankruptcy trustee would elect to file a claim for damages on behalf of the bankruptcy estate (Svensk Inkasso, Remissvar, Ju2023/01611).

Next steps

The government will now review the responses from the referral bodies and contemplate whether based on the responses amendments and/or alternative solutions are needed.

According to the Report the amendments to the Swedish Companies Act are proposed to enter into force from 1 July 2025 onwards. However, the repealed provisions in Chapter 25 Sections 13–20(a) would still apply if the obligation to prepare a control balance sheet arose prior to 1 July 2025.

We will keep you updated on the progress.