Transactions January 2018

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Draft Bill of 1 December 2017 for amending section 348 bis of the Spanish Companies Act

By Josep Enrich

About a year ago, on 1 January 2017, section 348 bis of the Capital Companies Act (hereinafter referred to as “LSC”) became effective again, whose application had been on hold since 2 October 2011 due to the delicate economic situation that the country was then undergoing, the Legislator being aware of the impossibility to apply a legal precept with such economic and financial effects in such context.

Section 348 bis LSC attempted to solve or reduce the conflict between controlling and non-controlling members as regards dividend distribution seeking to eradicate the abusive practice by controlling members when systematically denying such right with the evident economic damage that such denial implies to non-controlling members, whose claim is no other than making their share in the Company profitable by sharing the profits thereof.

1. The current section 348 bis and its defects

Section 348 bis provided for the possibility that as of the fifth financial year counted from the registration of the company with the Companies Registry, if the General Meeting did not agree the dividend distribution of, at least, a third of the profits from the corporate purpose operation during the previous year, the member or members that may vote in favour of such distribution would be vested with the Right of Withdrawal within a term of one month, in the same manner as provided for in section 346 et seq. of the LSC (Right of Withdrawal).

Although it is true that in some cases the entry into force of such section had dissuasive effects on abusive actions by some controlling members, in practice, this has entailed a clear conflict of interests, thus the high risk that the validity of the current content of such legal precept may have for the continuity and economic stability of the majority of companies, becoming evident. The main practical problem of such precept arises from the lack of cash flow of companies to distribute dividends, particularly because the main part of the Spanish industrial network consists of small and medium-sized businesses, whose economic capacity is limited; and the financial damage accrued from the capital reduction that implies the exercise of the Right of Withdrawal by members, with devastating effects in companies, which may even be forced to petition the declaration of commercial bankruptcy.

2. Proposal to amend section 348 bis

Since the entry into force again of section 348 bis, two amendment proposals have been filed, the first one in April 2017 by the ERC Backbench “in order to prevent the increasing litigation because the section is unclear” and the second one in December 2017 by Partido Popular Backbench with the aim of “finding balance between financial sustainability of the company and the legitimate aspiration of shareholders to share profits, whenever reasonable”, the latter being published on 1 December 2017 in the Chamber journal.

Such balance is sought by means of the following amendments:

  • The application of the Right of Withdrawal is conditional on the absence of by-laws provisions that may provide for otherwise, so that it becomes an operative issue under the Bylaws. We should qualify, however, that as we are dealing with the removal of the Right of Withdrawal, it should be approved unanimously pursuant to section 347.2 LSC, unless the Right of Withdrawal is recognised to such members that have not voted in favour of such resolution.

  • In view of the requirement of one sole financial year without distributing dividends, the amendment requires a three-year term without distributing dividends. Therefore, now three uninterrupted years would be required to be able to resort to the Right of Withdrawal due to non-dividend distribution, the calculation of such term being restarted in the event the year is closed with a loss.

  • The minimum percentage of profits to be distributed is reduced from one third to one fourth, and also allows to meet such percentage by means of a weighted average of the last five years, thus allowing a lower profit distribution in such years in which the reinvestment thereof is required.

  • The reference “profits from the corporate purpose operation” is deleted, since it implies an excessively complex determination because it is a too vague definition and thus creates legal uncertainty.

  • The expression “as of the fifth financial year” is replaced with “after the fifth financial year” in order to remove any possible misinterpretation of the version in force, which could lead to consider the Right of Withdrawal as exercisable at the beginning of the fifth financial year as of the incorporation of the company in respect to the result of the fourth year.

  • As regards the subjective exclusion of listed companies already included in the section in force, the amendment proposal extends it to such companies whose shares are listed for trading in a multilateral trading system, such as, for example, the Alternative Stock Market.

  • Finally, bankrupted companies or such companies that may have communicated the competent court for petition of declaration of bankruptcy the initiation of negotiations to reach a refinancing agreement, obtain adhesions to an early proposal of arrangement or reach an out-of-court payment agreement, are expressly excluded.

3. Conclusion

The amendment proposal dated 1 December 2017 preserves the protection for non-controlling members and at the same time seeks to remove the unbalance resulting from the capacity to act abusively that the wording of section 348 bis granted to controlling members and the damage that this may imply for the company.

Although the capacity to act of non-controlling members would be limited by the new content of the legal precept, we must remind that the LSC has a protection mechanism for non-controlling members to abuses of the majority by means of that set forth in section 204.1 second paragraph of the LSC, which provides for as contrary to the company interest and therefore capable of being challenged, such resolutions of the General Meeting imposed abusively by the majority, which are considered as such resolutions that “without meeting a reasonable requirement of the company, are adopted by the majority in their own interest and to the unjustified detriment of the other members”.

With such mechanism, companies are protected from the irreparable damages that the deliberated invocation of the Right of Withdrawal could cause in default of the dividend distribution and simultaneously the non-controlling members’ right to share the profits of the company, is protected.