Distributions to shareholders: inspiration from the ‘partnership en commandite’?

In case of an irregular distribution a shareholder – even in good faith – is less deserving of protection than a creditor

A previous post had a look at the ancient partnership en commandite as a treasure-trove for company law reform. This post explores what we can learn from the ‘partnership en commandite’ for the regulation of  distributions to shareholders.

Dubious distributions

In any company, a distribution to a shareholder (e.g. a dividend) should be the cause of some unease. The basic deal of any company is that shareholders are subordinated to company creditors. A distribution allows shareholders to skip the line: they can get company assets even while some company creditors are yet unpaid.

The conflict between shareholders and company creditors becomes particularly sharp in a limited liability company. If the company makes a bad turn and becomes insolvent, there will not be enough assets to satisfy all creditors. As a rule, creditors cannot go after the shareholders, even if the distribution enriched the shareholders at the expense of the creditor.

To top it off, shareholders themselves decide – either directly or through the directors they have appointed – whether assets are distributed to them.

It should come as no surprise that distributions are regulated by mandatory rules. These rules are the surprisingly thin line between a legitimate distribution and an abuse of corporate assets.

The novelty the Belgian Company Act of 1873: a derivative claim for creditors

In this respect it is remarkable that the French Code de commerce of 1807 did not have a rule on distributions to (limited or unlimited) partners in a ‘partnership en commandite’. In the following decades legislators saw the need to abandon this regulatory insouciance. A striking example was article 21 of the Belgian Company Act of 1873, which still lives on as article 206 of the current Belgian Company Code (‘BCC’):

“Third parties can force [the limited partner] to return any interest or dividends distributed to him, if such distributions are not taken from the non-fictitious profits of the partnership. The unlimited partner has recourse against the manager for any distributions he had to return, in case of fraud, bad faith or serious negligence by the manager.”

The provision sets a very rudimentary cap on distributions: they need to be taken from the ‘bénéfices réels’. Distributions cannot eat up the contributions made by the partners; hence, they need to be taken from profits. And those profits should not be the result of creative accounting.

Over time company law has come up with more pointed tests than ‘bénéfices réels’. This is not an issue where history can teach us a lot, other than that no test will be a waterproof protection for creditors.

What could be inspiring for modern company law reform is the pioneering enforcement mechanism of the Belgian rule. It gives third parties (read: company creditors) standing to claim against shareholders who received a distribution. The creditors do not have to rely on enforcement by a bankruptcy trustee.

In addition the partner who is defendant against a claim by a creditor for an irregular distribution cannot invoke all the defences that he would be able to invoke against the company itself ( L. en S. Fredericq, Handboek van Belgisch handelsrecht, I, 554-555, nr. 674).

Good faith of shareholder is irrelevant in case of irregular distributions

One such defence of a partner is his good faith about the irregular nature of a distribution he has received.

If the partnership claims repayment, the limited partner can rely on his good faith to avert repayment (L. en S. Fredericq, Handboek van Belgisch handelsrecht, I, 555, nr. 675). If however a partnership creditor claims repayment based on art. 206 BCC, good faith is irrelevant (ibid., 555, nr. 674). The latter part of the article leaves no doubt about this.

The ancient rule for the ‘partnership en commandite’ seems in this respect more creditor-friendly than the rule in article 16 of the Second Company Law Directive (in Belgium transposed in article 619 BCC and made applicable to other corporate forms) :

“Any distribution made contrary to Article 15 must be returned by shareholders who have received it if the company proves that these shareholders knew of the irregularity of the distributions made to them, or could not in view of the circumstances have been unaware of it.”

This shareholder-friendly rule is not unanimously well received (see R. Tas, Winstuitkering, kapitaalvermindering en -verlies, in NV en BVBA, 2003, 298ff). Yes, it is unpleasant for a shareholder to pay back moneys which he has received in good faith. But it also unpleasant for a creditor in good faith not to be paid in full when at the same time a subordinated shareholder can hold on to company assets which have been distributed to him.

Recent scholarship may bring a solution. This solution is not found in company law, but in insolvency law, in particular the rules on voidable transactions (actio pauliana).  It is increasingly recognized that a dividend or another distribution is a transaction without any consideration given in return (e.g. S. De Dier, Nietigverklaring van bestuursbesluiten, 2016, nr. 223ff). Such transactions can be more easily challenged in case of an ensuing insolvency than transactions for value. Good faith is no valid defence in case of a transaction without consideration.

This development brings modern company law back to the antique rule for the ‘partnership en commandite’: if creditors (or a bankruptcy trustee on their behalf) sue for repayment of irregular distributions, the good faith of a shareholder is irrelevant.

Joeri Vananroye

Author: Joeri Vananroye

Professor of economic analysis of law (KU Leuven), attorney (Quinz)

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