A previous post mentioned the rudimentary rule on distributions in the ‘partnership en commandite’ (limited liability partnership) in article 206 of the Belgian Company Code (‘BCC’), dating back to 1873:
“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.”
Today we discuss how one word in this antique (yet inspiring) rule foreshadows a topical subject: “interests” (in French: “les intérêts qu’il a reçus”; in Dutch: “de hem uitgekeerde rente”).
Why mention interest payments which refers to the remuneration for debt? The rule aims to regulate distributions to the limited partner, who holds equity.
The parliamentary history reveals that the Belgian legislator was concerned with arrangements which gave the limited partner a right on a fixed yearly distribution, like the interests a creditor is entitled to (J. Guillery, Traité des sociétés commerciales, 1875, II, 84, § 438). The discussion clearly distinguishes between the fixed claim of a creditor and the residual claim of a shareholder. The right of a shareholder/partner is inconsistent with a claim for a fixed interest.
At the same time, it was made clear by contemporaneous authors that it is legitimate for a limited partner to be entitled to an interest if this is done in another role as creditor (ibid., II, 88, § 442). This line between a forbidden interest (or at least one subject to claw back) as limited partner and a legitimate interest as a limited partner who also ‘happens to be’ creditor seems thin, almost impossible to draw and at its worst a matter of mere cosmetics.
Not all authors welcomed this distinction (which seems to add something to the text of the code). Yet the distinction made that article 206 BCC never blossomed into a mature theory on the dual role of creditor and shareholder played by the same person. Up until today, this dual role is hardly a topic in Belgian law.
The ambiguous position of a limited partner in a ‘partnership en commandite’ is a fertile laboratory to think about debt, equity and the intricacies of a dual role. A previous post mentioned how the limited partner is in many legislative texts still referred to as a “lender”. The prohibition to meddle with the business of the partnership – still in force in most continental jurisdictions – puts the governance rights of a limited partner in the corner of a holder of debt.
Yet in case of insolvency there is little doubt that the claim of a limited partner is subordinated to that of a creditor (R. Saleilles, “Etude sur l’histoire des sociétés en commandite”, Annales de droit commercial 1895, 50, § 20).
In his masterpiece on the history of the ‘partnership en commandite’, Raymond Saleilles mentions how in the 17th century it was a common type of fraud for limited partners to pretend in the case of bankruptcy that they were creditors (ibid., 55, § 28). This position switch allowed them to escape their subordinated claim and to share in the assets with the creditors of the partnership:
“Savary nous signale une fraude très fréquente dans le cas de commandite entre négociant et particuliers. Comme ces commandites ne devaient pas être publiées, rien ne révélait aux tiers le caractère d’associés des commanditaires. Sur les livres du commerçant ils étaient inscrits comme simples créanciers, préteurs de deniers; et, si le négociant tombait en faillite, les autres créanciers de ce dernier n’avaient aucun moyen de preuve pour établir le titre d’associé des bailleurs de fonds et les empêcher de concourir avec eux. Ils étaient obligés de subir le concours des bailleurs de fonds, qui, en réalité, étaient des commanditaires associés;”
This 17th century fraud has a very modern ring to it.
For sure: modern legislation on company publicity no longer allows partners or shareholders to hide their status as holder of equity. Here we made progress since the 17th century.
But economically a very similar result can be obtained – openly – by structuring the investment in a shrewd way: a small equity investment by the shareholders and a large investment using debt with the same shareholders as creditors.
If things go well, the shareholders share in the upside as the holders of equity. If things take a wrong turn, they have as creditors a protection against the downside. This protection can be made even stronger if they make themselves secured creditors of the company. The increasingly easy availability of security interests as a legal tool allows structures with a downside protection for shareholders that would make the 17th century fraudsters burst with envy.
Increasingly legal scholars have misgivings about this dual role of shareholder and creditor. In many countries (Spain, Germany, Austria, Italy) the legislator stepped in to automatically subordinate shareholder loans to the claims of other creditors. Dutch authors have argued in favor of a similar rule for Dutch law.
It is time for Belgian authors to join this discussion.
We were almost there in 1873.