The issue raised is whether, in the event of a capital increase in a limited liability company, which is carried out without a monetary contribution, the rest of the partners have a preferential subscription right.
This problem was recently dealt with the by the General Directorate of Legal Security and Public Trust (Dirección General de Seguridad Jurídica y Fe Pública – DGSF), formerly known as the Directorate General for Registers and Notaries. In a resolution issued on 7th February 2020, the case was analysed wherein a limited liability company carried out a capital increase with the off-set of credits. The Commercial Registry of Madrid rejected the registration of the public deed of capital increase taking the view that a preferential subscription right was not offered to those partners who did not participate in such operation, as set forth in article 304 of the Spanish Capital Companies Act (Ley de Sociedades de Capital – LSC), and subsequently, a basic right of said partners was violated. The point of view of the Registry remained unchanged in spite of the existence of two resolutions issued by the DGSF in 2012 and 2015 in which preferential subscription rights in capital increases not made in cash were excluded. One of the arguments is that, if the partner is deprived of such right, a “convenient instrument for diluting the stake of the minority in the share capital of the company” is put in the hands of the absolute majority of shareholders or partners.
Indeed, article 93 b) of the LSC provides for the basic right of every partner or shareholder to the preferential right when new membership interests are created. Therefore, merely upon reading this article, it should be possible for this right to be exercised in any capital increase.
However, article 304 of the LSC provides that “In increases of a company’s capital with issue of new membership interests or new shares, ordinary or preferred, out of cash contributions, each member will be entitled to assume a number of membership interests or subscribe a number of shares proportional to the nominal value of those it holds.”
As a preliminary issue, it should be noted that the wording of article 304 applies to both joint stock companies and limited companies. And unlike the regulations of the former Limited Liability Companies Act of 1995, now the LSC, it excludes the preferential subscription right of the partner in cases of a non-monetary contribution capital increase. Therefore, an increase by offsetting credits or by the contribution of rights, movable or immovable property of a partner would not allow the rest of the partners to exercise their basic right of preferential subscription.
The resolution of the DGSF to which we refer admits without doubt that article 304 of the LSC means a reduction in the basic right of the partner or shareholder and at the same time does not question the intention and scope of this article of excluding the preferential subscription right in non-monetary increases, so that finally the DGSF rejects the decision of the Registrar and orders the registration of the public deed of capital increase.
Nevertheless, the resolution of the DGSF does not completely conclude the question insofar as a door is left open for the legal challenge of the decisions taken for the capital increase when they are not justified in the interests of the company, making a reference to the Judgment of the Supreme Court of 23rd May 2008, with elements of bad faith or abuse of rights. Thus, we may think of a combined action of certain partners and directors in the exclusive interest of one or more partners, which results in a capital increase by offsetting credits or contributing certain assets, such operations not being in the corporate interest of the company; this type of action, may be considered an act of bad faith or an abuse of rights which would allow the challenge of the capital increase agreement before the courts to be sustained. The casuistry may be extensive: What happens when the value of intangible assets is debatable, but it is endorsed by the directors’ report provided for in article 300? We may also consider cases of a contribution of credit rights which may finally result in bad debt which the director agrees to in his own interest, albeit hidden. Or simply, an unnecessary indebtedness brought about by the majority partner with the aim, in the medium term, of converting the credit into share capital/membership interests and watering down the participation of the minority partner or partners.
Therefore, the DGSF does not rule out the possible challenge of the company decision when this becomes tainted by an abuse of rights or bad faith. However, a partner who could not exercise the preferential subscription right may not base a challenge on the infringement of article 304 of the LSC, the content and intentions of which have been clarified, but may instead found a challenge upon the breach of the principle of good faith which must be coupled with the exercise of rights, provided for in article 7 of the Spanish Civil Code. This means having to analyse the specific characteristics and the background of each case in order to decide whether possibilities of challenging the decision of the partners or shareholders exist with guarantees of success.
Eduardo Vilá
Vilá Abogados
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20th November 2020
