Transformation of Legal Capital Rules in Estonia -- Inevitability or Permanent Misunderstanding?

AuthorAndres Vutt
PositionMagister iuris, Lecturer of Civil Law, University of Tartu
Pages111-117

Andres Vutt

Magister iuris, Lecturer of Civil Law, University of Tartu

Transformation of Legal Capital Rules in Estonia -- Inevitability or Permanent Misunderstanding?

1. Introduction

On 1 January 2006, extensive amendments to the Commercial Code (CC) 1 entered into force with the aim of regulating some as yet unsolved problems, and elaborating on some as yet ambiguous regulations2. Such aims are undoubtedly right and noble, and it would be unfair to doubt the intentions behind the attempts to improve legal regulations. Then again, a well intentioned aim does not in itself guarantee that the correct result is attained. This article studies some legal capital rules amendments, which corroborate the question whether we have understood the message of the EU and other Member States correctly, and what do we want to say with our laws to Estonian, as well as foreign, undertakings. This article is also concerned with the issue of whether our rules are objectively justified or not.

The following amendments to the CC were studied:

- an obligation came into force that a public limited company and a private limited company must use generally recognised experts for the valuation of assets upon a valuation of a contribution in kind, if they are available in that field (§ 143 (1), § 249 (1));

- a private limited company is prohibited to acquire or take as security own shares in an amount that exceeds 10% of share capital (§ 162 (2) 1 1 )).

It is beyond doubt that both of the above amendments made the situation stricter than before. A valuation method for contribution in kind was not provided for by law before; it was regulated by way of articles of association. It has always been provided in the Act, though, that an auditor must audit the valuation of the contribution in kind, whereas for a private limited company such a requirement has been in force only if all contributions, other than in cash, collectively form more than one-half of the share capital or if the value of a contribution in kind exceeds 40,000 kroons (i.e. minimum capital of a private limited company). The reason for the last derogation is to allow faster and simpler incorporation of a company3. The nominal limitation on the acquisition of own shares of limited liability company was not earlier prescribed by law.

2. Legal capital rules in the EU, Estonia and other Member States

Legal capital rules are enforced in Estonia in accordance with the 2nd Company Law Directive4. That directive has repeatedly been criticised by academics, whereas the position that the directive is too regulative, unreasonably strict and also ineffective, is quite unanimous5. Recent steps in the EU, with regard to that directive, also clearly show that at the EU level there is agreement with the criticism, and several conceptual amendments are being planned. The first of these will take place in the near future, since the European Parliament has already approved simplification amendments 6 to the 2nd directive based on the SLIM plan7. Those amendments do not concern the concept of the directive, only individual issues, including the payment for shares by contribution in kind. In addition, the Commission Company Law Action Plan 8 , prepared on the basis of the report 9 by group of company law experts, sets forth that the possibility of enforcing alternative capital protection rules and preparation of the directive amendments based thereon should be studied. Since no clear position has been taken on future developments in this issue, then no amendments can be expected before 2009.

The abovementioned EU future amendments apparently show a clear message to the Member States -- the current legal capital rules are not justified and must be significantly modified. Although the EU has neither amended the current rules, nor expressed any clearly unambiguous positions regarding the future, the general message should nevertheless be understandable: the current formality-based rules will change in the near future.

Valuation of application of the 2nd directive in Estonia shows that Estonia has transposed the directive to national law almost exactly, and, considering the very regulative nature of the directive, this is not surprising. Since the directive was already transposed before Estonia joined the European Union, then the Estonian message to the EU at that time was very clear -- we will follow EU requirements and are thus an exemplary European country. This declaration was actually made without much of a sacrifice, as the provisions meeting the EU requirements were transposed to Estonian law with the Commercial Code that came into force in 1995, which for the first time in Estonian history enforced contemporary company law, and since it was a fresh start, the choice of sources was relatively free (at least there was no reason to exclude the transposition of EU requirements). This approach was fine with the EU, as there has never been a problem with Estonia in this regard.

Complying with the EU rules is in itself a positive thing, but raises the conceptual question whether Estonia has not been too eager to adhere to those rules. Such a question is relevant especially due to the fact that in Estonian law the 2nd directive requirements are applied equally to public limited companies as well as to private limited companies.

Pursuant to article 1 of the 2nd directive, it is mandatory for the Member States to apply the directive to public limited companies only. Since a public limited company and a private limited company are similar companies by nature, then the Member States face a question whether and to what extent should the directive be applied to private limited companies. Whereas practice varies from one Member State to another -- some have provided altogether different rules to private limited companies in comparison with public limited companies, others apply the principles of the directive to all companies. The difference is especially striking in Germany where practically no provisions of the directive are applied to a GmbH -- this is especially noteworthy, since the directive was largely based on German law.

German choices clearly show that making the choice has depended greatly on whether the Member State has chosen the system of one or two limited liability companies. A fine example of the first is Great Britain, where the transposition of the requirements of the 2nd Company Law Directive did not mean formation of two independent legal forms; instead the existence of two types of companies was achieved by enforcing special rules10. The same solution was used in the Nordic Countries11. Yet, similar technical solution has not entailed the same result, as a private limited company in Great Britain is known as an especially liberal type of company, whereas the same cannot be claimed about a Swedish privata aktiebolag. The main difference here is the fact that Great Britain has not provided a minimum capital requirement for the private limited company and, above all else, this clearly evident, yet substantively irrelevant circumstance, has brought about a situation where a private limited company in Great Britain has become extremely popular in all of Europe12.

Estonian private limited company rules are created on the basis of the traditional continental European two companies system, but the actual difference in the rules of those companies, at least with regard to capital rules, is not remarkable. There are several reasons for that, one of the most important being the need to establish a structured legal environment in the place of the earlier lack of regulation, a part of which was the enforcement of very clear and strict rules on private limited companies.

Two types of trends are evident in European countries today. On one hand, there are the Nordic Countries, where Sweden, as a typical example, has, regardless of the Public Limited Company Act 13 coming into force from 2006, not changed the current situation, where mostly the same rules are applied to all companies. On the other hand, several other Member States have amended their laws to try to liberalise rules on private limited companies or establish alternative types of companies to enable undertakings to use limited liability with less formalities14.

With regard to applying the 2nd directive to private limited companies, a noteworthy change has also occurred in the EU. As the 1993 Commission study on the application of the 2nd Company Law Directive's requirements for limited liability companies 15 gave a recommendation to apply the requirements of the directive also to those companies, then today no more such recommendations are given. If to analyse the recent developments, then it is evident that the EU has not concentrated even to all public limited companies but to listed companies only, which in turn gives a reason to doubt whether the application of the 2nd directive requirements for private limited companies, as carried out in Estonia, is still reasonable.

3. Valuation of contribution in kind

Coming back to the amendments viewed in this article, it is necessary to clear up the reasons of these amendments. The motivation for the amendments to § 143 (1) and § 249 (1) of the CC that regulate the valuation method of contribution in kind is given in the explanatory memorandum: it is not reasonable to valuate contribution in kind "pursuant to the procedure prescribed by the articles of...

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