Financing of the company by the founders through loan

Contracting and implementation of the loan to the company from the founders is almost entirely governed by the provisions of the Law on Contracts and Torts.

The Companies Act in the part Additional Payments and Loan to the Company (Articles from 178 to 181) prescribes manner of esblishing the additional payment obligation, consequences of failure to make addititonal payment and return of the additonal payments, but does not provide specific rules relating to the loan. Provisions of the Companies Act which regulate payment limitations to the company’s founders, approval of a transaction in which there is personal interest and company’s share capital increase contain norms that are important for the contracting and implementation of loan.

The Law on Cotract and Torts doesn’t impose restrictions when it comes to the conclusion of the loan contract and the lender can be both as a business entity and natural person. According to the provisions of Article 557 of the Law on Contract and Torts by a loan contract the lender shall assume the obligation to transfer ownership to the borrower of a specific amount of money or other interchangeable objects, while the borrower shall assume the obligation to restitute after a certain time to him the same amount of money, or same quantity of objects of the same kind and quality.

Also there are no precise limits prescribed for the free determination of the amount, interest rate and repayment period of the loan.

But the conclusion of a large number of loan agreements, as well as contracting excessively high interest rates and very long repayment terms of the loan (eg, 50 years) can lead to doubt the validity of the contracts and it may result in the criminal responsibility of the contractors.

Rules of Limitations on Payments to Founders and Loan

Provisions of the Companies Act and in Article 182, paragraph 1 and Article 275 prescribes limits to restitute the loan received from the founders, in order to avoid the potential risk of defrauding creditors.

The general rule is prescribed by the provisons of Article 182, paragraph 1 of the Companies Act, according to which a company may execute payments of profit to its members, return of additional payments, loan and similar, as well as other payments on any grounds, exclusively in keeping with the memorandum of association and provisions of the Companies Act on limitations of payments.

The provisions of the Companies Act about the limitations on payments are contained in Article 275, while in other places they refer to the application of this Article. According to the provisions of Article 275 of the Companies Act a company may not make payments to stockholders (mutatis mutandis applying and members of a company) if, according to the latest financial statements, the company’s net assets are lower or would become lower due to such payment, than the amount of paid up share capital increased by the reserves that the company has to maintain pursuant to the law or articles of association, if any such reserves are in existence, except in the case of reduction of share capital.

Additional requirement is that the total amount of the payments made to stockholders for a business year may not be higher than the profit at the end of that business year, increased by retained earnings from previous years and the amounts of reserves provided for distribution to stockholders, and decreased for the losses brought forward from previous periods and the amounts of reserves that the company has to maintain pursuant to the law or articles of association, if any such reserves are in existence. Notwithstanding of the mentioned requirments from the paragraphs 1 and 2 of the Article 275 of the Companies Act, a company may always pay its stockholder (mutatis mutandis applying and member of a company) who is a natural person on the grounds of an employment agreement

The stockholders (mutatis mutandis applying and members of a company) who received payments contrary to the provisions of the Article 275. of the Companies Act shall make a return of the same amount to the company, in case they knew or must have known that payment was made contrary to the provisions of this Article.

The Loan as a Transaction in which there is Personal Interest of the Founders

The persons who, under the provisions of Article 61 of the Companies Act, have special duties towards the companyy have a duty to notify transactions and activities in which there is personal interest. That obligation applies to the loan i.e. the loan agreement.

The following persons have special duties towards the company:

General partners
Members of a limited liability company who own a significant share in the company’s share capital or limited liability company member who is the controlling member of the company in terms of Article 62 of the Companies Act
Shareholders who own a significant share in the company’s share capital or a shareholder who is the controlling shareholder of the company in terms of Article 62 of the Companies Act
Directors, supervisory board members, representatives and procurators
Liquidator.

Other persons may also be designated as persons with special duties towards the company by means of a memorandum of association, or articles of association.

The person from Article 61 of the Companies Act shall notify the board of directors, i.e. supervisory board in case of two-tier management system in the company, of the existence of personal interest (or interest of its affiliated person) in the legal transaction entered into by the company, or in the legal action taken by the company. Notwithstanding, in case of a company which has one director, notification shall be sent to the general meeting, i.e. supervisory board in case of a two-tier management system

It shall be considered that there is a personal interest of the person referred to in Article 61 of the Companies Act in case of:

Entering into a legal transaction between the company and that person (or its affiliated person); or
Legal action (taking actions in court and other proceedings, waiving the rights, and similar) that the company undertakes towards this person financial relationship with it (or with its affiliated person), and if it can be expected that the existence of such a relationship (or towards its affiliated person); or
Entering into a legal transaction between the company and a third party, or undertaking a legal action towards a third party, if such third party is in a affects its actions; or
Entering into a legal transaction, i.e. undertaking a legal action by the company from which a third party has commercial interest, if such third party is in a financial relationship with it (or with its affiliated person), and if it can be expected that the existence of such relationship affects its actions.

In case of existence of personal interest, under Article 65 of the Companies Act, as well as in other cases provided by the Companies Act, entering into a legal transaction, or undertaking of a legal action is approved by a majority, which is regulated by the provisions of the Article 66 paragraph 1 of the Companies Act, unless differently specified by a memorandum of association, or articles of association.

Termination of the Obligation to Restitute the Loan

The obligation to restitute the received loan may be terminated not only by fulfilling the contractual obligations of the borrower, but also by unenforceability, forgiveness of debt, compensation, conversion of the debt to the company’s share capital, etc.

The Loan of Founders as a Base of the Company’s Share Capital Increase

Also the company’s share capital increase may be one way of entering funds or financing company by the founders.

According to the provisions of Article 146 paragraph 1 item 3 of the Companies Act the share capital is increased by converting (conversion) of claims towards the company into the share capital.

It isn’t necessary that converted claim has been formed on the basis of the loan agreement, but it can be any other debtor-creditor relationship.