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Journal of Corporate Law Studies Volume 12, 2012 - Issue 2
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Original Articles

Risk-Based Equity Requirements: How Equity Rules for the Financial Sector can be Applied to the Real Economy

Lukas Handschin Full Professor for Corporate and Accounting Law, Faculty of Law, University of Basel. This essay was written with the collaboration of Andreas Steffen, LLM, whom I thank for the expert research, Tony M Schütz, MLaw, whom I thank for checking the references and footnotes, and Dr iur Christopher Kee, whom I thank for his support with the drafting of this article in English. Comments are welcome: [email protected].
Pages 255-293 | Published online: 30 Jan 2017

  • SA Ross, RW Westerfield and BD Jordan, Fundamentals of Corporate Finance (McGraw-Hill/Irwin, 9th edn, 2010), 23; due to this systematic risk, investors in shares require a return equivalent to the risk-free rate with an additional premium. See G Arnold, Handbook of Corporate Finance, A Business Companion to Financial Markets, Decisions & Techniques (Financial Times/Prentice Hall, 2nd edn, 2010), 245–57.
  • J Rickford, “Reforming Capital, Report of the Interdisciplinary Group on Capital Maintenance” (2004) 15 European Business Law Review 919, 928 (Rickford Report); W Schön, “The Future of Legal Capital” (2004) 5 European Business Organization Law Review 429, 440; Second Company Law Directive 77/91/EEC [1976] Preamble: “provisions should be adopted for maintaining the capital, which constitutes the creditors' security”.
  • L Handschin, “Das Eigenkapital als Risikoreserve” in PV Kunz, D Herren, T Cottier and R Matteotti (eds), Wirtschaftsrecht in Theorie und Praxis, Festschrift für Roland von Büren (Helbing Lichtenhahn, 2009), 69, 80.
  • J Armour, “Legal Capital: An Outdated Concept?” (2006) 7 European Business Organization Law Review 5, 16: “there may clearly be benefits to imposing dividend constraints based on net asset values”, ie on real equity; Rickford Report, supra n 2, 968: “in what conditions is it legitimate, in the cause of creditor protection, to restrict a company's freedom to pay a return to its shareholders?”; see also European Court of Justice, Case C-212/97 Centros Ltd v Erhvervsog Selskabsstyrelsen [1999] ECR I-1459.
  • IAS 16.6: “Depreciation is the systematic allocation of the depreciable amount of an asset over its useful life”; IAS 38.8; IAS 36.9: “An entity shall assess at the end of each reporting period whether there is any indication that an asset may be impaired. If any such indication exists, the entity shall estimate the recoverable amount of the asset”; US GAAP Accounting Research Bulletin no 43, ch 9C, para 5: “Depreciation is a systematic and rational process of distributing the cost of tangible assets over the life of assets”.
  • Ross et al., supra n 1, 23–24.
  • See also Armour, supra n 4, 10.
  • Cf Rickford Report, supra n 2, 943. The Rickford Report questions the concept of equity in principle, based on the (correct) assessment that nominal equity alone cannot safeguard the rights of creditors.
  • Under US GAAP, FAS 144.15, the upward revaluation of assets generally is not allowed; US GAAP Codification of Accounting Standards (ASC) 360.
  • IAS 16.29 and 16.30.
  • P Böckli, Schweizer Aktienrecht (Schulthess, 4th edn, 2009), 1091–93; F Vischer and F Rapp, Zur Neugestaltung des Schweizerischen Aktienrechts (Stämpfli, 1968), 31.
  • Hidden reserves are resources not listed on a balance sheet, such as land or a building shown at a value less than its market value. This valuation difference is a hidden element of a company's equity. See L Handschin, “Corporate Risks, Risk-Bearing Ability and Equity” (2011) 22 European Business Law Review 189, 205.
  • See also Fourth Company Law Directive 78/660/EEC [1978], Art 33(2): if a Member State deviates from the general valuation principle at purchase or production price set forth in Art 32, revaluation reserves for the value superseding the purchase or production price “must be entered in the revaluation reserve under ‘Liabilities'”.
  • IAS 16.39: “If an asset's carrying amount is increased as a result of a revaluation, the increase shall be recognized in other comprehensive income and accumulated in equity under the heading of revaluation surplus. However, the increase shall be recognized in profit or loss to the extent that it reverses a revaluation decrease of the same asset previously recognized in profit or loss.” Under UK GAAP, FRS 15.63: “Revaluation gains should be recognized in the profit and loss account only to the extent (after adjusting for subsequent depreciation) that they reverse revaluation losses on the same asset that were previously recognized in the profit and loss account. All other revaluation gains should be recognized in the statement of total recognized gains and losses.”
  • IAS 38.85: “If an intangible asset's carrying amount is increased as a result of a revaluation, the increase shall be recognized in other comprehensive income and accumulated in equity under the heading of revaluation surplus. However, the increase shall be recognized in profit or loss to the extent that it reverses a revaluation decrease of the same asset previously recognized in profit or loss.” Under US GAAP, “reversal” of impairment loss is generally not allowed (for goodwill see ASC 350–20–35–13; for other intangible assets see ASC 350–30–35–14, 350–30–35–20). Under UK GAAP, FRS 10.43, the revaluation of intangible assets is prohibited after their initial recognition at cost or fair value on acquisition, unless it has a readily ascertainable market value.
  • IAS 40.62: “any remaining part of the increase is recognized in other comprehensive income and increases the revaluation surplus within equity”. Under US GAAP, ASC 360, impairment of “long-lived assets held for sale” are not “reversed” when there is a subsequent increase in value. Under UK GAAP, SSAP 19.13, “changes in the value of investment properties should not be taken to the profit and loss account but should be disclosed as a movement on an investment revaluation reserve, unless the total of the investment revaluation reserve is insufficient to cover a deficit, in which case the amount by which the deficit exceeds the amount in the investment revaluation reserve should be charged in the profit and loss account.”
  • FAS 115.12b: “Investments not classified as trading securities (nor as held-to-maturity securities) shall be classified as available-for-sale securities” (original emphasis); FAS 115.13: “Unrealized holding gains and losses for available-for-sale securities (including those classified as current assets) shall be excluded from earnings and reported in other comprehensive income until realized except as indicated in the following sentence. All or a portion of the unrealized holding gain and loss of an available-for-sale security that is designated as being hedged in a fair value hedge shall be recognized in earnings during the period of the hedge, pursuant to paragraph 22 of Statement 133. Paragraph 36 of FASB Statement no 109, Accounting for Income Taxes, provides guidance on reporting the tax effects of unrealized holding gains and losses reported in other comprehensive income” (original emphasis). Under the US GAAP, ASC 320, changes in fair value of trading securities are recognised in earnings and those available-for-sale securities are recognised for comprehensive income, but earnings and changes in fair value for held-to-maturity securities are not recognised.
  • Handschin, supra n 12, 198–200.
  • See supra Section A.2(b).
  • See infra Section B.3.
  • Ross et al., supra n 1, 22.
  • Ross et al., supra n 1, 22: “Liquidity refers to the speed and ease with which an asset can be converted to cash … Any asset can be converted to cash quickly if we cut the price enough. A highly liquid asset is therefore one that can be quickly sold without significant loss of value. An illiquid asset is one that cannot be quickly converted to cash without a substantial price reduction.”
  • Eg Switzerland: Swiss Code of Obligations (Obligationenrecht, OR), Arts 620(2) and 680(1); Germany: German Stock Companies Act (Aktiengesetz, AktG), §55 (only possible in the case of shares with restricted transferability); UK: Companies Act 2006, s 561(1)(a); shareholders have a right but usually no duty to fund additional equity.
  • Handschin, supra n 12, 193–94, with numerical examples.
  • Arnold, supra n 1, 544–50; Ross et al., supra n 1, 401.
  • Handschin, supra n 12, 194.
  • PO Mülbert, “Corporate Governance of Banks” (2009) 10 European Business Organization Law Review 411, 412 and 422.
  • Basel Committee on Banking Supervision, “Basel III: A Global Regulatory Framework for More Resilient Banks and Banking Systems” (Bank for International Settlements, December 2010, rev June 2011) (Regulatory Framework).
  • Regulatory Framework, Ibid, 1, no 4; see Ross et al., supra n 1, 23. By an increase in leverage both, potential rewards as well as potential losses are increased. Leverage increases the overall risk exposure.
  • H Hannoun, “Towards a Global Financial Stability Framework” (Bank for International Settlements, 26–27 February 2010), 10, available at http://www.bis.org/speeches/sp100303.pdf (accessed on 20 July 2012).
  • For the phasing in of the requirements See Basel III Compliance Professional Association, “The Basel III Accord”, available at http://www.basel-iii-accord.com (accessed on 20 July 2012). For a comparison of Basel II and III regulation requirements see M Ojo, “Basel III and Responding to the Recent Financial Crisis: Progress Made by the Basel Committee in Relation to the Need for Increased Bank Capital and Increased Quality of Loss Absorbing Capital” (22 September 2010), 5–8, available at http://ssrn.com/abstract=1680886 (accessed on 20 July 2012). See Regulatory Framework, supra n 28, 17 no 57: Basel III increases the quantitative requirements of core first-tier capital to 4.5%. Additionally, the banks will be required to build a “capital conservation buffer” of an additional 2.5%, leading to a core capital of 7%. This “capital conservation buffer” may be undercut in times of distress. A “countercyclical buffer” between 0 and 2.5% shall cope with specific risks arising from national markets in which the respective bank operates. The first-tier core capital will be steadily built up through a transition period until 2015, the “Capital conservation buffer” until 2019 and the overall first-tier capital must reach a level of 6% by 2015. Furthermore, second-tier capital instruments are harmonised and the third-tier capital is eliminated.
  • Basel Committee on Banking Supervision, “Strengthening the Resilience of the Banking Sector”, Consultative Document (Bank for International Settlements, December 2009, issued for comment by 16 April 2010), available at http://www.bis.org/publ/bcbs164.pdf (accessed on 20 July 2012); Regulatory Framework, Ibid, 13 no 53. Core first-tier capital must consist of common shares and retained earnings. For the rare case of non-joint stock bank companies, a set of principles leads to comparable levels of first-tier capital; Regulatory Framework, Ibid, 2 no 9: forms of hybrid capitals are still admissible up to 15% as first-tier capital, but will eventually be phased out. For a definition of the “common shares” see Regulatory Framework, Ibid, 13 no 53.
  • Hannoun, supra n 30, 11.
  • Handschin, supra n 12, 201.
  • Basel Committee on Banking Supervision, “Countercyclical Capital Buffer Proposal”, Consultative Document (Bank for International Settlements, July 2010, issued for comment by 10 September 2010), 2, available at http://www.bis.org/publ/bcbs172.pdf (accessed on 20 July 2012); AR Admati, PM DeMarzo, MF Hellwig and P Pfleiderer, “Fallacies, Irrelevant Facts, and Myths in the Discussion of Capital Regulation: Why Bank Equity is Not Expensive”, The Rock Center for Corporate Governance at Stanford University Working Paper Series No 86, Stanford GSB Research Paper No 2063, Draft (First Draft 27 August 2010, this draft 18 March 2011), 7–11.
  • See Arnold, supra n 1, 569: “The important issue is at what point does the probability of financial distress so increase the cost of equity and debt that it outweighs the benefit of the tax relief on debt?” and 578: for the function of the overall cost of capital, a U-shaped relation for the equity/debt rate is postulated. However, a best debt/equity ratio cannot scientifically be established.
  • Such as capital tax or tax on profits. In Switzerland, realised capital profits from the sale of shares are exempt from the income tax at the level of a natural person. See Swiss Federal Direct Tax Act, Art 16(3). This might have a positive effect on the equity level. For findings of effects of countercyclical fiscal policies see P Aghion, D Hemous and E Kharroubi, “Cyclical Fiscal Policy, Credit Constraints, and Industry Growth”, BIS Working Paper No 340 (Bank for International Settlements, February 2011), 31, available at http://www.bis.org/publ/work340.pdf (accessed on 20 July 2012).
  • Admati et al., supra n 35: the authors are sceptical whether the prescribed level of equity is sufficient. It is argued that even a significantly higher equity requirement would only limit a bank's risk structure. These findings may also hold true in the non-financial sector. However, if research were to show that in fact equity is more expensive in that sense in the non-financial sector, one reason might be that companies are able to externalise some of the risk to creditors that are unable to negotiate conditions, and therefore are unable to consider the counterparties risk-bearing ability.
  • See P Angelini et al., “Basel III: Long-Term Impact on Economic Performance and Fluctuations”, BIS Working Paper No 338 (Bank for International Settlements, February 2011), 19–20, available at http://www.bis.org/publ/work338.pdf (accessed on 20 July 2012).
  • Basel Committee on Banking Supervision, “Calibrating Regulatory Minimum Capital Requirements and Capital Buffers: A Top-Down Approach” (Bank for International Settlements, October 2010), available at http://www.bis.org/publ/bcbs180.pdf (accessed on 20 July 2012).
  • Regulatory Framework, supra n 28, 3 no 12: the stress-testing controls risks arising from the banking and the trading book. In order to comply, the value-at-risk must withhold a simulated one-year period of continued significant financial stress. For implementation in the EU see Directive 2010/76/EU [2010].
  • Regulatory Framework, supra n 28, 3 no 12 and 4 no 16.
  • Ibid, 5 no 19: the countercyclical buffer controls valuation risks arising from changing economic cycles. For more forward looking provisions (replacement of IAS 39) see 6 no 23.
  • Ibid, 5 no 20: “one of the most procyclical dynamics has been the failure of risk management and capital frameworks to capture key exposures—such as complex trading activities, resecuritisations and exposures to off-balance sheet vehicles—in advance of the crisis”.
  • A main problem arose from the procyclical effects of the Basel II internal credit risk models used. See European Central Bank, “Financial Stability Review” (December 2009), 149–50, available at http://www.ecb.int/pub/fsr/html/index.en.html (accessed on 20 July 2012); Ojo, supra n 31, 2. See also Regulatory Framework, supra n 28, 5 no 18: the tendency of market participants to behave in a procyclical manner was amongst other reasons induced by the used accounting standards for market-to-market assets and held-to-maturity loans.
  • Basel Committee on Banking Supervision, “Principles for Sound Liquidity Risk Management and Supervision” (Bank for International Settlements, September 2008), 1, available at http://www.bis.org/publ/bcbs144.pdf (accessed on 20 July 2012).
  • Basel Committee on Banking Supervision, “Basel III: International Framework for Liquidity Risk Measurements, Standards and Monitoring” (Bank for International Settlements, December 2010) (Framework for Liquidity Risk), 3: the controlling instrument is the “liquidity coverage ratio”.
  • Ibid, 25–31 nos 119–36: “net stable funding ratio”.
  • See also Mülbert, supra n 27, 432–33.
  • For Switzerland: Commission of Experts for Limiting the Economic Risks Posed by Large Companies, “Final Report of the ‘Too Big To Fail' Commission of Experts” (30 September 2010), 56, available at http://www.sif.admin.ch/dokumentation/00514/00519/00592/index.html?lang=en (accessed on 20 July 2012): “The new regulations set out under Basel III are intended as minimum standards. They are binding on all banks and are therefore designed to apply to all international financial institutions, irrespective of their systemic importance. The calibration is geared to the average, and fails to address the TBTF problem effectively. Moreover, the calibration does not take into account the special situation in Switzerland.”
  • Regulatory Framework, supra n 28, 2 no 8 and 27 no 91.
  • European Central Bank, “Financial Stability Review, Summary” (9 December 2010), available at http://www.ecb.int/pub/fsr/html/summary201012.en.html (accessed on 20 July 2012); see also Mülbert, supra n 27, 431: “know-your-structure”.
  • Framework for Liquidity Risk, supra n 47, 31 no 138.
  • Basel Committee on Banking Supervision, “External Audit Quality and Banking Supervision” (Bank for International Settlements, December 2008), 4–5, available at http://www.bis.org/publ/bcbs146.pdf (accessed on 20 July 2012): national supervisors' reliance on external auditors' expertise has increased. As most supervisors increasingly rely on audit to complement supervisory processes, the issue of transparency at the level of the audited banks and the audit firms is of significant concern for effective supervision. Furthermore, high standards in audit enhance market confidence, particularly in times of financial distress. Other concerns arise at the level of the audit firms. Major audit firms have become globalised, resulting in complex firm structures and a lack of transparency at the level of the audit firms.
  • P Clement, “The Missing Link: International Banking Supervision in the Archives of the BIS” in S Battilossi and J Reis (eds), State and Financial Systems in Europe and the USA (Ashgate, 2010), 167, 170.
  • M Obstfeld and AM Taylor, Global Capital Markets. Integration, Crisis, and Growth (Cambridge University Press, 2004), 126–35; CR Schenk, “The Regulation of International Financial Markets from the 1950s to the 1990s” in Battilossi and Reis (eds), Ibid, 149, 150–51.
  • Clement, supra n 55, 168–73.
  • N Crafts, “Globalization and Growth in the Twentieth Century”, IMF Working Paper WP/00/44 (March 2000), 51: “there is no evidence that abolishing capital controls per se raises the rate of growth … but quite good reason to believe that financial liberalization significantly increases the risk of a subsequent financial/currency crisis”; N Crafts, “Globalisation and Economic Growth: A Historical Perspective” (2004) 27 World Economy 45, 45–49.
  • S Solomon, The Confidence Game. How Unelected Central Bankers are Governing the Changed Global Economy (Simon & Schuster, 1995), 435.
  • Capital Requirements Directive 2006/48/EC [2006] and 2006/49/EC [2006]; see http://ec.europa.eu/internal_market/bank/regcapital/index_en.htm (accessed on 20 July 2012). For the implementation of the Basel III Accord, amendments will be made after a public consultation phase. See also I MacNeil, “The Trajectory of Regulatory Reform in the UK in the Wake of the Financial Crisis” (2010) 11 European Business Organization Law Review 483, 509–12.
  • The G20 reached an agreement on the implementation of the Basel III rules at the Korea summit on 11 and 12 November 2010, available at http://g20mexico.org/images/stories/canalfinan/docs/repcore/01seoul.pdf (accessed on 20 July 2012); decisions by the G20 are not legally binding.
  • AktG, § 7.
  • OR, Art 621.
  • French Commercial Code (CCom), Art L-224-2.
  • Second Company Law Directive 77/91/EEC [1976], Arts 6(1) and 9(1), paid up to at least a quarter. For the European private company (SPE) see MM Siems, L Herzog and E Rosenhäger, “The Protection of Creditors of a European Private Company (SPE)” (2011) 12 European Business Organization Law Review 147, 156–58.
  • Whether the legal capital of eg €37,000 for other public companies (France: CCom, Art L-224–2) or €50,000 (Germany: AktG, § 7) is an entry barrier to an own company respectively a negative economic stimulant is to be challenged. The reduction in tax and bureaucratic hurdles related to the set-up and operation of a company would probably be more effectual.
  • Armour, supra n 4, 7.
  • B Manning and J Hanks, Legal Capital (Foundation Press, 3rd edn, 1990), 30.
  • W Schön, supra n 2, 440; J Armour, “Share Capital and Creditor Protection: Efficient Rules for a Modern Company Law” (2000) 63(3) Modern Law Review 355.
  • J Armour, “Who Should Make Corporate Law? EC Legislation versus Regulatory Competition” (2005) 58 Current Legal Problems 369, 369. For a further discussion on legal capital requirements and the Second Company Law Directive within the EU see H Eidenmüller, B Grunewald and U Noack, “Minimum Capital in the System of Legal Capital” in M Lutter (ed), Legal Capital in Europe (de Gruyter, 2006), 17, 17–19.
  • Armour, supra n 4, 7–8.
  • IAS 37.
  • ASC 410 for “Asset Retirements and Environmental Obligations”, ASC 420 for “Exit or Disposal Cost Obligations”.
  • ISA 570: “Going Concern Assumption”.
  • M Gelter, “The Subordination of Shareholder Loans in Bankruptcy” (2006) 26 International Review of Law and Economics 478, 480; DA Skeel Jr and G Krause-Vilmar, “Recharacterization and the Nonhindrance of Creditors” (2006) 7 European Business Organization Law Review 259, 260; A Cahn, “Equitable Subordination of Shareholder Loans?” (2006) 7 European Business Organization Law Review 287, 292.
  • For a comparative overview see Gelter, Ibid, 478; Cahn, Ibid, 292; J Barneveld, “Legal Capital and Creditor Protection—Some Comparative Remarks” in DFMM Zaman, CA Schwarz, ML Lennarts, HJ de Kluvier and AFM Dorresteijn (eds), The European Private Company (SPE). A Critical Analysis of the EU Draft Statute (Intersentia, 2009), 81, 100; M Gelter and J Roth, “Subordination of Shareholder Loans from a Legal and Economic Perspective” (Summer 2007) 5 CESifo DICE Report 40, 40: UK rules do not address shareholder loans specifically.
  • Skeel and Krause-Vilmar, supra n 75, 260; Cahn, supra n 75, 292; A DeNatale and PB Abram, “The Doctrine of Equitable Subordination as Applied to Nonmanagement Creditors” (1985) 40 Business Lawyer 417, 421–29; M Nozemack, “Making Sense Out of Bankruptcy Courts' Recharacterization of Claims: Why Not Use § 510(c) Equitable Subordination?” (1999) 56(2) Washington and Lee Law Review 689, 693 and 716.
  • German Modernisation of Private Limited Liability Companies Act (Gesetz zur Modernisierung des GmbH-Rechts und zur Bekämpfung von Missbräuchen, MoMiG, BGBl I, 2026).
  • German Insolvency Act (Insolvenzordnung, InsO), §§ 39(1) no 5, 44a, 135 and 143 and Creditors' Avoidance of Transfer Act (Anfechtungsgesetz, AnfG), §§ 6 and 6a.
  • Second Council Directive 77/91/EEC [1976], Art 6(1); for admissive reduction below that amount see Art 34 (capital reduction below the minimal capital requirement followed by a subsequent capital increase).
  • Second Council Directive 77/91/EEC [1976], Art 15(1).
  • With the exception of reserves formed under Art 22(1)(b) of the Second Council Directive 77/91/EEC [1976] for the purchase of own shares, this reserve is non-distributable.
  • For capital increase see Art 25(1) and for capital reduction see Art 30 of the Second Council Directive 77/91/EEC [1976].
  • Second Council Directive 77/91/EEC [1976], Art 22(1)(b).
  • Second Council Directive 77/91/EEC [1976], Art 32(1) as amended by Directive 2006/68/EC [2006]: “In the event of a reduction in the subscribed capital, at least the creditors whose claims antedate the publication of the decision on the reduction shall at least have the right to obtain security for claims which have not fallen due by the date of that publication. Member States may not set aside such a right unless the creditor has adequate safeguards, or unless such safeguards are not necessary having regard to the assets of the company. Member States shall lay down the conditions for the exercise of the right provided for in the first subparagraph. In any event, Member States shall ensure that the creditors are authorised to apply to the appropriate administrative or judicial authority for adequate safeguards provided that they can credibly demonstrate that due to the reduction in the subscribed capital the satisfaction of their claims is at stake, and that no adequate safeguards have been obtained from the company.” Art 32(2): “The laws of the Member States shall also stipulate at least that the reduction shall be void or that no payment may be made for the benefit of the shareholders, until the creditors have obtained satisfaction or a court has decided that their application should not be acceded to.” Art 32(3): “This Article shall apply where the reduction in the subscribed capital is brought about by the total or partial waiving of the payment of the balance of the shareholders' contributions.”
  • Second Council Directive 77/91/EEC [1976], Art 15(1)(a).
  • Second Council Directive 77/91/EEC [1976], Art 15(1)(c): “Earned surplus test”.
  • P Santella and R Turrini, “Capital Maintenance in the EU: Is the Second Company Law Directive Really That Restrictive?” (2008) 9 European Business Organization Law Review 427, 460; Rickford Report, supra n 2, 943; E Micheler, “England” in Lutter (ed), supra n 70, 413, 414.
  • Rickford Report, supra n 2, 971.
  • UK Companies Act 2006, s 643(1)(b)(ii): “has also formed the opinion … that the company will be able to pay (or otherwise discharge) its debts as they fall due during the year immediately following that date”.
  • New Zealand Companies Act, s 4(1).
  • New Zealand Companies Act, s 52(2).
  • See also Schön, supra n 2, 440–41: “The argument that such creditors [unable to adjust] are only interested in the present liquidity of the company is unconvincing”.
  • See also Schön, Ibid, 445.
  • Rickford Report, supra n 2, 975: “any more that that [the result of the bare bet asset test] is the maximum which it would be prudent to distribute”.
  • Ibid, 975–76.
  • Ibid, 976.
  • Schön, supra n 2, 440; for concerns regarding the shareholders right to approve reduction in capital see Micheler, supra n 88, 425–26.
  • H Fleischer, “Legal Capital: A Navigation System for Corporate Law Scholarship” (2006) 7 European Business Organization Law Review 29, 30; Armour, supra n 4, 6.
  • Schön, supra n 2, 441: legal capital as a collective contractual offer that particularly protects involuntary creditors and creditors unable to adjust, and lowers transaction costs for all creditors.
  • Switzerland: OR, Arts 717 and 754; Germany: AktG, § 93(1); France: CCom, Arts L 225–251 and L 225–257; UK: under s 172(1)(a) of the Companies Act 2006 a director must not take risks that, from his subjective point of view, endanger the company's long-term success; G Morse et al. (eds), Palmer's Company Law: Annotated Guide to the Companies Act 2006 (Sweet & Maxwell, reprint, 2008), 167: “The directors must make decisions that are calculated to be for the long-term benefit of the members [of the company] as a whole”; PL Davies, S Worthington and E Micheler, Gower and Davies' Principles of Modern Company Law (Sweet & Maxwell, 8th edn, 2008), 263–65; R Watter and K Roth Pellanda, “Article 717” in H Honsell, NP Vogt and R Watter (eds), Basler Kommentar, Obligationenrecht II, Articles 530–1186 OR (Helbing Lichtenhahn, 4th edn, 2012), Art 717 n 7–14a; E Homburger, “Articles 707–726” in P Gauch and J Schmid (eds), Zürcher Kommentar, Obligationenrecht, Teilband V 5b, Der Verwaltungsrat, Article 707–726 OR (Schulthess, 1996), Art 717 n 816; Böckli, supra n 11, 1765–78 and 1991–92.
  • However, these duties can be understood as duties owed to the shareholders, creditors or the corporation itself; Switzerland: OR, Art 756(1); Germany: AktG, § 93(2); France: CCom, Art L 225–251; UK: Companies Act, s 170(1); Multinational Gas and Petrochemical Co v Multinational Gas and Petrochemical Services Ltd [1983] Ch 258 CA; Peskin v Anderson [2001] 1 BCLC 372 CA; D French, SW Mayson and CL Ryan, Mayson, French & Ryan on Company Law (Oxford University Press, 28th edn, 2011), 480–81: only the company itself can bring in an action for a breach of duty; G Morse et al., Charlesworth Company Law (Sweet & Maxwell, 17th edn, 2005), 164 and 297–99: only under special circumstances fiduciary duties arise which place directors in a fiduciary capacity towards shareholders or creditors.
  • H Hansmann and RH Kraakman, “The End of History for Corporate Law”, Yale International Center for Finance Working Paper No 00–09 (January 2000), 10, available at http://www.law.harvard.edu/programs/olin_center/corporate_governance/papers.shtml (accessed on 20 July 2012): “[t]he reason for these rules, however, is that there are unique problems of creditor contracting that are integral to the corporate form, owing principally to the presence of limited liability as a structural characteristic of that form”.
  • Armour, supra n 4, 16.
  • West Mercia Safetywear Ltd v Dodd [1988] 4 BCC 30 (CA UK); Nicholson v Permakraft (NZ) Ltd (in liq) [1985] 1 NZLR 242 (CA NZ); see Rickford Report, supra 2, 985.
  • A Keay, “Moving Towards Stakeholderism? Constituency Statutes, Enlightened Shareholder Value, and More: Much Ado About Little?” (2011) 22 European Business Law Review 1, for a discussion of the stakeholder-friendly terminology of s 172(2) of the UK Companies Act 2006; Company Law Review Steering Group, “Modern Company Law for a Competitive Economy: Completing the Structure”, Modern Company Law Review Consultation Document URN 00/1335 (November 2000), 34; Hansmann and Kraakman, supra n 103, 7. For the “enlightened shareholder value” see also L Timmerman, “Principles of Prevailing Dutch Company Law” (2010) 11 European Business Organization Law Review 609, 615–16; DG Baird and MT Henderson, “Other People's Money” (2008) 60(5) Stanford Law Review 1309, 1323–28.
  • UK: Insolvency Act 1986, s 214. For US fraudulent transfer law see A Engert, “Life Without Legal Capital: Lessons from American Law” in Lutter (ed), supra n 70, 646, 669–71.
  • JC Lipson, “The Expressive Function of Directors' Duties to Creditors” (2007) 12 Stanford Journal of Law, Business & Finance 224, 224.
  • Keay, supra n 106, 6–8. For Japan and other East-Asian jurisdictions see also Mülbert, supra n 27, 428.
  • For an oversight of the respective case law see Lipson, supra n 108.
  • Ibid, 280. For an “enlightened shareholderism” see Keay, supra n 106, 2.
  • Lipson, Ibid, 288.
  • JC Lipson, “Directors' Duties to Creditors: Power Imbalance and the Financially Distressed Corporation” (2003) 50 UCLA Law Review 1189, 1245–46.
  • UK Insolvency Act 1986, s 214(2)(b): “at some time before the commencement of the winding up of the company, that person knew or ought to have concluded that there was no reasonable prospect that the company would avoid going into insolvent liquidation”. For an analysis of these duties under British and German fraudulent transfer law see T Bachner, “Wrongful Trading—A New European Model for Creditor Protection?” (2004) 5 European Business Organization Law Review 293, 297; Engert, supra n 107, 669–70; G Wagner, “Distributions to Shareholders and Fraudulent Transfer Law” (2006) 7 European Business Organization Law Review 217, 219–20.
  • DG Baird, “Legal Approaches to Restricting Distributions to Shareholders: The Role of Fraudulent Transfer Law” (2006) 7 European Business Organization Law Review 199, 203.
  • Engert, supra n 107, 669; both stem from the Roman actio pauliana. For Europe see CG Paulus, “Claw-back Rules and Creditors' Protection” in Lutter (ed), supra n 70, 325, 325–27.
  • Bachner, supra n 114, 318.
  • UK Insolvency Act 1986, s 214(2)(b).
  • Bachner, supra n 114, 303: “the responsibility of directors, as described in Re Continental Assurance, does not go beyond a continuous and careful monitoring of whether the company is still solvent”; IF Fletcher, The Law of Insolvency (Sweet & Maxwell, 3rd edn, 2002), 708: Professor Fletcher even considers that the mere probability of insolvency could trigger director's liability towards creditors under the respective provision.
  • For private limited companies: GmbHG, § 64(1); for public limited companies: AktG, § 92(2).
  • See also Bachner, supra n 114, 299, with a translation of the respective German rule.
  • See also D Kershaw, “Involuntary Creditors and the Case for Accounting-Based Distribution Regulation” (2009) 2 Journal of Business Law 140, 144; Davies et al., supra n 101, 263–65; L Glanzmann, “Die Pflicht zur angemessenen Kapitalausstattung der Aktiengesellschaft” (1997) 1 Aktuelle Juristische Praxis 51, 52–53. See also supra Section B.3.
  • G Krieger and V Sailer, “§ 93” in K Schmidt and M Lutter (eds), Aktiengesetz, Kommentar, I. Band, §§ 1–149 (Cologne, O Schmidt, 2008), § 93 n 10–6: among the duties defined by the business judgment rule is the rule that no excessive risks can be taken.
  • F Dornseifer, Corporate Business Forms in Europe: A Compendium of Public and Private Limited Companies in Europe (Stämpfli, 2005), 252: “One of the fundamental obligations of the management board is to file a petition for the commencement of insolvency proceedings if the corporation becomes insolvent or in the event of over-indebtedness, ie if the asset of the company no longer cover the liabilities.” S Kalss, N Adensamer and J Oelkers, “Director's Duties in the Vicinity of Insolvency—A Comparative Analysis with Reports from Germany, Austria, Belgium, Denmark, England, Finland, France, Italy, the Netherlands, Norway, Spain and Sweden” in Oelkers, “Director's Duties in the Vicinity of Insolvency—A Comparative Analysis with Reports from Germany, Austria, Belgium, Denmark, England, Finland, France, Italy, the Netherlands, Norway, Spain and Sweden” in, “Director's Duties in the Vicinity of Insolvency—A Comparative Analysis with Reports from Germany, Austria, Belgium, Denmark, England, Finland, France, Italy, the Netherlands, Norway, Spain and Sweden” in” in Lutter (ed), supra n 70, 112, 142: from the comparative analysis, the conclusion is drawn that the duties that arise in these jurisdictions in the vicinity of insolvency “are measures that are designed to be taken before it is too late, ie before the company is insolvent”. Hence, these duties also imply a duty to monitor the risk-bearing ability.
  • For the interdependence of financial resources and equity see supra Section A.5.
  • For how these rules help to define the correct amount of equity see supra Section C.8.
  • Mülbert, supra n 27, 420.
  • Ibid, 420.
  • In particular, physical assets such as production plants, machinery and raw materials.
  • Schön, supra n 2, 437.
  • See supra Section B.4.
  • Mülbert, supra n 27, 436: “banking regulation … produces ever more regulation … to the lawyer's full employment act, one may greatly doubt whether banks' corporate governance should indeed map the way forward for corporate governance in general”.
  • Ibid, 422.
  • Dysfunctional credit and money market pose a threat to the whole economy; see supra Section B.2.
  • Mülbert, supra n 27, 434: firms outside of the banking sector can be of systemic importance as well, and therefore the systemic importance criterion fails to explain why “banks should be subject to a unique legal regime”.
  • Commission of Experts for Limiting the Economic Risks Posed by Large Companies, supra n 50, 3; see also Mülbert, supra n 27, 434.
  • J Armour, G Hertig and H Kanda, “Transactions with Creditors” in RH Kraakman et al (eds), The Anatomy of Corporate Law, A Comparative and Functional Approach (Oxford University Press, 2nd edn, 2009), 115, 132.
  • Siems et al., supra n 65, 156–57; KJ Hopt, “The European Company Law Action Plan Revisited: An Introduction”, Law Working Paper No 140/2010 (February 2010), 6, available at http://ssrn.com/abstract=1554662 (accessed on 20 July 2012); FN Ewang, “EU Minimum Capitalisation Requirement, An Analysis and Critique of the EU's Minimum Capitalisation Requirement” (Charles Sturt University, 21 September 2007), 2–3, available at http://ssrn.com/abstract=1015708 (accessed on 20 July 2012); GYM Chan, “Why Does China not Abolish the Minimum Capital Requirement for Limited Liability Companies?” (2 August 2009), 4–7, available at http://ssrn.com/abstract=1442791 (accessed on 20 July 2012); Fleischer, supra n 99, 31–33.
  • Cf Armour, supra n 4, 16–18.
  • Ibid, 27.
  • P Davies, “Directors' Creditor-Regarding Duties in Respect of Trading Decisions Taken in the Vicinity of Insolvency” (2006) 7 European Business Organization Law Review 301, 309–10; Armour, Ibid, 17; Armour et al., supra n 137, 130–34; Chan, supra n 138, 9–11.
  • See supra Section C.6.
  • Fleischer, supra n 99, 37.
  • Hopt, supra n 138, 6.
  • See supra Section B.
  • Ewang, supra n 138, 20.
  • Mülbert, supra n 27, 412; see also supra Section B.
  • See supra Section B.3.
  • See supra Section B.2; see also Chan, supra n 138, 16.
  • See also Mülbert, supra n 27, 413 and 434.
  • See Armour, supra n 4, 18; supra Section D.1.
  • See supra Section A.2(b).
  • See supra Section A.
  • Armour, supra n 4, 19.
  • Davies et al., supra n 101, 257; see also supra Section E.
  • PO Mülbert, “A Synthetic View of Different Concepts of Creditor Protection, or: A High-Level Framework for Corporate Creditor Protection” (2006) 7 European Business Organization Law Review 257, 369: “With respect to the shareholders, the lack of personal liability of the corporation's debts (limited liability) will serve as a powerful incentive to cause the company to act opportunistically, either in the form of a subsequent distribution of assets to its shareholders or by taking on riskier business projects, ie projects with more volatile earnings prospects.”
  • Armour et al., supra n 137, 133.
  • E Micheler, “Disguised Returns of Capital—An Arm's Length Approach” (2010) 69 Cambridge Law Journal 151, 184; Baird, supra n 115, 200; Wagner, supra n 114, 227: “The protective function aims at avoiding the externalisation of risk to the detriment of outside creditors. One important element of this function is to prohibit the distribution of such assets of the limited liability company which are necessary to cover the claims of outside creditors.”
  • Siems et al., supra n 65, 152.
  • Rickford Report, supra n 2, 967; Mülbert, supra n 27, 422: banks are different in regard to their systemic risk and in regard to their vulnerability to bank runs. See also supra Section D.2.
  • See supra Section C.8.
  • See supra Section C.8.
  • Davies, supra n 141, 304.
  • Ibid, 310.
  • Krieger and Sailer, supra n 123, § 93 n 10–6.
  • A Keay, “Directors' Duties to Creditors: Contractarian Concerns Relating to Efficiency and Over-Protection of Creditors” (2003) 66(5) Modern Law Review 665, 668.
  • supra Section C.8.
  • Ibid: in civil law, under the premise of stakeholderism; under common law, arguably under an “enlightened shareholderism”; see also Keay, supra n 106, 2–8.
  • Under fraudulent transfer law, see supra Section C.8.
  • See supra Section E.2.
  • Armour et al., supra n 137, 131.
  • Handschin, supra n 12, 200.
  • Keay, supra n 166, 683, 699 and 686: “directors must be informed so that they can ensure that their company is not engaging in wrongful trading”; see also supra Section C.8.
  • Also ISA 315.15 a—c; ISA 315.16: “If the entity has established such a process (referred to hereafter as the ‘entity's risk assessment process'), the auditor shall obtain an understanding of it, and the results thereof. If the auditor identifies risks of material misstatement that management failed to identify, the auditor shall evaluate whether there was an underlying risk of a kind that the auditor expects would have been identified by the entity's risk assessment process. If there is such a risk, the auditor shall obtain an understanding of why that process failed to identify it, and evaluate whether the process is appropriate to its circumstances or determine if there is a significant deficiency in internal control with regard to the entity's risk assessment process.” ISA 315.17: “If the entity has not established such a process or has an ad hoc process, the auditor shall discuss with management whether business risks relevant to financial reporting objectives have been identified and how they have been addressed. The auditor shall evaluate whether the absence of a documented risk assessment process is appropriate in the circumstances, or determine whether it represents a significant deficiency in internal control.”
  • Arnold, supra n 1, 114: however, “[t]he risk-adjusted discount rate method relies on an accurate assessment of the riskiness of a project. Risk perception and judgment are bound to be, to some extent, subjective and susceptible to personal bias.”
  • See supra Section A.2(b).
  • Eg Switzerland: OR, Arts 675(2) and 671; Germany: AktG, §§ 58(4) and 150; German Commercial Code (Handelsgesetzbuch, HGB), § 272 (2); IAS 37.14: “A provision shall be recognized when: (a) an entity has a present obligation (legal or constructive) as a result of a past event; (b) it is probable that an outflow of resources embodying economic benefits will be required to settle the obligation; and (c) a reliable estimate can be made of the amount of the obligation. If these conditions are not met, no provision shall be recognized.”
  • IAS 37.14.
  • IAS 37.40.
  • IAS 37.39.
  • Fourth Company Law Directive 78/660/EEC [1978], Art 33(2).
  • See supra Section A.2(b); admissible deviation from the purchase and production price valuation method set forth in the Fourth Company Law Directive 78/660/EEC [1978], Art 32.
  • Fourth Company Law Directive 78/660/EEC [1978], Art 33(2)(a): more liabilities means less distributable profit.
  • Cf Santella and Turrini, supra n 88, 440–44.
  • See J Rickford, “Legal Approaches to Restricting Distributions to Shareholders: Balance Sheet Tests and Solvency Tests” (2006) 7 European Business Organization Law Review 135, 172.
  • See supra Section A.2.
  • See supra Section A.1.
  • For the concept within corporate law: Davies et al., supra n 101, 151–52; SJ Grossmann and OD Hart, “An Analysis of the Principal-Agent Problem” (1983) 51 Econometrica 7, 43: “More complicated principal-agent problems arise when not only is the principal unable to monitor the agent, but also the agent possesses information about his environment … which the principal does not”; Micheler, supra n 88, 426. Further, a capital regime as proposed by the Rickford Report might inflict with the right of shareholders to approve reductions of capital.
  • Also, the Second Council Directive 77/91/EEC [1976] Preamble states: “Whereas Community provisions should be adopted for maintaining the capital, which constitutes the creditors' security, in particular by prohibiting any reduction thereof by distribution to shareholders where the latter are not entitled to it and by imposing limits on the company's right to acquire its own shares.”
  • See the amendments to the Second Council Directive 77/91/EEC [1976] set forth in Directive 2006/68/EC [2006] (4): “Public limited liability companies should be allowed to acquire their own shares up to the limit of the company's distributable reserves”; Second Council Directive 77/99/EEC [1976], Art 19(1)(c).
  • According to the Second Council Directive 77/91/EEC [1976], Art 19(2): “where the acquisition of a company's own shares is necessary to prevent serious and imminent harm to the company”; see also New Zealand Companies Act 1993, s 52(1), which allows the board to authorise distributions if the liquidity test permits so.
  • Handschin, supra n 12, 207–08.
  • However, the Second Company Law Directive leaves it to the Member States to determine which reserves are distributable. For the requirement of auditing see Fourth Council Directive 78/660/EEC [1978], Art 51(1): “(a) Companies must have their annual account audited by one or more persons authorized by national law to audit accounts. (b) The person or persons responsible for auditing the accounts must also verify that the annual report is consistent with the annual accounts for the same financial year.”
  • Handschin, supra n 12, 209.
  • Ibid, 209.
  • See supra Section C.8 and E.
  • Böckli, supra n 11, 1545 and 1619; H Fleischer, “§ 91 AktG” in G Spindler and E Stilz (eds), Kommentar zum Aktiengesetz, Band 1, §§ 1.178 (CH Beck, 2007), § 91 n 13.
  • See supra Section B.3 and E.
  • See supra Section B.2.
  • Rickford Report, supra n 2, 974 n 191: for a solvency test “[e]ven a short term asset surplus requirement is too rigid for a company which is able to borrow”; a company is solvent when it holds sufficient high quality equity that can be turned into liquidity at any given time without suffering inadequate losses and can do so without exceeding its risk-bearing ability.
  • See supra Section C.6. However, the solvency test should be applied as an additional tool to adjust equity to an adequate level, like a simple version of the Basel III liquidity test.
  • IAS 1.25–26 requires the management to assess the entity's ability to continue as a going concern; ISA 570.3–7; ISA 570.3: “detailed requirements regarding management's responsibility to assess the entity's ability to continue as a going concern and related financial statement disclosures may also be set out in law or regulation”; ISA 570.4: “In other financial reporting frameworks, there may be no explicit requirement for management to make a specific assessment of the entity's ability to continue as a going concern. Nevertheless, since the going concern assumption is a fundamental principle in the preparation of financial statements as discussed in paragraph 2, the preparation of the financial statements requires management to assess the entity's ability to continue as a going concern even if the financial reporting framework does not include an explicit requirement to do so.”
  • See supra Section C.8.
  • See supra Section F.2.
  • Fourth Council Directive 78/660/EEC [1978], Art 51(1)(a): companies (listed under Art 1) must have their annual accounts audited; see also Armour et al., supra n 137, 128–30.
  • ISA 570.6–7; ISA 570.7: however, there are limitations on the auditor's ability to detect misstatements in regard to future events that may endanger an entity's ability to continue as a going concern, and therefore the “auditor's report cannot be viewed as a guarantee as to the entity's ability to continue as a going concern”/
  • ISA 570.2.
  • ISA 570.2: “Going Concern Assumption”.
  • See also ISA 570.6: “The auditor's responsibility is to obtain sufficient appropriate audit evidence about the appropriateness of management's use of the going concern assumption in the preparation of the financial statements and to conclude whether there is a material uncertainty about the entity's ability to continue as a going concern.”
  • See Rickford Report, supra n 2, 974–75; see also R Veil, “The Regime of the Capital Directive versus Alternative Systems” in Lutter (ed), supra n 70, 75, 84–85. For the director's certificate see the New Zealand Companies Act 1993, s 52(2).
  • See supra Section C.1.
  • See supra Section E.4.
  • See supra Sections C.8 and F.7.
  • See supra Section E.2.
  • See supra Section F.6.
  • See supra Section F.8.
  • See supra Section F.7.

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