It is not uncommon for companies to incur temporary losses in the course of their business activities. These losses may occur, for example, during an initial investment phase when the costs incurred exceed the income, or as a result of an economic downturn.
To protect creditors in such situations, the Swiss Code of Obligations defines specific measures for cases where losses accumulate and the company becomes overindebted. It is essential that both the owner and the members of the board of directors of a company (in the case of a stock corporation) are familiar with these legal procedures, as serious sanctions may be imposed in the event of non-compliance.
The guidelines laid down in the Swiss Code of Obligations form the basis for effective management of these financial risks. A thorough understanding of the various aspects of these regulations is crucial for identifying potential losses and taking appropriate measures to avoid overindebtedness. In the following, we will take a closer look at the core concepts that are relevant for assessing a company's financial health and complying with legal requirements.
What is a balance sheet loss?
A balance sheet loss occurs when, in a company’s balance sheet, the assets no longer cover the liabilities, meaning that the share capital is not fully covered by the assets on the asset side. This leads to a situation where the assets are lower than the sum of debt capital and equity.
While such a balance sheet loss does not in itself have any immediate legal consequences, it is an important warning signal for the board of directors and management to initiate appropriate measures.
A determined balance sheet loss also prevents resolutions on the appropriation of profits from being passed, since there is no distributable base, which results in a distribution block. Despite the seriousness of this situation, from an insolvency law perspective a balance sheet loss does not necessarily represent an immediate threat.
What is undercoverage?
Undercoverage occurs when a company’s equity – including reserves – is no longer sufficient to cover total assets. This usually happens when the assets do fully cover the debt capital, but represent less than 50% of the equity, consisting of share or company capital and reserves.
This is a critical financial situation which shows that liabilities exceed equity and that the company may not be able to meet its long-term obligations.
What is a 50% capital loss?
A 50% capital loss pursuant to Art. 725a CO is understood as a qualified form of undercoverage. It exists when half of the share capital and the legal reserves is no longer covered. In this case the law imposes specific obligations to act. Legal reserves include:
- Statutory capital reserves that cannot be repaid to shareholders
- Protected statutory retained earnings
- Revaluation reserves
- Reserves for treasury shares
What measures are available in the event of capital loss?
If a capital loss is identified, the board of directors takes measures to eliminate the capital loss. If these measures fall within the competence of the general meeting, an appropriate meeting is convened. Restructuring measures in the event of capital loss include a number of aspects. The most common restructuring measures are:
- Capital increase – A capital increase raises the equity of a stock corporation by issuing new shares on the market.
- À fonds perdu payment – Contribution by the owners without demanding any consideration
- Waiver of claims by creditors – Waiver of part of the claims
- Conversion of debt into equity – Liabilities are converted into shares
- Revaluation of fixed assets – In the event of restructuring, for example, real estate may be revalued
If the company is not subject to audit (opting-out), the last annual financial statements must be audited by means of a limited audit before they are approved by the general meeting. The board of directors appoints the licensed auditor.
What is overindebtedness?
If the capital loss increases to the point where the company’s liabilities are no longer covered by its assets, the company is overindebted. If there is a well-founded suspicion of this, interim financial statements based on going-concern values and on liquidation values are drawn up without delay and submitted to a licensed auditor (or the existing audit firm).
If the company is overindebted in both interim financial statements, the bankruptcy judge is notified. This may be waived if the company’s creditors subordinate their claims in the amount of the overindebtedness to those of all other creditors (subordination).
What are the reasons for overindebtedness?
Overindebtedness can be fostered by various conditions, but it is often the result of the interplay of several factors. Examples include high investments, poor market conditions or even disappearing markets, non-payment of receivables, poor management, political instability and missed product opportunities.
This is why you should not abandon the sinking ship in the event of overindebtedness!
In such a situation, it often seems obvious for board members to resign and have themselves removed from the commercial register in order to evade responsibility, but this is not advisable. Members of the board of directors remain liable for everything that happened before their resignation, regardless of whether they still hold this position.
Likewise, shareholders are advised against having receivables repaid to them before notification is made to the court. This can be contested after the opening of bankruptcy proceedings and may lead to criminal proceedings for preferential treatment of creditors.
Misconceptions about overindebtedness
Debt ≠overindebtedness
In principle, a distinction must be made between debt and overindebtedness. Debt merely means that a company has liabilities, which, as mentioned above, is not in itself a cause for concern.
Overindebtedness ≠insolvency
Another common misconception concerns the insolvency of an overindebted company. The two grounds for insolvency – overindebtedness and insolvency – are independent of each other.
In the case of overindebtedness, a period of one year is considered, during which the company’s asset situation and its development are assessed. Insolvency, on the other hand, is a liquidity status as of a specific date, covering a short period of 3 weeks.
The liabilities are compared with the available liquid funds. In practice, however, it is common for overindebted companies also to be insolvent.