|
A Problem for Investors in Bulgaria
Center for the Study of Democracy
Law Reform and Comparative Law Program Issue No.
2 - February 1992
By
William D. Meyer
Central and East European Law Institute
American Bar Association
This material has been published as part of the
“Issues in Bulgarian Law” series prepared by the Law Reform and
Comparative Law Program, a project of the Center for the Study of
Democracy in Sofia, Bulgaria. Other issues in this series
include:
Issue №1 – The Bulgarian Law on Foreign
Investment
THE TREATMENT OF NON-MONETARY
CONTRIBUTIONS
A Problem for Investors in Bulgaria
-
The recent passage by the National Assembly of the
Law on Economic Activity of Foreign Persons and on Protection of
Foreign Investments represents a major step forward in the nation's
efforts to build the legal structures for foreign investment in
post-Communist Bulgaria. Many of the perceived shortcomings in the
prior Law on Foreign Investment were removed, making Bulgaria more
attractive to Western investors.
One area of significant improvement in -the new Law
is the deletion of the requirement of a US ,000 cash investment
in a commercial firm. Under Article 3, paragraphs (1) and (2) of
the Law, foreign investors are permitted to engage in economic
activity on the same basis as Bulgarian citizens, with a few
limited exceptions. This provision clarifies the right of foreign
investors to invest by contributing non-monetary assets to
Bulgarian firms. Contributions of this type are permitted under the
Law on Commerce for Bulgarian citizens, and this right is now
extended to foreigners.
The new Law, however, does not address the more
general restrictions on non-monetary contributions contained in the
Law on Commerce passed in May of 1991. Yet these limitations may
significantly reduce the amount of non-monetary foreign investment
which will be made in Bulgaria. Restrictions of this type also
substantially impede domestic investment of non-monetary assets in
new firms.
This outcome is particularly unfortunate because
these impediments need not exist. With a clear understanding of the
issues and the methods used elsewhere to deal with those issues,
Bulgaria can devise other mechanisms to fairly regulate these
investments. Towards that goal, it is helpful to understand the
nature of the problem.
THE PROBLEM
Non-monetary contributions under the Bulgarian Law
on Commerce are highly regulated. The cash value of any
non-monetary contribution to a firm must be stated in the Articles
of the firm. [Article 72, paragraph (1)] When the firm is
registered, the court must appoint three experts to value to the
contribution. [Article 72, paragraph (2)] If the value assigned by
the experts to the non-monetary contribution is less than stated in
the Articles, the latter must be adjusted to reduce the
contributor' s share to the lower value. While the investor may
withdraw his contribution if he disagrees with the valuation, the
net effect of this procedure is to make private investment
decisions subject to significant regulation by public
authorities.
Moreover, this valuation requirement applies to all
forms of business organizations permitted by the Law on Commerce.
Under that Law, five forms of organization are recognized: general
partnership, limited partnership, limited liability company, joint
stock company, and public limited company. Regardless of the form
of organization, non-monetary contributions must be valued using
the above procedure.
The impact of this requirement on investors is
threefold. First, the freedom of the market is removed.
Businesspersons cannot negotiate with other investors to set the
value of a particular asset. Instead the State, in the persons of
three court-appointed experts, will impose a value on the parties.
Many investors will be discouraged by the thought of spending time
and money to structure a new organization, only to have their plans
overturned by three State-appointed experts.
Second, the delays and costs inherent in such a
system will impede business. The registration system is cumbersome
and slow. Experience to date with the system suggests that it is
often unworkable. Large amounts of time are required for judges to
find and appoint experts, wait for their report, review it, and
either approve or reject the registration. Experts on some subjects
are difficult to find or refuse to serve. If different types of
assets are contributed to the same firm, multiple three-expert
panels must be appointed to value the various kinds of assets for a
single firm. Modem business does not accept delay, because market
opportunities move too quickly. And, since the fees of the experts
must be paid by the registrant, the costs of registration are
increased.
Lastly, the uncertainty caused by the system
dissuades businesspersons from even attempting such investments.
Businesspersons dislike uncertainty. Under the procedure created by
the Law on Commerce, no investor can know in advance what value
will be placed on a non-monetary contribution. One of the fallacies
often accepted by governments is that there is a scientifically
ascertainable value for an item of non-monetary property. In
reality, the value of such property arises only from a person's
ability to utilize it to make money. No expert, particularly one
with little or no experience in such matters, can scientifically
determine the value of many types of property, especially forms of
intellectual property such as patents, technical knowledge, or
copyrights. Investors know this, and will avoid legal systems which
leave their fate in the uncertain hands of unknown and undertrained
experts.
WHY IS THIS IMPORTANT?
New investments are the life blood of any economy.
Non-monetary contributions are an integral part of the investment
made in many new businesses. Domestic and foreign investors often
have assets of a non-monetary nature which they are willing to
invest in a new business.
The impediments to non-monetary investment raised by
the Law on Commerce cause particular problems in the area of
foreign investment. The loss of control, delay, cost and
uncertainty of the existing system dissuades foreign firms or
businesspersons from making such investments in Bulgaria.
The loss of such foreign investment may have
substantial impacts on the nation. An often-stated goal of
Bulgaria's long term economic strategy is to become the
"Switzerland of the Balkans." By utilizing the nation's highly
educated population and geographic position, the nation hopes to
become a center of technology for the region.
Private Western companies have knowledge and
technology to contribute to this effort. Frequently they are
willing to contribute this intellectual property to an overseas
joint venture, so long as the process is reasonable and their
property is protected. This type of non-monetary investment would
help Bulgarian companies become competitive, and move the nation
towards its technological goals. For these reasons, the removal of
unnecessary impediments to such investment should be a
priority.
Because the present Law on Commerce contains
impediments to non-monetary contributions which are neither legally
or economically necessary, consideration should be given to
amending that law. In this way, Bulgaria can increase its ability
to attract foreign investors and move forward with the
modernization of its economy.
POTENTIAL SOLUTIONS
The treatment of non-monetary contributions to
business firms is not a new issue. Legal systems around the world
have faced the issue and dealt with it in different ways. The
solutions developed by other countries offer alternatives for
Bulgaria to consider in reviewing its present system. Among the
solutions utilized in the West are the following:
- Do not require any expert valuation, but impose liability
on the contributor if the value of the non-monetary contribution is
improperly overstated.
-
In several European commercial codes, there is no
requirement that the value of a non-monetary contribution be
established by an independent appraiser. Instead, these laws allow
the members of a firm to negotiate and set the value they place on
the contribution. At the time of registration, the court does not
question this value. The reasonableness of the valuation only
arises if there is a problem, i.e. if the firm liquidates and
cannot pay its creditors. Under such circumstances, the court can
determine if the value was improperly overstated and, if it was,
impose personal liability on those making the valuation.
For example, under the Polish Commercial Code,
founders of a limited liability company need only state in the Deed
of Association the name of the shareholder making a non-monetary
contribution, the subject of the contribution, and the number and
amount of the shares given in exchange. [Article 163, paragraph
(1)] Upon registration, the Company is simply required to note that
some shareholders made non-monetary contributions. [Article 166]
The valuation issue does not arise unless the company becomes
insolvent within three years after the date of registration. If
that occurs, and it is determined that the non-monetary
contributions were accepted at an amount "far in excess of their
real value" at the time the Deed was made, the shareholder who made
the contribution and the members of the Management Board who
accepted it with the knowledge of this state of affairs are jointly
and severally liable to make good the loss to the company. [Article
176, paragraph (1)]
The systems of other countries use similar
mechanisms. Under the Hungarian Company Act, members of firms who
make non-monetary contributions are liable for five years from the
date of contribution for losses suffered if the value of the
contribution at the time of transfer was not equal to the value
indicated in the Deed. [Article 22, paragraph (3)] French laws
governing a societes a responsabilite limitee (SARL) or
limited liability company contain analogous provisions.
These provisions maintain the European philosophy of
conserving capital to pay firm debts, while at the same time
freeing investors from the delay, cost, uncertainty and loss of
control which arise from the procedures in the the Bulgarian Law on
Commerce. The authors of these laws recognized that valuation is
only important upon insolvency. Rather than impede all firms by
creating a cumbersome registration process, these laws focus only
on those few firms who overstate their capital and quickly go
insolvent. These laws also rely upon the threat of personal
liability to persuade investors to place a reasonable value on
non-monetary contributions when forming a firm. While not
eliminating impediments, such an approach dramatically improves the
mechanisms for registering both foreign and domestic
investments.
2) Require valuation by an expert chosen by
the parties, and impose liability if the value of the non-monetary
contribution is overstated.
Another approach utilized in Europe is to require
that non-monetary contributions to firms be valued by an expert,
but to allow the parties to retain the expert. This value is stated
at the time of registration, but the court will simply accept the
value if other conditions are met. Impartiality could be enforced
by imposing liability in the event of insolvency, if it is
determined that the expert has overstated the value of the
contribution.
The best example of this approach is in the
Czechoslovak Joint Stock Companies Act. Under this Act, the
founders must create an establishment plan for a joint stock
company. One requirement for such a plan is that it state the
nature and value of the non-monetary contribution, the identity of
the contributor, and the name of the expert who made a preliminary
valuation of the contribution. [Article 17, paragraph (3) (e)j The
value assigned to the contribution by the plan cannot exceed this
preliminary valuation. [Article 181 After the stock is fully
subscribed, the company's general meeting determines the value of
the non-monetary contribution [Article 23] which can be no higher
than the amount stated in the plan or in the report of the expert.
[Article 24, paragraph (2)]
Though this approach is more cumbersome for an
investor than the first alternative, it at least reduces the delay
and uncertainty surrounding the investment. By having the appraisal
done prior to formation of the company, the investor would know the
anticipated value in advance. This value could be changed by the
general meeting but, assuming he had some voice in the decision,
the investor could feel reasonably confident that the valuation
would be accepted. At least he would not face the delay and
uncertainty of a three expert panel similar to that described in
the Bulgarian Law on Commerce.
Protection of creditors comes from two sources.
First, the expert's independent appraisal will be at least some
indication of value. Second, contributors and experts could be
personally liable if the value was improperly overstated. The net
result is still an impediment to investment, but less bothersome
than the existing Bulgarian Law on Commerce.
3) Ignore the value of capital when
registering firms.
-
A third, more radical approach is to abandon the
European concept of government involvement to verify and conserve
firm capital. Instead, Bulgaria could adopt the approach taken in
the United States, based on the idea that those who deal with the
company must take responsibility to protect themselves.
To understand this approach, one must recognize the
difference between the approaches to company regulation on the two
sides of the Atlantic. Under the typical European system, the State
assumes the role of guardian of company creditors by seeking to
insure that adequate capital exists for the repayment of debts.
Minimum capitalization requirements, valuation of non-monetary
contributions, corporate registration and other similar mechanisms
are used in furtherance of this goal.
In the United States, a far different approach
prevails. This scheme recognizes that capital is marginally
relevant, since it is the net equity of the company which protects
creditors. A company may have massive capital, but if it
accumulates even more massive debt, the creditors are harmed.
Moreover, in the United States, the burden is on the
creditor or investor to protect his own interest. The system
assumes that a potential creditor will
- make inquiry into the financial status of the company before
extending credit, and
- obtain adequate security to protect himself if there is
concern. Investors will likewise make their own determination
whether non-monetary contributions of co-investors are fairly
valued.
-
Finally, the system in the United States enforces
these goals with laws structured to protect a creditor who works
within the system. The accuracy of financial information is assured
by a well-defined system of accounting procedures, coupled with the
threat of personal liability for those who provide inaccurate
information. The adequacy of security is assured by a comprehensive
set of laws which provide a creditor with safe methods of securing
a debt.
The net result is that under the U.S system, stated
capital has little relevance to the protection of creditors.
Potential creditors examine the finances of a firm by looking at
its books and audited financial statements. These items are not
required by the commercial law; they are required by the market
since firms which cannot provide such information are often unable
to do business. Creditors then obtain from the firm the security
which they deem necessary to protect their interests. If problems
arise, these creditors are protected by the laws which reward the
diligent.
Because this approach is taken, corporate
registration in the United States is a formality. No court or
government official investigates the company other than to insure
the proper forms are signed and filed. With rare exceptions, no
minimum capitalization is required. The system simply relies upon
those involved to protect themselves; government involvement is
minimal.
The treatment of non-monetary contributions is
consistent with this philosophy. For example, the Model Business
Corporation Act which is intended to cover joint stock companies
provides that the Board of Directors of a company may issue shares
for "any tangible or intangible property or benefit to the
corporation, including cash, promissory notes, services performed,
contracts for services to be performed, or other securities of the
corporation." Before issuing the shares, the Board must determine
that the contribution is adequate. Once this contribution is found
to be adequate, the decision of the Board in conclusive. [Section
6.21] No court or government official reviews this information,
since it need not even be disclosed upon registration. A similar
philosophy is followed in laws dealing with other forms of
organization such as general partnerships, limited partnerships and
limited liability companies.
From a theoretical standpoint, this approach has
significant general appeal. In the foreign investment context, the
strengths are even more obvious. A foreign investor has little
incentive to overstate the value of a non-monetary contribution
because, if the firm goes insolvent, he will lose his investment
(e.g. patents, licenses, copyrights) in the insolvency. There is
little chance that he could abscond with money from the company
prior to insolvency due to the restrictions on repatriation of
funds contained in the foreign investment laws. More than even a
domestic investor, he has every incentive to make the business
prosper.
But reality intrudes upon theory. The reality is
that Bulgaria must operate in a European environment which places
emphasis on the identification and preservation of stated capital.
Moreover, the entire structure of the existing Law on Commerce
presupposes that the European approach to capital conservation will
be followed. The type of fundamental change needed to fully
implement a United States' style system is simply not practical,
though the concepts upon which they are based may influence changes
in the present Bulgarian system.
4) Adopt different approaches for different
types of firms.
Few European commercial laws adopt the Bulgarian
approach of identical treatment for non-monetary contributions to
all types of firms. Most European laws instead have different rules
for different forms of business organizations. For example, the
rules for partnerships may be quite different from the rules for
joint stock companies. This approach recognizes that the policy
issues vary from organizational form to organizational form. While
this approach may lack theoretical purity, it is a pragmatic
response to the various policy concerns which face authors of
commercial laws. If properly drafted, laws of this type offer an
investor choices concerning the form of organization which best
fits his situation. In short, this approach represents an improved
solution to a multi-faceted problem.
A PROPOSAL
As previously discussed, the Bulgarian Law on
Commerce recognizes five forms of business organizations. Each form
has distinct strengths and weaknesses. Yet the Law on Commerce
treats capital contributions to all five forms in precisely the
same manner. Since this treatment is extremely conservative, the
result is to significantly discourage non-capital contributions to
all forms of organizations.
But when the five forms are individually examined,
it becomes apparent that identical treatment, especially such a
conservative treatment, makes little theoretical or practical
sense. The solution for Bulgaria is to adopt the fourth alternative
discussed above: different rules for non-monetary contributions to
different forms of organizations. In this way, many of the policy
concerns expressed in the present law can be preserved, while those
forms of organization where the concerns have little validity can
be freed from unnecessary regulation. Equally important, the
Bulgarian system can become consistent with the modem European laws
on these issues.
Looking at the five forms of organization in the Law
on Commerce, the following changes could be made without seriously
disrupting the present law:
- General Partnerships
-
For general partnerships, the United States'
approach of not requiring any valuation of capital could be
adopted. The principal rationale for requiring valuation of capital
is to protect the capital for creditors of a limited liability firm
in the event of insolvency. But this rationale has no application
to general partnerships for two reasons.
First, there is no limited liability given to
members of general partnerships. On the contrary, the Law on
Commerce states that all partners have unlimited joint and several
liability. [Article] Second, general partnerships are not "capital
companies" under the European system. Thus, there are no minimum
capitalization requirements for general partnerships. For this form
of organization, creditors should be looking to the partners, not
capital, for protection in the event of insolvency. Under such
circumstances, the pre-formation valuation of non-monetary
contributions is essentially meaningless.
If the Law on Commerce was amended in this way, at
least one avenue of investment would open for investors where
valuation problems could be avoided. In exchange for assuming
personal liability, they could form a partnership without going
through the process of valuing their non-monetary contributions.
Creditors would have the same protections as when they contract
directly with the investor: his personal liability on the debt. As
a result, investment could be made more attractive with no
reduction in the protections offered creditors.
2) Limited partnerships
Limited partnerships pose a slightly different
problem. General partners in limited partnerships have unlimited
personal liability, but the limited partners are liable only for
the amount of their agreed contributions. One
approach would be to treat limited partnerships like general
partnerships, and have no valuation requirement for non-monetary
contributions. Since there is no minimum capitalization for limited
partnerships, and since general partners remain personally liable,
creditors should not be relying on capitalization to pay debts. The
elimination of valuation requirements for non-monetary
contributions should accordingly cause little harm, while
non-monetary investments would be encouraged.
On the other hand, some form of valuation of
non-cash contributions must take place for the internal
organization of the limited partnership. The share of each limited
partner must have some valuation, since this value is the limit of
a partner's liability. For this reason it may be preferable to
treat non-monetary contributions to a limited partnership like
contributions to a limited liability company, discussed below.
A third option would be to prescribe different
treatments for general and limited partners. No valuation would be
required for non-monetary contributions by general partners, since
they remain subject to unlimited personal liability. Non-monetary
contributions by limited partners could be subject to separate
valuation requirements of the type discussed below.
Regardless which option is chosen, there are no
strong policy reasons for maintaining the present system contained
in the Law on Commerce. The options described above provide
sufficient protection for creditors, without unnecessarily impeding
non-monetary investments in Bulgarian limited partnerships.
3) Limited Liability Companies
Because all members of limited liability companies
have limited liability, creditors of such companies do not have the
option open to creditors of partnerships, i.e. to collect
partnership debts from the general partners. To protect creditors,
many European countries have special rules for non-monetary
contributions to such companies. But those special rules do not
create a cumbersome system of regulation. Instead, the modern
European laws attempt to restore to creditors the rights they
otherwise would have had, in situations where the non-monetary
contribution was used to deprive the creditors of access to
monetary capital to pay debts.
The mechanism frequently adopted in Europe in such
situations is the first alternative discussed above: to dispense
with any expert valuation, but impose liability for improper
over-statement of the value of a non-monetary contribution. By this
approach, company members would lose the protection of limited
liability if they improperly acted. Creditors in such situations
would be returned to the position and the rights they had prior to
the formation of the company, i.e. the right to impose personal
liability on the investor. Yet the sort of cumbersome
administrative mechanism now contained in the Law on Commerce could
be avoided.
The laws on this subject in the various European
countries are similar, but each contains slightly different
provisions. If such a law is to be adopted in Bulgaria, it should
contain the following components:
-
-
a) The members of the company should be required to
state a value for non-monetary contributions at the time of
registration. This value need not be supported in any fashion other
than the signature of the members on the registration
documents.
b) Liability would arise if the company becomes
insolvent within a certain number of years after the registration
of the value. The length of time in existing laws varies from
country to country. In Hungary and France the period is five years,
while in Poland the period is three years.
c) Liability should be imposed only if it can be
shown that the value of the non-monetary contribution was
improperly overstated. As discussed above, non-monetary assets
often are extremely difficult to value. Investors should not be
liable when good faith, reasonable valuations turn out to be in
error. For this reason, liability should be based on fault, such as
negligence, gross negligence or intentional wrong doing.
d) The law should specify who may be liable. Some
European laws impose personal liability only on the person making
the contribution. On the other hand, the Polish Commercial Code
imposes liability on other members of the Management Board who
approved the valuation with knowledge that it was excessive.
e) Liability should be co-extensive with loss. That
is, if the non-monetary contribution was overvalued by 10,000 leva,
the liability of responsible persons should be limited to that
amount.
While these details must be discussed, the primary
concern should be to adopt some system of this type in Bulgaria.
The treatment of limited liability companies under the present Law
on Commerce is a deterrent to domestic and foreign investment. By
adopting a position consistent with general European law, Bulgaria
will remove this impediment without unnecessarily sacrificing the
protections for creditors.
4) Joint Stock Companies
The strongest arguments for the valuation of
non-monetary contributions can be made in situations where joint
stock companies are formed by public subscription. In partnerships
and limited liability companies, there is little need to protect
other investors from overvalued non-monetary contributions, since
these investors are few in number and presumably have adequate
information to protect their own interests. But where a joint stock
company is formed by public subscription, there may be many small
investors with little access to information concerning such
matters.
For this reason, several European company laws do
require outside valuation of non-monetary contributions to joint
stock companies. But these countries do not generally require
evaluation by a panel of three court-appointed experts. The delay
and expense of this type of system is too great in a modern
economy.
Instead, valuation of non-monetary assets is
performed by a single expert. In some countries the expert is
court-appointed, while in others he is retained by the contributor
as in the second alternative discussed above. The report of the
expert sets the maximum value for the asset, though the members of
the company are free to set a lower value.
For Bulgaria, a change to a system of this type
would be appropriate. A viable approach would be to change the
existing Law on Commerce to the following system:
a) Prior to formation of a joint stock company, a
founder must obtain a sworn valuation of a proposed non-monetary
contribution from a qualified appraiser.
b) When the proposal for opening subscription is
made, it must contain:
- The valuation report of the expert,
- A statement concerning the expert's qualifications; and
- A sworn declaration by the expert that he has no relationship
with the contributor, and that he will receive no compensation for
his valuation report other than his customary fee.
-
c) The proposal for subscription may value the
non-monetary contribution no higher than stated in the expert's
report.
d) If the subscription is completed, the
Constituent Assembly of the company must set the final value for
the non-monetary contribution. This value may be no higher than the
amount set forth in the proposal for subscription. If the
Constituent Assembly lowers the valuation, the contributor is free
to withdraw his non-monetary contribution.
e) If the joint stock company becomes insolvent
within a certain number of years, personal liability could be
imposed. The criteria for liability would be similar to those
discussed above in connection with limited liability companies,
with three exceptions:
i) In addition to imposing liability on the
contributor and other founders of the company, the law would make
the expert potentially liable.
-
ii) The expert's liability could arise not only from
overvaluation, but also from false statements concerning his
compensation, relationship with the contributor, or
qualifications.
iii) Subscribing investors as well as creditors
would be able to recover damages from persons liable.
By utilizing this system, Bulgaria could simplify
the use of non-monetary investments while maintaining protections
for creditors and investors. The use of private experts would free
the courts from the task of appointing three experts for every
company seeking to register and free the investor from the delay
and expense of this process. It would also permit an investor to
know the likely valuation of his non-monetary contribution in
advance, reducing the uncertainty which otherwise might dissuade
foreign investors in particular from further investment.
5)Public limited companies
Since this form has features of both limited
partnerships and joint stock companies, the regulatory scheme
applicable to either could be utilized. It may be more appropriate
to follow the scheme selected for joint stock companies, because
the Law on Commerce generally prescribes the same rules for both
types of firms. Regardless, the present system should be revised
for this type of firm to permit investors to move forward without
unneeded obstacles.
CONCLUSION
Economic progress in the modem world depends on new
investment, particularly in technology, ideas, and know-how. These
types of intellectual property frequently are the principal assets
of modem enterprises. Often, this property has great value, but
that value is hard to quantify.
The goal of any legal system should be to
facilitate, not impede, economic progress. Bulgaria is in need of
an infusion of innovative technology from the West, ideas which
firms in Europe and North America are willing to provide. The
present Law on Commerce unnecessarily slows the transfer of
non-monetary property, especially intellectual property. With
proper amendments consistent with approaches taken in the West,
Bulgaria can protect its citizens from exploitation while opening
the door much wider for needed foreign and domestic investment.
|
