The Montenegrin Law on Business Organizations prohibits the return of contributions to shareholders. But is capital reduction with simultaneous payment to shareholders permissible? This article explores the legal ambiguities and practical challenges arising from this question.
The current Montenegrin Law on Business Organizations ("the Law") aimed to modernize corporate law and provide more comprehensive regulation in this area compared to the previous law from 2002. Given the current circumstances, it will remain in force for just over four years, as a new draft of the Law is already in procedure and is expected to be adopted by the end of 2024.
One of the main criticisms of the current text of the Law is its under-regulation, which in practice leads to ambiguities in its application.
Paradoxically, the problem discussed in this text arose due to over-regulation, i.e., the explicit prescription of a legal concept that was previously unproblematic in practice and was applied even though it was not prescribed by law.
Namely, the current Law explicitly prohibits the return of contributions to shareholders. Article 56, Paragraph 1 (Prohibition of Return of Contributions) states: "Shareholders cannot be refunded their paid or contributed contributions, nor can they be paid interest on what they have invested in the company."
What is the Problem?
At first glance, this provision is not problematic. The prohibition of returning contributions is a general legal principle of corporate law and applies regardless of whether it is explicitly prescribed by law. The previous law did not prescribe this prohibition, but it was applied in practice without disputes.
So how did the problem arise when the current Law merely defined a concept that represents a general legal principle and was already applied in practice?
The codification of this prohibition led to the interpretation by the Central Registry of Business Entities (CRBE) that any capital reduction with payment to company shareholders is prohibited because such payments represent a return of contributions. This position of the CRBE is supported by the views of a certain number of judges at consultations organized regarding the application of the Law.
This interpretation has caused significant problems in practice. Even shareholders of companies with absolutely no obligations cannot carry out a capital reduction with payments to shareholders, which practically prevents companies from managing their assets and shareholders from managing their company.
Therefore, the contentious question is: Is it permissible under the current Law to reduce a company's capital with simultaneous payment to shareholders?
To answer this question, it is useful to briefly explain the legal nature of contributions, shares, the concept of prohibition of return of contributions, the methods and reasons for reducing a company's capital, and the connection between capital reduction and the prohibition of return of contributions. This will help us reach a clear conclusion on whether the capital reduction with payment to shareholders represents a permitted action or a prohibited return of contributions.
Contributions, Shares, and Company Capital
Contributions are assets (money, ownership rights, other property rights) that shareholders bring into the company and based on which they acquire a share/ shares. By contributing, the company's share capital is formed, and the contribution ceases to be part of the founder's assets and becomes the company's asset.
The company's share capital is the monetary value of all registered and, under this Law, recorded contributions of shareholders. It can be increased or decreased following the procedures prescribed by the Law. The share capital and the rules on its maintenance serve to protect creditors and as a guarantee that the company will be able to meet its obligations. Therefore, every company law specifically regulates the procedure of capital reduction, considering that it can lead to the inability or difficulty to satisfy creditors and their potential harm.
Prohibition of Return of Contributions
As mentioned above, by contributing to the company, that contribution becomes the company's asset, separate from the shareholders' assets. Due to the company's distinct legal personality, it is logical that a shareholder cannot simply retrieve the contribution they have made. Allowing the return of contributions would lead to legal uncertainty, undermine the separation of assets between shareholders and the company, jeopardize the protection of creditors, and compromise the concept of share capital and the legal personality of a business entity.
Article 56, paragraph 1 of the Law precisely addresses this, prescribing the prohibition of returning contributed contributions to shareholders, as well as the payment of interest on the contributed amount.
However, it is highly contentious to interpret that the aforementioned prohibition simultaneously represents a ban on reducing the company's capital through a legally prescribed procedure, with adherence to creditor protection provisions, and subsequently making payments to company shareholders.
Namely, Article 56, Paragraph 2 itself stipulates: "Payments in the acquisition of own shares, as well as other payments to company shareholders made in accordance with this Law, are not considered as return of contributions to company shareholders."
Therefore, the Law provides that it is possible to make payments to shareholders that are not considered a return of contributions, covering all situations where payments are made “in accordance with the Law”.
Thus, it is necessary to determine whether the provisions of the Law regulating capital reduction allow payment to shareholders. If so, then the payment after the conducted procedure of capital reduction would represent one of the exceptions provided in Article 56, Paragraph 2, and would not be considered a return of contributions.
Capital Reduction
Depending on the effects it causes, capital reduction can be divided into two types: effective capital reduction, which leads to an outflow of the company’s funds, and nominal capital reduction which does not lead to an outflow of the company’s funds. Nominal capital reduction is used, for example, to cover company losses or to create reserves for covering future losses, while effective capital reduction, which results in an outflow of funds and has a real impact on the company's ability to meet its obligations, is subject to strict rules on creditor protection, so this method of capital reduction can only be carried out if creditors are adequately protected.
Our Law, as special cases, prescribes only instances of nominal capital reduction, specifically: (a) reduction of capital to create or increase reserves for covering future company losses or for increasing the share capital from the company's net assets, and (b) capital reduction for covering losses.
However, it would be incorrect to interpret that capital reduction for other reasons is impossible because of this. Firstly, because there is no prohibition in the Law that capital reduction cannot be carried out for other reasons. Secondly, through systematic interpretation of the provisions of the Law, it can be determined that this was not the legislator's intention. For example, Article 221, which regulates creditor protection in the process of capital reduction, prescribes that the company cannot pay funds to shareholders until the creditors who have requested it due to the initiated capital reduction process are satisfied. Therefore, it is evident that the Law provides the possibility that after the conducted capital reduction process, payment can be made to shareholders and that the reduction is carried out for reasons other than those explicitly regulated by the Law (since in capital reduction due to forming reserves and covering losses, there is no payment to company shareholders). Thirdly, such an interpretation would lead to legally and financially unjustified restrictions on shareholders in managing the company and the company in disposing of its assets, which would violate constitutionally guaranteed rights. This is particularly significant in situations where the company has no operational problems, and the capital reduction would not in any way jeopardize the potential satisfaction of creditors.
Conclusion
Although the current Law unnecessarily regulated the concept of prohibition of return of contributions on one hand, and unjustifiably failed to explicitly prescribe the possibility of capital reduction with payment to company shareholders on the other, thereby creating the possibility for such contentious interpretations, it is possible, after conducting the creditor protection procedure, to carry out capital reduction with payment to shareholders, and this cannot be considered a return of contributions.
This conclusion is based on several reasons. First, Article 56, Paragraph 2 of the Law provides a sufficient legal basis, as it stipulates that payments to company shareholders made in accordance with the Law are not considered a return of contributions. Second, although the Law does not explicitly prescribe a capital reduction with payment to shareholders, a systematic, purposive, and logical interpretation can determine that such a possibility is allowed. Specifically, Article 221 stipulates that a company cannot pay funds to shareholders in the process of capital reduction until the creditors who have requested satisfaction are settled, which implies that payment to shareholders after the capital reduction is conditional upon meeting certain requirements, but not prohibited.
Therefore, the aim of the prohibition of return of contributions from Article 56, Paragraph 1 of the Law is to prevent a company from returning contributions to shareholders without capital reduction and creditor protection, not to restrict the company in disposing of assets or shareholders in management. An opposite interpretation would lead to unjustified restrictions on the rights of shareholders and the company itself in terms of property management, without a valid reason, which would be problematic from the perspective of constitutionally guaranteed rights such as freedom of entrepreneurship and property rights.
Also, it should be considered that neither the company, creditors, nor other persons with a legitimate legal interest are endangered by the company's assembly decision on capital reduction, thanks to the obligation of creditor protection. An opposite interpretation would imply that the provisions of the Law that provide for payment to shareholders after capital reduction, such as Article 221, Paragraph 5, are meaningless because their application would be impossible. This would also render meaningless the provisions of the Law on creditor protection, so if only cases of nominal capital reduction are allowed, creditor protection would be redundant and unnecessary.
Accordingly, such a restrictive interpretation would mean that investors would be forced to liquidate companies to access funds "trapped" in the company's capital if those funds are no longer needed for business operations, which is not only impractical but also harmful to the overall business environment and the state.
In view of all the above, it is necessary for the competent authorities, primarily the CRBE, to revise their position to enable lawful actions in cases of capital reduction and eliminate numerous practical problems that the current interpretation has produced in practice.
