A partner receives notice of an extraordinary general assembly to increase capital by a substantial amount within a short period. If they do not subscribe for their share, their holding falls sharply. If they do, they need liquidity they may not have. The arrangement may be a genuine necessity to rescue the company or fund its expansion, or it may be a calculated device to dilute a troublesome partner and remove them in practice from decision-making. Distinguishing the two is the subject of this article, under Companies Law No. 1 of 2016.
How Capital Is Increased
- Extraordinary assembly resolution: an increase amends the constitutive contract and therefore requires a resolution of the extraordinary general assembly by the prescribed special majority.
- Forms of increase: issuing new interests or shares, raising the nominal value of existing interests, or converting debts or reserves into capital.
- Contributions in kind: where the increase is by contribution in kind, an independent approved valuation is required. This is a sensitive point, as overvaluing a contribution made by one partner unjustly dilutes the others.
- Publication and registration: the increase is complete only on amendment of the constitutive contract and its registration and publication under the prescribed procedures.
- Actual payment: the increase must actually be paid up. A paper increase is a breach affecting creditors' and partners' rights.
Pre-Emption on Subscription
This is the partner's first protection:
- Its content: an existing partner has priority to subscribe for the increase in proportion to their existing holding, preserving their percentage in the company.
- Its purpose: preventing dilution against a partner's will, since they may maintain their percentage by subscribing.
- The period: a reasonable period must be allowed to exercise the right. A very short period may empty the right of practical content and is an indication of improper purpose.
- Waiver: a partner may waive or in some forms sell the pre-emption right, mitigating the effect of an inability to subscribe.
- Disapplication: a partner may be deprived of this right only by special resolution and for serious reasons connected to the company's interest, such as admitting a strategic investor, and such a resolution is subject to closer scrutiny.
- Unsubscribed interests: the resolution should state what happens to interests not taken up by the partners and how they are allocated among them or offered to third parties.
When an Increase Is Abusive
- Absence of need: increasing capital while the company holds sufficient liquidity or substantial reserves adequate for the stated purpose.
- Excessive amount: an increase far exceeding the requirements of the stated project, suggesting funding is not the object.
- Timing: a resolution taken following a dispute with a partner or their request for inspection or distribution, a strong indicator of purpose.
- Short period: allowing a period practically insufficient to raise the sum, particularly where the other partner was prepared in advance.
- Withholding profits then seeking capital: a stark contradiction, withholding profits on the ground of needing liquidity and then requiring partners to inject new funds.
- Effect: where the true purpose is shown to be diluting a partner rather than the company's interest, the resolution may be challenged as an abuse of the majority's power.
Protecting a Partner Unable to Subscribe
- Recorded objection: the first practical step, recording the objection in the assembly minutes with reasons and requesting a longer period in writing.
- Requesting information: asking to see the feasibility study and financial statements justifying the increase before voting. A refusal to provide them is a significant indicator.
- Proposing alternatives: proposing partner loans or bank financing instead of an increase. Rejecting alternatives without justification strengthens the inference of abuse.
- Selling the pre-emption right: where permitted, this mitigates the loss and converts the right into value.
- Judicial challenge: against the increase resolution or the disapplication of pre-emption, within the prescribed period.
- Valuation on exit: where matters end in the partner's exit, establishing abuse strengthens their position on the valuation of their interest.
Practical Guidance
- Provide in the shareholders' agreement for a minimum period to exercise pre-emption of not less than a reasonable duration.
- Require any increase to be justified by a written study circulated with the notice.
- Require a high special majority for increase resolutions, the strongest minority protection.
- Provide for a partner's right to sell the pre-emption right where they cannot subscribe.
- Note the timing of any proposed increase, as coinciding with an existing dispute is evidence worth recording.
- Do not sign minutes approving an increase without reservation if you object, as signing without reservation considerably weakens your challenge.
A capital increase is a legitimate financing tool that may become a means of exclusion, and the difference appears in the genuineness of the need, the timing, and the period allowed. Yamnak Law Firm advises on structuring capital increases and protecting minority rights and challenges abusive increase resolutions before the courts.
