Creditor Protection and the Application of the Solvency and Balance Sheet Tests under the Company Laws of Finland and New Zealand

Abstract

Creditor protection in the recently adopted Finnish Limited Liability Companies Act (FLLCA)1 has gone through structural changes compared to the preceding Finnish Limited Liability Companies Act of 19782. Novelties in the creditor protection of the FLLCA is that asset distribution is tied to maintaining the solvency of the company and contrary to the 1978 Act, creditor protection now covers also the company’s distributable reserves of unrestricted equity. Consequently, assets may be distributed only if the company has adopted a financial statement,3 which indicates the amount of the company’s reserves of unrestricted equity that may be distributed,4 unless otherwise ensues from a solvency test. The solvency requirement is set forth in Chapter 13, section 2 of the FLLCA: “Assets shall not be distributed, if it is known or should be known at the time of the distribution decision that the company is insolvent or that the distribution will cause the insolvency of the company.” It is important to notice that the solvency test applies not only to the distribution of reserves of unrestricted equity, but also to restricted equity even when the creditors have consented to its distribution in accordance with the creditor protection procedure laid down in chapter 14 of the FLLCA. The aim of this paper is to discuss the solvency test and the balance sheet test5 in chapter 13, section 5 of the FLLCA respectively, and assess how they should be carried out as well as what should be taken into account when doing so. Moreover, as an example I will compare the tests to creditor protection in the New Zealand Companies Act (NZ CA)6, with a special focus on whether the solvency test therein could help in the application or practical development of the solvency and balance sheet tests in Finland. The extreme distance of New Zealand to Finland and the fact that the common law system differs in both history and content from the Finnish legal system, were not the only reasons for selecting this creditor protection system as the point of comparison. It was chosen as an example of how two legal systems with different historical backgrounds and in two countries far apart can end up with rather similar mechanisms for solving conflicts of interest between creditors and shareholders, with the aim to prevent the opportunism of insiders, i.e. management and controlling shareholders. The comparison also serves as a tool for examining the control mechanisms of basically dispositive company legislation ex ante. The 1993 NZ CA reform is a valid reference point also in other respects, because its ideas and goals for modernisation were similar to those prevailing in the reform process of the FLLCA. Accordingly the NZ CA aims: “To encourage efficient and responsible management of companies by allowing directors a wide discretion in matters of business judgment while at the same time providing protection for shareholders and creditors against the abuse of management power.”7 In their extensive commentary of the NZ CA reform, Ross Grantham and Charles Rickett maintain that the act should 1) be understood as a model agreement between different interest groups in a company, 2) prevent any opportunistic behaviour of management and controlling shareholders, 3) in its extent and nature correspond to the risk of abuse of controlling positions and not prevent financial activities, and 4) be sufficiently simple and not too detailed.8 Thus it is no surprise that both the FLLCA and the NZ CA include provisions on creditor protection based on the maintenance of company solvency in addition to the traditional balance sheet test now used for determining the amount of net assets. The adoption of the solvency test also required reform of the regulation of modern limited liability companies and their activity. The traditional balance sheet and share capital-oriented creditor protection cannot be considered a sufficient means of meeting the requirements of good and efficient company legislation that protects all interest groups. The purpose of the solvency test is very simple. It aims to ensure the allocation of creditors in terms of assets and liabilities, by preventing such distribution of assets that would endanger the timely payment of receivables to creditors in the proper amount. Under NZ CA the solvency test is applied not only to the protection of creditors, but to fixed preferential returns on shares ranking ahead of those in respect of which a distribution is made.9 Technically, this entails that in the application of the solvency test under NZ CA the above-mentioned shares are considered debt according to their financial character.