The Italian Corporate Reform And The Financing Of Corporations: What Has Changed?

Saturday, January 1, 2005 - 01:00

As the readers of the Metropolitan Corporate Counsel already know from some of our previous articles, the Italian corporate law has been substantially reformed as of January of 2004, when Legislative Decree no. 6 of January 17, 2003 (the "Decree") entered into force. Several interesting amendments have been introduced with respect to the provisions governing how to finance the two main types of Italian limited liability corporations, namely SpAs (societá per azioni) and Srls (societá a responsabilitá limitata). In general terms, the Decree has materially reformed the whole architecture of SpAs and Srls, with a view of defining two different organizational models. In the new Srl, the role of the shareholders has been significantly accentuated and they have been afforded a great degree of flexibility as to how to shape the company to best suit their needs; the new Srl now aims at being the model for a small-size closely held corporation. The SpA, instead, has maintained its character of a more heavily regulated corporation that should be the model of choice for medium to large-size corporations and especially for those whose shares are publicly traded or widely dispersed.

In this article, we believe it useful to offer a brief overview of three topics, which would illustrate to what extent the Decree has changed the provisions for the financing of Srls and SpAs: 1) new forms of equity contributions; 2) new types of financial instruments; 3) new rules governing shareholders' loans.

New Forms Of Equity Contributions

Equity injections into Italian companies may be performed through cash or non-cash contributions. Among the non-cash contributions, contributions in kind (such as real property, intellectual property, know-how, etc.) and contributions of receivables have traditionally been allowed. The shares issued as a consequence of these contributions must be fully paid-in when the contribution is made.1

Until the reform, equity contributions consisting of the performance of activities or services were not allowed.2 The rationale behind such prohibition was partially due to the difficulty in determining their value, and partially to the circumstance that this would have potentially represented a material risk for the creditors of the company who would have to rely upon an equity asset of uncertain satisfaction.3 Such provision also mirrored the mainstream scholarly thinking that equity contributions must serve two main functions, namely that of organizing the company's shareholders' structure (so that the "weight" of each shareholder in a company should correspond to the actual portion of equity contributed and owned by same) and that of being a guarantee for creditors.

The reform, at least with respect to Srls, removed the aforesaid prohibition on contributing the performance of activities or services as the second paragraph of amended Article 2464 of the Italian Civil Code now reads that "all assets which have an economic value can be subject of an equity contribution." The same article specifies that contributions consisting of the performance of services or activities must be guaranteed by an insurance policy or a bank guarantee, which secures the performance by the contributing shareholder. If provided by the company's by-laws, the policy or the guarantee may be replaced by the relevant shareholder's payment of the corresponding monetary amount in escrow. The purpose of such policy or guarantee is to provide the company's creditors with an enforceable security in case of claims relating to the contributed services or activities.

Significant issues arise with respect to the drafting and the contents of such policies/guarantees when one thinks about the modalities in which the service/activity will in fact be performed: what if, for instance, the company receives a damage (and not a benefit) from the services or activities performed by the shareholder? Since, based on a liberal interpretation of the law, the guarantee would only cover - the failure to perform in the case mentioned above. the company's and the creditors' only remedy would be an action for damages toward the relevant shareholder.

Other possible difficulties can be foreseen if the quota belonging to the "service-performing shareholder" is ever to be transferred, as a monetary evaluation of same may represent a difficult task. In this case, some scholars have argued that one could resort to a sworn appraisal by an expert.4 This hardly seems to be a satisfactory solution, however, if one reads the Governmental Report accompanying the Decree, where it is stated that "the contribution of the shareholder often qualifies for his/her personal and professional qualities, rather than for the objective value of the contribution itself."

With regard to SpAs, the prohibition of equity contributions consisting of the performance of activities or services still stands. However, the reform now allows shareholders to allocate newly issued shares in a proportion that does not have to necessarily match the contributions made by the relevant shareholders. This can be used, for instance, as a method to assign more shares to a shareholder who has committed to provide services or activities to the company, thus achieving an end result which is not far from the one described for Srls. In addition, activities or services may be contributed into an SpA in exchange for a new type of hybrid security, as described in the following paragraph.

New Types Of Financial Instruments

Another interesting provision introduced by the Decree is the sixth paragraph of new article 2346 of the Italian Civil Code which reads: "The company may issue financial instruments that have economic or also voting rights, with the exception of voting rights in the general shareholders' meeting, in exchange for the contribution by shareholders or third parties of services and activities." This provision applies exclusively to SpAs and there are no corresponding rules for Srls.

The aforesaid class of financial instruments. although deriving from a concept which is not entirely new in Italian corporate law,5 raises some questions as to which category of securities they fall in.

Scholars agree that such instruments cannot be qualified as shares. On the other hand, they are not considered as bonds by the majority of the commentators, as they may grant their holders significant administrative rights. This is why such instruments are generally referred to as "hybrid securities," namely a type of security that falls in between bonds and shares. However, the recent tendency of broadening the categories of bonds and shares, by including in each of those "categories" securities which do not have the traditional traits thereof. makes the conventional distinction between shares and bonds more vague. In light of the above, the effort of identifying a third category, such as that of the financial instruments under article 2346, may appear pointless. As to the rights that such financial instruments can incorporate, article 2346 only states that such rights can be either "economic" or "also administrative". Article 2351. fifth paragraph, of the Italian Civil Code states that "Holders of financial instruments ... may vote on issues specifically identified," which means that the holders of such securities are denied "full" voting rights in the general shareholders' meeting.

What is definitely noteworthy is that article 2346 allows SpAs to issue the aforesaid hybrid securities in exchange for the contribution of services and activities. while (as we saw in the preceding paragraph) that same contribution cannot be made into SpAs for the purpose of issuing shares. Such hybrid securities can also serve the function to reward company's employees in a way alternative to traditional stock options. The second paragraph of article 2349 of the Italian Civil Code states that "The extraordinary shareholders' meeting may resolve upon the issuance in favor of employees of the company or employees of its subsidiaries of financial instruments, which shall be different from shares and which can grant their holders economic or voting rights other than the right to vote in the general shareholders' meetings." The rationale behind this provision is to thrust the involvement of the employees into the company's fortunes.

New Rules Governing Shareholders' Loans

With regard to Srls. article 2467 of the Italian Civil Code, as modified by the Decree, sets forth that the reimbursement of the shareholders' loans shall be made only after all other creditors of the company have been satisfied and, if such reimbursement is made during the year before the company is declared insolvent, the money reimbursed shall be returned to the company.

The second paragraph provides that any type of funds injected into the company, regardless of the form of such injection, shall be re-characterized as a shareholders' loan, and therefore, subjected to the regime described above, when certain circumstances apply, "such as (i) the disparity - also in consideration of the corporate purpose of the company - of the company's indebtedness compared to its net worth or (ii) a financial situation where an equity contribution would have been reasonable."

This provision reflects principles elaborated by case law and commentators in the past few years, providing that the repayment of shareholders' loans is subordinated to the payment of other creditors' claims.6 The rationale behind article 2467 is to deter the Srl's shareholders from funding the company by way of loans rather than equity contributions, in situations where the company would thus remain undercapitalized to the prejudice of its creditors. One concern however relates to the qualifying criteria set forth in the second paragraph of article 2467 of the Italian Civil Code, where reference is made to a criterion of reasonableness, which could give rise to inconsistent interpretations. In this regard, certain commentators have suggested that the first criterion (i.e., the imbalance between the net worth of the company and its indebtedness), should be construed as the explanation of the second, so that the entire provision should read as follows: "... in those cases in which a capital contribution would have been more reasonable, namely where there is an excessive disparity between the net worth of the company and its indebtedness."

With regard to SpAs, the aforesaid provisions regarding shareholders' loans, based on a literal interpretation of the reform, only apply to intercompany loans, although many commentators have raised the question why such rules should not apply to any loan made by a shareholder to SpAs, as there is no apparent reason for treating such scenario in a different manner.

1 Instead, in case of a cash contribution, the payment of 25% of same will be sufficient, unless the company is owned by a sole shareholder, in which case the contribution must be paid-in in full.
2 Several are the services and activities that can now be contributed, such as the authorization to use a trade name or the undertaking of non-compete obligations.
3 The same position adopted by the European Union, in its directive 77/91/CEE.
4 As in the case of contributions in kind and of receivables, as per article 2465 of the Italian Civil Code.
5 Certain atypical financial instruments, or hybrid securities, were allowed by the law and fairly widespread in the domestic corporate practice well before the reform (especially in the form of a certain type of preferred shares called "azioni di risparmio," which are shares with no voting rights in the general shareholders' meeting and priority in the distribution of dividends).
6 The Italian term used by the legislator is actually "postergazione," which basically means that a shareholders' loan is treated as a junior debt which has a lower priority than that of any other creditors'.

Stefano Crosio is the Partner in Charge of the New York City office of Gianni, Origoni, Grippo & Partners. Ruggero Gambarota is an Associate in the New York office. The authors are very grateful to Carlos D'Ercole, whose efforts and research provided an invaluable contribution to this article.