Lengua y Derecho I Legal Aspects of Capital (Pepe, Marcelo)

LEGAL ASPECTS OF CAPITAL

Chapter I

1) Provide a definition of capital:

Capital denotes the investment of the contributory which needs to be placed a monetary valuation in order to
quantify his share in the concern. Any such valuation, if carried out pursuant to the rules applicable according
to the different legal types, determines the nominal value of capital and is thereby abstracted from the assets so
contributed.

2) Capital as a static figure

As an abstract and static figure, capital represents the monetary valuation of members´ contributions; and it is
set out in the company’s constitutional documents and showed in its financial statement. Capital is thus seen as
a nominal liability figure (cifra de responsabilidad). It’s not the real reflection of the real resources of the
company.

3) Dynamic view/conceptualization of capital

Being considered from a real perspective, capital is seen as a portion of the net worth which initially serves for
determining the nominal amount of contributions on the company’s formation.
According to this real perspective, capital is capable of mutation depending on the commercial affairs of the
business (it can increase or decrease in value).

4) Distinguish between capital and contributions:

Capital as a notional figure may be distinguished from:
1. The contribution representing the promise of the contributory, either to give any item of property or to do
work or perform services, which have already been considered,
2. The assets it represents, which, as initial capital contributions, reflect the subject matter of the obligation to
contribute
3. The net worth, indicating the aggregate assets less the aggregate liabilities of a company, that may initially
coincide with the economic valuation of contributions but, most importantly, could be altered by increasing or
being reduced, depending on the development of the entity over a specified period.

5) Compare and contrast capital and net worth:

Whereas capital reflects the initially raised contributions by company members represented by an accounting
figure abstracted from the value of specific property, the net worth denotes a financial and commercial
concept, inherent in which is the idea of variation, meaning that the company´s net worth is likely to increase or
decrease depending on the financial position of the entity and its real commercial necessities.

6) What is the difference between nominal and real capital?

A third position, emphasized amongst European scholars, states that capital is capable of a dual
characterization. From a nominal approach, capital is firstly defined as an abstract or static figure set out in the
company´s constitutional documents and further showed in its financial statements. Capital is thus seen as a
formal, legal liability figure, only capable of being altered by the company´s organs upon strict compliance with
relevant legal rules. Capital is secondly considered, from a real perspective, as a portion of the net worth which
initially serves for determining the nominal amount of contributions on the company´s formation and is further
insusceptible of being disposed of, for purposes of protecting the company´s members and interested third
parties dealing with it.

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Lengua y Derecho I Legal Aspects of Capital (Pepe, Marcelo)

7) Identify three sections of the ACA and decide whether nominal or real capital is referred to
Both the nominal and real aspect of capital is deemed to be admitted in the ACA, which seems to refer to both
aspects of capital in relation to Companies Limited by Shares (Sociedades Anónimas). Hence, in section 186 it
refers to capital as a real figure (by prescribing that the terms capital – capital social- and subscribed capital –
capital suscripto- are to be used interchangeably). In section 205 + 206, the concept of nominal capital is
adopted.

Section 205 of the ACA provides “[Reduction for losses. Requirements] Reduction of capital may be decided
by a resolution of the Extraordinary General Meeting where the company has made losses. Any such reduction
is effected for purposes of bringing the capital into balance with the net worth of the company”.

Section 206 states “[mandatory reduction] The company must reduce its capital where losses absorb reserves
and fifty percent of capital”

8) Why must capital be raised or diminished according to elaborate corporate rules

The initial nominal value of capital is further capable of mutation depending on the commercial affairs of the
business and the diverse factors of risk inherent in commercial trade. However, it may only be further altered
(raised or diminished) upon the company complying with elaborate procedures to that effect by passing valid
resolutions supported by technical accounting reports. The objective of these statutory requirements and
practices is aimed at preserving the equivalence between capital and net worth and ensure the inviolability of
capital in order to protect both present or future members and creditors.

9) What are the principles governing the legal concept of capital?

a. The inviolability of capital: The capital amount is inviolable in the sense that it must be preserved for
the purpose of protecting the company´s creditors and members. The inviolability of capital constitutes a
principle of public policy incapable of being overridden by private agreement, as it is intended to
maintain the integrity of capital for members and creditors´ protection irrespective of the fact that capital
may subsequently be altered, increased or diminished.
The real legal scope of this principle signifies preservation of the equivalence between the initially-
stated or subsequently- varied value of capital with the value of the entity´s economic assets (tangible or
intangible) at any given time + for protection objectives (members and creditors), and irrespective of
future valid increases or reductions of the capital figure.
b. The productive function of capital: Corporate capital serves an economic function in the sense that it
constitutes a crucial element for the generation of the productive activity of the business concern. From
a productive perspective, capital constitutes a collection of economic assets, contributed by company
members and objectively valued, which is designed to facilitate the productive capacity of the business
concern. Capital contributions, in turn, facilitate the furtherance of the corporate objectsThe
proportionate relation between the company´s capital and its objects is ultimately designed to preserve
the guarantee function of capital, basically towards creditors, thereby assuring adequate resources
readily available for the fulfillment of contracts validly entered into.
- In this context, capital must be proportionally related to the company´s activity in order to ensure
proper assumption of economic risks and availability of assets in the event of execution. The

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majority of Argentine scholars support the view of the proportional and adequate relationship
between capital and corporate objects.
- The company´s objects the act/s that the company is entitled to carry out pursuant to its articles in
order to fulfill the purposes for which it was formed.
c. The guarantee function of capital: In the context of company law, the guarantee function of capital
denotes the assurance that the legitimate and valid expectations of third parties, namely creditors and
company members, will not be deceived. When considering creditors´ rights, the guarantee function of
capital satisfies a universal law principle stating that a person´s patrimony must remain available for the
satisfaction of creditors´ claims [el patrimonio como prenda común de los acreedores]. Concerning the
guarantee itself, the company must be able to secure sufficient availability of assets considering their
productive function, among other aspects, in order to enable creditors entitled to legitimate claims to
obtain payment thereof. The guarantee principle of capital assures creditors that the adequacy of
available corporate resources shall not be altered to their detriment.
- When it comes to company members, the guarantee function of capital is designed to secure the
preservation, increase and eventual return of their respective investments in the entity. The
guarantee function of capital thus enables company members to preserve their aliquot shareholding
in the company for the purpose of exercising voting and financial rights and, eventually, obtaining a
return of investment upon liquidation.

10) In what sense is capital intangible or inviolable?

The company´s capital is inviolable, meaning it is not capable of being altered. Thus, capital is said to be
intangible, in the sense that it may not be affected on the part of the company by procedures other than those
provided by statute.

11) What is the purpose of the valuation of non cash considerations?

The inviolability of capital requires valuation of non cash consideration and equivalence between the value of
contribution and nominal value of subscribed capital which prevents shares being issued below par. The fact
that dividends may only be distributed among members out of liquidated and realized profits preserves the
company´s capital form being diminished if members are allocated part of its assets when the company has not
been profitable.

12) Define undercapitalization of companies. Real and nominal undercapitalization

Undercapitalization means that the stated capital is grossly inadequate in relation to the business endeavor.
Legal scholars distinguish two classes of undercapitalization: real or material.
Real undercapitalization occurs where company members fail to contribute assets necessary to accomplish the
corporate objects.
Nominal undercapitalization occurs where capital contributions by company owners fairly reflect the needed
funds to carry out its objects but any such considerations were given by means of a casual title other than by a
legal title as contributory.

Registrar’s control powers: The Registrar is empowered to investigate, therefore legally qualify, the
proportionality of the initial-capital/objects correspondence, therefore refusing registration in the event of
inadequacy of capital in respect of the corporate purpose. It must also be remembered that registration
constitutes a company in Argentina  it’s upon registration that a company is vested with legal personality,
exists as such in law, pursuant to the legal type adopted, and enjoys a presumption of legality.

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Lengua y Derecho I Legal Aspects of Capital (Pepe, Marcelo)
13) What are the purposes of making up/preparing the entity´s patrimony?
The legal attributes attaching to corporate capital are designed to preserve the productive resources making up
the entity´s patrimony for a threefold purpose:
1. Allow the business concern to successfully carry out the activities described in its objects;
2. Let outsiders dealing with the entity (creditors of diverse nature) know the true magnitude (present
and future) of the company´s assets, in order to let them know the company´s patrimonial structure
and payment capacity. This information shall enable repayment of creditors´ claims and, in turn,
afford company´s creditors sufficient knowledge of the adequate availability of assets in case of
eventual execution thereof;
3. Assure shareholders the preservation of the proportional equivalence between the value of their
equity shares and the company´s capital which they represent. In this way, should the company´s
capital be raised, company members are afforded pre-emption rights thus being prevented from unfair
dilution of their shareholdings and fairly conserve their financial and voting rights in the company.

14) What is the difference between the economic and political factors inherent in the business and the
formal, historical figure of capital?
While the economic view of capital represents the patrimony of the entity as it engages in business, the formal
and historical one only reflects the company´s assets in formation.

15) What is the difference between a close company and a public one?
On the one hand, close companies are characterized as personal-type structures. Thus, composed of:
 Centralized management and control powers
 Restriction on transferability of shares
 Identity between property and corporate control
On the other hand, public companies have
 The anonymous character of its members
 Delegation powers of directors
 Free transferability of shares
 Disclosure requirements and dissociation between members’ property and corporate control.

16) Classify guaranties

Guaranties may be classified in relation to two aspects:
a. By considering the person assuming an additional payment undertaking upon default of the principal
obligation, giving rise to the so called personal guaranties. In personal guarantees the debtor
himself or a third natural or legal person other than the main obligor secures the principal
indebtedness, as is the case with sureties in ordinary contracts or accommodation parties in
negotiable instruments.
b. A real guaranty may be envisaged as an additional subjective right of the creditor exercisable over
certain property of the debtor or of a third party, duly ascertained, thereby affording him a
proprietary interest in respect of the charged assets. Assuming that the security interest has been
created in pursuance to sufficient publicity requirements, the security interest holder is afforded
conservative faculties and real actions in respect of the secured property, preferential execution
powers over the affected property. A real guarantee may also be referred to as a security interest as is
the case with the Common Law terminology in this respect. Under Argentina law the mortgage, the
pledge, the right of anticresis, debentures or negotiable obligations bearing a fixed or floating charge
and trusts created for guaranty purposes may be distinguished among security interests.

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17) Define “security interest”
Under English law, whenever a creditor is afforded a payment priority over specified property of the debtor or a
third person, a security interest has been created. “A security interest is created when a person (the creditor) to
whom an obligation is owed by another (the debtor) by statute or contract, in addition to the personal promise of
the debtor to discharge the obligation, obtains rights exercisable against some property in which the debtor has
an interest in order to enforce the discharge of the debtor´s obligation to the creditor. It gives the holder of the
security a proprietary claim over assets, normally the debtor´s, to secure payment of the debt.

18) Classify securities according to English law

Security interests may be divided broadly in:
a. Consensual security interests arise by way of agreement of the parties. As regards to consensual
securities, English law recognizes at least the following: The mortgage, the charge, the pledge and the
lien.
b. Non-consensual securities are those security interests that arise by operation of law.

19) What rights do security interests confer?

 Security interests confer a proprietary right on their holders,
 Secured lenders are afforded payment priority over unsecured claims and shall, pursuant to the seniority
of their claim, also prevail over any lees senior security holders.
 The holder may take possession of the security and foreclose it. The right of enforcement allows a
secured creditor to take whatever steps are available to enforce the security. This right of enforcement is
further enhanced by the fact that English insolvency law permits a chargee to remain outside the
insolvency proceeding and to enforce his charge independently of such proceedings.
 A secured creditor may have the right of pursuit. This arises when a company in violation of the rights
of a chargee disposes of the property subject to the charge and it entitles the chargee to pursue his claim
into the proceeds of the disposition.
 He may also be able to assert a claim against the property subject to the security unless it is acquired by
a bona fide purchaser for value.
 A charge affords a chargee a measure of control over the business of the debtor company. The company
may have to report regularly to the chargee and if the company gets into financial difficulties, the
chargee may be made privy to the management decisions.

20) The crisis of the traditional concept of capital

Capital has ceased to be a mere static formal figure fixing the nominal amount of contributions on the company
´s formation to reflect the real economic and financial situation of the business it represents. According to this
modern trend, in addition to the initial static figure determined in the company´s constitutional documents,
capital is formed by the subsequent economic resources capable of becoming part of the assets of the company
as it engages in business thus causing further capital increases, as may be duly decided by the entity.
Similarly, capital must be defined with regard to the net economic resources underlying the formally stated
capital amount. Thus, it comprises other items such as revaluation of assets (integral adjustment), share
premiums or irrevocable contributions to capital to be further capitalized, referred to as “Aportes irrevocables a
futuros aumentos de capital”.
Asset Revaluation such revaluation is designed to adjust the historical value of assets in consequence
of the loss of their purchasing power + constitutes a nominal increase of the company´s assets.

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The capital increase resulting from the revaluation of assets must be distinguished from the
increase due to a dividend capitalization or where other undistributed special reserves (share
premiums) are to be capitalized. Although the capital increase in all these cases finds its source
in capital reserves, the asset revaluation causing the raising of capital does not reflect a real
financial increase of the company´s net worth.

In conclusion, the legal notion of capital is broadened to include, apart from the initial capital contributions upon
formation of the entity, or following a capital increase, its integral adjustments as well as other items recordable
as net worth accounts of the company’s balance sheet, such as undistributed reserves or share premiums,
amongst others.

21) Shares issued at a premium

Share premiums represent a supplementary contribution to be paid in by existing or new shareholders upon new
shares being issued above their par value (at a premium). Share premiums do not constitute a gain as they
represent a consideration above the nominal value of subscribed shares.
Purpose of issuing shares at a premium Any such premium (prima de emisión) is intended to preserve the
rights of existing shareholders in the company´s net worth, basically, retained earnings. Payments for shares
above their par value are thus designed to preserve existing company members´ aliquot holding against new
shareholders´ participation in retained earnings at the expense of the former.
Under Agentine company law, share premiums constitute a special reserve fund (s 202 of the ACA)
Share premiums may be capitalized, provided an extraordinary general meeting resolution exists. Likewise,
under English company law, shares may be issued at a premium (above their nominal value) in either a private
or public company and the whole of the premium is placed in a share premium account.

22) Reserves

Reserves: those sums taken out of distributable profits which will ultimately increase the amount of the net
worth (corporate funds made up of distributable profits earmarked for a special purpose)
- These reserves are freely disposable and constitute patrimonial reserves to be further capitalized.
These funds must be distinguished from earmarked funds to meet corporate needs other than those
assigned for future capitalization purposes (ex. amortization reserve funds, guarantee reserves, etc)
- Mandatory reserves reserva legal

Chapter III

Capital increase

A. Internal Funding
It takes effect by the company capitalizing its existing funds and without shareholders´ disbursements at the
time the issue takes place. Capitalization is therefore referred to as internal funding effected by the distribution
of fully paid up shares (acciones liberadas) -shares also referred to in English law as bonus shares-.

Reasons:

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Lengua y Derecho I Legal Aspects of Capital (Pepe, Marcelo)
 A company wants to strengthen its financial ability to trade in business + attain a consolidated market
position through the increase of its economic and productive capacity.
 To rationalize the company’s resources (to balance its capital amount with the value of the worth where,
due to the profits reaped by the business, the net assets exceed the notional figure representing capital).
Hence, certain reserve funds may be transferred to the company´s capital account by capitalizing
retained earnings or other special balance sheet reserves. The company may, in turn, pay dividends to
its members through the allotment of shares, thus effecting a dividend capitalization.
 Due to an inflation adjustment in order to reflect the real value of depreciated assets because of inflation.

Section 189 of the ACA: “The company must have regard to existing members´ proportionate equity holdings
upon capitalization of reserves or any other special fund recorded in the balance sheet. Members´
proportionate holding in the company must also be preserved upon existing members taking up shares in lieu
of dividends or by any other means being allotted paid-up shares”.
 The capital increase through the issuance of fully paid up shares operates to rationalize the company´s
resources. Accordingly, certain balance sheet funds, such as the share premium special reserve fund,
retained earnings, members´ contributions for future capitalization purposes may be transferred to the
company´s capital account therefore increasing the capital figure in the amounts so transferred
 In a case of internal equity funding by a dividend or reserve capitalization, however, shareholders are
not entitled to exercise pre-emption rights, neither are they afforded rights of accretion, as any such
rights may only be asserted upon a capital increase through newly issued shares for cash.
Types:

a. Dividend capitalization: when the company allots fully paid up shares in lieu of dividends. From a
legal standpoint, a dividend capitalization constitutes a form of cancellation of a debt, namely that
arising from the future and eventual right of the shareholder against the company to collect dividends.
b. Asset revaluation (see above)
c. Inflation adjustment: when the company´s nominal capital is increased in order to reflect the real value
of depreciated assets in consequence of the loss of the purchasing power of money due to inflation
d. Capitalization of free reserves: taking reserves from one account of the balance sheet and put them on
the capital account. It’s and increase of capital due to a rationalization process, it’s a nominal increase
(not a profit/gain).
e. Capitalization of Premiums (see above “shares of premium”)

B. External Funding
The company may raise its capital structure by bringing to the capital account of the balance sheet items
previously recorded as liabilities or non cash consideration given by third parties dealing with it, as where the
company distributes shares in consideration for non cash contributions or in order to cancel a preexisting debt
(debt capitalization)
Basic characteristic of a capital raise by external funding The company resorts to third parties´ assets
rather than to its own resources + the company obtains disbursements in cash by existing shareholders or new
investors, thereby raising its capital amount by means of a new issue of shares.

Types:
1. Loan capital funding the company is granted a loan or, by any other means, receives cash in its
capacity as borrower. The supplier of such funds (the lender) is legally regarded as a creditor of the

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entity. The company may, in order to secure payment of the incurred debt, grant a security interest to its
lenders by issuing debentures coupled with a charge exercisable on certain or a collection of the
company`s assets. Holders of debentures are thus creditors of the company who are acknowledged
payments rights against the company and whose position differs from that of equity holders (members)
who are entitled to voting and financial rights in the company.
2. External equity capital funding  there’s a real economic capital increase in consequence of receiving
resources from outsiders. The company is externally funded upon:
a. Debt capitalization (exceptional) the issuance of shares due to the capitalization of
pre-existing debts.
b. Capitalization of non cash contributions shares are allotted in consideration for non
cash contributions
c. The issuance of debentures convertible into shares upon the exercise of the conversion
option by convertible debenture holders, shares shall have to be issued in their favor in
order to duly reflect the relevant conversion into shares and the nominal capital amount
of the company shall accordingly have to be raised.

Where capitalization takes place in consequence of external funding by the issuance of equity shares, however,
shareholders are afforded pre-emption rights, that is, they are given priority over external investors to
subscribe for the newly issued shares in proportion to their existing holding.
Further, company members are entitled to accretion rights, that is, the right to proportionally increase their
holding over undersubscribed shares of the same class. However, Accretion rights may only be exercised in
proportion to the shares effectively subscribed at the time of the relevant increase

Corporate process of capital increase

The board of directors must decide to raise the company´s capital through a valid directors´ meeting
The minutes of the meeting must evidence the justification of the company´s reasons why the capital was
decided to be raised (the quorum of the relevant meeting may not be less than the absolute majority of its
members. The director´s meeting shall state as a specific item of the agenda the intention to increase the capital
of the company.
Once the relevant capital increase has been validly proposed by directors and duly decided and approved by
shareholders, the third step concerns the carrying into effect of the decision which means issuing the relevant
shares representing the increase and accordingly entering into share subscription agreements.
If the increase of capital is the consequence of internal capital funding which, as has been seen, does not require
shareholders´ disbursements (s189 of the ACA), shareholders shall be allotted shares fully paid up.
Finally, the shareholders´ resolution deciding the capital increase shall be registered with the IGJ for purposes
of control and binding effects as against third parties interested

New issue by private subscription

Under the Argentine company legislation, private companies may raise their capital by private subscription, that
is, without offering their shares to public.
Pursuant to the provisions of the ACA, private companies may raise their capital up to its quintuple amount
without amending their articles, upon such provision having been expressly provided. The increase is decided
by resolution of the general annual meeting, following its quorum and majorities requirements and further
registration. The company´s capital shall only be deemed effectively raised upon the amount of the increase
having been subscribed and effectively paid in, either in whole or in part.

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Companies offering their shares to the public, governed by section 299 ss. 1 of the ACA, may decide to raise
their capital up to any limit without amending their articles.

Rights of members who cannot afford to subscribe newly issued shares  Dissenting minority shareholders
who cannot afford the subscription of newly issued shares in consequence of a capital increase can, in turn,
exercise appraisal right.

New issue by public offering of securities

According to section 198 of the ACA public companies may raise their capital by means of a public offering of
its equity securities. They may increase their capital up to any limit without amendments to their articles. In the
case of a capital increase through external equity funding by public offering of securities, company members
are likewise entitled to pre-emption rights and rights of accretion.

Capital increase under English law

Under English law the company´s capital is made up of the issued share capital, the share premium
account (if any) and the capital redemption reserve (if any).
The issued share capital comprises the aggregate subscribed shares that the company has issued,
whether paid-up or unpaid.
The share premium account is made up of the sums transferred thereto in consequence of the company
issuing shares at a premium. In other words, it represents the aggregate amount of the value of the premiums.
This account is treated as paid-up capital + it increases the amount of company’s net assets. The issued share
capital shall only be increased when the company resolves to use the share premium account to pay up new
shares to be allotted to members as fully paid bonus shares. In this case, the sums making up the share premium
account, being capitalized, are transferred to the capital account and new shares shall accordingly be issued.
The capital redemption reserve represents the amount by which shares are redeemed wholly out of
profits which are accordingly transferred to a reserve called “capital redemption reserve”. The capital
redemption reserve is a notional liability. the company must transfer amounts to a reserve, called the “capital
redemption reserve” where shares of a limited company are redeemed or purchased wholly out of the
company’s profits. the capital redemption reserve reflects the amounts disbursed out of profits by the company
upon purchase of its own shares, or on cancellation of its own shares held as treasury shares. The capital
redemption reserve constitutes a notional liability reflecting paid up capital which, when used by the company
to pay up new shares to be allotted to members as fully paid bonus shares, as is the case with the share premium
account, increases the issued share capital of the company.

- The company´s capital does not automatically fluctuate in order to reflect the economic mutation of
the net worth. It therefore remains unaltered until increased by a further issue of shares, which must
be made in conformity with legal requirements.