22.4 Regulation of shareholder funding from a (legal) economic perspective

The main rule that shareholders are entitled to the company’s unlimited profit potential, but only share in potential losses up to their contribution, means that shareholders can externalize costs to creditors and other company stakeholders. Thus, the risks resulting from a high-risk financing structure are not only borne by the shareholder, but also – and sometimes primarily – by these parties.1 Many professional creditors, such as banks and credit companies, are perfectly able to protect themselves against these risks. For example, they usually stipulate compensation for these risks in the form of a risk premium on the interest rate that the company has to pay on the credit. In addition, the professional creditors can stipulate personal guarantees from shareholders and, in this way, contract around the limited liability shield; they may also demand security on the company’s assets. Moreover, loan agreements usually impose contractual limitations on shareholders’ ability to change the company’s risk profile ex post – that is, after the credit has been furnished – for example by making distributions, raising additional loan capital or changing the risk profile of the business activities. However, there is no such thing as a totally infallible credit agreement, so that the shareholder sometimes can prejudice professional creditors by changing the company’s risk profile beyond the expectations of the parties.

Not all of the company’s creditors are capable of protecting themselves against a transfer of risks by shareholders. Trade creditors, employees, consumers and, in particular, involuntary creditors are frequently not in a position where they can influence the terms and conditions of their relationship with the company. This means that, to a certain degree, shareholders can externalize the costs of the business to specific creditors of the company, especially if they undercapitalize the company, withdraw capital from the company or have the company raise extra loan capital.

In the run-up to the credit crisis, it was demonstrated that shareholders sometimes prefer a (too) high-risk financing structure on rational grounds;2 this gives rise to the question regarding how the law must impose limits on the shareholder’s discretion to decide on the financing of the company. In my opinion, limited liability serves to protect shareholders from run-of-the-mill company risks and special, unforeseen risks. However, it does not aim to enable shareholders to pass on reasonably foreseeable costs to third parties. For that reason, I believe that under specific circumstances, shareholders may have the responsibility to adequately fund the company at the time it is incorporated or when its activities have changed, such that the funding is in reasonable proportion to the nature and scope of the business activities and the risks resulting from this. Nor may shareholders expose creditors to risks that they reasonably did not have to allow for by capital withdrawals and leveraging. In short, the regulation of shareholder funding serves to prevent shareholders from externalizing reasonably foreseeable costs to the creditors and other stakeholders of the company.