How to deal with in-kind contributions is a sticky business
While there are a number of methods for bringing needed capital into a company, one of the most flexible ways continues to be the tried and true in-kind contribution. In the nearly nine years since the enactment of the June 14, 1991 "Law on Companies with Foreign Participation," which set forth the guidelines for how foreign investors could conduct business in Poland and invest in Polish companies, the concept of in-kind contribution as meaning something other than a cash contribution has served as an umbrella for all sorts of creative funding mechanisms. In response, several court decisions have been issued that have played a decisive role in defining limitations on in-kind contributions.
Getting back to the "Law on Companies with Foreign Participation," early investors may still remember that foreign individuals and corporate shareholders had to make in-kind contributions to a company's capital in the form of either assets transferred from abroad or assets purchased in Poland with Polish currency obtained from the sale of convertible currencies in a foreign exchange bank. With the changes in Poland's foreign exchange law, these restrictions were abolished. Hence, as a starting principle, any asset with economic value may be contributed in-kind.
Nonetheless, it is important to point out that the Polish Commercial Code does not clearly define what assets may be contributed in-kind. As we all know, accountants, economists, and lawyers pride themselves on coming up with creative solutions, such as finding economic value in assets that might otherwise seem bereft of such. And, sooner or later as the "solutions" become more and more creative, the courts usually step in to draw the line on what is permissible creative and what is pure fantasy. Despite a number of judicial decisions, some forms of in-kind contributions, especially intangible assets, still remain subject to debate.
One of the question marks is whether a shareholder's own (monetary) receivables may be contributed in-kind. In other words, may I contribute a debt owed to me by the company in which I am a shareholder as an in-kind contribution to that company? The opponents of this stance claim that a shareholder's receivable may not be included in the company's balance sheet. As indicated by practice, however, a contribution of this type is usually clearly marked, is subject to valuation, is tradeable, and allows for a reduction in the company's indebtedness. Although the concept that an existing receivable may be contributed in-kind has been accepted in jurisprudence, court decisions have been negative as regards the paying up of shares with a shareholder's obligation to pay a specific amount of money to the company in the future. This difference in the position taken with respect to existing receivables and future obligations arises mainly from the fact that the conversion of any indebtedness into the share capital of a company is based upon a contractual setting off of a shareholder's receivable from the company against a company's receivable from the shareholder on account of the payment for the shares.
What seems to be fairly clear is that a third party receivable from the company may be contributed in-kind in the event that the third party becomes a shareholder in the company. In other words, I, not being a shareholder of Company X, lent it a specific sum of money. Company X and I (as long as nothing in the Articles of Association of Company X would prohibit the transaction) may agree that I will acquire shares in Company X as repayment of the loan. There is one caveat Company X must have real assets to cover the "purchase price" of the newly issued shares. Canceling out an unpayable debt by issuing worthless shares is not permitted.
Another "asset" that definitively may not be contributed in-kind is a credit arranged for the company by its shareholder. The justification for this position is that it is not possible to effect a valuation. This does not mean, though, that shareholders granting loans to the company in which they hold shares have no avenues left for converting the loan into equity in the company. It is still possible, for example, to convert the shares held into privileged shares.
Whenever you are considering increasing the share capital of a company through an in-kind contribution (regardless of its nature), you should plan on amending the company's articles of association. Recent judicial interpretations, particularly by Warsaw courts, suggest that in the event of an increase in the company's share capital and the payment for shares with an in-kind contribution, it is necessary to amend the articles of association. This amendment should indicate the shareholder acquiring the shares in return for the in-kind contribution, the substance of the in-kind contribution and the amount of shares issued.
If real estate (including those ever-prevalent perpetual usufruct rights to land) is contributed to the company, the transfer of the title should take the form of a notarial deed executed after the increase of the share capital has been registered with the court. Moreover, making an in-kind contribution does not relieve a shareholder or the company from the necessity of obtaining any required permits.
As a final note on this issue of economic value and creativity, a company's management board is liable for the accuracy of the valuation of the in-kind contribution.
This article was prepared by Lejb Fogelman, the managing partner of Hunton & Williams Poland, with the assistance of Joanna Fonfara, an associate attorney.
