By: Andrés López
Private financing, whether bank, multilateral or by loans from partners, applied to the mercantile and commercial operations of companies in Guatemala has been and continues to be the most common means by which an entity capitalizes itself to increase the volume of its operations by investing in goods for its production, fresh capital to attend its suppliers or any other destination that allows its healthy activity.
When such financing comes from one of the partners or investors external to the company, and that for different reasons the company cannot pay or due compensate the partner or investor, our legislation contemplates the way in which such liabilities can be converted into a debt capitalization if so, provided by the decision-making body of the entity with the consent of the creditor.
This capitalization consists of the conversion of the liabilities owed to one or several of its shareholders or investors, into equity of the latter, which in other words, converts its creditors into partners and its existing partners increase their social participation, increasing their voting power and consequent decision during their operations, this being a viable alternative to solve the contingent liabilities of such companies.
Personally, I consider that with the entry of the new Insolvency Law in Guatemala, it has become evident that many times the entities that cannot face their debts, may suffer payment insolvencies and enter into liquidation processes, since many times they are unable to satisfy the debts of their creditors, and it is in this part where taking into account the capitalization of debt becomes into the reduction of the risk of insolvency by eliminating the liabilities accumulated by a company. It is important to emphasize that the shareholders have the responsibility to take care, like a good parent, of the business of the corporation, to which effect it is not enough to have a good administration, but rather that the corporation has sufficient capital to meet its short-, medium- and long-term obligations. Likewise, those creditors who, not being partners of the company, may find in the business a disruptive way of investing through the capitalization of their claims.
It is curious that the capitalization of debt in Guatemala can be applied, but not to all commercial companies, but only to those entities that structure their capital stock through shares called “stock companies”, the typical example being the corporation, This is because the only way to compensate debts is through the appreciation or conversion of the amounts of liabilities in a certain number of shares of the debtor entity, therefore in the entities that are not stock companies, and that operate through contributions, such as the limited liability company, since they operate through contributions, the financing granted by any of its partners cannot always be translated into securities such as shares. It should be noted also that in Guatemala the capitalization of liabilities or debt does not have a specific regulation, but it is a relatively common practice, to reduce the negative accounting items and that in the long run the exchange of debt for shares can be an incentive to clean up its finances and lighten part of the obligations that can greatly affect its income statement or the continuity of its operations.
The capitalization of debt as a legal business, from the legal and doctrinal point of view, in my opinion can be configured in some cases as a type of payment by compensation, as an abnormal means of extinction or fulfillment of obligations, by converting at the time of the capitalization in partners in the case of its creditors, or in turn to the social entities with their own partners, in both cases to those who owe some amount for any concept by their own; It could also be classified in other cases as a payment by confusion, where the creditor becomes a shareholder of the debtor, having both qualities at a certain point of the operation.
These operations are applicable to entities of all sizes, whether local or multinational, since they allow the balancing of their debts or liability accounts, at least in the short term, and offer a viable but intrusive solution, considering that the creditors, now new shareholders, are already part of the entity’s highest decision-making body, and can exercise their voting and economic rights, since they become new partners, and are granted the same rights and obligations as the initial and/or pre-existing partners.
According to the Argentine author Ariel Angel Dasso1,, the capitalization of liabilities is constituted by a compensation, in that sense, according to the above mentioned, the debt that such creditor has against the company would be compensated with the debt that will be assumed in the subscription of the new shares. For the capitalization of debt to operate, it is necessary that the debt to be offset and the shares to be issued can be issued for an appraised amount, which can be valued by mutual agreement and in case of discrepancy could be done through a valuation of assets, and which must be issued within the maximum limit of authorized capital of such entities at the time of the transaction.
On the right of first refusal of the constituent shareholders
It is likely that after capitalizing a debt, both new and old shareholders will not obtain profits or dividends within the following fiscal period, but it allows the entity to continue with its operations and clean up its finances in the medium term, by extinguishing part of its debts in a compensatory manner and avoiding damaging its cash flow.
It should be noted that the Guatemalan Code of Commerce establishes and recognizes the right of first refusal to existing shareholders at the time of issuance and subscription of new shares, which may be restricted if so established in the corporate deed, therefore in the event that this is not regulated in said deed, the partners must waive the right of first refusal and raise the decision to the Shareholders’ Meeting of the entity to approve the debt capitalization operation previously. The latter regardless of whether it is necessary to increase its capital stock (authorized capital) prior to issuing shares and formalizing such capitalization, since there may be cases in which the existing authorized capital is subscribed and paid in full.
As we can see then, the issue of the treatment of corporate debts and their capitalization to compensate them can result in a useful scheme in operations that are supported by shareholders and investors, and that becomes viable for those who may have interest in obtaining greater participation in the debtor entities and so it is decided by the same existing partners.
If you have any doubts about this issue or any other matter related to debt capitalization and the procedures allowed by the Law, LatinAlliance can advise you in the best way to solve or structure the credit solutions for your business.