The Norwegian Limited Liability Companies Act states that all limited liability companies must have adequate equity and liquidity.
This requirement is fundamental and must always be met. The provision has an impact on the company's dividend basis and all capital transactions undertaken by the company.
As a member of the board of directors or the company's management, you will often come across these terms, and it is crucial that you understand what they mean.
It's also important to be aware of the consequences of not complying with the requirements, as the board and key personnel can be held personally liable if the company does not have adequate equity and liquidity. This makes it essential for all board members to have a good understanding of the regulations and their practical application.
In short, equity is assets minus liabilities. An important clarification is that the Companies Act refers to the company's real equity, not the book equity. This means that you must also consider the added value of the company's assets and liabilities.
Liquidity means ability to pay and refers to the company's ability to pay its ongoing expenses such as bills, salaries, development costs, taxes, etc.
There is no concrete answer to this question. Each assessment is discretionary. The prudence assessment is a specific overall assessment of the company's ability to pay its obligations, usually at least 12 months ahead.
The overall assessment consists of several factors, where the assessments mainly relate to the company's risk and scope, the company's debt structure and debt scope, as well as the phase the companies are in.
In other words, the assessment covers the risk and scope of the business. This applies to both general market risk and any special risks associated with the business. If your company has high risks, you will face stricter equity requirements than companies with low risk. Businesses with unpredictable revenues, high tied-up capital and that are vulnerable to external factors are often considered higher risk than businesses that are characterized by stable customer contracts, predictable revenues, low fixed costs and the ability to quickly adjust expenses to revenues.
Another important factor in the overall assessment is the relationship between equity, debt, the composition of debt and the terms of the company's obligations. You can't look at equity in isolation, but you must also consider the relationship between equity, debt, the composition of debt and the terms of the company's obligations.
The company's life phase is also considered. If the company is in a growth phase after starting up, it may be justifiable to accept deficits and declining equity during a transitional period if there is a realistic plan for future profitability. Such assessments must necessarily be based on documented and realistic business plans that show how the deficit will be turned into a profit. This must be objectively justified with specific measures and deadlines. The growth phase assessment has its limitations and cannot be used indiscriminately in bad times or when the company finds it opportune.
As a board member, you have a statutory duty to act. This is important to be aware of.
The duty to act arises if a situation arises, that means that the company's financial position can no longer be considered justifiable in relation to the risk and scope of the business. This is a discretionary assessment that the board must make based on the company's specific situation, see above.
Should this occur, the board must immediately convene a board meeting to assess which measures can improve the company's financial position. These may include measures such as raising capital from existing owners, the sale of assets, cost reductions or other strategic measures. If the board concludes that there are no realistic measures that can restore adequate equity and liquidity, the board is faced with the difficult choice between voluntarily dissolving the company or filing for bankruptcy. Failure to act in such a situation may result in personal liability for the board members.
If the board does not fulfill its duty to act in accordance with sections 3-4 and 3-5, board members and/or the CEO, collectively or individually, may be liable for damages.
Also read: Board responsibilities in a limited liability company (AS)—an overview
For the board to be able to make the above assessment and maintain an overview of the company's position, it is important that the board has/establishes good reporting routines and that the dialog with the CEO is good. The board must receive all relevant information to assess the company's actual financial position. This is a responsibility the board has if the company is active.
The requirement for adequate equity and liquidity is not just a legal formality - it is a tool to ensure the company's long-term survival and protect those with interests in the company, not least to ensure coverage for the creditor community .
As a board member or CEO, you should ensure that the company has systems in place to continuously monitor the financial situation. If you have any doubts about the company's financial position, it is important to clarify the actual financial circumstances internally in the company and seek legal assistance at an early stage.
Do you need help concerning adequate equity and liquidity? Contact Magnus Legal for legal assistance.