Advantages and Disadvantages of Legal Capital Rules in the Model Business Corporation Act and the European Union Second Council Directive

Corporation Act (MBCA) is a model set of law credited to the Committee on Corporate Laws of the Section of Business Law of the American Bar Association. This is followed by twenty-four states. The MBCA was first created in 1950 and the final version came up in 2002.

The first thing that the law accepts is that Corporations are classified as “legal persons” which means that they have rights like natural persons. In the United States, companies like McDonald’s and Google, are corporations and can sue or be sued and enter into contracts. They can also have assets and debts .

One of the benefits of MBCA is that shareholders of the company are not personally liable for the business debts, obligations and liabilities of the corporation. Shareholders liability is limited to the extent of their investment in the company. Thus personal assets like home and car are outside the purview of liability for company debt.

A corporation has other advantages as well. It has ability to raise capital as well as issue stock with a view to finance any expansion or other activities of the company. They can issue multiple classes of stock which will carry voting rights and share of profits. They can issue a public offering, which allows them to trade publicly in NASDAQ, New York Stock Exchange or other stock exchange.

There are two disadvantages in the Corporation act. The first concerns excessive paper work. Financial statements have to be created and audited. These cost time and money especially in case outside persons are to be hired.

Another significant disadvantage is the creation of double layer of taxation to which the company is subject. The first is when the company files taxes as a business with the Internal Revenue Service. The second tax happens when the corporation issues dividends to the company’s shareholders. Shareholders will also pay tax on dividends received by them

A directive is a legal act of the European Union which requires member states to achieve a particular result without dictating the means of achieving that result. The legal basis for this directives is Article 288 of the Treaty on the Functioning of the European Union . The legal capital rules of the EU have been accepted by adopting the second directive. This imposes limits on minimum capital, contribution, distribution to shareholders and increases or reduces capital. The EU legal capital rules require a minimum limit of at least C25, 000. It also specifies that shares may not be issued for less than nominal value. Article 7 of the Second Directive also states that at least one quarter of the subscribed capital must be paid up at the time of commencement of business.

The limit of C25, 000 is too strict and many member states have differing views. In addition one of the major drawbacks of the EU directive which is in sharp contrast to US law, companies in the EU cannot re-purchase their own shares unless authorized by shareholders at a general meeting. In addition the company or any of its subsidiaries cannot purchase more than 10% of the subscribed capital. The purpose is perhaps to stop monopolies creeping in, but in effect it could hamper company growth and investment

Another aspect of the second directive( Article 23) is a blanket ban on a company advancing any funds or making loans with a view that the company can be acquired by a third party. This prohibition is so broad that some planned and leveraged buyout so much a part of commercial scenario in USA is prohibited.

EU law put fixed claimants at a priority as far as assets are concerned. The rules stipulate that in case a company posts losses so that the firms net assets fall below some specified minimum level then the company must either recapitalize or reorganize. In case this is not done then it has to go in for liquidation.

From the above we can see that the EU capital rules are not business friendly. The European Union legal capital rules are based on antiquated notions of legal capital and need to incorporate some aspects of U.S. Revised Model Business Corporation Act.

We can conclude that the Second Directive’s legal capital rules provide zero benefit to corporate creditors. This is not in line with latest concepts embodied in the US capital law is because the banks and accountants benefit and the incumbent management can retain their hold on the company, as it makes it difficult for new incumbents to enter the market.

Most theorists see the primary function of boards of directors as monitoring the actions of managers on behalf of shareholders


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