Company law is an extensive legal area that is thoroughly regulated in legislation today, primarily through the Limited Liability Companies Act and the Public Limited Companies Act. Behind the many individual rules, however, lie a few central legal principles that both justify and interpret the corporate legal rules. These principles are crucial for understanding company law as a whole and form the foundation for the various provisions in the legislation.
This article highlights the most central principles in company law. The principles we review represent the fundamental pillars of company law and have direct significance for practical corporate management, shareholders' legal position, and the protection of various interests related to the company.
The Principle of Indirect Liability
One of the most fundamental characteristics of limited liability companies and public limited companies is the principle of indirect liability. This principle is enshrined in §1-2, first paragraph of both the Limited Liability Companies Act and the Public Limited Companies Act, which states:
"Shareholders are not liable to creditors for the company's obligations."
This means that it is the company itself – and not its shareholders – that is liable for the business's obligations. The company's assets are thus separate from the shareholders' other assets, which forms the basis for a clear distinction between the company's and shareholders' finances. This principle constitutes one of the most important differences between limited liability companies and personal company forms such as general partnerships.
The Principle of Limited Liability
As a supplement to the principle of indirect liability, the principle of limited liability applies. This is enshrined in §1-2, second paragraph of both the Limited Liability Companies Act and the Public Limited Companies Act:
"Shareholders are not obliged to make contributions to the company or, in case of the company's bankruptcy, to a greater extent than what follows from the basis for the share subscription."
This principle means that shareholders do not become liable for company debt beyond the amount they have subscribed or purchased shares for. The company's potential bankruptcy will therefore not have direct consequences for shareholders' private finances, and creditors cannot demand that shareholders cover the company's debt with their personal assets.
The principle of limited liability is not absolute, as shareholders in certain cases can become liable on special grounds:
Through contractual obligations, such as guarantees
Through liability for damages for losses suffered by creditors, if the shareholder intentionally or negligently has caused the loss
In very special cases through piercing the corporate veil, where shareholders can be identified with the company
The Principle of Restricted Equity
The principles of indirect and limited liability must be seen in conjunction with the principle of restricted equity. This principle means that the share capital (along with certain funds) constitutes the company's restricted equity, and that this sets limits for the company's freedom of action with respect to distributions.
§8-1, first paragraph, first sentence of both the Limited Liability Companies Act and the Public Limited Companies Act states:
"The company may only distribute dividends to the extent that it after the distribution retains net assets that provide coverage for the company's share capital and other restricted equity according to §§3-2 and 3-3."
This means that shareholders cannot freely dispose of the share capital; it is, as the name suggests, restricted equity. Only the company's unrestricted equity can be used for distributions, such as dividends, group contributions, gifts, loans to or security for shareholders, acquisition and pledging of own shares, and capital reduction.
Limited Significance for Creditor Protection
It is important to be aware that the restricted share capital in practice has limited significance as protection for creditors. There are no investment restrictions or requirements that the share capital must remain untouched in an account. As long as management acts within the company purpose, the share capital can be freely used for operations, investments, or other purposes.
Especially in companies with the law's minimum requirement for share capital (30,000 kroner for limited liability companies), the share capital provides no real creditor protection. This was one of the reasons for the reduction of the minimum requirement for share capital from 100,000 to 30,000 kroner in 2011.
Substantive Rules as a Supplement
To compensate for the limited creditor protection provided by the formal capital requirements, company legislation contains substantive, discretionary rules. §3-4 of the Limited Liability Companies Act requires that the company at all times shall have equity and liquidity that is "reasonable in relation to the risk and extent of the business in the company." This places a significant responsibility on the board, which must make independent assessments of what constitutes reasonable dividend distribution, even if the formal requirements for unrestricted equity are met.
The Principle of Shareholder Democracy
In limited liability companies and public limited companies, a democratic principle applies, which means that shareholders through majority decisions at the general meeting can govern the company through the election of the board and other central decisions. This principle is authorized in §5-17 of both the Limited Liability Companies Act and the Public Limited Companies Act, which states that a simple majority is sufficient for most decisions at the general meeting.
The democratic principle enables effective leadership of the company and allows a separation of ownership and management, which can be necessary to achieve professional management and to attract investors.
The principle of shareholder democracy is limited by two factors:
Minority rights: Statutory rights that give a shareholder minority the opportunity to exercise certain rights, such as demanding an extraordinary general meeting or investigation.
Requirements for qualified majority: For particularly important decisions, such as amendments to the articles of association, more than a simple majority is required (two-thirds majority).
The Principle of Minority Protection
The majority principle in company law creates a need for rules that protect minority shareholders. This is especially important in limited liability companies, where the shares are often not subject to normal market trading, and where the minority therefore may have difficulties exiting the company relationship.
The Limited Liability Companies Act contains several rules that provide protection for the minority, including:
Minority rights: Rights that can be exercised by a minority of a certain size, for example:
Right to demand an extraordinary general meeting (§5-6)
Right to demand an investigation (§5-25)
Right to demand a higher dividend determined by the district court (§8-4)
Right to assert claims for damages on behalf of the company (§17-4)
Requirement for qualified majority: For particularly important decisions, such as amendments to the articles of association, a two-thirds majority is required (§5-18).
Right to exit: In special cases, a shareholder can demand to be released from the company (§§4-24 and 4-17).
Prohibition of abuse of authority: The general clause in §5-21 prohibits the general meeting from making decisions that are likely to give certain shareholders or others an unreasonable advantage at the expense of other shareholders or the company.
The Supreme Court has in several cases upheld minority shareholders' claims for exit or setting aside the majority's decisions, especially in cases of "starvation" where the majority over a long period has refused to pay dividends despite good dividend capacity.
The Principle of Equality
The principle of equality is enshrined in §4-1, first paragraph, first sentence of both the Limited Liability Companies Act and the Public Limited Companies Act, and means that all shares of the same size have equal rights in the company. This ensures that shareholders have an equal and reasonable access to benefit from the company's business through the value the shares have and the dividend they entitle to.
The principle of equality does not prevent a majority shareholder from obtaining preferences at the expense of the minority as a consequence of the size of the shareholdings. The majority shareholder can, for example, "control" the general meeting and vote in those they want on the board, as a consequence of the majority principle. The principle of equality is linked to the share and not to the shareholder.
However, the principle of equality prevents:
A shareholder getting a greater right to dividends on their shares than other shareholders
A shareholder getting a larger share of the assets upon liquidation
A shareholder getting expanded voting rights on their shares compared to other shareholders
The legislation allows for the articles of association to determine that there shall be "shares of different types" (multiple share classes), but the principle of equality is manifested by the fact that such a division into different share classes cannot occur for shares that have previously been equal, without the consent of all shareholders.
The principle of equality is not absolute. It is the unjustified differential treatment of shares/shareholders it prevents. For differential treatment to be justified, it must be assumed that it is a result of a balancing of the collective shareholder interest (company interest) against the individual shareholder's interest.
The Principle of Prohibition of Abuse of Authority
The principle of equality must be seen in conjunction with the principle of prohibition of abuse of authority, which is enshrined in the general clauses in §§5-21 and 6-28 of both the Limited Liability Companies Act and the Public Limited Companies Act. These provisions mean that company bodies must not do anything that is likely to give certain shareholders or others an unreasonable advantage at the expense of other shareholders or the company.
The provisions establish a broad basis for minority protection and extend beyond both the principle of equality and the individual rules on minority rights. They typically address two situations:
Favoring certain shareholders at the expense of other shareholders: This refers directly to the principle of equality, but extends it to also cover decisions that do not change the relationship between the shares themselves. It especially covers advantages of an economic nature.
Favoring some at the expense of the company: The most practical case is that the majority's special interests are accommodated through benefits from the company, for example through favorable loans or unreasonable remuneration to the majority shareholders or their family.
The provisions only cover cases where a decision leads to an "unreasonable" advantage. They do not cover decisions that necessarily must favor some shareholders, such as decisions about time and place for the general meeting or about where the company's business shall be conducted.
The effect of a decision conflicting with these provisions is that the decision can be challenged and declared invalid by the court. In case law, it has also been established that an agreement that is affected by the abuse rules can be revised or justify exit from the company. Breach of the prohibition of abuse of authority can also lead to liability for damages for the person who has exercised the abuse of authority.
The Principle of Transparency
The principle of transparency means that everyone – shareholders, creditors, employees, and the public – has the right to become familiar with the company's articles of association and annual accounts, and thus gain insight into the company's financial position.
This principle is anchored in §8-1 of the Business Register Act and §8-1 of the Accounting Act, which give everyone the right to access company information registered in the Business Register and the company's annual accounts, respectively.
The principle of transparency also includes that the shareholder register/shareholder registry is open for inspection by anyone, including the company's competitors.
This openness can contribute to investors channeling capital to the company, but also to potential creditors or partners staying away from companies with weak finances or other problems.
The Principle of Loyalty
Company law must be supplemented with an unwritten duty of loyalty, which builds on general contract law principles. The Supreme Court has in several decisions confirmed that the duty of loyalty also applies in company relationships.
The duty of loyalty in company law means that:
Shareholders have a duty to act loyally towards the company and other shareholders: This can, for example, mean that a shareholder cannot exploit voting rights limitations in the articles of association in a disloyal manner.
The company has a duty to inform shareholders: The company must keep shareholders informed about matters of importance to their interests.
Majority shareholders have a special duty of loyalty towards the minority: Due to the power relationship between the participants, majority shareholders may have a more extensive loyalty obligation towards minority shareholders than vice versa.
The content of the duty of loyalty must be determined specifically through a balancing of various crossing considerations, and can be influenced by company-specific conditions. In a listed public limited company with many shareholders, the duty of loyalty will be less extensive than in a small limited liability company with few owners and close collaboration.
The Significance of the Principles in Practice
The reviewed principles constitute the fundamental pillars of company law and have decisive significance for the interpretation of individual rules in the legislation. In practical situations, the principles can:
Provide guidance in interpreting legal rules: When the legal text is unclear, the principles can indicate which interpretation is in line with the fundamental ideas of company law.
Supplement the legal rules: In cases where the legislation does not provide answers, the principles can function as an independent legal basis.
Guide discretionary judgments: When, for example, the board is to assess whether the equity is "reasonable," the principles will provide guidance on which considerations should be emphasized.
Provide a basis for judicial review: The principles, especially the prohibition of abuse of authority, give the courts the opportunity to review decisions that conflict with the fundamental values of company law.
Conclusion
The fundamental principles in company law constitute a framework that balances various considerations and interests – the consideration of efficient company operation, protection of the minority, creditor protection, and society's interest in transparency about companies' activities.
The principles are not static, but are developed and adapted through case law and legislative amendments. An example is the development from a formal creditor protection based on rules about restricted capital to a more substantive protection based on requirements for reasonable equity and liquidity.
For anyone working with company law – whether as an advisor, board member, or shareholder – it is crucial to understand these principles in order to navigate the complex regulatory framework that company legislation represents.
