Shareholder loans and subordination of claims

When a company needs liquidity, the quickest route is often a shareholder loan: the shareholder makes money available without going through a bank or a capital increase. It is a useful and legitimate tool, but it must be handled with precision, especially when the company runs into financial difficulty. That is when a little-known but decisive mechanism comes into play: the subordination of claims.

What a shareholder loan is

A shareholder loan is financing granted by a shareholder to their own company (GmbH or AG). Unlike share capital, it remains a debt owed by the company to the shareholder: it accrues any interest, has a maturity date and must be repaid. It is debt capital, not equity, and as such appears among the liabilities on the balance sheet.

There are several reasons to use one:

• to cover a temporary liquidity need;
• to finance growth without diluting shareholdings;
• to avoid the time and cost of a capital increase.

For it to be sound and recognised, the loan must be documented: a written contract stating the amount, interest, maturity and repayment terms prevents disputes, particularly from a tax perspective.

Interest and transfer pricing

If the loan bears interest, the rate must be at arm’s length. Every year the Federal Tax Administration publishes reference rates (maximum permitted rates) for loans between companies and related parties. Applying an interest rate that is too high can lead to tax adjustments and hidden profit distributions; a loan without documentation or economic rationale can be recharacterised. The rule is simple: treat the transaction as if it were between independent parties.

When the company is in difficulty: capital loss and over-indebtedness

The shareholder loan becomes delicate when the company loses ground. Swiss law sets out precise warning signs:

• in the event of a capital loss (when losses eat into part of the capital and reserves), the governing body must adopt restructuring measures;
• in the event of over-indebtedness (when the assets no longer cover the debts, i.e. the company is “over-indebted”), the duty to notify the court is in principle triggered.

Over-indebtedness must be assessed on both a going-concern and a liquidation basis. If it emerges, the governing body cannot ignore it: notifying the court is a duty, and failing to do so can result in the directors’ personal liability.

Subordination: what it means

This is where the subordination of claims comes in. The law allows the notification to the court to be avoided (or postponed) if certain creditors — typically the shareholders — declare that they subordinate their claims, in an amount sufficient to cover the over-indebtedness.

Subordinating means the creditor agrees to be satisfied last: their claim ranks behind all other creditors and will only be repaid once these have been paid in full. The claim is not extinguished and does not turn into equity; it remains a debt, but “at the back of the queue”.

To be effective, the subordination must:

• be declared in writing and clearly;
• cover an amount sufficient to offset the over-indebtedness;
• be unconditional with respect to its restructuring purpose.

Why it is a valuable tool

Subordination is often what allows a temporarily over-indebted company, but one with prospects of recovery, to buy time to restructure without having to go before the court. For the financing shareholder it is a way to concretely support the business: they place their own claim at the back of the line, giving breathing room to the other creditors and to the going concern.

Be careful, though: subordination does not solve the economic problem, it freezes it. It serves to gain time for a genuine restructuring (cost reduction, new revenue, capital increase), not to conceal it. Over-indebtedness merely “patched over” with subordinations, without real measures, will sooner or later resurface.

Loan or capital increase?

In difficult phases, the choice between a shareholder loan (with any subordination) and a capital increase depends on the objectives:

• the loan is flexible and reversible, but remains a debt and does not permanently strengthen the equity;
• the capital increase strengthens the structure in a stable way, improves the image towards banks and partners, but requires formal acts (public deed, amendment of the articles of association, registration).

The solution is often a combination: subordination to stabilise in the short term, a capital increase to restructure on a lasting basis.

Mistakes to avoid

• Granting shareholder loans without a contract or at non-compliant rates.
• Ignoring the warning signs of capital loss and over-indebtedness.
• Drafting a subordination that is generic or insufficient to cover the over-indebtedness.
• Using subordination as a permanent solution rather than as time to restructure.

How we help you

We help shareholders and directors structure financing to the company correctly: loan agreements, compliant rates, effective subordination declarations and the assessment between a loan and a capital increase during restructuring phases.

Do you want to finance your company or manage a difficult phase without risks for the directors? Discover the services of our capital division and set the operation up on solid foundations.