Negative net assets. Consequences for companies
If a company is unprofitable for several years, it might end up with negative net assets. We describe below the possible consequences of negative net assets.
What are net assets?
The net asset value of an entity is the total balance sheet value of the entity’s assets minus the total value of the entity’s liabilities.
When are companies required to calculate net assets?
Limited liability companies (in Russian “OOO”) must calculate their net assets in compliance with LLC Law as follows:
- Every year before the annual meeting of shareholders. Net assets are specified in LLC annual reports (Article 30(3) LLC Law);
- Before adoption of decisions depending on the net asset value, such decisions for:
- payment of share to shareholder(s) withdrawing from the company;
- distribution of net profit;
- major transaction;
- In other cases provided by law .
To calculate net asset value, the Ministry of Finance recommends applying the procedure for assessing the net asset value of joint-stock companies approved by the Federal Securities Commission of Russia and Russian Ministry of Finance Decree N 84n dated August 28, 2014.
If an LLC’s debts exceed the value of its assets, then the company will end up with a negative net asset value.
Consequences of negative net assets
If at the end of two or several consecutive financial years, a company’s net asset is negative, then the company will have to:
- increase its net asset value up to the amount of its share capital; or
- decrease its share capital.
If the asset value is less than RUB 10,000 (i.e. the minimum share capital amount), then the company must be liquidated. If the company is not liquidated, then state authorities could file a petition for compulsory liquidation (Article 35(6) Federal Law on Joint-Stock Companies; Article 30(4) LLC Law).
Decisions for share capital decrease must be adopted within 6 months of the end of the financial year.
The law provides no deadlines and no procedure for increase in net asset value.
If companies take no measures to resolve such issue, they may be liquidated by court order.
In practice, courts may recognize a decrease in net asset value as a deterioration in financial position, but if in such case:
- the rights and interests of creditors and third parties are not harmed;
- companies pay taxes and salaries to employees as well as submit financial statements in due time;
courts will dismiss petitions for liquidation and most likely propose that such bona fide companies take measures to get out of their current situation.
How to increase net assets?
The following options are the 2 most common ways to increase net assets:
- Asset revaluation (fixed assets and intangible assets);
- Money contribution to current account by company owners and shareholders.
It is best to revalue assets with the involvement of independent appraisers. If after the valuation, the net asset value increases, it will be necessary to increase additional capital.
If a company has valued its assets, then the company will be required to do this regularly in the future so that their value does not significantly differ from their current one (Item 15 RAS 6/01). If the company fails to do so, it will be subject to sanctions. In such case, the company chooses itself how often it will revalue its assets.
It should also be noted that the revaluation of fixed assets is carried out by groups. A single asset cannot be revalued on its own.
Contribution of funds
When shareholders contribute funds, such contribution is recorded in accounting as other income and increases net asset value.
This operation should not be seen as dubious, so appropriate decisions or agreements may be drawn up to document that funds are contributed to increase net asset value to the value set by law. It is also better to indicate as purpose of payment that the contributed funds are intended for net asset value increase. This way, the nature of the operation is indicated, and no additional questions will be raised by state authorities.
When a company’s net asset value is negative, this is not only a sign that it is in critical financial condition, but this could also result in the company’s liquidation.
However, if the company does not violate the rights of its employees, creditors or other entities and duly submits reporting to state authorities, then it could avoid liquidation and resolve this issue by decreasing its share capital or increasing its net asset value. In each case, it is necessary to:
- Check whether it is possible to do so from a legal standpoint (for example, verifying whether the company charter provides for any restrictions on contributions to assets by company shareholders);
- Determine the best way to resolve the issue from a legal standpoint;
- Implement the selected option in compliance with the law.
How may we help?
Our lawyers and tax specialists can review the situation in your company and advise on how to resolve the issue of negative asset value in the best possible way.