Corporate Liquidation Proceedings in Ecuador: The Recapitalize or Liquidate Rule in Times of COVID-19

The international spread of the COVID-19 is an unprecedented threat to the global economy. In our view, the current Ecuadorian corporate legislation, due to its archaic nature, will certainly not contribute to the survival of those companies who are facing financial difficulties as a result of the pandemic. The so-called ‘recapitalize or liquidate rule’ is one of those obsolete requirements whose redefinition is imperative in times of COVID-19.

In general terms, legal capital is a broad concept which, traditionally, has had three essential functions: internal corporate organization, creditor protection and corporate financing. As analysed in a recent paper written by one of us, the minimum legal capital under the Ecuadorian Companies Act fails as an adequate creditor protection mechanism (for both adjusting and non-adjusting creditors), and does not contribute to cover the different operational needs of companies, which will vary depending on their business activities. The minimum legal capital requirements for Ecuadorian private companies (called ‘compañías de responsabilidad limitada’) and public companies (called ‘sociedades anónimas’), according to the Superintendence of Companies’ regulation, ascend to USD $400.00 or $800.00, respectively. 

Under s.198 of the Ecuadorian Companies Act, corporate directors, under their general duty of diligence, have the obligation to call a general meeting of shareholders in the event of serious operational losses. This obligation is imposed when the qualified losses of companies rise to, at least 50% of their legal capital (which, in the majority of cases, are determined according to the minimum legal capital requirements referred above). This rule is also confirmed by s. 379, which requires the installation of a general meeting to consider whether the company, due to its operational losses, should be voluntarily liquidated or if any other measures could be adopted instead (such as a raising of its legal capital by the injection of fresh equity or a reduction of capital to absorb the company’s losses). Failure to comply with this procedure may result in the dissolution and liquidation of the company ordered by the Superintendence of Companies, the public agency which controls, inter alia, the liquidation processes of Ecuadorian corporations.

Our concern is that, given the trivial amount established as the mandatory minimum capital requirements in Ecuador, in times of COVID-19, this rule will lead to an increase of liquidation proceedings. Due to the financial difficulties generated by the economic impact of the COVID-19, a high number of Ecuadorian companies are expected to face significant operational losses, with the subsequent risk of liquidation if those losses are not adequately absorbed or, at least, reduced to an amount which, in proportion, represents less than half of their legal capital. In our opinion, the existence of qualified operational losses, derived from the negative economic impact of the COVID-19 (which, as a case of force majeure, cannot be attributed to companies or their directors), should not lead to the liquidation of those economically viable companies which, as a result of this pandemic, will face temporary financial difficulties. As such, we consider that the recapitalize or liquidate rule, established on the Ecuadorian Companies Act, should be suspended for the benefit of such companies. This measure, suggested to mitigate the negative economic impact of the COVID-19 in Ecuador, will also contribute to lighten the procedural burden imposed by the recapitalize or liquidate rule, which forces a company to recapitalize, reorganize its internal structure or liquidate, whenever it faces operational losses which fall below its legal capital.

Even though a significant number of companies will face operational losses which may rise to a significant proportion of their legal capital (which, incidentally, is purely nominal), the suspension of the mentioned duty should help to ensure the survival of financially viable companies in the long term, for the benefit of all the corporate constituencies related to them and, more broadly, of the business sector as a whole. As highlighted in a recent article written by Aurelio Gurrea Martínez, the suggested suspension should not be limited in time to the expiration of the State of Emergency (as the Spanish Parliament has determined). Instead, we consider that this suspension should remain long after the finalization of the State of Sanitary Emergency declared by the Ecuadorian National Government, since the economic impact of COVID-19 will likely continue long after the coronavirus outbreak fades.

The social and economic effects of the COVID-19 are currently impossible to calculate. However, the suspension of the recapitalize or liquidate rule could be an adequate response to address, at least in part, the adverse financial effects caused by this global pandemic.

Esteban Ortiz Mena is the Intendent of Companies of Quito at the Superintendence of Companies in Ecuador.

Paúl Noboa Velasco is a Corporate Lawyer at the Superintendence of Companies in Ecuador.