Payment for corporate stock by set-off

In the course of providing legal services, we have more than once come across the question of whether one can pay for stock of a joint-stock company (hereinafter referred to as JSC) by set-off of liabilities. While the situation with a business partnership is quite clear because art. 59 of ROK Civil Code states in no uncertain terms that: “it is forbidden to make contributions in the form of moral rights and other intangible benefits, or by set-off of members’ receivables from the partnership”, the JSC proved to have no such bright-line rule in place. Specifically, in our practice we came across a situation where payment for JSC stock was made by set-off of an investor’s receivables from the JSC and the legality of such payment was not called in question.

The following rationale can be offered for the validity of paying for stock by set-off of receivables from a JSC:

– unlike business partnerships, the legislation has no explicit ban on the payment for stock by set-off of receivables from a JSC;

– receivables from JSC are a monetizable property right; further, the law allows payment for stock with a property right;

– pursuant to s. 12 of the form of post-issuance report, enacted by the resolution of the Board of Republic of Kazakhstan Agency for the Regulation and Compliance Monitoring of the Financial Market and Financial Institutions of 30 July 2005, № 268, the JSC must specify payment options for shares. In this context, one of the payment options is described as:

“………

4) by converting a company’s liabilities into the company’s shares;

………..”.
– settlement of tax arrears of a part-government-owned company through additional authorized shares of the company (art. 32 of the ROK Law on Joint-Stock Companies (hereinafter referred to as the JSC Law) is an example of payment for shares by set-off of tax liabilities.

The above notwithstanding, note the following:

Pursuant to s. 1, art. 18 of the ROK JSC Law: “Placement of shares shall be made by the exercise by shareholders of the pre-emptive right on shares or other securities convertible into the company’s ordinary shares, subscription or auction held in the OTC market, or subscription or auction held on a stock exchange, as well as by convertion of the company’s securities and/or liabilities into the company’s shares where provided for by this Law and other statutes of the Republic of Kazakhstan.”.

In turn, payment for JSC stock by set-off is, essentially, conversion of JSC liabilities into JSC stock (the creditor receives JSC stock in lieu of repayment of JSC debt).

Further, pursuant to s. 4 art. 30 of the ROK JSC Law: “Conversion of securities and other liabilities to the company’s creditors into ordinary shares shall be subject to one of the following documents:

1) prospectus for the issue of securities convertible into ordinary shares of the company;
2) bank restructuring plan adopted as provided for in the legislation of the Republic of Kazakhstan on banks and banking;

3) rehabilitation plan if the company is an insolvent debtor, adopted as provided for in the legislation of the Republic of Kazakhstan on rehabilitating and bankruptcy”.

As is evident from the above provision, the list of documents that can be used as authority for the conversion of JSC securities and liabilities to creditors is exclusive.  Therefore, this provision suggests that conversion of securities and other liabilities to a JSC’s creditors into its ordinary shares may not be authorized by other documents.  I.e., the ROK JSC Law only allows the conversion of a JSC’s liabilities to creditors into its ordinary shares in the context of bank restructuring,  rehabilitation of insolvent debtor or conversion of a JSC’s stocks and bonds (for example, debentures) into the JSC’s stock (if the prospectus provides for such conversion).

In light of the above, we have found that payment for JSC stock by set-off of receivables from JSC can only be an option in the above context and where expressly provided for in legislation [1]. Otherwise, it is forbidden to pay for stock by set-off of receivables from JSC.

 

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[1] For example, according to sub-s 3), s. 2, art. 3 of the ROK Law on the Development Bank of Kazakhstan, the DBK’s mandate includes the provision of a subordinated loan with the option of converting it into shares or equity interests in the borrower (mezzanine financing).

Aizhan Karzhaubayeva

 

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