Section 3-4 of the Norwegian Public Limited Liability Companies Act (asl) stipulates that a public limited company must have adequate equity and adequate liquidity. These requirements must be met at all times. If this is not the case, the company's board of directors has a duty to act, whereby it must inform the general meeting and propose measures to rectify the situation, cf. Section 3-5 of the ASL.

If the board neglects its duties under Sections 3-4 and 3-5, this may result in personal liability for individual board members, cf. Section 17-1 of the Limited Liability Companies Act.

The reason we have such strict rules is primarily to protect the company's creditors.

Brief explanation of the terms:

By equity, we mean the capital in a limited company that the shareholders have contributed themselves, plus any capital that may have been earned through the company's operations and subsequently reinvested in the business. A simpler definition is that equity (EK) = assets minus liabilities.

Liquidity refers to a company's ability to pay its obligations as they fall due. If it is unable to do so and continues to receive reminders, collection notices and worse, the company is illiquid, provided that this situation is not temporary. Illiquidity normally leads quickly to bankruptcy.

The concept of prudent is obviously discretionary; there is no definitive answer as to where the line between prudent and imprudent equity or liquidity lies in a specific limited company. The law provides some guidance by stipulating that the concept should be measured against the risk and scope of the business being conducted. It is obvious that there is a big difference in risk between renting out commercial premises in a solid and well-run commercial building and starting up a loan-financed company that aims to develop a new search engine to compete with Google. Similarly, there is little doubt that more equity capital is needed to ensure the safe operation of a company that runs a capital-intensive manufacturing business with many employees, such as shipbuilding, compared to a business that offers consulting services.

It is always the actual equity that is decisive. Current accounting rules may – quite legally – mean that the book value of a company's assets does not necessarily correspond to their market value. Typically, depreciation rules may result in a property that a company has owned for a long time having a book value that is several times lower than its current market value. In such cases, the board has full authority to calculate the added value that the property represents beyond its book value when assessing whether the equity is reasonable. Conversely, the board must take into account liabilities that are not apparent from the accounts, such as a liability for damages that has recently been incurred.

It is essential that the board continuously monitors the activities of the company. For example, the board should ensure that the CEO complies with the minimum requirements of Section 6-15 of the Norwegian Public Limited Liability Companies Act, which requires her to provide the board with a report on the company's activities, position, and financial performance at least once every quarter. We recommend that the CEO report much more frequently, preferably monthly, and even more often in a crisis situation.

Furthermore, it is always good advice to ensure satisfactory documentation, and this also applies in this area. The board should therefore ensure that its communication with the general meeting/shareholders is in writing and that clear and descriptive minutes are prepared from all board meetings and general meetings, etc. Ultimately, this may be crucial in order for the board members to avoid liability for damages in the future.

It will normally be easier to assess whether liquidity is adequate. If it is not, the result will quickly become apparent in the form of reminders, collection notices, etc. Our advice is that the board should always ensure that the company prepares liquidity forecasts together with its budgets.

The framework established by Sections 3-4 and 3-5 imposes restrictions on the company's ability to pay dividends to shareholders or make other forms of distributions of funds, such as capital reductions, demergers, repayments, dissolutions, etc.

If equity and/or liquidity are no longer adequate, the board's duty to act in accordance with Section 3-5 is definitive. The board must then deal with the matter immediately, typically in an emergency board meeting. Remember that for reasons of time, this can often be held by telephone, but that minutes must then be prepared and signed afterwards. Furthermore, the board must convene an (extraordinary) general meeting within a reasonable time, at which the board shall give an account of the company's financial position and propose measures to ensure that the equity capital is once again adequate. Relevant measures may include shareholders contributing fresh share capital or a subordinated loan, inviting external investors to participate in a private placement (capital increase), the company releasing value by selling debt-free assets, or cutting costs through downsizing, moving to a more affordable location, closing a department, etc.

If the board concludes that no measures to improve equity are realistic, Section 3-5 (2) states that it shall propose that the company be dissolved. In the worst case, the company may prove to be insolvent, in that it is not only illiquid but also insufficient (the debt is higher than the total value of the assets), and then the board's only option is to file for bankruptcy, so that the company is declared bankrupt.