This article explains why the purchase of a shell company should be avoided today and even more so in the future under the new law, and that the formation of a new company is preferable when setting up a business (start-up).
At the end of this article, the possible effects of the revision of the law on legitimate transactions with company shares will also be discussed.
Seeking sound legal advice is therefore worthwhile both when founding a new company and when taking over an operating company.
1. What is trading in shell companies?
1.1 Definition
For decades, the Federal Supreme Court has declared the trading of shares and GmbH ordinary shares in shell companies null and void. The Federal Supreme Court defines a shell company as a company that has been largely liquidated economically and abandoned by the parties involved. The shell company has ceased its previous business activities and no longer has any material, economic substance. However, it has not yet been legally dissolved and is still entered in the commercial register. The company has mutated into a purely formal, legal entity.
On the assets side of the balance sheet, there are usually only cash assets and similar liquid assets as well as loan receivables from stakeholders and any losses carried forward. On the liabilities side, there is still equity (possibly only partially covered or no longer covered at all) and perhaps creditors due to the previous but now discontinued business activities. The income statement of a shell company is usually also very straightforward, as the discontinuation of the business activity means that no more business-specific income and expense items need to be reported, at least if the business activity was discontinued more than a year before.
1.2 Nullity
According to the Federal Supreme Court, trading in shell companies is null and void because it circumvents the liquidation and formation regulations. The correct procedure would be to liquidate the shell company, delete it from the commercial register (Art. 934 of the Swiss Code of Obligations; "CO") and to found a new company.
Nevertheless, trading in shell companies is widespread. The seller does it to try and avoid the expense of formally liquidating the de facto abandoned, possibly even over-indebted company and the associated costs as well as the corresponding time required. The buyer, on the other hand, hopes to avoid the formation costs and the necessary capital contribution by purchasing a shell company and to save time because he believes he can take over an existing company entered in the commercial register without delay. There is often also the hope of being able to use existing loss carryforwards for tax purposes in the future.
While the advantages for the seller of a shell company can be seen at first glance, this is not the case for the buyer. The purchase of a pre-existing company is always associated with risks. This applies both to the acquisition of operating companies and to the acquisition of shell companies, even if they have been inactive for years. Possible inherited liabilities include, in particular, third-party receivables (including taxes). In order to minimize these risks as far as possible, every company, including a shell company, must undergo a thorough due diligence process and individual share purchase agreements must be drawn up. The purchase agreement contains specific assurances on the part of the seller and regulates the possible claims of the buyer in the event of their breach. The due diligence and drafting of a purchase agreement usually involves a considerable amount of time and money. Even then, certain residual risks remain that do not exist when a new company is founded.
The purchase of a company therefore only makes sense if there is an interest in its business activities, but not if the intention is to acquire a shell company whose business activities are not sustainable or have already been abandoned and which has in fact already been liquidated. If the shell company is not sufficiently capitalized, the purchase price for its shares will be correspondingly low. However, to be able to commence business activities and avoid bankruptcy, the buyer will have to make a corresponding capital contribution after acquiring the shell company. As a result, this financial expense cannot be avoided either.
The supposed tax advantages of buying a shell company then turn out to be non-existent. This is because shell company trading is also regarded for tax purposes as a liquidation followed by the formation of a new company. In this case, the company's losses prior to the time of sale are eliminated due to the fiction of new formation at the time of the change of ownership or sale. The acquisition of a shell company therefore basically makes no sense.
2. What is trading in shell companies followed by abusive bankruptcy?
2.1. Bankruptcy riders, serial bankruptcy or organized corporate funerals
In recent years shell company trading has actually increased despite the disadvantages described above. However, the intention behind many of these transactions is not to avoid the formation costs by purchasing the shell company (which, as shown, is not possible anyway because a serious audit of the company would involve at least as much effort).
Rather, the company is deliberately "hollowed out" by the seller, i.e. the last remaining assets are sold (to the seller, a third party or in favor of a successor company). The buyer of the shell company also does not intend to build up a new, sustainable business. Rather, the seller and buyer and any intermediaries involved are aware that the company is undercapitalized or even overindebted and the buyer uses the shell company to make purchases for its account. This is done with the intention of never paying for these purchases or in the knowledge that the company will never be able to pay for these purchases and that bankruptcy proceedings will soon be initiated against it. Purchases are not only made for the buyer's own use. The shell company is often used as an intermediary. Since it does not pay its suppliers, it can offer its customers unrivaled low prices. Although the mostly unsuspecting and bona fide customers benefit from this, the suppliers and general competition are harmed. The bankruptcy proceedings that are later opened are usually discontinued due to a lack of assets.
The fact that bankruptcy can be delayed for so long is also due to the fact that claims under public law (e.g. taxes and premiums for compulsory accident insurance) can currently only be pursued by attachment, not bankruptcy. Even in cases with no attachable assets, such debt enforcement proceedings have not yet led to the opening of bankruptcy proceedings. Even an over-indebted company can continue to exist in this way, although it would be legally obliged to file its balance sheet, i.e. to apply for bankruptcy itself.
It has also emerged that certain individuals repeatedly use this "business model", i.e. they act commercially and repeatedly acquire and use such shell companies improperly. This is also referred to in non-technical terms as "bankruptcy riders", "serial filers" or "organized corporate funerals".
2.2. Invalidity of shell company trading in the event of over-indebtedness
In order to put a stop to these machinations, the nullity of shell companies will be enshrined in law as of January 1, 2025. The so-called Federal Act on Combating Abusive Bankruptcy contains amendments to several laws, namely the Code of Obligations (CO), the Debt Enforcement and Bankruptcy Act (DEBA), the Criminal Code (SCC) and the Federal Act on Direct Federal Taxation (FDTA).
The transfer of shares and ordinary shares in a company that no longer has any business activities or realizable assets and is also overindebted is also void by law from that date (Art. 684a newCO). In contrast to the case law of the Federal Supreme Court, this regulation requires, among other things, that the company is overindebted. This requirement was not yet included in the preliminary draft and was only added by Parliament. However, it cannot be assumed that the Federal Supreme Court will therefore declare trading in shell companies with companies that are not over-indebted to be permissible from now on (see para. 1 above).
2.3. New auditing competence of the commercial register offices
In order to be able to enforce this nullity, the commercial register offices are to be granted certain new powers. If, in connection with a registration, the commercial register office has a justified suspicion that a transfer of shares or ordinary shares is not permitted under the new legal regulation, it must request that the company submit its current signed and, if the company has an auditor, audited annual financial statements. Typically, shell companies disregard the obligation to keep accounts or the accounts are deliberately destroyed in order not to be able to prove over-indebtedness. If the company does not comply with this request from the Commercial Register Office or if the Commercial Register Office determines, on the basis of the documents submitted, that the company is overindebted and has neither business activities nor realizable assets, the Commercial Register Office will refuse the requested entry.
This new scrutiny competence of the commercial register offices is likely to have the desired effect. Unlike in the case of a limited liability company, the transfer of shares in a public limited company does not have to be entered in the commercial register. However, unlike a legitimate transfer of a company, the transfer of shell companies often involves not only replacing some or even all of the executive bodies, but also changing the company name and its purpose and relocating its registered office. All these changes must also be entered in the commercial register for a public limited company. The buyer of a shell company could therefore be faced with unpleasant surprises in the future and may not be able to enter the desired changes in the commercial register, even if it is not a bankrupt company.
In the revised Commercial Register Ordinance, the aforementioned amendments are cited as indications for the transfer of a shell company, even if they are not registered simultaneously but successively. Also deemed as indications are (i) if the company has the same legal domicile as a company that was refused entry in the commercial register in accordance with the new provisions, or (ii) if persons who transfer or acquire shares or ordinary shares were already involved in a transfer that led to a refusal of entry in the commercial register based on the new provisions (Art. 65a of the new Commercial Register Ordinance).
2.4. Cancellation authority of the commercial register office / opening of bankruptcy proceedings
However, refusing to register the change(s) with the commercial register under the given conditions is not the end of the matter. The competent commercial register office will ask the company in question to prove that the company does not need to be deleted, i.e. that the over-indebtedness has been eliminated and the company has resumed business activities. Under current law, the commercial register office issues the same request irrespective of a refused entry in the commercial register if it becomes aware by other means that a company no longer has any business activities and no longer has any realizable assets.
Although the elimination of over-indebtedness and the resumption of business activities does not result in liquidation and reestablishment, the protection of creditors and the capitalization of the company is basically satisfied. However, it remains questionable whether not only the elimination of over-indebtedness but also the entire capital loss can be demanded.
If the required evidence is not provided, the Commercial Register Office deletes the company from the Commercial Register. If third parties assert an interest in maintaining the entry, the Commercial Register Office will refer the matter to the court, which may open bankruptcy proceedings against the company (Art. 684a para. 3 newCO in conjunction with Art. 934 CO).
If bankruptcy proceedings are opened, creditors can register their claims as usual with the competent bankruptcy administration. The nullity of trading in shell companies does not therefore have the consequence of nullifying the good faith protection of third parties and the claims to which they are entitled. That would have overshot the intended target.
2.5. No new offenses
No new offense is being introduced in connection with the nullity of trading in shell companies, as one might expect. Abusive bankruptcy (see above para. 2.1) is not, in other words, elevated to an independent criminal offense. This is because abusive bankruptcy encompasses various aspects that are difficult to describe in a generally valid definition. This is one of the main problems in the search for effective measures against abusive bankruptcies. In the case of an abusive shell company trading or bankruptcy, however, a crime or offense that can already been punished under current law is often committed, such as fraud or a bankruptcy or tax offense. Unlike today, however, bankruptcy officials will in future have a duty of disclosure.
2.6. Activity bans
In addition, the court can in future impose bans on backers, agents and representatives, which is not the case today. This is because the main figures often act in the background with the intention of fraudulently bankrupting the shell company.
A central database is being set up to prevent the entry into the commercial register of persons with functions that are incompatible with a corresponding ban on activity. For data protection reasons, the structure of this database and the corresponding access rights are relatively complex. In the event of incompatibility, the commercial register office can delete the person concerned from the commercial register by order. Of course, these measures cannot prevent the backers from acting as backers in later cases.
2.7. Bankruptcy proceedings for claims under public law
In order to make it more difficult to delay bankruptcy in future, claims under public law must also be pursued via bankruptcy in future (see para. 2.1 above).
2.8. Opting out
As a further measure against abusive bankruptcies, the waiver of the limited audit (so-called opting out) will in future only be permitted for the financial years ahead. The corresponding application to the commercial register office must be made before the start of the relevant financial year (however, the waiver can still be submitted when the company is founded) and the application must be accompanied by the annual financial statements for the most recently completed financial year (except if the waiver is submitted when the company is founded; Art. 727a para. 2 and 2bis newCO). This new measure combats the practice whereby the limited audit is waived before the deadline for the ordinary general meeting expires, after which the ordinary general meeting approves the (unaudited) annual financial statements and then elects a new auditor. The waiver of the limited audit is not registered, but only the registration of the new auditors, so that it is not recognizable in the commercial register that the company did not have auditors at the time the annual financial statements were approved and therefore voted on non-audited annual financial statements.
The Commercial Register Office must also request the renewal of the waiver if the cantonal tax office informs it that the company has not submitted annual financial statements or if there are circumstances that give the impression that the conditions for waiving a limited audit are no longer met. If the company neither renews the waiver nor registers an auditor, the Commercial Register Office refers the matter to the court. If the company submits the annual financial statements following a request to renew the waiver, the Commercial Register Office forwards them to the tax authorities (Art. 62 para. 5 of the new of the Commercial Register Ordinance). The purpose of this is to take action against companies that do not submit a tax return but prefer to rely on an assessment by the tax authorities.
3. Effects on legitimate transactions with company shares?
In view of the case law of the Federal Supreme Court and the new statutory regulation, the question arises as to whether there will also be implications for transactions with legally compliant companies. In particular, the question arises as to whether nullity continues to exist in the case of shell company transactions carried out in the past, which were not followed by bankruptcy, but where the company was subsequently reactivated and any over-indebtedness was eliminated, or was not rather remedied by the aforementioned measures. Otherwise, trading in shell companies carried out in the past could also be relevant in the event of a subsequent sale of the company, which would have an impact on the scope of the audit (due diligence).
As shown, it is possible to cure the nullity (see para. 2.4 above). In principle, this must also apply if the commercial register office has not issued a corresponding request, for example because it could not identify any indications of shell company trading.
In this context, it is also important to note that the Federal Supreme Court itself makes distinctions and, for example, does not speak of a shell company in the case of a merely temporary cessation of business activities. It also allows the general meeting to revoke the dissolution resolution, at least if the distribution of the company's assets has not yet begun.
It should also be borne in mind that the concept of revocation of bankruptcy has not been changed, so that revocation of bankruptcy will still be possible in the future if the over-indebtedness has been eliminated or an agreement with the creditors or a composition agreement has been reached. In such cases, it would be contradictory to continue to qualify as void a transaction that may have taken place, which originally fulfilled the criteria of void shell company trading.
It should also be noted that the Federal Supreme Court has also declared null and void the trading of so-called shelf companies, whose purpose is the management of their own assets and which (as the name suggests) are founded virtually in advance in order to have a company available without delay in case of need (although as a rule, in such a case, amendments must be made to the articles of association, among other things to reflect the new purpose of the company, which also takes time).
4. Conclusion
The acquisition of a shell company should be avoided at all costs. The supposed advantages for the buyer do not exist and the actual costs exceed those of founding a new company, not to mention the risks that the buyer takes with such a transaction. Sound legal advice when setting up a company can avoid a lot of trouble. The same applies to the acquisition of an operating company.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.