Take the case in which the company has lost capital. What is the company allowed to do?
In this connection the law envisages that, in case of losses, the company cannot distribute profits among the partners until the capital has been reduced or replenished by the corresponding amount.
However, unlike what happens for companies with share capital, there is no obligation to reduce the capital whatever the amount of the losses incurred, even if the latter are such as to wipe out the entire capital.
While, however it is true that, if the company intends to continue to distribute profits to its shareholders, there is no escaping from the alternative laid down by the law: either the capital is used to pay for the losses, or the partners contribute the financial resources required.
Besides the reduction in capital because of operating losses, the it may also be reduced for what is termed capital in excess.
In this case the company decides to reduce the net worth of the company by choosing from two options that are available:
- it may release the partners from the obligation of making any further payments already promised but not yet effected;
- it may return to the partners the capital contributions they have already made.
Whereas, if the partners should decide to increase the share capital , how should they go about this?
The increase may result from new money coming into the company, or resources taken from the reserves of the company.
In the former case the capital increase is provided by having new partners join the company or by collecting new contributions from the existing partners.
In the latter case, the partners decide to release resources from existing capital account reserves.
In a partnership the setting up of reserves is not obligatory. However, the Memorandum of Association or the partners may unanimously decide to constitute a reserve, by setting aside profits which it decides not to distribute to the shareholders.
When financial resources are transferred from the reserve to the share capital, the each partner’s quota stock in the company rises in proportion to his/her attributed share in the profits, thus safeguarding also the position of the working partner.