Refund of Equity Interest upon an Partner’s Withdrawal

Difference between refund of Capital contribution and Refund of equity

	Refund of capital	Refund of equity
Partner’s Withdrawal	Remaining as a partner	Withdrawal as a partner
Valuation standards	Book value valuation	Market value valuation
Creditor protection procedures	Article 627 of the Companies Act	Article 635 of the Companies Act

Creditor protection procedures under Article 627 of the Companies Act:

This is a procedure to inform creditors of their right to claim objections regarding reduction of capital. The specific contents of the notice are as follows:
(i) The details of such reduction in stated capital
(ii) A statement to the effect that creditors may state their objections within a certain period of time

Creditor Protection Procedures under Article 635 of the Companies Act:

This is a procedure to inform creditors of their right to claim objections regarding the amount of refund of equity. The specific contents of the notice are as follows:
(i) The details of the equity interest refund that exceeds such surplus
(ii) A statement to the effect that creditors may state their objections within a certain period of time.

Creditor Protection Procedures for Refunds of Equity Interests upon Withdrawal of Partners

The procedures for protection of creditors in the event of a refund of equity interest are quite complicated because the necessity of procedures, the period for filing objections, and the content of the notice differ depending on the scope of the amount of refund of equity interest.

(1) When the amount of refund of equity does not exceed the amount of surplus of the entire company	Creditor protection procedure under Article 635 of the Companies Act: Not required
(2) When the amount of refund of equity exceeds the amount of surplus of the entire company, but does not exceed the amount of net assets:	Creditor protection procedure under Article 635 of the Companies Act: Required The period for filing an objection: one month
(3) When the amount of refund of equity exceeds the amount of net assets	Creditor protection procedure under Article 635 of the Companies Act: Required The period for filing an objection: 2 months

* In addition, the creditor protection procedure under Article 627 of the Companies Act may be required for reduction of the amount of capital.

(1) When the amount of refund of equity does not exceed the amount of surplus of the entire company

If the amount of return of equity does not exceed the amount of surplus of the entire company, the creditor protection procedure under Article 635 of the Companies Act is not required. The “surplus” here means the “capital surplus + retained earnings” of the entire company.

Example: From the following equity management chart, 2 million yen will be refunded to Partner B upon his withdrawal from the company.

Name	Capital	Capital Surplus	Retained Earnings	Total
A	1,000,000	1,000,000	1,000,000	3,000,000
B	1,000,000	0	1,000,000	2,000,000
Total	2,000,000	1,000,000	2,000,000	5,000,000

Since the company has a total surplus of 3 million yen (1 million yen + 200 million yen), the refund amount (2 million yen) is within the entire surplus. Therefore, the creditor protection procedure under Article 635 of the Companies Act is not required.

On the other hand, in order for Partner B to leave the company, the portion of Partner B’s capital shall be (i) reduced, (ii) transferred to capital surplus, then and only then (iii) refunded to Partner B. In this case, the creditor protection procedure (and application for registration) under Article 627 of the Companies Act regarding the reduction of the capital is required.

The results are as follows:

Name	Capital	Capital Surplus	Retained Earnings	Total
A	1,000,000	1,000,000	1,000,000	3,000,000
B	0	1,000,000	1,000,000	2,000,000
Total	1,000,000	2,000,000	2,000,000	5,000,000

As a method to avoid such reduction of capital, it is possible to transfer the capital surplus recorded against A to B and the capital recorded against B to A.

Name	Capital	Capital Surplus	Retained Earnings	Total
A	1,000,000	1,000,000	1,000,000	3,000,000
B	1,000,000	0	1,000,000	2,000,000
Total	2,000,000	1,000,000	2,000,000	5,000,000

The results are as follows:

Name	Capital	Capital Surplus	Retained Earnings	Total
A	2,000,000	0	1,000,000	3,000,000
B	0	1,000,000	1,000,000	2,000,000
Total	2,000,000	1,000,000	2,000,000	5,000,000

(2) When the amount of refund of equity exceeds the amount of surplus of the entire company, but does not exceed the amount of net assets:

If the amount of refund of equity exceeds the amount of surplus of the entire company but does not exceed the amount of net assets, the creditor protection procedure under Article 635 of the Companies Act is required, but the period for filing an objection is only one month. The “amount of net assets” here refers to the total of capital, capital surplus, retained earnings, and valuation and translation adjustments.

In addition, since a refund in excess of retained earnings will inevitably result in a decrease in the amount of capital, the creditor protection procedure under Article 627 of the Companies Act is also required (can be done conjointly or separately).

(3) When the amount of refund of equity exceeds the amount of net assets:

If the amount of refund of equity exceeds the amount of net assets, the creditor protection procedure under Article 635 of the Companies Act is required, and the period for filing an objection will be two months. In addition, since the amount of capital will inevitably be reduced, the creditor protection procedure under Article 627 of the Companies Act will also be required. If both are done conjointly, the period for filing an objection shall be two months.

Distribution of Losses to Remaining Partners

For Example, in following case, upon Partner A’s withdrawal from the company, a refund of his/her equity interest of 5 million yen at market value will be made. Even after reducing the total amount of 3 million yen of Partner A’s equity, there will still be a loss of 2 million yen. In this case, unless otherwise stipulated in the Articles of Incorporation, those losses will be distributed to the other Partners and their respective retained earnings will decrease.

Name	Capital	Capital Surplus	Retained Earnings	Total
A	1,000,000	1,000,000	1,000,000	3,000,000
B	1,000,000	0	1,000,000	2,000,000
Total	2,000,000	1,000,000	2,000,000	5,000,000

The results are as follows:

Name	Capital	Capital Surplus	Retained Earnings	Total
B	1,000,000	0	-1,000,000	0
Total	1,000,000	0	-1,000,000	0

Same thing happens when Partner A had losses from the beginning. Upon the withdrawal of Partner A, the amount of investment cannot cover the loss; thus, those losses will be distributed to the other Partners.

Name	Capital	Capital Surplus	Retained Earnings	Total
A	1,000,000	1,000,000	-4,000,000	-2,000,000
B	1,000,000	0	1,000,000	2,000,000
Total	2,000,000	1,000,000	-3,000,000	0

The results are as follows:

Name	Capital	Capital Surplus	Retained Earnings	Total
B	1,000,000	0	-1,000,000	0
Total	1,000,000	0	-1,000,000	0

It is not always possible to get the amount of investment back.

If Partner A’s withdrawal from the company results in the refund amount being less than the amount his/her investment in the company (capital + capital surplus: 2 million yen), and there is no effect on the other partners. It only reduces the refund to A (1 million yen).