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Insights Kazakhstan: Conversion of loan into share capital

Kazakhstan: Conversion of loan into share capital

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​​​​​​​​​​​​​​​​​published on 22 May 2024 | ​reading time approx. 2 minutes


In the Republic of Kazakhstan, one of the main and frequently used methods of securing the financial needs of Limited Liability Partnerships (“LLPs”) is the granting of loans by the participants/founders of the LLP (the “Participant”). However, while loans from a Participant are a common and convenient method of financing for LLPs, there are sometimes situations where an LLP is unable to fulfil its loan re​payment obligations. This may occur due to various factors such as economic difficulties, failed investments or mismanagement. In such situations, the Participant has a question about the possibility of converting the loan into the charter capital of the LLP. In our new article we guide you through the details of this process in Kazakhstan.​​

 

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In accordance with paragraph 1 of Article 715 of the Civil Code of the Republic of Kazakhstan[1] (hereinafter –the Civil Code of the Republic of Kazakhstan) under the loan agreement, one party (the lender) transfers or undertakes to transfer into the ownership of the other party (the borrower) money or things defined by generic characteristics, and the borrower undertakes to timely return to the lender the same amount of money or an equal number of things of the same kind and quality.
  
A loan agreement may be concluded on a reimbursable or non-reimbursable basis. 
  
At the same time, it is worth highlighting a legal restriction on obtaining a loan from individuals. Thus, according to paragraph 3 of Article 715 of the Civil Code of the Republic of Kazakhstan, citizens and legal entities are prohibited from raising mo​ney in the form of a loan from citizens as an entrepreneurial activity and such contracts are null and void. 
  
However, while loans from a Participant are a common and convenient method of financing for LLPs, there are sometimes situations where an LLP is unable to fulfil its loan repayment obligations. This may occur due to various factors such as economic difficulties, failed investments or mismanagement. In such situations, the Participant has a question about the possibility of converting the loan into the charter capital of the LLP. In particular, for example, by increasing the charter capital through the contribution of borrowed funds. 
  
In this case, it is necessary to first consider the legal requirements for increasing the charter capital of an LLP. Thus, the Law of the Republic of Kazakhstan “On Limited and Additional Liability Partnerships”[2]​ (the “LLP Law”) provides an exhaustive list of ways to increase the charter capital of an LLP, namely:
  1. additional proportional contributions made by all Participants;
  2. increasing the amount of the charter capital at the expense of the partnership‘s equity capital, including at the expense of its reserve capital; 
  3. additional contributions by one or more Participants with the consent of all other Participants;
  4. the admission of new Participants to the partnership.
  
In accordance with the above, there is no express prohibition against increasing the charter capital by way of contribution of loan from a Participant. 
  
However, notwithstanding the absence of a clear prohibition, it must be borne in mind that under the loan agreement, the Participant is a creditor to the LLP and the LLP is a debtor to the Participant. The Participant and the LLP have counterclaims. When the loan is converted into charter capital, the Participant‘s claims against the LLP will be set off (termination of counterclaims) and the loan amount should be treated as an (additional) contribution to the charter capital. In such a case, reference should be made to the provisions of Article 59 of the Civil Code of the Republic of Kazakhstan, which states that it is not permitted to make contributions by way of set-off of the participants‘ claims against the partnership. 
  
Based on the above, we believe that conversion of the loan into the charter capital is not admissible according to the requirements of the legislation of the Republic of Kazakhstan. However, a practical solution in thi​s situation may be to directly make additional contribution to charter capital of the LLP for the amount of the loan and then repay the loan to the Participant according to the terms of the loan agreement. ​
  

​​[1] Civil Code of the Republic of Kazakhstan (Special Part) dated 1 July 1999 № 409-I (with amendments and additions as of 25.03.2024).
[2] Law of the Republic of Kazakhstan dated 22 April 1998 No. 220-I “On Limited and Additional Liability Partnerships” (as amended as of 24.11.2021).

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