Lawyer Raymundo Larraín Nesbitt explains the recent regulatory changes affecting how business people can limit their personal liability on trading in Spain.
Passeig Maristany, Camprodon, Girona Province, Pyrenees.
By Raymundo Larraín Nesbitt
Lawyer – Abogado
8th of November 2015
Following up on last month’s article, Filing for Personal Bankruptcy in Spain (popularly dubbed as ‘Second Opportunity Law’), I have written this other one which aims to delve further on the matter and gives a few pro tips on how to limit one’s own personal liability should things pan out the wrong way.
The topic of this article will be the mitigation of personal liability on trading. I will gloss below over the main legal changes. I won’t include traditional legal solutions, such as traders incorporating limited liability companies, as they are more than covered elsewhere.
After eight years of severe recession, which has left in its wake five million unemployed and an anemic economy, it has dawned on many that the road to recovery passes through self-employment. Madrid’s central government has smelled the coffee and is busy spreading the gospel on passing new laws to incentivize entrepreneurship.
To better grasp the extent and scope of the new reforms I am forced to sidetrack and make a brief historic recap on personal liability. Traditionally Spain’s legislation has been anything but lenient on self-starters. The outdated nineteenth-century regulation on personal liability is found in both Spain’s Civil Code (S.C.C.) and Mercantile Code and is punishing compared to the modern take of fellow EU countries.
Article 1911 of the S.C.C. stipulates the liability of a private person is personal and unlimited, liable with all his assets now and in the future. Put simply, it institutes unlimited personal liability. If to this you add that effectively (*) there are no statute of limitations on mortgage-backed loans (the most frequent type of asset-based loan employed to fund startups in Spain) you have a potent recipe for disaster as it allows creditors unfettered access to borrower’s assets (current and future). Article 6 of the Mercantile Code rules likewise on the liability of married sole traders.
(*) Whilst it is true the S.C.C. rules the statute of limitations is twenty years on mortgage-backed debts the fact is this time frame can be renewed at any point from scratch making it, in practice, non-time-barred. A pristine example of a nineteenth-century anachronistic bias in favour of lenders.
It is generally accepted that only 50% of businesses survive the first year and of these 90% fail within the following five years. Stigmatizing young entrepreneurs who fail by socially branding them as financial pariahs is obtuse and short-sighted. Failure is required to succeed and laws in Spain should exercise a higher degree of flexibility allowing businesspersons to recover financially from mistakes within a reasonable timeframe i.e. five years; life is not black or white. Failure and success are intimately entwined. Oftentimes only through multiple blunders does one achieve success as it follows a series of trial and errors. Success is a by-product of failure.
It is counterproductive to place a lifetime financial millstone on entrepreneurs who fail with rolled-up interests to boot creating a debt spiral of which there is no escape. A business failure in Spain means you won’t (normally) get a second chance as personal liability is unlimited and in most instances not subject to a statute of limitations. This creates a perverse incentive NOT to start your own business and rather play it safe by working for someone else. I simply cannot stress enough how wrong and detrimental this is to the broader economy. Lawmakers are sending out the wrong message: risk-taking is bad.
This goes on to explain why it comes as no surprise that most youngsters in Spain are reluctant to start their own companies (understatement). Speaking from personal anecdote, most of my foreign friends, especially American and British, had in mind setting up their own businesses early on from a young age. After having worked for others, learning the ropes of the trade, most took the leap of faith starting their own companies. In stark contrast, from all my Spanish acquaintances and friends only a small handful ended up setting a business. And of them, none went to college… One concludes grimly that the more educated you are in Spain, the less inclined you will be to start your own business out of fear of failing; which is simply crazy and a perfect good waste of human talent. Squandering talent is an opportunity cost a modern economy can ill afford if it wants to stay ahead in the game and be competitive.
What makes countries’ economies powerful and vibrant are young, and not-so-young, businesspeople willing to put at stake their own assets to create a new business venture in pursuit of a dream. It is in my opinion a risk-taking mentality which drives economies forward and make countries great in their own right i.e. U.S. or U.K.
To further this purpose, governments, politicians and lawmakers at large should enable this by paving the way, cutting through unnecessary red tape and streamlining procedures for entrepreneurs to succeed. For it is these who will create jobs and push the economy forward, not the state. Governments will then be able to reap the profits through non-confiscatory tax collection and reallocation of resources where necessary.
Governments should at no time undertake the responsibility of job creation which must be left to the private sector. Laws do not create jobs. Unfortunately in Spain, this has not been the case historically and regulation is heavily biased towards lenders which act detrimentally to those seeking to start their own business and who refuse to rely on government handouts. The majority of young people starting out in Spain unsurprisingly harbour no ambition of creating their own business and seek working for someone else; preferably in the public sector as civil servants (mainly because they cannot be dismissed and income is guaranteed).
A prolonged eight-year recession has – fortunately – managed to break the gridlock and change this herd mentality. Faced with bleak job perspectives qualified young Spaniards are migrating in mass abroad (the UK being the favourite hotspot). Those who have not flocked abroad have been ‘forced’ to set up their own business in Spain as it has dawned on them they can no longer afford to wait sine die to find a job.
Moreover, Spain’s central and regional governments have wisely taken this on board and are busy toning down the administrative maze by helping entrepreneurs cut through the red tape, removing legal hurdles, subsidizing them or even going as far as cutting their losses by means of limiting their personal liability on trading debts on approving new legislation.
It is in one of these new laws, and its impact on personal liability, I will now centre on.
Law 14/2013, of 27th of September, in Support of Entrepreneurs
For this article’s sake, I will only focus on the single measure which arguably mitigates personal liability following Art. 8: by creating a legal mesh on a trader’s main home shielding it against creditors.
This law also creates the figure of a ‘Limited Liability Entrepreneur’ or ERL for short.
An entrepreneur, or ERL, can now protect his main home from creditors in Spain providing all the following criteria are met (this is not an exhaustive list):
• Property must be his main home (therefore, by definition, an entrepreneur must be resident in Spain to benefit from this protection).
• Property’s value cannot exceed €350,000 or €450,000 in cities with over one million inhabitants. This value is attained by multiplying the cadastral value by the local Tax Office’s coefficient. More on how to calculate this in my article La Complementaria or Bargain-Hunter Tax (under the heading ‘Pre-Emptive Measures’). It should be noted that this value is effectively well below the market value of a property.
• Lodge ERL status at both Land and Mercantile Registries.
• Debt-protection wards only against credits linked directly to trading activities.
• Detailed accounting must be lodged at the Mercantile Registry year-on-year. Failure to comply (lodge the accounts) within a given deadline (seven months as from fiscal year end) causes immunity loss in favour of debt-collection agencies.
Extent of liability: fully discharged*. Main home cannot be subject to creditor action i.e. it is embargo-free. The Land Registrar will now turn down any application (derived from trading activities) to embargo a legally earmarked property.
*Exception: Non-trading debts. Debts in the hands of public authorities, such as the Tax Office or Social Security, are still subject of action on the designated property i.e. embargoes.
Effects: as from the 29th of September 2.013.
What does this mean?
Put simply, it means the law, for the first time in well over a century, allows businesspersons to protect their main house from business debts. If a trader fulfils the requisites laid out above he can effectively create a legal firewall that insulates his property against claims arising from trading debts. Creditors are barred from seizing his main home to auction it off and recoup their debts. This is a first-timer.
What can a lawyer do for you?
Following this new regulation, a lawyer can weave a protection on your main home cocooning it against creditors. A failing business venture no longer need translate to businesspersons losing their main homes to creditors.
This law is a step in the right direction. Its overarching effort is commendable as it manages to single-handedly dent a legal monolithic block (unlimited personal liability) which had been widely accepted as immutable for well over a century; perhaps in due time this crevice will be expanded upon by other modern laws. Although these changes, viewed from Main Street, may seem altogether trivial, from a legal perspective they are a huge leap qualitatively; nothing short of a legal breakthrough or inflection point on personal liability.
However, I feel compelled to level a few criticisms. For starters the benefits (strictly from a personal liability mitigation point of view) are paltry compared to the array of new obligations it sets forth to fulfil the law’s protection. In other words, it is jarringly one-sided as the protection offered is scant compared to the number of responsibilities one must comply with to take advantage of it. Almost to the point of much ado about nothing, but ultimately not quite.
Another obvious criticism, aside from having only one measure to mitigate personal liability, is that it sets a value on the main dwelling which, to top it off, is not that high for Spanish standards. Perhaps it would have been wiser not to establish any value at all on a main house or at the very least set a much higher figure i.e. €1,000,000.
Additionally, what happens in cases when the property is held under joint names? Does the law protect only the share on the property that belongs to the partner which trades or both? What happens in cases where partners do not have separation of assets but a community of goods (co-ownership)? Does the other partner need to expressly consent this benefit or else is it over understood as it benefits them too? Many questions arise that can only be replied to by judges through rulings.
Still, despite its flaws and shortcomings, this law is better than nothing and must be welcomed. Kudos to lawmakers. There is still a lot of work to be done by ironing out pesky regional inconsistencies and building upon this legal breach to widen the gap and help self-starters to be up on their feet sooner; and most certainly not to pillory entrepreneurs financially for the remainder of their lifetime on having tried and failed.
From a practical point of view, leaving esoterics aside, this law translates into entrepreneurs sleeping at night soundly in the safe knowledge that their main dwelling is legally ring-fenced and cannot be embargoed or repossessed on the back of trading debts; particularly assuaging to those with underage children or who are single parents.
“Failure is so important. We speak about success all the time. It is the ability to resist failure or use failure that often leads to greater success. I’ve met people who don’t want to try for fear of failing.” – J.K. Rowling.
British novelist best known as the author of the Harry Potter fantasy series. Single parent high-achiever.
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- Filing for Personal Bankruptcy in Spain (Second Opportunity Law) – 10th September 2015
Please note the information provided in this article is of general interest only and is not to be construed or intended as substitute for professional legal advice. This article may be posted freely in websites or other social media so long as the author is duly credited. Plagiarizing, whether in whole or in part, this article without crediting the author may result in criminal prosecution. No delusional politicians or elephants were harmed on writing this article. VOV.
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