The legal reserve
Before distributing profits, the law requires setting aside the legal reserve. How much, until when, and why it matters for your annual meeting.
- Before distributing profits, you must set aside the legal reserve.
- It is at least 5% of net profits each year.
- It builds up until the fund reaches 20% of the capital stock.
- It applies to any commercial company: S.A. and S. de R.L. alike.
What the legal reserve is
The legal reserve is a fund the law requires you to build from part of the profits, before distributing them to the owners. Its purpose is to strengthen the company's equity and give it a cushion against future losses.
How it's calculated
From each year's net profits you set aside at least 5%, until the fund reaches one fifth (20%) of the capital stock (art. 20 of the LGSM). Once it reaches that cap, no further contributions are required.
The bylaws may set a higher percentage or a larger reserve, but never less than the law requires.
It comes before dividends
Profits are distributed only after the reserve is set aside. The management body must refrain from approving dividends if the reserve is not met, and any distribution of profits that ignores this rule is void (art. 21 of the LGSM).
If the reserve falls
If, due to losses or any other reason, the fund drops below 20% of the capital, it must be replenished from the profits of the following years, applying the 5% annual rule again until it is back at the cap.
Who is responsible
The management body (the Board of Directors or Sole Director in an S.A., or the Board of Managers or Sole Manager in an S. de R.L.) is jointly liable for making sure the legal reserve is set aside as the law requires.
- At the annual meeting, the year's results and, where applicable, the distribution of profits are approved.
- First you set aside the legal reserve; then you decide on the distribution.
- That's why the questionnaire asks about the year's result (profit or loss) and whether your reserve is already full.
This article is a general informational summary and is not legal advice for any specific case. For your particular situation, consult a Ramos Urías lawyer.