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Can shareholders pay themselves a dividend for Christmas?

The case law of the Czech Supreme Court confirms the new rules for the payment of profit share in capital companies.

There is no doubt that the main purpose of business is to generate profit. Probably few people set up or become members of a capital company for a purpose other than profit. Whether with the prospect of dividends or in the form of a profitable exit. The right to share in profit is one of the fundamental rights of a company shareholder and usually also a fundamental reason to “get” a company. The payment of profit within a company was and still is subject to a number of restrictions, in particular with regard to the protection of the economic health of a company and its creditors.

Our colleague Lola Florianová wrote about the possible loosening of the rules for the payment of profit for companies subject to the Business Corporations Act in her article published this March (The terms for the distribution of profit at corporations, past and present – has everything changed?). Importantly, the views discussed by experts have now been confirmed by the Supreme Court.

The current legislation states that the profit share is determined on the basis of regular or extraordinary financial statements approved by the supreme body of the business corporation (i.e., as a rule, by the general meeting). It applies to both limited liability companies (s.r.o.) and joint-stock companies (a.s.) that the general meeting must discuss financial statements no later than 6 months after the end of the reporting period (usually corresponding to a calendar year). The supreme body of the corporation also decides on the distribution of the profit share. Unless laid down otherwise in the Memorandum of Association, the profit share is distributed only among the shareholders, in which case it is a dividend. However, the Memorandum of Association may lay down that the profit share must also be distributed to other persons, typically the members of the statutory body. This is a bonus.

The statutory body (executive, board of directors) decides on the actual payment of the profit share, and the statutory body must also always verify, by means of an insolvency test, whether the company will not bring about bankruptcy by paying profit. The insolvency test was introduced by the Business Corporations Act; the Commercial Code lacked a similar rule.

During the effective period of the Commercial Code (i.e. until 31 December 2013), the Supreme Court of the Czech Republic repeatedly ruled that, in accordance with the fact that the general meeting is obliged to discuss regular financial statements within 6 months of the end of the reporting period to which the financial statements relate, if the general meeting wishes to decide on the distribution of profit, it must do so within the 6-month period (usually no later than 31 June of the following year). This meant that, after 6 months from the end of the reporting period, the financial statements for that period could no longer serve as a basis for the payment of profit. And so it was not even possible for shareholders to pay themselves profit as a Christmas present. In the court’s opinion, such “outdated” financial statements no longer reflected the actual economic situation and did not present a realistic picture of the company’s accounts.

Whether the case law limiting the age of the financial statements would still apply after the adoption of the Business Corporations Act was not clear. However, in its decision File No. 27 Cdo 3885/2017, the Supreme Court has now concluded that “with effect from 1 January 2014, regular financial statements prepared for the previous reporting period may serve as a basis for the distribution of profit until the end of the following reporting period”. Therefore, the 6-month limit will no longer apply.

The court based this conclusion on the existence of the insolvency test. The insolvency test means that the statutory body must always assess the current impacts of the payment of the company’s funds on its economic health, thereby reasonably reducing the risk of paying out profit based on out-of-date economic results.

The relaxation of the rules for the payment of profit is certainly welcome. However, the members of the statutory body will also bear greater responsibility in deciding on the payment of profit. Payment of profit contrary to the insolvency test constitutes a breach of due diligence and may give rise to the executive’s liability (even his/her liability for the company’s obligations under Section 68 of the Business Corporations Act).

Source:
Supreme Court’s decision File No. 27 Cdo 3885/2017 of 27 March 2019