Rules of profit distribution for joint stock and limited liability companies clarified
Late in March, the Supreme Court issued a decision significantly diverging from its previous case law concerning the rules of profit distribution for joint-stock and limited liability companies (capital companies). The case law had mostly been established under the Commercial Code no longer in force. Replacing the Commercial Code from 1 January 2014, the Act on Corporations has significantly extended the profit distribution options of capital companies. At the same time, it puts more demands on statutory bodies as the main guarantors of compliance with the law when making payments from profit and other components of equity.
At the times of the old Commercial Code, the Supreme Court forged the opinion that once the deadline for convening the general meeting to approve the regular financial statements had elapsed, the financial statements could no longer serve as a basis for making a decision on the distribution of a capital company’s profit. The lapse of six months, counted from the last day of the accounting period, was thus viewed as the latest date when the results as per the ordinary financial statements may provide a true and fair view based on which the shareholders/members could make a qualified decision on profit distribution. With the effect of the new civil law (the Act on Corporations), the professional public voiced the opinion that these rules no longer applied. The expected change in interpretation was already covered in the November 2017 issue of the then Financial Update, and the same conclusion has now been confirmed by Supreme Court decision No. 27 Cdo 3885/2017. This means that from 1 January 2014, ordinary financial statements may in principle serve as a basis for profit distribution until the end of the following accounting period.
The reason is that, unlike the previous legislation, the Act on Corporations explicitly stipulates an ‘insolvency test’, whose application should in itself be sufficient to achieve the aim pursued by the now obsolete case law, i.e. to prevent the siphoning of funds from a company to the harm of its creditors. In effect, the insolvency test restricts the payment of profits and other ‘own resources’ (and advances for such), if this should cause a company’s bankruptcy. The responsibility for observing this restriction is with the statutory body, whose members have the duty to exercise their offices with the due managerial care. For clarity’s sake, other ‘own resources’ mean components of equity other than profit and registered capital, in particular share premium and capital contributions, and decreases in the registered capital.
The same judgment also overrules another case-law rule, under which a general meeting could not determine the profit share to be paid to the members of the company’s bodies (a royalty) without approving at least a part of the profit to be distributed to shareholders/members (a dividend).
What remains valid is the rule that the right to a share in a capital company’s profit is its shareholders’/ members’ fundamental right. This means that if a company generates profit, the general meeting may decide not to distribute it to shareholders/members only for important reasons and while respecting the prohibition of abusing the voting majority. Important reasons may include, inter alia, the provisions of the company’s founding legal act (memorandum of association/deed of foundation) stipulating that a part of the profit is to be distributed among the members of the company’s bodies, its employees, or transferred to a fund established by such founding legal act. The remaining portion that is not used according to the rules stipulated in the founding legal act also does not have to be distributed to shareholders/members. Yet again, this has to be supported by serious reasons, including, for instance, the company’s financial situation or expected future expenditures requiring the creation of necessary reserves. For joint stock companies, these reasons have to be stated in the invitation to the general meeting.
The Supreme Court’s decision has opened a wide range of options on how to distribute a company’s profits. At the same time, it places rather high demands on statutory bodies, as the failure to observe the profit distribution rules would be viewed as a breach of due managerial care (fiduciary duties).