In the following article, which is the next in a series in which our law firm focuses in more detail on the changes that will bring the first extensive amendment to Act No. 90/2012 Coll., On business companies and cooperatives (Business Corporations Act), as amended (hereinafter referred to as “BCA”), the majority of which will take effect on January 1, 2021, we would like to explain in more detail another of the changes that the amendment will bring, namely changes related to distribution of profit and other own resources and also related to advances on the share of profits legislation.
In general
The new regulation introduced by Act No. 33/2020 Coll. of January 21, 2020, amending BCA and other related acts, should achieve terminological clarification, clarification of certain issues also in connection with the case law of the Supreme Court, achieve a more appropriate transposition of Directive (EU) 2017/1132 of the European Parliament and of the Council of 14 June 2017 on certain aspects of company law (the “Directive”); furthermore, systematic changes consisting in the transfer of rules between the regulation of specific companies and the general regulation of business corporations and, last but not least, changes in the concept of repayment of advances on profit sharing.
Share of profit and other own resources
Pursuant to the newly inserted second sentence of paragraph 1 of Section 34 BCA, it will be explicitly stated that on the basis of the financial statements it is possible to distribute profit and other own resources until the end of the accounting period following the accounting period for which the financial statements were issued. The purpose of this amendment was, according to the explanatory memorandum prepared in mid-2018, to clarify issues related to the decision of the Supreme Court of September 30, 2009, file no. 29 Cdo 4284/2007, published in the Collection of Judicial Decisions and Opinions under No. 80/2010. Due to its age and outdatedness, the explanatory memorandum thus overlooks another, more recent decision of the Supreme Court of March 27, 2019, file no. 27 Cdo 3885/2017-138, according to which, with effect from January 1, 2014, the regular financial statements prepared for the previous accounting period may serve as a basis for the distribution of profit until the end of the following accounting period.
Thus, although the amendment inserted into paragraph 1 of Section 34 of BCA constitutes a rule already reached by the case law of the Supreme Court, this can be seen as clearly positive in the sense that the rule will now be explicitly stated in the BCA. Moreover, the new wording of Section 34 BCA also applies this rule to extraordinary financial statements, while the decision of the Supreme Court applied this rule only to regular financial statements.
As can be seen from the above, one of the seemingly visible changes is that the rules set out in the provisions of Section 34 of the BCA are to apply not only to the distribution of profit, but also to the distribution of other own resources. The aim of this amendment was to achieve compliance with the Directive, the transposition of which, according to the explanatory memorandum to the BCA amendment, is inaccurate in the current amendment. At the same time, however, this change is largely related to the transfer of the current rules on the maximum amount to be distributed, specified separately for limited liability companies (Section 161 para. 4 of BCA) and separately for joint stock companies (Section 350 para. 2 of BCA) which have been transferred to Article 34 (2) of the BCA, included in Title I of the BCA common to all commercial corporations, to which the legislator resorted, despite the fact that the relevant rule contained in the Directive is consequently intended to apply only to public limited companies in the Czech Republic.
For this reason, in Section 34 para. 2 of the BCA, the term “the amount to be distributed” is used, regardless of whether profit or other own resources are distributed. It is thus intended to be worded closer to the Directive, which uses the term “the amount of a distribution to shareholders“.
In order to be consistent with the wording of the Directive, the rule itself, which sets the maximum possible amount to be distributed, has also been modified. This amount may not exceed the amount of the result of the last completed period increased by the result of previous years and by other funds that may be used by the business corporation at its discretion. These funds were not listed in the current regulation and it could be questionable whether they could be used in the calculation of the maximum amount to be distributed (these are both profit funds and other own funds / resources). In the words of the Directive, these are “sums drawn from reserves available for this purpose“. Although the possibility of distributing funds formed from profit can already be deduced today, explicit inclusion in the new legislation and its overall clarification is definitely a positive thing.
The last sentence of Section 34 para. 2 of the BCA then stipulates that funds whose establishment, change or termination is regulated by a legal regulation or articles of association in a manner that does not allow their distribution, may not be used for distribution. According to the explanatory memorandum, these should be primarily funds whose establishment, change or termination are regulated by accounting regulations, such as funds from revaluation of assets and liabilities, however, the BCA also contains such regulation (cf. Section 316 of the BCA – Special Reserve Fund for Own Shares).
The new regulation of paragraph 3 Section 34 BCA takes into account the distribution of other own resources and extends its effects to the conflict with a law other than the BCA, e.g. as stated in the explanatory memorandum, to the conflict with the Banking Act. Specifically, this is reflected in the provision that if the distribution is unlawful, shares of profits or other own resources will not be paid, and it is considered that those members of the statutory body who agreed with unlawful payment did not act with due care of proper manager. Unfortunately, the explanatory memorandum does not comment further on this subject, although, at least in our view, it is a significant interference in the responsibility for the decision to pay a share of profits and other own resources. This intervention is likely to place significantly greater demands on the statutory body, which should examine more closely whether the payment of profits and other own resources could be in conflict with any law, even if the conditions of the BCA and especially the maximum possible amounts to be distributed are met. The fact that the impact of this provision is extended to conflicts with unspecified laws and the obligations imposed by them is, in our view, completely disproportionate to the legitimate purpose for such a burden on private individuals.
The current amendment to paragraph 2 Section 34 of the BCA, where the rule for the maximum amount to be distributed has been inserted, is moved to paragraph 4. It is added to the rule that the law may also specify a different rule for the maturity of the profit share than the general maturity under this provision. The sentence on the rule for partnerships is deleted and therefore the rule in Section 34 par. 4 BCA should also apply to them. However, a general trading company has a special regulation of this rule in Section 112 para. 6 of the BCA containing a rule only for the maturity of a share in profit (not a share in other own resources) and has a maturity of 6 months, unless the articles of association or the highest body in the company decide otherwise. This special maturity rule then also affects the general partners of the limited partnership thanks to the reference in Section 126 para. 2 of the BCA. After the amendment takes effect, the general maturity according to Section 34 para. 3 of the BCA will then be applied to the part of the profit that fell to the limited partnership, which after taxation is divided among the limited partners in proportion to their shares (Section 126 para. 2 of the BCA).
Pursuant to paragraph 5 of Section 34 of the BCA, the rules for the distribution of profits and the payment of other own resources do not apply to the reduction of share capital. According to the explanatory memorandum, this explicit rule was included, as there were disputes in this area and other further disputes should to be prevented.
Advance on share of profit
With regard to the advance on profit sharing, Section 35 para. 1 of the BCA will now set out the rules for the bases and limits of the advance on share of profit, that have been moved here from Section 40 para. 2 of the BCA. An advance on profit sharing can be paid only on the basis of interim financial statements, which show that a business corporation has sufficient resources to distribute profit. The sum of the profit-sharing advances may not exceed the sum of the profit or loss for the current accounting period, profit or loss from previous years and other profit-making funds that the corporation may use at its discretion, less allocations to reserves and other funds in accordance with the law and the articles of association.
Furthermore, the amendment to the BCA in Section 35 para. 2 specifies detailed rules for the return of the advance on the share of profit, while the advance on the share of profit in the amendment to the BCA has undergone a fundamental change in the concept of the rule on the return of the advance. Under the current regulation, the profit share is not returned, unless the person to whom the profit share was paid knew or should have known that the conditions set out in the BCA were violated during the payment; in doubt, good faith is presumed.
The new regulation stipulates that the advance on profit sharing is returned within 3 months from the date when the regular or extraordinary financial statements were or should have been approved, unless the amount of profit to be distributed resulting from the regular or extraordinary financial statement is at least the sum of the advance payments paid in accordance with the law and the highest body of the corporation decided to distribute this amount.
According to the explanatory memorandum, the current rule is generally incorrect. In all commercial corporations, it is necessary for the share of profits to be returned if the conditions for the payment of the share of profits laid down by the BCA have been violated and it is not permissible for shareholders to be paid a higher share of profits than the company has achieved, even in if the partners were in good faith, the only exception can be allowed in the regulation of a joint-stock company, for which according to Article 57 of the Directive the share of profit paid in violation of the Directive (including legislation and the articles of association) is returned, except where the shareholder is in good faith. Therefore, the legislator allowed an exception only for a joint-stock company in Section 348 para. 4 of the BCA.
However, the above argumentation of the explanatory memorandum is, in our opinion, inconsistent with the concept chosen for the share of profit itself. Regarding the share of profit, the legislator decided to use the rules given by the Directive for joint-stock companies (in the Czech Republic for a joint-stock company) regarding the rules of the amount for distribution and setting its maximum amount also for other business corporations. Here, with regard to the concept of repaying the advance on the share in the profit, the legislator decided for a completely opposite approach and undoubtedly decided to give the importance of good faith only for the shareholders of the joint-stock company, to the burden of the shareholders of other types of corporations. The protection of good faith is one of the basic principles of the whole concept of the current Civil Code and it is surprising that the legislator has decided to deviate from this principle in this case, and in our opinion there is no reason to differentiate between a limited liability company, where shareholder will not be able to defend himself with good faith, and a shareholder of a joint stock company who will be able to do so. Both forms are widely used in business and the making such fundamental differences between them, which do not result from the typical differences between these companies, is, in our opinion, the deficit of a new regulation.
Limited liability company
The amendment to paragraphs 1 and 2 of Section 161 of the BCA took into account the above, i.e. that the rules set out there also apply to the share in other own resources. At the same time, by removing the phrase “or the general meeting” from the sentence of the second paragraph 1 of Section 161 of the BCA, it was achieved that the payment of a non-monetary dividend must be enabled by a articles of association. According to the explanatory memorandum, this was adopted to strengthen the protection of minority shareholders, so that the general meeting could not, by its simple decision, decide to pay a non-monetary dividend without being permitted by the articles of association.
Companies should therefore be advised to carry out an analysis of whether, in some cases, it is appropriate for them to pay a share of profits and other own funds as non-monetary dividend, and if this is indeed the case, to adjust the articles of association accordingly.
Joint-stock company
As in the case of a limited liability company, Section 348 to Section 352 of the BCA were amended in a way that the rules set out therein also apply to the share in other own resources.
Furthermore, the current paragraph 3 Section 348 of the BCA was removed and Section 349 of the BCA was reworded so that Section 349 of the BCA containes a general rule for all benefits for shareholders and according to this rule, the company provides all monetary benefits at its own expense and risk for shareholders or persons who has a separately transferable right exclusively by non-cash transfer to a bank account.
This expanded the persons affected by this rule and, as a result, removed the rule on payment to the bank account listed in the list of shareholders. The purpose of this adjustment, according to the explanatory memorandum, was that any distribution of own funds could only take place by non-cash transfer to a bank account, not only for shareholders (regardless of share form) but also for persons to whom a separately transferable right for a share in the profit, a share in other own resources etc., including persons entitled from the coupon, was transferred.
Although the reference to the bank account listed in the list of shareholders has been removed from the rule, according to the explanatory memorandum, the provision of monetary benefits will be based on the account listed in the list of shareholders, in the book-entry securities register (if registered) or shareholder or a person with separately transferable right to profit is obliged to provide the company on an ad hoc basis with the bank account details to which he wishes to be paid.
Furthermore, paragraph 4 of Section 348 of the BCA will provide an exception to the general rule for the return of advances on the profit share, according to which the profit share or other own resources are not returned, unless the person to whom the share was paid knew or should have known that payment, the provisions of the BCA have been violated.
The provision of Section 350 of the BCA was then completely repealed by the amendment, but it did not happen without compensation and, as is mentioned above, these rules for profit distribution are moved to the general regulation of profit and other own resources sharing common to all business corporations.
Temporary provisions
All changes concerning the rules for profit and other own resources distribution described in this article shall apply from the effective date of the amendment, i.e. from January 1, 2021.
Recommendations
In view of the above changes in the rules for profit and other own funds distribution, the statutory bodies in particular will have to pay more attention when deciding on the payment of share of profit and other own funds to compliance of such payments with all relevant laws governing their activities.
At the same time, the shareholders of business corporations will have to take into account that advances for profit sharing are generally refunded within 3 months from the date when the regular or extraordinary financial statement were or should have been approved, unless the amount of profit to be distributed resulting from the regular or extraordinary financial statement reaches at least the sum of the advance payments for profit paid in accordance with the law and the highest body has decided on the distribution of this amount, because only the shareholders of the joint-stock company can claim good faith in non-violation the conditions set by BCA by the payment of advance for profit.
Conclusion
In conclusion, the amendment to the BCA will bring some welcome clarifications and terminological consistency to the rules of distribution of profit and other own resources, but it will also bring some controversial changes, especially as regards the responsibility of statutory bodies for profit and other own resources sharing decisions and the application of the principle that the advance on the share of profits is refunded and not is not to be refunded only under certain conditions.
If you have any questions about the topic or the BCA amendment in general, we are at your disposal.
Mgr. Martin Pospíchal, lawyer – pospichal@plegal.cz
Mgr. Jakub Malek, partner – malek@plegal.cz
29. 05. 2020