In its recent decision,[1] the Supreme Court of the Czech Republic has considered the nature of advances on profit share paid by a joint-stock company to its shareholders. This decision is interesting in that it clearly defines the nature of the advance on profit share and further determines which corporate body should decide on it. Although there have been long-standing doctrinal conclusions on this matter, the Supreme Court has not yet addressed the issues discussed below in its decision-making practice.
Nature of the advance on profit share
The fundamental right of a shareholder, which forms one of his primary motivations for his participation in a joint-stock company, is his right to share in the company’s profits. This derives both from the wording of Section 256 of the Business Corporations Act,[2] as well as from the long-standing case law of the Supreme Court,[3] with which the professional literature fully concurs.[4] However, it is necessary to distinguish between the abstract and concrete aspects of this right, which are fundamentally different from each other.
The general existence of a shareholder’s right to participate in the company’s profits is not in itself sufficient to give rise to a shareholder’s entitlement to a specific performance by the company. It is necessary that this general right is complemented by other facts that “concretize” it and give rise to a specific claim of the shareholder against the company in form of a claim for payment of the determined share of profits. A similar principle applies not only to the profit share of the company, but also to the advance payments on the profit share.[5]
In the decision in question, the Supreme Court held that there is also an “abstract” right to an advance on the profit share pursuant to Section 35(1) of the BCA.[6] The concept of “advance” is even in the regime of advance payment for the share in the profits of a joint-stock company interpreted in a standard manner corresponding to the civil law regime, i.e. as a payment for a future obligation (debt), for the provision of which there is a legal reason (typically an implied agreement on the provision of an advance payment, or another legal reason, e.g. in form of a statutory obligation), and which must subsequently be accounted for as a repayment of the debt. In order to constitute a “specified” right to an advance on profit share, the prerequisite, i.e. a decision by the competent body of the joint-stock company to pay the advance on profit share, had to be met. Such a decision gives rise to a shareholder’s claim for payment of the advance.
Legal prerequisites for advance payment on profit share
The BCA contains a total of four conditions for the payment of an advance in Sections 35(1) and 40(3):[7]
- compilation of interim financial statements,
- sufficient resources for the payment of the advance as established in the interim financial statements,
- prohibition of creating loss to the company by paying the advance, and
- prohibition of bringing about the company’s bankruptcy by paying the advance.
The requirement to prepare interim financial statements has existed since the enactment of the BCA and is not new. Between the BCA and the Accounting Act,[8] there is an interdependency that entitles the company to prepare interim financial statements for the very reason that it is contemplating the payment of an advance on the profit share.[9] Meeting this requirement is therefore not problematic.
The second requirement is sufficient resources to pay the advance on the profit share. The company must assess whether it has sufficient own funds that can be distributed and therefore used to pay out the share of profits that will be “advanced”. The term “sufficient resources” was added to the BCA by its latest amendment,[10] by substituting the term “sufficient assets”. However, there was no material change in this respect, because, as the literature suggested,[11] whose opinion was confirmed by the Supreme Court in the decision in question, the term “assets” has the same meaning as the term “resources”.
The third requirement is compliance with the prohibition of creating loss to the company because of the advance payment. The BCA regulates this by setting a maximum amount of the advance, in a similar way as for the profit share. Therefore, it is possible to use the economic result of the previous years (of course, if it is a positive item), but also the economic result of the current financial year for the advance. Since the advance is paid on the basis of interim financial statements and the BCA allows the profits of the current financial year to be taken into account, it is possible to “advance” the share profit even during the current financial year, which has not yet ended. The last source available for the payment of the advance are the other available funds generated from profits. In any event, however, allocations to reserves and other funds that the company must make must be borne in mind.
The fourth and final requirement is the prohibition to cause bankruptcy by paying an advance under Section 40(3) of the BCA. Thus, a company cannot pay advances if it would thereby become insolvent or over-indebted within the meaning of the Insolvency Act.[12] This rule, which applies to the payment of a profit share, expressly applies to advances thereof. The company making the advance payment must therefore assess whether it has sufficient funds to pay it or whether it is possible to take a loan on those funds without the company becoming insolvent.
However, in addition to the above, there is another prerequisite for payment of the advance, although this is not explicitly mentioned in the BCA in relation to the advance. This is the general duty of the members of the governing body to act with due care. The members of the governing body will themselves make the payment of the advance and must therefore act with due care as it is an activity within the scope of their function. They must therefore not only ensure that the specific statutory conditions set out above are met, but they must also exercise due care to ensure that the advance is actually of an amount that will (eventually) be distributed to the shareholders as the profit of the company. They should therefore take into account the distribution of profits in previous years, the forecast of the company’s income and expenditure for the financial year, or the company’s plans.[13] If the members of the governing body fail to make this assessment, they become guilty of a breach of due care, even if the above-mentioned statutory requirements have been met.
Body deciding on the payment of the advance on the profit share
The BCA does not expressly provide for a special regulation regarding the body which is entitled to decide on the payment of the advance on the profit share. Section 421(2)(h) of the BCA regulates the powers of the general meeting of a joint-stock company with regard to the distribution of profits and Section 34(3) of the BCA regulates the payment of a profit share, but the BCA is silent on the decision to grant and pay an advance on a profit share. This matter will therefore fall within the competence of the governing body under its so-called residual competence pursuant to Section 163 of the Civil Code,[14] which was expressly confirmed by the Supreme Court in the decision in question, and the same conclusion has been reached by the doctrine.[15]
The Supreme Court further held in the decision in question that nothing forbids that the articles of association entrust the decision on the payment of the advance on the profit share to the general meeting. Thus, it is possible to provide in the articles of association that only the general meeting will decide on the granting of an advance on the profit share. However, even in such a case, the actual payment of the advance will be made by the governing body, which will be bound by the above-mentioned requirements. Thus, even if there were a valid decision of the general meeting to grant the advance, the actual payment might not take place if the governing body found that the legal prerequisites for the advance have not been met.
Another option is the possibility of the so-called one-time piercing of the articles of association, where the general meeting decides in a particular case to provide an advance on the profit share, although the articles of association do not give it this authority. In such a case, however, it will be necessary to comply with the requirements for the so-called one-time piercing of the articles of association, i.e. the decision has to be adopted by a qualified two-thirds majority in the form of a notarial deed pursuant to Section 416 of the BCA, otherwise it will not have legal effects pursuant to Section 45(3) of the BCA. Even in the case of a one-time piercing of the articles of association, it would again be the governing body that would make the payment of the advance, and therefore its obligation to carry out the above-mentioned assessment of the fulfilment of the statutory prerequisites for its payment would also apply.
In view of the amended wording of Section 435(3) of the BCA and Section 456(3) of the BCA, the governing body of a joint-stock company is obliged to follow the principles and instructions of the general meeting not relating to business management, even if this power of the general meeting is not expressly provided for in the articles of association of the joint-stock company.[16] As the payment of the advance does not fall within the scope of business management under the Supreme Court decision in question, it is not an instruction relating to business management and such an instruction is therefore admissible.[17] The governing body is bound by such an instruction if it is in accordance with the law, so in this case it will also have to assess whether the statutory requirements for the payment of the advance on the profit share have been met. Moreover, such an instruction is binding only on the governing body and therefore shareholders could not claim the payment of the advance on the profit share in the event of non-compliance.[18]
Applicability of the conclusions to a limited liability company
The above-mentioned conclusions of the Supreme Court’s decision in question, as well as the doctrinal conclusions mentioned above, are fully applicable to the limited liability company. The general regulation of the payment of advances on the profit share is regulated in the general part of the BCA (Section 35 and Section 40(3)), therefore it is also fully applicable to limited liability companies.
According to Section 171 of the BCA, any changes to the articles of association regarding the body deciding on the provision of an advance on the profit share will require a decision by a qualified majority at the general meeting in the form of a notarial deed; a one-time piercing to the articles of association may also be made by unanimous agreement of all shareholders in form of a notarial deed. The instructions of the general meeting regarding the payment of the advance will be similarly binding for the executive directors pursuant to Section 195(2) of the BCA.
Conclusion
The Supreme Court’s decision in question confirmed the doctrinal conclusions regarding advances on profit share in a joint-stock company, as it clearly confirmed their existence both in the abstract and the concrete form. Furthermore, it explained in more detail the conditions for the payment of advances and described the role of the governing body in the context of the payment of advances on profits. It set out in a clear manner what the role of the general meeting is in the context of the payment of advances and how its influence in the process can be enhanced. The conclusions of the decision are fully applicable to limited liability company. Overall, therefore, the decision in question has increased legal certainty and can be regarded as very beneficial.
If you have any questions regarding the issue of advances on profit share or the current legislation on capital companies, we are at your disposal. Please, do not hesitate to contact us.
Mgr. Martin Heinzel, attorney-at-law – heinzel@plegal.cz
Mgr. Tomáš Jančar, junior lawyer – jancar@plegal.cz
13. 06. 2022
[1] Judgment of the Supreme Court of the Czech Republic of 9 March 2022, Case No. 27 Cdo 3330/2020 (hereinafter referred to as the “decision in question”).
[2] Act No. 90/2012 Coll., on Commercial Companies and Cooperatives (Business Corporations Act), as amended (hereinafter referred to as the “BCA”).
[3] E.g. the judgment of the Supreme Court of the Czech Republic of 31 January 2022, Case No. 27 Cdo 1395/2020.
[4] E.g. ČECH, Petr, ŠUK, Petr. Právo obchodních společností: v praxi a pro praxi (nejen soudní) (Company law: in practice and for practice (not only judicial)). Edition I. Prague: Ivana Hexnerová – BOVA POLYGON, 2016. ISBN 978-80-7273-177-0, p. 360.
[5] This is a general principle with a broader application, which applies not only in the regime of a joint-stock company, but also, for example, in case of a settlement share as compensation for a free business share of a former member of a limited liability company. On this topic see, e.g. HEINZEL, Martin, JANČAR, Tomáš. Vypořádací podíl v s. r. o. po novele zákona o obchodních korporacích (Settlement share in an LLC after the amendment to the Business Corporations Act). Obchodněprávní revue, 2022, No. 1, pp. 23-28.
[6] The Supreme Court made this conclusion in the context of Section 40(2) BCA as amended until 31 December 2020, but this conclusion is also fully applicable after the amendment to the BCA with effect from 1 January 2021, when similar wording of this provision was adopted in Section 35(1) BCA as amended from 1 January 2021.
[7] In the version of the BCA until 31 December 2020, all these conditions were included in Section 40.
[8] Section 19(3) of Act No. 563/1991 Coll., on Accounting, as amended (hereinafter referred to as the “Accounting Act”).
[9] For more details, see Interpretive Opinion No. 27 of the Expert Group of the Commission for the Application of the New Civil Legislation at the Ministry of Justice of 9 April 2014 – on interim financial statements prepared for the purpose of payment of the advance on profits pursuant to the provisions of Section 40(2) of the CA. Available from: http://obcanskyzakonik.justice.cz/images/pdf/Stanovisko_27.pdf
[10] Act No. 33/2020 Coll., amending Act No. 90/2012 Coll., on Commercial Companies and Cooperatives (Business Corporations Act), as amended by Act No. 458/2016 Coll., and other related acts.
[11] DĚDIČ, Jan, LASÁK, Jan. Vybrané otázky rozdělování zisku, jiných vlastních zdrojů a poskytování záloh na dividendy v akciové společnosti po rekodifikaci (Selected issues of distribution of profit, other own resources, and provision of advances on dividends in joint-stock companies after recodification). Bulletin Komory daňových poradců, 2014, No. 1, pp. 22.
[12] Bankruptcy is defined in Section 3 of Act No. 182/2006 Coll., on bankruptcy and methods of its resolution (Insolvency Act), as amended.
[13] EICHLEROVÁ, Kateřina. Záloha na podíl na zisku v kapitálových společnostech (Advance on profit share in capital companies). Bulletin advokacie, 2014, No. 11, pp. 42-47.
[14] Act No. 89/2012 Coll., the Civil Code, as amended.
[15] DĚDIČ, Jan, LASÁK, Jan. § 35 BCA – Záloha na podíl na zisku (Advance on profit share). In: Lasák, J., Dědič, J., Pokorná, J., Čáp, Z. et al. Corporations Act. Commentary. 2nd edition. Prague: Wolters Kluwer, 2021.
[16] Cf. the explanatory memorandum to Act No. 33/2020 Coll.
[17] The doctrine arrives to the same conclusion. DĚDIČ, Jan, LASÁK, Jan. § 35 ZOK – Záloha na podíl na zisku (Advance on profit share), op. cit. sub 15.
[18] JOSKOVÁ, Lucie. Zásady a pokyny valné hromady a jejich dopad na odpovědnost členů volených orgánů. (Principles and instructions of the general meeting and their impact on the liability of members of elected bodies.) Commercial Law Review, 2022, No. 1, pp. 14-22.