One of the fundamental rights of a shareholder in a capital company is the right to participate in its profits. For this right to be exercised, several necessary conditions must be met, i.e., in particular the decision of the general meeting of the company on the distribution of profits and the adoption of the decision of the statutory body on its payment, of course in addition to the actual realization of profit.
The new Act No. 33/2020 Coll., Amending Act No. 90/2012 Coll., On Business Companies and Cooperatives (the Business Corporations Act), will enter into force on 1 January 2021. The forthcoming changes will significantly affect, among other things, the area of distribution and payment of profits and other own resources of business corporations.
We have decided to follow up on our article of 29 May 2020 and recall the basic changes that the amendment to the Business Corporations Acts (hereinafter referred to as “BCA”) brings in this area. This article is a loose continuation of a series of contributions from our law firm dealing with the first extensive amendment to the BCA.
Equity test
The provisions of Section 40 (1) of the BCA will extend the restrictions on the distribution and payment of shares of profits or other own resources to all capital companies and cooperatives, namely the obligation to apply the so-called equity test.
This test aims to ensure, in addition to maintaining financial stability, the informative value of the company’s registered capital data. This should be one of the criteria that the company must respect when distributing profits and other own resources. According to the current regulation of the BCA, the obligation to test equity was applied only to joint-stock companies.
The amended wording of Section 40 (1) of the BCA already provides for a ban on the distribution of profits or other own funds of all capital companies and cooperatives, if at the end of the last accounting period the equity resulting from ordinary or extraordinary financial statements or after this distribution, the equity will be reduced below the amount of the subscribed registered capital increased by funds that cannot be distributed according to the law or the articles of association.
Restrictions on the distribution of profits or other own resources – incorporation of the rules of the Act on Accounting
Through Section 40 (2), Section 28 (7) of the Act on Accounting, concerning the limitation of the distribution of profit or other own resources if development costs are reported in the balance sheet assets, will be newly incorporated and slightly reworded. In this case, the amount to be distributed is reduced by the amount of non-depreciated development costs.
In other words, the balance sheet test also includes non-depreciated development costs, which must exceed the resulting amount to be distributed to proceed with the distribution of the company’s resources. Thus, for systematic reasons, the provision in question takes over and clarifies the restrictive rule contained so far in the Act on Accounting.
Insolvency test
The insolvency test continued to be maintained after the amendment but is moved to Section 40 (3) of the BCA. Thus, in connection with the payment of any resources from the company, including the advance on the share of profits, the obligation of the statutory body to exercise this insolvency test applies.
It is a pity that the legislature determined, based on the newly expressed rule, that the provisions concerning the distribution and payment of the share of profits and other own resources should not apply to the reduction of registered capital. This also precluded the use of an insolvency test.
We think that it is appropriate to follow the insolvency test even in the case of a reduction in registered capital, as it is certainly undesirable for company bodies to ignore the economic condition of a corporation and bring it into financial difficulties or even cause it to go bankrupt.
The consequence of the refusal of the profit payment by the statutory body
It will now apply that the right to a share in the profit (or other own resources), which was not paid within the statutory period, expires unless the statutory body of the company has paid such an amount due to the risk of bankruptcy. The share of profit and other own resources will continue to be payable within 3 months from the date of the decision on the distribution of profit unless the decision of the highest body, the law, or the partnership agreement provides otherwise. The statutory body of the company decides on the actual payment of the share in the profit and on other own resources. It is stipulated that if the distribution conflicts with the law, the shares will not be paid. A member of the statutory body who has agreed to the illegal payment does not act with the care and diligence under the provisions of Section 159 (1) of the Civil Code.
The provision of Section 40 (4) of the BCA is aimed at cases where the General Meeting decides on the distribution of profits when the conditions of the insolvency test are not met, and the statutory body refuses to pay the profit. Thus, the amendment states in Section 40 (4) that the right to a share in the profit in the event of non-payment by the end of the accounting period expires, and the unpaid profit is transferred to the account of retained earnings of previous years. With this provision, the legislator intends to limit any outstanding liabilities of the company to shareholders in situations where approved distribution of the share of profit or other own resources did not consider the amount that is possible according to general and specific rules, but for example due to uncertain future development cash flow.
In addition to the above, we would like to draw attention to the further tightening that the amendment brings to the rules for the return of the paid share of profits, which will be newly included in Section 348 (4) of the BCA. Newly, good faith in complying with the legal conditions for payment will no longer protect shareholders from the obligation to return the paid share of profits. It means that the shareholder is obliged to return the profit paid to him if the profit will be paid out without complying with legal rules, even if the shareholder did not know about such a discrepancy. The protection of good faith will be maintained only in the regulation of joint-stock companies. A shareholder or other recipient of resources from a joint-stock company will be obliged to return the obtained funds only if he knew or must have known that the legal conditions had been violated during their payment. However, some aspects of the distribution and payment of a share of profit and other own resources will continue to be part of special arrangements for individual forms of business corporations.
Avoidance of so-called disguised profit payments
Finally, Section 40 (5) of the BCA will also contain a completely new rule, the aim of which will be to prevent the so-called disguised or hidden payment of profits. From 1 January 2021, business corporations will have an explicit ban on the provision of gratuitous services to shareholders and persons close to them through an amendment. Exceptions to this rule will be only ordinary occasional gifts, donations made in a reasonable amount for a public benefit purpose, a performance that has been complied with a moral obligation or decency, and benefits provided by a business corporation under the law.
Conclusion
Given the above, it is clear that in the area of distribution and payment of profits and other resources of business corporations, there will be relatively extensive changes since the new year, which will significantly affect one of the key rights of shareholders. We do not doubt that most of these changes are desirable and will go a long way towards clarifying the interpretation of the legal provisions and will lead to greater legal certainty. There are still several unresolved questions, the answers to which will be sought in particular by other case law of the courts.
In terms of application and practice, from the new year, from the position of the statutory body, it will be necessary to pay increased attention to decisions on the payment of a share of profit and other own resources, especially the compliance of such distribution of profit and other own resources with the law, taking into account all laws regulating such their activity.
If you have any questions regarding the topic of this article or corporate law in general, we are at your disposal, do not hesitate to contact us.
Mgr. Nikol Čišecká, junior lawyer – cisecka@plegal.cz
Mgr. Jakub Malek, partner – malek@plegal.cz
29. 12. 2020