An apparently straightforward situation has ended in a conclusion that has disturbed the Czech legal practice. By extensive interpretation, the Czech Supreme Court has broadened the requirements applicable for the distribution of profit. What was once a common practice has now become a serious liability for the statutory bodies of Czech limited liability companies required to audit their financial statements, as well as for joint-stock companies.
Background of the case
It was a clear case. After the company received an application for bankruptcy filed by a creditor, its general meeting decided to distribute a significant amount of profit. One month after this decision, the court declared bankruptcy over the company's assets. The bankruptcy trustee rejected the shareholders' receivables for the payment of the participation in profit. At first glance, and even for persons without any legal education, the shareholders' receivables seem illegitimate. It is therefore no wonder that the Supreme Court confirmed the bankruptcy trustee's approach. Nevertheless, the Supreme Court's reasoning has straddled the border of insolvency law.
The Czech Commercial Code (CC) sets several tests which must be complied with so that general meetings can decide on profit distribution. In a completely different context, it also stipulates that a company's annual general meeting must be held at the latest within six months from the last day of the accounting period.
Reasoning of the Supreme Court
According to the Supreme Court, the law implies that the audited financial statement of the company (if required) as of the last day of the accounting period must be available at the annual general meeting. The Supreme Court concluded on this basis that the six-month period is also the period during which the audited financial statements can be used as a basis for the distribution of profit. The decision related to joint-stock companies, but the same conclusions would likely apply to limited liability companies required to audit their financial statements.
As a result, companies can decide on the distribution of profit only within six months from the date as of which their audited financial statements were issued. Otherwise, they will have to arrange for new audited financial statements. However, the Act on Accounting explicitly states the situations for which audited financial statements must be prepared, and none of them relates to the decision of the shareholders or company to distribute profit. Therefore, it is questionable whether the company/shareholders have at all an option to decide on the distribution of profit later than in the above period.
Liability of statutory bodies
A serious threat in this respect is the liability of statutory bodies. Statutory bodies who paid out the dividend approved by the general meeting without complying with the statutory requirements (now including the six-month period) are jointly and severally liable for repayment of the distributed profit participation by the relevant shareholder. This liability is objective without any liberation options.
It seems that the Supreme Court's interpretation is too broad as it creates additional obligations not grounded in written law. Furthermore, this is the first decision of the Supreme Court in this respect, which can be further reviewed and amended. Nevertheless, legal and business professionals will have to take the decision into account for the future.
Regardless of whether or not the judgement is generally accepted, companies must comply with the new rule. Not only this rule should be complied with this year but, at their next annual general meeting companies should also take the opportunity to approve the profit distribution which was paid in the past in breach of this "newly discovered" rule.
This article was originally published in the schoenherr roadmap`11 - if you would like to receive a complimentary copy of this publication, please visit: http://www.schoenherr.eu/roadmap.
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