Until now, it has been disputed whether the general meeting of a limited liability company can decide to keep all profits made in the company, even though there are no serious reasons for not distributing the profits among the shareholders. The current decision of the Supreme Court of the Czech Republic, Case No. 27 Cdo 1306/2023 of 29 November 2023, published on 24 January 2024 (the “Decision”), makes it clear that the conclusions adopted in the circumstances of a stock company are not transferable to a limited liability company, i.e. that the general meeting of a limited liability company may (unlike a stock company) decide not to distribute the profit among the shareholders even if there is no serious reason for keeping such funds in the company (e.g. a planned investment of the company).
Generally
In the Decision, the Supreme Court of the Czech Republic dealt with two issues: (i) firstly, as already mentioned, to what extent the general meeting of a limited liability company is limited in deciding on the distribution of profits as to the possibility of (not) distributing all the profits among the shareholders, and (ii) secondly, how up-to-date the financial statements must be for the distribution of profits in the event of a change in the previously adopted decision of the general meeting on (not) distributing profits on the basis of the financial statements of the preceding completed accounting period.
In the following article, we would like to give you an overview of the circumstances of the Decision and provide a more detailed analysis of the two conclusions formulated in the Decision, including the impact on practice.
Distribution of profit in a limited liability company
In the circumstances which gave rise to the Decision, the appellant sought annulment of the decision of the general meeting of a limited liability company, in which it is a minority shareholder, to distribute the company’s profits among the shareholders. The general meeting in question decided on 8 January 2021 to redistribute the company’s profit for the year 2019 on the basis of the company’s financial statements for the financial year 2019, by distributing part of the profit among the shareholders and transferring part of it to the retained earnings account from previous years (in accordance with the procedure and rules laid down in the company’s articles of association). In contrast to the original decision of the general meeting on the how to use the company’s profit for 2019, according to which the company’s profit was not distributed to the shareholders, according to the new decision the profit for 2019 was to be distributed (based on the 2019 financial statements) only in part to the shareholders. The proceedings then raised the question of whether the general meeting of a limited liability company is obliged (by analogy with the general meeting of a public limited company) to distribute all of the profit to the shareholders of the company if it has no serious reasons for retaining the profit in the company.
In order to answer the above question, it was necessary to assess to what extent the statutory and case law rules governing the distribution of profits in the context of a stock company are transferable to a limited liability company. The general meeting of a public limited company is obliged to decide on the distribution of profits (to the extent that they are not to be allocated to the profit fund) to the shareholders, unless there are serious reasons for not distributing the profits to the shareholders (which must also be stated in the invitation to the general meeting).[1]
However, according to the Decision, these conclusions, i.e. in principle the obligation of the general meeting of a stock company to distribute profits to the maximum extent among shareholders, are not without further transferable to the situation of a limited liability company. Although both companies are systematically classified as capital companies pursuant to Section 1(2) of Act No. 90/2012 Coll., on Busines Corporations and Cooperatives, as amended (the “BCA”), only the stock company is a purely capital company. It is obliged to create a relatively high share capital, has a separate management of the company from the shareholders, whose participation in the management of the company is realized in principle only through the supreme body of the company – the general meeting, which decides on the majority principle. During the lifetime of a stock company, the shareholders are not liable for the company’s obligations. The shareholders’ participation in the company is therefore, in the context of the above, more or less only of a proprietary nature. The obligation of a stock company to distribute all profits of the company to the shareholders (unless this is prevented by important reasons on the part of the company[2] ) is one of the consequences of this fact – the payment of profits is the main purpose of the shareholder’s participation in the company as an investor in the stock company.
A limited liability company, on the other hand, is a mixed company that has some features of both a unlimited and capital company. Whether it is the very status of the shareholders who are liable for the company’s obligations[3] , the conditions for amending the content of the Memorandum of Association[4] , the possibility to limit or exclude the transferability of shares in the company[5] or the extent of the shareholders’ right to information, which is not limited to the general meeting[6] .
In spite of the dispositive nature of the regulation of both companies, which in various respects allows them to be inspired by the regulation of the other company in their legal acts of incorporation (i.e. a stock company may “approach” the regulation of a limited liability company in its articles of association and vice versa), this conclusion cannot be applied across the board to all parameters of the company. Thus, the Supreme Court of the Czech Republic concluded that “in view of the mixed nature of a limited liability company and the resulting partially different position of its shareholders, the general meeting of such a company is not restricted in deciding on the (non)distribution of profits as in the case of a stock company.”
Eligibility of the financial statements for the decision on profit distribution
Already in its resolution of 27 March 2019, Case No. 27 Cdo 3885/2017, the Supreme Court of the Czech Republic interpreted in the context of a stock company that proper financial statements are an eligible basis for the distribution of profits (only) until the end of the following accounting year. Viewing this conclusion through the lens of the primary protection of creditors when deciding on the distribution of a company’s profits, it is logical that it also applies to a limited liability company. As the Supreme Court described in the Decision, it is the shareholders of the company who are the “last in line” for the company’s resources; the distribution of profits must not have a negative impact on the company’s creditors in the first place. One of the tools of creditor protection is the obligation of the general meeting to decide on the distribution of profits according to the “actual” financial statements (showing the profit that can be distributed) and at the same time to respect the so-called balance sheet test. The assessment of whether the profit distribution under consideration “passes” the balance sheet test cannot be made without the current financial statements.
If the company distributes profits in violation of the above rules, creditors whose rights could be impaired by this decision do not have active factual legitimacy to challenge such a resolution of the general meeting in court and seek its invalidity (unlike shareholders, who do, but quite logically will not seek the invalidity of the decision of the general meeting on the distribution of profits, which is illegal, but beneficial to them). In this context (and in the context of its previous jurisprudence – see footnote), the Supreme Court of the Czech Republic held in its Decision that the only effective protection of creditors is the absence of legal effects of such a decision in the event of the adoption of a decision of the general meeting on the distribution of profits on the basis of no longer up-to-date and therefore ineligible financial statements. In other words, such a resolution of the general meeting is not (relatively) null and void but voidable (without any legal effect). It should be noted that the court takes into account nullity on its own motion, even without a petition.
Unjust enrichment and breach of due managerial care
A legal act that has no legal effect cannot be a valid legal title for the receipt of a profit share. The payment of a profit share pursuant to a decision of the general meeting without legal effect would then be considered as a transaction without a legal reason, giving rise to unjust enrichment on the part of the shareholders.
Another consequence of the Decision is the liability of the members of the governing body of the company for breach of due care. The Supreme Court of the Czech Republic applied the consequences of the decision of the general meeting to distribute profits in violation of the law and the balance sheet tests to the situation at hand (i.e. the approval of the distribution of profits by the general meeting on the basis of ineligible financial statements)[7] . This leads to a further implicit conclusion of the Decision, namely that if the members of the company’s statutory body agreed to the distribution of the company’s profits (contrary to the law) on the basis of ineligible financial statements, they did not act with due managerial care.
Conclusion
The Decision clearly answers the question whether the general meeting of a limited liability company is entitled to decide not to distribute profit among the shareholders, even though there are no serious reasons for keeping the profits in the company. Thus, according to the Decision, the conclusions adopted in the circumstances of a stock company in this matter are not transferable to the circumstances of a limited liability company.
The decision is furthermore crucial in its conclusion that a decision of the general meeting on the distribution of profits on the basis of outdated financial statements is (automatically) without legal effect, without the need to invoke its invalidity. The payment of a profit share in accordance with such an (ineffective) decision is a payment without legal justification and constitutes unjust enrichment on the part of the shareholder, and the payment of a profit share in accordance with such a decision constitutes a breach of the due managerial care of the members of the governing body who agreed to the payment.
The Decision is also relevant for the common practice of companies, where the original decision of the general meeting on the distribution of profits was later changed or completely revoked and on the basis of the “old” financial statements they decided again on the distribution of profit.
If you have any questions regarding corporate law, please do not hesitate to contact us.
[1] See Decision.
[2] Resolution of the Supreme Court of the Czech Republic of 27 March 2019, Case No. 27 Cdo 3885/2017 and Resolution of the Supreme Court of the Czech Republic of 25 February 2010, Case No. 29 Cdo 1326/2009.
[3] S. 132 (1) ZOK.
[4] SS. 147 (1), 171 et seq. of the ZOK.
[5] SS. 207 and 208 ZOK in the context of the resolution of the Supreme Court of the Czech Republic of 19 September 2017, Case No. 29 Cdo 5719/2016.
[6] S. 155 ZOK.
[7] § Section 34(2) and (3) of the CPL.
Mgr. Martin Heinzel, senior attorney-at-law – heinzel@plegal.cz
Rachel Kouklíková, legal assistant – kouklikova@plegal.cz
5. 4. 2024