Czech court ruling: If appointed as director, your employment ceases to exist

Under Czech law, the relationship between a company and its directors is a commercial relationship and not an employment one. Therefore, a performance (service) agreement rather than an employment agreement should be entered into. It is, however, not unusual for executive directors to have both a performance agreement and an employment agreement, or to only perform their position based on an employment agreement. The concurrent existence of two different regimes has long been subject to both doctrinal and case law interpretation, often with contradictory results.

However, according to prevailing opinions the new Czech civil law regulation, effective from 1 January 2014, does not allow directors’ employment to be governed by an employment agreement only. An employment agreement may only be concluded with a director if the director performs a different type of work under the employment agreement to his duties under the directorship.

Further controversies arise where a current employee (usually management) is appointed to the position of director. In this case, employees always have an employment agreement which they usually intend to keep, when appointed director.

Until recently, it was widely presumed that the only risk of this structure is that the employment agreement can be deemed to be suspended for the time of directorship. In other words, once the employee is appointed as a director, his employment agreement becomes ineffective, although it does not cease to exist. The employment agreement is automatically “renewed” after termination of the performance agreement.

However, the Supreme Court of the Czech Republic have recently adopted a rather different approach. The court indicated that once an employee is appointed to an executive body of a company (such as a director in the case of a limited liability company or a member of the board of directors in the case of a joint stock company etc.), the employment relationship ceases to exist as a result of an implied termination agreement between the parties. In other words, if they agree on appointment of the employee as director, they simultaneously agree to terminate their employment (notwithstanding whether such agreement is made expressly or not).

Implied termination of the employment relationship would have the following practical consequences:

• the director loses the protection against dismissal envisaged by the Czech Labour Code;
• the salary paid to the director during his appointment is not tax deductible for the company; and
• the company could in theory claim that the employee had no legal right to any salary paid and therefore claim it back (although the director could (and most likely would) argue that he has the right to receive remuneration for the performance of his position; the amount of such remuneration would be arguable and the director’s position would be uncertain).

Although the decision is based on the application of an old legal regulation which ceased to apply after 31 December 2011, it is likely that the reasoning adopted by the Court would be applied in interpreting the new regulation. To avoid the above risks, parties should therefore avoid using employment agreements for directors where possible and conclude a specific performance agreement with appointed directors that includes remuneration provisions to avoid potential disputes.