Czech Republic amends Act on Business Corporations with new rules on profit and equity payments and distribution

On 1 January 2021, the amendment to the Act on Business Corporations will come into effect (with some exceptions), bringing significant changes to the current act and providing corporations with greater flexibility in the distribution and payment of equity and profits.

Distribution of profit and equity

In addition to profit, the rules regulating profit distribution will also apply to other financial resources (equity) (in Czech: jiné vlastní zdroje), such as share premiums, capital funds and equity contributions outside of registered capital. The rules for calculating maximum distribution amounts will also change. Non-cash distribution of shares of profit or equity will only be allowed if permitted by the company’s articles of association whereas currently, non-cash distributions may be approved at the limited liability company’s general meeting .

Time limit for profit and equity distribution resolution

Currently, the law does not set a timeframe within which companies must decide on the distribution of profit and equity. To be safe, many companies often distribute their profit within six months of the final day of their financial statements, which is typically 30 June. This mirrors the timeframe the law sets for holding general meetings where the shareholders approve the financial statements. To comply with existing legislation, companies often employ 'advances' (in Czech: záloha na podíl na zisku) if they wish to distribute any profit after 30 June.

In line with the recent Supreme Court ruling (27 Cdo 3885/2017), the Amendment explicitly states that distribution based on profit and equity which reflects the latest financial statements (regular or interim) approved by the general meeting is permitted until the end of the accounting period following the accounting period for which the financial statements were drawn up. In practice, this means that a financial statement for the year ending 31 December 2019 can be used as the basis for profit and equity distribution until 31 December 2020.

Advances will remain in use for urgent distributions of profit either prior to the approval of the company’s financial statements by the general meeting through the use of the retained earnings accounts or for distributions of profit generated during the current financial year.

Balance tests

To prevent distributions and payments of profit and equity that would disadvantage company creditors, the Amendment introduces unified balance tests (i.e. an insolvency test and an equity test) for all limited liability companies, joint stock companies and cooperatives. The Amendment also modifies the rules of these balance tests.

Currently, the Act on Business Corporations requires an insolvency test for limited liability companies and joint stock companies and an equity test only for joint stock companies. The insolvency test prohibits the distribution of profit, equity and advances if this could result in a company’s bankruptcy. Distribution (payment) of profit, equity and advances in breach of an insolvency test or other legal requirements constitutes a breach of the statutory body’s (i.e. director’s or board of directors’) obligation to act with due care. A resolution of a general meeting in breach of an equity test has no legal effect.

Other rules of profit distribution

The Amendment contains several other rules regarding the distribution (payment) of profit, equity and advances. These include: (i) the automatic termination of the right to obtain profit share and (ii) the transfer of undistributed profit to the retained earnings account, if the general meeting approves profit distribution but the statutory body does not proceed with it due to a failure to comply with the insolvency test. However, an automatic transfer of the undistributed equity to the retained earnings account may be problematic in practice and subject to further interpretation by a court.

In order to prevent companies by passing the profit distribution rules, payments (both cash and non-cash) by companies to their shareholders are not allowed, except in certain instances such as common minor gifts or charitable gifts.

Any party that receives profit or equity distributed in breach of the statutory requirements is obligated to return it. Only shareholders of joint stock companies acting in good faith are granted special protection from this obligation.

Contact details

This article seeks to highlight the most significant changes in the Amendment regarding the distribution of profit and other financial resources by corporations. For more information on the Amendment to the Act on Business Corporations and its impact on Czech companies, contact your regular CMS advisor or local CMS experts.