The Czech Republic’s new Civil Code and its Business Corporation Act are effective since 1 January 2014. These two acts represent the leading elements of the re-codification of Czech civil law, which -- apart from many other changes -- has brought changes also in the area of payment of profit sharing.
For the purpose of this article, the term “Memorandum of Association” also incorporates articles of association and deeds of incorporation, the term “Shareholder” also encompasses stockholders, and “Company” refers to both a limited liability company and joint stock company.
Process of approval and payment of profit sharing
The fundamental precondition for payment of a profit sharing on the profit of the company is an ordinary or extraordinary balance sheet report that shows that a distributable profit exists and that has been approved by a general meeting. The distribution shall be approved by a general meeting. The task of the executive directors or of the board of directors of the Company is to duly verify the fulfillment of the conditions for the payment of profit sharing, define the legitimate persons who shall receive payment of such profit sharing, and appropriately decide about the payment of profit sharing.
Restriction of the payment of profit sharing
Different restrictions applied to the payment of profit sharing may be regulated by a memorandum of association. The shareholders may agree in the memorandum of association e.g. that the right to profit sharing applies only to the shareholders owning a particular type of a share or that profit sharing is payable only when the established financial targets are reached.
The Business Corporation Act defines the relevant legal restrictions for the payment of profit sharing. Such payment is forbidden when it would involve bankruptcy for a company. Under the Business Corporation Act, the amount designated for payment as a share in the company’s profit must not be higher than the financial result for the last accounting period reported in the financial statements, reduced by the mandatory allocation to the reserve fund by unpaid losses from previous years, and increased by the retained profit from previous years. Moreover, the joint stock company is not permitted to distribute profit if the equity determined from the annual or extraordinary financial statements is less than the company’s registered capital, or would be less than the company’s registered capital as a result of distributing the profit, increased by funds that are forbidden to be distributed between shareholders.
Advance payment of profit sharing
The Business Corporation Act newly regulates the possibility of an advance payment of profit sharing, including retained profit from previous years. The restriction of the payment profit sharing under the Business Corporation Act also applies for the advance payment of profit sharing. The memorandum of association may define another restriction or completely forbid the advance payment of profit sharing. If the advance payment of profit sharing has already been distributed and the company’s general meeting decides that the profit will not be distributed or such a profit decision is outstanding, advance payment recipients must return their advance payment to the company.
Persons legitimated to profit sharing
Primarily, shareholders have the right to profit sharing. Shareholders participate in profit distribution as determined in a resolution of the general meeting on the profit’s distribution between the shareholders in proportion to the size of their share holding, unless the memorandum of association provides otherwise.
The Business Corporation Act newly allows that the memorandum of association may broaden the circle of persons legitimated to profit sharing. The companies may extend profit sharing not only to the shareholders, but also to the statutory bodies, employees or external parties, e.g. creditors of a shareholder.
Right to fixed profit sharing
The next change that the new regulation brings is the possibility for the memorandum of association to regulate the right to fixed profit sharing. In the event that this option is chosen, if distributable profit is evident from the annual or extraordinary financial statements approved by the general meeting, fixed profit sharing becomes payable (due) without requiring any further decision of the general meeting.
Protection of good faith during the payment of profit sharing
According to the Business Corporation Act, the profit sharing that has already been distributed is not to be returned if it was accepted by its recipients in good faith. An obligation to return profit sharing exists only when the person who participated in the profit sharing knew, or should have known, that legal conditions were violated as a consequence of the payment. This approach will not be applied with regard to the advance payment of profit sharing.
Methods of the payment of profit sharing
The re-codified regulation of the limited liability company also newly enables the memorandum of association or the company’s general meeting, even without any authorisation of the memorandum of association, to set the methods of the payment of profit sharing in non-monetary forms: such companies can choose to pay profit sharing in a material form or as a rendition of services. The value of such a payment should not be higher than the amount the general meeting has approved for distribution.