Since 1 January 2014, limited liability companies in the Czech Republic are no longer required to create the so-called ‘reserve fund’ of up to 10% of the company registered capital. Nevertheless, should the obligation to create the reserve fund remain in the company founding documents, that follows the now-abolished wording of the old Commercial Code (CCC), the company will remain required to create such a fund without regard to what the new Act on Corporations (AoC) may say. This means that unless shareholders in limited liability company (LLC) do not change the wording of their company founding documents, following the procedure laid down by Section 777 para of the AoC, the company remains obliged to create (or continue to contribute into) the reserve fund also in 2014 and subsequent years in line with CCC (Cf. Section 777 para 4 AoC). We assume that a large number of companies will take this opportunity to abolish the reserve fund; in this connection it will have to resolve how to dispose of the funds that are tied in the reserve fund. One of the most usual solutions will be to transfer the money from the reserve fund into undistributed profit for subsequent distribution between the shareholders. In this connection, the companies should verify under what terms the funds from the reserve fund may be distributed between shareholders.
A limited liability company intending to distribute funds from the reserve fund must verify whether it complies with all conditions imposed on it by law and founding document applicable to distribution / payouts of profits or other funding from company own sources. Limited liability companies are subject to special regulation contained in Section 161 para 4 AoC, under which “…. Any amount to be distributed between shareholders may not exceed the amount of economic result attained in the last completed accounting period plus any undistributed profit from the previous years and minus losses suffered in previous years and contributions to reserve or other funds in accordance with this Act or founding documents.”
The company will also be required to review, before paying out these funds, whether it complies with the so-called insolvency test (Section 40 para 1 AoC). This provision prohibits payouts from profit or other assets / funds or provide advance payments if it would cause insolvency of the company (Act No. 182/2006 Coll., on Insolvency – AI). This provision applies to any pay-outs of the company, including any funds that are put away in reserve fund.
In this respect there lies a question, whether the LLC shall be obliged, when making the decision on distribution the money available in the reserve fund, to base its decision on the financial statements, which are no older than six months, as such obligation was generally defined by case law (Supreme Court 29 Cdo 4284/2007 of 30 September 2009) for valid decisions of the general meeting on distribution and pay outs of profits for the last accounting period among shareholders with respect to the CCC. The Supreme Court formulated back in 2009 that the deadline for convening a general meeting is both (i) the latest possible deadline with respect to approving financial statements and (ii) the final period in which the results presented in the financial statement may be considered to provide an actual realistic state of accounts of the company for the purpose of distributing profits therefrom. Does this six-month limit also apply to pay outs from reserve fund after 1 January 2014?
The existing case law, although formulated during operation of the now replaced CCC, may be applied also to the now effective AoC, in matters where it does not differ with AoC. The six-month deadline for approving the financial statements remained unchanged in AoC (Section 181 para 2 AoC), same as the rule that the share on the profits (for completed previous period) shall be determined on the basis or ordinary or extra-ordinary financial statements (Section 34 para 1). However, where AoC differs from CCC (leaving the possibility of providing advance payments toward future profits aside) is the fact that with respect to LLCs (unlike joint stock companies) the AoC abandoned the concept of the protective function of registered capital and replaced it with the insolvency test. Where the CCC (Section 128 para 1, Section 123 para 2 and Section 178 para 2) imposed a condition for distribution of profits in limited liability companies by measuring registered capital and equity based on financial statement, the AoC replaces this concept protecting creditors by imposing the insolvency test as an indicator of financial health of the company.
Therefore the question whether funds so far mandatorily accumulated in LLC reserve fund may be distributed using financial statements that are not older than 6 months, when it is apparent that funds accumulated in the reserve fund may only increase, but never decreased the amount, which is obtained by application of Section 161 para 4 AoC. In practical terms, the need for extra-ordinary financial statements may arise for instance in situation when an LLC amends the founding documents, abandoning creation of the reserve fund before 30 June 2014, but the funds from the cancelled reserve fund are transferred (accounted) toward undistributed profit and the LLC decides to distribute these, for example, only in October 2014 (i.e. long after expiry of the 6-month period).
Section 40 para 1 AoC imposes the obligation to carry our insolvency test before any pay out of profit or other funds but fails to more closely define the requirements of this test therein. It may be however derived that one should proceed in line with Section 3 para 1 through 3 IA. In practice the IA work with several types of test, including the liquidity test or financial statement / balance sheet test.
It is thus our opinion that it would not be appropriate to apply the arguments formulated in 29 Cdo 4284/2007 with respect to payouts from the reserve fund. The six-month period here cannot, in our opinion, raise the consequences anticipated in the case law (provide realistic or other picture on the health of the company) and its application lacks sense in AoC regime. It is obvious that any transfer of funds accumulated in the reserve fund into undistributed profit from previous periods will demonstrate itself in the financial statements only within internal structure, but not in the total amount of equity and logically only during the current but in completed previous year. Any ‘update’ of the financial statements completed before the end of the sixth month nor any update between the sixth and the twelfth month of the current year will not arrive at different result or findings with respect to own capital. It is therefore our opinion that ‘recency’ of financial statement for these purposes does not play any role. Leaving the mandatory insolvency test aside there does not exist any legal obstacle after expiry of the original six months that would prohibit pay out of the funds accumulated in the reserve fund to shareholders.
For the sake of completeness we would like to summarize that the six-month period remains mandatory under AoC for approvals of the financial statements and economic results for the immediately previous completed period, but it lost any logic in terms of distributing profits attained in previous years, including fund from abolished reserve fund, as long as LLC passes the insolvency test and complies with requirements of Section 161 para 4 AoC (see above).