Decision on Profit Distribution

The article addresses the possibility of adopting a decision by the general meeting regarding the distribution of profit after the general meeting has previously decided in the given calendar year that the profit from the last accounting period reported in the regular individual financial statements will not be distributed. The article concerns the distribution of profits among the partners of a limited liability company and the shareholders of a joint-stock company.

In limited liability companies and joint-stock companies, the general meeting of shareholders decides on the approval of the company's individual financial statements and on the distribution of the profit shown in the individual financial statements. For both legal forms of companies, the basic principles enshrined in Article 179(3) and (4) of the Commercial Code apply, which restrict in certain ways the possibility of distributing profits to the company's shareholders. Following these rules, when deciding on the distribution of profits and the payment of profit shares to shareholders, it is necessary to bear in mind (i) the mandatory allocations to the company's reserve fund, (ii) the obligation to prevent the company's bankruptcy, and (iii) the obligation to maintain a certain level of the company's equity. The payment of shares in the company's profits in contravention of the rules outlined above carries the risk of creating an obligation on the part of the shareholder to repay the wrongly paid share.

With reference to the aforementioned risk of a shareholder’s obligation to return improperly distributed dividends, we examine a situation where the company’s general meeting initially approved the regular individual financial statements for the last accounting period and decided not to distribute the profit reported in those financial statements but later reconsidered this decision. The question arises whether (a) a subsequent decision to distribute the profit reported in the last financial statements would be lawful and (b) whether such a decision is subject to any time limitation.

• Possibility of Reconsidering a Decision on Profit Distribution:

When the general meeting decides not to distribute the profit reported in the regular individual financial statements for the last accounting period, the nature of this "net" profit transforms into so-called retained earnings from previous periods, representing another component of the company’s equity. The use of this component of equity is not legally restricted, making retained earnings from previous periods a freely available resource from a legal perspective.

The legal framework for limited liability companies and joint-stock companies permits the distribution of other equity resources to shareholders. However, the restrictive rules for profit distribution, such as the obligation to prevent insolvency and maintain a certain level of the company’s equity, also apply to the distribution of other equity resources.

It follows that after a general meeting’s decision not to distribute the net profit from the last accounting period, a subsequent decision can be made to distribute retained earnings from previous periods (including retained earnings from the last accounting period) to shareholders. Nevertheless, the restrictive rules of the Commercial Code must also be observed when distributing retained earnings from previous periods.

In the literature it is possible to come across the opinion that the distribution of other own resources of the company does not have to be decided by the general meeting of the company. It is true that the law does not expressly confer the power to decide on the distribution of other own funds in the hands of the general meeting. However, in the case of retained earnings, we are inclined to the view that, notwithstanding the transfer of net profit to the retained earnings account, this item does not lose the quality of an economic result, the use (distribution) of which should continue to be decided by the shareholders in the general meeting.

• Time Considerations:

The question remains whether the general meeting can decide on the distribution of retained earnings from the last accounting period at any time after the financial statements for the last accounting period have been approved.

In addressing this question, we refer to Czech case law before the adoption of the Czech Business Corporations Act, specifically the decision of the Supreme Court of the Czech Republic published under R 80/2010. The conclusions of this court decision (as applicable to this article) were later confirmed, for example, in the decision of the Czech Supreme Court, file no. 29 Cdo 2363/2011. These decisions establish a rule that if the law stipulates a certain period for convening the general meeting, calculated from the last day of the accounting period, it logically follows that the general meeting should approve the results of that accounting period within this time frame. Moreover, this period should be the maximum possible timeframe within which the results of the last financial statements can be used as a realistic representation of the company’s accounts for decisions on profit distribution. After the expiration of this maximum period, the financial statements can no longer be used as a basis for profit distribution. At the time of these court decisions, the Czech Commercial Code in Section 184(3) provided a six-month period from the last day of the accounting period for convening the general meeting[1].

Section 179(4) of the Slovak Commercial Code similarly requires that when distributing profits or other equity resources (i.e., including retained earnings from previous periods), the company must verify the state of its equity based on the approved financial statements. Under the current Slovak Commercial Code, joint-stock companies and limited liability companies are required to submit financial statements to the appropriate body for approval within 12 months from the date the financial statements are prepared[2].

Applying the conclusions of the Czech case law to Slovak legal regulation, it can be concluded that the competent body may decide on the distribution of profit or other equity resources to shareholders based on the approved financial statements for the last period within a maximum of 12 months from the date those statements were prepared. After this period, a decision on profit distribution or other equity resources would only be possible based on new financial statements.

For completeness, it should be noted that the 12-month period for approving financial statements does not correspond to the period provided by the Commercial Code for increasing the company’s registered capital from its own resources (i.e., including retained earnings from previous periods)[3]. In the case of increasing the company’s registered capital from its equity resources, the law stipulates that the decision on the increase can only be made based on financial statements approved no more than six months earlier. This creates a discrepancy between the maximum time allowed for approving individual financial statements and the time frame for using financial statements as the basis for increasing registered capital from the company’s own resources. The explanatory memorandum to Act No. 264/2017 Coll., which introduced the 12-month period for approving financial statements into the Commercial Code, does not indicate that consideration was given to the time frame related to increasing registered capital from the company’s own resources[4]. We believe that for profit distribution and other equity resources, the decisive period is the maximum time allowed for approving the financial statements for the last period, i.e., 12 months. According to the law, the financial statements can be approved within this time, enabling the general meeting to decide on profit distribution.

The reference: https://www.epravo.sk/top/clanky/rozhodnutie-o-rozdeleni-zisku-4529.html

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[1] Section 184(3) of the Czech Act No. 513/1991 Coll., Commercial Code: “The general meeting shall be held at least once a year within the period specified by the articles of association, but no later than six months from the last day of the accounting period, and it shall be convened by the board of directors, or by a member of the board if the board does not decide to convene the general meeting without undue delay when required by law or if the board of directors is unable to make decisions over an extended period, unless otherwise stipulated by this Act.”
[2] Section 40(1) of the Slovak Act No. 513/1991 Coll., Commercial Code, as amended and effective from January 1, 2018. The wording of this provision of the Commercial Code effective until December 31, 2017, provided for a six-month period from the end of the accounting period.
[3]Sections 144 and 208(2) of the Commercial Code in its current and effective wording
[4] Explanatory Report to Act No. 264/2017 Coll.: “The proposed amendment aims to align the obligations under the Commercial Code with those under accounting regulations (§ 23a of Act No. 431/2002 Coll. on Accounting) considering the operation of the Register of Financial Statements while maintaining the rule that fulfilling the obligation to file financial statements in the Register of Financial Statements is considered as fulfilling the obligation to file the document in the Collection of Deeds. This is because the Register of Financial Statements and the Collection of Deeds communicate with each other to reduce the administrative burden. The deadline for the approval of financial statements is maximum, as is the deadline for their filing in the Collection of Deeds. Data from the Register of Financial Statements is generally transferred to the Collection of Deeds automatically.”