In the previous two parts of the series dedicated to the duties of governing bodies we addressed (i) the general duties imposed on governing bodies in any circumstances and (ii) the specific limitations and duties arising mainly from the loyalty standard that a governing body must comply with.
In this third part we will focus on some aspects of profit distribution and the consequent invalidity of resolutions of a general meeting. There is no doubt that even the extraordinary circumstances resulting from the current COVID-19 pandemic can prevent the upcoming season of general meetings and approvals for financial statements and profit distribution. With the very uncertain economic future, various efforts towards maximum monetisation of shareholdings in companies can be more than ever expected this year from different undertakings (whether minority or majority shareholders or creditors); a governing body will have to keep these conflicts of interest under control and ultimately resolve them. It is certainly not possible to make the direct conclusion that a governing body must automatically obey the supreme body and pay a profit share (or even an advance about which the body alone decides). On the other hand, the opposite extreme cannot be automatically accepted either.Below is a concise summary of the basic duties imposed in this respect on governing bodies by legislation and case-law.
It is certainly nothing new that several basic steps need to be taken to achieve the objective of profit distribution:
1. The first step – compiling financial statements – is more of a technical nature and will generally depend on the general duties mentioned in the previous parts – i.e. the duty to identify situations in which a governing body should require professional assistance, and the related duties in delegating powers to other persons (choice of the person, necessary governance and assistance and adequate checking of the execution).
2. Creating a profit distribution proposal (typically as a part of an invitation to the general meeting) is, however, a duty that will probably be fully the responsibility of a governing body. The case-law of courts of all instances often reminds us that compiling a profit distribution proposal may not be an easy thing to do at all. In fact, already since 2014, the Supreme Court has been maintaining that the right for a share in profit is one of the basic shareholder rights and a decision not to distribute any profit is possible only on exceptional material grounds (27 Cdo 3885/2017).
A governing body should also proceed in line with this conclusion in drafting a proposal for the distribution of profit or settlement of loss. For this purpose the Supreme Court defined in its case-law a “proportionality test” that every such ground for non-distribution of profit must pass in order to avoid deficiencies of the subsequent resolution. But the courts may not accept even a general reference to the need for a capital reserve due to estimated higher future costs (such as investments) or lower income as a material ground. We believe that not even a general reference to the situation connected with the COVID-19 pandemic may be necessarily sufficient and serve alone as an exceptional material ground for the non-distribution of profit. In contrast, if a governing body reaches the conclusion that profit should not be distributed, the argumentation stated in the proposed resolution forming part of an invitation to a general meeting should include further important and significant facts justifying such a conclusion.
Not only may the violation of these rules entail a breach of due managerial care, but it may also create a shareholder’s right for damages and for adequate compensation. In the case of some companies, the duty to have such a proposal approved in the internal approval system by other bodies also comes into play (depending on the legal form of the company and the founding legal act).
We would like to remind you of the frequently omitted duty pursuant to Section 66(c) of the Act on Public Registers and the Trust Register to file a proposal for the distribution of profit in the Collection of Deeds unless the proposal forms part of the financial statements.
3. In connection with another step – approval of financial statements – we have informed you previously that Lex Covid extended the time-limit for discussing the financial statements. While the standard time-limit for discussing financial statements at the general meeting is 6 months from the end of the relevant accounting period, moving forward the time-limit will be extended by 3 months from the date when the pandemic emergency measure is lifted. However, the latest date for discussing the financial statements is 31 December 2020. That said, this does not change at all the fact that the approved financial statements are a necessary prerequisite for the possibility to adopt a decision on the distribution of profit.
4. On the basis of the approved financial statements it is possible to subsequently decide on the distribution of profit. A majority of all present votes at a quorate general meeting suffices to adopt a resolution.
5.–6. But the work of a governing body does not end at this point. A governing body is authorised to decide on the payment of profit to shareholders, which may be done only upon the completion of an insolvency test. Naturally, for the insolvency test the standard of managerial care will be used again and the previously mentioned duty to recognise a need for professional assistance again becomes important. To make the payment of profit possible, it must follow from the insolvency test that the company will not cause bankruptcy to itself by the profit payment.
7. In connection with the profit payment it is necessary to keep in mind that for a joint stock company and a limited liability company profit is payable within 3 months from the adoption of a decision on its distribution unless otherwise provided for by the founding legal act. Companies distribute profit at their own expense and risk.
In the case of payment of profit advances, please note that profit advance payments are made on the basis of interim financial statements and that it only requires a favourable decision of the governing body. But it will still be very important to consider this decision, taking into account all aspects of due managerial care, as the payment of advances is to be made completely without the involvement of the general meeting (in many cases concern instructions discussed in the previous part will probably play an important role).
After the wave of general meetings fades away, another wave usually comes immediately - proposals for declaring the invalidity of resolutions adopted at these general meetings. In our opinion, this year will not be different. In contrast, as already mentioned above, it can be expected that all undertakings will try to cash out their shareholdings in companies, irrespective of their interests. Thus, it is not certain whether a particular person will attempt to take as conservative approach to the distribution of profit as possible, or whether they will aim to achieve the highest possible cash-out in the form of profit payment. It cannot be excluded that some persons will try to get rid of their shareholdings in companies, while manifesting such intent by various vexatious exercises of rights. However, it is for certain that if a general meeting decides contrary to their interests, the easiest way of reversing the situation is challenging the given resolution for its defects.
It seems that in its most recent case-law the Supreme Court has moderated these opposing tendencies to a certain extent. In its recent ruling (27 Cdo 787/2018), the Supreme Court states that a company’s interest in the stability of its internal relations is an interest that is worth legal protection. In many cases, breaches of legal regulations, the Memorandum of Association or principles of ethical behaviour may not have legal consequences that are serious enough to justify as substantial an intervention in the company’s relations as declaring a decision of its body invalid. A sanction in the form of declaring a general meeting resolution invalid must be commensurate with the gravity of the consequences caused by the breach of legal regulations, the Memorandum of Association or principles of ethical behaviour as well as the purpose of the legal regulation addressing the invalidity of the general meeting resolutions. This means that if there are no special circumstances justifying the declaration of the invalidity of a general meeting resolution, despite that the breach of legal regulations, the Memorandum of Association or principles of ethical behaviour did not have any serious legal consequences, there will always be a company’s interest in the court’s declaring a decision invalid. In the proceedings concerned, it is thus necessary to prove the serious legal consequences caused by adopting a given decision or special circumstances that overweigh the company’s interest in preserving its internal relations.
The Supreme Court also continues to require justification of protests that are a necessary prerequisite for commencing proceedings to declare the invalidity of general meeting resolutions, for which a general reference to a breach of legal regulations is not sufficient. Thus, even in this case, seeking professional legal assistance should be considered.
Last but not least we would like to remind you that Lex Covid made it possible to adopt decisions without calling a general meeting (per rollam) also in cases in which the Memorandum of Association does not allow adopting decisions in this manner. Thus, the shareholders need not necessarily meet physically and distance voting suffices.
Our corporate team remains at your disposal to analyse specific cases. As the situation of each individual company needs to be considered on an individual basis, a more detailed legal analysis may help a governing body and provide it with a means of protection against shareholders or creditors.