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Absurd Ruling on Dividends

Absurd Ruling on Dividends

23.5.2012 9:40
Autor: Martin Šolc, KŠB

If they do not meet the deadline, they will be unable to pay out dividends for another six months.

The Supreme Court sometimes throws out the baby with the bathwater, as it did two years ago in a ruling which stated that decisions on paying out dividends must be make within six months after the date of the financial statements. If you think that this two-year old ruling is history and no longer applies, you are wrong. Corporations can still feel the impact today, which is by no means pleasant.

The Supreme Court’s ruling requires corporations which record a profit or any other distributable equity component in their annual financial statements to refrain from making a decision to pay out shares in profit (as well as other distributable equity components) in the second half of the year. This applies even if the company’s financial situation has improved considerably since the date of its last annual financial statements.

No-Entry Signs at Accident-Prone Locations

The pay-out to which the Supreme Court’s ruling applied was very likely illegal since the company to which it related first decided to distribute profit by transferring it – after the mandatory contribution to the reserve fund had been made and losses covered – to the retained profit account. However, the company then received a bankruptcy petition, which is why it made another – second – decision to pay out profits.

So far so good, as to the correctness of the decision. However, it seems that the Supreme Court wanted to avoid justifying the reason why its decision differed from a statutory rule. The Court could, for example, have referred to a conflict with good business ethics. Instead, the justices attempted to create a new rule which, I believe, lacks support in both national law and acquis communautaire.

The ruling’s justification reads as follows: “The deadline by which a general meeting shall be convened, calculated from the last day of the accounting period, is logically not only the deadline that determines when the general meeting (provided that things proceed in the due and ordinary course) must approve the results of the accounting period, but also the latest deadline by which the results of the annual financial statements that are to be considered at the regular general meeting can be regarded as results providing a true picture of the joint-stock company’s accounting, in accordance with which the shareholders can duly decide how to distribute profit. An extraordinary general meeting held in November 2002 cannot make a decision on the distribution of profits under due annual financial statements that provide a picture of the joint-stock company’s accounting as of 31 December 2001.

The Supreme Court made a decision on a particular case and transformed it into a general rule. In layman’s terms, the Supreme Court’s actions are somewhat similar to placing no-entry signs at accident-prone locations. The decision entirely ignores a commercial company’s day-to-day life.

Ruling v. Practice

To illustrate my view, allow me to present two recent examples.

Example 1: A law firm discovers in the course of a due diligence investigation that a financially fit target company paid out profits in the second half of the previous year. A great deal of major players have done so in good faith in the past, including, I believe, a number of state-owned companies.

However, the Supreme Court’s two-year old ruling poses a number of new questions. Does the company which paid out the dividend have the right to reclaim it (the recipient’s mistake seems to be a legal mistake, which is why the recipient does not enjoy protection based on good faith)? Are the current board members, as prudent managers, required to reclaim the payment to avoid committing a crime themselves? And, if they fail to do so, does their duty to act as a prudent manager require them to hold liable those who paid out the dividend in line with the text of the law?

Example 2: A parent company owes CZK 100 million to a bank. The loan is secured by a pledge over a subsidiary’s assets. The subsidiary has CZK 200 million worth of undistributed profit and is itself in need of a major acquisition loan, which it needs to secure by pledging its assets. The bank says: “It’s simple, how about just paying out a dividend to the parent company, the parent company will repay the loan, and the subsidiary is then free to take the loan?” Wrong decision. As it is already the second quarter, pursuant to the Supreme Court’s ruling everybody is forced to wait until the following March before the dividend can be paid out.

The solution, however, is clear. The ban on paying dividends 6 months after the date on which the financial statements are made should apply only in cases where the company has lost a portion of its equity, regardless of whether that happens in the first half or not. But in this Gotham City of ours it appears that clear solutions do not apply.

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