How to cash out your company profits in times of pandemic

The year 2019, as well as the previous ones, are described as years of economic prosperity. A number of companies have managed to generate profits that they did not regularly pay out due to dividend taxes, for example.

Today, however, these businesses may also face existential problems caused not only by closed operations, but by the overall decline in the economy’s performance, which means lower revenues and unpaid invoices.

Thus, one of the solutions offered to entrepreneurs is the payment of dividends. We know from experience that the entrepreneur is not normally reconciled to having to bear the consequences of secondary insolvency and, for example, pay full severance to employees in addition to complying with the notice period, thanks to the renunciation of “his dividends”.

This is all the more worrying for some entrepreneurs if they have been paying social security contributions for their employees, with the result that they are protected by unemployment benefits that almost fully replace the employee’s previous salary for six months or more.

However, the payment of dividends is not entirely flexible, mainly because of the worsening situation. Shareholders and company directors should be thoroughly aware of their options and limitations not only when paying dividends, but also capital funds or preferential payment of their claims out of the company’s assets.

When paying out any funds from the company’s assets, a careful balance must be struck between the rights and interests of the shareholders in their payment on the one hand and the interest in protecting the company’s assets and solvency and the rights of its creditors on the other.

Company property is not the property of a shareholder

In this respect, it should first of all be noted that the company’s assets, which include the profit generated by the company or the aforementioned capital funds, are legally separate from the assets of its shareholders.

This is one of the basic principles of the legal regulation of companies and instruments for the protection of the private property of their shareholders. We also know it as the so-called. corporate veil, thanks to the existence of which the shareholders are in principle not liable for the company’s obligations at all (§ 154 (1) of the Civil Code) or only to a very limited extent (§ 106 of the Civil Code).

However, in view of the relatively widespread cases of abuse of this institute for the purpose of misappropriation of the company’s assets by its shareholders to the detriment of creditors, several institutes have been introduced into the Commercial Code in recent years which tighten the liability of statutory bodies for the unlawful siphoning off of the company’s assets by its shareholders.

Their common purpose is to protect the company’s creditors against the shareholders’ diverting assets from the company in such a way as to render the company unable to meet its obligations to its creditors (insolvency) and thus ultimately lead it into bankruptcy.

The risk of bankruptcy needs to be assessed

It is precisely to protect the solvency of companies that the so-called liquidity test was introduced into the Commercial Code, along with other provisions relating to the new institution of a company in crisis.

According to the above test regulated in § 179 par. 4 of the Civil Code, a company may not distribute its net profit or other own resources to its shareholders if, taking into account all the circumstances, it thereby causes its bankruptcy. There may not always be a direct temporal link (immediacy) between the payment of profits or other own funds and the company’s bankruptcy.

However, there must always be a cause and effect relationship. In other words, it is necessary that the payment of profits or other resources is, if not the main, at least the most significant cause of the company’s insolvency. Again, it should be noted that the liquidity test is equally applied to the payment of capital funds and other own funds of the company in addition to the payment of profit shares.

In practice, the statutory body is thus, in addition to the other conditions set out in Art. 3 and 4 of the Companies Act, it is also obliged to examine whether the decision taken by the General Meeting on the payment of dividends or capital funds will not, taking into account all the circumstances, cause the company’s bankruptcy. In this context, it may be advisable for the statutory bodies to have an external expert assess whether the payment of dividends or capital funds will cause the company’s insolvency in order to have a relevant basis for their further action.

In our practice, however, we have also encountered an opinion supported by a court decision (decision of the Regional Court in Žilina, sp. marked. 14Cob/144/2018 of 7. 2. 2019), that the negative conditions preventing the distribution of profits in § 179 para. 4 of the Civil Code must be fulfilled cumulatively, and thus only cases where the payment of dividends would not only cause the company’s bankruptcy, but also result in a reduction of the value of the company’s equity below the value of its share capital together with the reserve fund and other funds that cannot be distributed among the shareholders, can be considered a violation of this provision.

Such a legal view may thus open up some scope for businesses to pay dividends even in times of pandemic. In other words, even if the payment leads to the insolvency of the company, but it passes the equity test (which does not fall below the value of the share capital as a result of the payment), such a dividend payment will not be in breach of section 179(1)(a) of the Act. 4 CC.

In the event of an unlawful payment, the statutory body is obliged to recover from the shareholders the return of the unlawfully paid dividends back to the company. In the event of a breach of this obligation, the statutory body is liable for the damage caused to the company (Article 194(6) of the Civil Code). In addition to this responsibility, in the light of the amendment no. 87/2015 Coll. from 1. January 2016 also added a statutory liability of the statutory body for the reimbursement of undue payments.

This is one of the expressions of the broadly conceived prohibition of the return of deposits, which was explicitly implemented by the above-mentioned amendment to the Commercial Code by the provisions of Sections 67j and 67k of the Commercial Code, together with other provisions relating to the new institute of a company in crisis. According to the amended regulation, the statutory body is liable for the return of the unjustified dividend back to the company, both to the company and to its creditors.

Responsibility is not absolute

With effect from 1. January 2018, a new institute of liability of the controlling person for the bankruptcy of the controlled person was introduced into the Commercial Code, breaking the previously relatively tight corporate veil protecting the shareholders.

According to the newly introduced provision of Section 66aa of the Civil Code, “the controlling person shall be liable to the creditors of the controlled person for the damage caused by the bankruptcy of the controlled person, if by his/her actions he/she has substantially contributed to the bankruptcy of the controlled person. The controlling person shall be exempt from this liability if it proves that it acted with knowledge and in good faith that it was acting for the benefit of the controlled person.”

However, in view of the above quoted wording of the provision of § 66aa, it is questionable to what extent and if at all this provision can also be applied to the decision of shareholders on the payment of dividends (and other own resources), which could potentially contribute to the company’s insolvency. The provision of § 66aa of the Civil Code conditions the liability of the controlling shareholder for damage caused to creditors “if he substantially contributes to the bankruptcy of the controlled person by his actions”.

In contrast, the provision of § 179 para. 4 of the Companies Act, which specifically regulates the conditions for the distribution of profits, prohibits a company from distributing its net profit to shareholders only “if, taking into account all the circumstances, it thereby causes its insolvency”. The extent to which the legislator considers the payment of dividends to contribute to the company’s insolvency is thus different in the two cases.

Secondly, any decision by the shareholders (as controlling persons) to pay dividends or capital funds is in a way always an act to the detriment of the company (as a controlled person), as it leads to the siphoning off of funds from its assets for the benefit of the shareholders.

Therefore, if §66aa CC were to apply also to cases of dividend payments that could potentially contribute to the bankruptcy of the company, the shareholders could never rely on the liberalisation ground of “acting for the benefit of the controlled person” in such cases and their liability would thus be absolute.

In practice, this would mean that the legislator intended to punish the shareholders’ actions leading to the payment of dividends more severely than their other actions with the same consequences. However, neither the explanatory memorandum nor the literature on this provision suggests such an intention of the legislator.

An online version of the article is available here https://pravo.sme.sk/c/22388093/ako-si-vyplatit-zisk-z-firmy-v-case-pandemie.html