Distribution and Payment of Profit in a Limited Liability Company (s.r.o.) and a Joint-Stock Company (a.s.)

Legal Framework for Profit Distribution and Payout

Basic rules of the law: The distribution of profits is primarily governed by Act No. 90/2012 Coll., on Business Corporations (ZOK), which sets out the general framework for all capital companies (i.e., limited liability companies and joint-stock companies). According to the ZOK, a share of the profit can only be determined based on ordinary or extraordinary financial statements approved by the company's supreme body (the General Meeting).

In other words, before profits can be distributed, financial statements for the given period must be prepared, and these statements must be approved by the General Meeting (or the sole shareholder in a single-member company). The decision is usually based on the ordinary year-end financial statements, but exceptionally, profits can also be distributed based on extraordinary financial statements during the year (e.g., for a planned advance payment on profits).

To whom can profits be paid: As a standard, profits can only be distributed among the company's partners or shareholders, in proportion to their shares. In an LLC, the profit share is determined by law according to the ratio of their business shares; in a joint-stock company, it is based on the ratio of the nominal value of the shares owned by the shareholder.

However, the memorandum of association or articles of association may specify a different method – it is possible to agree on deviations, such as preference shares with a higher dividend, or that a certain partner is entitled to a different profit share than corresponds to their contribution (but the principle of equal treatment must be respected).

Furthermore, the law allows the memorandum of association or articles of association to stipulate that profits can be distributed to persons other than just the owners of shares. In practice, companies thus pay out a portion of their profits to, for example, members of statutory bodies in the form of tantièmes (bonuses) or to employees as a motivational share – but only if the memorandum of association permits it and the General Meeting approves it. Without such a provision, paying profits to "non-shareholders" would not be possible.

Profits are primarily paid in cash (unless the memorandum of association or a resolution of the General Meeting states that an in-kind share may be provided, for example).

Time Conditions:

Current legislation also sets deadlines within which profits can be decided upon and paid out. The financial statements must be approved by the General Meeting no later than 6 months after the end of the relevant accounting period (typically by June of the following year). Based on such approved financial statements, a decision on profit distribution can then be made no later than the end of the following accounting period (i.e., by the end of the following year if it concerns ordinary financial statements).

Furthermore, the approved profit share is payable within 3 months from the date the General Meeting decided on its distribution, unless the company specifies a different deadline. The memorandum of association or the General Meeting's resolution itself can therefore set a longer or shorter due date, but if they do not, the executive director (or the board of directors) has a statutory period of three months to actually pay out the approved amounts.

An Important New Rule:

If the profit cannot be paid out within this period due to non-compliance with legal conditions (e.g., due to a repeatedly failed insolvency test, see below), the right to a share of the profit expires at the end of that period, and the unpaid profit remains in the company. The law thus motivates companies not to postpone payouts indefinitely and to resolve obstacles preventing the payout in a timely manner.

The Role of the General Meeting and the Statutory Body

The General Meeting decides on the distribution, but the statutory body decides on the payout: The Act on Business Corporations grants the power to decide on the distribution of profits to the company's supreme body, which for both LLCs and joint-stock companies is the General Meeting (or the sole partner or shareholder acting within the competence of the General Meeting if the company is owned by one person).

It is therefore the General Meeting that determines how much profit will be distributed, to whom, and in what form (whether in cash or otherwise). Subsequently, it is the task of the company's statutory body – the executive director (for an LLC) or the board of directors or administrative board (for a joint-stock company) – to decide on the actual implementation of the payout and to ensure the approved shares are paid to the entitled persons. Simply put: the General Meeting gives the instruction "what and to whom to pay," and the statutory body ensures "that it is actually paid."

Duties before and after the decision: The statutory body is responsible for preparing the documents for the General Meeting – especially the financial statements and the proposal for profit distribution. Based on these documents (and a possible recommendation from the supervisory board in a joint-stock company), the General Meeting decides by resolution to approve the financial statements and distribute the profit. However, the process does not end there. Before the actual payout, the board of directors or executive directors must verify that the payout does not violate legal conditions - in particular, by conducting an insolvency test.

If the General Meeting has approved the payout, but it turns out that the payout would be contrary to the law (e.g., a deterioration in the financial situation causes the tests to be failed), the statutory officers must not pay out the money. They have a so-called braking function: they verify the legality and can delay the payout until the conditions are met. For advice on corporate law, contact us at konzultace@arws.cz.

For example, paying out a dividend despite the threat of insolvency may lead to creditors not being paid – the statutory officers then bear the consequences (in extreme cases, they may even be sued in insolvency proceedings or penalized for breach of duty).

On the other hand, the General Meeting as a whole bears no responsibility; however, individual partners (shareholders) can challenge the invalidity of a General Meeting resolution if the profit distribution was approved in violation of the law or the memorandum of association. A court would likely annul such a resolution as invalid, or it would be regarded as if it had never been passed if it contradicts mandatory provisions of the law.

Administrative steps: After the profit distribution is approved, the statutory body is tasked with paying out the individual shares. In practice, this means, for example, making bank transfers to the accounts of partners/shareholders (the profit share is paid at the company's expense and risk, usually non-cash).

For joint-stock companies, a so-called record date for dividend payment is often set – typically a few days after the General Meeting, which determines which persons are entitled to the dividend (e.g., shareholders registered on that date).

If the company does not set such a date in its articles of association or in the resolution, it is automatically the date of the General Meeting. In an LLC, the record date is usually not an issue, as the circle of partners is clear on the date of the decision. The executive directors should also ensure the correct taxation of the paid-out profit – for natural persons, a 15% withholding tax on the profit share (dividend) applies, which is paid by the company. This is also part of the legal obligations during the payout, although the tax aspects are beyond the scope of this article.

Tests the Company Must Pass Before Paying Out Profits

To ensure that the profit payout does not disrupt the company's financial stability and endanger its creditors, the ZOK establishes several financial tests. These tests determine how much profit (or other equity) the company can safely distribute. If the tests are not met, the profit must not be paid out. Here are the individual tests that must be performed before the payout:

1. Balance Sheet Test (Distributable Profit Test):

The General Meeting must not approve a payout of an amount higher than the company's available profit. Simply put, the amount to be distributed must not exceed the sum of: (a) the financial result of the last completed accounting period (net profit for the year), (b) the financial results of previous years (retained earnings, or uncovered losses), and (c) other funds that the company can freely dispose of.

Any mandatory allocations to reserve or other funds according to the law or the memorandum of association are deducted from this sum. This gives us the maximum amount that can be distributed. If the General Meeting were to decide to pay out more, the resolution would have no legal effect. In practice, this means, for example, that old uncovered losses must be covered by future profits before the company can start paying dividends; also, capital funds earmarked for a specific purpose (e.g., a reserve fund, if the company is required to create one) cannot be used for payouts.

Note: An amendment introduced a rule on development costs into the balance sheet test – if a company has capitalized development costs in its balance sheet assets (e.g., software development expenses recorded as long-term assets), the amount available for distribution is reduced by the as-yet unamortized portion of these costs. In other words, a company with large investments in development cannot pay out all its accounting profit but must retain a portion corresponding to the unamortized development as a reserve.

2. Equity Test:

The second test is also performed by the General Meeting when making its decision. Its purpose is to protect the company's share capital and maintain a certain level of financial stability. Profit cannot be distributed if the company's equity would fall below the level of the (subscribed) share capital plus any statutory or contractual reserve funds. In other words, the accounting equity after the payout must not be lower than the sum of the registered capital plus non-distributable funds.

If the profit payout were to result in negative equity on the balance sheet, this is of course also inadmissible. Again, a decision contrary to this rule is ineffective. In practice, the company must therefore ensure that even after paying out the announced dividends, it will have a sufficient balance of its own resources (e.g., capital + reserves + retained earnings from previous years) above the share capital threshold.

3. Insolvency Test (Bankruptcy Test):

The third test lies primarily on the shoulders of the statutory body at the time of the payout. The company must not pay out a share of the profit if it would thereby cause its own bankruptcy. Bankruptcy under the Insolvency Act means that after the payout, the company would be unable to pay its due liabilities (insolvency) or its debts would exceed its assets (over-indebtedness).

This insolvency test is critically important: before each payout, the executive directors or board of directors must assess the company's current financial situation (cash flow, liabilities, receivables) and evaluate whether paying out the proposed amount will not leave it without money for further operations and debts. This includes, for example, checking whether the company will have sufficient funds to pay all invoices and loans on their due dates after the payout. The insolvency test must also be met when paying an advance on a profit share (so-called interim dividend).

If insolvency is imminent, the payout must not take place – the statutory body should postpone or cancel it. Since 2021, the law even explicitly states that if the profit is not paid out by the end of the following year precisely because of a repeatedly failed insolvency test, the right to the profit share expires (such profit will remain in the company's retained earnings).

When to perform the tests? The balance sheet and equity tests are assessed as of the date of the last financial statements (typically December 31 of the previous year) and are verified by the General Meeting when making the decision. In contrast, the insolvency test assesses the current situation at the time of the payout and is performed by the statutory body just before the payout. However, the statutory officers must also oversee the correct execution of the first two tests – if the General Meeting overlooks something and approves a payout in conflict with the tests, the executive directors/board of directors should not carry out the payout.

What to Watch Out For When Distributing Profits

Even a seemingly simple decision to pay out profits can hide many legal pitfalls. What should you, as owners and managers, watch out for?

1. Validity of the General Meeting's Resolution:

The decision on profit distribution must be adopted in accordance with the law and the memorandum of association/articles of association. If the General Meeting was not properly convened, is not quorate, or decided in conflict with the mandatory tests or articles of association, its resolution can be challenged and declared invalid or ineffective by a court. This would call into question the legal claim to the paid-out profit.

Therefore, ensure compliance with all formal requirements when convening and conducting the General Meeting (invitations, majorities, notarial deed where required, etc.).

A General Meeting resolution on profit payout that contradicts the statutory tests (e.g., approves a higher amount than the balance sheet test allows) has no legal effect – such a decision is treated as if it were never made, and the paid-out amount constitutes unjust enrichment. In practice, the company would have to reclaim such improperly paid-out profit from the partners. It is definitely better to prevent the invalidity of a resolution and the subsequent return of money through a prudent approach.

2. Payouts in Violation of the Law:

As explained above, the statutory body must not pay out profit if the conditions (tests) are not met. If a payout were to occur in violation of the law, several sanctions are possible:

• as mentioned above, the recipients will have to return the money to the company, as it constitutes unjust enrichment

• the executive directors or members of the board of directors who approved the payout expose themselves to the risk of liability for damages and may be required to cover the losses caused to the company or its creditors

• in an extreme case, if an unauthorized payout were to lead the company to bankruptcy, it could also be a breach of duty under the Insolvency Act (e.g., liability for causing bankruptcy). It is therefore not advisable to take the legal restrictions lightly – it's better to double-check that everything is in order.

3. Insolvency Situations:

Pay special attention to the insolvency test. A company may have sufficient profit on paper, but if it lacks liquidity (cash) and has large payments due, paying out dividends can easily cause insolvency. Do not underestimate the signs of financial difficulties – if you know that, for example, customers owe large amounts or that you will have to repay a loan, consider a lower profit payout and keeping a reserve.

Definitely do not pay out profits from a loan or other external sources; dividends should come from genuinely earned money, not at the expense of the company's future survival.

4. Prohibition on Circumventing the Rules:

The law prohibits companies from providing partners and persons close to them with any gratuitous benefits (gifts, etc.) with the aim of circumventing the restrictions on profit payouts. For example, it is not legal to "extract" money from the company by having executive directors pay themselves or their family members an apparent gift instead of profit.

Such conduct would be unlawful. Similarly, a loan to a partner instead of a dividend may run afoul of the rules on so-called financial assistance or the general duty of loyalty. In short, a transparent payout of a profit share according to the law is the only correct way to get profits from the company to its owners.

5. Register of Beneficial Owners:

Another relatively new obligation is to check the entry in the register of beneficial owners. According to the Act on the Register of Beneficial Owners, a profit share cannot be paid to a person who is not properly registered as a beneficial owner in this register. This measure is aimed at combating anonymous ownership and money laundering.

In practice, this means that if your company has a partner that is a legal entity (or a trust fund), and this partner does not have a registered beneficial owner, no profit share may be paid to it until the situation is rectified. Likewise, if you are personally the beneficial owner of your company, you should be registered in the register, otherwise the company cannot pay out profit even to you.

Before a planned payout, it is therefore worthwhile to check whether everything is in order in the register of beneficial owners, so that the payout does not have to be postponed.

6. Non-payment of Profits and Minority Protection:

A situation may arise where a company reports a profit, but the General Meeting decides not to pay it out (to leave it as retained earnings or use it otherwise). From a legal point of view, the General Meeting has the right to do so, provided it has serious reasons and it is not an abuse of the majority's rights to the detriment of minority owners.

A typical legitimate reason is an uncertain economic outlook, the need to reinvest profits in development, covering losses from previous years, or, for example, creating an employee fund. Minority partners/shareholders who would like to receive a dividend may not agree, but if the majority justifies its decision with serious reasons for the benefit of the company, a court will not invalidate such a decision.

However, beware of the opposite situation – if the majority repeatedly refuses to pay out profits without a reasonable justification, the minority can defend itself in court. The solution is always to carefully record the reasons for the decision not to distribute profit in the minutes of the General Meeting. Open communication with investors or partners about the reasons for reinvesting profits also helps to prevent disputes.

Best Practices for a Safe Profit Payout

Finally, we offer some practical recommendations from an experienced legal advisor that will help you minimize the legal risks associated with the distribution and payout of profits:

1. Plan ahead: Before the end of the financial year, calculate the expected profit and consider how much of it you will be able to pay out. Consult with your accountant about which items will affect the distributable amount of profit (e.g., uncovered losses from previous years, funds, investments in development). This will give you a realistic idea of the maximum amount for distribution according to the balance sheet test.

2. Keep a reserve: Although you may be tempted to distribute the entire profit, prudence dictates leaving a portion as a reserve. The business world is uncertain – creating a financial cushion in the company can protect against future problems. At the same time, you can easily avoid violating the equity test; the equity will remain comfortably above the share capital level. Moreover, it looks good to banks and business partners when a company does not pay out all its profits and strengthens its stability.

3. Thoroughly check the tests: Before each decision on a payout, perform a careful check of all tests. Check the current financial statements: the amount of retained earnings, funds, the value of equity. Perform a model calculation of what the assets and liabilities will look like after the planned payout. If you are not sure yourself, get an expert opinion from a financial advisor or auditor, especially for larger amounts.

For the insolvency test, create a simple cash-flow plan for the following months: list expected payments and revenues. Make sure that even after deducting the planned dividends, enough money remains in the account for all liabilities.

4. The formal side of the decision: Follow the prescribed procedures for convening and making decisions at the General Meeting. Formulate the resolution on profit distribution clearly – state the amount to be distributed, or the percentage of profit, and specify who is entitled to it (partners' shares, or tantièmes, etc.). You can also state the payment deadline directly in the resolution (if you do not want to use the automatic 3 months). Have the minutes of the General Meeting signed and keep them. For a joint-stock company, arrange for a notarial deed if required by law (a notarial deed is mandatory, for example, for decisions on changes to the articles of association or share capital; for dividends, it is typically not, but it is good practice for unambiguous proof of the decision). Documentation is key for any subsequent audits or disputes.

5. Communicate with the owners: If the company has more than one owner, communicate openly with the partners/shareholders about the intention to pay or not to pay out profits. This will prevent conflicts. For example, explain to minority partners why you are proposing to keep part of the profit in the company (development, investment) – this will increase their trust and reduce the risk of them challenging the decision. Conversely, if you are planning to pay a high dividend, let managers and creditors know so they are not surprised by the outflow of capital.

Do you want professional representation? Contact us at konzultace@arws.cz.

6. Beware of advances: If you decide to pay an advance on profits during the year, strictly adhere to the legal conditions. Have interim financial statements prepared and actually verify from them that you have sufficient profit to pay the advance. Remember that if you later have to return part of the advance (if the annual profit is lower than the paid advance), it can be administratively and financially unpleasant. Therefore, pay out advances rather conservatively – preferably less, so you don't have to return them later. We cover advances on profits in this article.

7. Consult a lawyer in case of uncertainty: Every company has its specifics – whether in the wording of its memorandum of association or in its financial situation. Do not hesitate to ask for legal advice if you are not sure whether you are proceeding correctly. An experienced Prague-based lawyer specializing in corporate law can help you with checking resolutions, interpreting articles of association, or identifying risks that might not even occur to you (e.g., restrictions in loan agreements regarding profit payouts).

In these cases, prevention is a cheaper and more certain path than subsequently resolving disputes or rectifying damages.

In Conclusion: Don't Underestimate the Legal Side of Profit Payouts

The distribution and payout of profits in capital companies is a key moment in a firm's life, when the owners receive a reward for their entrepreneurial efforts. To ensure this reward is not associated with legal complications, it pays to adhere to the described rules and procedures. As entrepreneurs, you will surely appreciate the ability to avoid invalid decisions, sanctions, or even endangering the stability of your company.

Remember: the legal regulation of profit payouts protects not only creditors and the company, but also you – it helps ensure that you are taking profit from your company in a sustainable and fair manner.

If you have any doubts regarding profit payouts or need advice on a specific situation (e.g., setting conditions in the memorandum of association, paying out profit within a group of companies, etc.), do not hesitate to contact us at konzultace@arws.cz.