Member Facing Enforcement Proceedings and Their Potential Expulsion from the Company

A Ticking Time Bomb in Your Company: Why Is a Partner Facing Enforcement Proceedings a Serious Risk?

The first and most serious risk is a reputational threat. Information about the enforcement proceedings is publicly available in the Central Register of Executions, and the seizure of a share is publicly visible in the Commercial Register. Business partners, banks, insurance companies, and potential investors now routinely vet their counterparts. Discovering that a key person in your company is facing enforcement proceedings immediately raises doubts about the financial stability and credibility of the entire company.

Closely related to a damaged reputation is the threat of financial paralysis. Banks may perceive a partner's enforcement proceedings as an increased credit risk, which can lead to a reassessment of existing loan agreements, worse conditions for further financing, or the outright rejection of a new loan application. The company can thus find itself without the necessary operating funds.

Last but not least, there is the risk of operational chaos. The process of enforcement and the potential expulsion of a partner can create tension and disputes within the company, paralyzing strategic decision-making. Furthermore, by issuing an enforcement order, the bailiff prohibits the partner from disposing of their share and the company from consenting to its transfer, which can block planned transactions, an investor's entry, or a company restructuring.

Solution Options: From Agreement to Forced Expulsion

The situation with a problematic partner can be resolved in several ways, from amicable to forced. The choice of the right approach depends on the specific circumstances, particularly the partner's willingness to cooperate and the nature of their misconduct.

1. Agreement to terminate participation: The fastest and least confrontational route, which requires the consent of all partners.

2. Expulsion by the general meeting (caducity procedure): Possible especially in cases where the partner is in default with their contribution or supplementary contribution obligation.

3. Expulsion by court order: A last resort for cases where a partner breaches their duties in a particularly serious manner.

4. Acquisition of the share in an enforcement auction: A strategic option for the other partners to gain control over the share and prevent a third party from entering the company.

Expulsion of a Partner by Court Order: When and How to File a Lawsuit?

The court-ordered expulsion of a partner under Section 204 of the Business Corporations Act is a last resort (ultima ratio) that can be taken if a partner breaches their duties in a particularly serious manner, thereby jeopardizing the company's functioning. However, this process has strict rules.

Written Call for Rectification

Before filing a lawsuit, it is absolutely necessary to send the partner a written call to fulfill their duties and explicitly warn them of the possibility of expulsion. Without meeting this condition, the court will dismiss the lawsuit without further consideration. This call is not just a formality but a key strategic step. A correctly formulated and delivered call forms the basis of a successful lawsuit and, in some cases, can lead to an agreement without the need for litigation.

The lawsuit is filed on behalf of the company by its statutory body. However, if the statutory body is inactive, following a legislative amendment, any other partner can file a so-called derivative action. In such a case, this partner is also authorized to take the preceding steps, including sending the call for rectification.

The Reason Must Be a 'Particularly Serious Breach of Duty'

The law does not precisely define this term. However, case law indicates that it must be conduct that fundamentally harms the company's interests. This could include, for example, a breach of the duty of loyalty, damaging the company's reputation, engaging in competitive activities contrary to the articles of association, or systematically abusing rights to block the company's operations.

It is crucial to distinguish between a breach of a partner's duties and a breach of an executive director's duties. A partner cannot be expelled for mismanaging the company as an executive director. For managerial misconduct, they can be removed from the position of executive director and potentially sued for damages, but they cannot be expelled as a partner for this reason. The grounds for expulsion must be a breach of their duties arising from their role as a partner.

Enforcement on a Share: An Opportunity for Other Partners

Initiating enforcement proceedings on a problematic partner's share doesn't have to be just a threat. On the contrary, it opens up a unique opportunity for the other partners to resolve the situation and gain full control over the company. The enforcement process can paradoxically serve as a catalyst for an inevitable restructuring of ownership relations.

Once the bailiff issues an enforcement order to seize the share, it is delivered to the company. The company is obliged to inform the bailiff whether the share is transferable and under what conditions. The primary method of monetizing the share is a public auction, of which the company must inform the other partners.

This is the key moment. The other partners have a statutory advantage similar to a pre-emptive right: if they make the same highest bid in the auction as another bidder, the share will be awarded to them. This mechanism gives them a powerful tool to prevent an undesirable third party from entering the company and, at the same time, to elegantly buy out the problematic colleague's share.

If the share is not sold even in a repeated auction, the partner's participation in the company terminates on the day the notice of the unsuccessful auction is delivered. In such a case, the creditor is satisfied from the so-called settlement share, which the company pays to the former partner.

The Power of Prevention: How a Properly Drafted Articles of Association Can Protect You

The best crisis management is prevention. The articles of association are not just a formal document required to establish a company; they are a key risk management tool. They can be seen as a 'prenuptial agreement' for your business—setting the rules for when things don't go according to plan.

A carefully prepared articles of association can significantly strengthen your position:

• Restriction on the transferability of the share: You can set special conditions for the transfer of a share. This complicates the sale of the share in an enforcement auction to anyone other than the existing partners.

• Specification of a partner's duties: The articles can clearly define duties beyond the statutory scope, such as a detailed non-compete clause or a detailed regulation of the duty of loyalty. A breach of these will then be an more easily provable reason for expulsion.

• Pre-emptive right: Although a statutory 'priority right' in an auction exists, the articles of association can further strengthen the position of the other partners by establishing a contractual pre-emptive right in the event of enforcement proceedings.

• Clear rules for the settlement share: The articles of association can and should define a precise and unambiguous method for calculating the settlement share. This will prevent lengthy and costly disputes over its amount in the event that the share auction is unsuccessful.

Properly drafting the articles of association is the cornerstone of a healthy company and the prevention of future disputes. We address this as part of our services in the field of corporate law. You can find more about this service on our website.

Solutions with an International Element? Rely on the ARROWS International Network

If the partner facing enforcement proceedings is a foreigner or the enforcement title was issued abroad, the situation becomes more complicated. It is necessary to apply not only Czech law but also the relevant European regulations and international treaties.

If the enforcement title was issued in another EU member state, its enforcement in the Czech Republic is governed by the Brussels I bis Regulation (EU Regulation No. 1215/2012). This regulation significantly simplifies the process, as a judgment issued in one EU state is enforceable in others without the need for further recognition proceedings.

When paying out a settlement share to a foreign partner, tax aspects must be considered. This income is subject to withholding tax in the Czech Republic. However, its rate (typically 15%) may be reduced or even completely eliminated based on the relevant double taxation treaty, which takes precedence over Czech law.

Thanks to the ARROWS International network, built over ten years, we handle cases with an international element on a daily basis. Whether it's communicating with foreign authorities, applying international treaties, or optimizing cross-border transactions for tax purposes, we have the necessary know-how. Do you need legal assistance with an international scope? Contact us at consultation@arws.cz.

How Can ARROWS Specifically Help You?

Resolving a situation with a partner facing enforcement proceedings requires a comprehensive legal strategy, speed, and precision. At ARROWS, we specialize in this area, and thanks to our experience working for over 150 joint-stock companies and 250 limited liability companies, we know how to protect your company's interests. We pride ourselves on the speed and high quality of the services we provide.

In this area, we can provide you with:

• review and preparation of articles of association that will preventively protect your company,

• preparation of all documentation for general meetings and court proceedings to protect you from formal errors,

• legal consultations and risk analyses to help you choose the best strategy,

• representation before courts and administrative authorities in proceedings for the expulsion of a partner and within the enforcement proceedings,

• expert training for company management in corporate compliance and risk management.

We are also proud of our ability to connect our clients when they have interesting investment or business opportunities, and we are always happy to hear your business ideas.

Whether you are facing an acute crisis or want to protect your company preventively, our specialists are ready to help. For a no-obligation consultation and a tailor-made solution proposal, write to our Prague-based legal team at consultation@arws.cz.