Settlement among partners

The End of a Business Partnership: What Are Your Options?

Essentially, there are three main scenarios that lead to the termination of a partnership:

• Voluntary and planned departure: A partner decides to end their active involvement and leave the company by mutual agreement.

• Transfer of a share: A partner sells their share, either to an existing partner or to a third party who joins the company.

• Forced departure: Relations between partners escalate to the point where their continued cooperation is impossible, leading to disputes and often the forced expulsion of one of them.

With the exception of a direct sale of a share, the central point of the entire process is the settlement share. This is a property right and financial compensation due to a partner whose participation in the company has ended for reasons other than the transfer of their share. Its correct determination and taxation are the alpha and omega of a successful settlement.

Ways to Terminate Participation: Agreement or Battle?

The Business Corporations Act (ZOK) offers several mechanisms for a partner to terminate their participation in a company. Choosing the right path is a strategic decision that will fundamentally affect not only the speed and cost of the entire process but, above all, the financial outcome for all parties involved.

Transfer of a Share (§ 207 ZOK): The Fastest, but Not Always Possible, Route

The most common and usually simplest method is the sale (transfer) of a share. A partner can transfer their share to one of the existing partners or to a third party outside the company. The key is that in this case, the departing partner does not receive a settlement share from the company, but a purchase price from the acquirer of the share.

However, this path has its pitfalls. The transfer of a share to a person who is not a partner generally requires the consent of the General Meeting, unless the articles of association state otherwise. Obtaining this consent can be difficult in a tense atmosphere and can block the entire process.

Agreement of All Partners (§ 203 ZOK): The Gold Standard That Requires Consensus

The ideal solution, especially in smaller companies, is a written agreement among all partners to terminate the participation of one of them. Such an agreement must have officially certified signatures and provides maximum flexibility in setting the terms. In practice, however, reaching a consensus, especially if the departure was preceded by disputes, is the biggest obstacle.

The lawyers at ARROWS have extensive experience in mediating and negotiating participation termination agreements that protect the client's interests while allowing the company to continue operating.

Withdrawal from the Company (§ 202 ZOK): When Can You Unilaterally Leave?

A partner cannot leave the company whenever they please. The law gives them the right to withdraw unilaterally only in strictly defined cases. Typically, this occurs when a partner disagrees with a fundamental change in the nature of the business or with the imposition of a so-called additional contribution obligation and voted against it at the General Meeting.

Expulsion of a Partner (Kaduce): The Last Resort for Breach of Duty

If a partner seriously breaches their duties, the others can defend themselves by expelling them. This process has two basic forms:

• Expulsion by the General Meeting (§ 151 ZOK): This applies exclusively to cases where a partner is in default with their contribution obligation or additional contribution obligation. The process requires adherence to strict formal steps, including a written notice and the provision of an additional deadline.

• Expulsion by Court (§ 204 ZOK): The company can seek the expulsion of a partner in court if they breach their duties in a "particularly serious manner." This could include, for example, damaging the company's reputation or violating the duty of loyalty. However, this is a time-consuming and evidence-intensive court dispute.

Termination of Participation by Court upon a Partner's Motion (§ 205 ZOK): An Escape Route from Being "Trapped"

In situations where insurmountable disagreements paralyze the company's operations and neither an agreement nor a sale of the share can be reached, a partner can propose to the court that their participation be terminated. The condition is that it "cannot be fairly required of them to remain in the company." This is a last resort for deadlock situations.

Risk Table I: Choosing the Wrong Path and Its Consequences

Choosing the incorrect procedure can lead to serious complications. The following table summarizes the main risks associated with each method of terminating participation and shows how they can be prevented with the help of experts.

The Settlement Share: How Much Will You Actually Receive and When?

Determining the amount of the settlement share is the financial core of the entire process and the most common source of disputes. It is crucial to understand how the law regulates this calculation and what options you have to influence it.

How Is Its Value Determined? Two Main Methods

The Business Corporations Act establishes a two-phase procedure for determining the amount of the settlement share:

1. Primary method (§ 213 ZOK): The company is first obliged to try to sell the so-called released share without undue delay for a reasonable price. The proceeds from this sale, after deducting reasonably incurred costs and setting off any claims against the partner, constitute the settlement share.

2. Secondary method (§ 214 ZOK): If the share is not sold within 3 months, or if the articles of association directly provide for it, a calculation is made. In such a case, the amount of the settlement share is determined from the value of the equity as ascertained from extraordinary financial statements prepared as of the date of termination of the partner's participation.

What Is a "Reasonable Price"? A Key Source of Disputes

The law does not define what is meant by a "reasonable price" when selling a released share. It is precisely the unclear value of the company and the share that is a breeding ground for protracted and costly disputes. In practice, it is often necessary to have an expert valuation report prepared to determine the market value of the share, which is the only objective way to prevent future disagreements.

The Role of the Articles of Association: Prevention Is the Best Medicine

The articles of association are not just a document needed to establish a company. They are a crucial risk management tool. They allow partners to establish a method for calculating the settlement share that differs from the law. A well-written agreement can contain a precise formula or valuation procedure, thereby eliminating uncertainty and the potential for future conflicts.

Our Prague-based lawyers at ARROWS specialize in preparing and reviewing articles of association that include clear and indisputable mechanisms for calculating the settlement share, thereby protecting your investment and minimizing the risk of future litigation.

Payment Deadlines: When Will You Get Your Money?

The law also sets deadlines for payment. If the share is sold, the company pays out the proceeds without undue delay after the sale. If the share is not sold and the amount is calculated from equity, the company is obliged to pay the share within one month of the expiry of the three-month period for the sale.

Tax Implications of the Settlement: Who Pays, What, and How Much?

Tax aspects are an often underestimated but absolutely crucial part of a settlement. Ignorance of the rules can lead to significant financial losses for both the departing partner and the company and its management.

Taxation on the Side of the Departing Partner (Natural and Legal Person)

Income from a settlement share is subject to a 15% withholding tax for the partner (whether a natural or legal person). The most important rule that can significantly reduce the tax liability is the possibility to reduce the tax base.

The base for calculating the 15% tax is reduced by the acquisition price of the share, provided the partner can credibly prove it to the company. If the partner fails to document the acquisition price, the tax is withheld from the full amount of the settlement share.

The lawyers and tax advisors at ARROWS will help you prepare all the documentation to prove the acquisition price of the share, ensuring that you do not pay more tax than is absolutely necessary.

Obligations of the Paying Company

The company acts as the tax payer. This means that it is legally obliged to calculate, withhold, and remit the tax on the settlement share to the relevant tax authority, and to pay the departing partner the net amount after taxation. This obligation places considerable responsibility on the executives, who are liable for the correctness of the procedure.

Is the Payment of a Share a Tax-Deductible Expense for the Company?

The unequivocal answer is no. The payment of a settlement share is not a tax-deductible expense for the company. It is not an operating expense but a disposition of equity, which does not reduce the corporate income tax base. The company therefore receives no tax relief from this transaction.

When an Agreement Fails: How to Resolve Disputes and Protect Your Rights?

If negotiations fail and the situation escalates into open conflict, it is necessary to know your legal options and be able to use them effectively. Most often, disputes revolve around the value of the company and the amount of the settlement share, but often the battle is also fought over the very validity of the steps that led to the partner's departure.

Invalidity of a General Meeting Resolution: How to Defend Against Expulsion?

If your participation was terminated by a decision of the General Meeting (e.g., by expulsion), and you believe that this decision is unlawful, you can defend yourself with an action for the invalidity of the resolution. The reason for invalidity may be a conflict with the law, the articles of association, or good morals. Often, it involves formal errors, such as defects in the convening of the General Meeting.

However, to successfully challenge a resolution, it is crucial to follow two formal steps. First, the partner must raise a reasoned protest against the adopted resolution directly at the General Meeting. Second, the action must be filed with the court within strict deadlines – within 3 months from the day they learned of the reason for invalidity, but no later than 1 year from the adoption of the resolution.

Our lawyers at ARROWS have extensive experience with these disputes and will guide you through the entire process of challenging an invalid resolution, from filing a protest to the final court decision.

Protection of Minority Shareholders

The law also provides protection for minority shareholders against abusive conduct by the majority. If it is clear that an expulsion is merely a pretext to get rid of an inconvenient partner, the court will not grant such a motion. ARROWS effectively represents minority shareholders and protects their rights against the abuse of power by the majority.

Settlements with an International Element: What If a Partner or the Company Operates Abroad?

In today's global economy, it is not uncommon for a partner in a Czech company to be a foreigner, or for a Czech company to own assets abroad. Such an international element adds another layer of complexity to the settlement process.

It is necessary to address fundamental questions, such as which legal system will govern the entire process, which is regulated by the Act on Private International Law. Even more important is the correct application of international double taxation treaties. These treaties can modify the standard 15% withholding tax and determine which state has the right to tax the income.

Thanks to our ARROWS International network, built over ten years, we handle cases with an international element on a daily basis. We ensure not only the application of the correct law and tax treaties for our clients but also communication with foreign authorities and partners, thereby saving them time and protecting them from the risk of double taxation.

Conclusion: Why Is Professional Legal Assistance Crucial in a Settlement?

A settlement with a partner is one of the most complex and risky processes in a company's life. It involves not only complex legal steps but also demanding financial calculations, tax obligations, and often strong emotions. The risks are significant: financial losses due to a poorly determined share, lengthy court disputes, tax penalties, and, last but not least, the personal liability of executives for procedural errors.

In this case, professional legal and tax advice is not a luxury, but a necessity. An experienced team will ensure that the entire process runs efficiently, in accordance with the law, and with minimal stress for all involved. Our experience from long-term care for more than 150 joint-stock companies and 250 limited liability companies allows us to anticipate problems before they arise. At ARROWS, we provide comprehensive services from the preparation of contracts and internal policies, through representation in courts and administrative bodies, to tax consulting and expert training for management.

We would also be happy to hear your new business ideas and connect you with relevant partners from our network.

Do not leave such a crucial life and business decision to chance. Contact us and arrange a consultation where we will discuss your situation and propose the best course of action to protect your assets and the future of your company.