COVID-19: An obstacle for distributing dividends?
The effects of the implemented measures to prevent the spreading of the Corona Virus (known as COVID-19) have started to kick in, albeit not only in a positive way: Most businesses face perilous financial strains, even though the balance sheet of the previous financial year possibly shows a huge profit. This is caused by the fact that many of them have been forced to shut down their operation and stay closed. Shareholders of an Austrian limited liability company (“GmbH”) are generally entitled to dividends in the total amount of retained earnings as shown in the balance sheet – or are they not?
Prohibition of profit distribution – sec 82 para 5 Austrian Limited Liability Companies Act (“GmbHG”)
Current losses can pose an issue when distributing dividends: If these losses affect the company’s assets in the long term, they decrease the amount of the distributable reatained earnings (“balance sheet profit”) due to sec 82 para 5 GmbHG. They might even wipe out the entire balance sheet profit. Please note the timeframe: Only losses incurred between the end of the financial year and the adoption of the financial statements are relevant. By contrast, losses incurred between the adoption of the financial statements and the appropriation of profits or the dividend distribution itself can be disregarded in regard of sec 82 para 5 GmbHG. However, this detail will be hardly relevant, as the appropriation of profits usually takes place upon, or immediately after, the adoption of the financial statements. The financial statements usually have to be adopted within 8 months from the accounting date (iyear-end), i.e. in most cases by 31 August of the following year, since 31 December is a very common balance sheet date. However, the legislator has extended this deadline to 12 months due to the Corona crisis. Thus, during the entire year 2020, the adoption of the financial statements can be resolved within 12 months from the accounting date; this is effective for all adoptions outstanding as of 22 March 2020.
Scope, impact and duties
Only losses which affect the company’s assets in the long term and therefore also affect the balance sheet are relevant. Hence, an impairment of built-in gains (“hidden reserves”) is not to be considered.
For computation of the distributable amount, an interim balance sheet reflecting the incurred losses until the adoption of the financial statements has to be drawn up. These losses are to be deducted from the previous year’s balance sheet profit. In case there is still a profit left, such amount can be distributed to the shareholders. The assessment whether the losses are permanent has to be conducted on a case-by-case basis. However, directors should act with the diligence of a prudent business man and assume that they are permanent.
Furthermore, it is the directors’ duty (and the supervisory board members’ – if there is one) to inform the shareholders during the annual general meeting that substantial losses have been incurred. However, in most cases this will not be possible, since the financial statements are usually adopted by written shareholder resolutions. The same is true for the appropriation of profits. Consequently, they should explicitly be informed in writing prior to passing the resolution.
Consequences in case of a violation
If the shareholders unlawfully decide to distribute dividends, despite substantial losses, the directors should to refuse distribution. In case they put the shareholders’ resolution into effect, they are liable for damages to the company itself. Their general obligation to adhere to shareholder resolutions does not release them from this liability. Unlawful shareholder resolutions are not binding on directors, on the contrary, they are obliged to disobey them. In addition, according to sec 25 para 5 GmbHG, even lawful shareholder resolutions do not release directors form their liability vis-à-vis the company, if and to the extent that their compensation (damages) is needed in order to settle the creditors’ claims.
How to deal with the issue?
Directors should always double-check shareholder resolutions regarding the distribution of dividends, especially in times like these. That can prevent them from being held liable for damages. However, if the directors act with such caution, they might fall in the shareholders’ disgrace, which might prompt the shareholders to recall them. Such a revocation as a reaction to the refusal of a director to (unlawfully) distribute dividends is admitted from a corporate law perspective. However, recalled directors can take (a cold) comfort from the fact that their revocation does not necessarily terminate their employment contracts.
In order to lawfully distribute as much retained earnings as possible, the financial statements should be drawn up and adopted as soon as possible. Even if substantial (presumably) long-term losses have already been incurred, at least parts of the balance sheet profit could be saved and distributed that way.
From a financial perspective, however, it might seem wise to retain the profit and carry it forward onto new account. If the company’s financial situation has somewhat improved by the end of the current financial year, the recently incurred losses will maybe not be considered long-term anymore, at least not in the same amount as right now. Accordingly, the balance sheet profit from 2019 could be distributed (lawfully) at that end of the current financial year.