The process leading up to payment of dividends by a company, although highly formalised, is familiar to the players and should not present great difficulties. But it nonetheless requires vigilance, because failure to comply with the statutory requirements can have serious consequences, particularly as it is easy to fall afoul of the changing regulations.
One of the amendments to Poland’s Accounting Act which entered into force in 2017 is the requirement to conclude a contract with the auditor to examine a company’s accounts for a period of no shorter than two years (previously the act did not specify the period for which the contract should be concluded). This change might appear minor and uncontroversial, but if it is ignored or noticed too late it can be have far-reaching consequences.
Thus it would be worthwhile to review the key stages in the process leading up to distribution of the net profit earned by a company to its shareholders.
Obviously the first step is preparation of the financial report for the last fiscal year. The management board of the company is required to ensure that the report is prepared within three months after the end of the financial year (Accounting Act Art. 52(1)). Under Art. 52(2) of the act, the financial report must be signed by the person entrusted with maintaining the company’s accounting books, and by all members of the management board.
Here it should be added that beginning 1 October 2018, the financial report will have to be made in electronic form and bear an electronic signature or a signature confirmed by a “trusted profile” on the ePUAP system. But regulations requiring electronic submission to the registry court of the financial report, the auditor’s report (if applicable), and a copy of the resolution or decision of the corporate authority on approval of the annual financial report and distribution of profit or coverage of loss, as well as the business report in instances specified in the act, has already entered into force on 15 March 2018.
It should be borne in mind that the supplementary information in the financial report should contain a recommendation by the management board on how the profit should be applied (we do not address in this article the issue of coverage of losses generated by the company in the current year or prior years). But this recommendation is not binding on the shareholders’ meeting of a limited-liability company (or general meeting of a joint-stock company), which has discretion to dispose of the profit as it sees fit, within the bounds established by law.
Selection of audit firm for at least two years
First it should be determined whether the company meets the statutory criteria requiring the financial report to be audited. In the case of companies other than banks and not falling into other strictly defined groups, these criteria are met if at least two of the following conditions apply (Accounting Act Art. 64(1)):
- Average annual employment (equivalent of full-time positions) of at least 50 people
- Balance-sheet total at the end of the financial year in PLN equivalent to at least EUR 2,500,000
- Net revenue from sale of goods and products as well as financial operations in the financial year in PLN equivalent to at least EUR 5,000,000.
But before the auditor begins to examine the financial report, there are two more formal conditions that must be met.
First, the shareholders’ meeting (or general meeting, or other authority indicated by the articles of association or applicable provisions of law) must adopt a resolution on selection of the audit firm (Accounting Act Art. 66(4)). There is an important statutory restriction here, which is that the director of the unit (i.e. the management board in the case of a company) cannot make this selection—but this does not mean that the management board cannot submit a recommendation to the authority empowered to select the auditor.
Second, based on the resolution by the competent authority on selection of the audit firm, the company’s management board should conclude a contract with the selected firm to examine the financial report.
It should be pointed out, however, that with respect to examination of financial reports for fiscal years beginning after 16 June 2016 (Art. 284(1) of the Act on Auditors, Audit Firms and Public Supervision), the contract must be concluded for a period of no less than two years (Accounting Act Art. 66(5)). The amended provision is somewhat poorly worded, requiring that the “first” contract with the audit firm be concluded for this period, but adding that the contract may be extended “for further periods of at least two years.” This means in practice that this provision applies not only to the “first” contract with the auditors, but also each successive contract.
Consequences of lack of resolution on selection of auditor
So what happens if a company concludes a contract with auditors despite failure by the competent authority to adopt a resolution on selection of the audit firm? And what consequences would follow from any discrepancy between the resolution and the contract (e.g. if the resolution selects the audit firm for examination of the financial report for 2017 but, in light of Art. 66(5) of the Accounting Act discussed above, the contract states that it covers examination of the financial reports for both 2017 and 2018)?
In answering these questions, the relationship between the resolution on selection of the auditors and conclusion of the contract with the auditors should first be explained. In light of Art. 66(4) of the Accounting Act, it should be recognised that conclusion of a contract with an audit firm for examination of the financial report is an activity which under Art. 17 §1 of the Commercial Companies Code requires a resolution of the shareholders’ meeting (or general meeting) under sanction of invalidity. Moreover, under Art. 17 §2 of the code, the consent must be given before the transaction is concluded or within two months after it is concluded (in which case the consent will have retroactive effect from the date of conclusion of the contract).
The practical consequence of failure to adopt a resolution on selection of the auditors (or adoption of the resolution after the end of the statutory period for doing so) is not only the invalidity of the contract with the auditors as such, but also the defectiveness of the actions taken by the auditors. As discussed below, dividends may be paid to shareholders only after approval by the shareholders’ meeting (or general meeting) of the audited financial report, and if the auditors were not validly selected, their examination of the financial report will not qualify as an audit of the financial report within the meaning of the Accounting Act. Thus, in turn, payment of the dividend in that case will be deemed to be a payment made in violation of law. This follows directly from Art. 53(3) of the Accounting Act, under which distribution or coverage of the net financial result of units required to file a financial report may occur only after approval of the report by the competent authority, preceded by expression of the auditor’s opinion on the financial report. Division or coverage of the net financial result not made in compliance with this condition is invalid by operation of law.
This situation threatens the consequences set forth in the Commercial Companies Code, in particular Art. 198 and 350, which require payments to be refunded to the company and impose liability on the management board members (see also the earlier article on legal consequences of improper selection of auditors).
Consequences of concluding a contract with the auditors for less than two years
Similar consequences, i.e. the invalidity of the transaction, will also arise in the case of conclusion of a contract with auditors that does not comply with Accounting Act Art. 66(5). And in this case the act provides for criminal liability of the person who concluded such contract for the company (Accounting Act Art. 79(9)).
Once the shareholders’ meeting (or general meeting) has selected the firm of auditors, and the management board has concluded a contract with the selected firm, the next step is for the auditors to examine the financial report, draw up an opinion, and present it to the management board.
It is only at this time that the shareholders’ meeting (or general meeting) may adopt a resolution approving the company’s financial report, and further, a resolution on division of the profit. The ordinary (annual) meeting of shareholders for this purpose must be held within six months after the end of the financial year.
This resolution then serves as the basis for the entitled shareholders to seek payment of the dividends owed them by the company.
But when adopting the resolution on division of the profit for the last financial year, it is important to bear in mind the statutory limitations on the amount of the dividend. Under Art. 192 of the Commercial Companies Code, the amount designated for distribution among the shareholders must not exceed the profit for the last financial year plus:
- Undistributed profit from prior years, and
- Amounts assigned from profit to reserve and supplementary capital which are eligible for distribution.
This amount must be reduced by:
- Uncovered losses
- Own shares, and
- Amounts that pursuant to law or the articles of association must be transferred from the profit for the last financial year to reserve capital or supplementary capital (for example, in joint-stock companies, it is mandatory to transfer 8% of the profit for each financial year to the reserve capital until the reserve capital reaches at least one-third of the share capital—in order to cover potential future losses).
Thus, while the shareholders generally enjoy discretion in deciding how to apply the company’s profit, there are certain legal restrictions in this regard that must be borne in mind.
Maciej Szewczyk, legal adviser, and Dr Kinga Ziemnicka, legal adviser, M&A and Corporate practice, Wardyński & Partners