Commercial Code Amendments Extend Options for Payment of Dividends - International Law Office

Former Provisions
Amendments
Principles

Former Provisions

Under the former Commercial Code, which was in force until December 31 2005, dividends were paid to shareholders once a year on the basis of the approved annual report and the procedure for the payment of dividends was established by either the company's articles of association or a resolution of the general meeting. The wording of the former code implied that the payment of dividends in two or more instalments during the year on the basis of the specific annual report was precluded. However, this issue was clarified by two judgments of the Supreme Court of November 14 2002 and February 10 2004, which held that a company has the right to decide, either in the articles of association or at the general meeting, whether to pay a dividend in one payment or in instalments. The court stressed that, if made by resolution of a general meeting, such a decision can be made only once a year on the basis of the approved annual report. Therefore, under the former code a company could not change its mind during the year as to how to pay dividends and dividends could not be paid in advance. The restrictions on choosing payment procedures were imposed in order to protect creditors' interests and preclude the adoption of a resolution on the payment of dividends without an audit of the company's state of business or without approval by a general meeting. This prevents a decision regarding the payment of dividends without determining the company's financial status; this status may deteriorate within a short period of time, which would prevent the distribution of dividends. The former code did not include regulations pertaining to the preparation of an interim report, which would have allowed the payment of dividends in instalments instead of as a single payment.

Amendments

The new Commercial Code, which came into force on January 1 2006, states that dividends can be paid only on the basis of an approved annual report. The new code retains the options for establishing the procedure to pay dividends (ie, in the articles of association or by decision of the general meeting). Although the new code gives companies further powers to determine the procedure for the payment of dividends, these powers are limited by other considerations, including the following:

• If the decision as to how a dividend shall be paid takes an unreasonably long time, it may be seen to conflict with good practice and the principle of good faith. In such cases a dividend may lose its designation under procedures prescribed by law.
  
  
• In certain cases a single dividend payment, rather than instalment payments, may be contrary to the company's best interests.
  
  
• The suspension or termination of instalment dividend payments may be possible if further dividend payments may significantly damage the company's financial status or affect its solvency.

The new code abolished the prohibition on the advance payment of dividends. Under the new code, the articles of association may provide that the company's management board can make advance payments of up to half the estimated profit to shareholders after the financial year has ended and before approval of the annual report. To do so, a figure must be established that represents 50% of the dividend amount that would be paid after the annual report has been approved. This amendment makes the procedure for the payment of dividends to shareholders more flexible by anticipating the acclerated transaction of the payment if the share of profit to be distributed is clear but the general meeting has not yet occurred.

In order to pay advance dividends, a general meeting of shareholders must be convened to amend the articles of association and approve those amendments. The new code amended the quorum for amendments to the articles of association - instead of the previous 50% quorum, the articles of association may be amended only if at least two-thirds of the shareholders participating in the meeting approve the amendments. The general meeting resolution on the amendments to the articles of association enters into force at the same time as the corresponding entry in the Commercial Register.

Once the articles of association have been amended, the company's supervisory board has the right to adopt a resolution to pay dividends in advance by determining the amount of a dividend and giving the management board the task of arranging the payment of dividends and the declaration and payment of income tax. To do this, it must be considered that the percentage of dividends paid in advance will not exceed 50% of the profit subject to distribution between shareholders.

Principles

The new code sets out the following principles for the distribution of profits:

• The company may decide only once in regard to the payment of dividends on the basis of the approved annual report.
  
  
• The articles of association may give the management board of a public limited company the right to make advance payments to shareholders of up to 50% of the amount subject to distribution with the consent of the supervisory board after the end of the financial year and before approval of the annual report on the basis of the presumed profit.
  
  
• The payment procedure for dividends set out by the articles of association or by resolution of the general meeting must conform with good practice and the principle of good faith, and must not damage the rights of either the shareholders or the company.
  
  
• A public limited company may abstain from the payment of dividends or suspend or terminate payments by instalment if the payment of dividends would significantly damage the company's financial status, including negatively influencing the company's solvency.

For further information on this topic please contact Ilmar-Erik Aavakivi at Advokaadibüroo Aivar Pilv by telephone (+372 6 404 650) or by fax (+372 6 404 653) or by email (iea@apilv.ee).