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Profit Dividends Agreement

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Profit Dividends Agreement document sample

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                                                                                   SOVA & PARTNERS 
                                                                                              Law Firm
                                                                           




                                   PAYING DIVIDENDS
                           DIVIDENDS AND PRACTICAL ISSUES THEY RAISE



NOTIONS AND REGULATIONS; GENERAL RULES

The aim of shareholders/partners when setting up a commercial company is, mainly, to make
profits and share profits among them.

Dividends are that part of a commercial company’s profit that is due to shareholders proportional
to the number and value of the shares owned or in conformity with agreements between
shareholders.

The basic regulation for dividends is to be found in Law no. 31/1990 regarding commercial
companies. References to dividends are also included in special normative acts, such as the Tax
Code and Government Emergency Ordinance no. 26/2000 regarding associations and
foundations.

Dividends are distributed out of the net profit made by the commercial company. Net profits are
determined by deducting from the gross profit the common expenditure of the company (for
instance benefits to administrators and employees, etc.), their part bound for reserve funds, and
profit taxes.

The size of the dividends is established by the general shareholders’ meeting, which approves the
balance sheet, the account of profits and losses, and notes the existence of amounts to be
distributed. The net profit derived by the company is shared as follows: part of it is distributed to
shareholders in the form of dividends, while other part of it is withheld to be made available to the
company for establishing certain funds. For the fully privately owned companies, the law provides
for no restrictions in the distribution of the net profit as recorded in the balance sheet, and,
consequently, it may be fully distributed as dividends. In the case of fully or mainly state owned
companies, the distribution of profits is regulated under Government Ordinance no. 64/2001.

The essential condition for the distribution of dividends consists of the existence of profits, as
established at the end of the tax year in annual financial statements. When there is no profit, no
dividends may be distributed to shareholders; when dividends are paid without the existence of
profits, they are deemed fictitious. According to Article 73 of Law no. 31/1990, administrators are
jointly liable to the company for the real existence of the paid dividends.


DEADLINES FOR PAYING DIVIDENDS

The provisions in force of Law no. 31/1990 specifically mention that the dividends must be paid
within the time limit established by the general shareholders’ meeting, but no later than 8 months
after the approval of the annual financial statements.

The regulation of this deadline was the consequence of many practical instances in which the
general shareholders’ meetings decided on the distribution of dividends, which they failed to pay



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to the shareholders even 3 years after the distribution date. This triggered the prescription of
dividends (the loss of the shareholder’s right to be paid dividends to take the matter to the court).

When the general shareholders’ meeting fails to agree on a deadline, and it only agrees that
dividends will be distributed and what their size is, shareholders are entitled to be paid the
dividends immediately, failure of which may be addressed to the court in order to oblige the
company to pay them the dividends. The significance of the 8-month deadline provided for by the
law is not that shareholders have to wait 8 months for the commercial company to pay them
dividends, but that the deadline established by the general shareholders’ meeting shall not be
exceed 8 months. The nature of the 8-month deadline is also important as regard the prescription
of the shareholders’ right to court action, which is 3 years after the date the dividends are due.
This is the date to be established by the general shareholders’ meeting, or, in the lack of such a
date, the date of the general shareholders’ meeting when the annual financial statements and the
distribution of dividends are approved.

When the general shareholders’ meeting violates the legal provisions and establishes a deadline
that exceeds 8 months for paying the dividends, any of the shareholders that did not attend the
session or voted against and asked that his/her opposition be recorded in the minutes of the
meeting may request and win the cancellation of the decision concerned.


PENALTIES FOR DELAYED PAYMENT OF DIVIDENDS

In the past, there used to be contradicting discussions and decisions of the courts of law
regarding the application of interests when the payment of dividends established by the general
shareholders’ meeting was be delayed, but now the issue is regulated by the insertion of specific
provisions in Law no. 31/1990, according to which failure to pay the dividends shall compel the
company to pay penalties calculated for the time of the delay that are equal to legal interests. The
level of the legal interest rate as well as the way of calculating it are regulated under Government
Ordinance no. 9/2000 regarding the level of legal interests on money dues, as subsequently
modified and competed. Accordingly, the legal interest rate applicable in case of delayed payment
of dividends shall be the reference rate of the National Bank of Romania, as published in the
Official Gazette, part I; the interest rate due in the first half of the year is the one established in the
first business day of the year, while the interest rate due in the second half of the year shall be the
one established for the first business day of the month of July.


PERSONS ENTITLED TO DIVIDENDS WHEN SHARES ARE ASSIGNED DURING THE
FISCAL YEAR

An issue related to dividends on which the courts of law have followed a disjointed jurisprudence
and pronounced contradicting decisions regarding persons entitled to be paid dividends when,
during the tax year, a shareholder assigns his shares to another person by sale.

The diverging decisions were the result of a mystifying and debatable wording of Article 67 (6) in
Law no. 31/1990, which says “the dividends owed after the date of the assignment shall belong to
the Assignor (our note: the Buyer), unless otherwise agreed”. It should be mentioned that the
wording of Paragraph (6) in Article 67 was introduced under Government Emergency Ordinance
no. 32/1997 and has not been modified or completed ever since.




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                                                                                   SOVA & PARTNERS 
                                                                                              Law Firm
                                                                           




Cases involving the issue have also reached the Supreme Court of Justice and Cassation, which,
in its capacity as a court of appeal, also issued diverging decisions.

In a series of case decisions, the Supreme Court of Justice and Cassation ruled that the
dividends recorded for the time when the Seller was a shareholder shall be due to him, instead of
to the Buyer, because the latter cannot justify by any title having been paid dividends for the time
he was not a shareholder.

In other more recent case decisions, the Supreme Court of Justice and Cassation ruled that the
dividends paid out after the date of the sale of the shares shall in principle be due to the Buyer, as
they may also be due to the Seller, if the parties so agreed under the share assignment
agreement.

This decision of the Supreme Court of Justice and Cassation corresponds to most of the opinions
voiced in the specialist law literature about this issue, according to which the words in the law
“dividends due after the date of the assignment” does not construe as dividing the amount
concerned between an amount attached to the time when the Buyer was a shareholder and
payable to him, and another attached to the time when the Seller was a shareholder. In this
sense, “dividends due after the date of the assignment” should be construed as the total of
distributable dividends corresponding to the shares concerned as an effect of the decision of the
general shareholders’ meeting adopted after the assignment.

We fully agree with such an opinion and the recent jurisprudence of the Supreme Court of Justice
and Cassation, because the legal and practical arguments decisively tip the balance in favour of
such an interpretation. Thus, from a practical point of view, the distribution of dividends should not
be performed by considering the time when the Seller and the Buyer were shareholders, pure and
simple, because it may be possible that the net profit distributable in the form of dividends was
derived either exclusively or to the greatest extent in either of the times, which leads to inequitable
situations. Major difficulties would also emerge in the case of successive assignments during one
fiscal year, as the problem would arise of more than two persons sharing in the dividends.

It would be a good thing if the Romania law givers intervened, as they have already done in
connection with other issues related to dividends, to clarify things by modifying the legal text: if all
the dividends are to be paid to the buyer of the shares, then un unequivocal wording will be
required (for example: “the dividends to be distributed after the assignment date”, instead of “the
dividends due after the date of the assignment”); if, on the contrary, the dividends are meant to be
shared between the Seller and the Buyer, the criteria against which the sharing shall be made
should be clearly stated.

As a conclusion, it should be remembered that the interpretation currently given to Article 67 (6) of
Law no. 31/1990 is that when, during the fiscal year (according to the accountancy legislation, this
is, as a rule, the calendar year), a shareholder sells his shares to another person, he shall be
disqualified from being paid dividends, even when he has the capacity as a shareholder for most
of the tax year, unless otherwise agreed with the Buyer.

In fact, even when he reaches an agreement with the Buyer that he is entitled to dividends
proportional to the length of time he was a shareholder or other criteria, in reality the Seller has no
more control over the reception of the dividends once he assigns his shares and the general
shareholders’ meeting may discretionarily decide on the distribution and paying of the dividends in
favour of the shareholders, as well as on their size.


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                                                                                              Law Firm
                                                                           




In practice this is quite often translated into abuses on the part of the buyer of the shares when it
is about a majority stake in the commercial company in question, which may avoid the distribution
of dividends despite recording a net profit by ploughing the profit back in funding investment
projects, in reserve funds, etc. On the other hand, when it is not about a majority stake, the
commitment of the Buyer to this end has no value, as he does not have any decision-making
power or the possibility of guaranteeing the distribution and paying of the dividends.

Consequently, in most of the cases, the Seller fools himself when hoping to be paid dividends for
the time prior to the assignment, when he was a shareholder, and it would be wiser for him to
recover the value of the dividends in the selling price for his shares.


CRITERIA FOR DISTRIBUTING DIVIDENDS

An issue related to dividends that was finally settled by a legislative solution regards the criteria
against which dividends are distributed. Pursuant to Article 67 (2) in Law no. 31/1990, dividends
are paid to shareholders proportional the shareholders’ contributions to the paid-up capital stock,
unless otherwise stated in the articles of incorporation. The law makes a distinction between the
registered share capital, pledged by the partners, and the paid-up capital, which is the total value
of contributions made that become part of the commercial company’s assets.

Law no. 31/1990, as it stands now, specifically allows shareholders to establish in the articles of
incorporation the way of sharing the shares among shareholders. This specific permission was
absent from the initial version of the law, which triggered some contradictory discussions
regarding the possibility of shareholders to eschew the general rule of pay proportional to the
contribution quota to the share capital.

This possibility of shareholders translates into the shareholders being allowed to agree on a
disproportionate share of the profits, so that some of them may be entitled to a larger share of the
profit compared with their contribution to the share capital of the company, whereas others will
have a smaller sharing compared with their initial investment.

The possibility of shareholders deciding in this respect is not discretionary, however, but limited
by the provisions in the Civil Code (Article 1513), according to which contracts under which a
shareholder stipulates that the gains are entirely his shall be null and also null shall be the
agreement under which one or more shareholders are exempt from bearing losses. Such clauses
are currently called “leonine clauses.”

In practice, leonine clauses are not met worded like this, as they are disguised in more discreet
formulas. The ingenuity of shareholders in this respect has proven quite prolific. An example of
such clause is the one under which a minimum share of the profits is secured for a certain
shareholder, which is tantamount to exempting him from bearing losses.

The sanction against such clauses agreed between shareholders is absolute nullity, which results
in ignoring them and treating them as they did not exist, so that the dividends shall be distributed
proportional to the contributions to the share capital.




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                                                                                    SOVA & PARTNERS 
                                                                                               Law Firm
                                                                            




THE POSSIBILITY OF PAYING DIVIDENDS IN ADVANCE

Until the adoption of Government Emergency Ordinance 32/1997, which modified and completed
Law no. 31/1990, in the practice of commercial companies there were various ways of making
use of getting parts of the dividends in advance: advance pay subject to the servicing of a 10%
tax rate at the end of the year, according to the results in the annual balance sheet; advance pay
subject to the servicing of a 10% tax rate upon collection and tax regularisation at the end of the
year according to the balance sheet.

This practise was justified by the idea that, when the articles of incorporation mentioned that the
partners may take out of the company’s cash amounts to cover their private expenditure, they
may take out the amounts as advances on dividends.

Controversies related to this issue were generated by Article 272, point 5 (former Article 266,
Point 5) in Law no. 31/1990, under which the founder, manager, director, executive director or the
legal representative of the company collecting or paying dividends in any form out of fictitious
profits or profits not for distribution for the lack of a financial statement or running contrary to such
statements will be liable to between one and 3 years in prison.

In practice, the distribution of dividends in advance was considered neither specifically regulated
by the law, nor forbidden, so it might be performed based on a special balance sheet drawn up in
the year and approved by the general shareholders’ meeting, a solution that was nonetheless
deemed on the edge of the law even back then.

Following the specific mention in Article 67 of Law no. 31/1990, the pay of dividends out of profit
established in an annual financial statement related to the tax year that passed, it became clear
that the dividends may be collected only after the close of the fiscal year and the approval of the
annual financial statement by the general shareholders’ meeting (usually in the first four months
of the year that follows the year for which the dividends are paid), only when the existence of
profits and losses may be certified.

I believe that the solution of the law makers to oblige an owner to wait 12 months to collect his
money rights in the form of dividends is neither moral, nor logical in economic terms, given that
the owner pays profit taxes each quarter. Practically, dividends are kept in bank accounts and
lose value, but they are incomes of the shareholders. There is no logic to forbid access by the
shareholders to dividends as long as the company is in no danger of going bankrupt.

The mechanism for dividend collection in advance should be a simple one: tax on the dividends
would be paid upon collection; dividends due to each shareholder at the end of the year would be
deduced from the total of advances collected throughout the year; at the end of the tax year, the
tax paid on the advances would be deducted from the tax due on the dividends for the whole
year.

Pending the necessary modifications, however, it should be remembered that during the year
advances on dividends may not be paid, under any circumstance and in no form, as that would be
an offence punishable with one to three years’ imprisonment.




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                                                                                              Law Firm
                                                                           




ISSUES RELATED TO TAXING DIVIDENDS

For taxation purposes, the Tax Code defines the notion of “dividend” as a cash distribution
performed by a commercial company to a shareholder as a result of the shareholder holding
shares in the commercial company concerned, with some exceptions duly mentioned (for
example: distribution in connection with the liquidation of a legal persons). In terms of the Tax
Code, if the amount paid out by a commercial company for the goods or services supplied by a
shareholder exceeds the market price for the goods or services concerned, or the amount is paid
for the personal advantage of the shareholder, the difference or the full amount, as appropriate, is
considered a dividend.

Tax on dividends shall be paid into the Budget before the 25th day of the month following the
month when the dividend is paid. When the dividends distributed are not paid by the end of the
year when annual financial statements have been approved, the tax on dividends will be paid by
the 31st of December of the year concerned.

Dividends are subject to taxation by withholding at source. This means the tax is due by the
shareholder to whom the dividends are paid, but the calculation and withholding of the tax is
performed by the commercial company paying out the dividends to the shareholder concerned.

According to Article 6 in Law no. 241/2005 regarding the prevention and combat of tax evasion,
intentional withholding and non-payment of the amounts representing taxes or contributions
taxable at source (tax on dividends included) within 30 days, at the longest, after due date, is an
offence punishable with between one and three years in prison.

Net dividends distributed to a shareholder that is a commercial company no longer fit in the
category of revenue taxable by the latter, becoming non-taxable revenue, as a result of the fact
that such incomes have already been subjected to a full taxation system (on profit and on
dividends).

After the date of Romania’s accession to the European Union, the dividends paid by a Romanian
commercial companies to another legal person of Romania or another European Union member
state will be exempted from taxation, on condition that the beneficiary of the dividends has hold of
at least 15 % (10% as of 2009) of the shares in the Romanian company concerned for two
uninterrupted years prior to the paying of the dividends.




Roxana Eftimie
Senior Partner
Sova & Partners




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                                                                                              Law Firm
                                                                           




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