Until 1 July 2023, the principle applied under the applicable law in Latvia detailed that dividends could be calculated only in proportion to the shares held applied to Latvian private and public limited liability companies (AS and SIA). This principle could not be changed by way of mutual agreement between the founders and members of the company. The aforementioned principle also had an impact on the interpretation of payments to members that do not constitute a distribution of profits when dividends are paid by such a proportion. Thus, if a member of a limited liability company held 25% of the shares, the member could not be paid more than 25% of the amount to be paid as a dividend. For small and medium-sized enterprises, where several members are personally involved in the day-to-day running of the business with varying degrees of intensity, this restriction created unnecessary problems. Thus, if members sought to pay dividends to a person whose shareholding did not correspond to the proportion of the profits attributable to that person for the payment of dividends, they had to consider whether this was legally possible and the tax consequences of such a payments. This led to the need for a reassessment as to whether the derogations from the so-called proportionality principle in the calculation and payment of dividends might nevertheless be possible and permissible.
After various discussions and consultations, the legislator therefore decided to amend the existing framework to be more flexible. On 1 July 2023, changes to the Commercial Law entered into force, which provides that:
“Dividends shall be paid to a member in proportion to the amount of the nominal values of the shares held by them unless the statutes provide otherwise.”
Accordingly, as a result of the amendments to the Commercial Law, members may now determine dividends differently, i.e., not in proportion to their shareholdings, but on the basis of the provisions of the company’s articles of association. The legislator has not regulated the specific ways and rules according to which derogations from the so-called proportionality principle in the calculation and payment of dividends would be permissible, which means that the formula for determining dividends is determined by the founders or members themselves, potentially leading to unfair use of those rights.
Under such circumstances, questions arise in the context of the protection of the rights of minority shareholders. Minority shareholders may be able to ask the court to invalidate a decision of a meeting of members if such a decision is contrary to the applicable law or the articles of association, by applying to the court and possibly seeking injunctive or interim relief. However, it is to be expected that, in most cases, the new legal framework will not be abused in limited liability companies where, in some cases, the majority shareholders wish to divert profits to the benefit of the majority shareholders only and the minority shareholders will have no choice but to apply to the courts if, for whatever reason, they have been unable to influence the relevant amendments to the articles of association or have acquired shares only after the articles have been amended to derogate from the so-called proportionality principle in the calculation and payment of dividends.
For dividends to be distributed, other than on a pro-rata basis, the articles of association must first contain a clause allowing for such a departure from the so-called proportionality principle. To amend the articles of association, limited liability companies must obtain more than 2/3 of the votes for such a proposal (unless the articles of association provide for a higher number of votes of the authorised share capital). The content of the proposal may refer to the principle that dividends may be distributed, other than on a pro-rata basis. Our recommendation is to accept such an approach where there is a quorum of 100% and 100% of the votes are cast in favour of providing for a different payout arrangement, i.e., all shareholders of the company are present and agree to the change in question. In private limited liability companies, where the number of shareholders is often less than 5-10, this is also practicable, but for companies with several dozen shareholders, it may be difficult to achieve the quorum and unanimity already required by law for a change.
It is important to note, the receipt of dividends is perhaps the most important property right arising from the ownership of shares in a company. It follows that non-payment of dividends would be contrary to the rights of a shareholder. In our view, the provisions of the Commercial Law also expressly provide for the payment of dividends to shareholders in the absence of a decision to allocate profits to the company. Accordingly, if the principle of dividend distribution changes from the so-called proportionality principle to some other approach, then in any situation dividends, albeit in some cases less than under the so-called proportionality principle, must be paid unless the minority shareholder has specifically and expressly waived the dividend.
Case-law, in the future, will highlight whether the courts are willing to uphold amendments to the articles of association that are driven and supported by a majority of the shareholders, but not all 100% of the voting share capital, providing for a departure from the so-called proportionality of dividends in favour of a majority decision of the shareholders.
In our view, it may be the case that amendments to the articles of association, which are carried out in bad faith, provide for disproportionate payment of dividends to the detriment of the rights and interests of minority shareholders should be declared invalid by the courts, even if a resolution to that effect has been passed at a meeting of the shareholders.
The calculation of dividends and the rules concerning their payment are laid out in the Law on Annual Statements and Consolidated Annual Statements and the Commercial Law, as well as in privately negotiated agreements, or the relevant restrictions arising from financial instruments and obligations to creditors. If the articles of association provide for a formula which deviates from the existing rules of the Commercial Law, concerning the calculation and payment of dividends, such distribution must be discussed with financial experts so that there is no doubt as to the workability of the formula, its compliance with the laws and regulations and the interests of the shareholders.
It would therefore be better to stick to clear principles or to express the formula in monetary units rather than in terms. For example, if the net profit for the financial year exceeds EUR 500,000, then 20% of the amount exceeding EUR 500,000 is paid to the shareholders who are on the board of directors, and the remainder is distributed in proportion to the shareholders’ shares in the share capital of the company concerned. When envisaging such changes within existing companies, it is also important to determine when this “different distribution” takes effect and when it ceases to apply in a variety of different situations, such as when a shareholder of the board resigns or is dismissed for misconduct.
The vaguer and more unspecific the formula set out in the Articles of Association for the different procedures in calculating and paying dividends, the more likely it is there will be disputes between the shareholders, which will likely be resolved in lengthy proceedings before the Latvian courts.
Overall, this new dividend regulation under Commercial Law is a welcome innovation and it is hoped that investors will be able to adapt to it and the courts will delve deeper into the aspects of the commercial activities aimed at generating, motivating and distributing profits more fairly and in a way that is appropriate to the circumstances, which may not correspond to the proportion of shares held by the relevant shareholders to the total shares in the company.
The debate is likely to continue as to what are the most effective and appropriate means of protecting the rights of minority shareholders where amendments to the articles of association are envisaged about the calculation and payment of dividends which are not in the interests of those minority shareholders, prejudicing their right to an adequate share of the profits in the event of a dividend payment, or where amendments to the articles of association have already been approved at the meeting of shareholders, but the opportunities created by the amendments are exploited in bad faith by the majority shareholders, unduly prejudicing the rights and legal interests of minority shareholders.
August 18, 2023 by Gints Vilgerts, Managing Partner
