Legal guide for company directors and CEOs in the Czech Republic

BREAKING: Coronavirus (COVID-19) considerations for directors

1. What are the key issues for directors during the COVID-19 crisis?

Many of the measures imposed by governments around the world, including in the Czech Republic, to combat the spread of COVID-19 have had an immediate impact on companies’ businesses. Even companies that are not directly affected by the measures are starting to feel the strain from the economic slowdown caused by this crisis. The question for the company’s management is what the obligations of the board are to ensure that the company remains on a solid financial footing, and what are they obliged to do if serious commercial or financial problems are foreseen.

In general, it is a director’s duty to promote the company’s success for the benefit of its shareholders. A duty to avoid insolvency goes hand in hand with this general obligation. In the event of impending insolvency, the directors are obliged to convene a general meeting and propose a solution, e.g. potentially additional (equity) funding or a stand-still agreement. The suitable measures depend on the seriousness of the situation of the respective company. If there is no such solution to the impending insolvency, the company will most likely become insolvent. Then it is the duty of the directors to file an insolvency petition (see exceptions set out by Lex Covid below). Failing to do so would typically result in unlimited liability of the directors and may also lead to the directors being disqualified from taking up directorships in the future.

On the other hand, filing an insolvency petition when the company is not insolvent can cause the directors to be liable for damaging the company’s reputation and decreasing its value.

Given the above, it is crucial for the directors to reasonably assess the situation and choose the best possible solution. Directors are not expected to be experts in every area that will arise in connection with company management. However, they have an obligation to use the help of an expert, either within the company or an external adviser, when there is a need to do so.

For more information on this topic, please see the CMS law-now article.

2. What government relief measures have been made available to directors?

In the Czech Republic, a new Act no. 191/2020 Coll., referred to as Lex Covid, was adopted to assist companies through the crisis with effect as of 24 April 2020 (“Lex Covid”). The most relevant measures for companies and their directors include:

Meetings of corporate bodies: Meetings of corporate bodies are allowed to be held in the form of so-called per rollam voting, i.e. by submitting votes in writing without any meeting taking place, by using technical facilities for live remote voting or by submitting votes in writing prior to the general meeting (correspondence voting), even if such options are not expressly provided for in the company’s constitutional documents.

The rules for holding a corporate body’s meeting in the above forms, which are stipulated by law or by the company’s constitutional document, are not affected. Should the rules not be stipulated yet, the directors are obliged to set them out with respect to shareholder meetings. The shareholders must be acquainted with the rules in advance of the meeting.

Terms of office: The term of office of a director or board member which would normally expire by lapse of time during the period of Lex Covid’s effectiveness or within one month after the emergency measures are terminated, will be automatically extended. The term is extended for a maximum of three months after the emergency measures cease to apply. Should a director or board member not want their term to be extended, they need to inform the company thereof in writing before their term expires.

If a term expired in the time between the announcement of the emergency measures and the date of effect of Lex Covid, such term of office has not been extended but renewed based on the respective board member’s consent. The term of office is renewed on the date of delivery of the member’s consent to the company and expires after the lapse of three months from termination of the emergency measures. This may be applied only if the respective corporate body has not appointed a new person to fill the vacancy, whereupon the former member’s term of office will not be renewed.

Lex Covid allows for co-option, i.e. a situation where the board itself may temporarily appoint a member to fill a vacancy until the next meeting of the body which normally elects the board members, even if this is not permitted in the company’s constitutional document. This is possible only if the number of the corporate body’s members has not fallen below half and all current members of the board vote in favour of such co-option.

Deadline for discussion of the company’s financial statements: Lex Covid extends the deadline for a general meeting to discuss a company’s financial statements. Generally, the annual financial statements must be discussed by the general meeting within six months following the end of the company’s financial year. Lex Covid extends this period to three months after termination of the emergency measures if the period would otherwise end during the three-month period after the emergency measures cease to apply. In any case, the annual financial statements must be discussed by 31 December 2020 at the latest.

3. What changes have been made to directors’ duties as a consequence of the COVID-19 crisis?

To bring relief to companies and their boards in the current situation, Lex Covid provides that the statutory duty of the directors to file for insolvency will be suspended if the insolvency has been predominantly caused as a result of the pandemic. The suspension is proposed to remain in place for six months following termination of the current state of emergency, but no later than until 31 December 2020.

The above does not apply in cases where the insolvency occurred before the adoption of the emergency measures or if the insolvency is not mainly caused by the circumstances connected to the emergency measures.

Boards should also be aware that their remaining duties, e.g. the duty to promote the company’s success for the benefit of its stakeholders, remain in place despite the suspension.

Directors duties and responsibilities

1. What form does the board of directors take?

In the Czech Republic, private limited companies typically have one or more executive directors, who may either act as individual corporate bodies or, rarely, form a collective board.

Joint stock companies (“JSC”) by default form two collective boards – a board of directors, members of which have an executive role in the company, and a supervisory board, which has a non-executive, controlling function.

The Act on Business Corporations allows JSCs to implement a single director or “monistic” structure. In such a case, the executive powers are carried out by a statutory director and the controlling powers are carried out by an administrative committee.

This guide concentrates on the rules applicable to a limited liability company’s executive directors and members of a JSCs’ board of directors; i.e. directors who have an executive role within the company.

2. What is the role of non-executive or supervisory directors?

The supervisory board oversees the activity of the board of directors on an ongoing basis. It makes requests and suggestions regarding organisational, technical, commercial, financial, personal and other business activities related to the company and its business activities.

The supervisory board reviews the ordinary, extraordinary, consolidated and, where appropriate, interim financial statements as well as a proposal on profit distribution or coverage of loss and submits its opinions to the general meeting. The supervisory board is entitled to review all documents and records concerning the company’s activities, check whether the accounting records are kept properly and in accordance with reality, and check whether the company’s business or other activities are carried out in accordance with the articles of association and applicable legal regulations.

Where applicable, the supervisory board also reviews the report on relations between related parties prepared by the directors and notifies the results of such review to the general meeting.

3. Who can be appointed as a director?

In general, a natural person or a legal entity may become a director. In a JSC with a monistic structure, only a natural person may be appointed as a statutory director. There are no restrictions on who can become a director as regards their residency or nationality.

A director may not simultaneously be a director of another company with an identical or similar business activity, unless the companies have the same holding company (i.e. they are part of one corporate group). However, this restriction may be removed if approval of all shareholders is obtained.

A member of a board of directors may not at the same time be a member of the supervisory board or be another person authorised to act on behalf of the company, based on the records in the commercial register.

4. How is a director appointed?

In the case of a limited liability company:

  • a director is appointed at the general meeting, or by a written resolution of the shareholder(s)
  • the law does not limit the term of office and the appointment is usually made for an unlimited term
  • the minimum number of directors is 1 (or such higher number as is prescribed by the memorandum of association), and
  • the memorandum of association must include the precise number of directors.

In the case of a regular JSC:

  • the method for appointment of a director is determined by the general meeting, unless the articles of association expressly provide for appointment of directors by the supervisory board
  • the appointment period is one year unless the articles of association or the performance agreement provide otherwise; directors may be re-elected
  • the number of directors is 3 unless otherwise provided for in the articles of association, and
  • the articles of association must include the precise number of members of the board.

In the case of a JSC with a monistic structure, the statutory director is appointed by the administrative committee.

Irrespective of the corporate structure of the entity, the appointment is effective immediately or from a future date determined in the decision. The name, address, date of birth and date of appointment of the director must be registered with the commercial register (Companies Register) kept by the regional courts.

5. How is a director removed from office?

A director may resign from their office by giving notice of their resignation to the relevant statutory body which appointed the director, i.e. the supervisory board or the general meeting. However, they may not do so at a time which is inconvenient for the company. The director’s tenure terminates one month after receipt of the notification unless the relevant statutory body of the company approves a different date at the request of the director.

A director is always subject to removal by a resolution of the statutory body which appointed the director, i.e. the general meeting, supervisory board or administrative committee as applicable.

If directors are appointed for a fixed term, their appointment will also terminate by expiry of their term if they are not re­appointed at the relevant time.

Any change in the director’s office must be registered in the commercial register kept by the relevant regional court. Registration has a declaratory effect towards third parties.

6. What authority does a director have to represent the company?

The executive directors, board of directors and statutory director, as applicable, are “statutory bodies” ("statutární orgány") of a company and their actions are deemed to be the actions of the company itself. This means that the directors have full authority to represent the company (solely or jointly – see below) and that this authority cannot be limited in any way in their actions toward third parties. There is no need for the directors to have special authorisation for certain acts to be valid (for example, the sale of real property), although certain material legal actions do require the approval of the general meeting, supervisory board or administrative committee, as applicable. A director’s act will always bind the company, unless the director acts outside the powers conferred by general law.

Only a general meeting of a limited liability company – not its directors – has the authority to decide (amongst other things) on: changes to the registered capital; changes of directors (limited liability company), members of the board of directors (JSC), supervisory board and administrative committee members; decisions as to a sale of the business or, in the case of a JSC, a decision to seek permission for shares to be publicly traded; and on such other matters set out in law, the memorandum of association or articles of the company.

In the case of limited liability companies, a memorandum of association specifies whether each director may bind the company solely or whether two or more signatories are necessary. This information is entered in and made publicly available in the commercial register.

In the case of a JSC, decisions of the board of directors are adopted by a majority of votes, unless otherwise specified in the company’s articles of association. The articles specify whether relevant members of the board of directors may bind the company individually or whether two or more signatories are necessary. Similarly to limited liability companies, this information is entered in and made publicly available in the commercial register.

Notwithstanding the above, and regardless of whether the internal signing requirements are publicly accessible, the company will be bound by an act of a director (limited liability company) or the board of directors (JSC) towards third parties; even if such an act is contrary to the memorandum and articles of association of the company (but is otherwise lawful).

Any limitation on the authority of the directors to represent the company (apart from the limitation described above, whereby a director acts contrary to the law) which is included in the memorandum or articles of association, or is given by a decision of the general meeting, will have no effect towards third parties. However, the company may sue the director who acted outside their authority for damages.

7. How does the board operate in practice?

A single director can manage a limited liability company by themselves, provided compliance with the company’s memorandum or articles of association is adhered to.

As regards a board, a company is generally permitted considerable flexibility regarding its operation. All directors must be given notice of each meeting, although there are no specific requirements as to the form this should take, unless the company chooses to prescribe rules in its articles or internal rules. A board of directors adopts its resolutions by a simple majority of votes of the total number of its members, unless the company’s articles provide for a qualified majority. The company’s articles may even permit voting in writing, or by means of communication with persons outside the meeting room, provided that all members of the board agree.

8. What contractual relationship does the director have with the company?

A director does not have to be, and in most cases is not, an employee of the company. The basic contractual instrument setting out the rights and responsibilities of a director toward the company is an executive service or performance agreement. It is not a statutory requirement to have such an agreement in place. Where concluded, the agreement must be approved by the company’s general meeting.

The general rights and duties between a company and a director are governed by the provisions of the Civil Code governing an order (“příkaz”), unless implied otherwise by an executive service or performance agreement, where concluded, and the Act on Business Corporations.

As regards remuneration, unless agreed otherwise in the executive service agreement it is presumed that the exercise of the office is free of charge. Any payment by the company to a director that is not specified by law, the internal rules of the company, or explicitly stated in a performance agreement concluded between the director and the company and approved by the general meeting can only be made with the general meeting’s approval.

9. What rules apply in respect of conflicts of interest?

The Act on Business Corporations sets out restrictions on a director’s activities to prevent conflict of interest situations. The articles of association may stipulate additional limitations. Under the Act on Business Corporations, a director may not:

  • carry on, either on his/her own behalf or on behalf of a connected person, any business activity that is of the same kind as, or is connected to, a business activity of the company, or enter into business relationships with the company
  • mediate business activities of the company for other persons
  • take part in the business activities of another company as an associate with unlimited liability, or hold a controlling interest in another company with the same or similar scope of business
  • perform the office of a director or other statutory or other body, or be a member, of another legal entity which carries on the same or similar business, unless the companies are members of the same holding group.

If a director becomes aware of a conflict that may arise between their interest and the interest of the company during the exercise of their office, they must declare that to the other members of the board as well as the supervisory body or, if not established, the general meeting. The same applies to potential conflicts of interest of persons who are closely related to a board member, and persons influenced or controlled by that member.

In addition, a director must notify the general meeting of an intended entry into an agreement with the company where they are acting as a director. The same applies to contracts between the company and any person who is closely related to the director, and persons influenced or controlled by them.

10. What other general duties does a director have?

The duties of a director are set out in the Act on Business Corporations and are supplemented by a number of other binding rules. In general, the directors must:

  • exercise their range of powers with due managerial care, i.e. the directors are obliged to act (a) in favour of the company (i.e. loyalty) and (b) with diligence and knowledge, and not disclose confidential information and facts to third parties if such disclosure might be detrimental to the company
  • act in the best interest of the company; the burden of proof lies with the director if they are allegedly in breach of such duty of care
  • follow the principles and instructions adopted by the general meeting, provided that they conform to law and the articles of association
  • keep all mandatory evidence, accounts and a list of shareholders and keep shareholders informed of matters regarding the company
  • convene a general meeting at least once a year. This period may be shortened, but not prolonged, by the company’s memorandum or articles of association or by law. In addition, the directors are obliged to convene a general meeting of the company in specific circumstances (for example, upon a shareholder's request or if the company is in a poor financial situation)
  • attend the general meeting
  • produce minutes of general meetings and file notifications to the commercial register and other authorities as required
  • file, without undue delay, an insolvency petition to initiate insolvency proceedings in respect of the company if the conditions stipulated by insolvency law are met. If this duty is breached (even negligently) the directors will be liable for the damage corresponding to the difference between the amount of the receivable identified in the insolvency proceedings and the amount of the receivable that the creditor actually received.

11. To whom does the director owe duties?

The director’s duties are owed to the company itself, rather than to its shareholders. In practice, when the company is solvent this means acting in the best interest of the shareholders as a whole.

12. How do the director’s duties change if the company is in financial difficulties?

Directors have a statutory duty to promote the company’s success for the benefit of its shareholders. This includes a duty to avoid insolvency. Directors are obliged to convene a general meeting and propose a solution, e.g. additional (equity) funding or a stand-still agreement, in case of impending insolvency. If there is no apparent solution to the impending insolvency, then the company will most likely become insolvent. This is when the duties of the board typically shift towards the company’s creditors and the directors will be obliged to file an insolvency petition. Failing to do so would typically result in unlimited liability for the board members. This liability is significantly wider under Czech law than the English concept of wrongful trading. It may also lead to the directors being disqualified from taking up directorships in the future.

On the other hand, filing an insolvency petition if your company is not insolvent could make board members liable for damaging the reputation of the company and decreasing its value.

Directors are not expected to be experts in every area that will arise in connection with company management, but they are expected to show that their decision-making and future expectations were based on sound reasoning, and use the help of an expert when there is a need to do so.

13. What potential liabilities can a director incur?

Directors owe their duties to the company and are therefore potentially liable to the company itself in respect of any breach of those duties; directors will not generally incur direct liability to individual shareholders. Most of the general duties under the Act on Business Corporations are fiduciary duties and as a result a director in breach may be liable to compensate or account to the company.

In the event of bankruptcy, the insolvency court may decide that a director is liable for fulfilment of all the company’s obligations if he/she knew or should and could have known that the company was facing an imminent threat of bankruptcy and, in breach of the duty of due care, failed to take all necessary and reasonably foreseeable steps to prevent it.

It is also possible for directors to assume personal liability to third parties if the circumstances show that they held themselves out as doing so, or if they led the third party to believe that they had authority to act on the company’s behalf.

14. How can a director limit his/her liability?

Any arrangement between the company and a director for relieving the director from liability for damage caused by them to the company, or limiting their liability, is null and void.

A company is permitted to purchase directors’ and officers’ insurance on behalf of its directors, and it is usual for such insurance to be put in place.

Helen Rodwell
Helen Rodwell
Managing Partner
Prague
Image of Lucie Halloova
Lucie Halloova
Senior Associate
London