Disproportional Dividend Distribution in Latvia: How Flexible Really Is it Today?

In 2023, amendments to the Commercial Law of Latvia changed the game for dividend distribution. Previously, dividends had to be split proportionally among shareholders based on their ownership stakes. The amendments may seem to offer complete freedom: just add a line to your articles of association saying "the company may distribute dividends disproportionally," and you could create any distribution mechanism you wanted. It looked like total flexibility with minimal legal requirements. Sounds simple, right? Well, not quite. While this change initially appeared to give companies unlimited freedom, the reality has turned out to be a little more complex.  This article breaks down the legal framework developments and reflects on the current situation of disproportionate dividend distribution in Latvia.

Legal Framework - Recent Developments

Commercial Law stipulates the basic rule that the dividends should be paid out to shareholders proportionally to the sum of nominal values owned by them, unless the company’s articles of association provide a different distribution procedure.

While it seems that the basic rule provides relatively full flexibility, the Register of Enterprises adopted two decisions (Decision No. 1, Decision No. 2 - in light of the Economic court case)  that significantly clarified the framework of the basic rule regime and narrowed the scope and its flexibility, requiring detailed provisions in the articles of association as the only internal rulebook for implementing the disproportional distribution mechanism. The following passages briefly introduce the State Notary and court key findings on the disproportionate dividend distribution framework:

1. Because articles of association bind the company internally (founders, shareholders, and officers), they must spell out every rule that binds shareholders and also the rights that each shareholder is entitled to. Since the law requires the articles of association to be undeniably clear about the rights each share entitles its shareholders to, there cannot be a situation where the mechanism of dividend distribution is not clear, understandable, and binding to each of the shareholders. Therefore, initiating another internal document as a source of information for the disproportionate dividend distribution mechanism does not meet the legal threshold.

2. Additional legal nuance concerns linkage to other documents. The Economic court case established that an abstract scope of rights to dividend distribution is unlawful, particularly in cases where the dividend amount would be determined by a shareholders' resolution each time dividends are distributed. This notion and such a view were also stipulated in the Register of Enterprises decision, stressing the matter of unified understanding. Furthermore, the decision acknowledges that, while shareholders may be entitled to disproportionate dividends, there cannot be a situation where a shareholder is omitted from the right to receive dividends – it is the inherent right of a shareholder, therefore, companies must avoid introducing a mechanism where some shareholders do not have the right to receive dividends.

The aforementioned decisions have established important foundational principles for disproportionate dividend mechanisms in Latvia: (i) the mechanism must be determined exclusively in the articles of association, with references to external documents being insufficient; (ii) every shareholder must retain the right to receive dividends; and (iii) the mechanism must be sufficiently clear and transparent so that all shareholders, as well as third parties, can understand how dividends will be distributed.

Despite these rules, significant questions remain for venture capital deals. In startup investments worldwide, it's common for investors to receive dividends first (or receive higher amounts), while other shareholders may receive nothing during certain periods. Furthermore, companies typically keep their dividend distribution formulas confidential, particularly when dealing with complex ownership structures or employee incentive programs.

Given the principles established by the Register of Enterprises and the Economic court, it would be of considerable interest to observe how the current legal framework might accommodate typical venture capital structures and other common international disproportional dividend practices, such as preferential dividend rights or arrangements where certain shareholders may not receive distributions during specific periods, present an intriguing question as to whether the existing regulatory scope leaves room for such mechanisms or whether they might fall outside the boundaries contemplated by the authorities.

Practical Implications 

1. Publicity / Public Strategy Exposure

The articles of association are a publicly available document, serving to increase trust, transparency, and good governance among shareholders, management, board members, and within the company, while also making information accessible to third parties. However, the requirement for a full and clear dividend distribution mechanism in the articles may raise significant concerns about confidentiality and competitive positioning for the company.

When the mechanism in the articles of association spells out how dividends deviate from pro rata distribution - especially in situations where certain shareholders or investors receive preferential treatment or motivational mechanisms through dividends - market competitors can access this information freely and react to it in ways that can lead to negative consequences for the company, for instance, by attracting key employees with higher dividend treatment. This exposure alone can weaken the company's negotiating leverage or even encourage competing offers that "outbid" the disclosed terms to attract the same investors or shareholders. Companies therefore, must carefully balance the benefits of disproportionate dividend mechanisms against the strategic risks of mandatory public disclosure.

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 2. Mechanism Adaptability / Changing Business Needs

Business conditions change rapidly. Market disruptions, such as the COVID-19 pandemic, can fundamentally alter business environments. A dividend structure that is optimal under current circumstances may become unsuitable as market conditions evolve. The challenge is that specific disproportionate dividend provisions must be incorporated into the articles of association, and amending these provisions can be complex and may present significant obstacles.

If the current dividend approach becomes inadequate, amendments to the articles of association will be required. This necessitates convening a shareholder meeting and obtaining approval from a qualified majority of shareholders. If the shareholders are unable to reach the required voting threshold, or if any shareholder exercises a veto right, or if multiple shareholders vote against the proposed amendment, the disproportionate dividend mechanism cannot be modified to address the new circumstances. This inflexibility may adversely affect all shareholders and impair the ability to achieve equitable dividend distribution.

3. Threshold Requirements / Sufficient Detail Standards

While decisions of the Register of Enterprises clarify that dividend distribution mechanisms must be specific and detailed in the articles of association, these decisions do not provide a clear threshold for what constitutes 'sufficiently clear' detail. The general principle requires that mechanisms be understandable to all shareholders and third parties, but there is no definitive standard. The same mechanism, when described in different ways, may be accepted in one case but rejected in another, thereby creating inherent uncertainty in the registration process.

Further complicating this uncertainty, it remains unclear whether strategies or mechanisms that include several variables, particularly those that are difficult to define clearly and result in dividend distribution methods that are not easily understandable or predictable, would be rejected by the Register of Enterprises as insufficiently clear. Such complex mechanisms might technically satisfy the requirement for detailed provisions while still creating confusion about actual dividend outcomes for shareholders.

The Register of Enterprises requires "sufficient information," but there is no clear checklist or defined standard. This uncertainty cuts both ways – it gives you flexibility to design what works for your company, but it also means the Register might reject your articles if they think you haven't provided enough detail. This could lead to delays and multiple rounds of revisions when you're trying to set up or modify your structure.

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The Opportunity (Despite the Challenges)

Despite these challenges, the ability to deviate from pro rata dividend distribution represents a valuable legal development. While the Register of Enterprises decisions have narrowed the scope of flexibility, implementation remains feasible for companies willing to navigate the requirements. With proper attention to the applicable legal framework, disproportionate dividend distribution can offer meaningful practical flexibility.

Experience suggests - both from national practice and comparable international approaches – that this flexibility tends to work more effectively when structured around clear, measurable variables. Some commonly successful approaches include:

·   Time periods that trigger different dividend patterns,

·   Key performance indicators or milestones,

·   Financial prerequisites,

·   Share-category-based limitations,

·   Other metrics, mechanisms and strategies.

The key to successful adoption of disproportionate dividend distribution lies in careful planning and professional guidance to navigate the legal requirements and other considerations while achieving specific company goals and minimizing potential risks.

Wrap-up & conclusions

Recent developments in the legal framework have demonstrated that while flexibility for disproportionate dividend distribution exists, it is not unlimited. Several important considerations must be taken into account, from public exposure of strategies to regulatory uncertainty. Nevertheless, when structured and defined properly, this mechanism provides a valuable option for companies to tailor their dividend approach to specific business needs.

Current limitations and legal scope create grey areas and different concerns, particularly in venture capital contexts where the common practice of preferential dividend arrangements can result in investors receiving back their investments while founders receive no dividends, with distribution mechanisms often remaining confidential in shareholder agreements rather than public articles of association, and others. Nevertheless, companies in Latvia have substantial flexibility to implement effective dividend distribution mechanisms tailored to their business needs. When prepared in accordance with case law and Register of Enterprises decisions, these mechanisms can offer meaningful opportunities for strategic dividend planning.

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The information in this article is general and not intended as legal advice. It is for information purposes only and does not reflect any particular situation or circumstances and should not be relied upon as a source of professional advice.

Authors: Jēkabs Senkāns, Lawyer and Daiga Kroņkalne, Junior Lawyer at Venture Faculty