Corporate groups under the Czech Republic’s new civil law
February 2014 | LEGAL & REGULATORY | CORPORATE LAW
Financier Worldwide Magazine
An extremely important legal change occurred on 1 January 2014 in the Czech Republic. After more than 10 years of tremendous effort from its creators and uncountable hours of fierce discussions between its devotees and critics, a new civil law became effective. With the aim of cleansing the legal system of its socialistic past and unnecessary complexities, the legislators prepared a modern, practical and easy-to-use law which should reflect the needs of private and business life in the 21st century. In connection with this unprecedented fundamental change in law, the largest since the Velvet Revolution in 1989, more than 200 laws have been repealed and more than 70 laws substantially amended.
Among the newly enacted laws, the Civil Code (Act No. 89/2012 Coll.), dealing with all private law matters of individuals and corporations, and the Act on Business Corporations (Act No. 90/2012 Coll.), concerning corporate matters and dealings of business corporations, are critically important. In this article we will focus on some of the key changes introduced to relations within corporate groups under the new civil law. Special attention will be given to liabilities of a corporation exercising influence, i.e., the influential corporation, over another corporation, i.e., the influenced corporation. Legal risks ensuing from these relations within corporate groups may be particularly important for foreign holding (mother) corporations and their local subsidiaries seated in the Czech Republic.
In order to safeguard the interests of creditors and to increase flexibility within corporate groups, the new law introduces three levels of relationship within a corporate group: influence relations, control relations, and relations within corporate groups (concerns). While control relations have not undergone substantial changes under the new law, with the exception of broadening the scope of presumed control, influence relations and relations within concerns have been either newly codified or undergone substantial changes. Despite the obvious similarities and overlapping in these three levels of relations, there are also basic differences which the new law distinguishes rigorously.
Any influential individual or corporation which may, by using its influence within an influenced corporation, directly or indirectly, significantly and decisively affect the influenced corporation’s behaviour (actions) to the influenced corporation’s detriment, indemnifies the influenced corporation for any such detriment. In addition, any such influential entity guarantees the claims of the influenced corporation’s creditors that the influenced corporation is unable to fulfil as a result of the influence. Importantly, however, any such influential entity will only be liable under this influence relation rule, if it has significantly and decisively affected the behaviour of the influenced corporation, the influenced corporation suffered harm as a result of such influence and there are no conditions on the side of the influential entity exculpating the influence exercised by the influential entity. A shareholder with voting rights in the corporation, typically a controlling entity within a corporate group structure, will most likely be considered an influential entity. However, given that any influence must be ‘significant’ and ‘decisive’ and must lead to ‘harm’ to the influenced corporation, the risk that any common exercise of voting rights by a shareholder (controlling entity) in a corporation (controlled entity) will be considered as influence with all the mentioned negative consequences for the influential entity is remote. On the contrary, the influence relation rule could be triggered by various shadow directors, or de facto directors, who in fact directly influence management of a corporation without being a corporate body of such corporation. The influence relation rule may thus be quite important for lenders in the case of facilities agreements including provisions enabling them to influence the behaviour of debtors in the event of their default.
It is evident that while generally guarding the interests of shareholders and creditors of corporations, the new law brings uncertainty to influential entities and their behaviour vis-à-vis corporations in their sphere of influence. Fortunately, the new law recognises this and does not leave influential entities without a defence. Thus, if influential entities show that while exercising influence they could have reasonably and in good faith presumed that they acted with full awareness and in the defensible interests of the influential entities, they will not suffer the negative consequences of the influence. Although the burden of proof stays, quite understandably, with the influential entities, the influential entities will no doubt have difficulties finding grounds for their defence. This may be the case until case law specifies in greater detail objective criteria for exercising ‘full awareness’ and acting in ‘defensible interests’.
The situation is easier for entities that exercise their influence within corporate groups (concerns), i.e., groups where one or more entities (managed entities) are subjected to integrated management of another entity or entities (managing entities). Within corporate groups, a managing entity will not be liable for harm caused to the managed entity, if the harm has been caused in the interest of the managed entity (or other corporate group member) and it has been or will be settled within the corporate group. In other words, this means that if the harm caused to the managed entity has been or will be settled within the corporate group by appropriate consideration or other demonstrable benefits ensuing from the membership in the corporate group, the managing entity will be stripped of the liability for the harm. Importantly, however, there will be no defence for harm caused by the managing entity to the managed entity, if, as a result of the influence of the managing entity, the managed entity has become insolvent.
One may argue that within corporate groups the managed entities may abnegate the right to the appropriate consideration or other demonstrable benefits and thus effectively circumvent the new law. This line of argument is prudent but fundamentally false, since the new law would consider any agreements limiting or precluding any rights of managed corporations within corporate groups as ineffective. As a matter of the new law, there is limited space for manoeuvring and legal creativeness of managing entities as the rules for the relations between the managed and managing entities are clear, concise and easy to interpret.
In general, the new rules safeguarding the interests of creditors and shareholders of corporations by regulating influence, control and corporate group structure relations bring much needed safety to these relations, while leaving enough breathing space and flexibility for the structures to effectively pursue their business aims. Obviously, for now it is too soon to judge the real effects of the new law as it has become effective only recently, but there is a strong belief that it signals a move in the right direction. If influential, controlling or managing entities, including foreign entities exercising influence over entities in the Czech Republic, prudently exercise their influence in line with the applicable rules while managing the potential risk of harm caused by their influence, the new law should only benefit their business efforts.
Jan Kotous is a senior associate and Kateřina Pechanová Babická is an associate at Wolf Theiss. Mr Kotous can be contacted on +420 234 765 214 or by email: firstname.lastname@example.org. Ms Babická can be contacted on +420 234 765 226 or by email: email@example.com.
© Financier Worldwide
Jan Kotous and Kateřina Pechanová Babická