Chaining of SROs still an issue

The Czech Republic is such a free country that even chaining of companies is not allowed, writes Arthur Braun of bpv Braun Partners

Expert files|Business Essentials|Companies
Guest Writer | 10.02.2012
Chaining structures can cause problems once a due diligence is made

Now, what does this chaining mean? This means the provision in § 105 para. 2 Commercial Code which was introduced in 2001 and which prohibits a Czech s.r.o. to have as sole shareholder another s.r.o. (or similar legal form if it is a foreign company) with only one shareholder. Despite the almost 11 years of existence by now, thousands of Czech s.r.o. still have this illegal structure and — at least theoretically — face liquidation by decision of the Commercial Court.

Even though there are no cases known that companies were actually liquidated by such a court decision, in practice such a chaining structure may cause problems once a due diligence is made into the s.r.o., and lawyers will only be too happy to herald a finding in their investigations. Moreover, we had already encountered that such s.r.o. had problems getting bank financing.

In practice you see many companies having 99% and 1% ownership, which on its own creates administrative problems as shareholder meetings require more paperwork and the 1% shareholder is not exempt from dividend tax under the relevant EU directive (as well as some double tax treaties).

So we have pure formalism that causes costs in daily management and additional taxation — why? The reason lies in a wrong interpretation of the Art. 2 para.2 of the Twelfth Council Company Law Directive 89/667/EEC of 21 December 1989 on single-member private limited-liability companies that interestingly enough has been shared by many of the new EU members of the 2004 and 2007 accession waves.

The Czech Republic interpreted the provision that allows national laws to sanction chaining “…may, pending coordination of national laws relating to groups …” as an order to prohibit. The idea was that with payment of one basic capital you should not be able to create a chain of, say 10, s.r.o. paying the same basic capital into each company and thus increasing creditor protection.

Arthur Braun

The Czech and Slovak solution (giving 1 % share to the grandparent company) obviously does not help the creditors of the s.r.o. a lot. And slowly it has come to the mind of reasonable people that the basic capital is anyway not the most efficient measure for protecting a company’s creditors, otherwise there would not be so many companies in the insolvency register with basic capital in the hundreds of Mio koruna.

Poland for instance solved this differently. There, only at the moment of incorporation the limited liability company must have more than one shareholder. In practice, immediately after incorporation the shares are unified, thus reaching the desired (and economically most reasonable structure). Romania on the other hand, will give a small shareholding to the limited liability company itself in order to circumvene a similar prohibition in its corporate law.

Good news for Hungarian shareholder, making it a positive model for the region, finally: Their lawmaker simply deleted the former prohibition on chaining form its corporate laws after seeing that it failed to reach its goals.

The reform of Czech corporate law scheduled to take effect in 2014 will delete the chaining prohibition also for the Czech s.r.o. Interesting is the reasoning of the new Act on Corporations (done by the Ministry of Justice) as it rightly points out, “it is not necessary to encumber Czech companies more than necessary.” But the 2012 reader may ask with the same right: If the lawmaker now accepts that the provision is an unnecessary encumberment to the Czech s.r.o., why did he not delete it together with the other changes of the Commercial Code that took place on 1 January 2012 but keeps the provision for more years?

So one misunderstanding will have had a lifespan of at least 13 years.

Rechtsanwalt and advokát Arthur Braun is a partner at bpv Braun Partners 

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