On 1 January 2012 the legal framework regarding conflict of interest in Sec. 196a of the Czech Commercial Code (“CC”) was significantly changed by an amendment of the Commercial Code, followed by a recent decision of the Czech Supreme Court, which turned the old practice upside down.

Loans and security

Before 1 January 2012, Sec. 196a par. 1 and 2 of the CC stipulated that certain transactions (e.g., loans, securing debts, etc.) could only be executed with the prior consent of the general meeting and had to be concluded under the conditions customary in commercial dealings (podmínky obvyklé v obchodním styku). These requirements applied to the transactions between a company and its statutory body, members of supervisory boards, procurists, other persons entitled to conclude such agreements on behalf of the company or their related persons (osoba blízká). The same applied to transactions with companies on behalf of which the same persons can act.

In addition, for the granting of a guarantee the practice required that it be evaluated by a court-appointed independent expert followed by some kind of confirmation that the guarantee is provided under the conditions customary in commercial dealings. This was caused by an incorrect cross-reference referring to the regime of asset’s transfers.

As of 1 January 2012 the requirements for transactions securing debts (including granting of guarantee) were simplified and unified. In response, the only requirement which remains in place is to obtain the consent of the general meeting with such transactions, unless the controlling entity secures the debts its controlled entity. If the consent is not granted when required, the transaction will be held as null and void. As a result, expert evaluations shall no longer be required in terms of validity of the transactions. The general liability of the executives, board and supervisory board members to act with the care of diligent manager and not to allow the company to enter into detrimental transactions unless special conditions are fulfilled remains unchanged.

Transfers of assets

The amendment changed also the consequences of a transfer of assets that violates the regulation set forth in Sec. 196a par. 3 of CC.

If the sale/purchase of assets involves companies creating a concern or a company and its founders, shareholders or persons acting with them in agreement or the persons specified in paragraphs 1 and 2 of Sec. 196a of the CC (see above), special requirements have to be fulfilled if the consideration is equal to or higher than 1/10 of the company’s registered capital.

In such a case, (i) the transferred asset has to be evaluated by a court-appointed independent expert; (ii) can be transferred for consideration which  matches the award of the expert; and (iii) only with the general meeting consent (even if subsequent), if the sale/purchase occurred within three years from the company’s incorporation.

If any of these conditions are not complied with, the transaction is deemed as null and void unless a statutory exception applies. This had severe consequences in particular as regards real estates. If the first transfer of real estate was null and void, the whole string of subsequent transfers was also null and void and the subsequent transferee, even if in good faith, did not legally acquire the assets, unless acquired by way of expiration of 10 years prescription period. The amendment, therefore, changed the treatment of subsequent property transfers. The aim is to give greater protection to the subsequent transferee. Now if the subsequent transferee acts in good faith, he/she will legally acquire the ownership to the real asset immediately.

To make the change complete, the Czech Supreme Court changed its opinion as regards the asset transfers without expert evaluation. Surprisingly and contrary to its previous stable decision making, in February 2012 it has ruled that the lack of evaluation by a court-appointed independent expert does not necessarily cause the invalidity of transfer as long as the consideration received by the selling company was customary in commercial dealings. As this entire concept will completely disappear with the new Act on Corporation, effective from 1 January 2014 this revolution, although reasonable and welcomed, seems to come a bit late.

Conclusion

The new legal framework is definitively a step forward as it simplifies the security transactions in terms of cost of the debtors and for good of the creditor – conditions customary in business dealings will not be a reason of their invalidity anymore. However, we do not expect the expert evaluations to disappear completely as they may still be of use as one of the tools mitigating the potential commercial/criminal liability of the executives/members of the board of directors of the companies which provide security.

The amendment has to be evaluated positively also with respect to asset transfer regime. Apart from mentioned removal of the invalidity of further assets transfers, where the first transfer violated Sec. 196a par. 3 CC, we may see the movement in old practice represented by the latest resolution of the Czech Supreme Court. The new practise will strengthen the protection of good faith of subsequent transferees and remove the paradoxical and common situation, where the transfer on arm’s length basis was held invalid only for lack of expert evaluation. Unfortunately, this will not change the position of already affected individuals and entities.