| Author: |
Aleš Kubáè, Ambruz & Dark, advokáti, v.o.s |
| Publication: |
Czech business weekly |
| Date: |
14. 5. 2007 |
The recently published PricewaterhouseCoopers (PwC) CEE M&A Survey 2006 reveals that the number of merger and acquisition transactions in the Czech Republic in 2006 increased by 11 percent with a total of 269 disclosed M&A transactions and an average deal size of $91.8 million (Ka 2 billion/E 72.4 billion). Mergers and acquisitions as a tool for business expansion and profit increase are becoming more popular, especially with foreign investors. But are there any legal risks connected with acquisition of a Czech target?
Some contracts include provisions requiring the consent of one party in the event the other party is acquired by another company, and/or enabling one contracting party to withdraw from the agreement, charge a contractual penalty or perform any other hostile act if there’s a change in the shareholding of the other contracting party or the other contracting party ceases to exist as part of the post-acquisition restructuring process. These provisions are usually the first to look for when performing a due diligence in the Czech target company, as their implications can in some cases have a significant impact on the Czech target’s business in the postacquisition period, especially if these provisions are included in agreements securing financing of the business activities of the Czech target and the foreign investor isn’t prepared to change the financing structure.
Timely identification of the change of control provisions enables the investor to arrange for fulfillment of the requirements imposed by such provisions or amend the respective contracts prior to adopting the final decision on acquisition. Furthermore, knowledge about the existence of such provisions strengthens the investor’s negotiating position as he can, in most cases, argue that fulfillment of such a requirement is connected with additional costs or represents a certain risk for the Czech target’s future and that such circumstances should therefore be adequately reflected in the transaction documents. Employee issues The PwC survey identifies that most M&A transactions are executed close to the investor’s home country. Cultural differences seem to be one of the key factors for acquisition in a particular country and give us a clue as to why companies from Western Europe consider the CEE region so attractive. Investors seem to be aware that it’s especially the good relationships between management and employees that play a decisive role in the future profitability of the target company.
Bearing in mind the importance of employee satisfaction, it’s not surprising that employee issues are one of the most important topics to consider prior to acquiring a company in the Czech Republic. Although the new Czech Labor Code establishes more flexibility in employment relationships, Czech labor law is still rigid and makes many changes in employment relationships disadvantageous for the employee, and difficult and costly for the employer. Employee issues become even more important in cases when post-acquisition restructuring is connected with laying off some of the Czech employees.
It should also be noted that Czech labor law doesn’t provide clear solutions to some problems that could emerge in connection with acquisition and subsequent restructuring of a Czech target. For example: what happens if the investor plans to merge two of its companies in the Czech Republic and, based on the concluded collective agreement, employees of the acquiring and the acquired company have different levels of employee benefits? According to nondiscrimination principles, the employees of the one merging company shouldn’t have a different level of benefits than the employees of the other once both companies are merged. But does the merger in this case automatically result in the necessity to provide all employees with the higher level of benefits (from which employees of one of the merging companies benefited before the merger), or is it possible for the two collective agreements to coexist for a certain period of time?
Given the uncertainty brought by the new Labor Code, the best solution for the investor acquiring a Czech company is again to perform a detailed due diligence to identify such issues and negotiate conditions with the seller that adequately reflect such risks.
Intra-group transactions It might seem that past intra-group transactions executed by the Czech target are of little importance to the investor acquiring the Czech target. Shouldn’t all past transactions be already reflected in the company’s accounting? So why should the investor care?
In fact, the intra-group transactions of the Czech target are one of the first things to review. Czech regulation of intra-group transactions is strict, and breach of the rules often leads to legal invalidity of the transfer. In the worst-case scenario, this might result in losing control over a substantial part of the company’s assets in the post-acquisition period, regardless of the records made in the company’s accounting.
Again, an example: Article 196a Section 3 of the Czech Commercial Code stipulates, among other things, that if the company or a person controlled by such company acquires property from its founder, shareholder or person acting in concert with it or another entity forming the same group of companies or other specifically listed persons (such as the members of the board of directors) for counter-fulfillment exceeding one-tenth of the registered capital as at the day of acquisition or sells such property to these persons, the value of the transferred property must be determined on the basis of a courtsworn expert’s analysis. If such a transaction is carried out in the three years after registration of the company in the Commercial Register, it must further be approved by the general meeting.
A judgment of the Czech Supreme Court adopted in 2001 introduced the interpretation that if the above requirements aren’t fulfilled, the respective transaction is legally invalid and can’t therefore have the desired legal implications (i.e., the transfer of the ownership right to the property) from the moment the respective legal act was executed. Bearing in mind that the minimum registered capital of Czech limited-liability companies is Ka 200,000, any intra-group transaction executed by a limited-liability company with minimum registered capital, in case of which the transaction value exceeds Ka 20,000, is subject to the above requirements and, if these requirements aren’t respected, must be considered as not having caused the ownership right to be transferred to or from the Czech target company. An investor acquiring the company several years later might then be surprised at the magnitude of the tax burden, especially with respect to value-added tax (VAT) and the undesirable legal implications with respect to ownership of the company’s assets that may be triggered by such breach.
Once again we come to the conclusion that a detailed due diligence and careful preparation of the acquisition agreement are the key factors for the success of an acquisition. Removal of legal deficiencies in the post-acquisition period may become extremely costly, if at all possible. It’s therefore recommended that investors pay close attention to selection of their legal advisers and ascertain whether these advisers have sufficient experience with the due diligence processes of Czech companies.
