June 2009 – This article discusses the latest controversial judgement of the Czech Supreme Court which stipulates that guarantees falling under Section 196a of the Czech Commercial Code do not need to be appraised by a court-appointed expert to be valid.
Section 196a (1) and (2) stipulate that a Czech limited liability company or a Czech joint-stock company (“Czech Company”) can enter into a loan agreement with (i) its directors, (ii) members of its supervisory board, (iii) its procurement holders or (iv) other persons entitled to conclude such an agreement on behalf of the Czech Company or (v) persons related to persons listed under (i) to (iv) (the “Persons”) or an agreement that secures the obligations of the Persons only with the prior consent of the general meeting and on arm’s length terms.
Section 196a (3) stipulates that, when a Czech Company purchases assets from or sells assets to a related person for a consideration equal to at least 10% of its subscribed registered capital, the value of such assets must be appraised by a court-appointed expert. If the assets are purchased within three years of the date the company was founded, the purchase must be approved by the general meeting of the company.
Section 196a (5) stipulates that Section 196a (1), (2), and (3) also applies when a guarantee is provided to related persons.
The wording of Section 196a (5) does not give any guidance on:
i) how Section 196a should be interpreted in relation to guarantees, especially what the court-appointed expert should opine on in relation to guarantees, and
ii) when the consent of the general meeting should be obtained.
The prevailing market practice is that, if the guaranteed amount equals at least 10% of the subscribed registered capital of the guarantor, a court-appointed expert will opine on:
i) the value of the guarantee,
ii) the consideration to be paid by the company whose debt is guaranteed to the guarantor, and
iii) whether the guarantee was provided at arm’s length.
In addition, if a Czech Company grants a guarantee to a company with which it shares the Persons, then the guarantee must be given (i) at arm’s length and (ii) with the prior consent of the general meeting.
First attempt of the Czech Supreme Court to give guidance on how to interpret Section 196a (3) in relation to guarantees
In this judgement[1], the Court ruled that, for a guarantee to be valid, the “price” of the assumption of a guarantee obligation does not have to be appraised by a court-appointed expert.
Although this judgement was probably driven by the Court’s intention to help the business community, it created unwelcomed legal uncertainty. In the end, this judgement was not accepted by the market or legal scholars as persuasive authority on this point of law because the judgement:
i) relates to the wording of Section 196a effective before 1 January 2001 and refers to the “price” of assets and not the “value” of assets,
ii) is not sufficiently reasoned,
iii) does not make it clear whether the Court has considered all possibilities of what a court-appointed expert should opine on in relation to guarantees (i.e. appraise the consideration to be paid by the company whose debt is guaranteed to the guarantor and whether the guarantee was provided at arm’s length),
iv) does not discuss opposing views expressed by leading legal scholars on this issue or why it prefers its interpretation to theirs,
v) has not been published in the official collection of important judgements of the Czech Supreme Court[2], and
vi) may be in breach of constitutional law as the Court has interpreted Section 196a contrary to the explicit wording of the law[3].
The latest attempt of the Court to give guidance on how to interpret Section 196a (3) in relation to guarantees
In this judgement[4], the Court ruled that:
i) Section 196a contains contradictory rules about under what conditions the consent of the general meeting of the company is required in connection with granting guarantees. Consequently, Section 196a cannot be interpreted literally, but logical and purposive arguments must be used,
ii) although the guarantee obligation has a monetary value for the debtor which could be appraised, it is not required in relation to guarantees − the reason being that such appraisal is not required in relation to (a) a security in the form of a pledge and (b) interest payable under a loan agreement, which also fall under the scope of Section 196a and have a monetary value that could be appraised,
(iii) a Czech Company is sufficiently protected because it must provide a guarantee with the consent of the general meeting and at arm’s length, and
(iv) if the guarantee was invalid insofar as it was not appraised by a court-appointed expert, it could unfairly prejudice the rights of innocent third parties.
The latest judgement is more valuable to the market because it:
(i) relates to the currently effective wording of Section 196a,
(ii) is better reasoned,
(iii) makes it clear that the court has considered what else could be appraised in relation to guarantees besides the amount of the guaranteed obligation; and
(iv) explicitly stipulates that no expert opinion is required in connection with granting a guarantee by a Czech Company that falls under the scope of Section 196a.
However, the latest judgement could be disregarded by legal practitioners for the following reasons:
(i) unfortunately, the Court’s arguments presented in the judgement are not entirely convincing[5], and
(ii) it may be in breach of constitutional law as the Court has interpreted Section 196a contrary to the explicit wording of the law[3].
While the judgement is definitely positive news to the market in the sense that the Court has interpreted an unclear section of the Czech Commercial Code in a way that could decrease transaction costs and increase the speed of business transactions, it remains to be seen whether it will be accepted as authority by the lower courts and legal scholars and whether it will help to change the prevailing market practice in relation to the appraisal of guarantees.
____________________________________
[1] 29 Odo 996/2004, dated 30 August 2005
[2] Judg ments published in this collection are deemed to be more persuasive and are more likely to be followed by lower courts.
[3] Section 196a (5) stipulates that Section 196a (3) applies to guarantees. Section 196a (3) stipulates that the value of the transferred assets must be appraised by a court-appointed expert. Yet the Court has concluded that guarantees do not need to be appraised by a court-appointed expert.
[4] 29 Cdo 3276/2008, dated 22 April 2009
[5] For example, the Court has stipulated that a Czech Company is protected even if no expert appraisal is required, because Section 196a (1) (2) applies to granting guarantees by a Czech Company. Consequently, in the Court’s view, a guarantee must be provided at arm’s length and with the prior consent of the general meeting. However, Section 196a (1) (2), in our view, applies only to guarantees provided by a Czech Company to entities with which the Czech Company shares the Persons. Guarantees provided by Czech Companies to other entities are outside the scope of Section 196a (1) (2).