Board members, prick up your ears. Note what a recent verdict has to say about contracts not approved by the supervisory board

Nevertheless, if that is the case the company’s management should still proceed with caution.

The timing of court decisions can sometimes be funny. Take, for example, a recent ruling by the High Court in Prague and the Supreme Court in Brno. In April 2012, two verdicts made on the same legal subject matter only a day apart entirely contradicted each other. In instances such as this, however, the Supreme Court’s view prevails since it is the highest judicial authority in the Czech Republic and its rulings are binding for all other courts.

The gist of matter was this: Section 193(2) of the Czech Commercial Code provides that any contract entered into whereby a company is to acquire or dispose of assets whose value exceeds one third of its equity in a single accounting period (based on the most recent financial statements or consolidated financial statements) is subject to the approval of its supervisory board or, if the company has issued listed shares, the approval of its general meeting. This rule has been present in the Commercial Code for over ten years.

Not all companies comply with the rule in practice, however. In different cases, the High Court and the Supreme Court each ruled on the same issue, namely on the validity of an executed contract where the value of the assets to be disposed of exceeded one third of the company’s registered capital and approval was not granted by the supervisory board.
 
The High Court in Prague, which ruled on an appeal filed by one of the parties to the dispute, agreed with the opinion of a lower court that the rule was designed to protect a company’s assets “against deliberate intervention by the board of directors which could harm the company”. The final ruling agreed with the lower court’s opinion and held that the absence of approval from the supervisory board renders the agreement absolutely invalid.

How to find out the amount of the other party’s equity

The Supreme Court, however, took a different approach and stated that the rule does not apply to conflicts of interest (i.e. situation in which the interests of the statutory body are in conflict with the company’s interests) or situations where an affiliated party is the counterparty to the company. Nor does it apply to situations where the contractual partner can easily learn that the contract it is about to enter into is subject to the approval of the other party’s supervisory board, such as in the case of related parties transactions per Section 196a of the Commercial Code. In each of the circumstances outlined above, agreements not approved by the company’s supervisory board are invalid.

The third reason – the contractual partner’s inability to know that the contract is subject to the supervisory board’s approval – is the key one. “Even if a joint-stock company discloses its annual financial statements by depositing the same in the collection of documents of the commercial register, it is required do so after the financial statements have been audited and approved by the general meeting, with such disclosure to be made within 30 days after both said requirements are complied with (…),” stated the judges in the ruling. If the contract is entered into before the financial statements are disclosed, the other party has no chance of knowing the actual up-to-date amount of the first party’s equity and therefore whether the contract is subject to the supervisory board’s approval. In that case, the conclusion that the contract is ineffective because approval was not granted by the supervisory board denies the principle of legal certainty and reasonable arrangements of relationships. Therefore, the contract is valid and effective even if the supervisory board did not approve it.

Companies which have entered into a contract that was in conflict with the said provisions can “more or less” relax. The contract will not be considered invalid or ineffective, not even retroactively. But this does not mean there is no cause for concern. If approval is not granted by the supervisory board where the law requires it, members of the Board may be found to have violated their duty of due managerial care.