Liability for Czech Subsidiaries in 2014 (or the Liability of Foreign Mothers and their Czech Daughters)

The personal liability of directors will also be affected.

Lawyers are sometimes tasked with resolving liability issues that develop between foreign parents and their Czech subsidiaries, such as when a parent seeks to settle a dispute and demands that its Czech subsidiary renders performance, even though the consideration will be received by the entire corporate group and not necessarily by the Czech subsidiary. Another typical example is when a parent takes out a loan (or any other form of financing) and requests its Czech subsidiary to offer up its own assets as security.

These days there are several basic rules to follow. Generally, directors of Czech subsidiaries are required to pursue the Czech company’s best interests as an isolated entity and to act with due managerial care. If they do not, they could be held personally liable for any resulting damage. Moreover, if a lawsuit is filed, the burden of proof lies with the directors and not with the claimant. As far as the execution of particular agreements is concerned, generally a shareholder’s instructions are not binding on the Czech subsidiary and do not release the directors of the Czech subsidiary from liability. If the Czech subsidiary suffers damage as a result shareholder control, however, the shareholder will be liable, with compensation generally to be given by the end of the accounting period in which the damage was suffered.

Transfer of the Burden of Proof

One substantial change to be introduced when the new law comes into effect in 2014 is that the burden of proof in respect of a shareholder’s liability will be transferred to the defendant. If a shareholder (the parent company) or its director is sued for damage suffered by the Czech subsidiary or its shareholder, it will be the defendant who is responsible for proving in court that he/she/it is not liable for the damage.

With regard to the liability of a shareholder’s directors, the differences between the current and the new rules are more or less technical. While now all members of a shareholder’s or another controlling party’s statutory body act as guarantors, under the new rules they will be liable on a joint and several basis with the shareholder. Moreover, this will only apply to the directors who were directly involved in exercising control rather than to all board members.

The law in its current form states that foreign parent companies can legally influence their Czech subsidiaries (thereby eliminating their liability) but only within certain fixed limits. For example, while a particular action may be disadvantageous for the Czech subsidiary it must be beneficial for the corporate group as a whole. This principle will be preserved in the new Corporations Act for companies under unitary management, subject, however, to a duty to prove that the disadvantages to the Czech subsidiary have either been compensated or are at least counterbalanced by the advantage of being a member of the corporate group.

In addition, if a foreign parent company wishes legally to influence its Czech subsidiary in a particular transaction, it is currently required to enter into a control agreement which must be approved before a notary public. As a result, the shareholder is required to pay the Czech subsidiary’s accounting loss every year. Control agreements, however, will disappear in two years’ time as the new Corporations Act will abolish them entirely. As a result, a shareholder’s right to give its Czech subsidiary instructions that are not advantageous for the subsidiary will arise as soon as the Czech company announces on its website that it forms a corporate group with its shareholder and is under unitary management. In addition, the web address must be registered in and available at the Czech Commercial Register. In practical terms, however, bear in mind that, under Czech procedural law, in the event of a dispute, the contents of a website must be confirmed by a notary public.

Lead us not into insolvency!

The absolute limit for giving instructions to subsidiaries is – and will continue to be after 2014 – that the Czech subsidiary must not become insolvent as a result of those instructions. Any instructions or other act of control that renders the Czech subsidiary insolvent will at all times be accompanied by the risk that the shareholder and its directors will be held personally liable. While this principle was previously only inferred, it will be defined explicitly in the new legislation.

Lastly, one other feature to be introduced by the 2014 legislation is a new type of penalty to be imposed on all directors of a shareholder or on other controlling parties (without their being required to be formally on the shareholder’s or any other controlling party’s board) if the Czech subsidiary goes bankrupt as a result of any control exercised. If that happens, the penalty – which will be imposed by a bankruptcy court – will be a three-year ban on membership in the statutory body of any Czech corporation.