A large number of various types of transformation take place in the Czech Republic annually. However, each transformation has its pitfalls. In an interview with Jan Šafránek, partner of bnt Prague office, we discover what principles of company transformations in practice work and what do not.
Is it possible to say what forms of transformation are most popular in the Czech Republic?
It’s absolutely clear. Mergers by acquisition and spin-offs are the most common types of transformations in the Czech Republic. Merger by acquisition is the process whereby two or more companies cease to exist and another already existing company, the so-called acquiring company, becomes their general legal successor. All assets and liabilities of all companies being acquired, as well as all employees, are transferred to the acquiring (succession) company. In the case of a spin-off, an earmarked portion or portions of assets of the company that is being divided is transferred to one or more acquiring companies. A process whereby the spun-off part of the assets is transferred to already existing acquiring company is called a spin-off by merger. A process whereby the spun-off part of the assets is transferred to a new company is called a spin-off with the establishment of a new company (new companies). A combination of both types is also possible. The biggest advantage of spin-off is that the company being divided does not cease to exist at the moment of the spin-off. In practice I quite often encounter also a change in the legal form, most often a change from a joint stock company to a limited liability company or from a limited partnership to a limited liability company.
What is the most common reason behind the transformation of a commercial company?
In my opinion, the main driving force of all transformations is a combination of two factors. Firstly, transformations are generally tax-neutral. Therefore, the transformation allows you to move assets, debts and people between companies involved in the transformation without any adverse tax impact on such companies. Secondly, moving the assets, debts and people is very simple. All you need to do is to have a transformation project and to meet all legislative requirements of the Transformation Act (in particular, the obligation to provide information to partners, creditors and sometimes also debtors of the involved persons, the obligation to inform/discuss the transformation with employees of the involved companies, the obligation to work together with a notary public, and sometimes with an expert, etc.). In addition, legal effects of the transformation occur as of one moment, namely the date of the registration of the transformation in the Commercial Register. The transformation can be, and often is, challenging from the organizational, time and financial points of view, however, these negatives are balanced by the fact that the transfers of assets and debts occur lawfully as of the date of the registration of the transformation in the Commercial Register, and without the need of any separate meetings with all contractual partners of the companies involved.
There are a number of reasons for the transformation. One of the typical scenarios is a pre-acquisition transformation. In such event a portion of assets (debts and persons) that are being sold is earmarked into a separate company. This is followed by the transfer of the ownership interest in the company, not the direct transfer of individual items of assets or debts and individual persons. Another typical scenario is restructuring of the business. In such event individual and often unrelated parts of the business are earmarked into separate companies or real estate is earmarked from operating or production companies so that the real estate be protected to the maximum extent possible against risks associated with conducting business. Contrary to that, mergers often occur after acquisitions or within the establishment of joint ventures.
What economic risks have to be taken into account in relation to transformations?
As I have already mentioned, transformations tend to be tax-neutral. However, it is prohibited that tax reasons be the sole or main reason for transformation. If it were the case, the companies involved could attract the attention of financial authorities. In general, I would answer this question rather by giving a recommendation. Prior to each transformation, it is appropriate to model opening balance sheets of acquiring companies, or of the company that is being divided, in order to find out (not only economic) implications of the transformation. This is how we can find out that the transformation may cause bankruptcy of any of the companies involved (such transformation cannot be at all implemented since such implementation would be illegal), or that any of the acquiring companies or a company being divided might have negative equity as a consequence of such transformation, or that such transformation may lead to impaired credibility of any of the companies involved or recoverability of claims of the creditors of the companies involved.
What legal issues may endanger a company transformation?
Based on my rich experience, the only relevant risk for the transformation are often the companies themselves and their representatives. The companies involved should be aware that to carry out a transformation is demanding from the organizational, time and financial points of view, and it should be given appropriate attention. This means that excellent co-workers should be allocated to this process and they should have enough time to carry out tasks related to the transformation, and, ideally, the implementation of the transformation (and in particular its coordination) should be entrusted to an experienced advisor, attorney or tax advisor. The transformation should be managed and coordinated by one person based on a schedule agreed in advance. In the event of spin-off the maximum attention should be given to the definition of the parts of assets that are to be transferred to individual acquiring companies.
In general, a transformation may be impeded by prosecution of a legal entity. In such event the transformation is basically only possible with the consent of the court. Some transformations cannot take effect, unless the respective administrative authority, such as the Office for the Protection of Competition, Czech National Bank, etc., grants its consent.
How challenging can the transformation be from the time and cost points of view?
In terms of time, it has to be taken into account that the transformation will take at least 3–4 months. If an expert is involved, it can take up to 5–6 months. Naturally, everything can be accelerated but in my practice I have seen transformations implemented faster than in three months only very exceptionally. By implementation I mean a period from the decision to carry out the transformation to the registration of such transformation in the Commercial Register. Fast and problem-free transformation is not possible without a close collaboration with one of the notaries.
Jan Šafránek, together with Lola Laštovičková, are main authors of the Practical Commentary on the Czech Transformation Act, which is currently being published by Wolters Kluwer Publishing. More information available here.