Investment banks and other financial institutions structuring cross-border finance involving the Czech Republic are facing the unusual exterritorial effect of the Czech legal regulations prohibiting chains of single shareholder companies. The prohibition may also affect the legal affairs of entities domiciled outside the Czech Republic.
The most common way for foreign investors to do business in the Czech Republic is to establish a subsidiary company in the form of a limited liability company. This legal form is very similar to the German GmbH and resembles a limited liability company, as it is known in the UK. The subsidiary is an independent legal entity acting on its own account and having separate liability; such a subsidiary structure normally constitutes a reliable protection from liability for the shareholder.
In general, Czech law allows the formation and existance of a single shareholder limited liability company with a foreign legal entity as the sole shareholder. In fact, foreign investors frequently use the single shareholder company structure, involving a shareholder domiciled in a country with a more favourable taxation regime.
However, the Czech Republic, using its discretion in accordance with Article 2 of the Twelfth Council Company Law Directive (89/667/EEC), laid down special provisions on prohibition of chains of companies where a single shareholder company is the sole shareholder of another company. Pursuant to the Czech Commercial Code, a limited liability company which has a single shareholder (whether the shareholder is an individual, corporation or another entity) cannot become the sole shareholder of another limited liability company by way of (i) formation of a new Czech company, (ii) acquisition of 100% shares in the Czech company, or (iii) change in the shareholding structure of the foreign limited liability company which is the sole shareholder of the Czech limited liability company. The relevant provisions do not apply to joint-stock companies.
After a period of legal uncertainty, Czech courts and jurisprudence took the view that the prohibition of chains of single shareholder companies applies to any single shareholder limited liability company registered in the Czech Republic regardless of the fact that its sole shareholder is a foreign limited liability company whose affairs are not governed by Czech law. From this point of view, the fact that the laws of the jurisdiction of the sole shareholder do not prohibit chains of single shareholder companies is irrelevant. Thus, any single shareholder limited liability company, irrespective of the jurisdiction where it is incorporated, may not become the sole shareholder of a limited liability company organised under Czech law. On the contrary, if a Czech single shareholder limited liability company becomes the sole shareholder of a limited liability company incorporated outside the territory of the Czech Republic, the prohibition resulting from the Czech Commercial Code will not apply, and the legal feasibility of the structure will be considered exclusively pursuant to the laws of the place of incorporation of the foreign subsidiary.
A breach of the prohibition on chains of single shareholder companies has fundamental legal consequences. Without exception, a subsidiary established in violation of the prohibition is deemed invalid. As a result of such invalidity, the subsidiary will not be eligible for registration with the Commercial Register, and therefore its sole shareholder or any person acting on behalf of the invalid subsidiary will be directly liable for the acts effected by the invalid subsidiary. If the breach of the prohibition is discovered after the registration of the subsidiary in the Commercial Register, the courts are obligated to declare the subsidiary invalid and order its liquidation.
To prevent a breach of the prohibition, notaries and registration courts require evidence of the fact that the foreign founder of a Czech limited liability company or the foreign purchaser of 100% of its shares is not a single shareholder limited liability company. Typically, this may be evidenced by registry extracts or articles. As already noted, the prohibition does not apply to joint-stock companies. Czech registration courts have the competence to decide whether the legal form of a foreign sole shareholder corresponds to the legal form of a limited liability company pursuant to Czech law. As regards companies organised under the laws of EU member states, the company types listed in the Twelfth Directive as limited liability companies will be considered to be subject to the prohibition. The form of companies organised under the laws of other jurisdictions is assessed on a case-by-case basis.
The exterritorial effect of the Czech prohibition of a chain of single shareholder companies may be easily overcome by establishing a Czech subsidiary in the form of a joint-stock company instead of a limited liability company. However, the corporate administration of a joint stock company is more complicated than that of a limited liability company. Another solution is to install more than one shareholder at the Czech subsidiary. Again, this increases the cost of administration of the participation because the decision-making of two or more shareholders, though they are affiliated, is more complex in terms of documentation requirements than the decision-making of a single shareholder.
Pavel Marc and Ondrej Manek