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Slovakia: The Pitfall Named 59a – Still an Issue?

Slovakia: The Pitfall Named 59a – Still an Issue?

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One could argue that transparency and safeguard regulations in related-party transactions of companies should be well established and should not be an issue in M&As in the current environment. However, this is not the case with Section 59a of the Slovak Commercial Code, which found its way into the Code via the implementation of the Second Council Directive 77/91/EEC.

This Slovak implementation is an example of a narrow-minded approach, where formalistic requirements placed on related-party transactions carry serious and occasionally irreversible legal consequences, regardless of whether the transactions were made for a fair value.

The purpose of Section 59a is to introduce transparency to certain transactions between a company and its related parties. When a company acquires assets with a value exceeding 10% of its registered capital for a consideration based on an agreement (e.g., a purchase agreement or potentially even a contract for works) with its shareholder, founder, or a person directly or indirectly controlling or controlled by such persons, the company is obliged to have the value of such assets determined by means of an expert appraisal. The agreement will not become effective until it is filed in the publicly available Collection of Deeds along with the expert appraisal. Otherwise, the assets at stake and the price paid based on the agreement shall be considered unjust enrichment and must be returned. Furthermore, where registration in a special register (such as the Cadastral Register for real estate) is required for the transfer of the ownership title to become effective, the filing must occur prior to the registration.

The issue of Section 59a usually arises in real estate projects involving developers who acquire the real estate at the outset through an existing entity and then transfer it to their SPVs at a later stage (such as prior to initiation of the building permit process or when developed and ready for sale). The developers often fail to exhibit due care when carrying out such intragroup transfers and overlook the potential applicability of Section 59a. They also tend to believe that because they have executed the transaction at arm’s length and for a fair value, any formal deficiencies can be rectified. As a result, it is not uncommon to discover historic transfers in due diligence processes that do not fulfil the requirements imposed under Section 59a.

Unfortunately, the formal requirements tend to prevail over substance, and if they are not fulfilled before the transfer of real property is registered in the Cadastral Register, the deadline will have been missed. Unlike other jurisdictions which allow the remedying of such formal deficiencies by the subsequent producing of proof showing the fair value of the underlying transaction, there are judgments of Slovak courts rejecting late attempts to remedy and basically hold such transactions invalid. By neglecting this obligation in the Slovak corporate environment, a real estate SPV may thus not in fact be the owner in part or whole of its core assets. This may raise a serious red flag for further divestment that could jeopardize the entire transaction. There can be also severe side effects, particularly if numerous third party relations are attached to the property (e.g., through leases or secured financing). The issue is complex and often irreversible. In some cases, it may only be remedied by a reverse transfer of the defective property or by a merger between the affected entities. In other situations, where a realistic remedy would be achieved with difficulty, title insurance was procured. 

The situation with Section 59a was partially improved in 2016 when limited liability companies were no longer required to comply with the regulation, leaving it applicable only to joint stock companies. However, historical transactions with LLCs remain affected, and certain investment structures (such as real estate entities used by collective investment schemes) may still only be pursued via JSCs.

In light of the above, when assessing the title of an SPV in M&A transactions, attention should be paid to Section 59a during the legal due diligence process. We also advise taking a conservative approach in structuring transactions with exposure to related parties, as unjustified efforts to avoid the application of the regulation (e.g., by claiming the exemption of having the transaction executed in the ordinary course of business) may frustrate the future disposition with the property. 

By Juraj Fuska, Partner, and Alex Medek, Associate, White & Case Bratislava

This Article was originally published in Issue 7.12 of the CEE Legal Matters Magazine. If you would like to receive a hard copy of the magazine, you can subscribe here.