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Merging makes sense for companies with losses

Authors: Ludvík Juřička, Ambruz & Dark law firm
Dagmar Faltová, PricewaterhouseCoopers
Publication: Prague Business Journal, 22/04/2002

In the right circumstances, a merger can be a suitable solution for a company with losses.

If a company suffers negative equity, its statutory representatives have certain obligations. A statutory representative acts on behalf of a company and is liable not only for its operation, but also for any damage caused to the company by a breach of his or her duties. The statutory representative is also liable to the General Meeting of the company and is obliged to follow its instructions.

When the statutory representative determines that settling losses would use more than half of the company's registered capital, he or she must convene a General Meeting that will decide whether to wind up the company or adopt another measure—such as merging with a company that has positive equity.

Generally, a merger of two companies means that one is wound up without liquidation and deleted from the Commercial Register, while the other company becomes the legal successor. Both act as independent legal entities until the merging company (the one being acquired) is deleted from the Commercial Register. The business assets of the merging company, including its rights and employment obligations, pass to the successor on the day the merger is entered in the Commercial Register.

The common perception is that a merger is a very complicated process. However, when both companies have the same shareholder, the merger process can be quite simple. For example, two companies (A and B) owned by one shareholder are to merge. Company A has negative equity and settling its losses would use more than half of its registered capital.

Two scenarios are possible:

1. Company B has sufficient positive equity for the legal successor to have positive equity; or
2. Company B has insufficient positive equity for the legal successor to have positive equity.

The first scenario is less time-consuming and easier from an organizational point of view than the second option because no business shares for shareholders of the legal successor arise in the merging company. Company A is wound up without liquidation and deleted from the Commercial Register, and company B becomes the legal successor. The merging company is not obliged to have its equity evaluated by an official report if both companies agree. It would not be necessary to liquidate the merging company because this company would dissolve within the merger.

The second solution is more problematic and the merger would have more legal complications. The question arises as to whether the merger can be listed in the Commercial Register if the legal successor has negative equity. The court could decide that the merger is not an adequate solution if negative equity still exists after the merger. Solutions for this scenario could include:

bullet Increase of own capital by contributing money into other capital funds (simple procedure)
bullet Increase of the registered capital (complex procedure)

As of Jan. 1, 2001, the Czech Commercial Code states that a shareholder may increase the own capital by contributing money. Such a contribution must be approved by the General Meeting of the company and a notary record is required for such a decision.

The procedure of increasing the registered capital is quite lengthy. The increase is effective the day it is entered into the Commercial Register.

To decide which company should become the legal successor, it is crucial to consider the tax implications of the merger. If company A has accumulated tax losses in addition to negative equity, it is more practical tax-wise to keep company A as the legal successor. If company A is to be dissolved within the merger, the tax losses declared by the company cannot be transferred to the legal successor.

The same rule is applicable for the transfer of a 10 percent allowance from the input price of newly purchased property that the dissolved company didn't fully use in previous taxable periods. This type of claim expires in the event of a merger. Transformation by a merger is not considered a breach of the conditions stipulated by the Income Taxes Act related to investment allowance. Therefore, neither the dissolved company nor the successor is obliged to increase the tax base by the previously applied investment allowance.

So the merger could be considered a viable option if the legal successor will end up with positive equity. If there is a risk that the legal successor will have negative equity, the shareholder should decide to increase own capital or registered capital of one of the merging companies to avoid potential problems with registration of the merger.

Contacts:

Ludvík Juřička
Ambruz & Dark, advokáti, v.o.s.
e- mail: ludvik.juricka@cz.pwcglobal.com

Dagmar Faltová
Tax Services, PricewaterhouseCoopers
e-mail: dagmar.faltova@cz.pwcglobal.com

 

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