Since their inception in 1996, related-party transaction requirements have often proven to be a headache for investors (and a favourite due diligence finding for lawyers). The rules set out in Section 196a of the Commercial Code are designed to avoid the abuse of companies by the entities/individuals that control them. In a related-party transaction, the price for any transfer of assets that amount to over one-tenth of a company’s registered capital must be determined by a court appointed expert. The Supreme Court has repeatedly and consistently ruled (i) that the expert valuation must be made prior to the contract, (ii) that the price in the contract must be the same as determined in the valuation, and (iii) that a failure to comply with these rules will result in the contract being invalidated. In real estate transactions, violation of Section 196a causes a major defect in the title chain.
Lately, we have seen some movement in the still waters of the related-party transaction rules. Efforts have been made to improve legal security, but these efforts have caused problems in interpretation. Let us consider two of the most important developments.
- New legislation: more protection for owners of real estate
An amendment to Section 196a of the Commercial Code (effective as of 1 January 2012) provides that if assets acquired in violation of the related-party rules are further transferred, the new owner still obtains good title (provided that he acts in good faith i.e. he did not know about the violation of Section 196a).
Unfortunately, the wording of the amendment is not definitive as to whether it applies to real estate transactions. The amendment refers to the “appropriate use” of a provision of the Commercial Code which concerns “goods”. However, in legal theory, real estate is generally not regarded as “goods”. As the purpose of the amendment is to protect good-faith owners and reference is made to the appropriate use of the provision protecting the owners of “goods”, we interpret the amendment as also protecting “good-faith owners” of real estate. However, this interpretation will need to be tested by the judicature. Until then, we expect the market to be reluctant to rely on the new amendment.
- New Supreme Court decision: good intentions causes confusion
The Grand Senate of the Supreme Court has issued a decision (No. 31 Cdo 3986/2009) in which it upheld a related-party transaction that had not precisely followed the rules of Section 196a. The parties transferred real estate for a purchase price, the price being based on oral information supplied by a valuer. The valuer was appointed by a court and the valuation report was made only after the transaction was completed, not before. The price in the report was the same as in the purchase agreement. Contrary to its former practice, the Court ruled that in this case the transaction was valid.
This decision has attracted a lot of attention and has been interpreted by some to mean that a valuation by a court-appointed expert is no longer required in related-party transactions. Such a conclusion could be misleading. The decision concerns a very particular set of facts and any generalisation must be made with great care. Importantly, the court only said that when it is “obvious” that a related-party transaction was for a market price, the mere absence of a prior proper valuation will not invalidate the transaction per se. The Court did NOT, however, say that proper valuations are not required prior to related-party transactions. This obligation still emerges directly from the law.
The Court displayed good intentions in seeking to uphold common sense and the true spirit of protecting parties in related-party transactions. However, to avoid any hasty conclusions, the reasoning of the Court must be carefully reviewed; otherwise there is a risk that the decision might be misinterpreted. We strongly recommend that the correct procedure of the Section 196a is always followed, including having the price determined by a valuation of a court-appointed expert prior to the transaction.
The new amendment to Section 196a should increase the security for owners of real estate, but the favourable interpretation outlined needs support from the courts before being widely relied upon. The decision of the Supreme Court on the related-party transaction rules refers to a particular case, and should not be interpreted extensively. In general, the decision does not change the rules for related-party transactions.