The sale of NPLs increased in Croatia in the last years. What could materially hit buyers is if an NPL sale ends up as a transfer of a business unit.

Transfer of a business unit – potential repercussions

Over the past two years, the sale of non-performing loans 1 (“NPL“) has gained momentum in Croatia, with a dozen NPL transactions initiated and quite a number completed. In 2015, banks alone sold EUR 500 million NPL claims (including off-balance sheet items). One of the legal issues that emerged in NPL transactions that could materially hit buyers is whether an NPL transaction can end up in a transfer of a business unit of a creditor. Some repercussions of this include extra liability of the buyer for debts of the business unit, automatic transfer of employees and different tax treatment (eg application of VAT).

Transfer of debts of a business unit to the acquirer arises out of the Croatian Civil Code of Obligations. Accordingly, the person to whom a business unit or a part of a business unit is contractually transferred shall be liable for debts pertaining to such unit or its part, jointly and severally with the previous holder, up to the value of assets of the business unit (whereas provisions on excluding or limiting liability in the agreement would produce no legal effect towards third-party creditors).

The transfer of a business unit’s employees to the acquirer arises out of the Croatian Labour Act. Thus, if a legal transaction results in the transfer of a business unit/undertaking, businesses or parts thereof (retaining their economic integrity), all employment contracts of the workers employed with that business unit or part thereof – or of those who are connected with the business or part of business being transferred – shall be transferred to the new employer (the buyer). The affected workers shall retain the rights arising from their employment with the previous employer, including rights under applicable collective bargaining agreements, patronage of workers’ council, if any, etc. In addition, the new and the old employer shall be jointly and severally liable for obligations to the employees that arose prior to the transfer.

Defining a business unit

In the absence of a civil/corporate law definition of a business unit, such a definition shall be sought in Croatian legal texts (traditionally relying on German law and legal writings).

Accordingly, a business unit shall be regarded as a conglomerate of objective, subjective and organisational components, with objective components being the assets without which the business unit cannot operate, subjective components being eg the skills of the employees, and organisational components being the platform interconnecting objective and subjective components (managers, business plans, budget, etc.). It is an organised economic and legal unity – a living organism, without prejudice to the importance of any of the components for the life of the unit. In addition, a business unit needs to have a market presence (with permanent direction) and the goal of making a profit.

Among local laws, only the Croatian General Tax Code provides a definition of a “business unit”, calling it an aggregate of all assets and obligations which, in an economic and organisational sense, make a standalone entity/unity capable of independently carrying out its activities. Further tax regulations define “transfer of business unit” as a transfer of the assets, claims, rights and obligations that make up the short-term and long-term assets of the business (enterprise) so that it can continue to independently carry out its activities as a going concern.

The management of an NPL portfolio can easily be regarded as a living organisation on a standalone basis through the cited components: objective (loans and assets), subjective (manpower handling the portfolio) and organisational (separate part of workout department of the creditor, assigned personal, budget, IT support, etc). Nevertheless, it is certain that a material number of NPL transactions will not trigger this issue, nor was this the original intention of the Croatian regulator of the banking sector – the Croatian National Bank. Yet, over and above the regulations, a due standard of professional care in NPL transactions implies legal, financial and tax analyses via facti on a case-by-case basis.

Therefore, the answer to whether or not an NPL sale has the potential to lead to the transfer of a business unit lies in a proper due diligence. Some of the parameters to be examined are: the structure of the portfolio, the percentage of the portfolio (compared to the entire size of the creditor’s portfolio), the percentage of the creditor’s employees handling the portfolio (compared to the entire size of the creditor’s staff), the percentage of non-performing clients of the creditor (among all the creditor’s clients), etc. While the risk of business transfer is latent in most NPL transactions, it lies in the hands of the potential buyer and must be carefully addressed.

Nevertheless, it is certain that a material number of NPL transactions will not trigger this issue, nor was this the original intention of the Croatian regulator of the banking sector – the Croatian National Bank. Yet, over and above the regulations, a due standard of professional care in NPL transactions implies legal, financial and tax analyses via facti on a case-by-case basis.