Binding instructions of the parent company in the draft Holding Law.

The draft amendments to the Commercial Companies Code introducing the so-called holding law provide for the possibility of establishing a group of companies. Companies participating in such a group will be able to pursue not only their own individual interests but also the interests of the group of companies, provided that this does not infringe the legitimate interests of creditors and minority shareholders or partners of the company.

The basic legal institution envisaged by the drafters to ensure that the parent company can efficiently manage the group of companies is a binding instruction issued by the parent company to the subsidiary.

Obligations of the parent company in connection with issuing instructions

The draft does not impose many requirements on the parent company as to the content or form of the instruction.

Pursuant to the proposed Article 21(2) § 1 of the Commercial Companies Code, a parent company may issue a binding instruction to a subsidiary belonging to the group of companies concerning the management of the company's affairs if this is justified by the specific interests of the group of companies. The instruction shall be issued in writing, in document form or electronically (Article 21(2) § 2).

The instruction is to be issued by the parent company. It should therefore be assumed that the submission of a statement regarding the issuance of an instruction will be made in accordance with the rules of representation of the parent company vis-à-vis third parties.

The draft does not specify whether the issuance of an instruction requires a resolution of the parent company's management board. It seems that the instruction will be subject to a similar assessment as other activities of the parent company, and only after analysing the substance of the specific instruction and the risks associated with its issuance will it be possible to determine whether the issuance of the instruction exceeds the scope of the parent company's ordinary activities. As part of this analysis, it will be necessary to take into account the potential negative effects of executing the instruction, in particular the risk of the parent company incurring liability towards the creditors or shareholders of the subsidiary.

The instruction is to concern ‘conducting the company's affairs’. The management of the company's affairs should be understood as all activities undertaken by the management board of a given company, concerning both financial and non-financial matters, relating to its activities and preceding activities of a representative nature outside the company. In essence, therefore, the parent company may take any decision on behalf of the subsidiary relating to its activities. There is no obstacle to the instruction prescribing a specific course of action in the strategic sphere (e.g. participation in public procurement procedures or withdrawal from such a method of acquiring customers) as well as in the sphere of individual actions (e.g. conclusion of a contract with a selected supplier, employment of a specific person).

The instruction must be ‘justified by a specific interest of the group of companies’. The draft also does not impose any obligations on the parent company to justify the instruction. When issuing an instruction, the parent company does not have to demonstrate how compliance with the instruction contributes to the implementation of the group's strategy or how it affects the interests of the group of companies. It may therefore be surprising that the drafters use the term ‘specific’ interest of the group of companies, which seems to suggest that the instruction should be related to a specific part or type of the companies' common interest.

The draft requires that the instruction be in writing, in documentary or electronic form (but not under pain of nullity). In order to preserve the documentary form of a legal transaction, it is sufficient to submit a declaration of will in the form of a document in a manner that allows the person making the declaration to be identified. This means that it will be sufficient to issue an instruction by e-mail or other means of communication that allows the content of the instruction to be reproduced and the identity of the person issuing the instruction to be established.

Obligations of the subsidiary in connection with receiving the instruction

Compared to the minor requirements for the instruction on the part of the parent company, the draft imposes a great many obligations on the subsidiary receiving the instruction.

Under the proposed regulations, upon receiving an instruction, the management board of the subsidiary will be required to adopt a resolution on whether to execute or refuse to execute the instruction. In addition, at the end of each financial year, the management board of the subsidiary will be required to prepare a report on the subsidiary's links with the parent company, indicating all binding instructions received from the parent company.

The draft Article 21(3) § 1 of the Commercial Companies Code provides that the execution of an instruction from the parent company by a subsidiary belonging to the group of companies requires a prior resolution of the management board or board of directors of the subsidiary. Such a resolution shall indicate:

the specific interest of the group of companies justifying the execution of the parent company's instruction by the subsidiary,

the expected benefits or losses of the subsidiary resulting from the execution of the parent company's instruction,

the anticipated manner and time of repairing the damage suffered by the subsidiary as a result of complying with the parent company's instruction.

According to the draft, the management board of a subsidiary may accept an instruction for execution if it does not violate the interests of that company or if it can be reasonably assumed that the damage suffered by the subsidiary as a result of executing the parent company's instruction will be remedied in a timely manner by the parent company or another company belonging to the group of companies, but no later than two years from the date on which the event causing the damage occurred. When adopting a resolution on the parent company's instruction, the management board of the subsidiary will also be required to take into account the benefits obtained by that company in connection with its participation in the group of companies during the last two financial years.

The proposed regulation means that after receiving a message from the management board of the parent company saying ‘please conclude the attached agreement with company XYZ, which will provide accounting services to the group companies’, the management board of the subsidiary – despite not having received the relevant information from the parent company , should identify on its own the interests of the group of companies that justify the conclusion of such an agreement, the expected benefits for the subsidiary and the assumed manner of possible redress for damage suffered as a result of complying with such an instruction. The result of such an analysis should be presented in the form of a management board resolution, which should be adopted before the instruction is carried out.

These obligations appear to be very difficult to fulfil, both in terms of substance and form, and failure to comply with them will result in the members of the subsidiary's management board being unable to be released from liability for the execution of the parent company's instruction.

It is also surprising that the same obligations regarding the acceptance of instructions apply to all three types of subsidiaries distinguished by the proposed holding company law provisions. The resolution to accept the instruction for execution is to be adopted by both companies that are 100% subsidiaries of the parent company and companies in which the parent company holds at least 75% of the share capital, as well as other subsidiaries.

Refusal to execute an instruction

The division into the above-mentioned categories of subsidiaries is important for assessing whether a company may refuse to execute an instruction.

According to the draft, a single-member subsidiary cannot refuse to execute a binding instruction from the parent company.

A subsidiary in which the parent company holds at least 75% of the share capital may refuse to execute an instruction only if its execution would lead to the insolvency of that company or to a threat of insolvency.

Any other subsidiary is obliged to refuse to comply with an instruction if there is a reasonable concern that it is contrary to the interests of that company and will cause it damage that will not be remedied by the parent company or another company belonging to the group of companies within the next two years, counting from the date on which the event causing the damage occurs, and if this adverse circumstance poses a threat to the continued existence of the subsidiary. The proposed provisions additionally provide that the articles of association or partnership agreement of a subsidiary may introduce stricter requirements for refusing to comply with a binding instruction from the parent company.

It should be emphasised that the proposed provision defines the grounds for refusing to comply with an instruction in an unclear manner. In particular, neither the draft itself nor its explanatory memorandum provides any guidance on what constitutes an ‘adverse circumstance posing a threat to the continued existence of the company’.

Refusal to execute an instruction, like acceptance of an instruction, will require a resolution of the subsidiary's management board. Such a resolution should include a justification setting out the reasons for the decision not to execute the instruction, with reference to one of the permissible reasons for refusal set out above.

The far-reaching formalism of the response to the parent company's instruction, combined with the lack of requirements as to the content, form and justification of the instruction by the parent company, may constitute a significant obstacle to the operation of the management boards of subsidiaries belonging to the group of companies. It seems that in order to ensure more effective operation of the holding company, especially in the relationship between the parent company and a wholly-owned or almost wholly-owned subsidiary, these requirements should be relaxed in the final version of the regulations.