How the Court Review Process does (not) Work
While the mechanism of transfer of minority shareholders’ shares to the principal shareholder is described in the law very clearly and accurately, the court proceedings where correctness of share prices is reviewed are defined in an utterly ambiguous and confusing way.
Immediately after the introduction of the law “squeeze out Czech style”,
OSMA submitted to representative Dolezal, through a lawyer, several questions
(in Czech) concerning the application of the law that he sponsored. Representative Dolezal did not offer any useful answers
(in Czech) to those practical questions. The cunning representative was able to come up only with empty phrases, useless as a solution to the problem he caused.
After several years of “squeeze out Czech style”, the following problems with the review process can be pointed out:
a) The law establishes the principal shareholder’s obligation to grant “adequate compensation” but it does not define what compensation is adequate or how it should be calculated;
b) Therefore, judges in review proceedings (CLC Section 183k and likewise Section 220k) do not know how and about what exactly they are supposed to decide; judges do not understand the intricacies of share valuation, and the best solution they see is to appoint for the proceedings a review expert who would determine the correct amount of compensation instead of them;
c) The problem is that even the review expert appointed for the proceedings does not have clear instructions about what amount of compensation is correct (adequate); every expert has a different opinion about adequacy; cash-flow-based valuation is complicated by so-called discount rate that depends namely on the interpretation of the term “adequacy”;
d) A vicious cycle is created when the court says that determination of “adequate compensation” is an expert question, and refuses to interfere materially with the review expert’s valuation, while solution of the question what that “adequate compensation” actually is, is exclusively a legal problem that was created because the pertaining legal description is utterly unsatisfactory;
e) The result of this situation is that the amount of “adequate compensation” determined by an expert is in the Czech Republic a lottery caused most of all by the ambiguity of the term adequacy that every expert interprets his own way; there are no rules for valuation of shares for squeeze out, which exacerbates randomness of the valuation result; a sad story of its own is the depressing level of “expertise” of many Czech so-called experts (see the section “The Principle of the “squeeze out Czech style” Law”); there is also a general problem that Czech experts depend financially on paid contracts that principal shareholders, unlike to minority shareholders, may or may not award them, and therefore the notion of an impartial valuation by an expert is unrealistic not only at valuation before transfer of shares but also afterwards in the review process; in review proceedings, review experts cannot deviate from valuation procedures used earlier with other companies for the purpose of “squeeze out Czech style” (ordered by principal shareholders) because that would be an admission that the previous valuations were done incorrectly; wrong evaluation methods are therefore used in review proceedings as well.
f) An active role of the court in the review process is critical for determining the fair compensation; when it comes to the legal term “adequate compensation”, it is not possible at all to escape the vicious circle without a court interpretation, and without material supervision of the review expert in the review proceedings, the robbed shareholders have no chance to win fair compensation.
It is a mystery why Czech courts are not looking for inspiration to foreign jurisdiction in this ambiguous legal situation when it is not quite clear how the amount of compensation should be reviewed. One of the main reasons must be the overly developed passivity of Czech judges that is deeply ingrained in the Czech judiciary from the time of the totalitarian regime (something that lawmakers could have easily predicted). It is much easier for a judge to request a determination of the “correct” amount of compensation from a review expert with the assertion that it is an expert question, rather than to tackle the unfamiliar subject himself.
The Czech version of squeeze out should follow the German and Austrian law, as it is directly stated in the explanatory memorandum of the pseudo squeeze out law (so-called transfer of equity to the principal shareholder pursuant CLC Section 220p). In the Czech Republic as well as in Germany and Austria, an expert valuation is used to determine share prices. In all three states, the explanation of compensation is equally brief, mentioning only the obligation of the principal shareholder to provide “adequate compensation”. Also the same is the rule that correctness of the amount of provided compensation can be judged only after the transfer of shares to the principal shareholder. The nature of squeeze out is therefore the same in all three states (if we do not take into account that almost all related protection of minority’s rights, included in German and Austrian regulations, is missing in the Czech law). If the explanatory memorandum of the Czech law openly states that the template for the law was the German and Austrian law, it would be only logical and inspiring to investigate how the review process works in Germany and Austria where it has a long track record and has been therefore thoroughly tested by their courts.
It is well known from German and Austrian court proceedings that on request of the squeezed out shareholders, courts there have to review the discount rate, whose correctness they have to carefully justify, and other crucial factors (correctness of the financial plan and the question which company property is necessary for operations and which is not). Only results of such court deliberations constitute in the review process binding guidelines for a review expert (initial parameters of the valuation).
Most of all, it is clear in neighboring German speaking countries what it means “adequate compensation” (there is nothing to review in court proceedings at all if this crucial legal question is not answered). There is no doubt that adequate compensation can only be such that buys an alternative investment with the same yield and risk. Execution of the squeeze out law is in agreement with the Constitution only if this condition is met because only that way the squeezed out shareholders can be compensated for the loss they suffered, as they can then reinvest with the same return the funds they received.
However, courts in the Czech Republic do not follow any of this. When confronted with the information about the way the German and Austrian review process is conducted, Czech judges are mostly quiet or they stubbornly maintain that we are in the Czech Republic and not in Germany or Austria. Of course, it is so easy and thus tempting to transfer all the work to a review expert, and so difficult, within one’s own responsibility, to deal with the unfamiliar complexities of shares valuation! The motto of Czech judges can be summarized this way: “Let an expert value the shares; it is not my business”. So far, we have not heard that any Czech judges would have questions of conscience because their, gently said, lax approach makes them fit into the post-communist machine that made it possible for principal shareholders to rob hundreds of thousands of small investors out of tens of billions of Czech crowns (billions of US$).