What are binding instructions in holding company law

On 13 October 2022, the long-awaited amendment to the provisions of commercial law became a fact – for on that day the provisions regulating the issue of holding structures came into force. The introduction of holding company provisions to the Commercial Companies Code is the legislator’s response to the needs of the market, as the hitherto regulations in the area of company groupings have not been widely applied in practice.

The adopted form of the amended regulations is an attempt to balance the interests of the holding company’s participants, i.e., the interests of the group of companies (represented by the parent company), the interests of subsidiaries, and the interests of minority shareholders and creditors of those companies.

Due to the wide range of entities participating in a group of companies, the new regulation covers many instruments, several of which are described in this article.

The interests of a group of companies and the liability of the parent company

The key power vested in the parent company under the new regulations is the right of the parent company to issue a so-called binding instruction to a subsidiary.

When can a company issue a binding instruction?

A parent company may issue a binding instruction when it is justified by the interests of the holding company, while respecting the interests of the creditors and minority shareholders of the subsidiary.

What is the purpose of a binding instruction?

The purpose of issuing an instruction is to oblige the subsidiary to take action to further the interests of the holding company as a whole. The interests of the holding company are therefore not the interests of the parent company (although in practice this may turn out to be the case) or the sum of the interests of the individual companies within the group.

This interest should be treated as an independent category, and its achievement may even mean acting against the interest of the company that carries out the instruction, and in extreme cases against the interest of all companies in the group.

Is there a need for such changes?

The introduction of the possibility of issuing binding instructions into the Commercial Companies Code is undoubtedly a response to market needs. Under the previous regulations, there was no formal possibility of issuing such instructions, with the exception of agreements on the management of a subsidiary, which, however, were rarely concluded in practice.

Did the law not provide for such possibilities before?

It should be noted, however, that part of the doctrine was in favor of the possibility for shareholders of a limited liability company to issue instructions to the management board, which resulted from the fact that the applicable regulations did not explicitly exclude such a possibility.

This is related to the fact that only the provisions relating to joint-stock companies contain a direct prohibition on the general meeting of shareholders and the supervisory board from issuing binding instructions to the management board (Article 375¹ of the Commercial Companies Code). The regulations governing limited liability companies do not contain such a prohibition.

However, this view raised legitimate doubts. If such an instruction was issued to the management board of a limited liability company, there was a risk that acting in accordance with the instruction would expose the management board to both civil and criminal liability. Therefore, it is not surprising that the above doubts were a source of internal disputes, which sometimes even led to the termination of cooperation between the management and the company.

What are the benefits of the amendment?

The decision to commence operations in the form of a holding company in accordance with the provisions in force as of October 13, 2022, therefore gives the parent company the right to issue binding instructions to its subsidiary, and to members of the management boards of subsidiaries a basis for taking efficient action without being held liable for actions that may cause damage to the subsidiary.

The issuance of a binding instruction by the parent company therefore has far-reaching consequences for the parent company in terms of liability for damage caused to the subsidiary. It should be noted that in the event that:

• the implementation of a binding instruction results in damage to the subsidiary, then:
  • a member of the management board, supervisory board, audit committee and liquidator of the subsidiary, as well as
  • a member of the management board, supervisory board, audit committee and liquidator of the parent company acting in the interest of the group of companies

– shall not be liable in this respect, including liability:

• for damage caused by an act or omission contrary to the law or the provisions of the limited liability company agreement or the articles of association of a joint-stock company;
• for damage resulting from failure to perform or improper performance of their duties, including failure to exercise due diligence resulting from the professional nature of their activities or failure to maintain loyalty to the simple joint-stock company;

• issuing a binding instruction, the execution of which will result in damage to the subsidiary that will not be repaired within the period specified in the binding instruction, the parent company shall be liable for the damage, unless it is not at fault;
• issuing a binding instruction, the execution of which will result in a reduction in the value of a shareholder’s share or shares in the subsidiary, the parent company shall be liable for the damage;
• in the event of ineffective enforcement against the subsidiary, the parent company shall be liable for the damage caused to the creditor of the subsidiary, unless it is not at fault or the damage did not arise as a result of the subsidiary’s execution of a binding instruction.

Liability for the consequences of the subsidiary’s performance of a binding instruction will therefore, as a rule, be borne by the parent company.

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The procedure for issuing binding instructions is formalized and requires, under pain of nullity, written or electronic form.

What elements constitute a formal instruction?

According to the new regulations, a binding instruction should include at least:

• the expected behavior of the subsidiary in connection with the execution of the binding instruction;
• the interest of the group of companies which justifies the execution of the binding instruction by the subsidiary;
• the expected benefits or losses of the subsidiary which will result from the execution of the binding instruction, if any;
• the anticipated manner and date of compensation to the subsidiary for any losses incurred as a result of the execution of the binding instruction.

Should a binding instruction be strictly followed by a subsidiary?

However, in order for a binding instruction to be carried out, cooperation between the parent company and the subsidiary is necessary, in which the entities involved should examine the situation as described below. The mere issuance of a binding instruction by the parent company does not automatically trigger the obligation of the subsidiary to carry it out.

A binding instruction should first be analyzed by the subsidiary to determine whether there are any obstacles that would force the subsidiary to refrain from executing the instruction, and only after a positive verification can the concept proposed by the parent company be accepted. The subsidiary’s decision is expressed in an appropriate resolution, and only a resolution stating that there are no obstacles to the execution of the binding instruction will oblige the subsidiary to carry out the instruction.

Decision to execute or refuse to execute a binding instruction

What should a subsidiary do before complying with a binding instruction?

Before taking action, a subsidiary should first:

• examine whether there are any grounds for the subsidiary to adopt a resolution refusing to comply with the binding instruction;
• if it finds that there are grounds justifying refusal, the subsidiary should adopt a resolution refusing to comply with the binding instruction;
• if it finds that there are no grounds justifying refusal, the subsidiary should adopt a resolution to comply with the binding instruction.

A resolution on refusal to execute a binding instruction shall be adopted if the subsidiary determines that:

• execution of the binding instruction would lead the subsidiary to insolvency or to a state of imminent insolvency – this rule applies to all subsidiaries, i.e. both those in which the parent company is the sole shareholder and those in which other entities participate alongside the parent company (as minority shareholders);
• there is a reasonable concern that the binding instruction is contrary to the interests of the subsidiary and will cause it damage that will not be remedied by the parent company or another subsidiary participating in the group within two years from the date of the event causing the damage, unless the articles of association (statutes) provide otherwise – this rule applies to subsidiaries in which other entities participate alongside the parent company (it does not apply to subsidiaries in which the parent company is the sole shareholder);
• there are other grounds justifying refusal to comply with a binding instruction which the subsidiary has included in its agreement (articles of association).

What difficulties may arise when a subsidiary assesses the validity of a binding instruction?

First of all, it should be noted that the grounds for refusing to comply with a binding instruction, based on the concepts of insolvency, threat of insolvency and reasonable concern that the instruction is contrary to the interests of the subsidiary, are usually difficult to determine unequivocally in practice.

At the time of issuing a binding instruction, the management board of the subsidiary may find it difficult to assess whether the execution of such an instruction will result in insolvency or a threat of insolvency, even if the content of the instruction includes information about the expected damage to the subsidiary, together with an indication of the manner and date of its repair.

A justified fear that a binding instruction is contrary to the interests of the subsidiary and will cause damage to the company that will not be remedied within two years of the event giving rise to it is also a condition that is difficult to determine at the time of deciding whether to refuse to comply with a binding instruction.

In this area, an additional question arises concerning the analysis of a binding instruction in the context of the subsidiary’s interest – will the subsidiary’s management board bear civil and criminal liability in this respect?

The exclusion of the subsidiary’s liability only occurs at the stage of damage resulting from the execution of a binding instruction, and not at the stage of deciding whether to execute or refuse to execute a binding instruction, and furthermore, it only concerns liability for damages towards the company.

Modification of grounds for refusal to execute a binding instruction

Is it possible to modify the grounds on which a subsidiary may rely to justify its refusal to comply with a binding instruction?

The grounds for refusing to comply with a binding instruction may be changed in the articles of association of the subsidiary, and may be either broadened or narrowed.

It should be noted that a subsidiary:

• acting pursuant to Article 21⁴ 3 of the Commercial Companies Code, may provide in its articles of association (statutes) additional grounds for refusing to comply with a binding instruction;
• acting pursuant to Article 21⁴ 2 of the Commercial Companies Code, may waive the grounds for refusing to comply with a binding instruction based on a justified fear that it is contrary to the interests of that company and will cause it damage which will not be remedied by the parent company or another subsidiary participating in the group of companies within two years from the date of the event causing the damage.

However, bearing in mind that it is in the interest of the parent company that the subsidiary carries out the instructions issued, in practice, the grounds for refusal should be narrowed rather than broadened. As a result, Article 21⁴ § 3 of the Commercial Companies Code may prove to be rarely used.

This is supported by the fact that the provisions do not require the consent of all shareholders of the subsidiary to amend the articles of association in this respect. Therefore, a situation may arise in which the parent company, as a shareholder of the subsidiary, decides on its own to exclude the grounds specified in Article 21⁴ § 2 of the Commercial Companies Code, as a result of which the refusal to execute a binding instruction may be based solely on the grounds provided for in Article 21⁴ § 1 of the Commercial Companies Code.

In this context, it is worth mentioning the relevant rights of minority shareholders to demand the redemption of their shares in the event of disagreement to amend the articles of association with regard to extending the grounds for refusing to execute a binding instruction.

Conclusions

In summary, the binding instructions given to the parent company undoubtedly constitute an instrument that will enable efficient management of the group of companies in crisis situations, in particular in the event of a conflict of interests between group members. In such situations, the parent company will be able to exert real influence on the subsidiary, while striving to achieve the interests of the entire group and protecting the members of the subsidiary’s management board from the consequences of a decision that may not be directly dictated by the interests of the subsidiary.

However, it should be noted that the procedure for issuing binding instructions is formalized, which in turn will lead to a longer decision-making process and, in extreme cases, even to a paralysis of the company’s operations, particularly in situations where a quick response from managers is required.

Due to the fact that the regulation on holding structures is optional and the organization of the process of implementing binding instructions involves considerable formalities, it can be assumed that the introduction of such a solution may be used to achieve specific, less popular objectives, purposes, e.g. when one of the companies in the group concludes contracts and, in this context, among other things, to secure the claims of creditors against the assets of the companies belonging to that group.

Author: Katarzyna Gelo, trainee attorney