Executive Summary:

The Austrian Supreme Court has recently provided guidance on how to structure cash pooling arrangements so that the risk of violation of the strict Austrian capital maintenance rules is minimized. In essence, the decision indicates that if there is

• sufficient commercial justification;
• no special default risk that could prove an existential risk to the Austrian company,
• sufficient and ongoing insight into the financial situation of the group entities participating in the cash pooling arrangement to allow the management of the Austrian company to ascertain the default risk,
• an effective means of reaction by the Austrian company to a subsequent deterioration of the financial status and corresponding increase of the risk of default by the participating group companies, such as termination of the arrangement or choosing to discontinue crediting the cash pooling account,

the cash pooling arrangement is likely to be deemed valid and lawful by the Austrian courts, even if it entails the assumption of default risk for group entities by the Austrian company.  If the Austrian company is able to obtain liquidity when required and receives consideration where it provides liquidity to other group companies the argument for commercial justification is supported.

Notional cash pooling generally raises fewer capital maintenance concerns than effective cash pooling (zero balancing).

 Navigating the shoals in international cash pooling arrangements demands specific foresight if Austrian corporations are involved.

International cash pooling arrangements allow multinational groups to optimise their liquidity and debt management. Where Austrian GmbH’s or AG’s are implicated, Austria’s notably stringent capital maintenance rules need to be heeded when structuring the cash pooling arrangement. Failure to do so can result in the liability of the managing directors and shareholders, individually, as well as in rendering the transaction invalid.

STRINGENT AUSTRIAN CAPITAL MAINTENANCE RULES

Under the – comparatively stringent – Austrian capital maintenance rules (Sec 82 of the Act on Companies with Limited Liability, Sec. 52 of the Act on Stock Corporations), the only funds that can be distributed to shareholders are distributable profit; any other provision of funds or benefits to the shareholders is deemed an impermissible repayment of the capital contribution and the underlying transactions are accordingly rendered null and void. In many instances, violations of capital maintenance rules also constitute a covert distribution of profits with resulting tax law implications. All benefits provided to any group companies other than its own (direct and indirect) subsidiaries are caught. 

The list of potential triggering violations is extensive and includes any service or goods provided to shareholders on a basis other than arm’s length, e.g.

• the provision of loans to parent or group companies (To the extent benefits are provided to the company’s own direct or indirect subsidiaries, capital maintenance rules do not apply. Accordingly, “group companies” in this article refers to all direct and indirect parent companies as well as their subsidiaries but does not include the subsidiaries of the Austrian GmbH under discussion.),
• the provision of securities (guarantees, pledges, set-offs, mortgages) for or co-signing of loans to shareholders or other group companies,
• various corporate restructuring cases, including down-stream, upstream and side-joinder mergers, if the company in consequence ends up with lower assets and/or higher debts.

Transactions with shareholders and group companies are “safe” If the shareholder or group company pays an appropriate arms-length consideration or if the transaction is commercially justified, particularly because it provides a commensurate benefit to the company.

Third parties may be required to repay any benefits obtained in the course of transactions in violation of the capital maintenance rules if they colluded in such transactions or if the violation of the capital maintenance rules was conspicuous and the third party failed to make the indicated inquiries.

CASH POOLING

Cash pooling permits optimisation off the consolidated finances of a group and facilitates liquidity planning and financial management. Effective cash pooling or “zero balancing” entails the flow of funds to and from the master account from the participating cash pooling accounts.  Notional cash pooling, on the other hand, is undertaken only on an arithmetical basis and does not involve the actual transfer of funds.

Many international groups that are active in Austria engage in either effective or notional cash pooling. When entering into these – often multi-national – arrangements, the parties involved are occasionally  unaware of the specific legal risks lurking in cases involving  an Austrian corporate entity, and they assume default risk for parent and/or group companies.

While Austrian legal literature has discussed – somewhat contentiously –  to what extent cash pooling may violate capital maintenance rules, the Supreme Court has only recently been asked to rule on this issue (17 Ob 5/19p):

THE FACTS: GROUP CASH POOLING WITH DUTCH PARENT COMPANY AND DUTCH BANK

In the case at hand, a Dutch bank had entered into a notional cash pooling arrangement with the Dutch parent of the European part of the (Australian-based) group. One of the participating group entities was an Austrian GmbH. The cash pooling arrangement with the Dutch bank provided that

• the participating group companies could terminate the cash pooling at any time and
• they could, moreover, freely decide what amounts to credit or debit to their respective cash pooling account rather than their – separate – operational accounts (with different banks); and
• the Dutch parent company was responsible for ensuring that the aggregate balance of all accounts (the master account) was 0 or more at the end of each business day.   

Internally, the participating group entities were instructed by the parent company that excess cash flow was to be credited to the respective cash pooling account. If, on the other hand, they wished to obtain funds from the cash pooling account, they were required to obtain the parent company’s consent.

The Austrian entity profited from the cash pooling arrangement in the first two years, during which period its cash pooling account was generally negative. Its finances subsequently improved to the extent that it transferred over 2 million Euros to its cash pooling account.  In view of an outstanding tax liability of EUR 500,000 the company requested access to the commensurate amount from the cash pooling account, which at that point contained EUR 2.3 million. The parent company only gave approval for EUR 200,000. Shortly thereafter, insolvency proceedings were initiated over the Austrian subsidiary and subsequently over the Dutch parent company. The bank used the full balance on the Austrian cash pooling account in payment of the outstanding group debt.

The insolvency receiver of the Austrian GmbH demanded repayment of the EUR 2.3 million balance on the Austrian entity’s cash pooling account, claiming the bank was aware of the violation of capital maintenance rules implicit in the provision of security by the Austria company for the parent company/group, so that the cash pooling arrangement with the Austrian company was null and void.

THE SUPREME COURT’S DECISION

No invalidity vis-à-vis third party who was unaware of capital maintenance violation

The bank argued that it was not aware of the violation of capital maintenance inherent in the cash pooling arrangement. In particular, it was not privy to the parent company’s instruction that all excess cash must be credited to the respective cash pooling accounts. Based on the cash pooling agreement, it assumed that each of the entities could not only decide if and when to credit/debit amounts to the respective cash pooling account, it also assumed that each entity could terminate the arrangement freely at any time.

The Supreme Court found this argument persuasive and held that, since the potential violation of capital maintenance rules was not evident to the bank and since there were no grounds for the bank to undertake further investigations, the bank was not liable for repayment. Thereupon, the receiver’s claim against the bank failed.

Guidelines for structuring cash pooling transactions:

Additionally, the Supreme Court took the opportunity to – implicitly – provide some guidelines for cash pooling transactions:

1. Notional cash pooling is generally less problematic than effective cash pooling/zero balancing, unless detrimental in its terms, e.g. due to disadvantageous interest rates. 
2. Where an Austrian GmbH assumes a default risk of any kind, capital maintenance issues must considered. This is true in the current case, where the Austrian GmbH effectively pledged its claims against the bank – i.e. the claims against the bank for payment of the EUR 2.3 million credit on its cash pooling account – as security for payment by all participating entities.
3. The argument that the transaction was entered into at arm’s length – i.e. would have been entered into with third parties (non-group members) on the terms – does not apply, since group membership is the basis for such cash pooling arrangements.
4. However, such assumption of risk may be commercially justified, in which case the assumption of default risk does not violate capital maintenance rules. The Supreme Court refers to a 2005 case (6 Ob 271/05d) where it had found the provision of security for a loan to a minority shareholder commercially justified: the loan allowed the shareholder to continue operations and retain trained staff, which in turned allowed the company to obtain certain essential services from its shareholder which it could not provide internally.
5. If such assumption of default risk for a shareholder entails a special, potentially existential, risk for the company, a diligent manager would nonetheless be required to refrain from the transaction absent sufficient commercial justification.

The Supreme Court held the following factors to be relevant when reviewing the commercial justification of the arrangement:

• The financial situation of the parent company and the other participating companies.
  • If the financial situation of the participating entities raises concerns that the risk involved for the Austria GmbH could – from an ex ante perspective – be existential, the commercial justification may be in doubt: Before deciding whether a risk is commercially justified, a diligent manager of a GmbH needs to be able to ascertain the default risk of the participating entities and how high its own risk is

• The extent of the Austrian GmbH’s ongoing information rights concerning the cash pooling participants.
  • If the GmbH is not in a position to ascertain the financial condition of the participants, it will be unable to determine and manage its own risk on an ongoing basis.

• Whether the Austrian GmbH is entitled to terminate the cash pooling contract.
  • The Austrian Supreme Court believed the Austrian entity was presumably not entitled to terminate the cash pooling arrangement regardless of the participating company’s decreasing financial stability. Absent a means of reacting to increasing default risk, commercial justification will be harder to argue.

• The parent company’s – binding – instructions that all excess cash was to be transferred to the cash pooling account and that taking funds from this account required parent company approval.
  • This meant that the GmbH was not free to take funds from the cash pooling account and transfer it to its local account (with another bank), in effect ensuring that the funds on the cash pooling account were available to secure the total group balance. Consequently, the Austrian company had no way of managing its risk or reacting to a deterioration of their financial status and corresponding increase of risk.

• The benefits for the GmbH.
  • In the case at hand, the GmbH profited from the arrangement in the first 2 years of participation and was able to significantly improve its liquidity.

• Any consideration received by the Austrian GmbH for the assumption of risk for the other participating entities during the period where the GmbH made its credit available to the group.

Comment:

When structuring a cash pool arrangement, any parent company’s management and the Austrian company’s management would do well to consider – and document – the commercial justification of the cash management arrangement as related to such Austrian entity that assumes a default risk or otherwise provides benefits to other group companies other than its own subsidiaries. Failure to do so may result in personal liability of the Austrian management and of the shareholders and in the invalidity of the transaction for the Austrian company.

For information on corporate and banking / finance issues and disputes, please contact Katrin Hanschitz or your customary relationship professional at KNOETZL.