CMS Expert Guide to cash pooling in Croatia

a) Intro

Cash pooling is a concept not specifically recognized by the Croatian statutory framework. There is no case law on cash pooling in Croatia. Since cash pooling is not explicitly regulated by the Croatian law and there is no case law on the respective matter, many different questions regarding cash pooling remain unanswered. 

Nevertheless, cash pooling is legal and practiced in Croatia as part of regular banks’ services. Most of the cash pooling activities in Croatia are done between banks and local authorities (usually municipalities and cities). From the public sources, it can be determined that the most used type of cash pooling in Croatia is notional cash pooling.

b) Social interest and due diligence

The legal representatives of a limited liability company and joint stock company have a duty to manage the company's affairs with the diligence of a prudent businessman acting in the company’s best interest. Therefore, any decision of the legal representatives of the company to initiate cash pooling activities should be based on the legitimate expectation that the involved company would gain advantages from such involvement. The directors must weigh up the advantages and risks of cash pooling with the care and diligence of a prudent businessman, and determine if the advantages outweigh the potential risks.

c) Shareholder loan provisions

Notional cash pooling will not result in the creation of intra-group loans, since funds are not physically transferred, thus legal requirements as to shareholder loans do not apply. 

However, in case of physical cash pooling (transfers and draw-downs of funds to and from the master account by the participating companies have the nature of the granting and repayment of intra-group loans), legal requirements as to shareholder loans may apply. Certain restrictions as to shareholder loans should therefore be considered. For instance, when a company requires additional equity and, instead of contributing additionally to the company as prudent shareholder would do, the shareholder grants a loan to the company, that shareholder loan will (in the event of the company’s insolvency) be subordinated to third-party loans. If the loan is repaid and the Croatian insolvency procedure is initiated against the company within a term of one year of repayment, the shareholder may be obligated to return the repaid loan to the company (and raise a claim in the insolvency procedure).  

Furthermore, a joint stock company is forbidden from granting a loan to its shareholders or third persons for purchase of shares in itself. Funds placed in the cash pool by a subsidiary must therefore not be used by the parent company to obtain further shares in that subsidiary. Although the law explicitly mentions only a joint-stock company (and the purchase of its shares), Croatian courts might interpret such provision as applicable to a limited company as well.

d) Liquidity protection

In case of physical cash pooling, a general risk of participating in cash pooling is that a company may become insolvent if the monies transferred to the master account are not transferred back to the company or are not transferred in time. In other words, cash pooling could potentially adversely affect the liquidity of a participating company. 

Having that in mind, the legal representatives of a company should aim to envisage different protection measures in the cash pooling agreement to avoid potential insolvency. Potential different measures are explained in below sections.  

The obligation to protect liquidity is also a statutory obligation - the legal representatives of a company must respect different measures envisaged by the Croatian law such as risk management (identifying, measuring or assessing and monitoring risks) and implementation of relevant measures to ensure company liquidity. 

This risk does not exist in notional cash pooling since funds are not physically transferred.

e) Hidden distribution of profits

Profits may be distributed to shareholders only in compliance with statutory provisions and on the basis of a shareholder’s resolution. Hidden distributions of profits are not allowed. 

In case of physical cash pooling, there is a risk that in certain cases relevant authorities could consider transfer of money under cash pooling arrangement to the company’s shareholder as hidden distribution of profits. However, as long as the intra-group loan amount is fully recoverable, there is only a remote risk that intra-group loans in a cash-pooling arrangements could be considered as hidden distribution to shareholders.

This risk does not exist in notional cash pooling since funds are not physically transferred.

f) Insolvency proceedings – contestation of transactions

In case of physical cash pooling, cash pooling arrangements can be problematic from the perspective of insolvency proceedings of the company involved in cash pooling. In case the company involved in cash pooling enters insolvency proceedings, the insolvency administrator and creditors can, under certain conditions, contest transactions of an insolvent company before the court. In case the claim is accepted by the court, the recipients must then reimburse the respective amounts. Majority of payments which could be contested are the payments which occurred in the period of three months prior to submission of application for opening a bankruptcy procedure, but this period can in certain cases be even up to ten years. The insolvency administrator and creditors can issue a claim in the period of two years after opening of insolvency proceedings. 

This risk does not exist in notional cash pooling since funds are not physically transferred.

a) Intro

If the legal representatives or shareholders of a company breach their statutory obligations when conducting cash pooling activities, they could be civilly or criminally liable for such act, as explained below.

b) Liability of directors

If the legal representatives of a company breach the duty of diligence of a prudent businessman when performing cash pooling activities, they can be held liable for any damages which their breach has caused to the respective company. In such case, the legal representatives’ liability is joint and severable. The liability is determined in a dispute before a court and the legal representatives must prove that they have acted in accordance with the diligence of a prudent businessman to exempt themselves from liability. In addition, if the legal representatives breach their duty of diligence of a prudent businessman gravely, Othe claim for damages can be submitted by creditors who have failed to collect the suffered damages directly from the respective company. The statute of limitations for claims for breach of a legal representative’s breach of duty of diligence of a prudent businessman is five years. 

The legal representative’s obligation to compensate damages does not exist if the legal representative’s action is based on a lawful shareholders’ resolution.

In case the legal representatives of a company, by performing cash pooling activities, inflict damage to company’s creditors or lead the company to insolvency, in exceptional cases, they could be found criminally liable. 

c) Liability of shareholders

As regards liability of shareholders, general rule applies stating that the shareholders of limited liability companies and joint stock companies are not personally liable for actions of the company.

However, in exceptional circumstances, piercing of the corporate veil may occur, in particular if the shareholder of a company abuses the fact that it is not liable for the company’s obligations. It will be deemed that the abuse occurred, for example, Jin case it uses the company to inflict damage to creditors, if it unlawfully manages the assets of a company as if they were its property and if, to its own benefit or for the benefit of another person, reduces the assets of the company, even though it knew or must have known that the company would not be able to meet its obligations. These situations should be taken into account when conducting cash pooling activities so they can be avoided.

In case the shareholders of a company, by performing cash pooling activities, inflict damage to company’s creditors or lead the company to insolvency, in exceptional cases, they could be found criminally liable.

a) Intro

Please find below certain measures/actions which can be taken to reduce liability risks.

b) Corporate power

A company can generally take part in a cash-pooling activities as long as the articles of association or a shareholders’ decision does not prohibit participation in a cash pool. An additional affirmative shareholders' resolution is recommended in any case since the legal representative’s obligation to compensate damages does not exist if the legal representative’s action is based on a lawful shareholders’ resolution.

c) Cash pooling agreement

All parties of the cash pooling agreement should agree on certain measures to reduce potential risks arising from the cash pooling: 

• monitoring the economic situation of other companies involved in the cash pool so it is possible for a company to swiftly react to a potential economic crisis of involved companies;  
• frequent exchange of financial data and liquidity plans between the involved companies;
• including the obligation to immediately notify other companies on the relevant circumstances or events which could lead to deterioration of the financial situation of the respective company;
• possibility of fast termination of the cash pooling agreement;
• notional cash pooling should be used if possible;
• using target-balancing system.

d) Facility agreement

The facility agreement of the cash pooling participants with the bank should reflect the terms and conditions of the cash pooling agreement (namely the termination rights of each company) in order to reduce the risk of liability of involved companies, their legal representatives and shareholders. 

e) Guarantee

The participants of the cash pooling should diligently consider potential economic consequences of giving guarantees for due fulfilment of obligations arising from debit positions. Also, it should be borne in mind that provision of guarantees has similar treatment as shareholder’s loan under Croatian law, i.e., it may be affected by company’s insolvency.  

A company is “thinly capitalised” within the meaning of the Corporate Profit Tax Law if its borrowings from the shareholder holding more that 25% of the capital or from an affiliated company, exceed their respective share in the company’s capital by more than four-fold. The company will not be able to claim interest paid on the exceeding amount as tax recognized expense. Such interest will increase the recipient’s tax base and will be taxed at the rate of 10% for the companies with the annual revenue not exceeding HRK 7.5 mil (approx. EUR 1 mil), or 18% for other companies. 

Thin capitalization rule is not applicable if the lender is a Croatian taxpayer. Furthermore, if interests are higher than “safe haven” interest determined by the Ministry of finance of not in line with the arm’s length principle, the tax base need to be adjusted, i.e. the company will not be allowed to tax recognize exceeding interest. Such interest may also be considered as the payment of a “hidden” dividend, in which case withholding tax risk may also be triggered. Cash pooling itself shouldn’t trigger VAT.

With regard to opening a bank account of a Croatian entity with a foreign bank (meaning a bank with its seat outside Croatia) for the purpose of cash pooling, please note that although there are no restrictions for such act, there is an obligation to inform the Croatian National Bank about transactions entered into with non-Croatian entities and foreign account balances.