The first installment in a series of articles devoted to family businesses, which will be subject to a separate legal framework should the amendment to Act No. 112/2018 Coll. on the Social Economy and Social Enterprises and on Amendments to Certain Acts enter into force in its proposed form.
The proposed amendment to Act No. 112/2018 Coll. on the Social Economy and Social Enterprises and on Amendments to Certain Acts (hereinafter referred to as the “Social Economy Act”) provides for several fundamental changes to the legal framework. Among other things, it will introduce a definition of a family business into the legal system of the Slovak Republic, which has been absent until now. Since the proposed legislation is expected to impact the business environment, we are pleased to provide you here with more information on what a family business is, its functions and significance, and how this concept can be utilized in the business environment.
In our recent article, we highlighted a legislative initiative that will result, among other things, in the introduction of the category of so-called family businesses. As indicated by preliminary information regarding the upcoming amendment to the Social Economy Act, a separate section of this law will be dedicated to family businesses, and family businesses will thereby acquire a separate legal framework. If the proposed legislation enters into force in its current form, matters concerning family businesses will fall under the jurisdiction of the Ministry of Labor, Social Affairs, and Family (hereinafter the “Ministry”).
Among the key advantages of the proposed regulation for family businesses compared to other business entities are, above all, more favorable conditions for employing family members, the ability to use a portion of profits to strengthen external and internal relationships within the family business, more effective management of the family business given the interconnectedness of its individual members, and streamlining the generational transition process and related inheritance issues, with heirs having the opportunity to take over the management of the business. You can read more about the actual advantages as well as the shortcomings of the proposed amendments to family business legislation in a separate article. At the same time, the adoption of several measures aimed at developing family businesses is also planned, about which we have also prepared a separate article for you.
The proposed amendment to the Social Economy Act contains a relatively comprehensive definition of a family business. As for its basic characteristics, a family business is a commercial company, a cooperative, or a natural person—an entrepreneur—who:
- is an entrepreneur (pursuant to Section 2(2) of Act No. 513/1991 Coll., the Commercial Code),
- has a founding document that includes a commitment to harmonize managerial, business, ownership, and family relationships in a manner aimed at maintaining and developing family ties and family values,
- has established a family business council,
- is composed of members of a common family; this condition subsequently varies depending on the form of business in question. By way of illustration, a commercial company will be considered a family business, for example, if at least two members of the same family exercise, directly or indirectly, a majority of the voting rights and at least one member of the same family is a statutory body or a member of a statutory body, or when at least two members of the same family derive an economic benefit from the business activities of the commercial company amounting to more than 50% of the after-tax profit.
For the sake of completeness, we note that no new separate legal form is created for family businesses; rather, defining characteristics of a family business are established for entities already existing under existing legal forms of entrepreneurs. In practice, this means that it is not possible to establish a separate family business, as one must first be an entrepreneur (for example, by establishing a limited liability company), and only then, upon fulfilling all conditions, can the status of a family business be granted.
As can be seen from the above-mentioned characteristics, the assessment of membership in a common family will be crucial. According to the proposed amendment, members of a common family are considered to be (i) spouses, (ii) relatives in the direct line, (iii) siblings, and (iv) other persons in a family or similar relationship who are close to one another (a close person is defined in Section 116 of Act No. 40/1964 Coll., the Civil Code).
The legislator subsequently envisions dividing family businesses into recorded and registered categories.
The term family farm is specifically defined as a family business that engages in agricultural activities, including fish farming, or produces, processes, and trades in agricultural raw materials and products.
REGISTERED AND RECORDED FAMILY BUSINESSES
A registry of family businesses is to be established, in which family businesses will be entered. The Ministry will enter into this registry any entity that meets all the characteristics of a family business described above and that submits a written application to the Ministry on the prescribed form for this purpose.
The application must be accompanied by documents proving that the entity is indeed a family business, the family business council’s charter, and the founding document. The Ministry will, of course, assess whether all legal conditions for the registration of the business have been met. Therefore, we recommend that internal documents governing relationships within the family business be entrusted to experts, thereby preventing potential complications during the registration of the family business. Subsequently, the Ministry will register the family business as of the date the application is submitted. This type of family business is then entitled to include the designation “family business” or the abbreviation “r.p.” in its trade name, for example, even when conducting its regular business activities.
A registered family business represents a certain additional level compared to a registered family business. In addition to meeting the basic conditions required for a registered family business, a registered family business must also demonstrate that it conducts economic activities, has its registered office (place of business) in the territory of the Slovak Republic or another Member State, and that its statutory representatives have a clean criminal record, among other requirements. Regarding negative conditions, such an entity must not have violated the prohibition on illegal employment in the previous 3 years. Likewise, the entity must not be in bankruptcy, restructuring, or liquidation. As with a registered family business, it is necessary to submit a written application for registration of a family business on the prescribed form, which verifies the above-mentioned facts. If the entity meets all conditions and nothing prevents its registration, the Ministry will issue it a Certificate of Recognition of Registered Family Business Status. A registered family business is designated as a “registered family business” or by the abbreviation “r.r.p.,” which it is authorized to use together with its business name.
Compared to registered businesses, a registered family business will enjoy certain benefits under the law, but these also come with important obligations.
First and foremost is the obligation to use at least 15% of its after-tax profit to strengthen its internal and external relationships, i.e., for example, for education, pension provision, and recreational stays not only for members of the extended family but also for employees of the registered family business. These funds may also be used to provide health care, social assistance, and care for family members. A family business may also specify in its internal documents a higher percentage of net profit to be used for strengthening its internal and external relationships.
If the proposed legislation is approved in its current form, a natural person and a legal entity that is a registered family business required, upon registering their business, to also specify the percentage of after-tax profit that the registered family business commits to using to strengthen its internal and external relationships. The registered family business must rigorously monitor the cash flow of funds used in this manner and report it in its accounting records.
REGISTRATION OF FAMILY BUSINESSES IN THE COMMERCIAL REGISTER
Should the proposed legislation be adopted as outlined in the published draft, it is, of course, essential to consider the impact and implications of incorporating these provisions into current legislation. Since it can be assumed that the vast majority of family businesses will be commercial companies registered in the Commercial Register, it is essential that the registration of family businesses be reflected in Act No. 530/2003 Coll. on the Commercial Register and on Amendments to Certain Acts (hereinafter referred to as the “Commercial Register Act”). The proposed legislation therefore also provides that commercial companies entered in the Commercial Register that are family businesses will be required to record in the Commercial Register both the designation that it is a family business and the percentage of profits that will be used to strengthen internal and external relationships.
THE FAMILY BUSINESS COUNCIL AS A MANDATORY BODY
One of the basic conditions for granting family business status is the existence of a family business council. The family business council is a collective body of the family business consisting of at least three members. The activities and organization of the family business council are governed by its bylaws.
Its basic functions and tasks include, for example, determining the strategic direction of the family business, preparing the next generation to take over the family business, defining the rights and obligations of members of the extended family in relation to the family business, and planning and developing family policies focused on the family business, including ensuring alignment between the family business’s goals and the family’s goals. The majority of the family business council’s members must be members of the extended family.
The functioning of the family business board can be compared to the general meeting of a commercial company. Similarly, both the general meeting and the family business board are required to convene at least once a year, and minutes must be taken of the meetings. Similar conditions apply to decision-making by the family business board and its quorum. The family board has a quorum when a majority of its members are present, and decisions are made by a simple majority, i.e., a majority of the votes of the members present. However, the bylaws of the family business council may specify a different quorum.
For the sake of completeness, we note that the Family Business Council in no way replaces the establishment and operation of other corporate bodies under Act No. 513/1991 Coll., the Commercial Code (hereinafter the “Commercial Code”) for the relevant legal form of the company, such as the general meeting or the supervisory board.
FAMILY BUSINESS VS. SOCIAL ENTERPRISE
Social enterprises and family businesses exhibit certain similarities, which may be precisely why the legislature included legal provisions for family businesses in the Social Economy Act. One of the fundamental purposes of a social enterprise is to generate a positive social impact. In the case of a family business, the focus is on pursuing a higher purpose. Both of these goals are closely related; the only difference is perhaps that in the case of a family business, the pursuit of a higher purpose is directed at a significantly narrower group of individuals (family members). Another common feature is the allocation of profits, albeit in varying amounts. While a social enterprise is required to use more than 50% of its profits to achieve a measurable positive social impact (e.g., providing healthcare, services to support regional development and employment, or the provision of social assistance and humanitarian care), a registered family business is required to use 15% of its profits to strengthen its internal and external relationships (e.g., for pension provision or the education of family members). The legal regulations governing the process of granting the status of a registered social enterprise and a registered family business are similar.
FAMILY BUSINESSES ABROAD
Family entrepreneurship and the incorporation of family businesses into the legal systems of individual countries is nothing unusual. One example is Malta, which has had a specific law addressing family business issues in effect since 2016.
Our neighbors are not far behind either; for instance, the Czech Republic has incorporated the definition of a family business directly into the Civil Code, where, according to Section 700, it states: “A business is considered a family business if spouses work together in it, or if at least one of the spouses works together with their relatives up to the third degree or with persons related by marriage to the spouses up to the second degree, and if the business is owned by any of these persons. Those among them who work permanently for the family or for the family business are regarded as family members participating in the operation of the family business.”
Although Poland, Austria, and Hungary do not have a uniform definition of a family business enshrined in law, it cannot be claimed that this concept is unknown in these countries; quite the contrary. The absence of a uniform definition of a family business merely allows for a broader interpretation of which businesses may subsequently be designated as family businesses, for example, for the purpose of receiving various subsidies intended specifically for this type of business, or to ensure eligibility for participation in special programs focused, for example, on education, mentoring, strengthening family ties, and so on. The same applies to most other member states of the European Union.
