Category: Croatia

In the Croatian legal system, the relation between two legal principles – the principle that no one can transfer more rights to another than he himself has, on the one hand, and the principle of public trust in land registry, on the other – has been the subject of significant analysis and numerous discussions and Croatian Constitutional Court decisions.

The relation between these two principles is often analyzed from the perspective of the mortgagees (e.g., banks) who acquire their mortgages in reliance on the land registry status of the real estate. However, at the moment of enforcing their mortgages and collecting their receivables, mortgagees are sometimes confronted with third party non-registered owners of the real estate, who often successfully challenge the validity of the mortgage, claiming that the person registered in the land registry as the owner of the real estate, who provided the mortgage, is not in fact the actual owner. The impact that this may have on legal certainty and the principle of legitimate expectations is disastrous. Acquiring real estate rights (including a mortgage) on the basis of public trust in the land registry should represent a simple legal institute, which may be summarized in the following manner: (1) an acquirer of a real estate right concludes an agreement with a person who is registered in the land registry as the owner of the relevant parcel of land; (2) at the same time, the legal status of the real estate parcel registered in the land registry differs from the actual (non-registered) legal status of the property, however the acquirer has no knowledge of this mismatch. Now, to avoid being forced to investigate and determine the actual legal status of real estate, potential buyers may acquire a registered real estate right in its entirety on the basis of an agreement and acting on the principle of public trust in land registry, notwithstanding any third parties’ non-registered rights. In Croatian court practice however, this seemingly simple legal institute has become an extremely complex topic, to the extent that questions have arisen whether Croatian law supports public trust in the land registry at all. 

This topic was analyzed in decision no. U-III-103/2008, dated June 14, 2011 of the Croatian Constitutional Court. The court considered a mortgage of a bank which was contested by the spouse of the person registered as the (entire) owner of the mortgaged real estate, where the (non-registered) spouse claimed that she was the non-registered owner of one half of the ideal part of the real estate parcel and that consequently the mortgage was null and void with respect to that half. In prior similar cases, the Croatian Constitutional Court had emphasized that the principle that no one can transfer more rights to another than he himself has supersedes the principle of public trust in land registry. This resulted in complete legal uncertainty for the banks and other mortgage holders. In the June 14, 2011 decision, however, the court altered its position, stating that in disputes between banks holding mortgages and non-registered spouses, the courts should determine the good faith of all parties. This decision represented a step forward in protecting the legitimate interests of mortgagees and other security holders, but it did not solve all related doubts. 

This however does not represent the end of mortgage holders’ struggles with the public trust in the land registry. Specifically, Croatian law provides that public trust in the land registry will not apply to real estate rights acquired before January 1, 2017 with respect to parcels of real estate which represented “social ownership” in the past (i.e. a type of ownership from the socialist period). This proved to be controversial in large real estate projects involving land sold to the investor by a municipality which was later determined to be owned by the state. Such situations resulted in both the investors and the banks losing title to the land and entering into multi-year real estate disputes. However, public trust in the land registry will fully apply to real estate rights acquired after January 1, 2017. This, together with the evolving court practice of the Croatian Constitutional Court, should provide an investment incentive to investors and credit institutions, significantly lowering legal risks with respect to real estate projects in Croatia.

By Vjekoslav Ivancic, Partner, Ostermann & Partners

This Article was originally published in Issue 5.6 of the CEE Legal Matters Magazine. If you would like to receive a hard copy of the magazine, you can subscribe here.

Starting May 25, 2018 the General Data Protection Regulation will come into effect. Although it will apply directly in all EU Member States, Member States have the option to add additional regulations to certain specific situations. This article sets out a brief overview of the key provisions of the draft of the relevant Croatian law, which is in procedure before the Croatian Parliament at the moment of writing of this article.

Genetic Data: Processing genetic data in order to calculate the likelihood of disease and other health aspects of the data subject for the purpose of entering into or implementing life insurance agreements and agreements with a survivorship clause is prohibited. This prohibition applies when data subjects enter into such agreements in Croatia if the controller has permanent establishment or provides services in Croatia. The consent of the data subject cannot override this prohibition.

Biometric Data: Specific rules on biometric data apply to data subjects in Croatia when the processing is carried out by controllers having permanent establishment or providing services in Croatia, or when the processing is carried out by public authorities. The controllers from the private sector may process biometric data if the law prescribes it, or if it is necessary for the protection of persons, property, classified information, or business secrets. Also, the processing may be necessary for identification of the service user, in which case the explicit consent of data subject must be obtained. In any case, it is important that the interests of data subjects not be overridden by the need for processing (i.e., data subjects’ interests should be protected to a sufficient extent and balanced with the legitimate interest of the controller who processes biometric data in accordance with the law).

Special rules are prescribed for the processing of biometric data of employees. Processing may be permitted to record working hours and entry and exit from work premises, but it must be either prescribed by law or carried out as an alternative to another solution. In the latter case, explicit consent of the employee must be obtained.

The law explicitly states that these provisions do not affect the provisions of the GDPR regulating the data protection impact assessment (DPIA), meaning that the DPIA may still be necessary.

Video Surveillance: Processing data through video surveillance is allowed if necessary and justified for the protection of persons and property, under the condition that the interests of data subjects are not overridden (i.e., that data subjects’ interests are protected to a sufficient extent and balanced with the legitimate interest of the controller who uses video surveillance in accordance with the law).

The surveillance must be limited to those premises and areas, or parts of thereof, which need to be monitored for achieving its purposes. 

In case of recordings of video surveillance of work premises, additional requirements need to be met: the recording must be in line with occupational safety regulations, employees must be individually notified about the recording, and relevant information must be given to them before the employer decides to employ the video surveillance. In any case, it is prohibited to record video of work premises used for rest, changing clothes, or personal hygiene. There is a separate set of rules for recording residential buildings and public areas as well. 

Video surveillance imposes additional obligations on controllers and processors, including the obligation to visibly mark that a certain object or area is under video surveillance and to provide other necessary information to data subjects through such notice. Another obligation is to establish an automated system to record all access to recordings. Controllers and processors that do not fulfill these two obligations may be fined up to HRK 50,000 (approximately EUR 6,750). 

The recordings may only be accessed by the responsible person of the controller or processor, or another person authorized by the responsible person, and only for purposes such as the protection of persons and property. In cases of unauthorized use, the responsible and authorized persons may be fined up to HRK 50,000 (approximately EUR 6,750). 

Sanctions and Other Provisions: Companies should bear in mind that a final decision about a data protection breach may be published in a non-anonymized form in many cases (especially for repeated offenses or where the fine exceeds HRK 100,000 (approximately EUR 13,500). 

It is interesting to note that, apart from the monetary fines related to video surveillance, the law does not prescribe specific fines that can be imposed on responsible persons of the controllers or processors. Such specific fines were initially envisaged by the law, but those provisions were removed from the final draft.

Apart from a few additional specific provisions (e.g. provisions regulating processing of data for statistical purposes carried out by official authorities), further provisions of the new law mostly relate to the functioning and operations of the Croatian Data Protection Agency.  

By Marija Zrno, Attorney-at-Law, Gregor Famira, Partner, CMS   

This Article was originally published in Issue 5.5 of the CEE Legal Matters Magazine. If you would like to receive a hard copy of the magazine, you can subscribe here.

Croatia stands among the highest ranked countries when it comes to the compliance of its PPP legislative framework with international standards. Reports issued by international institutions such as the EBRD and the EIB have praised Croatia for its elaborate legal framework, strong institutional capacities, transparent procurement practices, easy access to justice (including arbitration), and a range of security instruments facilitating financing.

PPP legislation, implemented in 2014, is well-established and tested in practice. Selection of a private partner is governed by the public procurement legislation (adopted in January 2017), which implements the Public Procurement Directive 2014/24/EC. The concessions sector, which was considered underdeveloped compared to PPPs, has been improved by the (new) 2017 Concessions Act. 

Croatia seems to be advanced in a number of factors investors typically look at before making a PPP investment. The selection of the private party is made in a fair and transparent process. There are only limited exemptions allowing for direct negotiations, and the law provides clear rules on the choice of tender. Tenders are open to all candidates. Quick and effective legal remedies against decisions of the contracting authority made during the selection process provide protection for investors while minimizing delays in the award process.

The “bankability” of a project crucially relies on the availability of reliable security instruments relating to rights and assets of the private partner in the project and other instruments to contractually secure the cash-flow of the private party in favor of lenders. To stabilize a private partner (project company) in economic turbulence, “direct agreements” and “step-in rights” (without tender) are allowed; further, the possibility of government financial support or a guarantee of the contracting authority’s proper fulfillment of its obligations significantly reduces project finance risks.

A project may be awarded only after an economic feasibility study ascertains viability and financial sustainability over the whole life of the contract as well as the likely socio-economic benefits and environmental impact of the project.

However, while the market seems mature, and legislation seems advanced, there is still no significant take-off. 

Currently 15 PPPs have been contracted in Croatia, for a total value of HRK 2,540,265,929.00. If the Istrian Ypsilon project (1995) and the Zagreb Airport project (2013) are subtracted from the list, Croatia’s transaction record would come down to a limited number of small projects in social infrastructure. And no significant new project has taken place since January 2014. 

Luka Gruz, a long awaited concession PPP project in the Dubrovnik area, has been presigned under a preliminary concession contract but the negotiations between the investor and the Management Council of the Dubrovnik Port Administration failed, and the preliminary concession contract expired in July 2016. 

Why there is no significant transaction record?

Effective implementation of laws is a challenge in many countries, and Croatia seems not to be an exception. The country seems to be missing a firm commitment to develop PPPs., as here is no real PPP policy in the country and no single (uniform) project pipeline endorsed by the government. 

The public perceives PPP as an expensive model with no clear benefits. Value for Money (VfM) criteria are not well understood. The public often has limited knowledge about the benefits and advantages of PPPs which in turn leads to resistance. PPPs 

are often perceived by the public as an “expensive” model which favors private partners and functions as a means to hide the privatization of public wealth and services. This is especially the case in Croatia, where they have been associated in the past with corruption and negative experiences in the form of projects failures or badly managed projects.  

Financial institutions often voice concerns about project documentation that is not reliable and unprofessionally prepared. Funding of proper (professionally prepared) project documentation and establishing a project preparation fund seems crucial.

Croatia has the potential to develop PPPs significantly in the next ten years. However, the benefits of PPPs and concessions should be promoted, and both public and public servants should be educated on the main features of PPPs and concessions. This would contribute to the better reputation of PPPs and concessions and address concerns associated with these models. 

It is expected that Croatia will start to direct EU structural funds towards PPPs, primarily  by developing model documents in the following priority sectors: (i) public lighting, (ii) public building, and (iii) broadband.  

By Marija Musec, Partner, and Mia Kanceljak, Senior Associate, CMS

This Article was originally published in Issue 5.3 of the CEE Legal Matters Magazine. If you would like to receive a hard copy of the magazine, you can subscribe here.

Divjak, Topic & Bahtijarevic has advised Sazka Group on its acquisition of a controlling stake and entrance into a strategic partnership within Super Sport, a Croatian online and land-based sports betting operator. The deal closed in April 2018.

On financial matters Super Sport was advised by KPMG. 

The Sazka Group is a lottery and gaming operator with brands in Austria, Croatia, Cyprus, the Czech Republic, Greece, and Italy. The aggregate annual amount of bets placed with companies in which the SAZKA Group holds an ownership interest is in excess of EUR 17 billion.

In its press release, Sazka stated that, “SuperSport has grown rapidly since the business was founded in 2000 and holds licenses and concessions in land-based and online sports-betting granted by the Croatian Government until 2025.”

Robert Chvatal, CEO of the Sazka Group, added, “the acquisition of SuperSport, the market leading Croatian sports-betting company by GGR, has compelling strategic logic, giving SAZKA Group access to an attractive gaming market while strengthening the Group’s position in the dynamic online sports-betting industry.‘‘

According to DTB, “the engagement was extremely multi-layered and included expertise of DTB’s corporate and M&A, games-of-chance, employment, competition, litigation, and banking and finance teams.”

The deal was handled and supervised by Partner Mate Lovric.

Croatia’s Cipcic‑Bragadin law firm has merged with the independent legal practices of Marina Mesic and Ivan Juricic. Following what it calls “the trilateral merger,” Marina Mesic becomes a new named partner and Ivan Juricic joins as a senior partner at the firm, which will operate going forward as Cipcic‑Bragadin Mesic and Associates.

According to Cipcic‑Bragadin Mesic and Associates, Marina Mesic will divide her work between real estate and commercial practices, while Ivan Juricic will focus on the firm’s litigation practice.

Silvije Cipcic‑Bragadin, the Managing Partner of Cipcic‑Bragadin Mesic and Associates, commented: “Strengthening and consolidating our teams is an important step in enhancing our offer, aligned with the strategy to focus on industry sectors where the market unanimously recognizes us as leaders in these fields. To be able to do that, we needed to grow our team and the quickest and the most effective way to achieve that was by doing a strategic merger with other legal practices. We couldn’t do that from the in-house, we needed to open a partnership. Historically, in the market where we operate, that was an uncommon thing to do but that is exactly what we’ve done here — merging three legal practices into one firm. I would like to personally thank Marina and Ivan for coming on board and I believe that this will be another successful story for all of us involved. There is plenty more room to grow and we have always been open for new ventures. We are currently in the process of several other discussions in relation to strategic mergers and hope to add new partners in the months to come. Having knowledgeable and experienced people is what our clients want from us and by enlarging our team with such professionals and market leaders like Marina and Ivan, we are able to provide personalized, professional, quick and effective support to our clients, who will know how to reward that level of service.”

Marina Mesic added: “We were approached almost two years ago with a proposal to do a strategic merger with the Cipcic-Bragadin practice. At that time, that all seemed a little too complicated to be pulled off, especially since all our practices had a different client base, different ways of doing things etc. However, over time, we recognized all the benefits of a merger and started close negotiations, during which we were all able to align our interests, overcome differences and make this merger possible. We’ve developed a system through which all parties’ interests should be satisfied simultaneously, making the platform suitable for new mergers and lateral hires. It is great to see things are moving forward and we all feel very positive about our business and future prospects.”

Over the last years, Croatia has produced more electricity from renewable than from fossil sources. The share of renewables in electric energy generation varies depending on hydrological conditions, as the majority of electric energy in Croatia is generated from large hydropower plants.

Croatia will probably review its goal of 20 percent share of renewable energy (the “RES”) in final energy consumption – since it has already exceeded it. Indeed, the European Commission has proposed in its winter energy package to increase the RES to at least 27 percent by 2030, while Eurostat data shows that Croatia achieved a 29 percent share back in 2015.

In 2011, 45% of electric energy in Croatia was produced from renewable energy sources including large hydro power plants. In 2012, this share was increased to 49.5%, in 2013 to 65.2%, and in 2014 to 74.2%, although in 2015 the share decreased to 68%. Large hydro power plants produced from 42% to 67.3%, while other renewable sources (small hydro power plants, wind energy, solar energy, biomass, biogas, and photovoltaic systems) produced between 3% to 6.9% depending on the year.

(Lack of a) Legislative Framework

In January 2016 a new Act on Renewable Energy Sources and Highly Effective Cogeneration came into force, introducing a new incentive system for RES and highly effective cogeneration in Croatia. This system consisted of: (i) a market premium, and (ii) a guaranteed purchase price for RES facilities up to 30 kW.

The new incentive system envisages that an eligible electricity producer selling electricity on the electricity market will receive a market premium from the electricity market operator (HROTE) for the net electricity delivered from the production plant to the power grid. Eligible producers with production plants of installed power up to including 30 kW can enter into a power purchase agreement with HROTE for the purchase of electricity with a guaranteed purchase price.

One would think that Croatia is on the way to fully utilizing its (impressive) capacities. 

However, the Croatian Government has not yet adopted secondary legislation for the implementation of the new incentive system and new quotas for renewables have not yet been defined. As the quotas for inclusion of RES projects in the (now obsolete) feed-in-tariff system have been almost fully met, in order to enable further development of RES projects, it is essential to define new quotas based on which tenders for incentives will be published. 

In other words: No new quotas, and no tenders for incentives, equals no (new) projects.

Also, there is a lack of funds for financing the incentives for electricity produced from renewable sources. End users pay a monthly fee for promotion of electricity from renewable sources as a part of their monthly invoice for electricity utility, which is used to finance the promotion of production of electricity from renewables. For this reason, in August 2017 the Croatian Government increased the fee for promotion of renewables from 0.035 HRK/kWh to 0.105 HRK/kWh (VAT excluded).

Further impediments to the development of renewables include deficiencies in the distribution and transmission grid in Croatia and the failure to enact measures which would enable the country to take full advantage of available European funds.

Upcoming Developments / Opportunities in the Renewables Sector

Croatia has real potential to transform into an energy-efficient, sustainable renewable-based economy, with its small population, relatively low energy demand, ample sun and wind resources, large areas of forest, and large existing hydropower plant capacity. However, Croatia does not fully maximize its potential in renewables, especially involving solar and wind energy. Indeed, despite having the remarkable advantage of the Croatian coast, which provides incredible potential for solar and wind energy, there have not yet been any projects for offshore wind power plants.

The Croatian Energy Development Strategy envisages installation of 100 MW in small hydro power plants by 2020. As the environmental protection requirement is a big factor in planning a hydropower project, most of the hydropower potential left in Croatia could be problematic because of its biodiversity impacts and the fact that almost all Croatian rivers are planned for inclusion in the EU’s Natura 2000 network.

As the majority of large hydro power plants were built a few decades ago, Hrvatska Elektroprivreda will invest almost HRK 3.2 billion into the revitalization of the country’s largest hydroelectric power plants, which will increase their installed power by around 150 MW by 2022. Also, in the next 18 months, energy renewal is planned for 223 kindergartens, schools, faculties, and student homes at a cost of HRK 781 million, with HRK 348 million to be drawn from EU funds.

By Marija Musec, Partner, and Mia Kanceljak, Attorney-at-Law, Bardek, Lisac, Musec, Skoko Law Firm in cooperation with CMS Reich-Rohrwig Hainz  

This Article was originally published in Issue 5.2 of the CEE Legal Matters Magazine. If you would like to receive a hard copy of the magazine, you can subscribe here.

Back in the 2000s, the conditions for getting a loan from a Croatian bank were quite strict and complicated. Beside a good credit rating, the banks were asking for a number of securities: mortgages, guarantors, etc. Recognizing that as a good business opportunity, many foreign financial institutions (primarily banks and leasing companies, but also financial cooperatives) decided to enter Croatian market.

They offered relatively affordable and simple financing solutions for both Croatian companies and citizens. However, although it was required by law, many of those lenders decided not to establish subsidiaries in Croatia or to seek approval from the competent authorities for their local activities. At that time, the only consequence for this non-compliance would have been misdemeanor fines for the financial institutions and their local representatives.

Since such fines by the Croatian authorities against the foreign financial institutions without presence in Croatia were almost impossible to enforce, and as the activities of the local representatives were below the radar for the Croatian authorities, foreign financial institutions were almost completely undisturbed in their financing activities in Croatia.

Now, ten years later, those foreign financial institutions might be facing serious difficulties because of their decision to proceed on that basis, as, following a substantial number of non-performing loans, pending enforcement proceedings and political pressure, the Croatian Parliament has recently enacted a new Law on Nullity of Loan Agreements with International Character.

According to the Parliament, the purpose of the new law is to prevent further enforcement proceedings initiated by foreign lenders which were not registered in the Republic of Croatia when the relevant loan agreement was executed.

The new law provides that such loan agreements, including any security documents, are to be proclaimed null and void, retroactively, and without any time limitation. In order to get the loan agreement annulled, the borrower merely has to file a claim, as the new law explicitly stipulates that the Croatian courts are competent for such claims. Thus, even if the loan agreement provided for the competence of a foreign legal venue, the borrower is entitled to file the claim in Croatia.

The new law is very short und unfortunately quite unclear: it affects loan/credit products and is to be applied on borrowers and guarantors alike, as domestic consumers and/or legal entities. It applies to every kind of agreement, disregarding applicable law, if the agreement has been executed in the territory of Croatia and the lender (at the moment of execution) is not registered with the Croatian Court Registry, has not held a banking license from the Croatian National Bank, and/or has not satisfied conditions for doing business in Croatia in general.

 The problem for the foreign lenders lies not only in the fact that their loan agreements could be annulled, but also in the fact that this annulment would trigger the annulment of security documents like mortgages and guarantees. In other words, the already registered mortgages would be deleted and the guarantors released of their obligations.

Since the court decisions would have retroactive effect (a loan agreement would be proclaimed null and void from the moment of its execution), the parties will be obliged to return to each other all of the received proceeds: the borrower to return the lender the principal amount without interest, and the lender to return to the borrower the interest back to the borrower. In practice, the best case scenario for the foreign lender would be to retain the principal amount without interest; in the worst case scenario (if the borrower has not repaid the loan, partially or completely), the lender would have to initiate a new court procedure against the borrower, without having any security instrument of the borrower. 

Despite its harsh provisions, the new law cannot be applied on already repaid loans. Also, it does not affect borrowers which are State-owned entities or medium or large entrepreneurs pursuant to the rules of the Croatian Accounting Act.

Although there is still no relevant court practice at the moment of writing this article, the new law will obviously have significant impact on the Croatian judiciary system, in particular with regard to a possible non-constitutional effect due to its retroactive effects. 

By Branimir Ivekovic, Ivekovic Law Offices 

This Article was originally published in Issue 5.2 of the CEE Legal Matters Magazine. If you would like to receive a hard copy of the magazine, you can subscribe here.

A reputable international business journal once described Croatia as an “economic and political basket-case.” Nowadays, it is becoming increasingly difficult not to agree with this impression. Open any newsfeed or any business journal, or Google top stories related to Croatia, and chances are you’ll stumble across at least one article about Agrokor. The headlines are something along the lines of “To house 15,000 creditors for the largest creditor’s meeting ever, Agrokor considers renting a stadium in Zagreb.“ 

If this strikes you as odd, you were probably lucky enough to have spent the better part of 2017 in an underground facility with no wi-fi. To clarify, Agrokor, which is Croatia’s largest company, experienced a near-death experience in April of this year and almost went bankrupt. Saved from certain demise by the Croatian Government, Agrokor is – much to the dismay of its foreign creditors – currently undergoing a tailor-made procedure similar to bankruptcy, which should allow it to emerge as a going concern mid-next year. Whether this emergence will actually happen is highly debatable, as the extraordinary management currently in control of Agrokor is the first ever in Croatia.

Why not let the company go bankrupt? Well, when confronted with the possibility of our largest company going bust (and dragging the entire economy with it), the Croatian Government was not content to simply use its existing (albeit, perhaps, faulty) insolvency laws. Bankruptcy and pre-bankruptcy were quickly cast aside as possibilities and – voilà – an entirely new law, appropriately dubbed “Lex Agrokor,” was created. Developed in a haste, this specific piece of legislation introduced a number of new concepts never before seen or executed in local laws. 

To say that the situation put local lawyers in a bit of a fix would be a massive understatement. Lex Agrokor deviates from bankruptcy significantly, but also turns to it in certain aspects. Are previous local practices of any real use here? What should we say to clients whose rights need urgent and vigorous defending? For a while there, no one seemed sure. Seven months down the road, things are a bit clearer, but there isn’t a Croatian lawyer who hasn’t worked up a sweat trying to protect his or her clients in this ordeal. If one thing is certain, it is that Agrokor will continue to take up a lot of our attention in the months to come.

However, this does not mean that Croatian lawyers haven’t been keeping themselves busy on other fronts at the same time. An interesting trend among local companies is the development of various corporate governance best practices. Management boards are becoming more concerned with what their duties and responsibilities are, and they are keen to develop and maintain internal procedures as and prepare models for as many scenarios as possible. Local market players consult more, and more effectively, with their lawyers and compliance officers. 

In addition, data protection has been and continues to be a huge deal, as companies are just beginning to grasp how challenging it will be to adapt to the new system introduced by the General Data Protection Regulation. There isn’t an association, let alone an operating company, which doesn’t collect personal data, at least in some form, and the May 2018 implementation deadline for the GDPR is looking awfully close. Both management and operational levels of companies need to be well acquainted with the new regulation and what it brings to the field – particularly in light of the large fines for companies with global presence, which go up to 4% of annual group worldwide turnover. Consequently, many companies with a local presence have already begun their preparations and welcomed any and all legal assistance they could get. 

This shows that Croatia is not to be written off just yet. It is true that Agrokor has caused anxiety in the local economy, and we’ve had a front row seat to a years’ worth of good deals and opportunities making their way down the drain. But, even if some may have hit the brakes in 2017, the majority of operating companies in “Basket-Case Land” have continued business as usual. Realizing there is little or nothing to add to the Agrokor tale while it is being unfolded, they have invested time and money into that which they can affect: strengthening their inner corporate structures. And this is precisely what they should be doing, to keep moving forward. 

By Sasa Divjak, Senior Partner, and Ema Skugor, Senior Associate, Divjak, Topic, Bahtijarevic Law Firm 

This Article was originally published in Issue 4.12 of the CEE Legal Matters Magazine. If you would like to receive a hard copy of the magazine, you can subscribe here.

Unfair trading is often referred to as the cause of crisis in various sectors, holding down small and medium enterprises. In practice, unfair trading is sometimes improperly confused with predatory pricing or distortion of competition. Unfair trading may also trigger serious tax implications.

The Commerce Act: Unfair Trading

Selling below competitors’ prices is not forbidden per se. Lower prices can encourage competition and, of course, benefit consumers.

However, under Croatia’s Commerce Act, selling below cost plus VAT is considered unfair trading. Exceptions include when goods are sold close to their expiration date, are being withdrawn from assortment, or are sold as part of an ultimate sale when closing the store or as part of a company’s bankruptcy and liquidation, along with other fair reasons for selling below cost that do not result in the prevention, limitation, or distortion of competition. What constitutes a “fair” reason is decided by the audit authorities, so one may question the equal treatment of all market participants.

The Commerce Act also refers to “competition,” so unfair trading matters are sometimes mistakenly brought before the Competition Agency. Ultimately, however, breaches of the Commerce Act fall within the inspectorate of the Ministry of Finance, and do not fall within the authority of the Competition Agency.

The Competition Act: Predatory Prices

Predatory prices, which are used to abuse an undertaking’s dominant position on the market,  consist of selling products temporarily below their cost to squeeze-out a competitor or prevent it entry to the market, only to raise them afterwards. 

For the Competition Agency to determine that an infringement of the Competition Act has occurred, the allegedly-predatory pricing strategy must include an undertaking’s dominant market position and market power strong enough to act independently of competitors and consumers. 

Damage Claims

Indemnity claims for damages due to unfair trading or a competitor’s abuse of its dominant position should be addressed to the Court.

Tax Implications of Unfair Trading

Unfair trading is investigated and punished by the Ministry of Finance inspectorate. Practice has shown that its control may also take the form of significant transfer-pricing (tax) assessments. 

Transfer pricing generally refers to prices and conditions of transactions within multinational groups, which should be in line with market prices and conditions. This is primarily a tax problem because of the risk that a multinational group may use transfer prices to decrease its tax base in one jurisdiction or to move profit from one jurisdiction to another.

Since trading in a multinational group is regulated by an internal pricing policy, whether a company is part of a group is one of the factors considered when analyzing potentially unfair trading. This may require further analysis of transfer prices applied in group transactions, resulting in additional tax assessments. In short, if the inspectors determine that trading was unfair and that prices applied in related party transactions are not in line with the arm’s length principle, they will adjust the undertaking’s tax base. This is usually done by increasing the tax base on the conclusion that the costs of goods/services were too high and/or that the selling prices were too low. 

Transfer pricing analysis and conclusions of unfair trading may also result in adjustments to prices in non-related party transactions. If, for example, inspectors find that an undertaking operates at a net margin lower than the average competitors’ net margin and conclude that this is because of intra-group transactions preceding the transaction with unrelated parties, they may adjust the undertaking’s tax base to bring it into line with the level of its competitors.

These sanctions usually ignore other reasons for selling goods below cost (including VAT), such as enhancing entry to the market or selling “accessory” articles to improve sales of the main product, although, as such reasons do not in any way prevent, limit, or distort competition, they do not represent unfair trading.

In practice, undertakings that continuously make losses and have tax losses carried forward are likely to be subject to unfair trading control and transfer prices analysis.

Once in the authorities’ cross-hairs, undertakings may expect to face long and uncertain administrative procedures. Tax matters are finally resolved by Administrative courts, where procedures regularly last between three and four years. The levied tax obligations are generally payable before the court procedure – i.e., based on the final tax resolution.

To conclude, unfair trading is a threat to market and consumer trust and undertakings which are judged to be trading unfairly expose themselves to significant fines and tax audits. The rules on unfair trading should therefore be taken seriously and companies should review prevention measures carefully and regularly.

By Tamara Jelic Kazic, Partner, and Marija Zrno, Attorney-at-Law, CMS Zagreb

This Article was originally published in Issue 4.11 of the CEE Legal Matters Magazine. If you would like to receive a hard copy of the magazine, you can subscribe here.