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Until very recently, Trnava was just another sleepy, struggling town in post-Communist Europe. But in January, French carmaker PSA Peugeot Citro�n S.A. announced plans to build a massive manufacturing plant there, not far from Slovakia’s capital, Bratislava. National pride over that coup is running high � and breeding resentment among the country’s neighbors. For politicians, business leaders, and lawyers in nearby Poland, Hungary, and the Czech Republic � until 1993 the other half of what was once Czechoslovakia � Peugeot’s decision came as a stinging loss. All three countries had wooed the carmaker, lobbying for the thousands of jobs and millions of dollars the deal promised. The trio have engaged in bidding wars before. But the Peugeot loss was a reminder of how times have changed in the former Eastern bloc. No longer the darlings of foreign investors who flooded in after the Berlin Wall fell in 1989, all three countries are discovering what it’s like to compete for � and lose � outside investment. Foreign investment in each of the three central European nations appears to have peaked. In Poland foreign direct investment reached a record $10.6 billion in 2000. After hitting a record $4.45 billion in 1995, annual FDI in Hungary now hovers around $2 billion. Thanks to two large foreign investments, including a onetime infusion from a state divestiture, only the Czech Republic saw a sizable increase, from $4.9 billion in 2001 to around $7 billion last year. The slowdown is in part due to the global recession, and in part due to an overall slowdown in privatization deals. But even if the economy rebounds, the three countries’ looming admission to the European Union will end a number of pro-business policies. And unrelated systemic problems may make multinationals think twice about new investments in central Europe. The central European countries also have another worry: competition by other soon-to-be E.U. members, like Slovakia. After the Peugeot deal was inked, central European lawyers grumbled that the Slovaks violated E.U. rules that restrict state aid to private industry. But no formal complaint had been lodged at press time. To be sure, there is much to applaud about central Europe’s move into the E.U. It promises stability and predictability in a region long accustomed to political and economic turmoil. At a practical level, goods will flow more freely across borders. McKinsey & Company estimates that increased trade, higher productivity, and further investments will add 1 � 1.8 percent annually to central Europe’s growth. The next phase of E.U. membership � joining the euro club, in 2007 at the earliest � will eliminate worries over unstable local currencies and conversion hassles. But there are potential drawbacks too. Membership is likely to bring rising costs, caused by everything from higher wages to stricter environmental controls, as well as increasing competition within the union. Those considerations have many central Europeans wondering whether E.U. membership is worth the trouble. Yet the momentum toward entering the club seems unstoppable, even taking into account considerable voter ambivalence. Poland, Hungary, and the Czech Republic have spent the past decade overhauling their political and economic systems at breakneck speed to comply with E.U. regulations. European Union � inspired legislation spans everything from antitrust to intellectual property to labor laws. “The pace of change has been phenomenal,” says Elizabeth Lee, the London-based global general counsel at GE Consumer Finance. Her parent company’s various interests in banking, power, and other businesses has made it one of the region’s largest foreign investors. Companies like General Electric Company are paying attention to three particular areas of business law � bankruptcy codes, privatization, and taxes � that are in flux. Poland is in the process of overhauling its antiquated bankruptcy code to comply with E.U. laws. Until that happens, businesses that run into trouble there cannot seek court protection while they restructure. While the proposed legislation brings bankruptcy law there more into line with the West, it still has plenty of flaws, according to lawyers in Poland. In the Czech Republic, multinationals are watching the country’s privatization of three key industries: telecom, energy, and oil. The Czech Republic needs to limit its ownership of state assets and lower its deficit in order to eventually use the euro currency. But politics and financing problems killed many deals in the past and are likely to plague future sales. And in a move that’s also likely to curtail foreign investment, Hungary has started to repeal generous tax incentives, to bring its tax system in line with the rest of Europe’s. What should foreign investors make of these changes? Several experts offer reassurance. Although each sector poses its own challenges, the three countries’ relatively sophisticated and predictable markets make them good candidates for investment, says Edward Ryan, the associate general counsel who oversees Marriott’s worldwide lodging operations, including those in central Europe. Transportation and other parts of the countries’ infrastructure are becoming increasingly modernized, and workers are well-educated, notes local boosters like Peter Hegedus, the president of Hungarian power generator ABB kft and the president of the American Chamber of Commerce in Hungary. Above all, the decision as to whether to invest in central Europe boils down to whether a company desires a stable environment, or it can endure a risky playing field. Vladimir Petrus, the co � managing partner of Clifford Chance’s Prague office, says that some companies will migrate farther east, to non � E.U. member countries where the regulations are looser and the freedom to maneuver is greater than is the case in central Europe. But “on balance,” says Petrus, “the advantages [of E.U. membership] outweigh the disadvantages.” Solving Insolvency After a frenetic decade of growth, Poland is only now addressing a critical piece of any free market economy: its bankruptcy code. A bill wending its way through Parliament at press time is expected finally to give creditors the level of assurance they’ve long enjoyed in the West. Until now, Polish bankruptcy regulations have been based on a 1934 law written for small business owners, not multinational corporations. If the local bread maker went under, there were two likely outcomes under the old regime, jokes Roman Rewald, a Warsaw partner in New York � based Weil, Gotshal & Manges: The owner shoots himself, and the division of assets turns into a free-for-all. Or, the owner decides to stick it out, and he’s left begging creditors for more time (assuming, that is, that they don’t shoot him first). There was no formal mechanism for restructuring a struggling business. The system worked well enough when the Communist government owned everything � or, as Sylwester Pieckowski, a partner in the Warsaw office of Chicago’s Altheimer & Gray puts it, “where money was not money, and everything was illusion.” That, of course, all changed when the Communist government crumbled in 1990. Starting then, Poland saw an influx of foreign investors eager to buy state assets with cold cash and tap into the country’s consumer base of 38.7 million. But lately, and for various reasons, including an outmoded infrastructure and economic dependence on Germany, Poland’s economy has struggled. Unemployment is running at 18 percent, the highest in the region, and gross domestic product growth, a scant 1.2 percent in 2002, is slower than that of either Hungary or the Czech Republic. According to Pieckowski, business failures are rising fast in Poland, with some 6,100 bankruptcy claims filed in 2001 and more expected in coming years � a reflection of both the weak global economy and the emergence of normal business cycles. As part of its E.U. candidacy, Poland agreed to modernize its bankruptcy code. Under the proposed legislation, expected to go into effect later this year, Poland will adopt a modern system that, according to Rewald and Pieckowski, mirrors that of the United States. Most importantly, the new laws introduce a mechanism for restructuring a hobbled company, not just shutting it down and leaving creditors to fight over the spoils. To a westerner, the principles behind the new code seem almost elementary. Struggling companies can now turn to courts for help before going under. Similar to a U.S. Chapter 11 proceeding, Poland’s bill divides secured and unsecured creditors into separate voting groups, allows creditors to petition for plan changes, and permits the adoption of a restructuring plan even if the company objects. The proposed legislation also aims to streamline the liquidation process, saving both time and money. Crows Rewald, whose firm helped draft the legislation: “This law is at the forefront of most contemporary insolvency legislation in Europe.” Not everyone is so enthusiastic. Zdzislaw Wieckowski, a partner in White & Case’s Warsaw office, says that he worries that the reorganization rules would be ineffective, because judges lack sufficient authority to block frivolous Chapter 11 � type filings. Having once had too few rights, creditors would now have too much power and could manipulate the process by forcing companies into a formal restructuring. But Rewald says that the parliament was taking steps to address these concerns, primarily by giving bankruptcy courts more power. Reality Czech To GE’s Elizabeth Lee, the shift from planned economy to open market has nowhere been more dramatic than in the Czech Republic, a nation of 10.3 million. A stroll down Prague’s main drag, V�clavsk� n�mest�, where peaceful protesters more than a decade ago brought down the country’s Communist regime, shows a shopping district teeming with the latest fashions. A nearby bakery sells bagels alongside more traditional bread. “From the time of the Velvet Revolution, the country just picked up and went,” says Lee, who adds that Czechs have embraced electronic banking with fervor. Yet for all that newfound savvy and energy, the Czech economy remains dominated by state ownership. The government still owns majority stakes in the energy, oil, and telecommunications sectors. All are considered hot properties among large foreign investors. But efforts in the last two years to sell assets in those three areas have faltered, continuing a pattern of bungled privatization. Now, pressure is mounting on the government to unload those holdings. The E.U. standard says state ownership of national assets should not exceed 10 � 15 percent of a country’s GDP. As of 1999, the republic’s stake easily exceeded that, according to The Economist (down from 96 percent in the early 1990s). Failure to meet those limits could delay the republic’s entry into the E.U. At a practical level, the Czechs could really use the cash. The country’s 2003 deficit is expected to increase to 6.3 percent of the GDP, according to PricewaterhouseCoopers. There’s another compelling reason to shed more assets: The Czechs, like the Hungarians and the Poles, are hoping one day to join the E.U.’s single currency, the euro. That won’t happen for four more years, at the earliest, but in order to adopt the euro, a member country’s deficit cannot exceed 3 percent of GDP. Selling off assets will help the Czechs reach that goal. There’s a strong financial reason to privatize, too. Sales of government-owned industries contributed to much of the influx of foreign speculators into central Europe throughout the 1990s. According to McKinsey, over the last decade foreign dollars amounted to 10 percent of GDP in some central European countries. In the Czech Republic, government sales of banks and other state assets helped attract more direct foreign investment � $4.9 billion � than Hungary or Poland did in 2001. So for foreign investors with bulging wallets, privatization offers a clear path into a new market. That’s the model GE used when it set up its banking operation in the Czech Republic. The company arrived there in 1995, having first ventured into Hungary five years earlier. GE started off small, offering consumers loans to buy TVs and other appliances. Eager to expand, in 1997 and 1998 it acquired three distressed banks from the government. “We knew we had no chance of getting a banking license . . . until the government banks were sold,” explains GE’s Lee. “So it seemed better to [buy] one.” Today GE is one of the country’s largest consumer lenders. But privatization, Czech-style, isn’t always simple. Late last year a $1.8 billion deal to buy a 51 percent stake in Ceksy Telecom, a.s., the country’s main phone operator, crumbled when a consortium of foreign telecoms led by Deutsche Bank AG tried to buy a bigger share, and negotiations broke down over price. Similarly, a government bid to shed petrochemical and oil refiner Unipetrol, a.s., faltered when the winning bidder couldn’t line up the $400 million to finance the purchase. The government has also been unable to pull off a third deal involving the country’s primary power generator, CEZ a.s. Local lawyers attribute the failures to a combination of changing market conditions, especially in the sluggish telecom industry, and tough government demands. Stephen Kines, a partner in the Prague office of London’s Linklaters, adds that Czech authorities are in a difficult position. They need the money but don’t want to sell at too cheap a price. That’s a balance that the country is going to have to strike. Despite its spotty track record, the Czech government renewed plans earlier this year to sell shares in all three industries by early 2004. While some Czech lawyers say the sales will be hard to pull off while prices remain depressed, there’s reason for optimism: The Czechs don’t have much choice. Tax-Free Holiday Ends On a cold, late January evening away from the tourists and affluence of central Budapest, the Duna Plaza mall bustled with shoppers. David Bowie blared from speakers and ubiquitous Sony televisions plugged the new Lord of the Rings flick showing at the nearby Hollywood Multiplex. A McDonald’s kiosk dispensed McFreezes and a nearby Clinique counter touted the latest age-defying cosmetics. It’s a sign that prosperity and modern mall culture is the norm here � a prosperity fueled, in large part, by big tax breaks for multinationals. Welcome to Hungary’s capitalist revolution. It started much earlier than the Czechs’ and the Poles’. The Hungarian government began social and economic reform back in the early 1980s, giving it a big leg up when the central European gold rush began a decade later. In all, an estimated $25 billion has flowed into the country since 1989. The Budapest Business Journal estimates that more than half of the country’s top revenue-earning companies are now foreign-owned. General Electric came early to the party, acquiring in 1990 a lighting business and then expanding into myriad industrial sectors. Last year it bought a majority stake in Budapest Bank, the country’s ninth-largest. Other major foreign investors include Citibank, N.A., Philips Hungary Kft., and Nokia Corporation. Key to the country’s allure: the most generous tax laws in the region. At 18 percent, the country’s corporate tax rate is much lower than the 28 percent charged in Poland and 39 percent in the Czech Republic. In some cases, the biggest investors wouldn’t have to pay taxes for up to ten years because of the incentives. But now, along with E.U. membership, the tax man cometh. One of the final sticking points in Hungary’s treaty with the E.U., signed in Copenhagen this past December, centered on the country’s use of tax benefits to attract foreign dollars. After some heated discussions, Hungary agreed to rewrite its tax laws to comply with E.U. standards. Among other things, a popular loophole used by foreign-owned companies was shut down. So too were the ten-year tax holidays. For some companies, the changes will be costly. About a dozen foreign multinationals will be affected the most, including GE and Flextronics International Ltd., according to local chamber of commerce chief Peter Hegedus. The full extent of the hit, of course, depends on future revenues. But as of this year the multinationals who escaped taxes in the past because of incentives now will cough up something. They won’t have to pay the full rate just yet, though. Larger investors will receive a 75 percent discount on their tax bills, according to the chamber of commerce, until 2011. Smaller investors will pay 50 percent in coming years. Automobile manufacturers will additionally be given a discount of 20 � 30 percent. Hegedus says some foreigners aren’t happy about the changes. Sitting in his elegant office on a gritty roadway a few miles from central Budapest, he says some may sue over what are essentially revoked privileges. Companies, says the soft-spoken but influential business leader, “were quite disturbed that this would be a breach of their agreements.” But to Hegedus, the furor over taxes obscures the bigger point of what E.U. membership signifies for the region. Borders will disappear, and central Europe will emerge as the ideal gateway between the West and markets farther east. If that shopping mall is any sign, it’s already happened.

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