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CZECH REPUBLIC: An Introduction to Restructuring/Insolvency

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Czech Republic: Restructuring/Insolvency – Practice Area Overview

In 2020, the market trends and development of legislation in the area of Restructuring and Insolvency were significantly affected by the COVID-19 pandemic. Given the fact that the pandemic remains ongoing, some of the protective measures and changes brought by the insolvency legislation adopted in response to the pandemic will last into the first half of 2021. Only then will it be possible to have a more realistic picture of the extent of the damage done to business and the number of enterprises that were destroyed as a result of the pandemic.

Apart from this, the greatest attention in the Czech Restructuring and Insolvency area is focused on important legislative changes anticipated in relation to the transposition of the related EU legislation.

Restructuring/Insolvency in the times of the COVID-19 outbreak

Due to the pandemic, the Czech government was forced to adopt several strict restrictions on free movement, the sale of goods and provision of services, including a complete “lockdown” in the spring of 2020 and spring of 2021, which critically affected many economic areas and, in fact, destroyed certain enterprises. The sectors most aggrieved have been hospitality, the hotel industry, tourism and aviation. In order to prevent a complete collapse of business, certain changes were introduced in the insolvency legislation in April and November 2020 by the so called Lex COVID I and II laws, which were accompanied by state aid flowing to the most affected areas.

In addition to partial measures such as suspending repayment of loans or providing relief from the effects of the expiry of procedural time limits in all types of court proceedings, Lex COVID provided entrepreneurs with protection against the effects of insolvency law by giving them a “transitional period” in which to adapt to the new situation, overcome temporary losses of income, secure new financing and negotiate with their creditors on the conditions for the continued operation of their businesses.

During this period, entrepreneurs who fell into economic difficulties due to the pandemic were released from their obligation to file an insolvency petition, the violation of which is otherwise sanctioned by law and exposes company directors to liability. The relief was originally granted until 31 December 2020, but an amendment adopted in November 2020 prolonged the period until 30 June 2021. After this date, company directors will be, by default, obliged to file for insolvency without undue delay after they learn or, with due diligence, ought to have learnt about the insolvency or over-indebtedness of the company.

Creditors were not allowed to file insolvency petitions until 31 August 2020. In order to protect debtors that were undergoing financial difficulties as a result of the ongoing pandemic after this date, Lex COVID made it possible for such debtors to request a so-called “Extraordinary Insolvency Moratorium”, which shall be in place until 30 June 2021. The moratorium serves as a protection period that gives a debtor some breathing space from their creditors who cannot exert their rights against the proposing debtor, including the filing of an insolvency petition, and the court cannot declare the debtor in question bankrupt. The maximum duration of the extraordinary moratorium is 3 months, but debtors are entitled to request an extension for another 3 months thereafter.

The most welcomed feature thereof, however, is that the request for extraordinary moratorium is subject to less strict conditions compared to the ordinary moratorium, which is permanently contained in the Czech Insolvency Act. In particular, debtors are not obliged to obtain the written consent of the majority of their creditors, unless they are requesting an extension of an already attained extraordinary moratorium.

Many debtors welcomed this change and have taken advantage of the extraordinary moratorium, hence the number of applications therefor greatly increased during the pandemic. Since 2008, there were only 139 applications for moratorium in total, of which 64 were admitted from 24 April 2020 (adoption of Lex COVID I) until 31 August 2020 (first deadline) and the growing trend continued beyond this date.

As a consequence of the COVID legislation, the number of insolvency petitions dropped significantly in the summer of 2020 and there has not been any subsequent significant increase compared to previous years. The government measures indeed continue to delay the effects of the coronavirus crisis in the insolvency area. We will see in the following months whether it was really “the calm before the storm”, or whether enterprises will manage to survive after the protective measures expire once and for all on 30 June 2021.

Forthcoming legislation on preventive restructuring

Czech Restructuring and Insolvency law awaits some very important legislative changes in 2022. As an EU Member State, the Czech Republic is now obliged to ensure the transposition of the Preventive Restructuring and Insolvency Directive (“the Directive”).

The Directive, among others, aims to reduce the cost of insolvency proceedings and contains several key measures, such as preventive restructuring frameworks, in order to facilitate negotiations on preventive restructuring and restructuring plans.

In order to transpose the Directive, work on the draft Act on Preventive Restructuring and related amendments to the Insolvency Act and other legislation took place throughout 2019 and 2020, and continues in 2021, during which the legislative process is expected to be commenced. Originally, the deadline for the transposition of the Directive was 17 July 2021. However, as a result of the pandemic, the Czech Republic requested an extension of the deadline until 17 July 2022.

The new Act on Preventive Restructuring primarily focuses on shielding debtors when there is a likelihood of insolvency, but still a chance of the prevention thereof, and ensuring the viability of such debtor. The Czech statutory legislation so far lacks any functional tool enabling flexible, informal or semiformal out-of-court negotiations between creditors and debtors when the latter are beset by economic difficulties. The Czech Insolvency Act only provides formal insolvency proceedings before the court, the commencement of which requires the debtor to have already become insolvent. This applies to both bankruptcies and company restructurings (so-called “reorganisations”). As a result, reorganisations are relatively costly and lengthy processes with a large involvement of the insolvency court, let alone their completely public character as all documents are published online in the Insolvency Register.

This will change with the introduction of so-called “preventive restructuring” into Czech law. Preventive restructuring should allow entrepreneurs who are experiencing financial difficulties, while their businesses are still viable, to come to agreement with their creditors in order to avoid formal insolvency proceedings and keep their businesses running. The suggested procedure creates a path for out-of-court conduct between debtors and their creditors and a timely, non-public means of resolving crises. This process is intended to be conducted with minimal court interference. Rather, the court maintains the position of a supervisor who shall safeguard a fair and transparent process. The key document to be executed is the so-called “restructuring plan”, which will contain measures proposed to rescue the debtor’s business, an overview of their assets and debts, and a list of the creditors divided into groups according to their economic interests.

One of the greatest benefits of such out-of-court restructuring lies in that the restructuring plan binds even dissenting creditors provided that it is approved by the required majority of creditors (“cram-down”). Under the current conditions, debtors have no tools with which to overcome the disapproval of minority creditors in out-of-court negotiations and, in order to avoid formal insolvency proceedings, they usually have to reach a general consensus among all of their creditors. In addition, preventive restructuring does not necessarily affect all of the debtor’s creditors (debts) and assets, as is the case with formal insolvency proceedings, which makes preventive restructuring schemes more flexible.

The preventive restructuring solution is highly anticipated as it will bring a new opportunity for distressed companies to resolve their financial difficulties before “it’s too late”, which will have a positive impact on the preservation of debtors’ businesses and the satisfaction of their creditors’ claims, which is usually very low in formal insolvency proceedings.