Czech Republic – Restructuring under the Directive proposal – an opportunity or a threat?

12. 2. 2018

Authors: Petr Sprinz, Petr Chytil
Source: Lexology

Intensive debate is currently under way in EU bodies on the proposal for a directive that could have a substantial impact on insolvency proceedings and the restructuring process in individual EU Member States. The proposal No. 2016/0359/COD[1] (“Proposal”) submitted by the European Commission envisages, among other things, the establishment of a legal framework governing informal restructuring of corporations’ financial engagement (“Informal Restructuring”). There is no such instrument in the Czech Republic and it has often been called for not only by our clients. Apart from the Informal Restructuring, the Proposal makes it clear that the national insolvency law should be gradually increasingly harmonised in individual EU Member States. In this article we will introduce the Informal Restructuring concept and draw attention to certain issues encountered in the Proposal. In fact, there is a risk that a number of provisions will be misused.

In what way does the Informal Restructuring differ from reorganisation?

The Czech Insolvency Act provides for reorganisation as one of the methods of addressing a company’s bankruptcy. Reorganisation allows debtors to handle the crisis in a flexible way, which is especially expedient for larger entities. Nonetheless, a reorganisation is public, relatively costly and is governed by formal insolvency proceeding regulations.

As opposed to reorganisation, Informal Restructuring does not constitute a formal method of tackling bankruptcy. It is an out-of-insolvency and practically a non-public way of resolving a crisis; its aim is to prevent bankruptcy. Based on the Proposal, which establishes the duty of Member States to transpose the Informal Restructuring into national regulations, the corporations concerned should moreover keep at least partial control of their assets and the day-to-day operation of the business.

A stay of individual enforcement actions under Informal Restructuring

One of the key mechanisms of Informal Restructuring is proposed to be the stay of individual enforcement. This instrument restricts individual enforcement of claims by creditors, except for employees’ outstanding claims. The measure is primarily intended as a protection against creditors who are not willing to discuss restructuring, and are eager to enforce their claims individually.

It is at courts’ sole discretion to grant this measure. Since the instrument is at risk of being misused by companies seeking restructuring, individual creditors may apply to courts for refusal to grant the measure or for cancellation of an already granted measure. The duration of the stay measures should not, as a rule, exceed 4 months. The corporation concerned should prepare a restructuring plan in the meantime.

Other impacts of the above-mentioned stay of enforcement include, among other things: (i) the suspension of the obligation to file for insolvency; (ii) a limitation on the right of the creditors concerned to withdraw from contracts or to withhold performance from already signed contracts; (iii) the right of a corporation to request appointing a restructuring expert. These measures should facilitate the restructuring and protect the company from suppliers who would otherwise default.

Funding provided to debtors on the verge of bankruptcy and ways to address this

In our banking practice, we have many times experienced a strong reluctance on the part of banks and other entities to engage in refinancing of borrowers on the verge of bankruptcy. A number of clients did not want to risk that the funding provided could subsequently be challenged in insolvency proceedings. This is especially true of transactions with an international element where several differing insolvency regulations enter into play. Often, however, refinancing of existing credit exposure, or the increase in its volume, is one of the conditions for preserving plant operations and averting bankruptcy.

In this respect, the Proposal offers a solution: excluding transactions from respondent’s actions under the insolvency law. Furthermore, the Proposal allows Member States to grant preferential status to claims under the new funding compared to other claims registered in insolvency proceedings.

The Proposal seeks in particular to incentivise entities to provide the necessary funding not only to implement the restructuring plan but also to ensure the plant remains in operation during the restructuring negotiations. Our experience has shown that without cash-flow hedging, it is very difficult to prevent the value of company’s assets from falling until the restructuring plan has been endorsed.

However, the drawback of the protection of new funding lies in the fact that the restructured company could abuse the mechanism and conclude a disadvantageous funding agreement without being able to review it later. The role of respondents’ actions is often crucial in insolvency proceedings, since it is possible to use them to seek ineffectiveness of legal acts that have damaged the creditors. If the Informal Restructuring fails, the legitimate interests of other creditors may be jeopardised in subsequent insolvency proceedings as a result of new funding.

To prevent possible abuse, creditors are to be provided with double protection, both quantitative and qualitative. The protection will be granted only to financing that will be essential for resuming the day-to-day business of the borrower or for its survival until the restructuring plan has been endorsed. If the new financing transactions are made fraudulently or unfaithfully, other creditors will be able to counteract them.

What next?

The Proposal is currently being discussed by the EU Council’s working bodies and its final wording is likely to be modified further. The manner of transposing the regulation into the Czech system of laws, however, will be more fundamental than the final wording of the directive. If the Proposal is adopted, its transposition will result in a number of double-edged provisions. Although the Proposal seeks to introduce a number of anti-abuse instruments, the question is whether the protection will be sufficient or whether the new provisions will do more harm than good depending primarily on the quality of the transposition. If implemented, its practical application might reveal any other possible flaws.

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