End of extraordinary protection of debtors’ management members – restoration of the obligation to file a timely insolvency petition

29. 6. 2021

Authors: Dušan Sedláček, Jan Králíček

In response to the crisis caused by the COVID-19 disease epidemic, the so-called Lex Covid Justice was enacted, followed by Lex Covid Justice II, which introduced a number of significant changes, including in the field of insolvency law. We have discussed these laws in detail in previous articles available here and here. One of the emergency measures was the suspension of the obligation to file a debtor’s insolvency petition in the event of bankruptcy.

In this context, please note that as of 1 July 2021, the obligation of entrepreneurs and companies to file a debtor’s insolvency petition is renewed in full, including the potential liability of the management members under Section 98 et seq. of the Insolvency Act for damage if they file an insolvency petition late.

When is a debtor bankrupt?

The Insolvency Act provides for two forms of bankruptcy of a debtor – insolvency and over-indebtedness:

Insolvency

• a situation where the debtor’s business does not generate sufficient cash necessary to cover the debtor’s outstanding debts;
• the prerequisites are (i) a plurality of creditors, (ii) the existence of monetary debts more than 30 days overdue and (iii) the debtor’s inability to pay these debts.

Over-indebtedness

• an imbalance in the capital structure of a company where the debtor’s liabilities exceed the value of its assets;
• characterised by (i) a plurality of creditors, (ii) debts exceeding the value of the debtor’s assets;
• further operation of the debtor’s business is taken into account in the assessment of over-indebtedness.

What specific responsibilities do the management members have?

The law provides that the members of the statutory body of a debtor that is bankrupt must file an insolvency petition without undue delay after they became aware, or with due diligence should have become aware, of the debtor’s bankruptcy. That concept can be interpreted, in accordance with the case-law, as a short time limit which presupposes a very prompt reaction. The statutory body should monitor the company’s situation on an ongoing basis as part of its duty of due care and diligence. The most recent information on the company’s financial situation will currently be available primarily from the 2020 financial statements or interim financial reporting. It is therefore a fundamental obligation to check carefully whether the company does not meet the criteria of a bankruptcy.

How should the debtor’s management members proceed?

The debtor’s management members must act with due care and diligence; therefore, they must do everything necessary and reasonably foreseeable to avoid the bankruptcy of the company. In the event that an evaluation of the financial situation reveals signs of bankruptcy, the management members must immediately take steps to avert bankruptcy or proceed with filing an insolvency petition. In particular, the management members should:

• check the possibility of raising additional capital, e.g., through shareholders’ contributions;
• enter into negotiations with key creditors regarding their position on how to proceed or, if necessary, negotiate a repayment schedule;
• where appropriate, engage a crisis manager or approach legal and other advisors to assist in the restructuring or reorganisation of the company;
• assess whether bankruptcy can be averted, e.g., by bringing in an investor, and if not, then choose an appropriate method of resolving the bankruptcy and, for example, file a proposal to permit reorganisation together with the insolvency petition, prepared in cooperation with restructuring experts;
• consider whether it is appropriate to file a motion to declare a moratorium allowing the debtor to pay preferentially only claims directly related to maintaining the operation of the company (and to postpone payment of other claims) in order to negotiate a solution to the bankruptcy situation with its creditors or to prepare a reorganisation;
• avoid actions that would frustrate or hinder the possibility of satisfying creditors or favour creditors to the detriment of others.

Liability for failure to file an insolvency petition on time

Pursuant to Section 99 of the Insolvency Act, a person who has failed to file an insolvency petition on time shall be liable to creditors for damage or other harm caused to them by the breach of this obligation. This is personal liability that may be asserted against the debtor’s management members by the debtor’s creditors.

Liability for damage or other harm shall be discharged only if a management member proves that the breach of the obligation to file an insolvency petition did not affect the satisfaction of claims in the insolvency proceedings or if the person concerned failed to fulfil this obligation due to facts which occurred independently of his will (external circumstances) and which he could not have avoided even if he had made all the efforts that could reasonably be required of him. However, these grounds for the exclusion of liability have been interpreted restrictively in judicial practice.

HAVEL & PARTNERS provides comprehensive legal services in connection with informal restructurings of distressed companies and representation in insolvency proceedings. In this area, we primarily prepare, in cooperation with economic consultants, plans for informal restructuring of financial exposure or protect our clients from legal risks related to bankruptcy resolution.

Under the motto “Financing from A to Z” we connect the financing practice with the restructuring and insolvency practice. For more information, please see here.