Extraordinary changes to the Insolvency Act and Lex Covid as a helping hand in a time of crisis

1. 4. 2020

The current crisis caused by the SARS CoV-2 virus can be seen as a very abnormal situation. Measures adopted to prevent acceleration of the infection spreading may even have a devastating impact on a number of companies that are healthy in normal circumstances. The main problem to be faced by many entrepreneurs within a relatively short period of time is the lack of free liquidity for the payment of due liabilities.   

Inability to satisfy due liabilities due to a sudden massive loss of income may cause financial difficulties to many businesses that are healthy in normal circumstances. A halt to manufacturing or to business activities of the affected undertakings that are otherwise functioning well is undesirable from the perspective of the national economy as it could cause a rise in unemployment and further a spiral of economic decline.

A draft of the bill called Lex Covid responds, among other things, to a number of significant changes relating to insolvency proceedings. Please find below a general overview of new rules presented mainly from the perspective of entrepreneurs.

Extraordinary moratorium as a fast means of protection for a viable entrepreneur  

We regard as crucial the regulation of an extraordinary moratorium in the drafting of which we participated along with other insolvency law experts. The main objective of the extraordinary moratorium is to provide temporary protection to undertakings that are competitive in normal circumstances in the time of crisis and to help them overcome the loss of available funds by temporarily restricting realisation of collaterals or the commencement of enforcement proceedings or execution. It should create a breathing space and provide debtors with a higher level of comfort for reaching an agreement with creditors. This is crucial mainly after the entry into effect of the Civil Code, which substantially simplified the procedure for the realisation of collaterals. Nevertheless, unlike in the case of a standard moratorium, set-offs are not prohibited. Thus, the regulation also provides a certain degree of protection to creditors, as now more than ever everyone is a debtor and creditor at the same time.   

To ensure a higher level of flexibility the regulation of an extraordinary moratorium does not anticipate  a requirement for preliminary consensus by absolute majority of a debtor’s creditors; to declare an extraordinary moratorium the insolvency court should mainly check the formal aspects of the filed application. A debtor wishing to further extend an extraordinary moratorium will have to obtain consent by absolute majority of their creditors. Thus, to extend the effects of an extraordinary moratorium, consent is required from an absolute majority of the debtor’s creditors counted by the value of their claims.

The extraordinary moratorium is preventive by natureand therefore, its declaration is not conditional on filing an insolvency petition, which may have fatal consequences for a business that is healthy in normal circumstances. At the same time, the possibility to file a petition for an extraordinary moratorium will be maintained even after insolvency proceedings commenced upon the motion of a person other than the debtor. On the other hand, the extraordinary moratorium is intended only for those debtors who face problems – even temporarily – in connection with the COVID-19 pandemic and had not been bankrupt before the state of emergency was imposed.

However, a declaration of a moratorium also entails restrictions. Temporarily, debtors are obligated to refrain from such kind of acting which could lead to a substantial change in the composition, use or purpose of their assets or to their reduction to an extent greater than minor; nevertheless, these restrictions do not prevent debtors from using state aid in connection with the SARS CoV-2 pandemic. Declaration of an extraordinary moratorium does not even prevent a debtor’s creditor from filing an action with a general court; nevertheless, the time limits for exercising rights against the debtor during the effective period of an extraordinary moratorium will not start or continue.

During an extraordinary moratorium the insolvency court may also appoint a preliminary insolvency receiver and decide by a preliminary injunction, where appropriate, on imposing restrictions on debtors’ dealing with their assets. As soon as the extraordinary moratorium comes to an end without any insolvency proceedings being commenced, the debtor should be automatically deleted from the insolvency register so that such entry does not affect their future business after the crisis.

Protection of the debtor’s management

The Lex Covid draft bill brings a substantial change to the debtor’s obligation to file an insolvency petition due to bankruptcy. Many clients currently approach us with questions regarding the situation in which their partners stopped paying them while their overdue claims are mounting. In this time of uncertainty it is not desirable for viable businesses to prematurely file insolvency petitions against each other. Although the obligation to file an insolvency petition is not enforced in our country as draconically as in Germany, there is a real risk of which a large group of prudent and honest managers are afraid.

According to the draft bill, this obligation will be suspended from the effective date of the Lex Covid until the lapse of 6 months from the termination or cancellation of the pandemic emergency measure. However, this exemption is not applicable where bankruptcy had occurred before the extraordinary measure was adopted or where bankruptcy was not caused in connection with the pandemic.

Temporary limitation of creditors’ rights to file an insolvency petition

Lex Covid introduces a substantial limitation to creditors’ rights: without any exceptions a creditor’s insolvency petition cannot be filed until 31 August 2020 from the effective date of Lex Covid. A postponement of time-limits for opposable acts can be regarded as a sort of compensation for creditors as the draft bill proposes inclusion of the period for which the debtor’s obligation to file an insolvency petition is suspended in the time-limits prescribed for opposable acts.   

Some other important changes

Apart from the above, Lex Covid lays down further exemptions for debt discharge and reorganisations relating as a rule to mitigation of the consequences of a failure to adhere to a payment schedule or an adopted reorganisation plan due to the emergency measure adopted in connection with the pandemic .

Effect

This text introduced a draft bill which has been only approved by the government so far, and therefore it is possible that the exact wording of the individual measures will be further changed. But more substantial changes to the concept are rather unlikely to be made. Thus, without exaggeration, Lex Covid can be regarded as a revolutionary change in insolvency law despite its temporary nature.   

Conclusion

These days are full of news negative in tone. Therefore, these extraordinary amendments to the insolvency act aim at relaxing the mood a bit of those affected by the pandemic and at putting the economy in motion again.   

On this occasion, we would like to thank the members of the working committee for a great job and the experts from the Ministry of Justice who worked with us so hard, intensely and flexibly, nights and weekends.

We will be happy to answer any questions you may have relating to this or other subjects. We wish you good health and strength in this uneasy time.