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Distressed M&A and Selected Czech Law Specifics

Distressed M&A and Selected Czech Law Specifics

Czech Republic
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As the COVID-19 pandemic keeps reshaping the M&A environment across Europe with only deals at the late stage proceeding further, we may also expect the advent – albeit slow and gradual – of distressed M&A in the Czech Republic as businesses fall into financing difficulties. Some businesses will strip off non-core assets, while others will end up in bankruptcy. In each case, this instability presents a wide array of options for strategic investors.

The purpose of this article is to remind market players of selected key features of distressed M&A transactions while pinpointing a couple of specific features under Czech corporate and insolvency laws we deem worth considering given the current circumstances.

For further details on changes to Czech corporate law and insolvency proceedings as a result of COVID-19 you may also refer to the following articles: Czech Republic: LEX COVID and changes to corporate law or Czech Republic: LEX COVID – Changes to insolvency proceedings. 

Features of distressed M&A

Generally, while an official definition of distressed M&A is lacking, it is fair to conclude that the distress element relates to financial, business, operational or other form of company instability with potential to quickly bring the company to the verge of insolvency procedures.

Distressed M&A transactions differ from traditional M&A transactions mainly due to their overall timing where the escalated pace aimed at limiting restructuring harm results in transactions taking weeks rather than months. Naturally, this is reflected in the due diligence process, which concentrates on matters that are critical for the buyer, and the transaction documents negotiation process, where discussions about the scope and limitation of representations & warranties, available remedies or deferred purchase price commonly do not happen. In other words, transactions proceed quickly with a clean exit for the seller, typically the insolvency administrator.

The insolvency administrator generally plays a central role, as it liaises with several groups of stakeholders whose interests must eventually be aligned. The buyer should be in a position to present a strong plan to the target's creditors, key customers, employees and management, and proceed in a manner that does not put the signing/closing of the transaction at risk due to (preliminary) information leakage.

Shareholder in bankruptcy

While many investors may find themselves in a "waiting mode" they should still be mindful that time remains a key driver in a distressed M&A. Against this backdrop, and given that the most common company form in the Czech Republic is a private limited liability company (s.r.o. / GmbH / LLC), the investors should duly consider the impacts of the bankruptcy of a shareholder in a Czech private limited liability company on its ability to dispose with its share in such a company.

Essentially, upon a shareholder being declared bankrupt (prohlášení konkurzu) it will be the company that will dispose of a share owned by such a shareholder in an auction, using proceeds (decreased by auction costs) to be paid to the shareholder or into its insolvency estate as a settlement share. While other shareholders generally have a pre-emptive right, its use is limited due to insolvency law restrictions (e.g. in case other shareholders are from the same group). The investor should generally avoid such a situation as it brings additional complexity to the transaction structure.

Finally, the issue is not limited to shareholders subject to Czech corporate laws, i.e. it must be assessed whether under the legal regime applicable to the shareholder (e.g. German law) the shareholder would be deemed bankrupt or not.

Dynamics of insolvent business sale

In a distressed situation, the investor should be aware that once the company becomes insolvent during the sale process, it is the insolvency administrator who takes the lead when ensuring the business operation of the company and the disposal of its assets, while creditors have a decisive say.

When selling the assets from the insolvency estate, the insolvency administrator will seek the approval of the creditors' committee and in certain cases even the approval of the insolvency court to the terms of such a sale. As noted above, there is no or only limited room for contractual negotiations.   

A suitable way to go forward in a distressed M&A process could be to use pre-packaged reorganisation (where possible). The advantage is a significant acceleration of the procedure, the possibility to agree on the reorganisation plan and associated documentation in advance, and the possibility to choose the insolvency administrator, all in alignment with the creditors.

Needless to say, the best possible scenario would be to achieve the implementation of the transaction before the insolvency and avoid the complexity and pressure related to the insolvency proceedings. This would not, however, eliminate the potential risk of the transaction being challenged by the insolvency administrator in order to claw back a fraudulent transfer or a transfer that constitutes an undervalue or a preference. Therefore, it will be important to ensure that the transaction will not result in the preferential treatment of certain creditors and will be performed for an adequate consideration, i.e. it should not be a too-good-to-be-true deal.

Conclusion

All in all, distressed M&A requires a knowledgeable investor with a decent restructuring track-record combined with an experienced advisory "task force" team able to skilfully manoeuvre in a narrow set of market standard conditions applicable to a distressed M&A transaction, as well as mindful of current COVID-19 specifics.

Certainly, COVID-19 brings an added twist to M&A transactions, including distressed M&A, such as travel restrictions limiting in-person management meetings or site-reviews in a due diligence process, buyer's protection under SPA (disclosure, W&I insurance, etc.), merger clearance decision delays and many others, which all need to be carefully evaluated against the particular deal background.

By Vladimir Cizek, Partner, and Natalie Rosova, Attorney at Law, Schoenherr

Czech Republic Knowledge Partner

PRK Partners, one of the leading Central European law firms, has been helping clients achieve their business objectives almost 30 years. Our team of lawyers, based in our Prague, Ostrava, and Bratislava offices, has a unique knowledge of Czech and Slovak law and of the business environment. Our lawyers studied at top law schools in the United States, United Kingdom, Switzerland and elsewhere. They also have experience working for leading international and domestic law firms in a number of jurisdictions. We speak your language, too. Our legal team is fluent in more than 15 languages, including all the key languages of the region.

PRK Partners has one of the most experienced legal teams on the market. We are consistently rated as one of the leading law firms in the region. We have received many significant honours and awards for our work. We represent the interests of international clients operating in the Czech Republic in an efficient way, combining local knowledge with an understanding of their global requirements in a business-friendly approach. We are one of the largest law firms in the Czech Republic and Slovakia. Our specialised teams of lawyers and tax advisors advise major global corporations as well as local companies. We provide comprehensive legal advice drawing on our profound knowledge of local law and markets.

Our legal advice delivers tangible results – as proven by our strong track record. We are the only Czech member firm of Lex Mundi, the world's leading network of independent law firms. As one of the leading law firms in the region, we have received many national and international awards, in some cases several years in a row. Honours include the Chambers Europe Award for Excellence, The Lawyer and Czech and Slovak Law Firm of the Year. Thanks to our close cooperation with leading international law firms and strong local players, we can serve clients in multiple jurisdictions around the globe. Our strong network means that we can meet your needs, wherever you do business.

PRK Partners has been repeatedly voted among the most socially responsible firms in the category of small and mid-sized firms and was awarded the bronze certificate at the annual TOP Responsible Firm of the Year Awards.

Our work is not only “business”: we have participated on a longstanding basis in a wide variety of pro bono projects and supported our partners from the non-profit sector (Kaplicky Centre Endowment Fund, Tereza Maxová Foundation, Czech Donors Forum, etc.).

Firm's website: www.prkpartners.com

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