With a delay of over a year, Czech Act no. 284/2023 on preventive restructuring implemented the EU Restructuring Directive 2019/1023 into Czech law with effect as of 23 September 2023. This publication explains some of the key choices made by the Czech Republic upon the Directive’s implementation.
The implementing legislation and its interplay with existing insolvency law
By implementing the Directive via a self-standing Act on Preventive Restructuring (the “Act”), the Czech Republic has chosen to implement the restructuring framework outside of its current insolvency law, a choice shared with a number of other Member States. However, existing Czech insolvency law has not been comprehensibly revised in response to the introduction of the Act. This is a questionable choice given the fact the Czech insolvency act already provides for a reorganization option in which the debtor (assuming that it meets a certain size test) remains in possession of the estate and is protected by an automatic stay while proposing a plan, which in practice will take on average some 12 months from the commencement of the insolvency case. Recourse to this option has not been restricted in any way in connection with the adoption of the Act which means that at least some debtors are likely to explore the successive use of the preventive restructuring framework and of the reorganization option. In the extreme, given the outer limit on duration of restructuring stays of 12 months pursuant to Article 6(8) of the Directive, this could mean that a distressed debtor could spend on the order of two years in possession of its estate and shielded from the policing effects of both individual enforcement of debts and the collective enforcement through a liquidation-type insolvency proceeding. The risks of this sort of implementation are plain to see and it will be interesting to observe how Czech restructuring and insolvency courts will address them.
All corporate debtors will be eligible to use the preventive restructuring framework, barring those exempt under Article 1(2) of the Directive. The framework will not be available to individual debtors, and creditors will not have standing to initiate the process.
In order to be able to use the restructuring framework, the corporate debtor will have to be in a state of financial distress that is defined by reference to a certain “bandwidth of distress.” As a threshold, the debtor must be in a state in which its financial difficulties would, upon a comprehensive assessment, lead to the debtor’s insolvency if the proposed restructuring measures are not implemented. If this sounds rather vague, that is because it is, and the vagueness is amplified by the fact that the Act provides for no particular timeframe over which this “likelihood of insolvency” ought to be tested. The other, upper end of the bandwidth of distress is pegged at cash-flow insolvency, a point reasonably well defined in existing insolvency law, beyond which the framework will not be available.
Within this bandwidth of distress, the restructuring framework will be available to all corporate debtors who remain liquid enough throughout the restructuring attempt to pay running costs of their operations, including financial costs, and the transaction costs of the restructuring process.
Protection while in restructuring
Consistent with the Directive, the Act offers the restructuring debtor two protective tools – the general stay and the individual stay, both requiring a court order.
In order to apply for the general stay, the debtor must formally commence the restructuring, which involves the debtor sending out to affected parties a “rehabilitation project”, a sort of restructuring plan “light” which must define a number of key parameters of the proposed restructuring, including in particular the affected parties and their affected rights, as well as any non-affected parties. In addition to the information and disclosures mandatory in the rehabilitation project, an application for the general stay also requires the debtor to file with the court a statement of the liquidity gap (as defined for the purposes of the insolvency act’s definition of cash-flow insolvency) in order to demonstrate that the debtor is within the eligible “bandwidth of distress”, i.e. in particular that it is not cash-flow insolvent.
A successful application will lead to the court ordering a general stay (i.e. a stay against all of the debtor’s creditors, or against such categories of creditors as the debtor defined in the petition) for an initial period of 3 months, unless the debtor has applied for a shorter period. Subject to i.a. the consent of the majority of claims of affected parties, the court will be able to extend the stay by up to another 3 months. The majority of affected claims will also be able to achieve the lifting of the general stay.
Once ordered, the general stay will protect the debtor (and potentially also the debtor’s affiliates to whom the petition and the court order extended) against enforcement actions by secured and unsecured creditors, including creditor insolvency petitions, and also against discontinuation of essential executory contracts.
An individual stay will offer a similar protection in scope, however, it will only protect the debtor against individually specified creditors whose total number is limited to 3. The individual stay may be applied for and ordered before the restructuring is commenced (and therefore before the information mandatory in the rehabilitation project is available). However, in such case the debtor must commence the restructuring within the next 30 days on pain of loss of the effects of the stay.
Restructuring measures and rights that may be affected
The restructuring plan may contain just about every measure imaginable on the left-hand and the right-hand side of the debtor’s balance sheet as well as in its operations. In line with the Directive, employee claims are immune from being affected, as are several other categories of rights, including in particular contested rights. (For the purposes of determining whether a right has the status of a “contested right”, the Act provides for an accelerated claims-review process conducted by the restructuring trustee). Controversially, the Act quite explicitly assumes that the restructuring may affect not only monetary claims but non-monetary rights as well which is a choice that is quite likely to bring about more than one surprise. Also, the Act is not clear on the dividing line between “old” and “new” claims for the purposes of determining which claims are and which are not susceptible to being affected in the restructuring.
Drawing up and adopting the restructuring plan
The debtor must present the plan within 6 months of the commencement of the restructuring at the latest. The Act provides for no creditor committees or other means through which the negotiation process could be facilitated or financed which is likely to prove unhelpful particularly in cases where the creditor portfolio is dispersed. Once presented, the plan will be put for a vote which may take place in a creditors’ meeting or via mailed ballots. Unlike in insolvency proceedings, the plan meeting will not be organized by the court but the debtor himself with its outcomes certified by a notary public or the restructuring trustee.
Voting will take place in classes of affected parties as defined by the plan itself. Inside a class, a 75 per cent. majority of claims will be needed for approval of the plan (with no requirement for majority approval per heads). The plan will need to build separate classes i.a. for each secured creditor, for connected parties, and for shareholders. Nevertheless, a plan that would aim to alter the share capital or effect other changes which, under company law or the company’s statutes require shareholder approval, will also require a shareholder meeting vote and approval, giving a relevant shareholder minority a de facto veto over the plan. This is not only a retrograde development compared to the insolvency act which has allowed Czech reorganization plans to change the share capital of corporate debtors since 2008 with no need for shareholder meetings, but also a questionable implementation choice in light of the Directive’s Article 12 that requires Member States to make sure that shareholders may not unreasonably block preventive restructurings.
The best interest test and the priority rule in cross-class cram-down
A restructuring plan will require a court confirmation if not all the affected parties voted for the plan. Among a number of other checks, the court will be checking whether the plan conforms to the best interest test, which the Act formulates as the test whether the dissenting affected party would not be better off if the debtor’s insolvency was resolved in formal insolvency proceedings. However, the debtor will be able to shift any controversy over the best interest test into separate litigation outside of the plan confirmation process, provided that the debtor deposits a sufficient cash reserve with the restructuring trustee for the purposes of compensating the dissenting affected parties invoking the best interest test, and provided that the amount of such parties’ claims does not exceed 20 per cent. of the total amount of affected claims.
For the purposes of cramming the plan down on a dissenting class, the Act applies a strict absolute priority rule to dissenting secured creditor classes (subject to bifurcation of claims based on the assessed value of their collateral), and what could be called a “modified absolute priority rule” to dissenting unsecured creditor classes. The latter rule consists of a set of provisions that allows the shareholders to keep their interests in the debtor company provided that (a) no creditor class junior to the dissenting unsecured class receives or retains any value under the plan, (b) the dissenting class is to receive in cash at least as much under the plan as it would receive in insolvency proceedings, (c) the shareholders’ shares are entrusted to the restructuring trustee, (d) independent directors and auditors are appointed and retained throughout the period of performance of the plan, and (e) the debtor pays out to the dissenting creditors all of its profits for the period of 5 years, or up to the full amount of their claims.
At the first instance, restructuring cases will be dealt with by 8 regional courts, i.e. the same courts which deal with insolvency cases. Restructuring trustees will be appointed from among specially licensed insolvency trustees. The restructuring files were intended to be maintained via an electronic restructuring register, however, the government has not put that register in place, resulting in a rather unsatisfactory makeshift solution. This is all the more disappointing given that the Czech Republic was one of the first Member States to launch, in 2008, a fully electronic online insolvency register.