Restructuring and insolvency law in the Czech Republic

The Czech Insolvency Act (no. 182/2006 Coll.) and the European Regulation on Insolvency Proceedings (2015/848) are the primary legislation governing insolvency and restructuring proceedings in the Czech Republic. The EU Directive on pre-insolvency restructuring proceedings has not yet been implemented, but the process has started and is expected to be accomplished in the course of 2022. 

A restructuring of loans or other debts before the opening of insolvency proceedings against the debtor is not expressly regulated under Czech law. It is usually based on contractual arrangements and governed by corporate, commercial and labour law regulation. 

Since there are no specific out-of-insolvency restructuring proceedings regulated by statute in the Czech Republic, currently only insolvency proceedings can be initiated as a formal process. The initiation of insolvency proceedings always presupposes the filing of an insolvency petition. Such a petition can be filed either by the insolvent debtor or by a creditor. The insolvency petition must be based on the existence of a legal reason for the debtor’s insolvency, otherwise the court will not initiate insolvency proceedings.

These are the following legal reasons for insolvency under Czech law: illiquidity and over-indebtedness. In addition, the Czech Insolvency Act recognises impending insolvency as a reason for filing an insolvency petition. 
While a debtor’s petition for the initiation of insolvency proceedings can be based on any of these three reasons, a creditor’s petition cannot be based on impending insolvency.

Illiquidity 

Illiquidity occurs if a debtor has multiple creditors and payment obligations overdue for more than 30 days, and is unable to meet its payment obligations. There are several presumptions as to when a debtor is unable to meet its payment obligations (e.g. if a significant part of the payments of a debtor’s obligations has been suspended or the debts are overdue for more than 3 months).

Over-indebtedness 

Over-indebtedness as a reason to file for insolvency applies only to legal entities and individuals – entrepreneurs. Under Czech law over-indebtedness occurs if the debtor’s assets (considering potential positive going concern prognosis) no longer cover its liabilities (the balance sheet test). 

Impending insolvency 

Impending insolvency means that it is more likely than not that the debtor will not be able to meet a significant part of its due payment obligations on time.

Under the Czech Insolvency Act, debtors’ insolvency can be resolved by: 

• bankruptcy liquidation (konkurs) leading to the liquidation of the insolvent debtor
• formal reorganisation (reorganizace) that enables the debtor to continue in business, or 
• discharge of debts (oddlužení) as a specific method applicable mostly to individuals.   

Bankruptcy liquidation

In bankruptcy liquidation, the insolvency administrator takes over the powers from the debtor’s management and sells out the assets of the debtor (asset by asset, in bulk or the enterprise as a single asset) usually in a public tender in cooperation with the insolvency court and creditors’ bodies. Secured creditors have a right to give instructions to the insolvency administrator on how to administer and the method of the sale of the assets. Following the sale, the debtor is liquidated and deleted from the commercial register.

Formal reorganisation

Formal reorganisation enables the debtor’s management to remain in possession. The insolvency administrator’s role is limited to supervision, unless the insolvency court gives the administrator more rights. The debtor is supposed to prepare a reorganisation plan and win support for the plan among the various creditors’ group. There are no restrictions on the methods of reorganisation, but in practice the most usual method is a sale of the debtor to a new investor, and a capital entry of an investor into the debtor while reducing the debts of the debtor.

Currently there are no formal out-of-court restructuring proceedings regulated under Czech law.

As a matter of Czech insolvency law we can distinguish between preferential creditors, secured creditors, unsecured creditors and subordinated creditors: 

• preferential creditors – claims are satisfied in full from the insolvency estate (unless the estate is not sufficient to cover all preferential claims; preferential claims are listed in law and include claims of the trustee, costs of the insolvency and sale, employees’ claims, claims arising in the course of the insolvency, etc.)
• secured creditors – claims are satisfied in full or partly from the proceeds of their security 
• unsecured creditors – are usually satisfied with a single-digit dividend on their claims
• subordinated creditors – only receive a dividend (if any) if all other insolvency creditors have been fully satisfied. 

Under the Czech Insolvency Act, the debtor (its representative bodies) has a strict obligation to file an insolvency petition if it is over-indebted or illiquid (see point 3 above). In the case of impending insolvency, the debtor (members of the representative bodies, liquidator, statutory representatives of the debtor) are entitled, but not obliged, to file an insolvency petition. 

The petition has to be filed “without undue delay” after the debtor/its representative becomes aware of the insolvency or should have become aware of it in the exercise of due care. 

If the debtor (its representative) fails to file for insolvency in time, it faces several civil law risks. Each representative can be held personally liable for damages resulting from a late filing of an application for insolvency. 

In general, the law requires that representative bodies are fully aware of the financial situation of the company at all times, especially during financial difficulties. They have to undertake reasonable efforts to overcome the reasons for insolvency, e.g. by pursuing restructuring measures with immediate effect. If the representative bodies breach their obligation to act with due managerial care, they are obliged to surrender any profit they received in connection with such breach. In addition, breach of due managerial care leading to the company’s insolvency may result in the management’s duty to settle the remaining debts of the insolvent company.

The representative bodies of a company have the duty to supervise the financial wellbeing of the company to ensure that a petition for the initiation of insolvency proceedings is filed in due time (for the consequence of late filing, see point 6 above). If the insolvency petition is not filed in due time, the representatives are liable to the company’s creditors for any damage caused by such breach of duty. 

Furthermore, the representative bodies are required to provide the insolvency administrator, the insolvency court and creditors’ bodies with any cooperation necessary in connection with the insolvency proceedings.

The management remains in possession during formal reorganisation process and is expected to prepare, negotiate and implement a reorganisation plan to overcome the insolvency.    

Bankruptcy proceedings

Normally, an insolvency administrator (insolvency trustee) is appointed in the declaration of insolvency issued by the insolvency court. From that moment on, the debtor’s right to administer and dispose of assets belonging to the insolvency estate is transferred to the insolvency administrator. If the debtor disposes of assets after the opening of insolvency proceedings, such dispositions are ineffective or invalid (unless the Czech Insolvency Act states otherwise). The representative bodies are therefore normally not involved in insolvency proceedings. However, they have duties of disclosure and cooperation in order to assist the insolvency administrator, the insolvency court and creditors’ bodies with the fulfilment of their duties. 

Formal reorganisation

The situation is different in formal reorganisation, in which the debtor’s management remains in possession. However its rights to dispose of assets is limited, and each material disposal of assets requires the prior consent of the creditors’ committee and the insolvency administrator. 

Shareholders are under no direct obligation to comply with the duty to file for insolvency (see above). 

Shareholders have no obligation to provide additional funding to enable the company to survive. (LLC shareholders are liable for the obligations of the company up to the amount of their unpaid contribution to the company capital as registered in the Commercial Register.) However, if the legal structure of the company does not provide limited liability, the shareholders will be liable for losses. Furthermore, certain transactions between the company and its shareholders may be subject to clawback provisions. 

In general, shareholders have no right to make decisions on the assets belonging to the insolvency estate because the debtor’s assets are economically reassigned to the creditors. Shareholders can cooperate with the management of the debtor, however their role in insolvency/restructuring is effectively voluntary.

Shareholders can however be involved in the restructuring process of a company when a restructuring plan is drawn up. This is a type of overall settlement with the creditors which allows for the most varied of provisions, such as determining satisfaction quotas for certain groups of creditors. Shareholders can, but are not obliged to, design/negotiate specific regulations of the restructuring plan. Regulations about the rights of shareholders in particular can be part of the insolvency plan. After the plan has been drawn up, the creditors agree on it in groups, including the shareholders who vote on the plan as a separate group. The shareholders’ group vote is however not a decisive factor for the approval of the plan.

In general, the financial situation of the company should be the decisive factor in whether the company is solvently liquidated or whether insolvency proceedings are opened over the assets of the company. If the company meets the legal reasons for insolvency  – illiquidity or over-indebtedness – there is an obligation to file for insolvency and the shareholders cannot decide to liquidate the company voluntarily. 

If the company is solvent, it is not possible to choose insolvency proceedings to dissolve the company as the court will not initiate proceedings. If the shareholders (a general meeting of the company) decide to liquidate a solvent company, the appointed liquidator will be obliged to monitor the financial situation consistently. As soon as insolvency (i.e. illiquidity or over-indebtedness) occurs, there will be an obligation for the liquidator to file for insolvency without delay.

The Czech Republic does not currently have a legal framework for preventive restructuring. All restructuring measures (outside of insolvency proceedings) need to be negotiated between the company and its stakeholders within the regular legal framework, which usually requires the consent of all parties involved. 

The works on transposition of the Directive have already been initiated and the transposition is expected to be completed in the summer of 2022.

Only a small portion of the registered claims of unsecured creditors are satisfied (4-7% on average). The satisfaction rate for secured creditors depends on the value of the secured assets, but it rarely leads to the full satisfaction of secured creditors either. 

Usually, satisfaction rates are higher in restructuring proceedings (formal reorganisation).