Pre-pack insolvency sale in the Czech Republic: Current situation and outlook

A pre-pack insolvency sale, which is an expedited liquidation proceeding that allow for the sale of all or part of a debtor’s business as a going concern to the best bidder shortly after the insolvency proceedings are opened, is not formally regulated in the Czech Republic.

Although the market has developed a way to prepare the sale before insolvency begins and to finalise it after the formal insolvency process has begun, this process lacks the transparency that would help maximise recovery value for creditors. In addition, the sale often takes many months to close, which makes the pre-pack insolvency sale less attractive to investors.

This may change in the Czech Republic due to the EU directive harmonising certain aspects of insolvency law, a proposal of which was published by the European Commission on 7 December 2022. This article provides an overview of the legal situation for pre-pack insolvency sales in the Czech Republic and the expected impact the EU's Proposed Directive on current practices.

Existing framework in the Czech Republic

There is no formal legal framework regulating pre-pack insolvency sales in the Czech Republic. The lack of rules complicates the process because the sale of a distressed business must either be fully completed before insolvency is opened or finalised under the standard insolvency rules, which only reflect the pre-pack sale to a limited extent.

Typical steps in the process

The following steps are typical in pre-pack insolvency sales under the current rules:

• The management, together with its legal and restructuring advisers, prepares a reorganisation plan for the sale of the business or a viable part of it to an investor following a transparent tender process, as one of the restructuring measures.
• Although a tender for the sale of the business can be organised before the debtor’s insolvency formally opens, the tender usually takes place afterwards.
• The management must obtain the consent of creditors for the plan, which means at least half of the secured and half of the unsecured creditors calculated according to claim amounts must vote in favour of the pre-packed plan.
• The management files for insolvency and requests reorganisation according to the pre-packed plan approved by the creditors. The court declares insolvency and approves the plan.
• Although it should be possible to implement the court-approved plan immediately, due to the lack of clear rules and the risk of legal disputes, the debtors usually prepare an updated plan that reflects the creditors’ filed claims, expert valuation report, and the tender results reflecting the impact on the creditors’ recovery.
• The creditor classes established by the debtor and confirmed by the court must reapprove the updated plan.
• Once creditors and the court approve the updated plan, the sale can be carried out and recovery distributed to the creditors.

Risks and challenges of the current pre-pack insolvency sale

Closing a pre-pack sale usually takes from nine to 18 months from the opening of insolvency and is therefore often less efficient than expected. It may be possible to accelerate the sale process through a sale in bankruptcy liquidation, but this rarely happens in practice since bankruptcy liquidation effectively moves control over the process from the management (and creditors) to the insolvency practitioner who may have different views on how to sell all or part of the business to an investor.

Additionally, a pre-pack currently carries substantial risk for the management and other stakeholders, especially creditors willing to finance the debtor’s reorganisation leading to the pre-pack insolvency sale. For example, under the current rules, the management of the distressed debtor is required to file for insolvency without undue delay once the business fails to meet one of the insolvency tests, regardless of any bona fide effort to prepare a pre-pack insolvency sale. Therefore, there is only limited time to prepare the pre-pack sale before the opening of insolvency, which often compels management not to attempt the pre-pack at all.

Creditors willing to provide fresh funding to the debtor necessary to keep the debtor afloat until the sale can be closed are insufficiently protected by current rules, which can limit the ability of the debtors to find financing for the reorganisation plan. We believe that these weak spots can be addressed and the risk reasonably mitigated if the pre-pack sale is properly structured by experienced legal and restructuring advisers, even though the lack of formal rules makes the process challenging.

How will the Proposed Directive change the rules?

Unlike other EU jurisdictions that already have laws conducive to pre-pack insolvency sales, the mandatory introduction of pre-pack laws in the Czech Republic may significantly help rescue a good business from an insolvent company in a swift and transparent manner.

Under the Proposed Directive, Czech rules will need to formally incorporate two consecutive phases of the pre-pack insolvency sale:

• the preparation phase, aimed at finding an appropriate buyer for all or part the debtor’s business; and
• the liquidation phase, aimed at approving and executing the sale immediately after the insolvency is opened, and at distributing the proceeds to creditors.

Preparation phase will protect stakeholders and create transparency

The preparation phase will include a professional monitor appointed by the insolvency court. The monitor will be an insolvency practitioner who will oversee each step of the sale process, recommend the best bidder, and help ensure that the sale process is competitive, transparent, fair, and meets market standards.

In the preparation phase, the debtor may also benefit from a stay of individual enforcement actions despite formal insolvency proceedings not having been opened, which will be a new feature in Czech insolvency law.

Liquidation phase will lead to a swifter sale

On the recommendation of the monitor (i.e. insolvency practitioner), the court will approve the sale of all or part of the debtor’s business to the acquirer when the liquidation phase is opened. The selected investor will acquire the debtor’s business free of debts, obtain the executory contracts necessary to continue the debtor’s business, and benefit from the suspension of contracts that would lead to a business standstill, unless the investor is a competitor to the debtor’s counterparty. Both creditors and holders of equity in the debtor’s business will have the right to be heard by the insolvency court before the authorisation or execution of the sale.

The Proposed Directive also addresses issues that current Czech regulations do not sufficiently cover, such as the protection of interim financing and related security interests in the preparatory phase, the acquisition of the debtor’s business in pre-packs by parties closely related to the debtor, and the criteria to select the best bid in pre-pack proceedings.

For more information on the current Czech pre-pack sale regulations and how the proposed EU Directive could impact these rules, contact your CMS client partner or local CMS experts: Paul Stallebrass and Lukas Valusek.

This article is part of our Law-Now blog series "Harmonisation of Insolvency Laws in the EU", which will provide an overview of the EU Commission's draft directive, including the most important objectives and planned measures. The series itself will deal with the two exciting topics of the draft directive, "pre-pack proceedings" and "insolvency avoidance actions" and show how these topics are being discussed in the Member States and what the situation is like in individual non-Member States.