The Restructuring Review: Czech Republic
Overview of restructuring and insolvency activity
Before giving an overview of the Czech insolvency market for 2020, we would like to make an introductory comment. We understand that the majority of readers will be concerned with insolvency proceedings of corporate debtors. Thus, in this chapter, we will primarily focus on this type of insolvency proceedings. Any numbers given in this chapter relate only to insolvencies of corporate debtors unless specifically indicated otherwise. However, since attempts of Czech legislators to reshape insolvency proceedings of physical persons in order to implement EU Directive (EU) 2019/10232 continued in 2020 as well, we will also provide a brief overview of these endeavours.
Undoubtedly, one could hardly find an area of law that was more influenced by covid-19 in 2020 than corporate insolvencies. What has seemed unthinkable since the end of World War II eventually happened and markets around the world stopped for a considerable time, leaving businesses of all sizes deeply uncertain about the future and without the possibility of generating cash. Once again, cash became king and time became queen for most of the businesses in the Czech Republic. However, it is fair to say that when looking back to 2020, covid-19 influenced corporate insolvencies in a very different way than most of us might have expected. It was thought that the number of corporate insolvencies would skyrocket; however, the opposite was true. Surprisingly, compared to 2019 which had 1,081 newly initiated insolvency proceedings,3 the number of newly initiated insolvencies in 2020 fell to 979, the lowest number in the last five years.4
Numbers also declined among the major bank creditors, where Komerční banka, a.s. kept its leadership position with 114 registered receivables (174 receivables in 2019), followed by Československá obchodní banka, a. s. with 109 receivables (113 receivables in 2019). On the other hand, Česká spořitelna a.s. (80 receivables in 2019) and Českomoravská záruční a rozvojová banka, a.s. (88 receivables in 2019), who were in joint third position among the major bank creditors in 2020, slightly increased their numbers compared to 2019, both ending up on 89 registered receivables.5
Heavy state subsidy programmes, combined with legislative interventions since the spring of 2020, were mostly responsible for this surprising outcome. The interventions initially froze the debtor's insolvency petitions, as well as involuntary initiation of insolvency proceedings until August 2020 and then significantly reduced this option throughout the rest of 2020 and a significant part of 2021. The interventions also introduced an extraordinary moratorium, which provided debtors facing financial distress because of the covid-19 epidemic with protection against creditor insolvency petitions for three months. During this period, the debtor could also prefer its key creditors (utility providers, etc.) and could eventually extend the period for another three months, with approval of the creditors. The main idea behind the extraordinary moratorium was to provide debtors affected by the covid-19 epidemic with some breathing space and time to overcome the sudden lack of liquidity.
Indeed, the affected businesses would probably disagree with our view, but we consider that the legislative interventions were too strong and missed the main objective. Instead of solving financial difficulties of businesses, or encouraging them to solve them when it was still possible, the interventions merely froze the process and postponed what was inevitable. As a result, it considerably crippled one of the major purposes of insolvency law – to naturally reduce those who are unable to strive on the market.
This reminds us of a famous Czech fairytale in which the main character made Death drunk and locked it in a cellar to prevent it from making people die, only to realise how vital a role death plays in our everyday lives and in the world order. Thus, Death was eventually released from the cellar so it could perform its duties again. In a similar way, the Czech legislator will eventually realise the inevitability of corporate insolvency and the need to allow it to occur. The only questions is how long it will take and how much it will cost in the end.
General introduction to the restructuring and insolvency legal framework
Czech insolvency law is mainly governed by the Insolvency Act6, which entered into force on 1 January 2008. The Code of Civil Procedure7 also applies complementarily to the Insolvency Act and is used in cases not governed by Insolvency Act.8
The idea behind the Insolvency Act was to address the fundamental problems of the previous insolvency law, in particular, to ensure greater transparency and predictability of insolvency proceedings, increase creditors' influence on insolvency proceedings and, mainly, to encourage debtors in financial distress to resolve the problem at its early stages. The Insolvency Act was inspired by other modern insolvency regulations, in particular, those of Germany, Austria and the United States.9
i Insolvency tests and insolvency petition
The Insolvency Act recognises three causes for initiation of insolvency proceedings. Liquidity insolvency and balance sheet insolvency are the most common insolvency causes and refer to a situation where the debtor is undergoing financial distress. The third option, impending insolvency, occurs when, with regard to all the circumstances, it may be reasonably assumed that the debtor will face financial distress.
Liquidity insolvency is a situation in which the debtor cumulatively: (1) has multiple creditors (at least two);10 (2) has outstanding monetary liabilities that are more than 30 days overdue; and (3) is unable to fulfil those liabilities.11
Furthermore, the Insolvency Act enumerates a list of presumptions as to when the debtor is unable to fulfil its outstanding monetary liabilities, including: (1) seizure of payment of a substantial part of financial liabilities; (2) having financial liabilities more than three months overdue; and (3) inability to satisfy liabilities by way of court enforcement.12
The presumption of an inability to fulfil monetary receivables may be refuted by the debtor by a coverage gap. This happens when the debtor proves that the difference between the amount of its outstanding monetary liabilities and the amount of its available funds is less than 10 per cent. Even if the coverage gap is higher than 10 per cent, the debtor may demonstrate that the coverage gap will fall below this level within a reasonable time (usually from two to three months).13
From a practical perspective, liquidity insolvency is used in the majority of creditor insolvency petitions because it can be proved even without a detailed knowledge of inside information relating to the debtor and also provides the creditor with an option to use presumptions. The presumptions under (1) and (2) above are used most frequently.
Balance sheet insolvency
Balance sheet insolvency occurs if a debtor (either a legal entity or a natural person/entrepreneur) has multiple creditors, and, at the same time, the aggregate amount of its liabilities (due and not yet due) exceeds the aggregate amount of its assets (liquid and illiquid).
The Insolvency Act takes into account the going-concern principle when assessing a debtor's assets. One must not only consider the aggregate amount of a debtor's liabilities in relation to the aggregate amount of its assets; consideration must also be given to the future management of the debtor's assets (such as rental income, dividends and interest) and further operation of the debtor's business (expected profit, in particular), if it can be reasonably assumed that the debtor will continue to manage its assets and operate its business for the foreseeable future.14
Since determining balance sheet insolvency requires a lot of inside debtor information, the balance sheet insolvency test is used almost exclusively in debtor insolvency petitions.
Impending insolvency occurs when it can be reasonably expected that a debtor will not in the future be able in good time to meet a substantial part of its monetary liabilities.15
A company or person can be subject to insolvency proceedings even though not insolvent at the moment of initiation and must then use remediation methods to resolve the distressed situation, such as reorganisation (for a legal entity or entrepreneur) or discharge of debts (for a non-entrepreneur). Bankruptcy is not possible in the case of impending insolvency proceedings.
Opening of insolvency proceedings
Under the Insolvency Act, a debtor16 must file an insolvency petition without undue delay if it becomes aware or should have become aware17 of meeting the liquidity insolvency or balance sheet insolvency tests. The only exception when the debtor does not have an obligation to file an insolvency petition is with respect to an impending insolvency. Failure to exercise this duty may lead to personal liability of a debtor (in the case of a person) or the management of a debtor (in the case of a corporation) for damages.
In an insolvency petition, the debtor should ideally propose how its insolvency will be handled (bankruptcy, reorganisation or discharge of debts); however, it is not mandatory to do so. A petition for moratorium can be also included in a debtor's insolvency petition to gain further protection from creditors and additional negotiation time if reorganisation is the desired option.
Creditors are also entitled to file an insolvency petition against a debtor to maximise satisfaction of their receivables.18 Although creditors may use both liquidity insolvency and balance sheet insolvency as grounds for filing, the option of using the latter is largely theoretical because it requires deep insight into a debtor's accounts, which creditors usually lack (except for bank creditors with facility agreements and similar instruments). Filing an insolvency petition in case of a debtor's impending insolvency is not an option for creditors.
Creditors have higher standards than debtors with respect to filing an insolvency petition. Mainly to prevent frivolous and groundless petitions used to pressure a debtor, a creditor must own an overdue receivable and register it at the insolvency court. Furthermore, the creditor has an obligation to keep its receivable against the debtor on its books and duly document and verify the receivable when filing the insolvency petition. International creditors must also provide confirmation of the foreign state on the verification of their receivables.19
ii Types of insolvency proceedings
There are (except for specific circumstances relating to insolvency of payment institutions) three types of insolvency proceedings available under the Insolvency Act.20 Each type seeks to achieve different goals. Bankruptcy proceedings look to liquidation of a debtor's assets to achieve the highest satisfaction of creditors' receivables. A reorganisation focuses on maintaining a debtor's business and gradual satisfaction of creditors while keeping the debtor operational. A discharge of debts is a specific form of proceedings for natural persons (non-entrepreneurs) with gradual satisfaction of creditors and can function either on the basis of a sale of a debtor's assets or repayment of debts in instalments.
Bankruptcy is the default way of resolving a debtor's insolvency pursuant to the Insolvency Act after the commencement of insolvency proceedings or after an unsuccessful attempt to solve the insolvency by reorganisation or discharge of debts. It is also by far the most common way in which insolvency is dealt with in the Czech Republic.
The aim of bankruptcy proceedings is to satisfy the claims of registered creditors by monetising the debtor's assets. The proceeds of the monetisation are divided proportionally among the creditors, and, generally speaking, receivables that are not satisfied by a bankruptcy do not expire but usually continue to exist. The existence of the debtor (corporation or entrepreneur) is usually terminated after the bankruptcy proceedings are concluded.
By declaring bankruptcy, the insolvency court transfers the right to dispose of the insolvency estate, as well as to exercise debtor's rights and obligations, if they are related to the insolvency estate, to the insolvency trustee, appointed by the insolvency court.21 The insolvency trustee may monetise insolvency estate in several ways, namely by public auction, sale outside a public auction and sale of movables and real estate in accordance with the provisions of the Code of Civil Procedure on the enforcement of decisions, or by auction conducted by a bailiff. After a consultation with the creditors' committee, the insolvency trustee decides on the specific method.22
Secured creditors are entitled to receive the satisfaction of their receivable primarily from the proceeds of the monetisation of the collateral. In the event that specific collateral is subject to security rights serving several creditors, the creditors are satisfied in the order in which their collateral was perfected. Any part of the secured claim that is not satisfied from the collateral is then deemed to be unsecured and is satisfied along the unsecured claims pari passu.
If the debtor is a natural person or an entrepreneur whose turnover for the last accounting period prior to declaration of bankruptcy does not exceed 2 million Czech crowns (approximately €75,000) and who does not have more than 50 creditors, a special form of bankruptcy applies. In this minor bankruptcy certain specific procedures apply which simplify the process.23
A reorganisation is a remediation method for solving the insolvency, primarily focused on larger corporations and entrepreneurs. The Insolvency Act defines reorganisation as the gradual satisfaction of creditors' claims while maintaining the operation of the debtor's business, ensured by measures to improve the management according to the reorganisation plan approved by the insolvency court with ongoing control of its performance by creditors.24 In a reorganisation, disposition rights regarding the insolvency estate usually stay with the debtor; however, these rights can be reduced by a decision of the insolvency court.
Reorganisations are intended primarily for larger entrepreneurial debtors, specifically for debtors whose annual total net turnover for the last accounting period reached at least 50 million Czech crowns (approximately €2 million), or for debtors who have at least 50 employees. However, this restriction does not apply in the case of a 'pre-packed' reorganisation, in which, along with the insolvency petition, a reorganisation plan already approved by a majority of both secured and unsecured creditors is submitted to the insolvency court.25
Both the debtor and any of its creditors may request the insolvency court to approve a reorganisation. Upon the approval of the insolvency court, the debtor has 120 days to present a reorganisation plan (this does not apply in case of a pre-packed reorganisation, where the plan is already submitted along with the insolvency petition). Should the debtor fail to do so, creditors may present their own reorganisation plan.
The reorganisation plan generally describes the way in which the debtor business will be reorganised and also how the creditors will be satisfied during the reorganisation process. The reorganisation plan must follow an honest intention of the debtor to provide the creditors with satisfaction at least as high as in bankruptcy proceedings.26 Once the reorganisation plan is submitted, it must be approved at the creditors' meeting by a majority of creditors in each class. If approval is not reached in any particular class, the insolvency court may apply a cross-class cram down and approve the reorganisation plan, even given the disapproval of certain classes, if the reorganisation plan is fair to this class. At least one class must approve the plan before cross-class cram down is used.
Discharge of debts
Discharge of debts is a specific way of resolving insolvency for debtors who are not entrepreneurs or who do not have debts from entrepreneurial activity. Discharge of debts can be done in two ways. The first is the monetisation of insolvency estate. The second contemplates the debtor paying unsecured creditors in instalments for five years (maximum) a sizeable part of its income and secured creditors satisfying themselves from the proceeds of their collateral.27 If additional conditions are met, the debtor is cleared of its remaining debts at the end of the process.
iii Informal restructuring
Informal restructuring procedures are not formally part of the Insolvency Act and occupy a grey area between M&A and insolvency law. Regardless of this fact, they are generally performed on the Czech market. Such a lack of regulation results in significant uncertainty in negotiations for any out-of-court restructuring and lack of any form of protection of the debtor is a significant weakness of this concept. Due to various interests at play, creditors often fail to reach any consensus and a company in financial distress ends up in insolvency, even in cases where it would still have been possible to keep the company alive through timely restructuring if the debtor had been protected during a certain period from unilateral actions of creditors.
In the future, however, the implementation of EU Directive (EU) 2019/1023 should ease the restructuring process – especially the preventive restructuring. More importantly, creditors will gain certainty and protection during the process, as the current grey area practice would likely become a lawful part of Czech insolvency law. The Czech Republic must implement the essential features of the EU Directive (EU) 2019/1023 concerning preventive restructuring into national law by July 2021. Owing to the covid-19 crisis and the considerable slowdown of legislative bodies, in 2020 the Czech Republic requested an extension of this period for one year.
Nevertheless, until the implementation of the EU Directive mentioned above, creditors must rely on certain informal restructuring methods. One of the potential, and arguably the most popular, informal restructuring methods is the entry of a strategic investor who invests funds into the business in exchange for a share of a target, or creating a joint venture. Other methods include restructuring (reducing the cost aspect of a group holding, spinning-off of distressed and profitable assets and so forth) and selling non-core assets to generate cash. If bank financing is involved, certain protection of the debtor is usually achieved through standstill agreements, which, in exchange for strong supervision from financing banks, provide the debtor some time to restructure its business and carry on. However, standstill agreements are not common among cases where non-banking creditors are involved.
On the other hand, probable opportunities for investors lie in the acquisition of receivables and investing in targeted companies.
iv The taking and enforcement of security
The Insolvency Act recognises a secured receivable as a receivable secured by particular assets belonging to the insolvency estate. The secured receivable simply represents the strengthening of the position of the creditor (secured creditor), who satisfies its claims primarily by selling the collateral.
In insolvency proceedings, collateral is considered to be, among others, a lien (a mortgage), a retention right (a right not to extradite another's property until the debt is settled legally) or a transfer of a right as security (the debtor temporarily transfers some of his or her property rights to the creditor and only if the debtor fails to settle his or her liabilities does the creditor become the owner).28
The secured creditor may give instructions to the insolvency administrator concerning the administration of the collateral and exercises significant influence regarding the desired way of monetising the collateral in the bankruptcy proceedings.
Only if the proceeds from the sale of collateral exceed the amount of the secured receivable may the proceeds then be subsequently used to satisfy the receivables of unsecured creditors.29 On the other hand, if the proceeds do not cover the whole secured receivable, the unsatisfied part of the secured receivable is considered (in bankruptcy and reorganisation) as an unsecured receivable and is satisfied pari passu with the unsecured receivables. In the case of discharge of debts, the secured creditors can be satisfied only from the proceeds of the monetisation of the collateral.30
v Duties of directors of companies in financial difficulties
Under Czech law, members of the statutory body must perform their duties with due care.31 A breach of these duties might result in personal liability of the members of the statutory body, possible disqualifications from the function of a member of any statutory body (up to three years) and an obligation to return any monetary benefit received over the course of two preceding years preceding the initiation of the insolvency proceedings.32 A director or board of directors of limited liability or joint-stock company has an obligation to call a general meeting of the company to address the financial distress.33
Under normal circumstances, the Insolvency Act imposes an obligation on the debtor (and as a consequence its management) to file an insolvency petition without undue delay, upon it becoming aware (or when it should have become aware34) of meeting either the liquidity insolvency test or balance sheet insolvency test. The persons responsible for filing the insolvency petition are, among others, the members of the statutory body of the debtor.
Failure to file the insolvency petition on time may result in personal liability for damages caused to creditors by late initiation of insolvency proceedings and subsequently lowered satisfaction of their receivables. According to the Insolvency Act, these damages can amount to the difference between the amount of all receivables registered by the creditors in the insolvency proceedings (and acknowledged in the insolvency proceedings) and the amount received by the creditors during the insolvency proceedings.35 Since the average satisfaction of creditors in Czech insolvency proceedings ranges from approximately 3 per cent to 64 per cent (depending on the proceeding type and existence of security),36 the liability can be quite material. It is irrelevant whether a member of the statutory body has caused a breach of the obligation to file an insolvency petition or not.
However, the covid-related legislative interventions to Insolvency Act introduced a temporary suspension of the debtor's duty to file an insolvency petition for the initial period of six months from April 2020 and subsequently prolonged the suspension until 30 June 2021 at the latest. For the time being, the suspension meant that if the debtor was not insolvent prior to the covid-19 epidemic and indeed the epidemic caused its financial distress, the debtor and its management may focus on the restructuring of the business without incurring liability towards creditors for late filing of an insolvency petition.
Nevertheless, one must emphasise that the suspension did not eliminate the general obligation of members of corporate bodies to act with due care and to do everything necessary and reasonably foreseeable to avert the impending insolvency of the debtor. For the sake of completeness, it should be noted that the covid-related relief did not restrict debtors from filing for insolvency on their own initiative, even if they find themselves in insolvency due to the covid-19 epidemic.
Aside from the obligation to file for insolvency, the members of the statutory body are also personally liable for any damages caused to the creditors by wrongful actions of the debtor during an ordinary or extraordinary moratorium37 or while lacking creditors' committee approval for significant legal acts during a reorganisation. The members of the statutory body may also incur criminal liability for certain preferential actions or for diminishing the insolvency estate.38
vi Clawback actions
The Insolvency Act provides that legal acts (or omissions) of a debtor that may result in diminishment of an insolvency estate can be declared ineffective by an insolvency court based on a legal action filed by the insolvency trustee. The aim of this regulation is to prevent a debtor from diminishing the insolvency estate prior to the initiation of insolvency proceedings (where oversight from the insolvency court and insolvency trustee is exercised) so as to preserve the maximum satisfaction of creditors.
If the trustee's action is successful, the legal act in question will be declared ineffective by the insolvency court. With the legal act becoming ineffective in the insolvency proceedings, the debtor's counterparty must return the assets received from the debtor.39 The legal act still remains valid outside the insolvency proceedings.
According to the Insolvency Act, the following conduct provides the basis for potential clawback actions if performed one year (in the case of third parties) or three years (in the case of related parties) prior to the initiation of insolvency proceedings:40
- disposition without an adequate consideration: the debtor made a transaction (transfer of assets, provision of security, etc.) without consideration at all or adequate consideration;
- preferential treatment of creditors: a preferential legal act is a legal act as a result of which a creditor receives, to the detriment of other creditors, greater satisfaction than it would otherwise receive in bankruptcy proceedings; and
- deliberately diminishing the satisfaction of a creditor: a legal act by which the debtor intentionally diminished the satisfaction of a creditor.
Recent legal developments
In 2020, the covid-19 pandemic took the world by storm, and its impact on insolvency law was significant. It became apparent during the first days of the economic shut down in March 2020 that lawmakers had to step in with covid-related relief to prevent mass insolvency throughout the whole economy. Thus, the Czech government introduced a major, yet temporary, amendment of the Insolvency Act.
Aiming to prevent the unnecessary insolvencies of businesses hit by the covid-19 pandemic, the Insolvency Act amendment41 became effective in April 2020. It introduced, among other things, extraordinary moratorium, temporary suspension of a debtor's duty to file the insolvency petition (see above) and arguably the most controversial temporary suspension of all creditors' insolvency petitions.
In particular, the suspension of all insolvency petitions filed by creditors had a significant effect on the Czech insolvency market, as for more than four months (May to August), all debtors had a chance to focus on the restructuring of their businesses without fear that their creditors would initiate insolvency proceedings. To put the theory in numbers, the overall number of insolvency petitions dropped by almost 45 per cent in the period between May and August 2020.42
Further, the amendment introduced an extraordinary moratorium to shield debtors in financial distress from creditors for three to six months (an initial three were given even without the consent of creditors), during which creditors were not allowed to file insolvency petitions and debtors were allowed to prefer certain key creditors, such as utilities providers. All companies were eligible for the extraordinary memorandum, provided that:
- they were not insolvent prior to the covid-19 epidemic (the decisive date was 12 March 2020);
- their centre of main interest was in the Czech Republic;
- they have not carried out any distributions of profit or other monetary funds towards shareholders and finally; and
- the company requested the extraordinary memorandum in relation to impacts of the covid-19 crisis.
Overall, 61 companies took advantage of the new protection until 31 August 2020.43
Towards the end of summer 2020, with the daily cases rate spiking and another economic shutdown, it became clear that there was a need for another covid-19 relief package. Therefore, the Czech lawmakers adopted another amendment to the Insolvency Act.44 This time, however, they chose a slightly different approach. The lawmakers were clearly trying to provide a chance for companies to save their businesses by gaining enough time for these efforts. Thus, the suspension of the debtor's duty to file an insolvency petition was prolonged, and the extraordinary moratorium reintroduced. On the other hand, lawmakers were aware that some companies had reached a point of no return with no feasible plan or outlook for saving their business. With that in mind and considering widespread criticism of the suspension of the measure, general suspension of creditors' insolvency petitions was not part of the autumn amendment to the Insolvency Act.
Aside from the amendments to the Insolvency Act mentioned above, Czech companies had access to numerous covid-related programmes by the government focused on financially supporting companies in distress. Most notably, the 'COVID PLUS' guarantee programme for large exporters was introduced. Under this programme, the state-controlled export insurance and guarantee company provided guarantees for bank loans of up to 80 per cent of their value and subsequently 90 per cent of their value based on a rating given to the debtor. In this programme, over 91 applications were approved for the total amount of over 12.7 billion korunas.45 Another example of state subsidies was the 'COVID III' guarantee programme, focused on providing state-backed guarantees for companies with up to 500 employees whose economic activities were limited as a result of the covid-19 epidemic, with over 4 691 applications approved for a total amount of over 31 billion korunas.46
In a legal development unrelated to covid-19, the Czech government is currently working on the transposition of EU Directive (EU) 2019/1023 into Czech law.47 Apart from the preventive restructuring, as mentioned above, the EU Directive (EU) 2019/1023 also covers the principles of discharge of debts for entrepreneurs and small businesses after three years of insolvency proceedings. However, the Czech lawmakers took unprecedented action and suggested shortening the period for discharge of debts from the current five to three years not only for entrepreneurs and small businesses, but also for consumers (natural persons). For the sake of clarity – discharge of debts of consumers makes up 96.19 per cent of all proceedings relating to the discharge of debts, leaving as little as 3.81 per cent for entrepreneurs and small businesses. Such suggestion received heavy criticism from legal experts stressing that it could harm entrepreneurs and small businesses, the very group the EU Directive (EU) 2019/1023 is trying to protect by lowering the satisfaction of their receivables in insolvency proceedings of consumers and increasing the risk of secondary insolvency. Experts also highlighted that this goes directly against attempts to increase financial literacy among consumers in recent years.48
At this point, legal experts and lawmakers are still in the process of drafting legislation that would be acceptable for both the general public and legal experts, and everyone sincerely hopes that the final draft will be universally acceptable at the implementation deadline by July 2022.
Significant transactions, key developments and most active industries
Despite the government's intense endeavour to rescue covid-affected businesses, and the resulting decrease in the number of initiated insolvency proceedings, the Czech market recorded several significant distress cases in 2020.
Like many other countries, tourism became one of the most affected industries in the Czech Republic. Dozens of travel agencies got into trouble following a drastic decrease in their client numbers, and at the end of the year, even FIRO-tour, one of the best-known travel agencies operating in the Czech market for more than 30 years, had to close down after failing to secure its obligatory bankruptcy insurance for the upcoming year. For a brief moment, the company tried to continue operation as a 'mere' travel broker, buying time for a more comprehensive solution, but eventually had to file for bankruptcy in April 2021.
Czech Airlines (ČSA) sadly suffered a similar fate. This closely observed case involved repeated negotiations with Czech government representatives in an endeavour to rescue the sole national airline under the COVID PLUS subsidy programme. A political constraint on more intensive support was, however, the fact that 49 per cent of its parent company (also loss-making Smartwings, which, unlike the retail-oriented ČSA, focuses on b2b contracts with travel agencies), is ultimately held by a Chinese investor. Although both companies were still able to make use of the introduced subsidy programmes, it now looks like only the parent company will continue to fly with the support of the COVID PLUS subsidy programme.
Another area of business that was hit hard by the coronavirus crisis in 2020 was undoubtedly the fashion and clothing industry. A major example of this is BLAŽEK. An established brand, which operated a network of nearly 30 stores with over 100 employees just one year before the coronavirus crisis struck, could not be salvaged even by two extraordinary moratoria. However, the company managed to file for a pre-packaged reorganisation and the plan was eventually approved by the majority of its creditors. Successful with its reorganisation proposal was also Kara Trutnov, one of the Czech market's leaders in leather and fur fashion, which despite the initially proposed bankruptcy now looks forward to a brighter future backed by a major Czech investment group.
The Czech-Slovak investment group Arca Investments, which for many years attracted wealthy individuals and firms promising high revenue from its short-term bond and bill programmes, has also been facing severe financial problems. The company operated for over 20 years, focusing mainly on real estate or energy sector investments, and had been repaying its bonds steadily until June 2020. However, it then lost its bank financing during the coronavirus pandemic and the money collected from non-banking creditors was no longer sufficient to cover its liabilities and ventures. This is unsurprising, given that Arca has nearly 1,900 creditors with liabilities totalling approximately 18.6 billion korunas.
Another bond case with an unhappy ending was the investment venture EMTC group. Throughout 2017 and 2018 EMTC issued various volumes of bonds in the hope of financing the development of a unique mobile application focusing on the education of preschool children. Interestingly enough, the investor portfolio included both small financial market amateurs as well as notable public figures and respected professionals from various fields and lines of business. Over 800 of them filed their claims in the still ongoing insolvency proceedings, claiming receivables of almost 1.8 billion korunas. Unfortunately, it is painfully clear now that the majority of them will not recover anything.
It is only fair to mention that in light of the bond adventures like Arca's or EMTC's, Czech legal society has long been striving for a fundamental amendment to the governing legislation.
The matter of Vítkovice Heavy Machinery, which we briefly mentioned in last year's edition, also continued in 2020. The traditional Czech engineering company with a unique know-how in production of shafts for windpower plants got into financial difficulties mainly due to its underfinanced operation and the forlorn situation of the global market, where European heavy industry is facing cheap Asian competition on the one hand and strict European regulation on the other. Although there were several major financial players, including the well-known arms manufacturer Michal Strnad and his Czechoslovak Group, that tried to rescue Vítkovice Heavy Machinery, the company was definitively brought to its knees by the covid-19 crisis and a forced sale was inevitable. However, the result of a three-round electronic auction (unique in the Czech environment) was a relatively surprising bid amounting to three times the original reserve price.
What is interesting about Vítkovice's case is that despite the insurmountable distress, the insolvency administrator managed to keep the business running throughout the whole insolvency proceedings. All in face of the fact that originally, more than 160 creditors filed their claims for receivables exceeding 1.7 billion korunas.
One final case worth mentioning is, without a doubt, the bankruptcy of one of the eldest Czech publishing houses, Mladá fronta. Mladá fronta used to issue approximately 250 book titles a year and more than 40 magazines, including professional journals and children's magazines. Unfortunately, the operations were terminated due to insufficient funds and a subsequent mass employee exodus. Not only that, its owner at that time, a rather controversial Czech businessman, is currently also being prosecuted for alleged tax evasion. To end on a good note, however, let us mention that a partial salvation was brought about by Albatros Media, currently the largest Czech publishing house, which bought out and saved at least the book division of Mladá fronta, along with its employees.
Like most EU Member States, the Czech Republic has not yet adopted or implemented into its legislation the Model Law on Cross-Border Insolvency of the United Nations Committee on International Trade Law, and to our knowledge nothing indicates that a change in this respect is on the horizon. It is therefore the recast EU Regulation on Insolvency Proceedings49 that represents the main source of law concerning cross-border insolvency proceedings in the Czech Republic, both for its direct applicability among EU Member States,50 as well as for its notable influence on national legislation applicable in relation to non-EU countries. The regulation entered into force on 26 June 2017 and serves as a complex legal framework applicable to proceedings commenced after that date.
In 2020, the Czech Republic saw the beginning of a very interesting case concerning the use of said framework and the issue of COMI51 determination in particular. This is the above-mentioned Arca Capital insolvency proceedings. Although the group originates in Slovakia and has its registered seat there even today, the group itself filed the insolvency petition in the Czech Republic, claiming that most of its creditors and business endeavours are located here. And the majority of its creditors, including the biggest and only secured one, J&T Banka, agreed; also arguing that the applicable Czech legislation will provide for a clearer and more transparent proceedings, and is more likely to allow reorganization of Arca's business. Arca's founder and former owner Pavol Krúpa, who is currently in several multimillion-koruna disputes with Arca, on the other hand, claimed that the investment group is only trying to escape the objectively stricter legislation in Slovakia. Unfortunately, seeing as all relevant steps came in 2021 and the case is far from over as of today, we can only say we very much look forward to reporting on developments in the case in next year's edition of this publication.
To return to applicable theory, insolvency matters concerning non-EU countries in the Czech Republic are governed by the Act on Private International Law,52 which came into force as part of a significant civil law recodification in 2014. Its relevant sections dealing with cross-border insolvency matters53 provide that where the jurisdiction of Czech courts to commence insolvency proceedings is given under a directly applicable EU regulation, these proceedings will also apply to the debtor's property located in a non-EU country, provided such country recognises its effects within its territory and only to the given extent of such recognition.
Similarly, foreign decisions regarding insolvency matters are recognised in the Czech Republic under the condition of mutual reciprocity, provided that the debtor's COMI is in the country that issued the decision and that its assets located in the Czech Republic are not subject to an ongoing proceeding at the Czech courts.
Czech courts are also entitled to commence insolvency proceedings with regard to a branch situated in the Czech Republic and debts relating to this branch, and also to individuals with residence in Czech Republic.
In 2020, it became apparent that the economic crisis caused by the outbreak of covid-19 would not be just a seasonal bump. With stores closed for most of the year, many retailers faced problems in 2020. The fashion industry, which is very dependent on traditional shopping, was hit especially hard and saw several major insolvencies during 2020. But it would be a mistake to think that apart from fashion and retail, things were in order. Many other industries faced problems due to covid-19 and were able to keep themselves above water only thanks to heavy state subsidies. Among insolvency practitioners, automotive, travel services, manufacturing, HORECA, the wellness industry and commercial real estate are regarded as yet-to-fail industries in the aftermath of the covid-19 crisis.
Since Czech legislation reacted to this new scenario merely by freezing insolvency proceedings, instead of for example rapid implementation of preventive restructuring schemes under EU Directive (EU) 2019/1023, as was done in Germany, the problems of Czech businesses will simply be postponed. They will grow under the surface and will eventually erupt even more strongly in 2021 and the years to come. Once state subsidies are removed, we expect that many businesses will not be able to keep afloat and will start defaulting. Major market players such as banks, advisors and insolvency professionals expect to see a first wave of insolvencies in summer 2021. This aftermath of covid-19 and inability of the Czech legislator to deal with it accordingly may thus very well become the biggest challenge for insolvency law and insolvency courts since their establishment, and it remains to be seen how they will handle it. We are confident of their competence, but we expect a major slowdown in handling insolvency cases, since courts will be overburdened.
This outcome could have been partially offset by timely implementation of preventive restructuring schemes under EU Directive (EU) 2019/1023 into Czech insolvency law. This would allow some of the less affected businesses to solve their financial difficulties outside the insolvency proceedings to the benefit of both debtors and the insolvency courts. Since the Czech Republic failed to implement this Directive in 2020, it shall remedy this deficiency during 2021. There is a lively debate about whether the preventive restructuring schemes shall be part of existing insolvency law, or stand outside the insolvency scheme. Both options have certain advantages and disadvantages and we shall see which of those will eventually prevail.
Another vital question is how long the anti-covid-19 measures will last during 2021. Since the Czech Republic entered 2021 in a relatively severe lockdown, it will very much rest on the discipline of local people how fast the government can manage to get the disease under control and shops and services open again. If this happens fast, there is still a chance that many businesses will be able to recover by the end of 2021. However, if not, or if the opening is followed by another wave of covid-19, the outlook will be less optimistic.
Undoubtedly, 2021 will be a year of insolvencies. The question of how many of them we will see depends on a variety of factors and on the willingness of Czech people and legislators to do the right thing.
1 Tomáš Brožek is a senior attorney and Jan Dudik and Leoš Vavřík are associates at Deloitte Legal.
6 Act No. 182/2006 Coll., on insolvency and insolvency procedures, as amended (Insolvency Act).
7 Act No. 99/1963 Coll. on civil procedure, as amended (Code of Civil Procedure).
8 Section 7 of the Insolvency Act.
9 See the Explanatory Report to the Insolvency Act.
10 In order to prevent frivolous insolvency petitions, anyone who has acquired a receivable against a debtor from an insolvency petition six months prior to or after the commencement of an insolvency proceedings cannot be considered when assessing the number of creditors (Section 143(2) of the Insolvency Act).
11 Section 3(1) of the Insolvency Act.
12 Section 3(2) of the Insolvency Act.
13 Section 3(3) of the Insolvency Act.
14 Section 3(4) of the Insolvency Act.
15 Section 3(5) of the Insolvency Act.
16 Non-entrepreneurs do not bear the obligation to file an insolvency petition pursuant to Section 98 of the Insolvency Act.
17 While conducting reasonable care in the business.
18 Section 97(7) of the Insolvency Act.
19 See Section 105 of the Insolvency Act for further details.
20 Bankruptcy, reorganisation and discharge of debts.
21 An exemplary description of an insolvency estate can be found in Section 206 of the Insolvency Act.
22 Section 286 of the Insolvency Act.
23 See Section 314 et seq. for further details.
24 Section 316(1) of the Insolvency Act.
25 Section 316 and 148 of the Insolvency Act. Pursuant to Section 316(3) of the Insolvency Act, reorganisation is not permissible for debtors undergoing liquidation, operating as brokers or participating on a stock exchange.
26 Section 348 of the Insolvency Act.
27 Section 398 et seq. of the Insolvency Act.
28 Others include restriction of real estate transfers and assignment of a receivable for the purpose of lien. See Section 2(g) of the Insolvency Act for further details.
29 Section 298 and 305 of the Insolvency Act.
30 Section 398 of the Insolvency Act.
31 51 et seq. of Act No. 90/2012 Coll., Act on Commercial Companies and Cooperatives, as amended (Act on Business Corporations).
32 Section 63 et seq. of the Act on Business Corporations.
33 Section 182 and 403 of the Act on Business Corporations.
34 While conducting their duties with due care.
35 Section 99(2) of the Insolvency Act.
36 See Richter, T. Insolvenční právo. 2. vydání. Praha: Wolters Kluwer ČR, a.s., 2017.
37 Section 127 and 127a of the Insolvency Act.
38 For further details, see Section 222 et seq. of Act No. 40/2009 Coll., Criminal Code, as amended.
39 Section 235 et seq. of the Insolvency Act.
40 Section 240 et seq. of the Insolvency Act.
41 Act No. 191/2020 Coll, Act on Certain Measures to Mitigate the Impact of the SARS CoV-2 Coronavirus Epidemic on Participants of Civil Proceedings, Crime Victims and Legal Entities, and on Amendments to the Insolvency Act and the of Civil Procedure Act, as amended.
44 Act No. 460/2020 Coll., which amends Act No. 191/2020 Coll, Act on Certain Measures to Mitigate the Impact of the SARS CoV-2 Coronavirus Epidemic on Participants of Civil Proceedings, Crime Victims and Legal Entities, and on Amendments to the Insolvency Act and the of Civil Procedure Act, as amended.
45 Data as at 15 April 2021, see https://www.cnb.cz/cs/dohled-financni-trh/souhrnne-informace-fin-trhy/statistika-odkladu-splatek-a-uveru-v-programech-covid/.
46 Data as at 15 April 2021, see https://www.cnb.cz/cs/dohled-financni-trh/souhrnne-informace-fin-trhy/statistika-odkladu-splatek-a-uveru-v-programech-covid/.
48 See the official statement published by the Czech Bar Association on 12 January 2021:
49 Regulation (EU) 2015/848 of the European Parliament and of the Council of 20 May 2015 on insolvency proceedings, recasting and replacing the previously applicable Regulation (EC) No 1346/2000.
50 Replaced Regulation (EC) No 1346/2000. Denmark is not bound by this regulation or subject to its application.
51 Centre of main interest.
52 Act No. 91/2012 Coll., on Private International Law, as amended (Act on Private International Law).
53 Mainly Sections 111 to 116 of the Act on Private International Law.