This article provides general information regarding bankruptcy and restructuring proceedings under Czech law (focusing on corporate debtors and entrepreneurs only), including the description of the roles, rights and duties of particular stakeholders participating in both proceedings.
This is part of the PLC multi-jurisdictional guide to restructuring and insolvency law. For a full list of jurisdictional Q&As visit www.practicallaw.com/restructure-mjg.
This article provides general information regarding bankruptcy and restructuring proceedings under Czech law (focusing on corporate debtors and entrepreneurs only), including the description of the roles, rights and duties of particular stakeholders participating in both proceedings.
Czech insolvency procedures are governed by Act No. 182/2006, the Insolvency Act (Insolvency Act). The Insolvency Act applies to the majority of debtors, with certain exceptions such as financial institutions. The object of the Czech insolvency procedure is to organise the property relations of persons affected by the debtor's insolvency or imminent insolvency and to achieve the highest possible and proportional satisfaction of the debtor's creditors.
There are two main types of insolvency resolution methods for corporate and individual business debtors:
Bankruptcy liquidation (konkurs), that is, a sale of the debtor's assets (piecemeal or as a going-concern) with satisfaction of creditors through distribution of the proceeds.
Reorganisation (reorganizace), that is, a restructuring of the debtor's liabilities based on a reorganisation plan approved by creditors and court.
Both types of proceedings take place within the framework of a unitary insolvency proceeding, which is differentiated into the particular method of resolution of financial distress usually only after insolvency has been declared.
Insolvency proceedings are initiated by an insolvency petition (insolvenční návrh) filed either by a debtor or by a creditor. A debtor must file an insolvency petition without undue delay after it learns, or with due diligence ought to have learnt, about its insolvency. This obligation usually falls to the statutory body (statutární orgán), that is, the debtor's management, or the liquidator in a bankruptcy liquidation (if there are several such persons and if they are entitled to act alone on behalf of the debtor, this obligation falls to each of them).
A creditor who, due to its own fault, unsuccessfully files an insolvency petition is liable for the damages caused by the filing to the debtor and to other creditors. In case of doubt, the law presumes the creditors' fault. The directors or board members of the petitioning creditor are personally liable for these damages, unless they have taken action to prevent them. The damages must be claimed within three months from the dismissal of the petition.
One of the most important features of Czech insolvency law is that almost all documents on the particular court file are immediately available online. This also speeds up the entry into force of most decisions. Publication online of the insolvency petition immediately results in both a:
Stay of most collection efforts by creditors.
Prohibition on the debtor taking any actions out of the ordinary course of trading without the prior consent of the court.
The scope of statutory limitations over the debtor's ability to conduct its business can be further expanded by court-ordered interim measures.
The next step is (usually) the declaration of insolvency (rozhodnutí o úpadku), that is, the actual opening of the proceedings. Provided that the debtor's petition is formally correct and comprehensive the court does not call for production of evidence and considers the facts presented in the debtor's petition and its appendixes (the threatening insolvency) as evidenced. The insolvency should be declared within a maximum of 15 days, without a court hearing.
If there is a creditor's petition, and the debtor refutes the fact that it is insolvent, insolvency is usually declared only after a hearing. There are no firm deadlines and the creditor must prove the existence of multiple creditors and the actual insolvency of the debtor, which can take the form of either:
Balance sheet insolvency (předlužení), that is, debtor's assets (at fair market value) being lower than its liabilities.
Cash flow insolvency (platební neschopnost), that is, the debtor has more than 30 days overdue liabilities which it is unable to pay (the inability to pay is presumed in where the liabilities are overdue by more than three months).
The decision on declaration of insolvency also contains, among other things:
The appointment of an insolvency trustee.
An invitation to creditors to register their claims within not less than 30 days and not more than two months.
The decision also convenes a claims verification hearing (přezkumné jednání) where the insolvency trustee, the debtor and possibly also individual creditors comment on and review the legitimacy of individual claims (see below) and for a creditors' meeting (schůze věřitelů) which may also (and in case of larger debtors often does) decide on the insolvency resolution method.
Czech law contains a specific moratorium instrument, which enables a debtor to delay the initiation of insolvency proceedings by up to four months in order to obtain protection from creditors and resolve its financial difficulties, or to prepare an orderly winding-up. A moratorium is available only with the support of a majority of the debtors' creditors. The standard statutory effects of the initiation of the insolvency proceeding (for instance, stay of most collection efforts by the creditors) are preserved during a moratorium, and in addition, set-off is prohibited. A debtor protected by a moratorium can pay liabilities directly associated with the operation and maintenance of the debtor's business in priority and the counterparties to the supply contracts cannot terminate their contracts for past breaches.
However, debtors rarely apply for a moratorium before Czech courts, the courts are reluctant to approve them and most moratoriums fail to achieve their purpose.
Post-commencement financing (interim funding) may be provided based on an agreement with the debtor, or, after a bankruptcy liquidation is ordered, with the trustee. However it is always subject to consent by the creditors' committee. Existing secured creditors have a pro rata right of first refusal to provide the interim funding, if they match any funding offered by a third party.
Claims under interim funding have administrative priority (see below). Such funding can be secured by any free assets of the debtor, or, after the court has authorised a reorganisation procedure, proportionally by the collateral of existing secured creditors with the new creditor sharing in the collateral pro rata according to its value.
The court decides on the insolvency resolution method (sometimes in accordance with the binding resolution of the creditors' meeting) and orders either bankruptcy liquidation or reorganisation no later than within three months after the declaration of insolvency and generally only after the first creditors' meeting. Exceptionally, the decision on resolution method may be joined with the declaration of insolvency (for instance, where a reorganisation plan is accepted by more than half of each of the secured and unsecured creditors (by amount), the court authorises reorganisation, and where the debtor is a dissolved entity, the court orders bankruptcy liquidation).
Reorganisation is generally available only to debtors exceeding either:
Annual sales of CZK100 million (as at 1 March 2012, US$1 was about CZK18.5).
Minimum staff of 100 full-time employees.
Debtors that do not meet these thresholds may enter reorganisation only if they submit a plan pre-approved by the majority of secured and unsecured creditors within 15 days after the decision on declaration of insolvency. Therefore, the court normally waits at least 15 days after the declaration of insolvency, at which time it usually orders bankruptcy liquidation of debtors that do not meet the reorganisation thresholds.
Actual reorganisation is carried out based on a reorganisation plan (submitted primarily by the debtor, but in certain cases by the creditor(s)) approved by the creditors' meeting and the court. The approval of the reorganisation plan is a relatively complicated process (the creditors vote on the reorganisation plan by classes, the court has jurisdiction to intervene in case that the creditors' rights are impaired, and so on). The law does not prescribe the measures included in the reorganisation plan, meaning the reorganisation process is very flexible and can comprise any lawful measures, including debt/equity swaps, distributions in kind, entry of new investors or managed liquidations, and so on.
The closure of the insolvency procedure depends on the selected insolvency resolution method.
In bankruptcy liquidations, the procedure normally terminates after the court receives notice from the insolvency trustee on fulfilment of the schedule resolution (rozvrhové usnesení), which provides for distribution of the proceeds from the sale of the debtor's assets. Although unsatisfied claims against the debtor do not cease to exist after the bankruptcy liquidation, the termination of the bankruptcy liquidation is normally followed by cessation of existence of a corporate debtor.
In reorganisations, when the plan (or its essential portion) is consummated, the court will, on an application by the debtor supported by reports on the progress of the reorganisation by the insolvency trustee and creditors' committee, close the reorganisation and thereby the insolvency proceedings. If the debtor does not fulfil the plan (or there are other breaches), the court can convert it into bankruptcy liquidation.
Creditors whose receivables are secured by property of the estate under a mortgage or a title transfer security arrangement (or a similar right under foreign law) are secured creditors. Other creditors are unsecured.
Secured creditors and most unsecured creditors (see below) must register their claims on a special form. This includes subordinated creditors and affiliates' debt claims, which are not automatically subordinated, but are excluded from voting in matters concerning the debtor. Shareholders do not need to register their shareholdings (see below).
Creditors must normally register claims within the deadline set out in the decision on declaration of insolvency (or even before the declaration of insolvency, that is, anytime after initiation of the insolvency proceeding). Foreign creditors from EU member states may register their claims later, usually within one to two months from the delivery of an invitation on a special form by the court or by the trustee. At the time of writing there does not appear to be a consensus, whether this exception also applies to non-EU creditors.
Secured creditors have absolute priority over other creditors (even those with administrative priority) in respect of the proceeds of the sale of their collateral. They also have the right to instruct the insolvency trustee in respect of the administration of their collateral. In bankruptcy liquidation, the trustee must distribute the proceeds from the sale of collateral to the secured creditor(s), reduced only by the cost of sale (up to 5%), the cost of administration (up to 4%) and the trustee's fees (up to 2%).
In a reorganisation, a reorganisation plan must provide property with a net present value, as of the effective date of the plan, equal at least to the value of the collateral to each secured creditor who does not support the plan (absolute priority rule).
The court always appoints a valuation expert to determine the value of the collateral for the purpose of the absolute priority rule in a reorganisation, or bulk sales of assets in a bankruptcy liquidation, for determination of the division of proceeds to secured and to unsecured creditors. The creditors' meeting must approve the valuation report and the court formally confirms the valuation by incorporating it in a specific decision, which is not subject to appeal.
In bankruptcy liquidation, unsecured creditors are paid only after satisfaction of the secured creditors' claims (in respect of the proceeds of sale of the collateral) and on satisfaction of claims with administrative priority (see below).
In a reorganisation, the plan must provide each unsecured creditor with property with a net present value (as of the effective date of the plan) corresponding at least to the proceeds that the creditor would receive in a bankruptcy liquidation (based on the expert valuation). In addition, under the absolute priority rule, a plan can be approved even without the approval of a class of unsecured creditors, if the claims are paid in full or if no creditor with claims subordinated to the claims of the dissenting class (which are usually only shareholders) receives any distribution.
If a creditor registers a claim, which is then denied and admitted at less than 50% of the registered amount, the entire claim is disregarded by operation of law. The court may also, on demand by the insolvency trustee, order the creditor to pay to the estate a penalty in the amount of the difference between the admitted amount of the claim and the registered amount. Such a demand will be heard in separate adversary proceedings with the possibility to appeal. So far, Czech courts have been reluctant to impose such penalties. A similar rule applies if a creditor registers a claim as secured and it is later concluded that the security interest has lower ranking than asserted or the creditor's entitlement its value of less than 50% of the collateral alleged in the claim registration.
There is no risk of imposition of the penalty if the creditor does not exercise its rights in the insolvency proceedings (for instance, by exercising voting rights on the creditors' meeting).
Creditors may register their claims as conditional if it is not completely certain that their claims will arise. This usually concerns:
Claims under guarantees (where the main debtor may pay a portion of the claim).
Claims under current contracts (where it is not clear whether the debtor will withdraw and the creditor will incur a loss).
Claims under leasing arrangements (which may run to their end or the creditor may recover a portion of the claim from sale of the object of the leasing).
Recourse claims of third party security providers for the debtor (who may be held liable by the creditor and then entitled to recovery from the debtor).
In financing arrangements where an agent represents various participating lenders, it is usual for particular lenders to register their claims as conditional on non-recognition of the agent's claims (there is no case law on this matter so far). This reduces the risk of the penalties being imposed.
Administrative expenses, expenses associated with operation of the debtor's business and certain specific claims (such as employees' wages or personal injury claims) have administrative priority against unsecured claims. Such claims are not registered and are asserted directly against the insolvency trustee (even in a reorganisation). These claims may be paid at any time during the proceedings.
The debtors' shareholders do not have to register the claims arising directly from their shareholding (that is, from the shares, dividends or damages claims under corporate law, but not shareholder loans, which need to be registered as standard claims). In a reorganisation, if there is value to be distributed to the shareholders, such claims are reported to the insolvency trustee. Shareholders may vote on account of their shares only on a reorganisation plan, but cannot veto a plan when a creditor class is taking any haircut (if the plan meets all other criteria).
Certain claims are excluded from satisfaction in the insolvency proceedings, such as:
Interest accrued after the declaration of insolvency.
Claims from donations.
Expenses incurred by creditors in connection with claiming their rights in insolvency proceedings.
Exceptionally, interest on secured claims (up to the value of the collateral) accrues in the case of bulk sale of the estate in a bankruptcy liquidation. In a reorganisation, such interest must be regularly paid during the entire reorganisation proceedings. In addition, a reorganisation plan can provide for satisfaction of claims otherwise excluded from satisfaction (such as the creditor's attorney's fees).
Set-off is generally available to the creditors in respect of mutual claims until the declaration of insolvency, or until the filing of a proposal for reorganisation. However, set-off is not possible after the declaration of insolvency unless:
The set-off became legally possible (outside of insolvency) before the declaration of bankruptcy liquidation.
The creditor registers the claim which it wishes to set-off.
The creditor has not acquired the claim with knowledge of debtor's insolvency or through an avoidable act.
The creditor pays the amount by which the debtor's claim exceeds the creditor's claim, if any.
The court may order further limitations on the right to set-off, or authorise set-off where it is prohibited. In addition, the law prohibits set-off in a reorganisation and during a moratorium (unless the court decides otherwise). Orders on set-off may be important in the first days of insolvency proceedings in order to set up a cash management system for the debtor for the entire period of the proceedings.
Under the Insolvency Act, the insolvency trustee's/debtor's management powers depend on the stage of the insolvency proceedings. To determine the distribution of powers, the Czech Insolvency Act uses the concept of "disposition rights" (dispoziční oprávnění), which corresponds to the power to administer and dispose of the assets of the estate, including any shareholding interest, receivables or employment relationships.
The disposition rights belong to the:
Debtor (its management in case of corporate debtors) until the decision on insolvency resolution method.
Insolvency trustee in a bankruptcy liquidation.
Debtor in a reorganisation, unless the court orders otherwise.
The disposition rights of the debtor can be limited by interim measures issued by the court. If the disposition rights belong to the debtor (that is, its management), the role of the insolvency trustee is limited to:
Drawing up a list of the debtor's assets (but not to administer or manage the assets) and to lead any litigation related to the drawing up of such a list.
Review the claims and to lead litigation (and possibly settle) in respect of any such claims denied by the insolvency trustee.
Report to the creditors' committee and to the court and to inspect the debtor's books and records.
If the disposition rights belong to the trustee, the trustee acts in his own name and on the debtor's account.
Creditors represent their interest individually (by registration and assertion of their claims) and collectively (through the creditors' institutions).
Creditors normally have to register their claims (see above). The registered claims are reviewed (especially by the insolvency trustee) and their legitimacy may be disputed during the verification hearing. The insolvency trustee, but also the debtor and each creditor, can dispute the authenticity, amount or ranking of each registered claim, but only until the claims verification hearing. Thereafter, the list of claims is immutable.
The claims disputed by the insolvency trustee generally (or by the debtor in reorganisation) do not carry voting rights (unless the court orders otherwise) while the dispute is pending, although an objection against a claim raised by another creditor does not have this effect. Such a dispute can either take the form of a specific dispute within the insolvency proceedings, or, exceptionally, be joined with a pre-existing litigation in respect of the same claim. The insolvency trustee (in a bankruptcy liquidation) or the reorganisation plan must ensure that a portion of the assets of the estate necessary to satisfy the disputed claims is retained until the end of the judicial proceeding. This retention is then distributed based on the outcome of the dispute.
The creditors' institutions (věřitelské orgány) represented collective interests of the creditors in the insolvency proceedings. These include the:
Creditors' meeting. The creditors' meeting is the supreme creditors' institution. The creditors meeting may elect and remove members of the creditors' committee and their substitutes (or the creditors' representative in smaller insolvency proceedings). The creditors' meeting can also vote on removal of the court appointed insolvency trustee and, in case of larger debtors, also on the insolvency resolution method. The creditors' meeting may also reserve the vote on a matter falling within the scope of the creditors' committee. If there is no creditors' committee or representative, the creditors' meeting performs all their powers. Only registered creditors with admitted (unconditional) claims and creditors who are granted the voting right by the creditors' meeting or by the court may vote. If the debtor has employees, the relevant labour union is also entitled to attend the creditors' meeting.
Creditors' committee. The creditors' committee is the main representative body of the creditors and has extensive powers, in particular to approve various actions by the insolvency trustee (such as interim funding, sale of assets or terms of auction sale) and to investigate any documents. The committee has at least three and not more than seven members, each with a substitute member, which enters the committee if the original member resigns. Only creditors with registered claims can be members and the membership in the committee passes to a transferee of the member's claim. Unsecured creditors, even if they form a minority of the creditor body, elect in a separate vote at least one half of the creditors' committee members, with the remaining members being elected by the secured creditors only. Each member must be approved by the insolvency court. Affiliates of the debtor and insiders are excluded from the committee membership. Members of the creditors' committee must act in the common interest of all the creditors and are liable for breach of their duty to act with due care.
The insolvency court issues decisions in insolvency proceedings that are expressly provided for by the Insolvency Act (such as the declaration of insolvency, decision on the insolvency resolution method, approval of reorganisation plan, and so on). The court also continuously supervises the process and activities of the trustee and other stakeholders in the process and decides on related matters. The same judge hears also most of the disputes precipitated by the insolvency, such as disputes as to the validity of registered claims, as to the debtor's title to assets and claw-back actions.
Regional courts have jurisdiction, depending on the debtor's registered office. However, the same court (that is, the first court seized) is competent to hear the cases of all affiliated debtors. The court sits as a single judge, who is appointed for the entire proceedings. High Courts sitting in tribunals hear appeals, which are, however, admissible only in certain limited cases. Very exceptionally, an extraordinary appeal is possible, which is heard by the Supreme Court.
The insolvency trustee may challenge pre-petition transfers of assets (including payments and grants of security interests) as follows:
As invalid transfers, where the assets are included in the estate. If so, the counterparty can protect its title to the asset only by a lawsuit against the trustee before the insolvency court. The trustee can sell the assets after the court of first instance rejects the complaint, although the proceeds are withheld until the final decision.
As transactions at undervalue (právní úkony bez přiměřeného protiplnění), where the debtor made a transaction for a consideration substantially lower than the market price of the performance provided by the debtor.
As preferential transfers (zvýhodňující právní úkon), where the debtor made a transaction, which results into one creditor receiving higher satisfaction than it would otherwise receive in a bankruptcy liquidation, to the detriment of other creditors (such as a grant of security on a pre-existing debt or payment of a debt not yet due).
As actual fraudulent transfers (úmyslně zkracující právní úkony), where the debtor made the transfer with actual intent to defraud creditors and the other party knew or should have known about such intent. This knowledge is presumed in case of affiliates and insiders.
The insolvency trustee can recover invalid transfers without any time limitation (unless the owner acquired title by other means than the invalid transfer, such as adverse possession, acquisition of movables in good faith and so on). Constructive fraudulent transfers and preferential transfers can be recovered for up to one year before initiation of the insolvency proceedings. This period is extended for affiliates and insiders for up to three years and in actual fraudulent transfers for up to five years. A transfer can be challenged as a constructive fraudulent transfer or preferential transfer only if it took place while the debtor was insolvent or caused debtor's insolvency. For affiliates and insiders, this is presumed. The insolvency trustee must file the claw-back action within one year from the declaration of insolvency.
The Insolvency Act sets forth certain exemptions for constructive fraudulent transfers and preferential transfers, generally where the transaction was made under ordinary business conditions, on arms' length and that the counterparty was acting in good faith. The grant of security on new financing is also usually protected if properly structured.
As indicated above, the management of the debtor is under a duty to file an insolvency petition on behalf of the debtor without undue delay after it learns or with due diligence ought to have learnt about the debtor's insolvency. The management (the executives and directors) is personally liable for a failure to file the insolvency petition on time. The law gives a presumption that the damage that a creditor is entitled to recover corresponds to the entire unsatisfied portion of the creditors' claims. The liability is strict and mitigation is possible only if the defendant proves that the delay had no adverse effect on the extent of the creditor's satisfaction or if the petition was not filed due to circumstances beyond the defendant's control. To date, this liability has not been imposed by any final judgment. However, the courts can order managers to deposit funds to secure their liability on a preliminary basis and there have been cases where the courts have done this.
The liability of a shareholder acting as a shadow director, although not explicitly regulated in the Insolvency Act, cannot be excluded. Depending on the actual relationship between the controlling shareholder and the debtor, the shareholder could theoretically be held liable for protracting the crisis of the company by exercising influence over the distressed company (or its management) to prevent or delay the filing of the insolvency petition. However, such liability has not been tested before the Czech courts and it is not certain who would be entitled to claim damages from such a shareholder. In addition, a shareholder who enters into an agreement on the exercise of control with the debtor can be held liable for the debtor's liabilities in some circumstances.
The Insolvency Act does not have any provisions relating to cross-border insolvency or its own extra-territorial effects, except for certain technical sections relating to the interaction of Czech insolvency proceedings with insolvency proceedings in other EU member states.
Czech insolvency law has effect outside the territory of the Czech Republic only if Czech courts have international jurisdiction to open insolvency proceedings under Regulation (EC) 1346/2000 on insolvency proceedings (Insolvency Regulation), which governs cross-border insolvency proceedings across EU member states. However, the Insolvency Regulation does not regulate the effects of the insolvency proceedings in relation to third countries, which is a matter left to each member state's national law. A new act on conflicts of laws, effective as of 1 January 2014 will, to a limited extent, govern the extra-territorial effects of Czech insolvency law in respect of third countries and the recognition of third countries' insolvency proceedings. The law will make the Insolvency Regulation applicable to situations outside of its scope (that is, to extra-EU situations) where appropriate. However, it requires reciprocity for the recognition of foreign main proceedings opened in third countries and does not enable the recognition of foreign non-main proceedings (in contrast to the UNCITRAL Model Law on Cross-Border Insolvency 1997).
Qualified. Czech Republic, 2007; New York, US, 2010
Areas of practice. Restructuring and insolvency; real estate; M&A.
Qualified. Czech Republic, 2010
Areas of practice. Real estate; restructuring and insolvency.