Preventive restructuring finally arrives in the Czech Republic—and it may affect you more than you realise

After more than two years of delay, preventive restructuring has finally become available to companies in financial difficulties in the Czech Republic. Czech companies can now seek to restructure their troubled businesses outside formal insolvency proceedings with the help of new rules specifically designed to keep their viable business operating and to prevent insolvency. The new rules implement a dedicated EU directive on preventive restructuring that should have been implemented by member states by summer 2021.

The lack of preventive restructuring protection had been widely criticised in the business community for many years, as it was difficult to restructure companies in danger (in the “twilight zone”) without taking material legal risks.

Although primarily applicable to companies in the twilight zone that decide to change course, the new rules might also affect you if you are a business counterparty of such company or wish to finance its restructuring efforts. We offer you the following overview of how preventive restructuring is supposed to work in the Czech Republic and how it may affect you in the form of questions and answers.

What is preventive restructuring?

Preventive restructuring can be described as a set of measures and steps to help companies in financial difficulties keep their viable business operating and thus avoid insolvency by restructuring, without the need to go through insolvency proceedings. As insolvency usually carries negative reputation impacts in addition to other vulnerabilities, preventive restructuring, as a flexible tool without those risks, can make a material difference when considering restructuring options.

It is a voluntary and flexible process that requires cooperation with creditors. This requires limited, and in fully consensual situations almost no, active involvement of a court or other authority.

Who can use it?

Any business company or cooperative entity can access preventive restructuring protection, except for specifically licensed entities such as banks as well as investment and insurance companies.

There are a few conditions that a company must meet to use this tool, including:

1. the company must not be insolvent due to illiquidity (platební neschopnost) (over-indebtedness (předlužení) is not an issue), but its financial situation needs to be so serious that without restructuring, it will likely become insolvent;
2. its directors must act in good faith regarding the restructuring efforts, the viability of the business and its re-start; and
3. there must not be any dishonest intention (nepoctivý záměr) present in the behaviour of the company, such as misrepresentation, breach of agreement with creditors in restructuring, or providing undue benefit to a creditor.

How does the preventive restructuring process start?

Only a company seeking preventive restructuring may open the process. It starts with a letter from the company to the affected creditors with an offer to start negotiating a restructuring plan. Together with the initial letter, the company needs to deliver a recovery project (sanační projekt) and notify the restructuring court (restrukturalizační soud) of the start of restructuring.

The recovery project is a key document that analyses the company’s current situation, describes the roots of the difficulties and their seriousness, and offers solutions to fix the company’s deteriorating situation. It must demonstrate: (i) the ability of the company to survive as a  going concern that is able to create added value; (ii) a positive cash-flow; and (iii) its competitiveness in its market. The recovery project must also include a realistic and relatively detailed business and financial model and economic measures necessary to adopt until the restructuring plan is adopted.

The company is not strictly bound by the recovery project and the measures proposed in it; however, if it is based on false premises or incorrect data, it could hamper a successful restructuring.

As a complex and specific document impacting the course of the preventive restructuring and its final success, the early involvement of the company’s legal, tax and restructuring advisers to the process is highly recommended.

Who will be affected by preventive restructuring and how?

Not all of the company’s creditors will be affected by the preventive restructuring measures. It is the company that decides who will be an “affected party” in restructuring, i.e. whose rights against the company will be affected in the restructuring. Who will be an affected party, how their claims will be affected by the restructuring measures, and why any other creditors and their claims will not be affected by the restructuring, needs to be duly justified in the recovery project.

The affected parties (creditors) will negotiate with the company the terms of the restructuring plan and decide whether to accept it. The non-affected creditors do not have any material rights in the process as their claims should be fully met as if there were no restructuring. Some creditors and their claims must by law always remain unaffected, such as labour-related claims, certain types of damages and criminal punishment claims.

The company can propose that the claims of affected creditors may be reduced, their maturity extended, their interest rate reduced, and it may propose other infringements of creditors’ rights.

All creditors or some specific creditors chosen by the company might also be affected by a moratorium declared by the restructuring court at the company’s request, as a result of which it will not be possible to declare the company insolvent or enforce any claim affecting its assets for up to 12 months.

What is a restructuring plan?

A restructuring plan is a document drafted by the company after negotiations of restructuring measures with the affected parties. It defines the legal position of the affected parties and contains a summary of the restructuring measures that the company will take. The company can use a wide range of restructuring measures that may affect in particular the following aspects of its business:

1. its assets, including disposals of assets (divestments), sale and lease back arrangements, distribution of assets to creditors, and obtaining new financing;
2. its indebtedness, including changes in its maturity, amount, interest rate, composition of the security package, and related waivers;
3. its equity, including increases in the registered capital from existing shareholders, from new shareholders, or from its own sources, and debt-equity swaps;
4. its business operations, including changes in its product range, changes in marketing, purchasing, storage policy, logistics, cost-cutting measures, changes in headcount, and the introduction of new technologies and internal production management.

The plan must be adopted by the affected parties to become effective and eligible to be implemented by the company. For this purpose, the affected parties are divided in the plan into several groups according to their similar legal position and economic interests.

The restructuring plan is adopted when it is accepted by all groups of affected parties, i.e. when at least a three-quarters majority (calculated by value) of each group approved the plan.

What happens if an affected party disagrees with the restructuring plan?

Preventive restructuring is meant to be consensual and the company should seek the consent of all affected parties. However, the rules enable a creditor’s dissent to be overcome (the cramdown principle). If the votes of a dissenting affected creditor or creditors do not exceed one-quarter of the total votes (calculated by value) in their group, the plan is considered approved by that group.

If one or more groups of creditors refuse to approve the plan, it directly affects the rights of a dissenting creditor and under certain other circumstances, the plan becomes effective only if confirmed by the restructuring court. The affected party that voted against the plan may raise its objections to the restructuring court, which will decide whether to confirm the plan or not.

Is existing and new financing protected?

Yes. The Czech act recognises that preventive restructuring may not be successful without external financing that will enable the company to overcome the period of the negotiation and the implementation of the restructuring. Therefore, the rules provide to creditors who grant interim or new financing certain protection against legal challenges of the repayments the company makes or security established by the company for these purposes in any future potential insolvency.

How does the restructuring end?

Ideally by fulfilling the restructuring plan and its conditions. In less ideal circumstances, preventive restructuring may terminate on a decision of the company or on the declaration of the company’s insolvency.

How can we help you?

Preventive restructuring is a completely new process that will require the involvement of legal, tax and restructuring experts to guide companies in the twilight zone through the various steps of their restructuring and help with the documents and negotiations necessary for the successful adoption and implementation of the restructuring plan.

For creditors affected by a restructuring plan, we can help assess the impact of the plan on a creditor’s claims, identify any vulnerabilities in the offered plan, and help the creditor negotiate a better deal with the company.

For parties that wish to finance restructuring efforts, we can help with structuring the financing so that the risks of any legal challenges in any potential future insolvency scenario are mitigated.

For more information on preventive restructuring rules and how these could impact your business, contact your CMS client partner or local CMS experts: Petra Myšáková and Lukáš Valúšek.