Slovak case-low qualifies banks as related parties in insolvencies

Finance companies in Slovakia have felt endangered since 2019 when the Regional Court in Košice, acting as a second instance court confirmed a lower-court ruling that a financial party could be qualified as a related party in the eventual insolvency of the borrower as debtor. Despite the court's conclusions, there still remained some hope that the Supreme Court or Constitutional Court would overturn these decisions and rule that finance parties cannot become related parties to the debtor in standard financing relations for just doing their job and following prudential controlling rules for banking activities. But no high court decision was forthcoming.

Background

The concept of the related party to the debtor was introduced in the Slovak Insolvency Act in 2005. The concept was drafted so broadly that apart from corporate bodies, shareholders holding at least 5% share in capital or voting rights and their close relatives (e.g. spouse, children), the definition also covers anyone having a possibility to exercise managerial influence over the debtor corresponding to that 5% share.

By 2012, the qualification of finance parties as related parties started to have an impact on the claims that such a party was classified as subordinated, regardless of the security. The regulation intended to exclude the situations, typical at the time, when the members of the corporate bodies of the debtor or other related parties registered (and exaggerated) their claims in order to achieve as much control over the insolvency as possible. However, the broad definition with the unclear specification of the possible influence over the debtor hung like a sword of Damocles of the financial sector resulting in the case affecting Česká exportní banka, a.s. (CEB).

Case at hand

In 2008, CEB financed the construction of the greenfield steelworks Slovakia Steel Mills, a.s. (SSM) in eastern Slovakia. CEB granted over EUR 166 million in loans to the newly established Slovak entity. Despite the huge investment, the steelworks were never profitable and after its short existence SSM in 2012 attempted informal restructuring, partially through the sale of a part of its water enterprise and partially through debt restructuring. Since all assets of SSM were secured in favour of CEB, any sale of assets was subject to negotiations with CEB in order to agree on its waiver. The negotiations were not successful.

SSM´s attempt at formal restructuring failed due to the contestation by CEB. Thus, SSM went into bankruptcy in 2015 when the real fight started. Apart from many other contestations and disputes, the huge claim by CEB was contested by the trustee and other creditors, also from the related-party perspective.

As a result, the court ruled that the loan documentation (based on LMA standards) between CEB and SSM contained various standard clauses enabling the lender to have a certain level of information and prior consent control over the debtor, particularly in the event of default. In addition, under the share-pledge agreement, CEB as the lender could exercise voting rights in SSM subject to the fulfillment of two conditions – the occurrence of default and CEB's notification to SSM of its desire to exercise voting rights.

Even though CEB argued in court that it never used these rights in practice, the courts concluded that the existence of the mere possibility of exercising them was sufficient for qualifying as a related party. In addition, the real exercise of the management rights was evidenced in the opinion of the court through various documents (e.g. letters, emails, notes from the meetings) from informal restructuring talks in which CEB gave opinions to SSM, and the fact that some important decisions or actions were subject to the prior consent of CEB. The first-instance judgment declared CEB as a related party effectively subordinating its claim to all other creditors. The appellate court confirmed this ruling, making the judgments final and unappealable. Both the Supreme Court and the Constitutional Court in Slovakia rejected the remedies.

Final observations

In the light of these rulings, finance parties must be cautious in their management and communication with debtors, particularly during a distressed situation. It will be interesting to see whether the legislative bodies will amend the definition of related parties or if case-law will further develop – under the logic of the court arguments, the prior consent of certain governmental authorities, such as the antimonopoly office for merger clearance or the national bank for certain acquisitions, could qualify them as related parties in that they exercised influence over certain important transactions.

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