Preventive Restructuring as a Precursor to Insolvency Proceedings
A draft of a preventive restructuring act is being discussed in the Czech legal environment to implement the EU directive on restructuring and insolvency (directive (EU) 2019/1023). The aim of the new legal regulation is to introduce an out-of-court restructuring model with shorter times to improve operations and the balance sheets of debtors in financial difficulties. Different forms of out-of-court restructuring are common and frequently used in many foreign jurisdictions, e.g. arrangements in England and Wales. Unlike insolvencies, in preventive restructuring the court is a “mere” supervisor supported by the restructuring trustee in certain situations.
At the outset, I would like to note the draft act may be amended during the legislative process, but the philosophy of the act will remain unaffected.
ADVANTAGES FOR BUSINESSES
Currently, businesses can only be restructured in an out-of-court process based on a contract with selected parties, e.g. through a debt-equity swap, delayed or reduced installments, or through equity investment by existing or new parties.
The preventive restructuring mechanism allows the debtor to enforce the restructuring plan for the ‘affected parties’ by majority decision and through a ruling by the restructuring court. Dealing with possible insolvency can also have an advantage for the non-consenting ‘affected parties’ in the form of higher distributions than payments from bankruptcies or in the case of continuity of the debtor’s business.
Unlike in insolvencies, the debtor can select the parties affected by the restructuring, including the creditors. The legal position of the ‘unaffected parties’, including their contractual relationship and claims vis-à-vis the debtor, remain unaffected by the restructuring. The draft act explicitly excludes certain claims from the restructuring, e.g. employment claims, employee retirement insurance claims, personal injury claims, claims resulting from a breach of law, etc. Furthermore, claims subject to a court or arbitration dispute or claims for payment of services (e.g. bank fees) are excluded as well.
Preventive restructuring is an option for the debtor’s business. While a debtor needs to file an insolvency petition in case of insolvency, preventive restructuring is an option as a preventive measure (e.g. in case of the threat of insolvency). However, preventive restructuring is not available to debtors that are insolvent because of illiquidity.
During the preventive restructuring process, the existing directors of the company continue to manage the business and management does not pass on to the insolvency/bankruptcy trustee. The directors can adopt commercial and operative decisions with due care and according to the restructuring plan.
CONDITIONS FOR PREVENTIVE RESTRUCTURING
Preventive restructuring is available only to business entities (excluding banks, savings and credit cooperatives, insurance companies, reinsurers, health insurance companies, etc.) acting in good faith to sustain and to restore the operation of their business with the planned restructuring measures. The draft act provides a list of presumptions that can evidence bad faith among debtors, e.g. incorrect or incomplete information in the restructuring plan, the debtor distributed dividends or other equity to affiliated parties within the past year prior to the commencement of preventive restructuring, etc.
Restructuring is not available to entities subject to liquidation, declared bankrupt, or subject to preventive restructuring in the past five (5) years.
The restructuring plan is the fundamental document for the restructuring process and is an outcome of the negotiations between the debtor and the selected / affected parties. The plan provides for measures to prevent financial difficulties and chiefly to restructure the debtors’ assets, liabilities, equity, or to arrange for other changes in the operation of the business. The draft act provides for a list of exemplary restructuring steps for each category of restructuring measures that can be mutually combined or supplemented by other operational, contractual, personal, or balance sheet restructuring steps.
Furthermore, the restructuring plan needs to describe the debtor’s economic situation, the reasons for its financial difficulties, and provide a list of liabilities vis-à-vis the affected and unaffected parties, the situation of the secured creditors, and the reasons to approve the plan. Along with the plan, the debtor needs to provide interim financial statements as to the last day of the month preceding the month when the notification to commence negotiations about the restructuring plan was dispatched to the affected parties, and regular financial statements for the past three (3) financial years.
The restructuring plan is effective once approved by the affected parties. The draft act requires the approval of at least three-quarters of the affected parties of each class, and approval by each of the classes. The plan can be put to a vote at a meeting summoned to the debtor’s registered headquarters or the seat of the restructuring court, or put to a remote vote where the affected parties are invited to vote in a given period. The voting can be replaced by an agreement executed in the form of a notary deed.
In certain situations, there is required confirmation of the restructuring court, e.g. if a claim from an affected party that has not approved the plan is to be restructured; new financing will be provided; or the number of employees is to be reduced by at least one-quarter. The court can also postpone the effective date of the plan.
The proposed preventive restructuring mechanism is not only a suitable instrument to deal with serious operational issues arising from common business activities, but it can also be a business strategy instrument, e.g. new debt or equity investments from private equity firms and (multi-)family offices can be conditional to the completion of preventive restructuring.