ARTICLE
4 August 2022

Latest Changes To Insolvency Legislation

New Slovak legislation on preventive restructuring – "An ounce of prevention is worth a pound of cure."
Slovakia Insolvency/Bankruptcy/Re-Structuring

New Slovak legislation on preventive restructuring – "An ounce of prevention is worth a pound of cure."

On 16 March 2022, the Slovak Parliament passed the Act on Resolution of the Imminent Insolvency and on changes and amendments to certain acts (the Act), implementing the EU Directive on restructuring and insolvency 1. The Act became effective as of 1 May 2022; however, most of its provisions will become effective as of 17 July 2022.

Among other things, the Act introduced a new legislative framework for preventive restructuring. The preventive restructuring is designed as an early intervention procedure for businesses which find themselves in financial difficulties, while still being at the stage when the company is not technically insolvent and can be preserved as a going concern. As such, preventive restructuring offers an alternative to more invasive insolvency-driven procedures such as bankruptcy or formal court-administered restructuring.

Although informal standstill arrangements between debtors and their key creditors have been used in practice even before the adoption of the new legislation, the formal recognition of preventive restructuring is widely considered as a step in the right direction. While it is too early to judge whether the new legislation will in fact achieve the desired impact and some of its aspects would certainly require further clarification and fine tuning, the early sentiment from the business community is welcoming towards the changes.

Imminent insolvency – new rules

A corporate debtor may consider preventive restructuring as a route to solving its financial difficulties if it meets the test of imminent insolvency.

Even though the concept of imminent insolvency as suchis not completely new in the Slovak insolvency regulation, the term has lacked a comprehensive definition backed by consistent practice. Although the exhaustive definition of imminent insolvency continues to be missing, the new legislation clarifies that a debtor is in imminent insolvency particularly when it is at risk of cash-flow insolvency. This condition is satisfied when, considering all circumstances, a debtor can reasonably expect to become cash-flow insolvent within 12 calendar months.

The definition and consequences of cash-flow insolvency are also set to change. Until 16 July 2022 (i) a company is deemed to be cash-flow insolvent when it has more than one creditor and more than one financial obligation 30 days overdue, provided that such overdue obligations are not covered by the company's financial assets. In the event of cash-flow insolvency, there is no statutory obligation for the company (and its directors) to apply for bankruptcy – this statutory obligation exists only if the company meets the balance sheet insolvency test.

Under the new legislation a company will be deemed to be cash-flow insolvent when it has more than one creditor and more than one monetary obligation 180 days (during the period from 17 July 2022 to 31 December 2022) or 90 days (from 1 January 2023 onwards) overdue, provided that such overdue obligations are not covered by the company's financial assets. In the event of cash-flow insolvency occurring as from 17 July 2022, the company (and its directors) will be obliged to apply for bankruptcy.

The above changes are designed to incentivise companies to take a more forward-looking approach to their cash-flow projections and, in the event of expected financial turbulences, consider preventive restructuring as a solution to their financial difficulties well in advance.

Proactivity and transparency as key imperatives

If the company decides to resolve its imminent insolvency in preventive restructuring, directors of the company are obliged to act proactively with a view to finding a consensual arrangement in cooperation with the company's creditors.

The element of proactivity is vested under the broadened scope of duties associated with imminent insolvency. A company must continuously monitor its financial condition as well as the state of its assets and liabilities, in order to detect imminent insolvency in a timely manner. If an imminent insolvency occurs, the company must take appropriate measures to avert it without undue delay.

If the company is listed in a public registry of debtors (e.g. due to unpaid taxes, social security or health insurance levies etc.), this automatically signals that it may be at risk of imminent insolvency and the company must make an assessment to determine whether the risk of imminent insolvency exists. If the directors of the company do not possess sufficient expertise to make such an assessment, they are obliged to seek expert advice for this purpose.

Hand in hand with a more proactive role of the directors, the Act emphasises the role of advisors who will assist companies and their directors in their decisions concerning imminent insolvency and potential preventive restructuring. As a part of its role, the advisor prepares and comments on cash flow projections, income and cost projections, analysis factors affecting sustainability of the debtor's business and its ability to continue as a going concern, and provides opinions on draft restructuring plans and matters relating to the resolution of the debtor's imminent insolvency, among other things.

The new legislation also addresses the information asymmetry which may exist between the company facing an imminent insolvency and its creditors by emphasizing transparency and imposing an explicit obligation on directors to: (i) provide creditors with all important information for the purposes of making informed decisions and, (ii) refrain from any actions which could potentially frustrate the aims of preventive restructuring.

Private preventive restructuring

Preventive restructuring can be conducted as either a private or a public process.

Private preventive restructuring can be agreed between one or more institutional creditors (supervised either by the National Bank of Slovakia or an equivalent foreign regulator) and the debtor who is in imminent insolvency, and who is not subject to the effects of other bankruptcy or restructuring proceedings. Private preventive restructuring proceedings commence upon notification of the debtor to the competent court, provided that the debtor can give such notification only with the prior consent of the creditors being party to the private preventive restructuring proceedings.

Within three months of the notification of commencement of the private preventive restructuring proceedings, the debtor must submit to the court for its approval the concept of the preventive restructuring plan. If the debtor fails to do so, the private preventive restructuring proceedings are automatically terminated.

The Court shall reject the concept of the plan if it finds it potentially damaging to the economic interests of creditors who are not party to the private preventive restructuring. If the court approves the concept of the plan or fails to reject it within 15 days of its submission, the plan is deemed to be approved.

As opposed to publicly-held preventive restructuring, the approved plan in the private preventive restructuring is legally binding only upon creditors who have agreed to it, but not on other creditors.

Public preventive restructuring

In order to initiate a public preventive restructuring the debtor must submit an application to the competent court. The concept of the public preventive restructuring plan must be attached to the application.

The concept of the plan must be certain, comprehensible, realistic, sustainable, preferably consensual, and should contain all the necessary information for the affected creditors in order to vote on the public plan in an informed manner. Among other technical details, the concept of the plan must contain the debtor's cash-flow projections for the upcoming 6 months.

For the sake of transparency, at the time when the application for public preventive restructuring is filed, a debtor must be registered in the Slovak registry of public sector partners – a step requiring disclosure of the ultimate beneficial owner.

The Act provides for a list of parameters, upon which the competent court shall assess an application for public preventive restructuring. A court may only approve public preventive restructuring if: (i) the debtor is in imminent insolvency, (ii) the business of the debtor is considered viable (in Slovak "zivotaschopný"); and (iii) there is no other obstacle stipulated by the Act.

Further, the Act provides for a demonstrative list of scenarios when the business of the debtor shall not qualify as being viable. Among other things, these include situations where (i) there are grounds for debtor's dissolution, (ii) the debtor was already dissolved or entered into liquidation, (iii) the debtor is subject to the effects of other insolvency or restructuring proceedings, (iv) a third party commenced court-ordered enforcement proceedings (in Slovak: exekúcia) or enforcement of security in respect of debtor's assets and the debtor is unable to prove that the underlying debt owed by it to such a third party has been duly discharged; (v) the debtor failed to comply with its accounting obligations or its obligation to file the annual accounts; or (vi) the debtor has taken other actions threatening its financial stability (which includes payment of dividends or other equity distributions affected over the previous 12 months).

The court shall decide on the approval of the proposed public preventive restructuring within 10 days of the date of receipt of the completed application.

Once the court has approved the public preventive restructuring, the court would also appoint a trustee (selected on a random basis from the register of trustees kept by the Ministry of Justice) whose role is to oversee the debtor and its business in the course of public preventive restructuring. In the case of public preventive restructuring, the appointment of a trustee is not automatic – it is only required if: (i) as a part of the public preventive restructuring the court has also granted the debtor with temporary protection (see below), (ii) the appointment of a trustee was proposed by the debtor or by the majority of its creditors; or (iii) based on the concept of the plan there are reasonable grounds to believe that a certain class of creditors affected by the public preventive restructuring would not approve the plan and the debtor would need to seek a court's decision substituting such creditor's approval. The debtor shall bear fees and expenses incurred by the trustee, unless the appointment of a trustee has been proposed by creditors (in which case they shall bear the costs jointly and severally).

Temporary protection during public preventive restructuring

Once the court has approved the public preventive restructuring it can also grant temporary protection to the debtor for the duration of three months. The court may grant temporary protection to the debtor only if such a measure has been approved by (i) the majority of creditors holding claims which do not qualify as related-party receivables, or (ii) at least 20% of all creditors (calculated based on the total amount of claims which do not qualify as related-party receivables) provided that pursuant to the concept of the plan the proposed write-off (if applicable) does not exceed 20% of claim(s) and the proposed extension of maturity (if applicable) does not exceed one year for any of the creditors.

The decision of the court to award the debtor with temporary protection gives rise to significant protective effects. The debtor is protected against bankruptcy, restructuring, execution and enforcement proceedings. Similarly, it is not permitted to enforce any pledges against the assets of the debtor nor to set off a related-party claim against the debtor.

In case of a default of the debtor which occurred before temporary protection was granted, the creditor may not (over the duration of the temporary protection) terminate the contract, withdraw from the contract, refuse performance under the contract nor change the content of the rights or obligations under the contract. Further, the creditor is not permitted to terminate any financing agreements with the debtor, which was agreed before the temporary protection was granted on the grounds that the debtor does not fulfil the agreed financial covenants.

Hand in hand with the protective effects described above, the discretion of the debtor is limited over the duration of the temporary protection. As a part of their consent with the temporary protection, the creditors may determine which actions of the debtor are subject to the approval of the designated advisors. In addition, the debtor is generally obliged to limit its activities to actions which do not materially alter the composition of his assets. Other actions of the debtor are permitted subject to the approval of the creditors committee.

Affected vs. unaffected creditors

The public preventive restructuring is legally binding on all affected creditors.

In general:

  • any creditors whose claim arose before the decisive date 2 as well as;
  • shareholders of the debtor, to the extent that the plan contemplates the sale, transfer or issue of new shares in the debtor, a merger, amalgamation, division or change in the legal form of the debtor, or a change in the memorandum, Articles of Association or other similar documents of the debtor,

qualify as affected creditors for the purposes of public preventive restructuring. That said, certain categories of creditors (e.g. employees, minor creditors, tax and customs authorities, etc.) are expressly named as unaffected creditors and, as such, exempted from the effects of the public preventive restructuring.

Voting on the plan and cram down

Once the competent court has approved public preventive restructuring, the debtor shall convene a creditors' meeting, which shall be held no earlier than 60 days and no later than 70 days after the court's approval of the public preventive restructuring. The purpose of the creditors' meeting is to inform the affected creditors of the reasons for the imminent insolvency, to present them with the plan and to invite them to vote on the adoption of the plan. Any creditor claiming to be an affected creditor has the right to attend the creditors meeting. The trustee, the debtor's advisor and the judge overseeing the public preventive restructuring shall also attend the creditors meeting.

The plan is subject to approval by the respective classes of creditors. For this purpose, a separate creditors class shall be created for: (i) each secured creditor, (ii) unsecured creditors, (iii) creditors of claims which qualify as related-party receivables, (iv) subordinated creditors, and (v) shareholders.

The Act prescribes detailed thresholds by which the plan must be approved by individual creditors classes.

The debtor may request the court to confirm the plan within 7 days after the creditors' meeting was held. In parallel with the application to the court, the debtor must forward the confirmation application to each of the creditors who voted against the adoption of the plan at the creditors meeting. Such non-consenting creditors may file their objections against proposed confirmation of the plan within 10 days following their receipt of the confirmation application. The court shall rule on the application for confirmation of the plan within 30 days following the lapse of the statutory period during which the non-consenting creditors could file their objections against the application. If the plan has not been approved by one or more creditors classes, the debtor may, along with its application for confirmation of the plan, apply for a court's decision substituting approval by the respective creditors class (cram down decision). The Act specifies detailed conditions which must be satisfied in order for the court to issue a cram down decision. This is to ensure fair treatment of different creditors classes and prevent abuse of the cram down mechanism in the public preventive restructuring,

Expected impacts in practice

While the introduction of legislative framework for preventive restructuring in Slovakia is widely perceived as a positive development, from a business point of view the current status quo is generally seen as work in progress rather than a final cut.

One of the key topics which continues to be unresolved is the tax treatment of creditors' claims during preventive restructuring. In case of bankruptcy or formal court-administered restructuring, a creditor who filed its claims in the said proceedings can create provisions in respect of such claims and benefit from their tax deductibility. No such regime currently exists in respect of the preventive restructuring which, from a tax perspective, is likely to make preventive restructuring a less attractive option for creditors compared to bankruptcy or formal court-administered restructuring. Consequently, it is expected that, as a part of their decision-making, banks and other creditors will meticulously calculate the financial viability of the preventive restructuring, including the tax elements, against the anticipated costs in standard insolvency proceedings. Against this background, there is a strong argument that further amendments are needed to make the tax treatment of claims in a preventive restructuring more creditor-friendly, in order to incentivise the creditors to proceed with preventive restructuring instead of formal insolvency proceedings such as bankruptcy or formal court-administered restructuring.

Aside from implementing the new framework for preventive restructuring, the new legislation also introduced a handful of noteworthy changes into the formal insolvency proceedings, in particular in the field of digitisation. These include the requirement to conduct acts related to bankruptcy and insolvency proceedings in electronic form (including claims filing) as well as the option to hold creditor meetings by means of video conferences. The outlined changes have been implemented with the aim of making insolvency proceedings more creditor friendly and less administratively burdensome, an initiative which was supported and well received by the local business community.

Footnotes

1 Directive (EU) 2019/1023 of the European Parliament and of the Council of 20 June 2019 on preventive restructuring frameworks, on discharge of debt and disqualifications, and on measures to increase the efficiency of procedures concerning restructuring, insolvency and discharge of debt, and amending Directive (EU) 2017/1132

2 The first day of the calendar month preceding the calendar month in which the application for public preventive restructuring was submitted to the court.

Restructuring frameworks undergoing change - WT (wolftheiss.com)

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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