Czech Republic: Coronavirus - Insolvency considerations

Regulators and governments across CEE have introduced or are proposing several measures aimed at mitigating the worst economic fall-out of the coronavirus situation. These measures generally include either hard (i.e. legally mandated) or soft (recommended) moratoriums on loans allowing for payment deferment without triggering default provisions, special state-guaranteed emergency financing schemes as well as certain broader macroeconomic remedial measures (bail-outs to impacted small entrepreneurs, tax deferments, “kurzarbeit”-type labour-cost subsidies etc.).

However, as the situation escalates, it is possible that preventive measures alone may be insufficient in safeguarding the liquidity of companies most impacted by the crisis. Therefore, several jurisdictions such as Germany have proposed insolvency moratoriums/waivers, whereby the otherwise applicable legal obligation to file for insolvency by the distressed company´s directors is abrogated under certain narrowly drawn circumstances. Although no formal legislative proposal has yet been made in the Czech Republic with regard to such insolvency exemptions, these are being currently debated across professional associations and think tanks alike.

Insolvency Test

Czech Act No. 182/2006 Coll., as amended (the Insolvency Act), provides for two types of statutory insolvency tests. The first is the balance sheet test, which measures the general over-indebtedness of the company, i.e. whether its aggregate liabilities are greater than its aggregate assets. The second test is the “plurality of creditors” analysis, where an entity is deemed insolvent if it has at least two creditors with claims more than 30 days past due which it is incapable of satisfying. Under Czech law, the debtor´s directors have a legal duty to file for insolvency if, according to their professional opinion, the respective company meets either one of the aforementioned statutory insolvency tests.

This duty is not only a fiduciary one (with the directors being personally liable for breach thereof) but can, in extreme cases, give rise to criminal prosecution. Company directors would therefore be placed in a very difficult situation – weighing their personal legal liability against the irreparable damage of filing for insolvency prematurely as given how government incentives and rescue packages are in a constant state of flux and new information is emerging on a daily basis, the statutory analysis of whether the debtor is capable of satisfying claims is rendered far more difficult than usual. In this unprecedented situation, standard corporate governance customs and frames of reference are to an extent rendered moot.

Insolvency Filing Exemption

In this situation, a temporary waiver of the duty to file for insolvency may not only be a welcome reprieve but an economic necessity (not to mention that the over-taxed Czech judicial system would not be equipped to handle an epidemic of insolvency petitions). In the Czech Republic, such insolvency exemption would have to be implemented by amending the Insolvency Act (and certain other legislation such as the Corporations Act).

The purpose of the amendment would presumably include the extension of several procedural deadlines, including extending the currently existing provisions on interim three-month moratoriums, but would mostly consist of a waiver of the duty of qualified debtors to file for insolvency for an interim period (generally the next couple of months), provided the debtor´s insolvency was the proximate result of the current extraordinary economic situation (it is conceivable that the debtor would bear the full burden of proof, unless blanket exemptions were given by industry/sector). A less substantial alternative would be the temporary suspension of the balance sheet insolvency test, basically shifting focus to creditor-launched proceedings (if the plurality test is satisfied). In any case, in addition to either of the alternatives above, the fiduciary duty of the debtor´s directors would have to be temporarily abrogated as well.

Although at present no amendments to the Insolvency Act are being formally proposed by the legislature, the on-going debate as well as developments in neighbouring countries may result in the unprecedented temporary suspension of certain insolvency requirements, most likely along the lines of the above suggestions. The situation should be closely monitored for the near future.