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Quick and (un)reasonable – Amendment of Slovak Bankruptcy and Restructuring Act

On 23 April 2015 the parliament adopted relatively extensive amendments to the act on bankruptcy and restructuring and to the Commercial Code.

1. Amendment to Bankruptcy and Restructuring Act (“Lex Váhostav“) – why was it adopted?

Under the pretext of helping certain unsecured creditors in company restructuring, Váhostav – SK, a.s. (“Váhostav”) and as a reaction to related current issues, on 23 April 2015 the parliament adopted relatively extensive amendments to the act on bankruptcy and restructuring (“Bankruptcy and Restructuring Act” or “Bankruptcy act“) and to the Commercial Code (“Commercial Code”). Let us call the amendments “Lex Váhostav”. Not only does Lex Váhostav not solve the current problems of restructuring Váhostav, it introduces changes which will influence all entrepreneurs. These changes may not always have the desired effect. Thus it remains doubtful whether the “ultra-quick” Lex Váhostav will provide a useful and systematic solution.

 

2. What does bankruptcy and restructuring mean? How are they conducted, under what terms and conditions and wherein lies the difference?

The Bankruptcy act covers cases when a debtor gets into financial trouble, and does so in two ways. The first of these is sale of property and collective satisfaction of creditors (i.e. bankruptcy). The second way is gradual satisfaction of creditors in the form agreed upon in a restructuring plan (restructuring), though without sale of the debtor’s property. To simplify, a debtor is bankrupt if insolvent or over-indebted. An insolvent debtor is a debtor unable to fulfill at least two monetary obligations to more than one creditor 30 days after the due date. An over-indebted person is one that is obliged to keep accounts, has more than one creditor and the value of their obligations exceeds the value of their property. The sum of obligations does not include obligations of so-called related (subordinated) parties.

In bankruptcy the trustee can dispose of the property of a company by law. The trustee aims at selling property in the most favorable way and from the proceeds to achieve proportional satisfaction of all creditors who have filed claims. The court and the creditors supervise the trustee’s activities. After distribution of the proceeds, the company is dissolved and deleted from the companies register, i.e. it ceases to exist.

The fundamental principle with regard to restructuring and bankruptcy is the obligation to prevent bankruptcy, and, if a debtor’s bankruptcy is impending, to immediately take steps to avert it, such as to monitor its financial situation as well as the state of its property and obligations. Restructuring is one way of preventing insolvency. Restructuring can take two forms - formal restructuring (under the Bankruptcy act) and informal restructuring. Informal restructuring should be the primary goal of every debtor since it is fully in the hands of the debtor, the company remains in operation, creditors’ claims are generally fully satisfied and the company keeps its profile as a credible business partner.

But let us start at the beginning. The basic prerequisite for restructuring is that bankruptcy of the debtor is impending or the debtor is already bankrupt. The debtor can authorize the trustee to draw up a restructuring opinion. The trustee will determine if the prerequisites for restructuring are met. The court can only allow a restructuring on a positive recommendation by the trustee. In the second phase, creditors file claims against the debtor and the trustee evaluates these with professional care by determining if claims exist and in what amount. In this phase the trustee can considerably influence the course of proceedings by intentionally or negligently disregarding his duties, for example by acknowledging a claim which he should not and contesting (excluding) a claim which should be acknowledged.

The trustee convenes a meeting where the creditors choose their representatives on the creditors’ committee. Among other things, the committee ensures that all creditors are treated equally. Furthermore, the committee arranges with the creditor a restructuring plan which is legal and acceptable to most, or, in the best-case scenario, to all creditors. The plan is first approved by the creditors’ committee and then by the approval meeting. Finally, the plan has to be confirmed by the court.

 

3. What has changed and what are the deficiencies of Lex Váhostav?

The ultra-quick reaction by the government and the National Council to the situation with Váhostav resulted partly from ongoing debates and partly from efforts to find a quick political and populist solution to a long-term problem while making the solution acceptable to experts.

The amendment presents a brushed-up amendment to the Commercial Code connected with change and amendment of other regulations. The amendment to the Commercial Code introduces several new legal institutions, especially:

(i) a registry of disqualifications to include persons who are forbidden to act as statutory bodies or members of supervisory boards in business companies and cooperatives;

(ii) a definition of a company in crisis, if the ratio between its equity and its obligations is less than 4 to 100 (in 2016), 6 to 100 (in 2017) and 8 to 100 (from 2018); and

(iii) prevention of repayment of contributions to shareholders or liability of shareholders for certain acts.

All these changes should lead to greater responsibility of statutory bodies and shareholders for the economic situation of a company and increase financing from the equity capital of shareholders. The future effects of these changes are unclear since in some cases they can lead to lower investment in the development of a company and to complicating business activity. On the other hand, they might free the business sphere of undercapitalized companies and make statutory bodies more responsible for company decisions. We do not want to belittle the importance of the amendment to the Commercial Code, but Lex Váhostav raises more interesting topics for discussion.

 

Violation of obligation to file a petition for bankruptcy in time

A statutory body (e.g. managing director, board members) that violates the obligation to file a petition for bankruptcy in time must pay a penalty in the amount of EUR 12,500. Any agreement to avoid this penalty is forbidden. Creditors can also claim damages exceeding the penalty from those responsible. However, the penalty is too low to force statutory bodies to monitor the financial situation of the company more closely or to discourage them from fraudulent acts.

 

Possibility of employees to file a petition for bankruptcy

This is mainly a reaction to practical situations when employees are not paid their wages. At least five employees represented by a trade union can file a petition for bankruptcy against their employer for a relatively small administrative and financial burden. Mandatory representation of employees by a trade union seems useless. On the other hand, this institution could be abused for example by former employees filing a petition for bankruptcy as revenge and causing a company substantial damage.

 

Merger or demerger of a company

An agreement on merger or demerger of a debtor company must be approved by the trustee. Although the courts would probably see through speculative acts by a debtor, the legislator played it safe and conditioned the possibility of registration in the companies register with the trustee’s consent.

 

Reservation of title and financial leasing

If someone owns an item of property which the debtor unjustly retains, until the Lex Váhostav amendment their only chance was to file a motion to exclude the item from the bankruptcy estate. Now they can also claim this right similarly to a security right (such as a lien). However, the benefit of such a claim is doubtful since not everyone wants their property to be sold and converted into money, even if they get to keep the proceeds. We take the view that such items should not be sold but returned to their owner instead.

The good news is that the provisions of the bankruptcy and restructuring act related to financial leasing (such as the debtor purchasing a car by installments) enable the creditor to claim its own right similarly to secured claims. Currently such agreements cannot be effectively terminated or withdrawn from due to initiation of restructuring.

 

Granting voting rights (also in bankruptcy and restructuring)

Although voting rights in bankruptcy could be granted previously, Lex Váhostav enables creditors whose claims are contested by other creditors or already adjudicated by the court or another authority and secured creditors to be granted voting rights by preliminary decision. Lex Váhostav correctly applies this possibility in restructuring, though insufficiently, i.e., only to adjudicated and secured claims.

The court deadline is specified as “without undue delay”, but the court has no explicit obligation to decide up to a specific time, such as the first meeting of creditors, approval meeting etc. Correctly, the deadline should be set so that a contested creditor can vote even at the first creditors’ meeting (or approval meeting) (if the court decides in favour of a claim).

It also remains unclear why protection does not extend to all creditors, such as creditors whose claim has not yet been adjudicated, i.e. usual business partners.

 

Preparation and requirements for a restructuring opinion and petition for a restructuring permit

In this respect several changes have been adopted which should specify the requirements for transparent bookkeeping by the debtor and provide a true and precise picture of their financial situation. The trustee has new obligations to thoroughly assess acts of the debtor with related parties which could lead to the debtor’s “doom”. This should serve the court and especially creditors to evaluate the amount of satisfaction of their claims offered in restructuring as compared to bankruptcy.

If the trustee issues an opinion that recommends restructuring, the opinion should include the following:

• a statement by an auditor or expert whether the debtor’s financial statements give a true and precise picture of the facts which are the subject matter of bookkeeping and on the debtor’s financial situation;

• information as to what extent the debtor’s shareholders (members) distributed profits or other equity among themselves in last two years.

A petition for restructuring should include a list of all legal acts of the debtor exceeding a certain limit with related parties.

Conditions for the trustee (who is chosen by the debtor) to contest filed claim were also specified. Deficiencies in the debtor’s bookkeeping cannot be the only reason for contesting a claim.

 

Main changes in restructuring with regard to Lex Váhostav

After successful completion of restructuring, the debtor can only distribute profit or other equity among its members after claims by creditors from the group with unsecured claims (not related parties) are satisfied up to the amount of their acknowledged claims, i.e. up to 100% of their claims.

This probably most clearly illustrates how hastily the amendment was drafted. The wording is insufficient, easy to avoid and does not give creditors security that they will ever see a part of their claim, even if the company is successful in the future.

The worst aspect is that the legislator seems to have opened the door for “corrupt behavior” by legalizing arrangements on future satisfaction of claims from profits in exchange for voting for the plan. If the debtor makes a profit, it has to be distributed among the creditors who requested it proportionally to the amount of the claims of other creditors from their group. There is no specific key ensuring fair distribution which leaves room for agreement. It seems impossible for a creditor to prove disproportionality in the payment of claims to individual creditors.

To ensure greater protection, especially for small unsecured creditors, specifying a limit xx % and x months in order to ensure that at least a minimum amount of the claim must be satisfied within a maximum period would be helpful. Minimum satisfaction of creditors would be specified by law (or decree of the Ministry) according to the restructuring plan. Designation of limits and whether the limits themselves should be specified in the opinion or only in the plan should be left for expert discussion and not be discussed behind closed doors of the government or the Ministry.

 

Capitalization of claims

Provisions on an exchange of creditors’ claims for shares in the company are quite usual. However, in the case of the Lex Váhostav amendment entrepreneurs clearly expressed that they do not want shares in the company but cash. This institution especially protects unsecured creditors and is used in various legal systems (such as Germany, Austria). However, its introduction to our legal system was not prepared in a detailed and systematic way, especially with regard to sustainability and an acceptable debt burden for the debtor. As such, the new regulation can cause more harm than good. The supervisory administration of the debtor and its new earnings as well as sustainability of the plan should be specified in more detail. Questions regarding the debtor’s current shareholders and their participation in property as well as the shares of creditors after satisfaction of their whole claim also need to be solved.

 

Single use provisions

Naturally, the amendment also includes provisions which will never be used. Here, we mean mainly the trustee’s possibility to refrain from their function. In the current system when the trustee is chosen by the debtor this provision is mainly political and has no deeper legal meaning.

The senselessness of this provision is accentuated by the fact that the ultra-quick drafting of Lex Váhostav left no time to specify the trustee’s remuneration. That’s right. Since the trustee’s remuneration in the restructuring depends mainly on his agreement with the debtor, what will the remuneration of a trustee who is assigned to the debtor electronically by chance be? No one knows.

 

4. What remained in the bankruptcy act and should be revised?

Many lawyers and trustees expected that Lex Váhostav will solve a certain disproportion in the choice of trustee. These voices remain unanswered and the debtor can still choose a trustee who will draw up an opinion and manage and monitor the restructuring. Globally, there are several forms of reducing the risk that the trustee will favor the debtor or the trustee’s related creditors. These include the possibility to remove the trustee in the initial phase of restructuring, approval of the trustee by creditors (veto) or the court as well as the accidental choice of trustee or approval of any of his acts by the court. Every system has its pros and cons. It is disputable which system is best for Slovakia. The legislator decided that the choice of trustee by the debtor is in order and will continue to rely on the personal responsibility and honesty of every trustee and on greater control by the Ministry and the court.

Also problematic is the suspension of pending disputes by virtue of law which may seem an infringement of a creditor’s right to due process of law. The trustees are then under certain circumstances forced to contest claims filed in these proceedings and in the case of a lawsuit by a creditor the dispute is transferred to another court, which clearly prolongs the proceedings.

The situation of Váhostav also shows that provisions regarding conflict of interests of trustees should extend to the relationship between trustee and creditor or their related parties. The same applies to supervisory administration.

Sadly, the freedom granted to trustees and other subjects in restructuring in Western countries clearly cannot work in Slovakia, since some people will still try to systematically abuse the system. Honesty, responsibility and professional ethics of all participants should come first. It is mainly the task of the trustee and the court to complete the restructuring legally and fairly. The trustee is obliged to exercise his function in an unbiased way and with professional care and a large majority of trustees do so. However, there are indications of dishonest and biased actions by certain trustees. This adds to the perception of restructuring as a fraudulent activity organized by the debtor and the trustee in order to satisfy only chosen claims and to the least possible extent. In recent years the Ministry of Justice has tried hard to make trustees more professional and exercises greater control over them. However, it is mainly up to the judge supervising the restructuring process to reject a restructuring plan which is against the law. The judge can also reject an approved plan if acceptance of the plan was achieved by fraudulent action or grant of special benefits to a plan participant.

 

5. Conclusion

Lex Váhostav grants some increased protection to creditors and introduces new institutions to increase their protection, but the essential items remain unchanged. Assessing whether a specific case of restructuring or bankruptcy is illegal remains mainly with the court, the Ministry of Justice as well as with the criminal authorities. The responsible authorities need to accept responsibility for bankruptcy and restructuring matters and start to apply the institutions they have at their disposal. Even the best amendment to the bankruptcy act is only a piece of paper unless supported by actual results and actions. Exemplary sanctions might potentially discourage speculators.