A new law on addressing impending insolvency took effect in May 2022, which also amended and revised other legal regulations, notably the Bankruptcy and Restructuring Act, the Commercial Code, and others, most of which did not take effect until later, on July 17, 2022. The new law introduced new institutions, procedures, and rules into the Slovak legal system, the primary purpose of which is to prevent the negative consequences of economic failure by business entities. In the following article, we will provide a closer look at the adopted changes.
Bankruptcy is undoubtedly an undesirable situation and every entrepreneur’s worst nightmare. The Bankruptcy and Restructuring Act defines bankruptcy as a state in which a debtor is insolvent or heavily indebted. Since insolvency and over-indebtedness lead in the vast majority of cases to the dissolution of a business, the legislature decided to adopt legislation that could, to a certain extent, eliminate the risk of bankruptcy and thus prevent the dissolution of the business. We are referring to Act No. 111/2022 Coll. on the Resolution of Impending Insolvency and on Amendments to Certain Acts, which took effect on July 17, 2022, and through which the Directive on Restructuring and Insolvency was transposed into the Slovak legal system.
This Act regulates certain tools designed to address impending insolvency due to a debtor’s impending inability to pay, namely public preventive restructuring and non-public preventive restructuring. The adoption of this Act also led to amendments to other legal regulations, such as the Commercial Code and the Act on Bankruptcy and Restructuring.
In light of the new legislation, the Ministry of Economy has prepared practical guidelines for small and medium-sized enterprises, which are available on the Ministry’s website, including in English. These guidelines and manuals are intended to help navigate the new legislation and clarify the procedures and methods for utilizing the various legal instruments. The Ministry has also prepared a guide for entrepreneurs on preventive restructuring and the use of advisory services in this area, which may serve as a useful resource given the recent nature of the legislation.
As mentioned above, insolvency is defined as a situation where the debtor is either insolvent or over-indebted. Simply put, a debtor is considered over-indebted if they have more than one creditor and the value of their liabilities exceeds the value of their assets. This definition remained unchanged with the adoption of the new law. However, it is important to note that a change occurred in the definition of insolvency. Under the old legislation, a debtor was considered insolvent if they had at least two liabilities to two different creditors that were more than 30 days past due. However, with the entry into force of the Act on Impending Bankruptcy, a change occurred, and the aforementioned period was extended from 30 days to 90 days. For a natural person, the individual is considered insolvent if they are unable to fulfill even a single financial obligation more than 180 days past the due date.
We have explained what bankruptcy, insolvency, and debt are. But what does the new law on impending bankruptcy actually bring?
As stated in the explanatory memorandum, the new legislation is intended to serve as an effective tool for the timely resolution of a debtor’s situation so that the debtor can continue its operations and maintain its viability, and, above all, prevent bankruptcy and subsequent liquidation. The fundamental objective of the law is “to provide debtors with sufficient scope for effective, efficient, rapid, and transparent preventive restructuring at the initial stage when bankruptcy is ‘imminent.’ It is important to note that such preventive measures and the avoidance of insolvency proceedings not only increase the rate of satisfaction of creditors’ claims but also preserve existing jobs and, for example, the entrepreneur’s know-how.
What solutions does this law introduce?
To achieve these goals, several new mechanisms have been introduced, such as preventive restructuring, temporary protection, or so-called early warning tools. We will now describe the individual available mechanisms in more detail.
Preventive Restructuring
The Act also introduces preventive restructuring as a new method for the rehabilitation of commercial companies. In preventive restructuring, a debtor can address its impending insolvency through a rehabilitation plan, which the Act refers to as a public preventive restructuring plan and which must be realistically achievable. Preventive restructuring is simpler and less financially burdensome compared to “classic” restructuring under the Bankruptcy and Restructuring Act. The recovery plan may be drafted by the debtor themselves, or they may request assistance from a preventive restructuring advisor listed on the website of the Ministry. Subsequently, the recovery plan must be approved by the creditors and the court.
The Act introduces two forms of preventive restructuring—public and non-public. The fundamental difference is that non-public preventive restructuring can only take place with creditors subject to the supervision of the National Bank of Slovakia. In contrast, public preventive restructuring is possible with all creditors.
The advantage of non-public preventive restructuring is that it allows the entrepreneur to focus on the largest liabilities, in a less formal process and in closer contact with creditors.
The advantage of public preventive restructuring, given the inclusion of all creditors, is a comprehensive resolution of the entrepreneur’s liabilities, which still occurs within a relatively short timeframe. In this case, however, the debtor must be registered in the Public Sector Partners Register at the time of filing the petition.
The Process of Preventive Restructuring
Public preventive restructuring proceeds in several steps, during which the debtor is required to fulfill various obligations and requirements prescribed by law. The process can be divided into several parts.
- In the first step, the debtor must prepare as thoroughly as possible for the preventive restructuring itself. Particular attention should be paid to Section 10 of the Act, which sets forth the conditions under which preventive restructuring will be authorized, or conversely, defines the cases in which the court will not authorize public preventive restructuring, for example, if the debtor is in liquidation or there are grounds for the debtor’s dissolution, etc.
- If the conditions for authorizing public preventive restructuring are met, the debtor shall file a petition for authorization of public preventive restructuring with the competent court. The petition is filed exclusively electronically and, in addition to the general requirements for filing, must also contain a statement by the debtor regarding the fulfillment of the conditions for authorizing public preventive restructuring and a draft of the public plan (The requirements for this public plan and its draft are set forth below).
- If the court authorizes public preventive restructuring in accordance with Section 10 of the Act, the debtor is required to convene an informational meeting to be held no earlier than 15 days and no later than 20 days after the authorization of public preventive restructuring. Anyone who claims to be a creditor of the debtor has the right to attend the informational meeting. The primary purpose of this informational meeting is to familiarize creditors with the concept of the debtor’s public plan, i.e., the method of its recovery.
- Subsequently, the debtor is required to convene a creditors’ meeting. This meeting must take place no earlier than 60 days and no later than 70 days after the public preventive restructuring is approved, and it is chaired by the debtor. The primary purpose of the creditors’ meeting is for the creditors’ committee to approve the public plan. The creditors’ committee has three or five members, and its activities are directed by the chair of the creditors’ committee. Its duties are defined in Section 33 of the Act, and the essence of its activities lies in supervising the debtor’s actions during the public preventive restructuring.
- After the public plan is approved, the debtor is required to file a motion with the court for confirmation of the public plan within seven days. The court will either confirm or reject it. It will reject it, in particular, if the rules for the preparation, drafting, and approval of the public plan were not followed, if the public plan is vague or unclear, or if the new financing required to implement the public plan unfairly harms the interests of the creditors. A complete list of grounds for rejection is set forth in Section 45(1) of the Act. We note, however, that even if the court does not approve the proposed public plan, the debtor is not required to file for bankruptcy. It is important to realize that the debtor is still in a state of “imminent insolvency” and not directly in “insolvency.”
- However, if the court approves the public preventive restructuring plan, it becomes binding on the debtor, and the debtor undertakes to comply with and fulfill it. To enhance legal certainty for creditors, the public plan may stipulate that, for the duration of its implementation, a supervisory administration is established, whose role is to oversee and monitor the debtor’s business activities in accordance with the approved public plan.
Public Preventive Restructuring Plan
The Act sets forth several basic criteria that a public restructuring plan must meet, such as comprehensibility, feasibility, sustainability, and fairness in the sense of a fair distribution of the value of the debtor’s assets among the affected creditors.
The public preventive restructuring plan is divided into three parts—(i) the introductory part, (ii) the descriptive part, and (iii) the binding part.
The introductory part contains basic identifying information, such as the debtor’s identification, the administrator’s identification, and the competent court. In the descriptive section (Section 36(3) of the Act), the debtor provides, for example, a detailed description of their financial situation, identifies the affected creditors, and states the expected satisfaction rate for each affected creditor under the best-case scenario. In the binding section (Section 36(4) of the Act), the debtor describes the method of asset disposition, identifies the entities providing financing to the debtor, or describes other legal relationships to be established under the public plan.
Attached to the public preventive restructuring plan are, for example, a list of creditors, a list of assets, a list of related parties, or a list of employees. The final list of attachments is set forth in Section 36(6) of the Act.
Pursuant to Section 8 of the Act, the draft public plan must contain the elements of a public plan as specified in Section 36, i.e., in principle, all of the above-mentioned elements.
Temporary Protection
Temporary protection is an institution established by law, pursuant to which the debtor is to be granted sufficient material and, in particular, temporal leeway to effectively achieve the objective pursued by public preventive restructuring, namely the recovery of the enterprise.
Under the new legislation, temporary protection will consist of a three-month period (which may subsequently be extended by another three months upon the debtor’s request), during which the debtor is not required to file for bankruptcy and any proceedings already initiated will be suspended. However, it is important to note that in order for the debtor’s temporary protection to be granted, it is necessary to obtain the consent of a majority of creditors from the creditors’ committee.
The introduction of temporary protection has several positive effects for the debtor, for example:
- the debtor is not required to file for bankruptcy, and during the period of temporary protection, bankruptcy cannot be declared against the debtor or restructuring permitted; any bankruptcy or restructuring proceedings already initiated under the Bankruptcy and Restructuring Act are suspended;
- during temporary protection, enforcement proceedings cannot be conducted against the debtor;
- during temporary protection, it is not possible to initiate the enforcement of a security interest in property belonging to the debtor or to enforce such a security interest.
Temporary protection is clearly a beneficial mechanism for the debtor, shielding them for a certain period from the negative consequences of bankruptcy, enforcement, or the exercise of security rights. Thus, the debtor can continue to ensure the operation of their business while simultaneously focusing on effectively resolving the impending bankruptcy. An advantage is that the effects of temporary protection apply generally, i.e., to all of the debtor’s creditors. This means that there are no creditors with a privileged status who could circumvent the effects of the temporary protection granted and file a petition for bankruptcy or commence enforcement of a judgment.
Advisor in Preventive Proceedings
Another new feature is the introduction of the role of advisor in preventive proceedings. The law provides that the debtor’s statutory body shall consider engaging an advisor who possesses the professional knowledge and experience, as well as the technical and personnel resources, necessary to address the debtor’s impending insolvency, and who enjoys the trust of the relevant creditors. The advisor’s role is, for example, to prepare a projection of cash flows, revenues, and costs and their structure for the purpose of drafting a plan concept and a public plan, to examine the content and scope of factors affecting the sustainability of the debtor’s business and its ability to continue operations, including the degree of threat to its sustainability, or, for example, to examine and propose the need to implement specific measures and their anticipated impact on the sustainability of the debtor’s business.
The debtor may engage an advisor in preventive proceedings practically throughout the entire process, from the period immediately preceding the initiation of proceedings for the authorization of preventive restructuring until their conclusion, when the debtor will be “restored to health.”
The advisor’s services are provided for a fee, which must be reasonable. A fee is considered reasonable if, in total, it does not exceed one percent of the debtor’s turnover for the last calendar year. From the debtor’s perspective, it is certainly advisable to seek the assistance of an advisor, especially if the debtor lacks sufficient economic and legal knowledge, as the advisor in preventive proceedings is a guarantor of expertise and, by virtue of their position, should ensure the provision of high-quality services. However, the downside is the additional financial burden on the debtor. The law does not limit the use of services to a single advisor, so the debtor may utilize the services of multiple advisors, such as a lawyer and a tax advisor simultaneously.
The Ministry of Economy is required to publish on its website a list of advisors for small and medium-sized enterprises in the event of impending bankruptcy; as of the date of publication of this article, more than 50 entities, predominantly from the legal sector, are listed. The complete list is available here.
In the case of public preventive restructuring, the debtor is required to engage an advisor unless it obtains approval for temporary protection under Section 17(1) of the Act.
Special procedural provisions and subject-matter jurisdiction of courts
The new legislation also introduced subject-matter jurisdiction of courts for proceedings to address impending insolvency. The Act designates three district courts with subject-matter jurisdiction to which a debtor may submit a petition for authorization of preventive public restructuring. Specifically, these are the District Court of Košice I for the districts of the Regional Court in Košice and the Regional Court in Prešov; the District Court of Žilina for the districts of the Regional Court in Žilina, the Regional Court in Banská Bystrica, and the Regional Court in Trenčín; and the District Court of Nitra for the districts of the Regional Court in Nitra, the Regional Court in Trnava, and the Regional Court in Bratislava. The decisive factor for determining the court’s jurisdiction is the debtor’s registered office at the time the petition is filed. Appeals will be decided exclusively by the Regional Court in Banská Bystrica.
Impact of the Act on Impending Insolvency on Other Legal Regulations
Since the issue of impending insolvency is directly linked to the Act on Bankruptcy and Restructuring, changes have also been made to this legislation, and other amendments have been adopted to improve and simplify procedures. There has been a change in the definition of insolvency, as mentioned above; a definition of impending insolvency and the debtor’s obligations in connection with impending insolvency has been added, as well as, for example, the presumption of solvency. A significant change is the debtor’s obligation to file a petition for bankruptcy even in the event of insolvency (until July 16, 2022, this obligation applied only in the event of default) and also the prohibition on a debtor who has learned or could have learned (while exercising due professional care) of their insolvency from fulfilling due monetary claims in an amount greater than what would be allocated to the creditor upon satisfaction in bankruptcy (if it had been declared). This prohibition, or the corresponding obligation of the debtor not to fulfill a monetary obligation in a higher amount, applies from the very moment the debtor learned of or could have learned of their insolvency while exercising due professional care, i.e., regardless of whether bankruptcy has already been declared on the debtor’s assets.
Further details regarding the determination of insolvency and impending insolvency are regulated by Decree of the Ministry of Justice of the Slovak Republic No. 197/2022 Coll.
Other changes to the Bankruptcy and Restructuring Act also affect the filing of claims, which may now be submitted exclusively electronically and only to the trustee. The creditor is therefore no longer required to deliver a copy of the claim to the court. Please note, however, that the 45-day substantive deadline for filing a claim remains in effect; under this provision, the claim must be received by the court on the last day of the deadline—simply sending it is not sufficient. Another new feature is the option to convene a creditors’ meeting via videoconference, which we certainly view as a positive change that can contribute to the efficiency and improved accessibility of the meetings themselves. The deadlines for convening the first creditors’ meeting have also changed. Under the original legislation, the first creditors’ meeting was to be convened no earlier than the 15th day and no later than the 20th day following the expiration of the period for disputing claims. Under the new rules, the first creditors’ meeting must be held no earlier than 30 days and no later than 45 days after the expiration of the period for disputing claims, thereby creating a longer timeframe.
The Act on Impending Insolvency also amended the Commercial Code by expanding the definition of a company in crisis, which now includes a company facing the threat of insolvency—i.e., it need not be in a state of insolvency at that moment.
The adoption of the Act transposed the EU Directive into the Slovak legal system. We view the adoption of the Act on Impending Insolvency positively; however, its benefits will only become apparent through real-world practice and the utilization of the available new solutions. The timely detection of impending insolvency and its active resolution can contribute to preserving the existence of many businesses. Even if an entrepreneur is unable to handle the situation on their own, they may seek assistance from one of the advisors in preventive proceedings. At the same time, they may request temporary protection, thereby gaining at least a three-month window to resolve the adverse financial situation.
