[This is an English translation of an article originally published in Czech.]
Hundreds of companies become insolvent every year, although many of them could be saved if they addressed their financial difficulties correctly and in good time.
“In the Czech Republic, economic difficulties within a company continue to carry a considerable stigma. As a result, entrepreneurs often conceal and postpone dealing with their problems until it is too late,” says Michal Kuděj, founding partner of Tarpan Partners and Assistant Professor in the Department of Strategy at the Faculty of Business Administration of the Prague University of Economics and Business.
“Addressing problems early is essential to survival,” he adds. A new instrument in the form of preventive restructuring is also intended to help Czech entrepreneurs achieve precisely that.
Czech entrepreneurs have been able to use preventive restructuring since September last year. It is intended to provide them with a new way of responding to financial difficulties before reaching the point of no return, beyond which insolvency is the only remaining option. The new legislation therefore applies when a company encounters financial difficulties but still has an opportunity to resolve the crisis because it is not yet insolvent.
“Unlike insolvency proceedings, preventive restructuring is confidential and is generally not recorded in a public register. This makes it easier to resolve the problem without the company losing the trust of its customers or business partners,” Michal Kuděj explains.
An experienced expert in corporate finance and restructuring processes and a partner at Tarpan Partners, he also serves on the academic board of the Harry Pollak Centre for Restructuring and Insolvency at the Faculty of Business Administration of the Prague University of Economics and Business. He also participated in implementing the European directive that introduced preventive restructuring into Czech law.
“We designed the entire act as an option – a potential solution to financial distress, one could say. It therefore imposes no obligations on entrepreneurs, and the use of this instrument is entirely voluntary. Its purpose is to assist entrepreneurs affected by adverse developments within their companies,” Kuděj notes.
The principle of preventive restructuring is an agreement between the entrepreneur and their key creditors, particularly concerning capital restructuring and the continuation of the company’s operations – in other words, a consensus from which all stakeholders benefit.
“We still encounter entrepreneurs who hesitate to confront financial difficulties early enough,” adds Luděk Skoupil, a lawyer and Managing Partner of the Tarpan Legal law firm specialising in transaction advisory, due diligence, corporate strategy and finance.
“This is often associated with owners lacking strategic vision and the determination to face reality…” he says. In the Czech Republic, smaller and even medium-sized companies are relatively often managed not by professional managers, but by their founders, who allow themselves to be influenced by emotions and feelings. They then perceive the crisis as a personal failure. “Preventive restructuring may be the key to avoiding these problems and securing a future for the affected companies,” Luděk Skoupil adds.
When to address financial difficulties
According to experts from Tarpan Group, there is no single metric by which entrepreneurs can recognise that they are heading towards more serious difficulties. “It is different for every company. But certain indicators do exist, such as declining margins, accumulating inventory, growing liabilities and others,” Kuděj explains, referring to the early warning system introduced by the Czech Republic as part of the requirements of the European directive on preventive restructuring.
The early warning tool is intended to provide entrepreneurs with basic guidance when assessing the financial health of their companies. The Ministry of Justice launched it last year, and it is freely available on the justice.cz portal.
“The application is built on a precise system based on financial statement data, as well as information that is not publicly available,” says Michal Kuděj, who participated in developing the system.
Using the data entered, a sophisticated algorithm evaluates factors such as the probability of financial distress or the size of the coverage gap. The results are displayed using a traffic-light colour scale: green indicates sound financial health, orange signals a potential threat and red warns of a serious risk that may then be addressed through preventive restructuring, for example.
Advantages of preventive restructuring
An entrepreneur enters preventive restructuring by notifying the affected creditors and providing them with a restructuring project – a document outlining the changes necessary to preserve the viability of the business and presenting a recovery plan. The commencement of preventive restructuring is also notified to the competent court.
“The affected creditors are generally informed individually. The entrepreneur may, of course, also publish information about being subject to preventive restructuring on their website. Confidentiality is, however, one of the principal advantages of preventive restructuring, so we do not generally expect entrepreneurs to publish this information,” Kuděj notes.
Preventive restructuring therefore does not carry the stigma associated with insolvency proceedings. It can consequently protect the entrepreneur’s reputation and the trust of their business partners.
Preventive restructuring is also based on agreement and benefits everyone involved. According to the Tarpan Group experts, this is its second principal advantage. “Insolvency proceedings are inherently adversarial; their purpose is the collective satisfaction of the claims of an insolvent debtor’s creditors.
Preventive restructuring, by contrast, is based predominantly on consensus, requiring the agreement of at least 75 per cent – a qualified majority – of all affected creditors,” Skoupil explains.
Reaching an agreement also increases the likelihood of resolving financial distress many times over. “The process of reaching this agreement is regulated by law, guaranteeing the parties that their actions comply with the law. This is also crucial to their willingness to reach an agreement and thereby resolve the entrepreneur’s situation,” the lawyer explains.
This is another significant advantage of the new legislation. “It is not usually easy to negotiate an informal agreement with large corporations or banks, which are most commonly in the position of creditors. They will therefore always prefer the entrepreneur to present them with a formal proposed agreement – or, more precisely, an agreement following a predictable legal procedure, as is the case within preventive restructuring,” Michal Kuděj adds.
Last but not least, another advantage of preventive restructuring is the speed with which the situation can be resolved. While insolvency proceedings commonly last as long as five years, preventive restructuring should take only a fraction of that time.
“Thanks to the new instrument, it will therefore be easier to establish cooperation between entrepreneurs and creditors, including banks, leading to sustainable solutions and the protection of companies’ futures,” the founding partner of Tarpan Partners believes.
13. 5. 2024