Enacted Summary

In 2001, writing for the World Bank in the context of a Report on the Observance of Standards and Codes (ROSC), Gordon Johnson identified a number of weaknesses in the Czech insolvency regime, including inadequate resources for the courts, extremely slow proceedings leading to significant backlogs of cases, weak protection for creditor rights, and lack of professional criteria and training or adequate oversight over the administrative process. Other assessments released prior to 2007 reported similar shortcomings in the Czech Republic’s insolvency framework. Czech law had been amended piecemeal over the years since 1999, but with minimal overall success, as evidenced by the findings of these assessments. However, on July 1, 2007, the new Act on Insolvency and its Settlement Methods No. 182 of 2006 (the Insolvency Act) came into force, replacing the Act on Bankruptcy and Composition No. 328 of 1991 as the Czech Republic’s main insolvency law. The new Insolvency Act was found to be a solid overall improvement on the Czech insolvency framework. In contrast to previous evaluations, the 2009 European Bank for Reconstruction and Development’s (EBRD) Insolvency Law Assessment Project deemed the Czech Republic’s legal framework to be “highly compliant” with current international standards. The assessment noted that many improvements have been made, especially in the areas of estate assets, creditor rights, and reorganization. It is worth noting however, that the EBRD assessment is based solely on the content of the insolvency law. It has not evaluated or assessed the effectiveness or practical operation and application of those laws, nor has it evaluated institutional capacity to apply the law.

General Overview

According to a 2001 Report on the Observance of Standards and Codes (ROSC) prepared by Gordon Johnson for the World Bank, the Czech insolvency system was contained within a legal environment that "has been widely regarded as unsatisfactory" (p. 4). Johnson added that, during the 1990s, the bankruptcy framework was "ineffective and dysfunctional" (p. 5), bankruptcy proceedings were long and drawn out, providing little return to creditors, and there were few occasions of successful reorganization or restructuring attempts. The report also noted that "this left liquidation as the only viable option, which proved frequently ineffective for creditors and debtors alike" (p. 5). According to Johnson, this situation was directly attributable to weaknesses in existing Czech bankruptcy legislation and its institutional supports, which had resulted in the limiting of creditors’ rights. On the institutional side, there were few efficient bankruptcy professionals, including judges and administrators, further exacerbating the overall inefficiencies in the insolvency settlement process. In recognition of these problems, the Czech government began addressing legal deficiencies in 2000. Draft amendments to the Act No. 328 of 1991 on Bankruptcy and Composition (the Bankruptcy Act), the Czech Republic’s primary insolvency legislation at the time, were proposed. The amendments came into effect in May of that year.

According to Johnson, some of the 2000 changes were positive in their effects, including provisions that permitted the preservation of debtor property, allowed interim trustee appointments predating actual bankruptcy declarations, permitted the use of professional administration firms to participate in the process, offered creditors input into the liquidator selection process, and revamped the fee structure. One of the more troublesome changes introduced in 2000 was the establishment of a "vague and confusing" (p. 7) definition of insolvency that could inhibit filings and a further weaken secured creditor rights. Another questionable amendment permitted the courts "to dismiss the creditors' committee without well-defined criteria" (p. 7), Johnson added. Because the Bankruptcy Act concentrated on liquidations, they left virtually unaddressed the weaknesses that existed in the reorganization framework. They also largely ignored necessary institutional reforms, "that is, the organization of the courts, court procedures, and the regulation of the activities of all the professionals working in the system" (p. 7), Johnson noted. According to the ROSC, the system needed to be strengthened in order to improve the prospects of enterprise restructuring and enhance participation by creditors in the process.

Johnson explained that commercial matters were dealt with by the Regional Courts, to which bankruptcy judges belong. It had become the informal practice for certain judges to become "specialists" in bankruptcy, particularly in areas where such proceedings were most common. There was no particular specialized training or background required, however, for an individual judge to be chosen to serve in a bankruptcy matter. The report adds that "judges... complain of having to spend too much time monitoring and supervising trustees, a task that some acknowledge should be left to the Creditors Committee" (p. 9). The system also lacked any mechanism for monitoring and overseeing trustees and others involved in insolvency proceedings. While the Bankruptcy Act had expanded the oversight role of creditors and the Creditors Committee, the resources available to them to carry out this function were inadequate. Also absent from the system was any licensing or other requirement for individuals who register to serve as administrators or trustees.

Johnson reported on the response by Czech authorities to the World Bank report, noting that they "welcomed the assessment" (p. 14). They recognized the need to strengthen mechanisms for debt recovery and enforcement and for greater efficiency at the judicial side of the process particularly regarding sale for collateral. Reorganization procedures needed to be streamlined and the regulatory and institutional framework needed enhancement. Greater clarity was needed in the legal definition of insolvency and in the area of creditor rights. Finally, the liquidation process needed to be subject to some kind of established schedule, which was lacking at the time of Johnson's report. Finally, regulation and oversight of insolvency practitioners had to be covered by formal legislation.

Writing in 2003 for the EBRD, R. Harmer and N. Cooper summarized the findings of the EBRD Insolvency Law Assessment for a number of countries, including the Czech Republic, Insolvency regimes in these countries were evaluated in five “core essential” areas, namely; the commencement and effects of proceedings; the assets of the estate; the involvement and treatment of creditors; the reorganization process, and the terminal process. According to the report, the Czech insolvency framework held an overall "medium" rating pertaining to most of these areas. The Czech Republic also scored "very low" with regard to its "reorganization process" (p. 20) and "low" with reference to its "bankruptcy/terminal liquidation process" (p. 23), according to the 2003 report. The 2004 International Monetary Fund report reiterated that the Czech legal and judicial systems still displayed shortcomings, even after the passage of reform legislation. Chief among these were insufficient resourcing, judges and other professionals who lacked adequate professional experience in business and corporate law, a lack of transparency in court proceedings, and weak protections for creditor rights.

In its European Restructuring and Insolvency Guide for the Czech Republic, published in 2005, PricewaterhouseCoopers (PWC) reported that the government no longer contented itself with piecemeal amendments to insolvency legislation and was aiming for a full-scale revision of the law. Two new drafts of the Bankruptcy Act were in the works as of 2005, each taking a different approach to the problem. Under the first approach, certain earlier provisions were to be preserved, leaving control of proceedings in the hands of judges. The alternative draft was expected to bring creditors more fully into the process, giving them decision-making rights with regard to the insolvent firm's estate. The three bankruptcy alternatives (liquidation, restructuring, composition) were retained. Provisions allowed for debtors to be forced into bankruptcy if they met certain criteria, and the hope was that this would prevent debtor fraud or abuse while encouraging debtors to enter the process earlier, thus enabling better outcomes. The PWC report added that, as a European Union member, the Czech Republic adopted the EU Insolvency Regulation on May 1, 2004. The regulation primarily pertains to "mutual recognition of insolvency proceedings and secondary proceedings.”

In 2006, the EBRD conducted a follow-up evaluation of the insolvency regime in the country. The findings of this evaluation reiterated the “medium compliance” rating assigned by the 2003 EBRD assessment. It is worth noting however, that while the 2006 EBRD assessment is not publicly available, reference is made to it in a 2009 EBRD evaluation, the results of which are enumerated below. On July 1, 2007, the new Act on Insolvency and its Settlement Methods No. 182 of 2006 (the Insolvency Act) came into force, replacing the Bankruptcy Act as the Czech Republic’s primary insolvency legislation. The 2009 U.S. Department of Commerce (DoC), in its Country Commercial Guide to Doing Business in the Czech Republic, states that the new law “addresses important structural impediments such as the slow and uneven performance of the courts, weakness of creditors’ legal standing, and the lack of provisions for corporate restructuring” (p. 60). The new law was also observed to possess a clearer and more encompassing structure, with the use of more defined language as well as the implementation of deadlines. The DoC also reports that according to experts on the Czech legal system, the new law increases the efficiency and transparency of insolvency settlement system. A number of essential decisions have also been passed over to creditors under the new legislation, strengthening creditor rights in the insolvency process.

The EBRD, in 2009, conducted an assessment of the Czech Republic’s insolvency settlement system, based on this new Insolvency Act as part of the EBRD Insolvency Law Assessment Project 2009. In contrast to previous evaluations, the 2009 EBRD assessment deemed the Czech Republic as “highly compliant” with current international standards developed by a number of international organizations, including the World Bank. The assessment noted that many improvements have been made, especially in the areas of assets of the estate, creditor rights, and reorganization. Provisions surrounding the avoidance of pre-bankruptcy transactions in particular, were noted to be markedly strong. Possible further improvements in the Czech insolvency framework were highlighted in the areas of stays on creditors, reorganization, and the liquidation process. It is worth noting however, that the EBRD assessment is based solely on the content of the insolvency law. It has not evaluated or assessed the effectiveness or practical operation and application of those laws, nor has it evaluated institutional capacity to apply the law.

The 2010 "Doing Business” guide published in 2009 by the International Bank for Reconstruction and Development and the World Bank, looks at the insolvency regimes of 183 countries, among other issues, and evaluates their bankruptcy procedures. These procedures are evaluated across three dimensions: efficiency (measured in time required for completion of the process), cost (measured as a percentage of the debtor's estate), and recovery by creditors (expressed in cents on the dollar). The data is also compared to the averages achieved by the member states of the Organisation for Economic Co-operation and Development (OECD). In the Czech Republic, it takes an average of 6.5 years, nearly four times the average for member states of the Organization for Economic Cooperation and Development (OECD), which averages 1.7 years. The cost of proceedings averages 15 percent, whereas the OECD average is 8.4 percent. Recovery rates are low, averaging 20.9 cents on the dollar in the Czech Republic, while the OECD average is 68.6.