Amended regulatory legal framework for bankruptcy and restructuring presents more opportunities and makes it easier for a legal entity to be declared insolvent

As the world faces the COVID-19 pandemic and all the consequences that it brings, the issues concerning the continuity, restructuring and, alas in some cases, termination of activities of legal entities are becoming increasingly relevant.

The Law on the Insolvency of Legal Entities, which came into force on 1st January 2020, has superseded the previous Enterprise Bankruptcy Law and the Law on Restructuring of Enterprises. Thereby, the bankruptcy and restructuring processes have been brought together into a single (consolidated) regulatory framework since 1st January of this year, noting that, in certain circumstances, corporate bankruptcy is not the only viable solution to hand.

Amongst other issues addressed in the Law on the Insolvency of Legal Entities, one of the key modifications introduced by it concerns the concept of insolvency, which is crucial for a legal person to be declared in bankruptcy.

Under the previous Enterprise Bankruptcy Law, an enterprise may have been declared insolvent only in the presence of all of the following conditions, i.e.

  • the enterprise is in default (defaults the repayment of its debts or fails to carry out any prepaid works, etc.), and
  • the enterprise’s overdue liabilities (debts, incomplete works, etc.) are in excess of half of the value of the assets recorded on the enterprise’s balance sheet.

The concept of insolvency enshrined in the Law on Insolvency of Legal Entities, which has been applicable since 1st January of this year, stipulates the following conditions should be alternatives to each other, i.e. it is sufficient that:

  • the legal person is unable to fulfil its property obligations in a timely manner, or
  • the legal person’s liabilities exceed the value of its assets,

for the legal entity to be declared insolvent.

It is also evident from the foregoing that the Enterprise Insolvency Law requires that the overdue liabilities of an enterprise exceed half of the value of assets recorded on the balance sheet. Meanwhile, the Law on Insolvency of Legal Entities goes further as far as this condition is concerned. It makes it sufficient that the enterprise’s liabilities exceed the value of its assets.

In other words, a legal person may also be declared insolvent in cases where its liabilities are not overdue but exceed the value of its assets, or where the default in property obligations is negligible (e.g. delays of merely a couple of days).

It is clear that changes in the regulatory legal framework and the broadening of the insolvency concept present increasing options for an authorised person to be declared insolvent.

Another important aspect is the ranking of competing creditors, amended by virtue of the Law on Insolvency of Legal Entities, applicable since 1st January.

The new law establishes that, where a legal person is in liquidation due to bankruptcy, the claims of the lender secured by collateral shall be satisfied first from the pledged assets. The Enterprise Bankruptcy Law did not have any such provision whatsoever.

The Enterprise Bankruptcy Law, which was applicable until 1st January, provided for three ranks of competing creditors. In contrast, the Law on Insolvency of Legal Entities sets forth only two ranks of competing creditors. I have detailed them in the table below:

                Legislation

Rank

Enterprise Bankruptcy Law (until 01/01/2020) Law on Insolvency of Legal Persons (from 01/01/2020)
The following claims shall rank first: employment-related claims of employees;

claims for the compensation of damage resulting from mutilation or another bodily injury, contraction of an occupational disease or death as a result of an accident at work;

claims of agricultural entities for the payment to be made for agricultural products sold.

claims of creditors, which have granted new and/or mezzanine financing not secured by collateral and/or mortgage, arising from the legal person’s failure to repay its loans within the time limits set out in the contracts;

employment-related claims of employees;

claims for state social insurance contributions, compulsory health insurance contributions and contributions to the Guarantee Fund and to the Long-Term Employment Benefit Fund;

claims relating to outstanding obligations arising from the commercial activities undertaken during bankruptcy.

The following claims shall rank second: claims for taxes and other payments into the budget as well as compulsory state social insurance contributions and compulsory health insurance contributions;

claims relating to loans granted from the funds borrowed on behalf of the State and to loans subject to a guarantee offered by the State or by a guaranteed body, whose liabilities have been secured by the State guarantee;

claims relating to the assistance granted from the European Union and the public budget funds.

all remaining claims of creditors.
The following claims shall rank third: all remaining claims of creditors.

 

Both the old Enterprise Bankruptcy Law and the new Law on Insolvency of Legal Entities lay down an identical provision that the creditor claims shall be satisfied in two stages, subject to the ranking prescribed in the relevant law: the first stage will see the creditor claims satisfied without accrued interest and penalties. In contrast, the second stage provides for the remainder of creditor claims (interest and penalties). Nonetheless, the new Law on Insolvency of Legal Entities goes further and expands the list of priority creditor ranks.

It should be noted that, in addition to the major modifications already discussed, the new Law on Insolvency of Legal Entities has introduced other amendments or clarifications too, along with the modifications made in the restructuring processes.

It is likely that when this turmoil ends, there will be a strong demand for the existing businesses to be restructured in one way or another, possibly ceasing some of them in order to adapt to the new economic situation. Hence, the changes outlined above will be particularly relevant for the owners and executives of legal entities.

Should your business require advice, please consult our experts.

Associate Agnė Pimpytė is a tax law expert at Law Firm GLIMSTEDT

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