Beside the ongoing debates regarding the Extraordinary Administration Proceedings (EAP), which was a tailormade framework to manage the restructuring of Agrokor, market trends show a drop in numbers in both pre-insolvency and insolvency cases. This downward trend originates in the 2015 restructuring and insolvency reform that over-formalised the pre-insolvency process and discouraged debtors from using it. The reform also introduced summary insolvency proceedings for small businesses that are opened and concluded simultaneously if there are no assets available for distribution nor any employees.
Over recent years, Croatia has been busy wrestling with the restructuring case that emerged when one of its biggest companies, Agrokor, faced collapse. Agrokor was an agricultural, food and retail giant with shares in many subsidiaries. It was intertwined with the whole Croatian economy and had an annual revenue of approximately 15% of the Croatian GDP, as well as being significant source of employment in Croatia. Not long after its financial difficulties were made public, measures were taken to prevent any immediate and future negative impacts of corporate distress within "large systems" on the state's economy. A fast-tracked parliamentary procedure adopted the Act on the Procedure of Extraordinary Administration in Companies of Systemic Importance for the Republic of Croatia (Extraordinary Administration Act).
The "large system" in Croatia represents a company that, independently or together with its subsidiaries or affiliates, has over 5,000 employees and over HRK7.5 billion (€1 billion) in consolidated obligations. The Act stipulates a restructuring via an EAP to ensure liquidity and business stability and to avoid an insolvency filing. An EAP was carried out over Agrokor and its many subsidiaries and affiliates and was successfully concluded at the end of 2018, although legal proceedings regarding creditors' claims are still ongoing and many aspects of the EAP itself remain a subject of debate to this day.
One of the hot topics was the inclusion of affiliates and subsidiaries into the EAP regardless of their solvency status. The Constitutional Court ruled that the purpose of the EAP was to examine the solvency of each company involved, since the Extraordinary Administration Act provisions stipulate solely the procedural consolidation of the parties to enable a single proceeding and single settlement for all the debtors involved; no circumstance allows for a unique insolvency estate out of a separate legal entities' assets. Still, it is questionable whether the final settlement also contained the elements of substantive consolidation dismissed by the Constitutional Court and there are many pending lawsuits concerning this issue before the Supreme Court.
Excepting the EAP, Croatia's very own too-big-to-fail restructuring case, another significant development has been the inclusion of pre-insolvency proceedings within the new Insolvency Act, adopted in 2015. Prior to September 2015, pre-insolvency was a combination of administrative and court proceedings, and though it was severely criticized due to the controversies concerning its implementation, it still enabled a rather expedited restructuring. The 2015 insolvency and restructuring reform created many obstacles for pre-insolvency proceedings, resulting in a significant reduction in the number of distressed companies filing a petition and an increase in companies opting for informal settlements with large creditors instead.
The restructuring and insolvency models available in Croatia are pre-insolvency proceedings; insolvency proceedings; insolvency plan; and the EAP. Each of the model is conducted and supervised by a commercial court, but the managing regimes differ from retaining some representation and responsibilities for maintaining business to complete shift in the managing powers.
Pre-insolvency proceedings as a voluntary restructuring model may be initiated by a debtor under condition of imminent insolvency. Imminent insolvency exists if the court determines that the debtor will be unable to fulfil its outstanding monetary obligations upon their maturity. The debtor is "imminently insolvent" if it has unsettled monetary obligations registered with the Financial Agency, or if the debtor has defaulted on salaries, employment-related contributions or taxes for more than 30 days.
The Insolvency Act only enables the recognition of insolvency matters in the narrowest sense
The grounds for initiating insolvency proceedings are insolvency and/or over-indebtedness. Insolvency of a debtor is presumed if a debtor has one or more due and unsettled obligations recorded in the register for more than 60 days or if a debtor has failed to pay three consecutive salaries to its employee(s). A company is deemed to be over-indebted when its liabilities exceed its assets. Filing a petition for insolvency proceedings is mandatory within 21 days following the occurrence of either of the prescribed insolvency reasons. A petition may also be filed by the Financial Agency, which is obliged to submit a petition if its records show that a company has one or more registered outstanding payments over an uninterrupted period of 120 days.
Unless the insolvency plan is adopted to restructure a debtor's business, insolvency proceedings are completed after all the debtor's assets are sold, after which the debtor is liquidated.
The insolvency plan is a restructuring model within formal insolvency proceedings which allows for modifications of rules on sale and distribution of the insolvency estate. A proposed insolvency plan may be submitted by the insolvency administrator by the final hearing, at the latest.
The EAP is the restructuring model for companies deemed of strategic importance and applies only to companies or groups with more than 5,000 employees and €1 billion of debt.
Unlike in an insolvency proceeding, which lasts as long as there are assets left to be sold, all the restructuring models are time limited and the restructuring plan must be proposed and adopted within the certain time frame after opening of the proceedings.
Filing a petition for insolvency proceedings is mandatory within 21 days of the occurrence of either of the prescribed insolvency reasons (as discussed above). Persons obliged to commence mandatory insolvency proceedings who fail to do so are personally liable to creditors for any damage caused by this omission.
Management board members and liquidators could also face criminal liability since failure to initiate insolvency is a felony, with prescribed penalties of a monetary fine or imprisonment of up to two years. However, in practice these sanctions are rarely imposed.
From the day a formal pre-insolvency proceeding is opened to its completion, all pending civil, enforcement, interim measures and administrative proceedings against the debtor are stayed and initiating any such proceedings against the debtor is forbidden. This does not apply to creditors that are entitled to separate satisfaction; creditors with exclusion rights; debtor's former and current employees' claims up to prescribed amounts; security measures in criminal proceedings; and tax proceedings for determining the abuse of rights, since formal opening of pre-insolvency proceedings does not affect those. During this same period, the debtor may only make payments necessary for regular operations and fulfil the obligations attached to post-petition credit (discussed further below).
As for insolvency proceedings, the pending proceedings are suspended, legal disputes regarding the debtor's assets may no longer be filed but all claims must be filed within the insolvency proceedings and examined by the insolvency administrator. The insolvency administrator is entitled to continue any suspended proceedings if a claim has been determined and any creditor whose claim has been disputed by the insolvency administrator may initiate proceedings against the debtor. Also, once the insolvency proceedings have been formally opened, all creditors but creditors with exclusion rights are prevented from enforcing their claims and pending enforcement and interim measures proceedings are stayed.
Commencement of insolvency proceedings also affects some contracts. Namely, mandate and similar contracts relating to the debtor's assets are terminated, lease and employment contracts remain in place and all other contracts that have not been performed by either party in full may be either rejected or adopted by the insolvency administrator. When the insolvency administrator opts for rejection of fulfilment of any such contract, any damages incurred by the contractual counterparty may be filed as an ordinary insolvency claim.
All legal consequences of opening insolvency proceedings also apply to an EAP.
Priority, dissenters and asset sales
The insolvency estate's obligations, including the costs of the insolvency proceedings, maintenance and management expenses, the insolvency administrator's fees, certain employees' claims and other claims stipulated by the Insolvency Act, are payed as they fall due and therefore implicitly have preferential status.
The priority status of other claims is as follows:
- creditors with exclusion rights with proprietary claims regarding certain assets are not affected by the insolvency;
- creditors with separate satisfaction rights have priority over unsecured creditors in settling their claims out of the value of the security;
- creditors with claims of a higher priority are settled before creditors of a lower priority;
- claims arising from employment agreements have higher priority over other claims; and
- claims regarding interests, creditors' procedural expenses, fines, and loans replacing share capital have lower priority than the other claims.
As for post-petition credit, fresh money is not protected if it is granted outside the statutory limitations stipulated by the Insolvency Act regarding pre-insolvency and insolvency proceedings.
The debtor is explicitly forbidden from disposing or burdening the assets in the period after filing a petition until the formal opening of the pre-insolvency proceedings, so is therefore indirectly disabled from borrowing. Once the pre-insolvency proceedings have been opened, approval must be obtained from creditors holding two-thirds of total claims in value to enter into loan or credit agreements. Obligations arising from such loans are paid as they fall due. Where restructuring efforts fail and insolvency proceedings are opened, post-petition creditors have priority over all the other creditors except employees, who have a higher priority rank.
Within insolvency proceedings, the insolvency administrator is entitled to enter into loans, or other credit agreements, to secure financing for the resumption of the debtor's business. Approval of the creditors' committee for such undertakings is only required if a loan would significantly burden the insolvency estate. Creditors with claims arising from any post-petition loan are considered creditors of the insolvency estate and therefore their claims have priority and are paid as soon as they become due. The stipulation resolving the legal position of the providers of post-petition loans was introduced into the Insolvency Act by amendments in 2017 that were prompted by the adoption of Extraordinary Administration Act.
Post-petition crediting is also allowed during an EAP, providing the extraordinary commissionaire has granted approval to managing directors of subsidiaries and affiliates and that the extraordinary commissionaire has obtained approval of the creditors' committee, when required.
As a general rule, the Croatian Insolvency Act asserts the principle of equal treatment of creditors and the priority ranks of claims are established by law. Therefore, involuntary cramming-down of either individual creditors or classes of creditors within the insolvency proceedings is not possible, whether by court or insolvency administrator decision. On the other hand, a cram-down mechanism may occur within pre-insolvency proceedings or insolvency plan proceedings where the majority of creditors binds the minority. Once the legal majorities of votes have been reached and the court has approved a settlement or a plan that lowers the rank of some claims, it becomes enforceable against all the creditors.
The sale of debtor's assets is managed by the insolvency administrator and supervised by the court. However, the creditor's assembly is authorised to determine conditions regarding the disposal of assets and hence may facilitate the sale. If no conditions are set forth, rules which regulate enforcement apply, meaning that assets are sold at public auctions and that the starting price decreases at each subsequent auction. Prior to the sale of significant assets, including entire or a part of an enterprise, approval of creditor's council must be obtained. Although the sale of individual assets prevails, the Insolvency Act also sets out an option for selling the distressed debtor's entire business, a part of it, to ensure its continuation.
Challenging a debtor's transactions
The Croatian Insolvency Act provides for various grounds for clawback, with different suspect periods ranging from one month to 10 years prior to the opening of insolvency proceedings. Grounds for contesting transactions include, among others, the fulfilment of debt or granting a security that the counterparty could not have claimed or while illiquid, intention to disadvantage creditors including awareness of counterparty, granting security for shareholders' loan and undertaking transactions free of charge or for insignificant reimbursement.
Debtor 's transactions may be challenged before the court either by the insolvency administrator or the creditors. If the voidance motion is successful, transaction will be declared to be without effect and anything that was transferred from the assets of the debtor must be restored to the insolvency estate.
Croatia has somewhat modified insolvency and restructuring regimes for banking and finance sector.
Namely, neither pre-insolvency nor EAP can be initiated over a financial or credit institution, credit union, investment company, investment fund management company, insurance and reinsurance company, leasing company, institution for payments or institution for electronic money. Concerning restructuring and insolvency, some specific rules are also stipulated by the Credit Institutions Act, Capital Markets Act and Insurance Act.
Generally, the key figures in the restructuring and insolvency proceedings are the court, the insolvency administrator and the creditors within the creditors' committee and creditors' council. With only few exceptions, the only governmental institution which could impact the outcome of a reorganisation is the Ministry of Finance – if there is a substantial tax and/or contributions debt and a willingness to reschedule or writing-off such debts.
Additionally, the Government and the Ministry of Commerce can have a significant impact on an EAP since the commercial court appoints the extraordinary commissioner in accordance with a proposal made by the Government, and the Ministry of Commerce appoints the members of the Advisory Board.
Restructuring and insolvency proceedings affecting debtors from banking and financial sectors are subject to approvals and supervision of the respective regulators (the HNB and the Croatian Financial Services Supervisory Agency – Hanfa).
There are no provisions either within the Insolvency Act or the Extraordinary Administration Act enabling international jurisdiction for pre-insolvency proceedings and EAPs, but only for opening and conducting insolvency proceedings. Therefore, as long as the Croatian courts
have jurisdiction, an insolvency proceeding - and nothing else - can be opened in respect of a foreign debtor in Croatia; so, the only statutory restructuring channel open to a foreign debtor is an insolvency plan.
Croatian courts have exclusive jurisdiction regarding insolvency proceedings over debtors whose centre of main interest (COMI), defined primarily as the place of registered office, is situated within Croatia. Nonetheless, Croatian courts also have exclusive jurisdiction if the debtor's registered office is in Croatia but it is proven that its COMI is in another country whose legislation does not recognize COMI as a criterion for its courts' jurisdiction over insolvency proceedings; or otherwise, if the debtor's registered office is in another country but it is proven that its COMI is in Croatia. Croatian courts also have jurisdiction over secondary insolvency proceedings but only regarding debtor's assets situated within Croatia under conditions provided under Insolvency Act.
A foreign court decision concerning the opening of an insolvency procedure and/or the approval of an insolvency plan may be filed by a foreign insolvency administrator or by a creditor to the Croatian court. The court will recognise the decision if it was reached by a foreign body that has international jurisdiction under Croatian law, if the decision is enforceable under foreign law, and if the recognition is not against the rules of Croatian public policy.
As to providing assistance to foreign insolvency and restructuring proceedings, communication and cooperation duty between the courts and insolvency practitioners within the EU is set forth in Articles 41, 42 and 43 of the EU Recast Regulation. As for assistance to foreign insolvency or restructuring proceedings outside the EU, under the Croatian Civil Procedure Act, Croatian courts are obliged to assist foreign courts where stipulated by treaties and under condition of reciprocity, unless the assistance required is contrary to the rules of Croatian public policy. Furthermore, under the Insolvency Act, when secondary insolvency proceedings are opened in Croatia, the insolvency administrator appointed in such proceedings is obliged to cooperate with the foreign insolvency administrator appointed in the main insolvency proceedings.
Should a foreign cross-border business with a COMI in a foreign country and assets in Croatia contemplate a restructuring, the first consideration to is whether the chosen restructuring model will be eligible for recognition in Croatia.
A key potential issue concerns the type of statutory proceedings within which the restructuring is conducted. The Insolvency Act only enables the recognition of insolvency matters in the narrowest sense and some foreign restructuring options fall outside this interpretation. Therefore, the only statutory restructuring that might get recognition in Croatia is the insolvency plan adopted after the formal opening of an insolvency proceeding and its approval by the competent court. On the other hand, if "cross-border" related to other EU member states, the Regulation (EU) 2015/848 (the EU Recast Regulation) might put the debtor in a more favourable position, provided that the chosen restructuring instrument is listed in Annex A.
Also, if under applicable law the cross-border restructuring only covers the assets situated in the country in which the business has its COMI, secondary insolvency proceedings can be opened in Croatia regarding assets situated in Croatia and Croatian law would apply to such proceedings.
On April 30 2020, the Croatian Parliament adopted the Emergency Measures in Enforcement and Insolvency Proceedings Act (Emergency Measures Act). The Act entered into force on May 1 2020 and only applies for the duration of special circumstances that exist as a result of the Covid-19 pandemic, defined as:
... an event or a certain condition which could not have been predicted and could not be affected, which threatens the life and health of citizens, property of greater value, significantly damages the environment, disrupts economic activity or causes significant economic damage.
The intention was to only regulate actions taken during the special circumstances and exclusively caused by Covid-19. However, it is questionable whether the measures might also apply to other future special circumstances caused by a different event.
The application of the Emergency Measures Act expired three months after its implementation, on July 31 2020. At this point, the government exercised an option to extend the application period by a further three months, to October 18 2020.
Regarding insolvency proceedings, according to the Article 6 of the Emergency Measures Act, insolvency events arising during the special circumstances are not a prerequisite for filing petition for insolvency proceedings. Exceptionally, a petition for insolvency may be filed either by the debtor itself unconditionally or by the Financial Agency and the creditors when it is necessary to protect national interests and/or security, environment, or public health.
The other notable measure within the Act that will have an indirect effect on insolvency proceedings is the introduction of a standstill: the suspension of execution of all enforcement against all debtors (legal or natural persons) for a period of three months. Since frozen accounts for an uninterrupted 120-day period due to the unsuccessful execution of enforcement proceedings is a cause for an insolvency application, the standstill may enable debtors to carry out a restructuring within the given period to save the business.
The Hanfa, the financial sector regulator, approved the establishment of the Stability Fund, which is a publicly traded open-end investment fund (UCITS). The Fund has a fixed term of three years and is intended for institutional investors who can bear moderate investment risk and are willing to invest at least HRK1 million kuna ($157,000) over a three-year period. The Hanfa also banned dividend payments by insurance companies and some pension funds until April 30 2021 to protect their liquidity in the context of Covid-19, as well as a recent earthquake that affected Zagreb.
The most notable measure by the HNB has been to reduce minimum reserve requirement for credit institutions from 12% to 9%, with the aim of releasing additional liquidity that should support the banking system against the Covid-19 crisis. Changes were also made in monetary policy, with a decision to purchase the government bonds and enable pension funds, investment funds and insurance companies to trade them to maintain stability in the government securities market. The CNB has also obliged all credit institutions to retain 2019 net profits.
One of the most welcome changes for the Croatian market would be an earlier petition filing. This would boost the chances of a successful restructuring or at least enhance the creditors' claims satisfaction rate.
Unlike earlier legislation regulating pre-insolvency proceedings, which was seen as owner-friendly, current legislation is very strict. The market has shown a significant decrease in the number of entrepreneurs opting for such a restructuring tool due to the formality of the proceedings, which are exclusively court-governed, have no creditor participation and set a high threshold for adopting a restructuring plan. All of this, absurdly, makes pre-insolvency proceedings less flexible than an insolvency plan. On the other hand, choosing an informal out-of-court restructuring by negotiating with major creditors in any large restructuring may lead to assets being frozen, due to the complexity of negotiating processes.
An over-optimistic and pro-owner approach only served to shut down Croatia's restructuring industry. Its inefficient nature was even indirectly acknowledged by the state, which adopted the Extraordinary Administration Act to avoid the risk of having Agrokor fail to navigate through the existing statutory restructuring models.
Once the suspension of restructuring and insolvency proceedings imposed by the Emergency Measures Act is lifted, a significant increase in the restructuring mandates is expected.
If the legal framework remains unchanged, there is a high probability that most of restructurings will be done out of court, in a less complicated informal manner through direct negotiations between debtors and creditors. We assume that at some point amendments will be made to the Insolvency Act that will lower the thresholds required for the adoption of a restructuring plan or at least equalize them with the thresholds prescribed for the adoption of an insolvency plan.
Further considerations on handling the restructuring of a group of companies will remain. The EAP's high threshold for distressed companies of systematic significance means the EAP is out of reach for many smaller groups of companies that might perhaps have benefitted from its solutions if they were to find themselves in financial trouble.
Branko Skerlev is a partner with at BMWC law firm, where he heads the insolvency/restructuring practice, and a bankruptcy administrator before the Commercial Court in Zagreb, Croatia. Through his career, he has been widely exposed to bankruptcy and restructuring legal matters. As well as advising clients in private practice, Branko has served as a legal advisor to the Croatian State Bank Rehabilitation Agency and as a chief legal adviser for the Croatian leading private equity/alternative investment group, where he handled numerous complex insolvency and restructuring matters.
Branko's other areas of expertise mainly include corporate and M&A, with a special focus on private equity transactions and general investment funds legal issue. Branko is also a lecturer at the Zagreb School of Economics and Management.
Mislav Bradvica is an expert in EU, competition and regulatory law, with an emphasis on antitrust and regulatory litigation. Before establishing Bradica Marić Wahl Cesarec law firm, Mislav chaired Schoenherr's booming Croatian competition department. His experience includes working as a state officer in the Croatian Competition Agency, with special duties concerning cartel, abuse of dominant position and sector inquiry cases.
Mislav's erudition and enormous experience in handling regulatory matters lends our restructuring practice a cutting-edge advisory capability, with a deep capacity for strategic and innovative thinking.