The COVID-19 pandemic has turned the entrepreneurial daily routine upside down and overnight brought to the forefront a topic that is often avoided in good times. The times ahead require a serious and decisive turn towards restructuring to more easily emerge from the expected imminent recession.

Entrepreneurs affected by the corona crisis should prepare well in the coming months to address the (newly) arisen financial problems and wisely use the time granted by the Law on Intervention Measures in Enforcement and Bankruptcy Proceedings during special circumstances to consider and implement the restructuring of their business. As one of the measures to assist the economy following the declaration of the COVID-19 pandemic, the mentioned Law came into effect on May 1, 2020.

In the next three, or six months if the Government decides to extend the application of the Law, enforcement proceedings will be halted, default interest will not accrue, and all debtors who become over-indebted or unable to pay in terms of the Bankruptcy Act will not be obliged to initiate bankruptcy proceedings, nor can such proceedings be initiated against them unless they do so themselves. Furthermore, although not specifically regulated by law, most banks have granted a moratorium on loans for at least three months to a good portion of clients affected by the crisis. The ‘break’ from enforcement and bankruptcy proceedings is a good time for entrepreneurs to assess their positions, analyze obligations and possibilities, and prepare a quality restructuring plan that will help them bridge the difficult period.

Director’s Obligation

All of this is actually the duty of directors. Namely, the unavoidable Law on Financial Operations and Pre-Bankruptcy Settlement has set the framework within which illiquid entrepreneurs, or directors of illiquid companies, must operate. In addition to allowing illiquid entrepreneurs to make only those payments that are necessary for regular operations (e.g., priority claims, employee salaries, electricity, water, etc.), they must not take actions that would harm or put their creditors in a disadvantaged position, while at the same time being obliged to take financial restructuring measures to restore liquidity, under the threat of monetary fines that can reach a staggering 1,000,000 kuna. Considering the legal obligations and the dramatic drop in revenue for the vast majority of entrepreneurs, it is expected that Croatia will experience a wave of restructuring in the coming period. What is restructuring, actually? It involves a process or measures of a financial or operational nature taken with the aim of saving a company in financial difficulties, regardless of whether the process is conducted judicially or extrajudicially.

Out-of-Court Agreement

Extrajudicial restructuring of financial obligations in Croatia is not specifically regulated by law, meaning that such restructurings occur in the domain of obligatory law and are reduced to negotiating new terms with banks and other creditors. It is always useful to see what the situation is in other countries, especially in Slovenia and Serbia, which are significant markets for many of our entrepreneurs. That the situation in Slovenia is the same as in Croatia, i.e., that extrajudicial restructuring is not regulated by a special law, was confirmed to us by attorney Maja Žgajnar from Ljubljana, who has been advising clients on complex restructurings for years.

Unlike Croatia and Slovenia, extrajudicial restructuring in Serbia is possible as a voluntary procedure provided for by a special law that is conducted between the debtor and the creditor before the Serbian Chamber of Commerce. Attorney Milica Popović from Belgrade, who has many successful restructurings behind her, emphasizes that since such a procedure entails certain tax and other benefits, it is not uncommon for contracting parties in Serbia to opt for this form of extrajudicial restructuring. The result of extrajudicial restructuring, in the case of a successful conclusion of voluntary negotiations, is the amendment and supplementation of old contracts or the conclusion of new contracts under terms acceptable to the debtor and creditors.

The usual goal of this type of restructuring is to avoid an exhausting and lengthy bankruptcy procedure, obtain a new source of capital, and reduce operating costs with the aim of continuing under financially sustainable conditions. Therefore, it is logical that debtors and creditors usually proactively approach this type of restructuring before the debtor’s financial problems have irreversibly deepened.

‘Recording’ Obligations and Possibilities

Extrajudicial restructuring is most often carried out as refinancing or reprogramming of loans, sale of uncollectible receivables, leasing or sale of movable and immovable property that is not essential for the company’s operations, sale of companies or parts of companies that are performing poorly, converting receivables into equity, and taking other measures to reduce costs and reorganize operations. The key to success is to recognize the need and possibility of refinancing existing obligations early enough to timely initiate dialogue with banks and other creditors. Refinancing a loan involves closing one credit line with the help of a new and more favorable loan. As part of the preparations for restructuring, it is essential to accurately record obligations from various contracts.

In doing so, obligations should be viewed more broadly than just financial ones, and this is precisely what many do not do, thereby putting themselves in a difficult position later because they do not have a complete picture of their position and possibilities. It is important to analyze contracts in detail while considering whether the current crisis has called into question the viability of the agreed financial conditions and given statements and guarantees, or whether it is likely that they will be or already have been breached.

Possible Breach of Contract

In the event that the financial conditions from the contract have not yet been breached, but this can be expected, in order to avoid a breach and obtaining a waiver from the bank due to the breach, it is advisable to request a reset of financial conditions from banks or other creditors. If the breach of a particular financial condition is inevitable or has already occurred, it will still be necessary to request a waiver from the banks. Furthermore, in the case of having more than one loan agreement, it is not uncommon for clauses to tie the breach of conditions from one agreement to another, so it is important to establish dialogue with banks in a timely manner and eliminate potential breaches of conditions.

It will often be necessary to offer the bank additional security instruments, beyond those that secured the payment of the previous loan. Therefore, it is necessary to determine before negotiations whether there is any unencumbered property remaining, and if so, what its value is and whether it can be pledged. If an agreement on refinancing the loan with the existing lender cannot be reached, it is always possible to turn to another bank or alternative lenders.

How to Obtain Fresh Capital

In addition to reducing operating costs through refinancing or reprogramming loans, companies in crisis often need a new source of capital. Fresh capital can be obtained through new borrowing, but it is also possible by selling assets that the company can continue to operate without. The subject of sale can be various things or rights (real estate, movable property, business shares, companies, receivables, etc.). Regarding the sale of a company, two basic structures have developed in practice: the sale of business shares/stocks (eng. share deal) and the sale of individual parts of assets (eng. asset deal). In a share deal, the buyer acquires the business shares of the company, i.e., all its rights and obligations.

Thus, the possibility of selecting specific rights and obligations is excluded, making this structure suitable when the goal is to take over the entire business of a particular company. In contrast, if the goal is to acquire specific rights and obligations (e.g., real estate, machinery, receivables), an asset deal will be a better choice due to the possibility of selecting specific assets. Since each has its advantages and disadvantages, how the transaction will be structured will depend on the agreement of the contracting parties, the goal they want to achieve, and the tax treatment in the specific case.

Shares Instead of Debt

When a company is already practically insolvent, and to prevent the opening of bankruptcy proceedings, creditors sometimes decide to enter the ownership structure of the debtor instead of initiating bankruptcy proceedings. In this case, it involves converting receivables into equity as a method of debt restructuring. Legally, this means increasing the equity capital of the debtor company by introducing rights (claims of creditors), resulting in the acquisition of business shares or stocks in the debtor company, and thus acquiring management and property rights arising from the acquired business shares. As a counter-performance for the business shares, creditors release the debtor from all or part of the debt. Creditors will agree to this method when they assess that they will recover more this way than in the case of bankruptcy.

Court and Pre-Bankruptcy

When extrajudicial restructuring does not yield the desired results or simply the possibility of an agreement between the debtor and creditors is absent, both parties should consider the possibility of restructuring within the framework of judicial proceedings, i.e., pre-bankruptcy. The goal of the pre-bankruptcy procedure is to regulate the relationship between the debtor and creditors while maintaining the debtor’s activity, i.e., its restructuring and continuation of business. Judicial restructuring is similarly regulated in Serbia, while the solutions in Slovenia are somewhat different. Attorney Maja Žgajnar explains that Slovenia has provided for three special restructuring procedures: the procedure of forced settlement, within which already insolvent debtors are restructured, simplified forced settlement, which is similar to the first procedure but adapted for micro-entrepreneurs and craftsmen, and the procedure of preventive restructuring, which can only be conducted for debtors facing insolvency within the next year.

The comparative advantage of pre-bankruptcy over extrajudicial restructuring is the fact that from the day of its opening until completion, it is not permitted to initiate litigation, enforcement, administrative, and security proceedings against the debtor. Pre-bankruptcy is initiated at the request of the debtor facing inability to pay or a creditor, provided that the debtor’s consent has been obtained for this.

The Core of Success

The control over the initiation of the pre-bankruptcy procedure lies with the debtor. Along with the proposal for initiation, it is necessary to submit a proposal for a restructuring plan, which must contain measures of financial and operational restructuring and their impact on the liquidity and operations of the debtor. The restructuring plan is the core of the pre-bankruptcy procedure, and the success of the procedure depends on it and its acceptance by creditors.

When bankruptcy proceedings are opened, it is usually too late for restructuring. Unlike pre-bankruptcy, bankruptcy usually ends with the liquidation of the debtor’s assets and the distribution of collected funds to creditors. However, it is possible to carry out restructuring even in bankruptcy proceedings by accepting a bankruptcy plan, but this is rarely seen, and there is little chance that there are even grounds for conducting successful restructuring.

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