Amendments to the Lithuanian Law on the Insolvency of Legal Entities (the ‘Lithuanian Law on Insolvency’), a detailed analysis of which is available in ‘Lithuanian Law 2021: Substantial Changes’ (only in Lithuanian), were adopted in 2021, and with this the fundamental provisions of the Restructuring Directive 2019/1023 (the ‘Directive’) were implemented. According to statistics, in the past 20 years, Lithuanian businesses have been slow to make use of restructuring procedures (with only 550 procedures initiated) and only twelve percent of them have been successfully completed. Therefore, all steps taken to make this process more attractive have been very welcome. However, since the 2021 legislation was passed against the backdrop of a global pandemic and an immigration crisis, it can be posited that legislators did only the ‘bare minimum’ in transposing the Directive. Our analysis confirms this to be the case and identifies a number of deficiencies in the new law.
The Directive set out very commendable goals: to improve the accessibility of preventive restructuring schemes for businesses and to increase the efficiency of insolvency proceedings overall.
To achieve the first goal, the voluntary Early Warning System (EWS) for SMEs was launched in Lithuania in July of 2021. Pursuant to the EWS, a tax administrator identifies, based on an analysis of available data, companies that might encounter financial difficulties in the next 6 months and informs them via a self-service platform of their option to benefit from a consultation with the non-profit agency Enterprise Lithuania. Whether this measure works in practice is likely to depend on the quality and specificity of the advice received.
In principle, Lithuania already had a preventive restructuring system in place and, therefore, no significant change took place. A clarification was simply made that access to a business rescue procedure is available not only in the event of insolvency, but also when insolvency is probable. By the changes made, the concept of the probability of insolvency, which is defined to mean a situation when it is realistically probable that a legal entity will become insolvent in the following 3 months, had been technically separated from the previous definition of insolvency.
Unfortunately, Lithuania failed to take the opportunity to create truly business-friendly, out-of-court restructuring or other private procedures that might be attractive to businesses that do not wish to disclose their financial difficulties. This situation needs to be addressed in Lithuania, where there is still only one judicial restructuring procedure, because the new changes merely introduced the possibility for directors to make use of it in the probability stage of insolvency. Since the concept of probable insolvency is limited to insolvency within a short term of 3 months, the reformed regime does not guarantee access to various preventive restructuring aid measures at earlier stages.
Several other innovations were introduced by the 2021 law. First, the cross-class cram-down (CCCD) mechanism was regulated, thus eliminating the veto power of decision-makers in approving a restructuring plan and leaving it to the court’s discretion without the full consent of all decision-makers. Thus, the role of the court has been expanded. This process should lead to more successful instances of restructuring in Lithuania.
Another innovation was the introduction of the institution of substantive contracts, which were previously unknown in Lithuanian law. A substantive contract is defined as one that is necessary to ensure the continuity of a legal entity’s activities and upon termination of which the legal entity would no longer be able to carry out its economic and commercial activities. Although there is a ban on the termination of such contracts, the law does not specify whether a precondition of the ban is that the company itself be properly fulfilling its obligations under these contracts. This will have to be clarified by Lithuanian case law and doctrine.
The new law has also clarified when an insolvency administrator has to be appointed during the restructuring process, as well as when a qualified majority of creditors can request the appointment of an administrator and the creditors (and not the company) also pay the insolvency administrator's remuneration. Once again, a greater role is assigned to the court, which will have to decide in each case whether or not it is necessary to appoint an insolvency administrator.
Some changes can be construed as increasing the accessibility and attractiveness of restructuring procedures for the business sector. Legal protection has been furnished to investors by prohibiting the challenge of transactions providing new or interim financing; it is also foreseen that the special Lithuanian Guarantee Fund will provide compensation not only to employees of bankrupt companies, but also to those of restructured companies.
On the other hand, some provisions of the Directive, such as its reference to the duties of directors to take action to protect the interests of creditors, were only technically transposed, since they were already recognized in Lithuanian case law. The inclusion of these cryptically worded directors’ duties into the black letter of Lithuanian law has not contributed to clarifying it. These regulatory changes may lead to stricter liability for directors.
Overall, in our view, the reform implemented in 2021 was simply a technical transposition of the Directive that minimally implemented its provisions and did not present solutions to problems that persist in Lithuania in the business rescue area.
Further improvement of the legal environment for restructuring could come from two directions.
First, the legislature should seriously consider the needs of national businesses and the reasons for reluctance to use restructuring procedures. A possible reason is that, as mentioned above, Lithuania does not have any out-of-court, non-public procedures, but only a universal judicial insolvency process designed for large companies containing all possible safeguards and guarantees. There is a need for more specialized procedures tailored for micro-enterprises, as well as for companies which want more confidentiality.
Second, Lithuania will have to respond to initiatives planned by the European Union for the summer of 2022 regarding greater harmonisation in the prerequisites for initiating insolvency proceedings, company directors’ duties in the event of imminent/actual insolvency, etc. If the legislature’s response is informed by a better understanding of the weaknesses of the existing regime, further positive change is possible.
This article was previously published by the authors on the website of Oxford Business Law Blog.