New rules on the discharge of debt process and their impact on NPL transactions

Politicians and the media alike have lauded the new amendment to the insolvency act as the Czech Republic’s law of the year 2019. This is primarily because the new rules give new hope to many individuals who, until the amendment, could not enjoy the benefits of the discharge of debt process. It is anticipated that the debts of these individuals can now finally be dealt with appropriately. This article looks at the impact of the new rules on Non-Performing Loan portfolio transactions.

What has changed?

In short, the new rules have removed the infamous entrance gate for the discharge of debt process – this previously meant individuals were required to demonstrate their ability to repay at least 30% of their total debts by way of sale of their assets, or by a five-year repayment plan. Under the previous rules if this was not demonstrated or the affected creditors did not approve lower satisfaction in advance, the discharge of debt process would not be approved and the individual thus faced the risk of bankruptcy liquidation (without the benefit of the final debt discharge at the end of the road). As a result, thousands of over-indebted individuals, with multiple enforcement orders, were not properly motivated to file for insolvency and would instead move to the shadow economy. It is too soon to conclude whether this change will deliver the level of success that everyone had hoped, however, it will have a significant impact on the sale and purchase of NPL portfolios affecting every personal insolvency starting after 1 June 2019.

Old certainties are gone

The rationale behind the 30% entrance gate was that it was a reasonably reliable anchor for determining the minimum satisfaction rate for the creditors. Professional NPL purchasers acquiring thousands of individual debts from banks and consumer loan providers were able to assess the expected recovery rate for the NPL portfolio, using relatively stable statistical data, in which the 30% satisfaction threshold played a key role.

Now this relative certainty has gone, as the individual debtors will not need to demonstrate their ability to repay more than CZK 1,800 per month plus any statutory alimony obligations (if any). It appears that the effect of the change is that the overall satisfaction rate for the creditors will drop significantly. In addition, only CZK 900 per month from the above amount will be required to be paid to the creditors - this will have to be at least the same amount that is to be paid on the account of the insolvency administrator’s reward as a super priority claim.

If the debtors pay the above minimum amount for the required period and do not breach other conditions, the remaining debts will be discharged, regardless of the size of the unsatisfied portion of the debt.

Another uncertainty that will await the creditors is in respect of the duration of the insolvency. Under the new rules, the five-year repayment period has been eroded significantly. For example, if debtors repay 60% of their debts within three years, no further repayment will be necessary and the debt discharge may be granted. To get the debt discharge after three years, the subordinated claims (which now include amounts exceeding the original nominal value of the claim) will be disregarded.

Furthermore, debtors that enter retirement or have certain health disabilities will be granted the debt discharge after three years of the repayment plan, irrespective of the total final amount they are able to repay. Debtors will also be entitled to ask for a suspension from the payment of debts completely for as much as one year due to serious reasons, which will defer the satisfaction of the creditors.

New opportunities for those prepared

In order to offset some of the new changes in favour of the debtors, the creditors have been newly granted the right to satisfy their claims from the sale of the debtor’s assets (at the same time the instalment plan is approved). This should theoretically bring a new source of satisfaction to the creditors. The practical impact seems to be rather limited as the following debtors’ assets will be excluded: (i) assets secured to a secured creditor, (ii) debtor’s dwelling of a standard value and (iii) assets with net proceeds not exceeding the award of the insolvency administrator.

Secured creditors can satisfy their claims from the sale of the secured assets only, irrespective of the value of the security. It is therefore recommended that the value of the security be checked sufficiently in advance to ensure the correct decision is made in the process.

As a result of the amendment it is expected that in the future many more debtors will seek their debt discharge through formal insolvency proceedings, opening significant new opportunities for NPL professionals. The current methods of assessing the satisfaction rate and recoverability will, however, cease to function properly and should be re-defined using models based on precise understanding of the new rules.

If you have any questions about how the new rules may impact your business, please do not hesitate to contact us.