What is the legal status of bondholders and promissory note holders in insolvency proceedings?

A company is heading into insolvency. What does this mean for you as a creditor?

The aim of insolvency proceedings, as defined by the Insolvency Act (Act No. 182/2006 Coll.) under Czech legislation, is to arrange the debtor's property relations and achieve the highest possible and proportionate satisfaction of creditors from the debtor's assets, the so-called insolvency estate.

From the moment the proceedings are initiated, it is strictly forbidden for the debtor to repay their debts individually outside this formalized process. All claims must be asserted uniformly within the proceedings.

Although one of the basic principles of insolvency is the pari passu principle, i.e., equal treatment of creditors, in practice this is far from absolute. The law creates a strict hierarchy that determines the order in which creditors will be satisfied. Your position in this hierarchy is absolutely crucial to whether you will ever see your money again.

The Myth of Priority: What is the actual position of bondholders?

Many investors live under the dangerous misconception that owning a security automatically guarantees them a priority right to satisfaction. However, the reality is often quite the opposite and can lead to fatal financial losses. The gap between the marketing promises of issuers and the stark legal reality is vast.

Ordinary bonds = unsecured creditor

This is the most important and, for many, the most shocking fact. From the perspective of the Insolvency Act, the holder of a standard, unsecured corporate bond is an ordinary unsecured creditor. They have exactly the same standing as any supplier who sent goods to the company on an invoice and did not get paid. Your claim will only be satisfied proportionally from what remains after all priority and secured creditors have been paid.

Subordinated bonds: Last in line

Owners of so-called subordinated bonds find themselves in an even worse situation. These instruments often attract investors with a higher interest rate, which, however, comes at the cost of extreme risk. As the name suggests, claims from these bonds are subordinated to all other liabilities and are satisfied last of all, before shareholders. In practice, the chance of any recovery from a subordinated bond in insolvency is almost zero.

Secured bonds: The only real protection?

Secured bonds can be a bright exception. A secured creditor is one whose claim is backed by specific assets of the debtor, for example, a pledge on real estate or a production line. These creditors are satisfied separately from the proceeds of the sale of the given collateral. However, it is crucial that the security is validly agreed upon and legally enforceable.

The Czech legal team at ARROWS can perform a detailed audit of the terms of the issue and determine whether your security is truly valid and effective. Need legal assistance? Contact us at consultation@arws.cz.

A promissory note in hand: Are your funds safer?

A promissory note is historically perceived as a powerful tool for securing and enforcing debts. Its legal strength is undeniable, but even it has its specifics and hidden risks in the context of insolvency, which can unpleasantly surprise creditors.

The abstract nature of a promissory note

The main advantage of a promissory note is its abstract nature. This means that the obligation under the promissory note is legally separated from the original reason (cause) for which it was issued – whether it was a loan, a purchase price, or another transaction. For you as a creditor, this significantly simplifies your position: you do not have to prove the entire business case in the proceedings; presenting a valid promissory note is sufficient.

The Achilles' heel of a promissory note: The necessity of the original

However, this is where the greatest risk lies. Without presenting the original promissory note to the court, the claim cannot be effectively asserted and proven in insolvency proceedings. A copy, scan, or notarized copy is not enough. The right is inseparably embodied in the document, and if it does not physically exist or you cannot present it, your claim does not legally exist either. In practice, losing the promissory note is equivalent to losing the money.

Position in the proceedings

Despite its legal strength, a claim from a promissory note (unless separately secured, for example, by a pledge) is considered unsecured. Its holder is therefore ranked alongside other unsecured creditors in the insolvency hierarchy and is satisfied only proportionally from what remains in the insolvency estate.

ARROWS provides comprehensive legal advice on enforcing promissory note claims, including ensuring the correct procedure for submitting the original to the court. Do not hesitate to contact our office – consultation@arws.cz.

Most common mistakes of bondholders and how to prevent them

Insolvency proceedings are full of procedural pitfalls. Even a justified claim can be lost due to a formal error. The following table summarizes the most common risks and shows how we can help you avoid them.

Procedural maze: How to actively defend your rights in insolvency proceedings?

Success in insolvency proceedings depends not only on the validity of your claim, but above all on flawless and active procedural steps. The insolvency trustee is not your partner; their job is to protect the insolvency estate, which often means questioning creditors' claims. Without professional guidance, you can easily get lost in the procedural maze.

Step 1: A perfect lodgement of claim – the foundation of success

It all starts with a lodgement of claim submitted on the prescribed form. It must contain the exact identification of both you and the debtor, a detailed description of the reason for the claim, its exact calculation, and must be supported by all relevant documents (contracts, invoices, original promissory note). Any error can be an excuse for contestation.

The Prague-based ARROWS legal team prepares hundreds of lodgements for clients annually and knows all the pitfalls of this process.

Step 2: What to do if the insolvency trustee contests your claim?

If the trustee finds any deficiency in your lodgement, they may contest the claim – whether as to its authenticity (existence), amount, or priority (e.g., questioning the validity of the security). This starts an incidental dispute for you. This is essentially a lawsuit within the insolvency proceedings where you, as the creditor, must prove that your claim is justified.

ARROWS has extensive experience representing creditors in incidental disputes. For an immediate solution to your situation, write to us at consultation@arws.cz.

Step 3: Representation at the creditors' meeting – why active participation is crucial?

The creditors' meeting is the body where key decisions of the proceedings are made, such as the method of resolving the bankruptcy or the election of the creditors' committee, which oversees the trustee's activities. Your voting right is derived from the amount of your claim. Active participation gives you the opportunity to influence the course of the proceedings in your favor.

Our experience is built on long-term work for more than 150 joint-stock companies and 250 limited liability companies. Thanks to this, we understand not only the law but also the business needs of our clients, and we pride ourselves on speed and high quality of services.

When insolvency crosses borders: How we handle insolvencies with an international element?

In a globalized economy, it is not uncommon for a debtor to have assets, branches, or creditors in several states. Such a situation dramatically increases the complexity of the entire process. A case that would be complex at the national level becomes exponentially more demanding in an international context.

The key legal regulation in these cases is the EU Regulation on Insolvency Proceedings (2015/848). This determines which state's court is competent to conduct the main insolvency proceedings. The decisive factor is where the debtor has their Center of Main Interests (COMI). Secondary proceedings can then take place in other states where the debtor has assets.

For creditors, this means the need to navigate several legal systems, communicate with different courts and trustees, and coordinate their steps across jurisdictions. Thanks to the ARROWS International network built over ten years, we handle cases with an international element practically every day and can effectively coordinate legal steps across Europe and the world. Our clients thus have the certainty that their interests are professionally defended regardless of where the debtor's assets are located.

Practical threats for promissory note holders in insolvency

Promissory notes carry specific risks that differ from bonds. Underestimating them can lead to a complete loss of the claim, even if the debt is undisputed.

Don't wait until it's too late: Proactive steps and how ARROWS can help you

As practice shows, the winner in insolvency proceedings is the one who is prepared, acts quickly, and has professional strength on their side. Passivity and relying on the fact that "the law is on my side" almost always leads to unnecessary financial losses. The key to success is a proactive approach and professional representation from the very beginning.

The Prague-based ARROWS team is ready to provide you with comprehensive support at every stage. Whether you need to prepare bulletproof contract documentation to protect you from future problems, represent you in court or before administrative authorities, obtain necessary licenses, or conduct professional training for your employees, we are here for you. Our services are built on a deep knowledge of the law and the commercial environment in which our clients operate.

In addition, thanks to our broad client base, which includes leading Czech and international companies, we can connect interesting business and investment opportunities. We would be happy to hear your business idea as well.

Are you facing a problem with a debtor in insolvency or do you want to protect your investments preventively? Write to us at consultation@arws.cz and arrange a consultation. The first step to protecting your money starts right now.

Don't want to solve this problem alone? More than 2,000 clients trust the Prague-based ARROWS law firm, and we have been awarded Law Firm of the Year 2024. See our references HERE and it will be our honor to help you solve your problem. The inquiry is free of charge.