The High Court ruled: Transfer of a debt-ridden company to a white horse will no longer save the managing director

What is a “white horse” and why it is only an apparent solution

in business practice, a “white horse” is the name given to a person who formally takes over a debt-ridden or otherwise troubled company but does not actually manage it and serves only as a “holder” of the problems. Typically, this is a person who is on the board of dozens or hundreds of companies, often previously bankrupt, and his role is purely formal. Thus, the original managers sometimes naively think that if they quickly transfer the company to such an “entrepreneur”, they will absolve themselves of any responsibility – after all, the company is no longer theirs.

However, Czech law is based on the idea that it is not only the formal entry in the Commercial Register that is important, but above all the actual behaviour of the statutory body at the time when the company is in trouble. If, when bankruptcy is imminent, the managing directors do nothing more than wash their hands of the situation, remove themselves from office and transfer the company to someone who obviously cannot save it, the court may assess this as a breach of their duties. Thus, the transfer to a “white horse” does not work as a protective shield; on the contrary, it can be taken as evidence that the directors wanted to escape from creditors.

Importantly, creditors, insolvency administrators and courts are now much more sensitive to situations where a company ends up in liquidation or insolvency with virtually no assets but millions of dollars in debts. Where previously creditors often just wrote off debts helplessly, today they are increasingly looking for a way to hold specific people in the company’s management personally liable. And the “white horse” is a typical signal that the company’s story may not have been played fairly.

The courts are beginning to punish passivity

Generally, a limited liability company or a public limited company is liable for its debts with its assets, and the partners and directors are not personally liable. This is a basic principle of limited companies. But this “protective bubble” is not unconditional. Once the statutory body starts behaving recklessly, acting in breach of due diligence or refusing to deal with insolvency in a timely manner, its liability can approach personal liability.

The managing director must monitor and react to the company’s economic situation. It is not enough just to formally sign the financial statements. If a company is in long-term default, accumulating debts, losing key sources of income (e.g. premises, licences, contracts), it is the duty of the managing director to actively seek a solution – negotiate with creditors, seek restructuring, invite a crisis manager or, in the extreme case, file an insolvency petition. Ignoring problems or pushing them off to “someone else” is exactly what the courts are beginning to punish.

In practice, this may mean that the court will say: as a managing director, you did nothing to save the company or to resolve the bankruptcy correctly at the relevant time, but rather you made the situation worse or delayed it. The result? You are personally liable for the company’s debts to a certain extent. And in specific cases, that can mean paying millions of dollars out of your own assets – savings, real estate or future income. This is not a punishment for business failure, but for negligence or passivity at a time when it was clear that the problems were serious and needed to be addressed.

Case history: company with no assets, debts remained and the court went after the directors

One of the cases that shows this trend in practice is a case handled by the High Court in Olomouc. The company operated a guesthouse and a restaurant. When it stopped paying rent, it lost its establishment, i.e. its main source of income. Instead of actively seeking alternative premises, restructuring or an agreement with creditors, the managing directors decided to simply transfer the company to another entrepreneur. At the time of the transfer, the entrepreneur was already a statutory director of a large number of other companies, many of which went bankrupt. It was therefore only a matter of time for the creditors before this company too would ‘dissolve’ without assets.

And that is exactly what happened. The company disappeared without virtually any assets, but with a debt in the millions of crowns. This scenario would often have been the end of the story: the creditors would have accepted that there was “nothing to take from”. However, the landlord of the premises, which belonged to the original restaurant operation, did not accept this outcome. It decided to demand payment of the debt from the former managers personally – arguing that they had left the company when it was obvious that it was heading for bankruptcy and had not tried to remedy the situation.

The High Court agreed with the creditor. It found that the managing directors had done nothing to avert bankruptcy: they had not attempted to restore operations, had not negotiated with creditors, had not addressed restructuring. Their only response was to remove themselves from office and transfer the company to another person, without in any way ensuring that that person actually turned the company around. In doing so , according to the court, they breached their duties and incurred liability for the company’s debts. The creditor was thus able to satisfy its claim from the personal assets of the former managing directors.

Ladislav Bognár, President of the Trial Chamber: “The defendants as managing directors did nothing to avert the Company’s impending bankruptcy. Their only response to the threatened bankruptcy was to remove themselves from the position of managing directors, the purpose of which was certainly not to appoint a person whose task would be to avert the threatened bankruptcy.”

New tool: the action to supplement liabilities

The case described here was still governed by the older legislation. In the meantime, however, Czech law has introduced a new, considerably more systematic instrument: the action to supplement liabilities. This is a special mechanism that allows the insolvency administrator to claim that the members of the statutory body should replenish the company’s assets if their actions (or rather inaction) have contributed to the company’s bankruptcy or to the deepening of its debts.

To put it simply: if a company has debts of CZK 10 million and assets worth only half a million, the insolvency administrator can demand in court that the difference – CZK 9.5 million – be paid out of his own pocket by those who were at the helm of the company at the relevant time and did not act with due care. This instrument serves two purposes. First, it increases the chances of creditors recovering at least part of their claims, even if the company is “empty”. Second, it has a strong preventive effect – the statutory directors know that “playing dead” in a company crisis can have very expensive consequences.

But a lawsuit to replenish liabilities is not a “nuclear weapon” for every case. The law and the courts set quite strict conditions: it must be a situation where the company was insolvent, the statutory body did not file an insolvency petition in time or join the creditor’s petition, and it can also be shown that this inaction worsened the position of creditors. The courts also distinguish between ordinary business risk (a company can go bankrupt without any wrongdoing) and actual breach of the duty to act with due care.

Therefore, the use of a claim to supplement liabilities is evidence-intensive and requires meticulous work by the insolvency practitioner and his legal team. Even so, experts expect this tool to be used more and more frequently over time – especially in cases where the assets are minimal but it is clear that the statutory directors knew about the problems and failed to address them.