Impact of COVID-19 Pandemic on Lithuanian Insolvency Law

Striving to manage the COVID-19 pandemic crisis, the Lithuanian government announced a 3-month quarantine throughout the country on 16 March 2020. This meant severe business restrictions or even a forced cessation of all business in certain sectors and, accordingly, raised a serious threat of insolvencies. Lithuania, like many other European countries, eg Germany, Spain, Italy, Switzerland, adopted legal measures that suspended insolvency proceedings. The special Law on the impact of COVID-19 consequences on the application of the Insolvency Law (COVID-19 Impact Law) came into force on 25 April 2020. The particular circumstances of Lithuania also included the fact that a new Law on Insolvency of Legal Entities had very recently come into force on 1 January 2020 that expanded the concept of insolvency, which theoretically could lead to insolvency proceedings for many more companies than before.

The special law created three types of protection. First, during the period of the quarantine and for 3 months after its revocation, a director’s obligation to file for insolvency proceedings was suspended. However, it remained the director’s responsibility to initiate and carry out pre-insolvency negotiations with creditors. Second, the right of creditors to file for insolvency was restricted. Under regular provisions, the creditor can initiate insolvency proceedings only after offering the debtor to conclude an agreement on assistance within a time limit set by the creditor (which should be not less than 15 and not more than 30 days). Under the special law, the calculation of the mentioned time limit was suspended during the official period of quarantine in the country. Third, possibilities to terminate ongoing restructuring proceedings were limited during the quarantine period and for 3 months after its revocation.

Although court practice is still scant on the application of the COVID-19 Impact Law, courts examine two essential conditions before applying the safeguards provided by this law. First, it is imperative to prove to the court that the financial difficulties, which had a critical impact on a company’s financial situation and led to its insolvency, were a direct result of the global COVID-19 pandemic. Second, it must be proven that a business suffered financial losses and became insolvent after 16 March 2020, ie after the introduction of the first quarantine in Lithuania.

The ambiguous wording of the COVID-19 Impact Law raises questions about the validity (application) of the protection provided by it during the second quarantine, which began in Lithuania on 7 November 2020. The three-month period following the end of the first quarantine ended on 16 September 2020. In the Register of Legislation, this law is shown as still being valid and there is no indication of its revocation/invalidity. Further, the provisions of the law use abstract terminology that protections are applicable during the ‘quarantine’ period and ‘for 3 months after its revocation’.

However, the legislature’s intent to limit the applicability of this law only to the first quarantine is reflected not only in its explanatory memorandum, but also in the provisions of the law foreseeing the possibility of extending its protections, if necessary, until 31 December 2020 at the latest. The explanatory memorandum to the law stated that the term of protection provided should be sufficient to examine various options for restoring solvency, but not too long, to encourage directors to make immediate decisions. The World Bank Policy Note (December 2020) also states that these measures to flatten the insolvency curve should be short-term and unwound as soon as economic circumstances permit, as their prolonged application may lead to unintended side effects, eg the stream of pending cases may overload the judiciary.

Thus, all protections guaranteed by the COVID-19 Impact Law formally expired three months after the end of the first quarantine, ie on 16 September 2020. However, the wording used by the Lithuanian legislator is certainly subject to criticism. First, the legislature failed to fulfil its obligation to indicate clearly and unambiguously in the law itself not only the exact time at which it would begin to apply, but also the exact time until which the protection afforded could be applied.

Second, since the provisions of this law provide for the government’s discretionary right to extend the term of protection, doubts arise as it may contradict the general constitutional mandates. The Lithuanian Constitutional Court has stated that the time of entry into force or expiry of a higher-power’s legal act should not and cannot be made dependent on the lower-power’s legal act.

It had been anticipated that by the end of the year, with the resumption of a director’s obligation to initiate insolvency proceedings, many applications on the opening of insolvency proceedings would reach the courts from companies that had been hit hard by the quarantine. However, the number of insolvency cases steadily declined compared to the same period in 2019. Based on statistics that were provided comparing identical periods from 25 May until 14 December in 2019 and 2020, the number of bankruptcies of legal entities decreased by more than half—by as much as 51.4%, and the number of restructuring proceedings decreased by 25% in 2020.

On the one hand, this may have been due to the state’s immediate launching of economic recovery plans, particularly by providing large financial injections into business, as well as introducing legal protections. This support allowed businesses affected by the quarantine to avoid insolvency, but it also delayed the bankruptcies of weak companies that were on the verge of insolvency even before the pandemic. On the other hand, one of the possible reasons may be that both directors and creditors continue to believe to this day that the protections provided by the COVID-19 Impact Law have remained intact.

Therefore, in striving to ascertain legal certainty, it would be judicious to immediately and unambiguously explain to the business community the expiry (or extension) of the protections that were in force during the first quarantine. This is even more important because, as the World Bank emphasized in the above-mentioned study, communication is critical to ensure that short-term legal measures are not perceived as a new normal.

A more detailed analysis of these issues was published in the annual publication ‘Lithuanian Law 2020: Substantial Changes’ (only in Lithuanian).

Virginijus Bitė is Professor of Law at the Law School of Mykolas Romeris University.

Vilija Mogenytė is a PhD Student at the Law School of Mykolas Romeris University.

Salvija Mulevičienė is Associate Professor of Law at the Law School of Mykolas Romeris University.