After Czech Velvet Revolution, plodding legal evolution

In a different case in March, international arbiters in Sweden ordered the Czech Republic to pay $353 million to US-owned Central European Media Enterprises (CME) for failing to protect the investor from a contract breach. CME was the primary investor in the Czech Republic's most popular television station, TV Nova, until Vladimir Zelezny, the station's director and license holder, pulled the plug on the contract prematurely. Zelezny rented a new studio and began broadcasting the immensely profitable station independently, while denying CME's contractual right to provide programming. The CME dispute brought about several international arbitration cases, in which CME argued that Czech laws failed to protect its investment. The case will now cost Czech taxpayers about $35 per person, leading to widespread public demand for reform.

Numerous other foreign investors have complained about business losses resulting from lengthy court proceedings that tie up assets for years on end. Former Czech Finance Minister Vladimir Mertlik estimated that the sluggish legal system cost the country two percentage points of economic growth in 2002 alone.

A Western attorney working with foreign investors in Prague, who does not want to be named, says he does not tell clients the whole truth about the Czech legal system. "If I did, they would never come here," he says. "The Czech Republic may be relatively stable now, but the legal system has been totally spoiled by communist rule. In no other former East Bloc country was Soviet law taken to such an extreme."

Although lawyers say significant progress has been made in the past three years, the absolute lack of any form of business law after the anticommunist revolution in 1989 has been a difficult hurdle. "After the revolution, the Czech government had to institute basic laws governing free-market commerce," says Hynek Peroutka, a Czech lawyer with the Prague firm Peterka, Leuchterova and Partners. "The old communist laws didn't deal with these areas at all. Naturally, the new laws, which were instituted very quickly, were too simplistic and contained a lot of loopholes."

One of the most commonly abused loopholes in the 1990s was what Czechs nicknamed "tunneling," a process allowing owners to strip company assets using fraudulent receipts and let the company go bankrupt, taking down employees and creditors with it. Many people got rich quickly this way because they were legally untouchable for debts accrued to their defunct companies. Before reforms in 1996, the country lost millions of dollars and thousands of jobs to the "tunnelers."

"The lack of a legal framework or any real protection for creditors during privatization brought in some bad habits," says Lubomir Lizal, director of CERGE-EI, an economic research institution formed by Czech universities. "Bad debts have become part of the business culture. Once we are in the EU, though, Czech citizens will be able to use the EU legal system, and there will be huge pressure on the Czech courts to change."

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