After Czech Velvet Revolution, plodding legal evolution

Set to join the EU next year, Prague still lags in reforming commercial laws and the court system.

Last May, pensioner Jaroslav Dusek signed a contract with a small company to build his new home, and made the down payment. But the firm refused to start construction, demanding more money. After delivering the next payment and waiting two month, Mr. Dusek gave up and tore up the contract.

"That's 70,000 koruna (about $2,500) down the drain," he fumes, standing over his empty building site. "There is no chance of getting back what they owe me. If I take them to court it could take 10 years to settle and by that time the company will surely have disappeared. I would end up paying all the court expenses, too. There is no legal protection in this country."

Dusek's tale is common in the Czech Republic, where business law is just 13 years old. While this country once led the class among postcommunist transition states in terms of economic growth and political stability, commercial law is an area that is lagging.

"It is easy to break a contract, refuse to pay debts, and get away with it," says Jan Hanousek, head of the Center for Macroeconomic Research at Prague's Charles University. "This kind of behavior is embedded in business and politics here. When you sign a contract in this country, most people consider it little more than a piece of paper and, if you take someone to court, don't expect results any time soon."

European Union reports have repeatedly criticized Czech efforts at judicial reform, especially in the fields of business and contract law. Notorious for drawn-out court cases - tens of thousands of cases are backlogged in Czech courts - the justice system is also known for contradictory rulings and petty corruption.

The government has tackled business and contract law in several reforms since the late 1990s, bringing in reams of new legislation, but legal experts say enforcement is ineffective and the legal system still glacially slow.

As it moves toward joining the EU next year, the Czech Republic has come under increasing pressure both to upgrade its court system and enact and enforce new laws governing the marketplace.

"The EU has made clear that the Czechs will not see a single euro in development aid unless they reform their public procurement system," says Petr Greger, director of the Euro-Czech Forum, a joint institution of EU chambers of commerce. As a result, changes were made in June this year to make the public procurement process more transparent and competitive.

The European Court of Human Rights in Strasbourg and other international arbiters have also found fault with the Czech legal system. At least 50 complaints are pending before the European Court against the Czech government, claiming that the unreasonable length of court proceedings is a violation of human rights. The Czech state has already lost two such cases this year and has been forced to pay compensation.

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."