Five years after the new German Insolvency Code ( Insolvenzordnung) came into Insolvenzordnung force, German insolvency law is of considerable interest to both the national and international business communities. This is mainly due to the record number of corporate bankruptcies in recent years, including such spectacular cases as Kirch Media, Philipp Holzmann, Herlitz, Fairchild Dornier & Babcock Borsig. Corporate bankruptcies amounted to 26,600 cases in 1999. The number has increased to almost 39,500 cases in 2003 and amounts to about 19,300 in the first half of 2004. While stakeholders face the special challenges associated with corporate bankruptcy, investors in distressed assets are presented with unique opportunities. The following article provides an overview of German insolvency proceedings with a special emphasis on the restructuring instruments introduced by the Insolvency Code such as the plan of reorganization ("Insolvency Plan", Insolvenzplan) and self-admin- Insolvenzplan istration ( Eigenverwaltung). Eigenverwaltung
The Stages Of Insolvency Proceedings
Insolvency proceedings pursuant to the Insolvency Code are the only judicial proceedings available in Germany for the bankruptcy of corporations. The Insolvency Code came into force on January 1, 1999 and replaced the three separate legislative regimes previously in force, the Bankruptcy Act and the Composition Act for debtors situated in former West Germany and the Joint Execution Act for debtors located in former East Germany.
Insolvency proceedings commence upon a petition by the insolvent corporation or a creditor to the competent court, the "Insolvency Court" ( Insolvenzgericht). The German Insolvenzgericht Insolvency Code contains an insolvency prerequisite. The petition must show that the corporation is either unable to meet its payment obligations that have become due (illiquidity) or that its liabilities exceed the value of its assets (overindebtedness). The management of a corporation that meets either of these criteria is obliged to file for insolvency within a period of three weeks. The corporation (not the creditors) may also file a petition for insolvency once it establishes that it will be unable to meet existing payment obligations as and when they fall due in the future (imminent illiquidity).
Once the petition has been filed, the Insolvency Court is required to determine whether the corporation meets one or more of the above criteria for insolvency, and to take all measures that are necessary to protect the corporation’s estate. Such measures usually include the appointment of an interim administrator. The interim administrator is generally required to assist the Insolvency Court in determining whether one of the criteria of insolvency has been met and whether the value of the corporation’s estate is sufficient to cover the expected costs of insolvency proceedings.
When these matters have been determined, the Insolvency Court will enter an order formally opening insolvency proceedings. In this court order an insolvency administrator is normally appointed. This is usually the same person who was appointed as interim administrator. The administrator is in charge of the business and responsible for its management going forward, thus taking control away from the corporation’s managers. While an administrator is appointed in the vast majority of cases, the Insolvency Code allows the corporation’s management to apply for self-administration, meaning that the debtor is left in possession and is merely supervised by a creditors’ trustee. The court may only leave the debtor in possession if it is convinced that this will not disadvantage creditors. In practice, the courts have been very reluctant to enter an order of self-administration. The view is widely held that management which was not able to avert insolvency in the first place can hardly be deemed capable of coping with the crisis, once proceedings have commenced. However, there has been self-administration in some of the spectacular insolvency cases of the recent past involving groups of companies with international activities. The most prominent example is Kirch Media.
In its initial ruling, the court may also appoint a creditors’ committee which supports and supervises the administrator. In practice, it is common that a representative of each of the major groups of creditors is chosen ( e.g., banks, suppliers, g. employees). Moreover, the creditors will be asked to file their claims with the administrator within a certain period of time. The court will set dates for two creditors’ assemblies — an information hearing and an examination hearing. The information hearing is usually within six weeks, at the latest within three months, of the opening of insolvency proceedings.
At the information hearing the insolvency administrator reports on the corporation’s business situation and the causes of insolvency. He indicates whether it is possible to continue the corporation’s business in whole or in part, whether the adoption of an Insolvency Plan is feasible, and what effects would arise for the fulfillment of creditor claims. The creditors are called on to decide whether the court-appointed administrator should be retained or a new one elected. If the court has previously appointed a creditors’ committee, they will need to confirm its members or choose new ones. If no creditors’ committee was previously appointed, the creditors may elect one. They will also determine the further course that insolvency proceedings should take. Generally, creditors have the following options: (i) winding-up of the business; (ii) sale of the business as a going concern; or (iii) restructuring of the insolvent corporation by means of an Insolvency Plan. Creditors will frequently follow the administrator’s recommendation. In order for the creditors to make a decision, a resolution requiring a majority (calculated on the basis of sums of claims) of the creditors voting at the hearing must be passed.
At the examination hearing, the claims registered by the creditors are examined by the insolvency administrator with respect to amount and rank and either confirmed or denied.
Winding-Up Of The Business
The creditors will only choose to wind up (liquidate) the business if it cannot be sold as a going concern to an investor or restructured by means of an Insolvency Plan. Winding-up entails closing down the operations, laying off employees, terminating agreements of the corporation, and selling off any remaining assets. Funds obtained as a result of the sale of assets are distributed to creditors after the costs of the insolvency proceedings and the winding-up have been satisfied.
Sale Of The Business As A Going Concern
Under the laws in force prior to the Insolvency Code, it was in practice very difficult to reorganize a corporation, once it had become insolvent. The most common way of rescuing an insolvent business was for the administrator to sell it as a going concern by means of an asset deal to an investor. In the first years after the Insolvency Code’s enactment, such a sale remained the preferred instrument of administrators (and creditors) for dealing with the insolvency. It has the advantage of being a fairly simple means of realizing the value in the estate. It is in line with the German understanding that an insolvency procedure is less a means of protecting the corporate debtor from its creditors than a way of utilizing the estate’s assets efficiently to satisfy the creditors to the largest extent possible.
Even today, the sale of the insolvent corporation’s business as a going concern is the most common way of rescuing the business. Such a sale requires the approval of the creditors’ committee, or if a creditors’ committee has not been appointed, the approval of the creditors’ assembly. It can provide a number of advantages to an investor when compared to an ordinary acquisition outside of insolvency. In general, the debts of the business are left behind with the insolvent entity. Since the insolvency administrator has extensive powers of disavowing contracts unfulfilled as of the opening date, contracts that the investor wants to assume for business reasons are frequently renegotiated and more favorable terms agreed on. Most importantly, while employees are, in principle, assumed by the purchaser by opera tion of law, insolvency provides the opportunity to restructure the workforce and to negotiate terms with trade unions that would not be possible in an acquisition outside of insolvency. The purchase price paid by the investor is distributed by the administrator among the creditors in their order of priority. Once this has been completed, insolvency proceedings are terminated.
Restructuring By Means Of An Insolvency Plan
The creditors may instruct the insolvency administrator during the information hearing to draw up an Insolvency Plan. Only the administrator or the corporation’s management may propose a plan. The latter can submit a proposal as a prepackaged plan upon filing for insolvency. There are few rules about the contents of an Insolvency Plan, as it can be freely arranged and include all provisions that could be made in an individual contract. This can include, inter alia, waivers and alia deferrals of claims as well as restrictions of security rights. An Insolvency Plan usually provides for a reorganization of the insolvent corporation. It can also provide for a liquidation, although this can usually be achieved more readily without the plan. It divides the creditors into groups if creditors with varying legal positions are affected by it. The Insolvency Code provides that at least the following groups are established: secured creditors, if their rights are affected; ordinary creditors; and the different ranking groups of subordinated creditors, if their claims are not deemed to be waived.
In the event that an Insolvency Plan is proposed, the Insolvency Court will call a creditors’ assembly for a hearing during which the Insolvency Plan and the voting rights of the creditors (including the division into groups) will be discussed. The voting on the Insolvency Plan will follow this hearing. The creditors vote in their respective groups on the Insolvency Plan. The plan will only be accepted if all groups agree. In each group the majority of creditors must consent and the sum of their claims must constitute more than half of the sum of the claims of creditors voting in this group. The plan will be adopted without the consent of a group of creditors if the majority of groups have agreed and the Insolvency Court establishes that the creditors of the nonconsenting group are not disadvantaged by the plan, as compared to their position without the plan, and that they have a reasonable share in the economic outcome of the plan.
If creditors consent to the plan, it will be confirmed by the Insolvency Court and then become effective. The Insolvency Court will terminate insolvency proceedings and the different groups of creditors will be paid as provided for in the plan. The plan can also provide for post-approval supervision of the corporation if management is not intended to regain total control of its affairs immediately.
In the past, bankruptcy proceedings in Germany followed the course of the sale of the insolvent corporation’s business as a going concern or a winding-up of operations. However, since the enactment of the Insolvency Code, we are seeing an increasing number of insolvency plans adopted and debtors left in possession. This approach has proved valuable in large and complex insolvencies involving groups of companies, by combining the specific restructuring expertise of a reorganization specialist appointed to the board just prior to insolvency with the knowledge and experience of existing management. The Insolvency Code provides a flexible legal framework to cope with corporate insolvencies by allowing stakeholders to choose a solution that is best suited to deal with the particular circumstances of the insolvent company.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.