Germany: New Insolvency Culture In Germany?

Last Updated: 24 February 2012
Article by Dr. Marco Wilhelm, Kevin Philipp Lach and Dr. Malte Richter, LLM

Originally published February 22, 2012

Keywords: insolvency culture, ESUG, creditors, balance sheet,

New insolvency culture in Germany? The Act for the Further Facilitation of the Restructuring of Companies (ESUG) provides for significant changes to German insolvency law

On 13 December 2011, the Act for the Further Facilitation of the Restructuring of Companies (ESUG), the material provisions of which will come into force on 1 March 2012, was announced in the Federal Gazette. The ESUG bundles several reforms with regard to German insolvency law and will likely have significant effects on the daily practice. Generally, the restructuring of companies in financial crisis will be made easier. Creditors will have greater influence on proceedings and the managers of an insolvent company will now have a significantly better chance of restructuring the company themselves . In sum, the ability to plan and to predict the outcome of insolvency proceedings in Germany should increase considerably. This update outlines the most important innovations contained in the ESUG.

Preliminary Creditors' Committee

One of the core goals of the ESUG is to strengthen the influence of the creditors on the insolvency proceeding. In theory, such influence existed already under the former regime in the opening phase of the insolvency proceeding or upon the opening of the formal proceeding itself as a preliminary creditors' committee could be appointed by the court. However, the courts rarely made use of this possibility. Under the ESUG, the insolvency courts are now obliged to appoint a preliminary creditors' committee if the debtor fulfills at least two of the three following criteria:

1. a balance sheet total of at least EUR 4.84 million after the deduction of negative equity within the meaning of Section 268 para. 3 of the German Commercial Code;

2. a revenue of at least EUR 9.68 million within the twelve months preceding the date of the balance sheet;

3. an annual average of at least 50 employees.

Even in the event that these minimum requirements are not met, the court ought to appoint a preliminary creditors' committee if either the debtor, the preliminary insolvency administrator or a creditor applies for it and if individuals who are willing and suitable to serve as comittee members are presented.

Exceptions from the above apply only if the debtor has already discontinued its business, if the appointment of a preliminary insolvency committee would be inappropriate in light of the expected value of the insolvency estate or if the delay resulting from such an appointment would adversely affect the debtor's financial situation.

Appointment of the Insolvency Administrator

Under the former regime, the selection and appointment of the (preliminary) insolvency administrator fell exclusively within the power of the applicable insolvency court. Creditors usually had no or, at the most, merely informal influence. Their role was confined to voting out the court-appointed insolvency administrator and enforcing his replacement by another insolvency administrator in the first creditor's meeting. However, at this well-advanced stage of the proceedings, such replacement rarely took place.

Now, the preliminary creditors' committee obtains an important say in the selection of the insolvency administrator as well as in the ordering of a possible self-administration. For instance, the preliminary creditors' committee may determine certain requirements to be fulfilled by the insolvency administrator. In the event that the preliminary creditors' committee proposes an individual unanimously, the insolvency court is bound by such proposal, provided that the proposed individual is not unsuitable for assuming the position (e.g. due to lack of independence or experience).

In this regard, it is important to note that the proposed person's suitability will not be affected by the fact that he or she was proposed by the debtor or by a creditor or had advised the debtor in general form regarding the insolvency proceedings and its consequences prior to the insolvency filing.

Self-Administration

In the past, the filing for insolvency usually led to the appointment of a preliminary insolvency administrator. While, as a rule, the management of the insolvent company formally remained in office, it could only act with the consent of the preliminary insolvency administrator. At the latest upon the opening of insolvency proceedings, the management was fully replaced by the insolvency administrator as executive body. The possibility for the debtor to conduct the insolvency proceeding and restructure the company via self-administration – an option that had already existed under the former regime – was only allowed by the courts in exceptional circumstances.

Under the ESUG, the self-administration process shall be improved. It will now be easier for the management of the debtor to conduct the restructuring itself while being supervised by an insolvency trustee. The court may only reject a petition for the ordering of self-administration, if circumstances are known that lead to the expectation that self-administration could negatively affect the creditors' position. Here, the aforementioned strengthening of the creditors' committee's right to influence the proceeding becomes apparent again: in the event that the preliminary creditors' committee supports the debtor's petition for self-administration unanimously, the court cannot reject such petition.

Umbrella Proceeding

Furthermore, the ESUG introduces a new concept into the German insolvency code. The purpose of the so called "Umbrella Proceeding" is to encourage earlier filings for the opening of insolvency proceedings. Thereby, it intends to increase the chances for a successful restructuring. If this filing is made on the basis of threatening illiquidity or over-indebtedness (in any event not after the occurrence of actual illiquidity) and if it is accompanied by a petition for self-administration, then the insolvency court will, upon further application by the debtor, grant a period for the presentation of an insolvency plan provided that the planned restructuring is not evidently futile. During such period, which may last for a maximum of three months, the debtor can concentrate on the restructuring and can prepare a restructuring plan in self-administration under the supervision of a preliminary insolvency trustee while enjoying protection from all enforcement measures.

The debtor has to accompany his petition with a certification from a certified accountant, tax accountant or lawyer experienced in matters of insolvency law, which establishes that the debtor is in a condition of over-indebtedness or threatened illiquidity and that the planned restructuring is not clearly futile. To avoid conflicts of interest, the issuer of the certificate and the insolvency trustee must be different individuals. The insolvency court may only depart from the debtor's suggestion for a specific individual as insolvency trustee in clear cases of ineptness of the suggested individual.

The insolvency court can suspend the self-administration under the "Umbrella Proceeding" if the planned restructuring has become futile or the preliminary creditors' committee applies for such suspension. Where no preliminary creditors' committee has been appointed, any insolvency creditor or creditor with rights of separation may file such an application, provided that circumstances become known which lead to the conclusion that the "Umbrella Proceeding" will result in disadvantages for the creditors.

Expansion of the Insolvency Plan Proceeding

One of the further core objectives of the ESUG is to revitalize insolvency plan proceedings and to increase the scope of measures available under an insolvency plan. Prior to the ESUG, the German insolvency code already provided for possibilities to restructure companies by way of an insolvency plan subject to creditor approval. However, measures which interfered with rights of shareholders of the insolvent company were only possible with the approval of the shareholders. Furthermore, objecting creditors could cause substantial delay to the implementation of an insolvency plan.

In the future, measures which affect the capital structure of the insolvent company will be possible within the framework of an insolvency plan even against the will of shareholders. Shareholders will in future constitute a separate group for the purpose of voting on a draft insolvency plan. However, even in cases where the insolvency plan is rejected by the shareholders, the approval will be deemed given if, to state it in simple terms, the shareholders are economically not worse off as a consequence of the insolvency plan than they would be without it.

In future, a whole array of restructuring measures can be provided for by an insolvency plan. Every measure which is possible under corporate law, including, without limitation, the conversion of creditor claims (with the exception of tax claims from the tax authorities) into equity of the insolvent company ("debt/equity swap"), the transfer of shares in the company to creditors, or the reduction and subsequent increase of the statutory capital by issuing new shares in order to absorb losses can be made part of such plan.

Furthermore, legal remedies against the insolvency plan will be restricted. Creditors or shareholders will only be entitled to seek legal remedy against the plan if they have rejected it, voted against it and have substantiated that they are worse off as a consequence of the plan as compared with what their position would be without the plan and that this disadvantage cannot be made up for by a compensation payment.

Finally, the insolvency court can fully or partially annul, or prohibit for a period of up to three years, enforcement measures of such individual creditors which have not filed their respective claim until the meeting at which the vote over the insolvency plan is cast, provided that such measures endanger the implementation of the insolvency plan.

Outlook

While the aforementioned amendments, which shall apply for insolvency proceedings filed as of 1 March 2012, raise expectations of a strong focus on the restructuring of insolvent companies, German lawmakers are already debating the next insolvency law reform. Aside from amendments to the provisions on the insolvency of consumers, the next reform will also lead to amendments regarding the insolvency-remoteness of licences granted by an insolvent licensor. The new reform intends to ensure that the use of the licenses can be continued in spite of the insolvency of a licensor while at the same time protecting the creditors' interests. Currently, federal states and business associations are being given the opportunity to comment on the respective draft insolvency reform proposal of the Federal Ministry of Justice.

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