After the implementation of the European Restructuring Directive through the introduction of a new German Restructuring Code, Germany has a more attractive restructuring regime. Comparably to an English Scheme of Arrangement process, it will be possible to implement a restructuring plan which may foresee debt haircuts and other financial and corporate measures even against the vote of single obstructing "hold-out stakeholders", provided that a 75% majority of the stakeholders in each voting group approves the plan. Under certain conditions, it is even possible to "cram-down" a dissenting voting group entirely. This does not require the company to go through a formal insolvency process anymore. It is expected that these changes will fundamentally change the German restructuring landscape. For instance, insolvency forum shopping of German companies and classic debtor-in possession/protective shield proceedings are expected to become much less frequent.
Since 1 January 2021, Germany has a completely overhauled restructuring regime. Germany was obliged to change its existing rules in order to implement the European Restructuring Directive of 20 June 2019 (EUR 2017/1023, "Directive") into its national law. The Directive made it mandatory for EU member states to offer a "preventive restructuring framework" ("Framework") for companies in a financially distressed situation. In the midst of the German discussion on how to best implement the Directive, i.e., either with only small changes to the existing regime or with a big solution, came the COVID-19 pandemic ("Pandemic"). During the Pandemic e.g., mandatory insolvency filing obligations for directors had to be temporarily suspended and many German companies had to recur to loans (many of which are backed by the German state-owned development bank KfW) in nearly unprecedented levels to prevent their insolvency. Without these events, Germany might not have made the Framework effective half a year ahead of the transformation deadline prescribed by the Directive (June 2021), nor would it have opted for such a bold change. In other words: the use-case for the Framework is evident from the start since it is commonly assumed that the amount of state aid granted to German corporations during the Pandemic created unsustainable debt levels and hence a risk for an excessive number of non-performing loans and "zombie" firms. The goal is to address this potentially problematic situation in the least value-destructive fashion.
The Framework is incorporated in a newly introduced Restructuring Code, which will not replace, but complement the existing Insolvency Code. It offers an alternative way of dealing with the problem of hold-out positions in a restructuring without going through a formal insolvency process. A majority of creditors will henceforward be able to force a dissenting minority to implement financial and corporate measures such as haircuts and deferrals of debt, debt-to-equity swaps, changes to the security package and even a sales process over the debtor company if the requirements set by the new restructuring law are met. Outside of an insolvency process, these measures had up to now only been possible on a fully-consensual basis, i.e., with the consent of each single creditor whose position was affected; from now on, the consent of the creditors' majority can be sufficient. As experience from other restructuring regimes (e.g., the English Scheme of Arrangement) shows, the mere existence of a non-consensual option as a fallback scenario will often be sufficient to promote reasonable consensual solutions.
The Framework provides opportunities for a distressed company to restructure its debt and for creditors to implement a necessary and reasonable restructuring even against a dissenting minority of creditors. Given that the rules are completely new and the changes to the existing restructuring and insolvency regime are fundamental, it is not yet clear how the new rules will be construed by German (and European) courts. For directors representing a distressed German company, many uncertainties remain or have been newly created. For better or worse, it is a dramatic shift that merits a closer look into the details.
- Before accessing the Framework, a company may try to reach a (fully consensual) restructuring settlement with its creditors through the process of a restructuring moderation ("Moderation"). Such settlement can be sanctioned by the court and will then be protected from insolvency claw back in a potential future insolvency. If this fails, the Moderation can be smoothly carried-over into the Framework where majority votes are possible. Because of this possible easy transmission from a consensual Moderation to a potentially non-consensual Framework, we assume that many cases will be resolved in the Moderation phase already.
- The Framework facilitates the implementation of a restructuring plan ("Plan") which contains the necessary restructuring measures and is backed by the majority of creditors. However, such a Plan must exist in the first place and it must be convincing and sustainable. If that is the case, there continues to be a fair chance that the Plan may be adopted even without recurring to the Framework (e.g., in the context of a Moderation).
- The Framework is a very flexible toolkit consisting of a menu of (court) measures out of which a company can choose. It includes moratoria, a potential pre-examination of the Plan by the court and a voluntary in-court voting of the Plan and the appointment of a so-called "restructuring moderator", which can be ordered by the court upon demand of the company.
- Only the distressed company, but not its creditors can commence a restructuring process under the new Restructuring Code. Access to the Framework is limited to companies that are in a state of threatening illiquidity, but not yet actually illiquid or (technically) over-indebted.
- The centerpiece of the reform is the Plan whose content and adoption route is prescribed in detail in the Restructuring Code. The Plan can be implemented on the basis of majority votes and it may foresee haircuts, deferrals, debt-to-equity swaps, changes to the financial covenants and other financial and corporate measures. It can even affect collateral provided by other group companies or inter-creditor arrangements.
Background: Something had to be done
German restructuring experts from all professions used to look enviously to the legal restructuring regimes existing in other countries. It is not that a German insolvency process is - compared to those in other countries - particularly ineffective. But German law used to offer very limited alternatives. A company in financial difficulties would either have to find a consensual solution with its stakeholders in which everyone accepts a formal deterioration of its position in order to reflect the reality of the worsened situation of the company and to ensure its long term survival. Or, if that was impossible (or if dissenting creditors were not bailed out), it had to file for insolvency with all the effects that go along with such filing: an insolvency necessarily affects all creditors (also the small, non-financial ones); it still makes for a bad reputation; the legal entity will typically be dissolved; the shareholders will lose influence and their investment entirely and also the management will typically give away a large part of its decision-making power (and risks to be sued later-on by an insolvency administrator because of mismanagement or a belated insolvency filing). An insolvency filing was therefore not necessarily a credible threat against stakeholders playing on their holdout position.
Not so in other countries. US Chapter 11 rules, the English Scheme of Arrangement and the French Procédure the Sauvegarde allow for majority votes without the wide implications that would be felt by all creditors in a German insolvency process. These features, combined with the confidence instilled by highly professional London courts applying a regime which has been tested for many years, the market-standing of English law firms and the accessibility of the English language prompted an insolvency forum shopping especially towards London to make use of the English Scheme of Arrangement. This was possible even for German companies since many loan agreements used to be (and still are) governed by English law, which was sufficient to confirm the international jurisdiction of the English courts in such cases.
This development had not gone unnoticed by the German legislator who in 2012 made a reform designed to enhance self-administration and insolvency plan proceedings. Successfully, since over the last years, larger corporate insolvencies were typically carried out as self-administration proceedings (during which the directors of the company remain in charge of the company) and they have often concluded in an insolvency plan, which can be described as a restructuring agreement between the company's creditors and other stakeholders made effective by the insolvency court, potentially applying majority rules.
But still, in the Directive, the European legislator asked for more: All European member states have to make a "preventive restructuring framework" available in their jurisdictions until June 2021 which must foresee a list of defined features including, most notably, the possibility of majority decisions outside of an insolvency process: national law must provide not only for a possibility to overrule a dissenting minority within a creditor voting group, but also, under certain conditions, a dissenting group in its entirety ("Cross Class Cram-Down").
With the new restructuring law, Germany has implemented the Directive and it has, in some respects, even gone beyond what was required by the Directive.
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