German Insolvency Law - Insolvency/Bankruptcy

OBJECTIVE

Historically, the objective of the proceedings provided by the Insolvency Code (Insolvenzordnung, InsO) or its predecessor, the Bankruptcy Code (Konkursordnung, KO) has been the collective, non-discriminatory satisfaction of creditors on a pro rata basis. To achieve this objective, the proceedings provide a framework for the liquidation of the insolvent debtor's assets by an independent court-appointed insolvency practitioner, either by way of asset-stripping or the sale of the debtor's entire business, followed by a distribution of the proceeds to the creditors.

Following an increasing trend toward strengthening the chances for a restructuring of the debtor's business as opposed to liquidating it, the Insolvency Code also provides for reaching an arrangement with all stakeholders by means of an insolvency plan procedure designed to reorganize the business and enable the enterprise to continue as a going concern, including by way of selfadministration (or debtor-in-possession) proceedings.

INSOLVENCY STAGES

The insolvency proceeding can be divided into the preliminary insolvency proceeding and the final insolvency proceeding. Both stages are supervised by the Insolvency Court. Proceedings commence when the initial financial crisis of the company has led to an insolvency situation within the meaning of the Insolvency Code (see "Grounds for Filing for Insolvency"), prompting the management (or, in certain cases, the shareholders) to file for insolvency with the competent Court in order to avoid personal criminal and financial liability. Aside from filings by the management itself, filings for insolvency by creditors are also possible and common. As a rule, the Insolvency Court will react to the filing by appointing a preliminary creditors' committee and a preliminary insolvency administrator whose task it is to secure the assets of the debtor and to prepare the ground for the Insolvency Court's decision whether or not to open final insolvency proceedings.

GROUNDS FOR FILING FOR INSOLVENCy

Generally, and subject to the temporary exemptions further mentioned below, final insolvency proceedings will be opened if the Court finds that:

the debtor is illiquid (i.e., unable to pay its debts when due (Zahlungsunfähigkeit)); or
in the event that the debtor is a legal person or a legal entity that does not have at least one natural person who is personally liable without limitation, the debtor is overindebted (i.e., the debtor's assets do not cover its liabilities, unless the circumstances indicate that it is more likely than not that the company will be able to continue as a going concern in the next 12 months (Überschuldung)).

Pursuant to case law, illiquidity does not exist in the event of certain limited temporary liquidity gaps. However, the debtor is deemed to be illiquid in any event if it has stopped making payments as they fall due. The debtor itself can also file a petition voluntarily on the grounds of pending illiquidity (i.e., if it is predominantly likely that the debtor will become unable to meet its payment obligations when they fall due in the future (drohende Zahlungsunfähigkeit)). In general, a forecast period of the current and following financial year is to be used, but the period can be longer or shorter.

Regarding the question of whether or not a debtor is over-indebted, the crucial question is whether a positive business continuation forecast (positive Fortführungsprognose) can be made. The minimum requirements for the affirmation of such a positive forecast are the debtor's intention to continue its business and a continuously updated liquidity planning pursuant to which the debtor is predominantly likely to stay in business during the next 12 months and be able to pay its debts when due during the foreseeable future. The debtor's management should diligently document these facts, and, depending on the situation, it might be advisable to have an outside counsel prepare a professional opinion as to whether the requirements are met.

By temporarily modifying the above rules (currently limited until the lapse of 31 December 2023), the German Federal Government has, in the context of rising energy and raw material prices, passed the Act regarding the Mitigation of Consequences of a Crisis under Restructuring and Insolvency Laws (Sanierungs- und insolvenzrechtliches Krisenfolgenabmilderungsgesetz – "SanInsKG"). The SanInsKG has, in particular, (i) reduced the above-mentioned prognosis period regarding the debtor's business positive continuation forecast (positive Fortführungsprognose) from 12 months to only 4 months (thus allowing companies to more easily avoid the obligation to file for insolvency for over-indebtedness (Überschuldung)) and (ii) increased the maximum period for filing for insolvency due to over-indebtedness (Überschuldung) from six weeks to eight weeks (see also below).

COMMENCEMENT OF INSOLVENCY PROCEEDINGS

In general, the insolvent company itself or any creditor can file for insolvency of the company with the competent Insolvency Court, thus initiating preliminary insolvency proceedings. In the case of legal entities and companies without legal personality (ohne Rechtspersönlichkeit), every member of the representative body (Mitglied des Vertretungsorgans) or every personally liable shareholder, as well as every liquidator, are entitled to initiate preliminary insolvency proceedings. The Insolvency Court is, however, not entitled to initiate insolvency proceedings "ex officio". In the event of a creditor filing for insolvency of the debtor, the debtor's legal representatives are entitled to be heard by the Court. Creditors should therefore make sure to prepare the filing carefully and liaise with suitable insolvency practitioners in order to maximize their influence on the subsequent proceedings.

MANAGEMENT DUTIES

If there are indications for the existence of grounds for the opening of insolvency proceedings, the debtor's management must assess the company's financial status. In the event illiquidity or over-indebtedness exists, the members of the representative body or the liquidator(s) are personally obliged to file for insolvency, at the latest within three weeks after the occurrence of illiquidity or within six weeks (eight weeks until 31 December 2023 under the SanInsKG) after the occurrence of overindebtedness. The same applies in the case of companies without legal personality where no natural person is (indirectly) a personally liable shareholder. If a company is without management (Führungslosigkeit), the debtor's shareholders or the members of its supervisory board are obliged to file for insolvency, unless this person is not aware of the insolvency or over-indebtedness or the lack of management.

In the case of an obligation to file for insolvency, the filing must be made without delay, within a maximum limit of three weeks starting with the occurrence of the illiquidity or six weeks (eight weeks until 31 December 2023 under the SanInsKG) after the occurrence of the over-indebtedness. The filing should only be delayed this long if realistic options exist to avert insolvency. The obligation to file for insolvency also applies to the management of companies incorporated under the law of foreign jurisdictions if the actual center of main interests of such a company is in Germany. Omission or delay in filing leads to criminal and/or financial liability of the company's management personnel. For further details on the managing directors' obligation to file for insolvency, see: White Paper on German Insolvency Law – The managing directors' obligation to file for insolvency

PRELIMINARY PROCEEDINGS

The interim period between the filing for insolvency and the decision of the Insolvency Court whether or not to open final insolvency proceedings is often referred to as the preliminary insolvency proceeding (vorläufiges Insolvenzverfahren) or opening proceedings (Insolvenzeröffnungsverfahren). The Insolvency Court does not automatically open insolvency proceedings upon receipt of a corresponding filing. During the preliminary proceedings, it determines whether an insolvency ground does, in fact, exist. Except in cases where the debtor is a small company and does not reach certain economic thresholds, where its business operations have been discontinued, the appointment would be disproportionate or where the delay associated with the appointment would lead to an adverse change in the debtor's financial position, the Court will appoint a preliminary creditors' committee (vorläufiger Gläubigerausschuss). This committee's most important right at this stage is that it can nominate a candidate for appointment as the preliminary insolvency administrator by the Insolvency Court. In principle, the Court cannot depart from this suggestion if it is unanimous and the candidate is suitable. Therefore, the preliminary insolvency proceeding is a crucial stage for creditors, as they can use the preliminary creditors' committee to entrust the proceedings to an insolvency practitioner of their choice. This constitutes a significant deviation from the former law, which gave sole responsibility for the choice of the preliminary insolvency administrator to the Insolvency Court. For further details on the creditors' committee see: White Paper on Creditors' Committee

Usually, upon appointing the preliminary insolvency administrator, the Court will also order that all or certain transactions of the debtor require the preliminary administrator's consent, otherwise leaving the debtor's legal representatives in charge of conducting the debtor's business. However, it is in the Court's discretion to grant further powers to the preliminary administrator and even transfer the administration of the debtor's business entirely to the preliminary administrator. For creditors that are doing business with the insolvent company at this stage, it is important to determine what kind of power has been vested in the preliminary administrator and what other restrictions the Court has imposed (e.g., a stay of individual enforcement measures). Depending on such powers of the preliminary administrator, the creditor's claims resulting from business transactions with the debtor may be preferential or not. Generally, claims arising from transactions entered into by the insolvency debtor with the consent of the preliminary administrator rank only as unsecured insolvency claims. Creditors should therefore make sure to sufficiently secure their claims arising from transactions conducted during this phase of the preliminary insolvency proceedings in a way that is resistant to being contested. For further details on how to deal with a supplier in crisis, see: White Paper on Dealing with supplier in crisis.

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