European Perspective
All Change in Germany - A New Era in German Insolvency Law
Football is not the only arena where England and Germany have clashed in recent times. Insolvency and restructurings have been another battleground, and one in which England has had the upper hand. This has been evidenced by German debtors (usually individuals, but sometimes companies) migrating their centres of main interest ("COMIs") to Britain and also by German companies proposing English schemes of arrangement. The relative lack of German competitiveness compared to England’s, at least in some important areas of corporate insolvencies, as well as the perceived need to make Germany a more creditor-friendly country, has prompted a German rethink of its insolvency laws. This has resulted in the enactment by the German Parliament of a new Insolvency Act on 26 October 2011 (the "Act"). The Act (das Gesetz zur weiteren Erleichterung der Sanierung von Unternehmen, broadly translated as "the law for the further facilitation of the rehabilitation of companies") will significantly strengthen the rights of creditors and, to some extent, the rights of debtors in insolvency proceedings. The new law has been adopted by the German Parliament and will come into force early in 2012. Described herein are some of the main features of the Act.
Insolvency Officeholder May Be Proposed by Creditors
The Act introduces the right of creditors to request that the court appoint a specified individual as the insolvency officeholder. This is a fundamental change in German insolvency law. Although creditors in the past have occasionally put forward an individual to the court to act as the officeholder, certain insolvency courts have automatically disqualified the nominee on the basis of the view that anyone proposed by an interested party in the proceedings cannot be considered independent and therefore is not competent to hold office. Even where the insolvency courts in a particular region have not held this view, some judges in those courts have. In these instances, the court has appointed the officeholder under a rota (ladder) system, which does not always take into account the circumstances of the case (e.g., a need for the officeholder to have cross-border expertise). That said, some German insolvency courts and judges have been more receptive to these sorts of requests.
The Act provides that a nominated individual does not lack the required independence if he or she has been proposed by the debtor or by a creditor, or has advised the debtor prior to the insolvency filing in a general capacity on the possible course of action in an insolvency proceeding or its consequences. The court must appoint the individual put forward by a unanimous resolution of the preliminary creditors’ committee (the function and composition of which are described below), unless the nominated individual is not suitable to act as insolvency officeholder, taking into account any requirements set out in the committee’s resolution. If the court intends to appoint as insolvency officeholder an individual other than the one proposed in the committee’s resolution, the court must state its reasons in the order it makes for the opening of proceedings. This will make it difficult for the court to ignore the creditors’ choice when making the appointment.
The fact that creditors can influence the appointment of the officeholder will make it easier to effect prepackaged asset sales in German insolvencies. Such asset sales can be implemented under German insolvency law only after the court opens insolvency proceedings, which is usually two or three months after the initial application is made to the court, and if the creditors’ committee has approved the sale. However, if proper preparations have been made for the prepackaged sale and the sale clearly benefits all creditors, an earlier opening of insolvency proceedings is possible.
Preliminary Creditors’ Committee Established at an Early Stage
As a general rule, in larger insolvencies, the court is required under the Act to establish a preliminary creditors’ committee (vorläufiger Gläubigerausschuss) at an early stage of the proceedings. The composition of the committee, including the number of members, will be decided on a case-by-case basis by the court, but the committee will typically consist of an odd number of creditor representatives. In a large case, representatives can be expected to come from bank creditors, major suppliers, the local tax office, the employment office, and the Pensions Protection Fund (Pensions-Sicherungs-Verein).
The committee will have an important function similar to that performed by creditors’ committees in U.S. chapter 11 cases. For example, it can make decisions on the strategy the officeholder should pursue, such as whether a sale of assets should take place or whether the business should be continued. The insolvency officeholder will usually comply with resolutions of the committee, as he risks personal liability if he does not.
An important early function of the creditors’ committee is to nominate to the court the person it wants to serve as the preliminary insolvency officeholder (vorläufiger Insolvenzverwalter). The nominee can be expected to be appointed by the court (as discussed above) both as preliminary officeholder and, once the court formally opens the proceedings several weeks later, as officeholder.
The court must establish a committee if the debtor satisfies two out of three thresholds: (i) a balance-sheet total (Bilanzsumme, equivalent to a company’s total assets) of at least €4.84 million; (ii) revenues of at least €9.68 million in the 12 months immediately before the filing for insolvency; and (iii) an annual average of at least 50 employees. These thresholds were subject to some heated debate in legal and political circles and, as a consequence, were increased at a late stage of the legislative process. The thresholds now are identical with the criteria defining "small corporations" under section 267, paragraph 1, of the German Commercial Code. The thresholds were increased to address the concern that the volume of cases in which the court must establish a committee would soar to an unreasonable number.
However, a preliminary committee is not required if: (i) the establishment of such a committee would be inappropriate, giving regard to the value of the insolvency estate; (ii) a delay caused by the establishment of a committee would have an adverse effect on the debtor’s net assets; or (iii) the debtor has already ceased its business operations. In these situations, the court is not obliged to establish a preliminary committee but nevertheless has the discretion to do so if the court considers it appropriate (e.g., to preserve value or increase creditors’ participation in the insolvency proceedings). This exception from the general rule is sensible—in the situations where it applies, the chances of achieving a higher recovery for general unsecured creditors will increase, since the estate will incur lower costs and, at least in an ideal world, the insolvency officeholder will be able to act more quickly because he will not be obliged to consult with a committee.
Obtaining Order for Self-Administration Will Become More Common
One of the aims of the Act is to make it more likely that the court will order the debtor to be placed into self-administration (Eigenverwaltung) following an application to the court for the opening of insolvency proceedings. Self-administration is a "debtor in possession" procedure. This means that management remains in charge of the debtor’s business, rather than a court-appointed insolvency officeholder, once the court formally opens the proceedings. The concept is similar to the debtor in possession in chapter 11 cases under the U.S. Bankruptcy Code.
The purpose of this change is to encourage the management of companies in financial difficulties to file for insolvency earlier than is currently the case (i.e., before the situation becomes critical). Management can now expect that the court will make an order for self-administration, as opposed to making any other appointment, and so will remain in charge while the debtor attempts to restructure during the insolvency proceedings. The self-administration concept strengthened by the new law is a positive development for the debtor and, if the business or personal relationship with the shareholders is good, for the debtor’s shareholders as well.
Where the court makes an order for self-administration, the debtor will act under the supervision of the court and of a preliminary insolvency trustee (vorläufiger Sachwalter) appointed by the court. Provided that certain requirements are met, the court will grant the debtor a period of up to three months to prepare a restructuring plan (Insolvenzplan), which in some respects is similar to an English company voluntary arrangement. These requirements include the following: first, that the debtor is not illiquid (zahlungsunfähig) (i.e., it can pay its debts as and when they fall due for payment), and second, that the proposed restructuring is not considered to be "obviously without merit" (offensichtlich aussichtslos).
The debtor can request the court to make an order that prevents a creditor from taking enforcement steps against the debtor during this three-month period (a so-called protective shield, or Schutzschirm), except for enforcement over real property. The court also has discretion to make an order to establish a preliminary creditors’ committee, to prevent third-party owned assets from being removed by the creditors concerned, and to order other protective measures it considers necessary. However, the three-month period for preparing a prepackaged restructuring plan will come to an end if, for example, it becomes obvious that the proposed restructuring is without merit or if the preliminary creditors’ committee applies to the court to bring the protective shield to an end. When the period ends, the related protective measures come to an end as well. Automatic termination of the protective shield due to the illiquidity (Zahlungsunfähigkeit) of the debtor was removed from the draft Act at the last minute. These changes mean that the Insolvenzplan will become more popular with courts and insolvency officeholders as well as with debtors.
The fact that illiquidity will not automatically result in a lifting of the protective shield is expected to strengthen the shield’s relevance in practice. However, in many cases, creditors can be expected to accelerate their payment claims once it is public knowledge that a protective shield has been ordered by the court and that acceleration of debt claims can easily cause the illiquidity of the debtor. When a debtor becomes illiquid after the protective shield has come into force, the preliminary creditors’ committee (upon passing the necessary resolution) or a creditor may apply to the court for the protective shield to be brought to an end.
Debt-for-Equity Swaps
Under the Act, capital measures in connection with a debt-for-equity swap, the exclusion of existing shareholders’ subscription rights, compensation payments to shareholders exiting the company, the transfer of shares in the company, and other corporate measures may be provided for in an Insolvenzplan. The plan must provide appropriate compensation payable by the estate if the existing shareholders forfeit their shares as a result of these measures. If the shares in the insolvent company become worthless, however, no compensation need be paid.
An Insolvenzplan becomes effective once it has been confirmed by the Insolvency Court (Insolvenzgericht), and it is no longer possible to appeal the confirmation. A court will not confirm the plan if any of the following are not complied with in all material respects: mandatory provisions regarding the content of the plan, the process followed in putting it together, or its adoption by creditors and existing shareholders. Voting on the Insolvenzplan takes place in groups. The plan itself allocates creditors and shareholders to different groups according to their specific legal positions vis-à-vis the debtor.
Examples of relevant groups are secured creditors, creditors holding large claims in relation to other creditors, creditors holding small claims, employees, and shareholders. There will usually be more than one creditor group. In general, an Insolvenzplan is adopted only if all the groups vote in favour of it. In order for a creditor group to approve the plan, the majority of the creditors in that group (based on head count and total value of claims) must vote in favour. In the case of a shareholder group, the Act provides that a majority of the shareholders in that group need to approve the plan; majority is determined by the usual company law principles relating to shareholder votes. Any group, particularly a shareholder group, that votes against the plan may nevertheless be "crammed down" (i.e., their votes can be disregarded) if: (i) the members of the dissenting group are not worse off under the restructuring plan than they would be if there were no plan; (ii) they participate in an appropriate manner in the assets made available to the participants under the plan; and (iii) the requisite majorities of all other groups vote in favour of the plan.
An Insolvenzplan may provide for a cancellation of shares held by existing shareholders without any compensation if those shares have no value. This will usually be the case if the company is insolvent, whether on a balance-sheet basis or on a cash-flow basis. If a group of existing shareholders votes against this sort of plan, it can be crammed down, provided the members of the group would not have received anything if there had been no plan and the company had been liquidated. This is because the group members would not be worse off with the plan than they would be without it.
Members of a dissenting group need to benefit in an appropriate manner from the economic value that is made available under the plan. In exceptional cases, where the shares in the insolvent company still have some (residual) value, the Insolvenzplan must provide for: (i) the continuing participation of the existing shareholders in the company following the reorganisation in a way that reflects the residual value of their shares; or (ii) a cancellation of their shares in return for appropriate compensation.
The Act will prevent shareholders from blocking debt-to-equity swaps and other corporate measures with respect to debtors. It will also facilitate the restructuring of companies in insolvency proceedings and the participation of investors in such proceedings (e.g., through loan-to-own strategies).
There you have it. The Act will encourage financial restructurings in Germany and represents a shift towards a more creditor-friendly stance. However, it remains to be seen whether the new law will decrease the appetite among German debtors for COMI migrations (which have been small in number anyway) and English schemes of arrangement. In Germany, the prevailing view seems to be that all this will be achieved. Englishmen might be more sceptical, but only time will tell who is right. What is certain is that the German insolvency law is about to be modernised and gives stakeholders in a financially distressed company more control over how the insolvency proceeding plays out.
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A version of this article was published in the December 2011 edition of Corporate Rescue and Insolvency. It has been reprinted here with permission.
