I OVERVIEW OF RESTRUCTURING AND INSOLVENCY ACTIVITY
Many experts believe that in 2019 we reached a turning point in the development of the German economy in recent years. While in 2017–2018 markets remained strong, and access to liquidity continued to be accommodative both for investment and non-investment grade companies, the landscape changed in the first half of 2019. Economic growth is cooling down and companies in various countries announced a reduction in their workforces.
Despite the availability of cheap funding as a consequence of the asset purchase programme2 of the European Central Bank (ECB) and its generally loose money policy in past years, the outlook for the German economy has recently deteriorated. International trade conflicts are slowing world trade, economic growth in many large economies, especially China, is decelerating, the political balance worldwide is in a state of flux and the uncertainties surrounding Brexit are creating concerns in Germany and among the customers of German industry, which is very export oriented. Even though the gross domestic product (GDP) in 2018 was overall 1.5 per cent higher than in the previous year and the German economy has thus grown for the ninth year in succession, growth has lost momentum. In the previous two years, the price-adjusted GDP had risen by 2.2 per cent in each case, but growth was somewhat lower than announced in January 2018. The economic situation in Germany was split in the year 2018: in the first half of 2018, GDP rose significantly but in the second half of 2018 GDP declined by 0.2 per cent in the third quarter and remained at the same level in the fourth quarter. However, according to first estimates, GDP again increased by 0.4 per cent between January and March 2019 compared to the previous quarter.3 Nevertheless, there is no reason to give the all-clear.
These developments have had a major impact on the German restructuring market. The number of newly opened insolvency proceedings dropped from 153,549 in 2010 to 104,287 in 2017 and decreased further to 98,409 in 2018. Compared to the 2017 figures, this marks a 5.6 per cent decrease in overall newly opened insolvency proceedings. In 2018 the number of company insolvencies fell by 3.6 per cent compared to between 2017 (with a total of 19,552 in 2018). The 2018 figures mark a two-decade low in company insolvencies.4
However, in the current year of 2019, the phase of declining insolvency figures that has lasted since 2010 is likely to end and for the first time again more companies will go into insolvency according to industry experts' predictions.5 Already in January 2019, German courts registered 1,700 corporate insolvencies. This was 5.7 per cent more than in January 2018. In February 2019, 1,579 corporate insolvencies were reported.6 Even though this was 2.8 per cent less than in February 2018,7 experts expect insolvency activities to pick up further in the rest of the year, in particular in the fourth quarter.
At the centre of new insolvency proceedings is currently one of Germany's key industries – the automotive sector. The industry is facing the general problems of all economies of the European Union: worldwide trade conflicts and political uncertainties, the Brexit crisis and economic woes. But there are also industry-related problems. These include in particular the effects of the diesel crisis and the lack of a coherent and sustainable electric mobility strategy in many companies and countries. Car production rates in the second half of 2018 were 7.1 per cent lower than in the first half of the year.8 According to industry experts, the companies mostly affected of the changing conditions are less the manufacturers themselves but rather suppliers who are struggling with the developments. Suppliers are usually asked to pre-finance upcoming production orders, R&D and tooling to a large extent. This often leads to a stretched liquidity situation, which usually hits smaller suppliers hard. These developments will likely result in higher number of non-performing loans and distressed M&A transactions in the automotive sector, in particular with the aim to consolidate businesses with a focus on the production of parts for combustion vehicles.
Accordingly, the overall restructuring landscape shows a significant increase in financial corporate crises. The numbers are expected to increase even further over the course of the year reflecting expectations of an economic downturn. The prospects of a successful implementation of restructuring measures are also expected to decline which will most likely result in more insolvencies. In addition, the ability to finance restructuring measures is considered to be much more difficult than in previous years. It is expected that corporate loans will increasingly default in the wake of the negative economic situation.9
As regards the type of distressed transactions, the accommodative availability of liquidity, the continued growth of the German economy and the widely unchanged ECB monetary policy favoured mostly regular M&A transactions. However, international and national investors continue to show interest in German distressed debt and asset investments. In order to meet the various demands in a changing landscape, formal in-court insolvency proceedings were complemented by new mechanisms that led to a number of successful out-of-court restructurings and asset disposals from distressed companies as well as third-party driven trust structures.
The decreasing number of formal proceedings in the past already indicates that the German insolvency administration and advisory market was challenging in recent years. The business model of traditional insolvency administrators came under considerable pressure, and the German insolvency and restructuring landscape continued to follow a number of trends visible since the introduction of the Law for the Further Facilitation of the Restructuring of Companies in April 2012:
- Traditionally, German insolvency law and restructuring practice was focused on formal, court-driven proceedings. However, the focus has shifted more and more from traditional insolvency administration to pre-insolvency restructurings and self-administered processes; management officials tend to seek professional advice at an early stage and systematically explore options to negotiate consensual restructurings, often steered by chief restructuring officers (i.e., experienced restructuring experts).
- Restructurings of the passive side of the balance sheet are usually initiated by a debtor's proposal for a consensual arrangement (e.g., by seeking to amend bond terms by a majority vote in accordance with the German Bond Act 2009), entertaining debt-to-equity swap concepts or proposing 'amend and extend' solutions; in case these negotiations fail debtors prepare 'Plan B' scenarios as a backup (i.e., will have developed strategies for a formal insolvency that often include the initiation of 'self-administration' proceedings with the debtor pushing for a restructuring as a going concern via insolvency plan (see Section II.ii).
- Operational restructurings can be particularly onerous outside of formal insolvency proceedings as German insolvency law recognises a set of (e.g., labour- and contract-related) instruments that are not available in a pre-insolvency stage.
- Once the debtor – or a creditor – has filed for the opening of insolvency proceedings, the preliminary stage (often three months, see Section II.ii) of the proceeding is crucial for stakeholders, irrespective of whether the designated outcome of the insolvency is an asset sale to an investor, an insolvency plan restructuring, or a liquidation of the insolvency estate; deals are often fully negotiated at the preliminary stage and potential investors are generally well advised to approach the self-administrating management or the insolvency administrator as soon as possible.
Against this background, new European legislation and in particular the implementation of the Directive of the European Parliament and of the Council on preventive restructuring frameworks, on discharge of debt and disqualifications, and on measures to increase the efficiency of procedures concerning restructuring, insolvency and discharge of debt, and amending Directive (EU) 2017/1132 (the Directive on Preventive Restructuring Frameworks) has the potential to provide new features and may complement the existing mechanisms under German law effectively (see Section III).
II GENERAL INTRODUCTION TO THE RESTRUCTURING AND INSOLVENCY LEGAL FRAMEWORK
Insolvency proceedings in Germany are initiated by a formal filing to the competent insolvency court. Under German law, the debtor and each of its creditors are entitled to file for insolvency by asserting that the debtor is illiquid or over-indebted. An insolvency in Germany is always governed by the provisions contained in the German Insolvency Code and commencement of the proceedings is identical, irrespective of whether the parties involved seek a restructuring of the business or intend to have the assets liquidated and the sales proceeds distributed among the creditors.
i Duties of directors in a crisis situation
Directors of German companies are under a statutory obligation to file for insolvency without undue delay, but in no event later than after the expiry of three weeks, if the company is illiquid or over-indebted. The three-weeks period is only applicable, if there are restructuring efforts under way that may be expected to be successful. Otherwise, insolvency has to be filed immediately. These statutory duties may create considerable time pressure during negotiations over a consensual restructuring. Failure to file for insolvency in due time is a criminal offence and may result in personal liability of the managing directors to the creditors of the company.
Generally speaking, a company is illiquid10 if it is unable to meet its payment obligations as they become due. If the company actually ceases to make payments, illiquidity is presumed. Under certain circumstances, a company that is unable to discharge its due obligations out of available cash might still be considered liquid if it can be expected to be able to discharge its liabilities (including any liabilities becoming due in this period) during the following three-week period.
According to the German Federal Court of Justice, illiquidity occurs if the debtor is unable to meet at least 90 per cent of its liabilities that are due or will become due within the following three weeks, unless (1) it can almost certainly be expected that the liquidity gap will be completely or almost completely eliminated in the near future and (2) delayed satisfaction of the relevant claims is acceptable based on the specific circumstances in each individual case. If the debtor's liquidity gap is less than 10 per cent of its total due liabilities, illiquidity does not occur, unless it is already foreseeable that the liquidity gap will increase to 10 per or more cent in the near future.
Two concepts are relevant in this regard.
In principle, an insolvency filing obligation arises if the liabilities of the company exceed the value of its assets. Technical over-indebtedness is tested by drawing up an over-indebtedness balance sheet that does not follow normal accounting principles but special insolvency law accounting rules. The over-indebtedness balance sheet would, in particular, need to be based on liquidation values (i.e., showing hidden reserves and taking into account potential distressed sales discounts) and include the costs of liquidation.
Even in the event that the company is technically over-indebted, there is no obligation to file for insolvency, if the company has a positive continuation prognosis. Pursuant to a widely held view in legal literature, this criterion requires that the liquidity of the company is sufficient to ensure that the company will be able to pay its debts becoming due within the current and the subsequent financial year. This means that, effectively, the company is legally not considered over-indebted if continuation of the business, based on a reasonable and careful assessment, is more likely than not, regardless of whether technical over-indebtedness exists. The assessment as to whether the continuation of the business is more likely than not, must be based on: (1) a realistic business plan; (2) a corresponding and realistic cash-planning corresponding to such business plan; and, resulting therefrom; (3) an analysis that the business plan and the cash planning provide sufficient confidence that the company will be able to continue operations for at least the current and the next business year. In larger restructurings, a positive going concern prognosis is very often confirmed by an expert opinion that is prepared in accordance with the IDW S 6 standard issued by the German Institute of Auditors.
If challenged, the directors of the company bear the burden of proof. The statutory duties in fact require directors to take all necessary steps to put themselves in the position to timely recognise the occurrence of any insolvency trigger.
ii Overview of German insolvency law
German insolvency proceedings can be split into two phases, first the preliminary insolvency proceedings and second the main insolvency proceedings.
Preliminary insolvency proceedings
Preliminary insolvency proceedings serve the purpose of assessing whether main proceedings can be opened while at the same time preventing detrimental changes in the insolvency estate. To protect the estate of the insolvent company, the insolvency court normally appoints a preliminary insolvency administrator immediately. The main tasks of a preliminary insolvency administrator are to (1) secure and preserve the debtor's estate; (2) continue the business operations until the insolvency court decides on the opening of main insolvency proceedings; and (3) verify if the insolvency estate covers the costs of the proceedings.
The duration of insolvency proceedings depends on individual factors, such as the size of the relevant insolvency estate, the number of creditors, the complexity of the envisaged restructuring and the state of the company's bookkeeping. In practice, preliminary proceedings often last for approximately three months because under certain conditions, the Federal Labour Office bears the salaries of the debtor's employees for the three months preceding the opening of main insolvency proceedings. The payment of the salaries of the debtor's employees is a significant incentive for (preliminary) insolvency administrators to keep preliminary insolvency proceedings open for the period of three months as this means a considerable positive cash effect for the insolvency estate. In fact, the subsidy can be key for the continuation of the debtor's business in insolvency. It is established practice in Germany that banks pre-finance the salaries of the debtor's employees to ensure that the debtor's employees are paid regularly in the preliminary insolvency stage.
The German Insolvency Act does not explicitly provide for a moratorium as part of the preliminary proceeding. However, the insolvency court can order a variety of 'provisional measures'. These measures can be ordered jointly with the court's opening decision or separately at a later stage. In particular, the insolvency court may order that (1) a preliminary insolvency administrator is appointed, (2) assets that would be subject to a right of segregation or for which separate satisfaction must not be used or collected by the creditors and (3) that the assets may be used to continue the enterprise insofar as they are of considerable significance for the insolvency estate. The insolvency court can also order that claims cannot be individually enforced against the debtor. These measures aim to keep the insolvency estate together to enable the insolvency administrator to pursue a structured sale of the business as a going concern or implement other restructuring measures.
If at any time during preliminary insolvency the preliminary insolvency administrator concludes that the company is in fact not insolvent or that the insolvency estate does not cover the costs of the proceedings, the insolvency court will terminate insolvency proceedings. In this case, creditors are free to enforce claims individually.
Main insolvency proceedings
Main insolvency proceedings serve the purpose of (1) winding down the insolvency estate by disposing of the debtor's assets (including a disposal of the entire business or parts thereof as a going concern) and distributing the proceeds to the creditors in accordance with the applicable priority provisions, or (2) restructuring the company by implementation of an insolvency plan to be approved by the creditors by majority vote in groups (see Section II.ii).
Once insolvency proceedings are opened, the insolvency court will appoint a regular (non-preliminary) insolvency administrator. Upon opening of main insolvency proceedings, the power to dispose of and administer the insolvency estate shifts to the insolvency administrator. The insolvency administrator is under an obligation to act in the best interests of the creditors. He or she is not responsible towards the shareholders of the insolvent company and will attempt to dispose of or restructure the debtor's business with a view to maximise the distributable proceeds. Notably, the insolvency administrator's remuneration is in general calculated on the basis of the insolvency estate recovered for the creditors.
While the enforcement of security rights by individual creditors in the preliminary stage depends on whether the insolvency court has ordered interim measures in favour of the debtor, no individual enforcement of the rights of unsecured creditors is possible once main proceedings are opened and the realisation of security is widely restricted. The insolvency administrator will, as part of his or her standard exercise, also check whether security rights can be contested and are thus voidable. In particular, security that was granted within the last three months preceding the insolvency filing bears a significant risk of being contested once main proceedings are opened.
In large-scale insolvencies, a (preliminary) insolvency administrator will usually: (1) first seek contact with the debtor's main stakeholders (including creditors, unions and shareholders, if any anchor shareholder is identifiable); and (2) initiate a structured sales process to give as many bidders as possible the opportunity to examine the business and submit offers for the whole business or parts thereof. This process will in most cases already have been initiated at the stage of preliminary insolvency proceedings. Often a deal is already negotiated at the time main proceedings are opened or even signed subject to the conditions that: (1) the main proceedings are opened; (2) the creditors' committee or the creditor assembly, as the case may be, approves the deal; and (3) the preliminary insolvency administrator is appointed as insolvency administrator. If the debtor's management has already been in (advanced) negotiations with a bidder prior to insolvency, the administrator will often be inclined to treat such bidder as preferred partner. However, a structured M&A process will comfort the insolvency administrator's position as the outcome will demonstrate that she or he ultimately entered into a reasonable deal.
Creditors' influence on insolvency proceedings
In insolvency, the insolvency estate is factually 'owned' by the creditors. Correspondingly, insolvency proceedings are mainly controlled by creditors rather than by the management or the shareholders. The creditors assert influence via the creditors' assembly and the (preliminary) creditors' committee.
Preliminary creditors' committee
The institution of a preliminary creditors' committee is mandatory if the debtor meets certain criteria in relation to his balance sheet total, gross turnover and number of employees. The insolvency court is responsible for appointing the members and instituting the committee. In a reasonably prepared insolvency, the debtor will already have reached an agreement with the main stakeholders that they will send representatives into the preliminary creditors' committee. The court will then be in a position to institute the committee at the very beginning of the proceedings.
The (final) creditors' committee shall consist of representatives of: (1) the secured creditors; (2) the insolvency creditors with the highest claims; (3) creditors with small claims; and (4) the employees. The composition rules are also practised for the preliminary committee. A 'typical' result of the institution process would, thus, be a committee with five or seven members, representing banks, the employees, the pension protection fund, smaller (trade) creditors, factoring companies and commercial credit insurance providers. Shareholders of the insolvent company who are personally liable cannot be members of the (preliminary) creditors' committee.
The preliminary creditors' committee's most important power is its ability to influence the selection of the (preliminary) insolvency administrator. A unanimous vote of the committee in favour of a candidate overrules a deviating court decision, provided the person elected by the committee is eligible, independent and neutral.
After main proceedings are opened and prior to the first creditors' assembly, the insolvency court may institute a creditors' committee. The members of the creditors' committee are then elected by the creditors' assembly. The committee's main task is to assist and to supervise the insolvency administrator. Certain fundamental decisions, such as the disposal of the business (or parts of it) require the prior consent of the creditors' committee and the committee is involved in all material decisions relating to the insolvency proceedings.
The main creditors' representative body of German insolvency proceedings is the creditors' assembly that can set up the creditors' committee or revoke any court-appointed creditors' committee. Core decisions regarding the insolvency proceedings, such as the decision whether to liquidate the insolvency estate or to temporarily continue the business operations of the insolvent company, are taken by the creditors' assembly. If no creditors' committee is appointed, certain fundamental decisions require the prior consent of the creditors' assembly. The sale of the business operations to a shareholder of the insolvent company requires the prior approval of the creditors' assembly in any event. Decisions of the creditors' assembly are taken by simple majority according to outstanding amounts. Subordinated creditors and creditors entitled to segregation do not have any voting rights in the creditors' assembly.
Large corporates have in recent years often filed for insolvency in the form of 'self-administration', which is a special type of formal insolvency proceeding similar to US debtor-in-possession proceedings. If the management applies for the initiation of self-administration and the insolvency court follows that route, the court will order that the management of the debtor stays in charge of the operations of the company, to the effect that the restructuring or the liquidation of the debtor is not implemented by an insolvency administrator but (as the case may be) by the management itself. Self-administration may only be ordered if it is not expected that self-administration could work to the detriment of the creditors.
Self-administration is often considered to be an effective tool in a situation where insolvency is not a result of the failure of the current management but rather because of external circumstances or failure of the previous management. In this situation, it is often preferable to make use of management's skills and company-related expertise and to have management implement a restructuring (or liquidation via asset deal) rather than bringing in an insolvency administrator who would have to start from scratch.
The management in self-administration will be supervised by a court-appointed (preliminary) custodian who needs to approve material transactions and reports to the insolvency court. Self-administration requires a skilled management, and the initial filing requires thorough preparation. Often, an insolvency in self-administration is being prepared as a plan B to back up negotiations with creditors on a consensual restructuring of debt. That way, the management preserves its options, should out-of-court negotiations fail. These processes are often steered by a CRO who was hired specifically for that purpose. Self-administration can – and very often is – combined with insolvency plan proceedings, in which case management would not only prepare and develop the insolvency plan, but also implement the plan once approved by the creditors.
Insolvency plan proceedings
Insolvency plan proceedings are an instrument to restructure or liquidate (e.g., via an asset deal) the insolvent company while derogating from the rules for the regular insolvency proceedings.
The preparation of an insolvency plan may be initiated by the debtor's management or by the insolvency administrator; the latter either on her or his own initiative or upon request of the creditors' committee. Insolvency plans are, at least in large-scale insolvencies, tailored individually. The underlying concept is that creditors are often better off if the business of the insolvent company is continued. In addition, the insolvency plan procedure allows the implementation of corporate measures that could not be used otherwise. A restructuring and sale of the businesses via insolvency plan may be particularly favourable if the value of the insolvent company consists of non-transferable intangible (IP) rights, concessions, licences, patents, favourable contracts11 or other assets that are not transferable in the course of an asset deal transaction without third-party consent. Other aspects that call for a restructuring of the debtor may be an intact stock exchange listing, the debtor's position as group parent with non-insolvent subsidiaries and a specific tax position. Often, insolvency plans are used to restructure the insolvent legal entity (in contrast to a liquidation of its assets and a subsequent winding down of the entity) including by implementing haircuts, operational restructurings such as the termination of unfavourable contracts or a reduction of the personnel under insolvency rules. The restructured entity can then be sold and transferred to an investor who, as consideration, injects fresh money into the entity and pays a purchase price into the insolvency estate. The transfer will then be an integral part of the insolvency plan and will become effective upon court confirmation.
The German Insolvency Code allows the inclusion of shareholders into the plan and explicitly provides that: (1) the constructive part of the plan may set forth that creditors' claims may be converted into share rights or membership rights in the debtor with the creditor's consent (debt-to-equity swap); and (2) the plan may foresee a decrease or increase in capital, the provision of contributions in kind, the ruling out of subscription rights, or the payment of compensation to outgoing shareholders. In essence, an insolvency plan may set out any rule permissible under corporate law.12 Procedural requirements and approvals that would apply under relevant corporate law for the implementation of any such corporate measure are suspended and substituted by the rules on voting and adoption of the insolvency plan. This involves that corporate law minority rights are widely suspended. Dissenting shareholders have little to no option to challenge a restructuring via insolvency plan other than by means of the limited remedies provided in the German Insolvency Code.
However, an insolvency plan can also provide that the debtor is liquidated by selling off business units as a whole by means of one or more asset deals, while winding down the remaining businesses by terminating unfavourable contracts with customers or suppliers, or both, and reducing staff. Finally, an insolvency plan may also be used to modify the proceedings as such without containing any substantive provisions or regulating the winding down.
An insolvency plan needs to be adopted with a majority vote of the creditors. An insolvency plan is voted on within creditor groups as provided for in the insolvency plan and within the statutory rules governing the composition of such groups. An insolvency plan is accepted if: (1) within each group a simple majority of the voting creditors – in number and according to outstanding amounts – consents; and (2) all groups consent. To prevent obstructive behaviour of individual creditors, the consent of a group of creditors is, simplified, deemed to have been granted if: (1) the members of the respective voting group are not worse off under the insolvency plan compared to the prospective outcome of regular insolvency proceedings; and (2) the majority of groups has consented the plan (so-called cram-down). Minority creditors are protected since creditors that have been overruled need to be better off under the insolvency plan than in regular proceedings.
Protective shield proceedings
In 2012, the German legislator introduced a modified preliminary self-administration proceeding by implementing the Schutzschirmverfahren. It neither constitutes an own type of insolvency proceeding nor a mechanism to restructure a company outside of insolvency proceedings (no pre-insolvency restructuring mechanism). Instead, protective shield proceedings are designed to buy a debtor that is not cash-illiquid time in order to prepare an insolvency plan under self-administration without running the risk of being liable for delaying insolvency. While the protective shield mechanism was first used to prepare pre-packed deals by means of an insolvency plan while avoiding liability risks on the part of the managing directors, the use of protective shield proceedings has declined over the last years.
In parallel to the application for self-administration, the company can apply for protective shield proceedings, upon which the insolvency court grants, under certain conditions, a 'protection period' of up to three months during which management can prepare an insolvency plan. During protective shield proceedings, there is a ban on individual enforcement. Main proceedings are being opened at the earlier of the lapse of the protection period and the time on which the debtors hand the insolvency plan to the insolvency court.
Clawback rights are substantial under German law and are subject to constant debate in Germany, with numerous disputed aspects and sometimes incoherent high court decisions. Despite recent reforms to cut back perceived excess clawback rights, the clawback regime still produces harsh results and is not always intuitive from a creditor's perspective. Restructuring activities are not per se privileged in Germany, and fees paid for advisory services with respect to a failed restructuring may, therefore, be subject to clawback. In practice, insolvency administrators often raise clawback claims to open a forum for discussions on a settlement. In the end, those confronted with potential clawback claims will often agree to make settlement payments to avoid lengthy court disputes with an uncertain outcome.
Under German law, both legal and factual transactions can be challenged. The term 'transaction' encompasses all actions causing legal effects that may decrease the value of the debtor's assets to the detriment of insolvency creditors. A detrimental effect is determined objectively and requires that the relevant transaction has prevented, endangered, hampered, impeded or delayed the satisfaction of insolvency creditors as a whole. Detrimental effects are caused by a reduction of the debtor's assets as well as by an increase of its liabilities. According to the prevailing view in German legal literature, even a sale of assets for a fair market value consideration can be deemed to be detrimental to the creditors of the debtor if the proceeds are no longer available at the time of insolvency (indirect detriment). The entering into, amendment, cancellation or assignment of contracts or contractual obligations as well as the detrimental effects of asset transfers and other in rem transactions are the most typical transactions to be challenged under German law. Upon successful enforcement of a clawback claim, the other party is obliged to return the assets to the insolvency estate or, if such return is not possible, compensate the insolvency estate in cash.
Important clawback rights
Detrimental transactions by a debtor with a third party are voidable if made during the last three months preceding the filing for opening insolvency proceedings and at a time when the debtor had been illiquid (i.e., unable to pay its debt) while such third party was aware thereof. Knowledge of the financial stress situation by the third party is likely to be assumed following, for example, due diligence exercises, communication during negotiations or other inside information obtained in business relations.
Detrimental transactions implemented up to ten years prior to the filing for insolvency may be challenged if the debtor acted with the intent to harm other creditors and the other party was aware thereof at the time of the action. The standard of intent is rather low and is easily fulfilled according to the courts. It is in particular presumed if the purchaser had knowledge that seller's illiquidity was more likely than not (>50 per cent) within the current or the subsequent financial year (referred to as 'imminent illiquidity'). Generally, courts readily assume intentional actions by both the debtor and the respective third party, in particular if the third party is aware of a financial distress situation. As a rule of thumb, a debtor is deemed to have acted with the intent to harm other creditors if it is generally aware that the transaction at hand is to the detriment of other creditors (because it cannot reasonably trust that all current and future creditors will be satisfied) and continues to act despite this awareness. A debtor acts with the intent to harm other creditors if the company is illiquid at the time of the transaction. In addition, courts have developed a number of prima facie evidence norms that have indicative significance in a court procedure. Where the transfer of an assets or granting of collateral was legally owed by the insolvent party (e.g., under contract), an intent to harm the creditors will only be presumed by the courts if the other party had knowledge that at the time when the transaction was implemented the debtor was actually illiquid (rather than only imminently illiquid) and in such cases the relevant clawback period will only be four years (rather than ten years).
Informal restructuring instruments
In the German restructuring practice a number of informal (i.e., not court-governed) tools and strategies can be observed, particularly in large-scale and cross-border cases, which often require innovative approaches to overcome the deficiencies of statutory laws.
Parties are in principle free to negotiate amendments of loan agreements and other legal relationships at any time. Such settlements have legal effect only between the parties. From a debtor's perspective, the main difficulty in initiating consensual restructuring discussions is that creditors are not obliged to contribute and neither are they prevented from enforcing their rights. In particular, small or secured creditors often have little incentive to agree on compromises. In order to be successful, a debtor will have to persuade main creditors to enter into a moratorium or stay agreement at an early stage of discussions. All parties involved may have to accept that hold-out creditors will ultimately be satisfied in full while others accept haircuts or make other concessions.
Restructurings in particular in the SME segment are sometimes implemented or governed by share trust structures, whereby creditors aim to shift control over the shares in the debtor from the previous owner to a professional trustee and a new management. Trustee and interim management will, subject to several conditions, exercise the shareholder rights and perform duties on behalf of the former legal owner and, at the same time, on behalf of the creditors. The underlying trust agreements usually define conditions under which the trustee is entitled or obliged, or both, to initiate a structured sales process for the company or specific businesses.
The terms of bonds (including secured bonds) that are subject to German law and for which the German Bond Act 2009 applies can be restructured by majority vote of the creditors, provided that the bond terms explicitly foresee the possibility for such modifications. In addition, the bondholders must approve material amendments in a bondholder meeting with 75 per cent of the votes cast. Today, most bonds issued under German law contain a clause that enables amendments of the terms by creditor majority resolution. It is also market-standard to appoint a common representative to streamline communication with the anonymous groups of bondholders in a situation of distress.
III RECENT LEGAL DEVELOPMENTS
In April 2017, the German legislator introduced amendments to the German Insolvency Code to limit clawback rights. The aim of the reform was to increase the predictability of clawback risks for (SME) companies doing business with financially distressed counterparts. In addition to the reduction of the clawback period from 10 years to four years in case of congruent coverage (see Section II.ii at Clawback risks), the amendments provided for a better protection of payments following a customary deferral of payment granted along the chain of suppliers and employee's claims. The interpretation of clawback rules remains controversial, and it is doubtful whether the 2017 reform meant substantial progress for SMEs confronted with a distressed supplier or customer.
On 21 April 2018, the German Law for the Facilitation of Group Insolvencies came into force. New provisions were introduced to the German Insolvency Code, aiming to address procedural challenges that emerge under German insolvency law in relation to an insolvency of a German company that belongs to a group. In line with the approach taken on a European level for cross-border insolvency cases (Article 56 et seq. of EU Regulation 2015/848 on Insolvency Proceedings, which came into force on 26 June 2017), the fact that the insolvent company is part of a group does not open the gate to combined insolvency proceedings. Each company remains obliged to file for insolvency separately, and proceedings are strictly independent. However, the new provisions introduced rules governing the communication and coordination of and between insolvency administrators and insolvency courts. The law now specifically appreciates that the same person can be appointed as insolvency administrator for more than one group company and recognises the option to determine a comprehensive group venue, and in case of conflicting interest between group companies the appointment of an additional administrator to solve such situations. Consequently, the German Insolvency Code allows that a 'group insolvency court' steers group coordination proceedings and appoints an additional group coordinator (if required in case there is not one administrator for all entities) whose task is to develop a comprehensive group coordination plan. Creditor committees and insolvency courts are legally obliged to coordinate and exchange information.
However, the new Directive on Preventive Restructuring Frameworks (see Section I) will have by far the greatest influence on German legislation in the near future. The Directive was adopted by the European Parliament in March 2019 and by the Council on 6 June 2019. The Directive will enter into force in summer 2019, most likely in June or July. Member States will then have two years to implement the Directive in their national legislation. The Directive is being critically discussed among German insolvency and restructuring experts.
Practitioners and experts in the competent Federal Ministry of Justice are currently exploring how the instruments and procedures could be reconciled with domestic insolvency law and how the German legislator should best use the considerable discretion Member States ultimately have under the EU framework law. The expectation is that the implementation will have a considerable impact on German restructuring practice and will also require substantial domestic insolvency reforms (e.g., in relation to the German concepts of 'imminent illiquidity' and 'over-indebtedness' that are recognised reasons for a debtor to file for insolvency, creditor protection mechanisms and insolvency court powers). A number of market participants have expressed concerns that the Directive may create incentives for debtors to initiate inefficient and apparently unsuccessful restructurings and that the framework law would shift too much power from insolvency courts, insolvency administrators and creditors to 'ruthless' debtors and their advisers. Lately, concerns have mainly focused on the introduction of a 'relative priority rule' as opposed to an 'absolute priority rule' with respect to the adoption of a restructuring plan. Whether Germany uses its discretion for the implementation of the Directive to differentiate the new rules from the previous formal procedure and thus allow companies to effectively use the various possibilities of restructuring will also be crucial. However, it can be expected that the directive provides a supplementary element to a differentiated insolvency regime, which appears necessary in view of the above-mentioned requirements in the changing restructuring landscape.
IV SIGNIFICANT TRANSACTIONS, KEY DEVELOPMENTS AND MOST ACTIVE INDUSTRIES
Despite the decrease in the number of insolvencies in 2017 and 2018, so far in 2019 there have been a number of large-scale insolvencies as well as prominent out-of-court restructuring activities.
The case still gaining a lot of media and restructuring experts' attention is the insolvency of Germany-based airline Air Berlin in 2017. Following a preliminary self-administration, the businesses of Air Berlin were ultimately sold in pieces by Air Berlin's German insolvency administrator and, as regards Air Berlin's subsidiary NIKI, an Austrian insolvency receiver, in each case to competitors from the aviation industry. The Air Berlin insolvency was remarkable not only owing to its size and general importance for the functioning of the European transportation sector but also because the NIKI insolvency marked a prominent test for the interpretation of Article 3 EU Regulation 2015/848 on Insolvency Proceedings (definition of COMI in a group context).
At this stage, the insolvency of Air Berlin still triggers large repercussions. The insolvency administrator of Air Berlin sued Etihad Airways in December 2018. He believes that in April 2017, Etihad, as a major shareholder of Air Berlin, made a legally binding commitment in a so-called 'hard letter of comfort' to support Air Berlin financially for the next 18 months. The insolvency administrator demands at least €500 million in damages and the court has determined a preliminary total amount in dispute of €2 billion. Lately, Etihad has argued that the court in Berlin has no jurisdiction and that proceedings should be opened in London.
In February 2019 another German airline, Germania, filed for insolvency. The local court of Berlin (Charlottenburg) opened insolvency proceedings over the assets of the company after the business had been closed on 1 April. The assets will be realised and finally distributed to the creditors (i.e., restructuring efforts did not succeed). The insolvency of two airlines shows that the market is in a consolidation phase.
The same applies to the renewable energy sector. Companies affected in 2018 included Schletter, a Bavarian photovoltaic company that was eventually sold to an investment company. In 2019, the most attention so far has been paid to Senvion. Senvion is a leading manufacturer of wind turbines and operates worldwide. It filed for the opening of insolvency proceedings under self-administration for its German businesses at the local court of Hamburg in April. The situation is already affecting others in the industry – SSC Wind, which specialises in the construction and maintenance of wind turbines, recently filed for an opening of insolvency proceedings.
Moreover, as already discussed in Section I, the automotive supply industry is expected to change rapidly, potentially requiring financial and operational restructurings as suppliers face serious challenges with the diesel crisis and the lack of an electric mobility strategy in many companies. Questions of ownership and control over data will become crucial for suppliers' systemic importance in the supply chain.
Other industries affected 2018 include the service sector (gfz services) and the consumer goods industry (Kettler, and in 2019 Loewe). The fashion industry is also still in a state of upheaval: In spring 2019 insolvency proceedings opened over the assets of Gerry Weber and retailer AWG filed for insolvency under self-administration proceedings in January. The insolvency proceedings over the assets of Paracelsus-Clinics, a major clinics operator, ended in 2018 with the sale of the company.
For the past 20 years, German insolvency law was subject to constant reform and discussion. While the German government does not intend to implement further material insolvency law reforms soon, the coalition agreement of the present CDU/CSU and SPD government dated 7 February 2018 mentions a few projects to be implemented in the present legislative term. These are:
- the introduction of a professional law for the qualification and admission of insolvency administrators (and custodians) plus guidelines for professional standards of work;
- concentration of insolvency courts (introduction of one-stop-shop elements) and digitisation of insolvency proceedings; and
- increased insolvency protection of customers in property development projects.
However, the next challenge to hit German insolvency law is the implementation of the European Directive on Preventive Restructuring Frameworks. The implementation of the Directive may force the German legislator to revise several domestic insolvency law concepts and rethink fundamental creditor protection instruments (see Sections I and III). In particular, it will turn out whether German insolvency law can withstand increasing European competition and whether Germany remains attractive as an insolvency location. The Europe-wide introduction of the Directive has the potential to further trigger competition among national legislation, and companies may increasingly resort to forum shopping. The individual implementation in the Member States will then decide which legal system is more preferable in each individual case.
1 Martin Tasma is a partner at Hengeler Mueller. The author wishes to thank Torsten Göcke, who authored previous versions of this chapter.
2 The ECB ended the net asset purchase programme in December 2018 but intends to continue reinvesting, in full, the principal payments from maturing securities purchased under the programme for an extended period of time past the date when it starts raising the key ECB interest rates, and in any case for as long as necessary to maintain favourable liquidity conditions and an ample degree of monetary accommodation.
10 German insolvency law recognises an additional reason for the director to file for insolvency: imminent illiquidity. However, imminent illiquidity is not a mandatory reason for the director to initiate insolvency proceedings and practical importance is low.
11 Change of control clauses do not apply if contracts are transferred under a plan.
12 The structuring of reorganisations via an insolvency plan is complex and requires corporate, insolvency and tax expertise, in particular since DES/haircuts generally create taxable restructuring gains on part of the debtor that may qualify as mass debt and which may impede the entire restructuring.