I OVERVIEW OF RESTRUCTURING AND INSOLVENCY ACTIVITY
The covid-19 pandemic has the world and Germany firmly in its grip: the business model of entire industries is no longer viable, global exchange of goods and services is disrupted, unemployment rates rise significantly, stock markets collapse and travel is restricted – all of those effects have a significant impact on the economy. Globalisation is coming to a halt. It is expected that the consequences will go beyond what the world experienced in the course of the financial and economic crisis in 2008 and subsequent years. The situation is particularly challenging because the economy is already facing a tense situation: 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 still creating concerns in Germany and among the customers of German industry, which is very export oriented.
Despite the availability of cheap funding as a consequence of the pandemic emergency purchase programme (PEPP)2 of the European Central Bank (ECB) and its generally loose money policy in past years, the outlook for the German economy has deteriorated. In recent months, governments and central banks have put together rescue packages worth billions, but it is not yet clear whether these measures will have a lasting effect to strengthen the economy. In 2019, Germany's gross domestic product rose only a little, by 0.6 per cent, compared to the previous year.3 This means that the German economy grew for the tenth year in succession, but at a much slower pace than in the previous year. Moreover, according to the German government's forecast, GDP in 2020 will fall by 6.3 per cent.4 This would plunge the German economy into a severe recession, which would be worse than in 2009, at a time of financial and economic crisis and thus worse than during the entire post-war period.
These circumstances have had and continue to have a significant impact on the German insolvency and restructuring market. In 2019, the German local courts reported 18,749 corporate insolvencies. According to the German Federal Statistical Office, this was 2.9 per cent less than in 2018. The number of corporate insolvencies filed for thus fell to its lowest level since the introduction of the German Insolvency Code in 1999. The last time numbers rose was in the crisis year 2009 (up 11.6 per cent compared to 2008).5 In January 2020, the German local courts registered 1,609 corporate insolvencies. This was 5.4 per cent less than in January 2019. Even though the number of corporate insolvencies has fallen, the expected claims of creditors in the amount of €4 billion are significantly higher than in the same month last year: in January 2019, those numbers stood at €1.2 billion. This increase in claims and the simultaneous decline in the number of corporate insolvencies is due to the fact that more economically significant companies filed for insolvency in January 2020 than in January 2019.6 This trend continued in February 2020, a month still unaffected by the covid-19 crisis: there were 3.2 per cent fewer corporate insolvencies than in the same month the previous year.7
To highlight current developments at an early stage, the Federal Statistical Office for the first time compiled provisional data on regular insolvency proceedings opened in Germany. Accordingly, the number of regular insolvency proceedings opened increased by 1.6 per cent in March 2020 compared to March 2019. However, the number of proceedings opened in April 2020 fell sharply by 13.4 per cent compared to the same month last year. The economic crisis caused by the covid-19 pandemic thus did not result in an increase in the number of insolvency proceedings opened in March and April.
However, the absence of such an increase, or even a decline in the figures as in April, does not come as a surprise at the time of writing. On the one hand, time passes between the filing for and the opening of regular insolvency proceedings. It is only after the decision in court on the opening or dismissal of proceedings that the numbers are included in the statistics. This processing time has also been lengthened by the partially restricted operation of the competent insolvency courts during the crisis. On the other hand, the German government's aid measures for companies during the covid-19 pandemic will probably prevent a rapid increase in the number of insolvency applications in the short term.8 These measures include first and foremost the temporary suspension of the obligation to file for insolvency until 30 September 2020 for the time being, regulated in the Covid Insolvency Suspension Act of 27 March 2020 (see Section III.i). However, according to a recent survey of the German Chamber of Commerce and Industry of May 2020, one in eight companies still fears insolvency due to revenue losses caused by the covid-19 crisis.9 Some insolvency administrators estimate that the pandemic will trigger a large wave of insolvencies in the fourth quarter of 2020, i.e. after protection measures under the Covid Insolvency Suspension Act expire.
At the centre of restructuring efforts are still two of Germany's key industries – the automotive sector and machinery and plant engineering. In addition, the aviation industry and the tourism-sector generally have been hit hard. For the automotive and engineering industries, the generally tense situation of recent years resulting from the effects of the diesel crisis and the lack of a coherent and sustainable electric mobility strategy is now aggravated by the covid-19 crisis: to contain the pandemic, many manufacturers and suppliers have had to close down their plants at least partially and stop their supply chains. The long-term effects of these measures are hardly foreseeable today. The vast majority of experts therefore expect particularly high defaults in the area of corporate loans in the coming months. The willingness of banks to provide fresh money for restructuring cases is also likely to decline further and a higher default rate is feared. The overall restructuring landscape shows a significant increase in financial corporate crises. The numbers will 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.10
The covid-19 pandemic has also caused a standstill in the regular M&A market. Some large transactions that had already entered an advanced stage are still being completed. Smaller and medium-sized transactions are nearly always on hold or have been cancelled. However, M&A activities are expected to resume soon by investors who have sufficient liquidity and who are willing to take the opportunity and risk to acquire companies that have fallen into crisis as a result of the covid-19 pandemic. Debt securities of companies that until recently were rock solid are suddenly trading at massive discounts. In many cases there will also be further disposals of lucrative subsidiaries to cover liquidity needs. Presumably, the distressed M&A market will be a driver in M&A for the next years and it appears likely that there will be even more activity in the market in the future.
Against this background, the Covid Insolvency Suspension Act has had the greatest impact on German insolvency and restructuring legislation in spring 2020 (see Section III.i for details). In addition, 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 (see Section III.ii). In particular, the German restructuring community believes that the implementation of the Directive on Preventive Restructuring Frameworks is essential to address the effects of the covid-19 pandemic, since it has the potential to introduce a preventive restructuring framework to save companies with a promising business and financing model without the need to enter into regular insolvency proceedings.
II GENERAL INTRODUCTION TO THE RESTRUCTURING AND INSOLVENCY LEGAL FRAMEWORK
The following provides an overview of the main features of the restructuring and insolvency framework. The individual rights and obligations are in part significantly modified by the new Covid Insolvency Suspension Act. Details of the this act are described in Section III.i.
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 sale proceeds distributed among the creditors.
i Duties of directors in a crisis situation
Directors of German companies are, in principle, 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-week period is only applicable if there are restructuring efforts under way that may be expected to be successful. Otherwise, insolvency must 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 illiquid11 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.
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 cent or more 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 if 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) corresponding and realistic cash-planning consistent with 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 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 may be split into two phases: the preliminary insolvency proceedings and the main insolvency proceedings.
Preliminary insolvency proceedings
Preliminary insolvency proceedings serve the purpose of assessing whether the main proceedings can be opened while at the same time preventing detrimental changes to 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 preliminary 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 the 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 critical 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 applies must not be used or collected by the creditors and (3) that the assets may be used to continue the business 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.
Once insolvency proceedings are opened, the insolvency court will appoint a regular (non-preliminary) insolvency administrator. Upon the 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. She or he 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 maximising 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 the main proceedings are opened and the realisation of security is widely restricted. The insolvency administrator will, as part of her or his 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 a bidder as the preferred partner. However, a structured M&A process will support 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 its 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 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, which can set up the creditors' committee or revoke any court-appointed creditors' committee. Core decisions regarding the insolvency proceedings, such as the decision on 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 an insolvency plan may be particularly favourable if the value of the insolvent company consists of non-transferable intangible (IP) rights, concessions, licences, patents, favourable contracts12 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) 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 in 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.13 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 corporate law minority rights being 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 by 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 (in simplified terms) 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 have consented to the plan (cramdown). 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 protective shield proceedings. This constitutes neither a further 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 time for a debtor that is not cash-illiquid 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 and at the same time avoid liability risks on the part of the managing directors, the use of protective shield proceedings has declined over the last years. Recently, and especially during the covid-19 pandemic, protective shield proceedings have become increasingly attractive again.
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. After expiry of the protection period or, under certain conditions, after revocation of the granting of the protection period, the court decides on the continuation of the insolvency proceedings.
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 10 years prior to the filing for insolvency may be challenged if the debtor acted with 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 other party had knowledge that (1) the seller's illiquidity was more likely than not (over 50 per cent) within the current or the subsequent financial year (referred to as imminent illiquidity) and (2) the transaction had a detrimental effect for the creditors. 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.
Informal restructuring instruments
In German restructuring practice, a number of informal (i.e., not court-governed) tools and strategies may 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. To be successful, a debtor will have to persuade the 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 of 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
i Covid Insolvency Suspension Act
The Covid Insolvency Suspension Act (see Section I) had by far the most impact on German insolvency legislation in spring 2020. The aim of the Act is to facilitate the continuation of companies affected by the covid-19 pandemic. The affected companies and their representatives shall be placed in a position and have time to take the necessary measures required, in particular, to take advantage of state aid made available for the purpose or to make financing or restructuring arrangements with creditors and capital providers. By limiting the risk of liability and avoidance, the legislator intends to create a framework in which loans can be restructured and existing business relationships (e.g., between suppliers or leasing partners and the debtor) can be preserved. The main features of the Covid Insolvency Suspension Act, inter alia, include:
- The obligation of the managing directors to file of insolvency (see Section II.i) is in principle suspended until 30 September 2020. The suspension of the obligation to file for insolvency does not apply only if (1) the insolvency is not due to the effects of the covid-19 pandemic or (2) there is no prospect of avoiding an existing illiquidity. The burden of proof lies with the party claiming the existence or a breach of the obligation to file for insolvency. The managing directors are protected by the fact that, if the company was not illiquid on 31 December 2019, it is assumed that (1) the grounds for insolvency are due to the covid-19 pandemic and (2) there are prospects of eliminating an existing illiquidity.
- The opening of insolvency proceedings in respect of applications filed by creditors (third-party applications) was suspended until 28 June 2020 (unless the grounds for insolvency already existed on 1 March 2020).
- In principle, a managing director is liable vis-à-vis the company for payments that, contrary to the statutory prohibition of payments that are not essentially required to avoid a collapse of the business or the non-payment of which would constitute a criminal offence, have been made after the company becomes illiquid or over-indebted. According to the Covid Insolvency Suspension Act this statutory prohibition of payments was loosened substantially: all payments made in the ordinary course of business during the suspension period and which serve to maintain or restore the business operations are deemed to be made in accordance with the diligence of a prudent and conscientious manager and are therefore permissible.
- The granting of loans to companies in need of restructuring (fresh money) was subject to strict conditions under existing law. Lenders were faced, inter alia, with the risk of avoidance of certain transactions in insolvency. The Covid Insolvency Suspension Act provides for far-reaching privileged treatment of new loans under avoidance rules to encourage the provision of additional liquidity by granting such loans. Repayments of shareholder loans are protected under the same conditions as repayments of third-party financing. If loans that have been granted during the suspension period are repaid until 30 September 2020, repayments are not considered to be detrimental to creditors and are therefore not subject to avoidance in subsequent insolvency proceedings. Collateral provided by the debtor to secure third-party financing during the suspension period is also not subject to avoidance. However, this privilege does not apply to collateral granted for shareholder loans. The collateralisation of shareholder loans continues to be detrimental to creditors and can be avoided. Special rules apply for novation, prolongation and economically comparable circumstances, as well as for loans provided as state aid.
- Under existing law, lenders were always faced with the risk of liability under tort law for a delay in filing for insolvency to the detriment of other creditors (so-called lender's liability). In this respect, the Covid Insolvency Suspension Act provides for far-reaching privilege regarding the treatment of new loans or the prolongation of existing loans during the suspension period, thereby reducing liability risks.
- The Act affords protection against avoidance not only to lenders but also business partners of the debtor holding continuing obligations such as lessors, landlords and suppliers. In such cases, the relevant counterparty feared that they would have to return payments received in the event of the failure of restructuring efforts due to insolvency avoidance. This would be an incentive to terminate the contractual relationship by the fastest means possible and would frustrate the restructuring efforts. For this purpose, the Covid Insolvency Suspension Act, inter alia, provides that contractual performances (including the granting of security) that are rendered as agreed shall not be subject to avoidance. This does not apply if the recipient was aware that the debtor's restructuring and financing efforts were not sufficient to eliminate an illiquidity that had occurred.
ii Directive on Preventive Restructuring Frameworks
In the months prior to the covid-19 crisis, the new Directive on Preventive Restructuring Frameworks (see Section I) was expected to have the most influence on German legislation in the near future. The Directive entered into force in summer 2019 and must be implemented by the Member States in their national legislation by 17 July 2021. 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 that 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, which 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 on Preventive Restructuring Frameworks 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. 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 on Preventive Restructuring Frameworks 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 is expected that the Directive on Preventive Restructuring Frameworks will provide a supplementary element to a differentiated insolvency regime, which appears necessary in view of the above-mentioned requirements in the changing restructuring landscape.
There is a growing voice claiming that the framework should enter into force as quickly as possible to cope with the increased number of financial restructurings expected for the fourth quarter of 2020 as a result of the covid-19 pandemic.
IV SIGNIFICANT TRANSACTIONS, KEY DEVELOPMENTS AND MOST ACTIVE INDUSTRIES
In 2019 and so far in 2020, there have been a number of large-scale insolvencies as well as prominent out-of-court restructuring activities.
The airline business was hit hard by insolvencies over the course of last year and remains in a turbulent state. The insolvency of Air Berlin in 2017 triggered 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 'hard letter of comfort' to support Air Berlin financially for the next 18 months. The insolvency administrator demands at least €500 million in damages. Etihad had argued that the court in Berlin has no jurisdiction and that proceedings should be opened in London. The London High Court accepted jurisdiction at the end of 2019, but in January 2020 the insolvency administrator appealed against the decision.
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 2019. The assets will be realised and finally distributed to the creditors (i.e., restructuring efforts did not succeed).
Following its parent company Thomas Cook and its German subsidy, Condor entered into self-administration proceedings in December 2019. Polish Aviation Group (PGL), the parent company of Polish airline LOT, was planning to acquire Condor. In April 2020, it was announced that PGL dropped its planned acquisition of Condor because its subsidiary LOT may resort to state aid itself. According to reports, the German state could also step in temporarily as owner. The insolvencies and restructuring efforts of many airlines show that the market, which was already in a consolidation phase in 2019, could implode as a consequence of the covid-19 pandemic and the collapse of air traffic. The survival of many companies will depend on whether government support measures take effect to help these particularly hard-hit sectors out of the crisis.
The same applies to retailers and the fashion industry. In early 2019 insolvency proceedings opened over the assets of Gerry Weber. Self-administration proceedings were revoked by the local court of Bielefeld with effect on 31 December 2019. According to information provided by the company, Gerry Weber will continue its operational restructuring into 2023. Despite closing many shops due to the lockdown during the covid-19 pandemic, the company is optimistic that the restructuring will be successfully completed. In April 2020, department store chain Galeria Karstadt Kaufhof applied for protective shielding proceedings. Due to the covid-19 crisis and the state-ordered closure of shops, the department store chain plans to close 62 of the total of 172 department stores.
The automotive industry also remains the problem child of the German economy. Pressmetall Group, a manufacturer of aluminium die-casting components with more than 700 employees, filed for insolvency under its self-administration in December 2019. Previously, companies such as Weber Automotive and Avir Guss had already filed for insolvency. The automotive supplier Veritas has filed for insolvency during the covid-19 crisis with the Hanau local court in April 2020. Approximately 2,200 employees at the German locations are affected by the insolvency. It seems particularly dramatic in the current crisis that many of the suppliers found themselves in financial difficulties before the covid-19 pandemic and their business model was considered anything but secure in light of the changing economic landscape. Whether a restructuring or a sale is even realistic in the current crisis is often uncertain.
In 2019, a lot of attention was paid to Senvion. The company was a leading manufacturer of wind turbines and operated worldwide. It filed for the opening of insolvency proceedings under self-administration for its German businesses at the local court of Hamburg in April 2019. Initially there was still hope of being able to maintain the company as a whole in view of a good order backlog. In September 2019 the creditor assembly approved the insolvency plan to sell the assets of the company in pieces.
V INTERNATIONAL and future developments
For the past 20 years, German insolvency law has been subject to constant reform and discussion. The upcoming challenges for the German insolvency law regime are mainly (1) the practical implications for day-to-day business following the introduction of the Covid Insolvency Suspension Act and (2) the implementation of the European Directive on Preventive Restructuring Frameworks into the national framework.
With the Covid-19 Insolvency Suspension Act, the legislator has reacted rapidly to the sharp increase in corporate insolvencies expected as a result of the covid-19 pandemic by temporarily suspending the obligation to file for insolvency. The effects of the new legislation on the liability of managers extend far beyond the suspension period provided by the Act. In particular, the Act is intended to create a safe harbour for lending and similar financial measures for potential investors and lenders to facilitate the continuation of businesses during the crisis. It will only become clear in retrospect, perhaps years later, how the individual provisions of the law will be interpreted by the courts. Against this background, creditors and investors are well advised to closely observe the legal peculiarities during the crisis, not only to avoid liability risks but also to be able to exploit possible advantages of the new frameworks.
The implementation of the Directive on Preventive Restructuring Frameworks may force the German legislator to revise several domestic insolvency law concepts and rethink fundamental creditor protection instruments (see Sections I and III.ii). In particular, it will determine whether German insolvency law can withstand increasing European competition and whether Germany can establish itself as an attractive location for restructuring in the future. In view of Brexit and the withdrawal of the United Kingdom from the European legal framework, there is room for manoeuvre, which could be filled by the German system. The Europe-wide introduction of the Directive on Preventive Restructuring Frameworks 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 preferable in each individual case. It remains to be seen whether a possible rapid implementation of the Directive can help to mitigate the economic impact of the covid-19 crisis in the medium term.
1 Martin Tasma is a partner at and Moritz Müller-Leibenger is an associate at Hengeler Mueller.
2 The PEPP is a temporary asset purchase programme of private and public sector securities recently increased by €600 billion to a total of €1,350 billion. All asset categories eligible under the existing asset purchase programme are also eligible under the new programme.
11 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 its practical importance is low.
12 Change of control clauses do not apply if contracts are transferred under a plan.
13 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 claims against the estate and which may impede the entire restructuring.