The Restructuring Review: Germany
Overview of restructuring and insolvency activity
With the introduction of measures to mitigate the effects of the covid-19 pandemic, the global economy seemed to be set for a path of sustained recovery, with growth rates in 2021 the highest in more than four decades.2 Despite the significant momentum, the wake of the pandemic is still holding the world and Germany in a tight grip. Strengthened economic activities in 2021 promptly led to a shortage in supplies and a general disruption of supply chains. Inflation rates have also surged as a result, leading central banks to contemplate further interest rate hikes, which would likely dampen the economic recovery. In addition, the outbreak of the Ukraine crisis severely unsettled the global economy, and commodity and energy prices grew significantly, the long-term economic effects of which are still to be seen. The recent economic recovery thus remains fragile.
These ongoing difficulties are reflected in the situation of the German economy. The gross domestic product (GDP) in Germany was only 2.9 per cent higher in 2021 than in the previous year and has thus not yet reached pre-pandemic levels. However, the forecasts for 2022 look promising despite the Ukraine crisis. Germany's GDP is expected to rise by 3 per cent in 2022 compared with the previous year, according to forecasts.3
The number of insolvencies does not match these economic indicators: in 2021, German courts reported 13,993 corporate insolvencies. According to the Federal Statistical Office, this was 27.2 per cent lower than in 2019, the year before the outbreak of the covid-19 pandemic.4 The number of filings for corporate insolvency fell to their lowest level since the introduction of the Insolvency Code in 1999. Thus, somewhat paradoxically, the economic hardship caused to many companies did not result in an increase in corporate insolvencies. This is mainly the result of the extensive aid measures and legislative changes enacted by the German government to prevent a surge of corporate insolvencies. It remains to be seen whether an increase in corporate insolvencies will occur by the end of 2022 after the effects of state aid measures have slowly worn off.
Restructuring efforts in 2021 focused mainly on industries that were severely affected by the consequences of the covid-19 crisis. The automotive industry, in particular, suffered from disruptions in supply chains and rising energy and raw material prices. Overall, though, the number of restructuring cases stagnated in 2021. In a survey conducted at the end of 2021, only 16 per cent of professionals in bank restructuring departments said they had received more restructuring cases in the past six months.5 However, 49 per cent of respondents expected that the number of new restructuring cases will increase or increase significantly over the next six months.6 Although experts do not foresee a wave of insolvencies in the near future, it appears inevitable that some heavily indebted companies will soon experience trouble in refinancing.7
In the mergers and acquisitions (M&A) market, the situation is different. As a result of the covid-19 pandemic and expiring state aid measures, companies are in a weak position and therefore a potential target for buyers. Experts expect a significant increase in distressed M&A deals in 2022. Such an increase had not yet occurred at the beginning of 2022. This could be related to the effects of the Ukraine crisis as many transactions have been put on hold.8 The Ukraine crisis poses challenges for the M&A market because not only are companies with direct links to Russia affected but also companies whose valuation has come under pressure as they are not able to achieve their full potential due to higher energy and raw material prices and interruptions of supply chains.9
In light of the above, the covid-19 crisis still had the greatest impact on the German insolvency and restructuring sector in 2021. This is reflected in the most significant insolvencies and restructurings during this period (see Section IV). Now that the pandemic seems to be more manageable, the economic recovery faces further headwinds. Despite the occurrence of only few cases over the course of the past year, the newly implemented Corporate Stabilisation and Restructuring Act (StaRUG), which was introduced at the beginning of 2021, might prove to be an additional tool to handle these challenges (see Section III). As its scope is mainly limited to financial restructurings, operational measures will continue to be addressed by the general insolvency legal framework (see Section 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 is obliged 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 within insolvency proceedings 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 statutory obligation to file for insolvency without undue delay, but in no event later than after the expiry of (1) three weeks if the company is illiquid or (2) six weeks if the company is over-indebted. The period is applicable only if there are restructuring efforts under way that are expected to be successful. Otherwise, insolvency must be filed immediately. These statutory duties might create considerable time pressure during negotiations over a consensual restructuring. Failure to file for insolvency in due time is a criminal offence and might 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 falling due within the next three weeks. If the company actually ceases to make payments, illiquidity is presumed. Even if there is a liquidity gap at the end of the three-week period, the company is not considered illiquid if such a gap is smaller than 10 per cent of the payment obligations due on the relevant reference date, unless it is already foreseeable that the gap will soon exceed 10 per cent. On the other hand, a liquidity gap greater than 10 per cent might still not trigger illiquidity if (1) such a gap will almost certainly be reduced in the short term and (2) delayed satisfaction of the relevant claims is acceptable based on the specific circumstances in each individual case.
Two concepts are relevant in this regard.
A company is over-indebted if its liabilities exceed the value of its assets. Technical over-indebtedness is tested by drawing up an over-indebtedness balance sheet that follows 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.
Despite the occurrence of technical over-indebtedness, a company is not considered over-indebted if it has a positive continuation prognosis. After legislative changes in early 2021, this criterion requires that the liquidity of the company is sufficient to ensure that the company will be able to pay its debts due within the next 12 months. Based on a reasonable and careful assessment, the company's continuation must be more likely than not. 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 a 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 the next 12 months. The continuation prognosis must be prepared and updated on a rolling basis. 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 recognise in a timely manner the occurrence of any insolvency trigger.
ii Overview of German insolvency law
German insolvency proceedings are split into two phases: preliminary insolvency proceedings and 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 to the insolvency estate. To protect the estate of the insolvent company, the insolvency court usually appoints a preliminary insolvency administrator immediately who will (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 whether 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. This is a significant incentive for (preliminary) insolvency administrators to keep preliminary insolvency proceedings open for the entire period, 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 during insolvency proceedings. 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 proceedings. However, the insolvency court can order a variety of provisional measures. In addition to appointing a preliminary insolvency administrator, the court may order that (1) 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 (2) 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 (preliminary) insolvency administrator to prepare a structured sale of the business as a going concern or implement other restructuring measures.
The insolvency court will terminate insolvency proceedings if the preliminary insolvency administrator finds that the company is not insolvent or that the insolvency estate does not cover the costs of the proceedings.
Main insolvency proceedings
Main insolvency proceedings serve the purpose of either (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) 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 statutory obligation to act in the best interests of the creditors. They are not responsible towards the shareholders of the insolvent company and will act to maximise the distributable proceeds.
During the main insolvency proceedings, a moratorium applies with the effect that no individual enforcement of the rights of unsecured creditors is possible and the realisation of security is widely restricted. The insolvency administrator will, as part of their standard exercise, also check whether security rights can be contested and are thus voidable. In particular, security that was granted within the past three months preceding the insolvency filing bears a significant risk of being voided.
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 negotiated at the time when main proceedings are opened or even signed subject to the conditions that (1) main proceedings are opened; (2) the creditors' committee or the creditors' assembly, as the case may be, approves the deal; and (3) the preliminary insolvency administrator is appointed as insolvency administrator.
Creditors' influence via creditors' assembly and (preliminary) creditors' committee
During an insolvency, the insolvency estate is factually owned by the creditors as the shareholders will usually be 'out of the money'. 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.
The main creditors' representative body in German insolvency proceedings is the creditors' assembly. Core decisions regarding the insolvency proceedings, such as 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 its prior approval 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.
Before the first creditors' assembly convenes, the insolvency court may appoint a creditors' committee. Thereafter, the creditors' assembly can set up a creditors' committee or revoke any court-appointed creditors' committee. 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. It 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. It would typically consist of 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.
During preliminary proceedings, 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. Its composition follows the rules set out above for the creditors' committee. In a reasonably prepared insolvency, the debtor will already have reached an agreement with the main stakeholders to the effect that they will send representatives into the preliminary creditors' committee. The court will then be able to institute the committee at the very beginning of the proceedings. Most notably, the preliminary creditors' committee may 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 that the person elected by the committee is eligible, independent and neutral.
Self-administration proceedings and protective shield proceedings
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 company's application for the initiation of self-administration meets certain criteria, the court will order the management to remain in control of the insolvent company and appoint a (preliminary) custodian. The custodian serves as a kind of supervisor to the management, who has to approve certain material transactions and who reports to the insolvency court. In early 2021, the prerequisites for entering into self-administration proceedings were further tightened, requiring the debtor, inter alia, to submit financial planning for the next six months. In any event, self-administration may be ordered only if it is not expected that self-administration will work to the detriment of the creditors.
Self-administration is often considered to be an effective tool if the insolvency is not a result of the failure of the current management but rather because of external circumstances or failures of the previous management. Rather than bringing in an insolvency administrator, it will often be preferable to retain management's skills and company-related expertise to implement a restructuring (or liquidation via an asset deal).
Self-administration proceedings may be applied for during both preliminary and main insolvency proceedings. For preliminary proceedings, the company may also apply for protective shield proceedings, a subtype of self-administration, which essentially serve the purpose of buying time for the debtor. Under protective shield proceedings, a liquid debtor may prepare an insolvency plan under self-administration without risking personal liability for delaying the insolvency. If certain prerequisites are satisfied, the court may grant a protection period of up to three months during which a ban on individual enforcement applies. After expiry of the protection period or its revocation, the court will decide on the continuation of the insolvency proceedings. The use of the instrument has declined over the past years but has seen a significant increase during the covid-19 pandemic as it faces less stigma.
Self-administration requires skilled management, and the initial filing requires thorough preparation. Often, an insolvency in self-administration will be 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 chief restructuring officer 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 it is 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 their 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 continues. 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 (intellectual property) rights, concessions, licences, patents, favourable contracts11 or other assets that are not transferable 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. Restructuring measures implemented by means of an insolvency plan often include implementing haircuts of outstanding debt, operational restructurings (such as the termination of unfavourable contracts) or a reduction of personnel under insolvency rules. The restructured entity can then be sold and transferred to an investor. This will typically 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 it may foresee (1) a debt-to-equity swap subject to the creditors' consent and (2) 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 corporate measure permissible under corporate law that would otherwise be difficult to implement.12 Its adoption may substitute certain procedural requirements and approvals, as the case may be. 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 be 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. It 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 with the prospective outcome of regular insolvency proceedings and (2) the majority of groups have consented to the plan (cramdown). Minority creditors are therefore protected.
Clawback rights are substantial under German law and subject to constant debate, with numerous disputed aspects and sometimes incoherent High Court decisions. Despite recent reforms to reduce its perceived excess, 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 in respect of 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.
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 the 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 detrimental if the proceeds are no longer available at the time of the 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 a 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 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 a third party was aware thereof. Transactions for nil consideration are also voidable if they have been effected within the four years immediately preceding the insolvency filing.
In addition, any repayment of shareholder loans within the year immediately preceding the insolvency filing is voidable. The same applies to comparable transactions with a similar economic effect (e.g., any payments by the company to a third party to settle a liability secured by the shareholder). Moreover, security granted to secure a shareholder loan is voidable if the security was granted within the 10 years immediately preceding the insolvency filing.
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. However, the Federal Supreme Court recently slightly tightened the prerequisites under which intent may be assumed. Knowledge of the other party is, in particular, presumed if it had knowledge that (1) the seller's illiquidity was more likely than not (over 50 per cent) within a period of (generally) 24 months (referred to as imminent illiquidity) and (2) the transaction had a detrimental effect for the creditors.
iii 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 they are not 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 might have to accept that holdout creditors will ultimately be satisfied in full while others accept haircuts or make other concessions.
Restructurings, in particular in the small and medium-sized enterprises 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.
Recent legal developments
The StaRUG remains the most important legal innovation in 2021 and 2022. It came into force on 1 January 2021 implementing Directive (EU) 2019/1023 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).
StaRUG introduced a pre-insolvency restructuring framework to be initiated by the debtor on the basis of a restructuring plan. The framework is accessible in the case of imminent illiquidity (i.e., if the occurrence of a liquidity shortfall within 24 months is more likely than not), provided that the company is neither over-indebted (taking into account the restructuring as envisaged by the restructuring plan) nor illiquid. The restructuring measures implemented in the restructuring plan can be limited to certain types of creditors (e.g., financial creditors), provided that the selection is appropriate.
To become effective and binding upon all creditors affected by the restructuring plan, the plan must be approved by a majority of at least 75 per cent of the total number of all of the rights in each class. However, the new framework not only allows the majority of creditors within one class to outvote the dissenting minority within one class of creditors but also allows consenting classes to overrule a whole dissenting class of creditors (cross-class cramdown). The approval of a dissenting class of creditors is deemed to be granted if (1) the majority of classes has voted in favour of the restructuring plan, (2) the relevant dissenting class is not worse off under the plan as compared with its situation without the plan and (3) the relevant dissenting class receives a fair share in the plan value.
The court's involvement is optional upon the debtor's request for individual restructuring instruments. The debtor can choose between different instruments generally available under the framework (modular pick-and-choose approach) (e.g., stay on enforcement and court-organised voting on the plan). As well as changes to, for example, financing agreements such as haircuts or maturity extensions, the plan may provide for changes to the corporate structure of the company (such as a debt-to-equity swap). In this respect, certain privileges apply to the effect that the corporate measures set forth in the plan do not have to meet stricter corporate law requirements as long as they meet the requirements of StaRUG. The plan provides protection from clawback risks for new financing granted under the plan.
The new pre-insolvency restructuring framework introduced by StaRUG represents a powerful addition to the German restructuring toolbox, but it is also characterised by many compromises and concessions made in the legislative process. In particular, the framework does not allow for the termination or alteration of employment agreements or unfavourable contracts, hence practically limiting its scope of application to financial restructurings. Also, as a last-minute change, the Ministry of Justice dropped a proposal according to which the duty of the managing directors to observe the interests of the company and its shareholders would have shifted in a crisis situation to a prioritisation of the creditors' interests.
The introduction of a restructuring framework allowing for non-consensual restructuring against the will of dissenting minorities outside formal insolvency proceedings certainly marks a major shift in German law13 and will strengthen the German restructuring market. The newly introduced framework will present a viable alternative to the restructuring of German companies on the basis of an English law scheme of arrangement or a company voluntary arrangement. In the past, we saw German companies move their centre of main interests to the United Kingdom to access English law restructuring procedures. Although important questions surrounding the recognition of a restructuring plan sanctioned under the new framework in other jurisdictions are still open and unresolved, we believe that the new framework will substantially limit cases of 'restructuring tourism' experienced over the past 15 years. In particular, non-consensual haircuts or restructuring of financial debt will be achieved more easily and without the need to initiate formal insolvency proceedings affecting all stakeholders of the company and often destroying value and reputation with trade creditors and customers (insolvency stigma).
In practice, even after more than a year, the number of restructurings conducted under the StaRUG is still quite limited (see also Section IV). The regulations under the StaRUG are complex and yet widely untested, requiring a company in crisis to seek extensive legal advice. Hence, it might be some time before the procedure will also be accessible to and attractive for Germany's economic backbone, Mittelstand, which consists to a large extent of many small and medium-sized companies. As StaRUG is particularly suitable for financial restructurings, the mechanism might be used often in the future to deal with rising debt levels of German companies that have increased as a consequence of recent economic crises.
Significant transactions, key developments and most active industries
Despite the historically low number of corporate insolvencies due to the measures taken in response to the covid-19 pandemic, 2021 and 2022 so far have shown a significant number of large-scale insolvencies as well as prominent out-of-court restructuring activities.
As in the year before, the retailer and fashion industries are still struggling to cope with the wake of the covid-19 crisis. Adler Modemärkte was one of the first large-scale companies to file for insolvency in self-administration in January 2021 after the suspension of the filing obligation ended in 2020. The company received a loan in the amount of €10 million from the Germany Economic Stabilisation Fund and formal proceedings were opened in July. The company was acquired by Zeitfracht Group upon successful implementation of an insolvency plan. It has since experienced a rapid recovery and managed to regain profitability by 2022. Through the proceedings, 137 of the 160 stores were saved and 2,600 of 3,100 jobs were retained.
Making use of the newly implemented restructuring toolkit StaRUG, Eterna has undergone a financial restructuring of its holding entity leaving the operational side untouched. The restructuring court recently confirmed the restructuring plan that was previously approved by the creditors. The plan provides for a significant haircut for bondholders and a waiver of a shareholder loan in the amount of €32 million. In addition, the shareholder agreed to provide additional equity to pay the remaining debt under the bonds and finance the operational business, and a new investor also provided new capital.
The aviation industry has also continued to suffer under the pandemic, with airport operator Frankfurt Hahn filing for insolvency proceedings in October 2021, followed by its parent company, which filed for insolvency in November 2021. In connection with the insolvency of the airport, several other subsidiaries of the Chinese HNA Group have also filed for insolvency. The formal insolvency proceedings were opened in February 2022.
Another branch of the travel industry affected by the covid-19 pandemic was local public transport. Abellio, a public transport train operator, sought cover under protective shield proceedings in self-administration. The Local Court of Berlin-Charlottenburg opened formal insolvency proceedings in self-administration in October 2021.
Following the far-reaching transformation of the automotive industry and the semiconductor crisis, many German automotive suppliers are under pressure more than ever. The Local Court of Passau opened formal insolvency proceedings over the assets of A-Kaiser, a producer of lightweight aluminium components, after a major customer ended its relationship with the company. The insolvency administrator sold parts of the estate by way of an asset deal. A-Kaiser also received government aid only a few months earlier. Bolta-Werke, another supplier for the automotive industry, filed for insolvency after the shortage in semiconductors forced customers to postpone orders and left the company with a collapse in sales. It seeks to restructure through the insolvency proceedings and has support from its customers, enabling it to continue its business operations.
One of the most prominent cases in 2021 was the insolvency of Greensill Bank. The Local Court of Bremen opened formal insolvency proceedings in March 2021 after the German Federal Financial Supervisory Authority (BaFin) filed for insolvency of the company. Only a few weeks before, after KPMG, the auditor mandated by BaFin, was not able to confirm the existence of material assets, BaFin imposed a moratorium effectively freezing the bank's assets. The company's parent, which is also insolvent, financed supply chains by acquiring receivables and packaging them into bond-like securities sold to investors. The company attracted many retail and institutional investors with comparatively high returns, among them several municipalities heavily invested with the bank. Although retail investors are secured by the statutory deposit guarantee and the deposit guarantee fund up to a certain maximum amount, municipalities are not and fear a significant haircut. Roughly €500 million of investments not secured by the deposit guarantee are at stake. In addition, criminal charges were brought against the former management.
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 will now mainly be (1) the return to normal after some of the extensive government aid measures have ended, (2) tackling of substantial debt levels of German companies while dealing with the economic effects of the new political landscape, and (3) the further implementation of StaRUG into the national framework and practice.
After certain legal measures to prevent an increase in corporate insolvencies during the covid-19 pandemic ended in 2021, it remains to be seen how the German economy will cope with the return to standard, pre-crisis insolvency laws. This is especially the case considering the economic hardship relating to the crisis in Ukraine and interest hikes depressing hopes for a swift economic recovery. Furthermore, repayments of government aid will become due in the near future, straining the financial flexibility of many companies.
Finally, the implementation of StaRUG forced the German legislator to revise several domestic insolvency law concepts and rethink fundamental creditor protection instruments. Practice will show whether German insolvency law can withstand increasing European competition and whether Germany can establish itself as an attractive location for restructuring in the future. StaRUG might play a significant role in this. Despite its limited practical use in the past year, it remains to be seen in the course of the next years whether StaRUG can nevertheless prove to be a useful tool in combating the upcoming challenges. The Europe-wide introduction of the Directive on Preventive Restructuring Frameworks has the potential to further trigger competition among national legislation, and companies might increasingly resort to forum shopping. The individual implementation in the Member States will then decide which legal system is preferable in each individual case. In the Netherlands, for example, the system of pre-insolvency restructuring proceedings differs from the German system (e.g., judicial involvement in the Dutch proceedings is reduced to a large extent). It therefore remains to be seen whether the proceedings in certain countries will be more attractive for the parties involved than those in other countries.
1 Martin Tasma is a partner and Moritz Müller-Leibenger is a senior associate at Hengeler Mueller.
2 Information based on a report of the United Nations, 'World Economic Situation and Prospects 2022', available at https://www.un.org/development/desa/dpad/publication/world-economic-situation-and-prospects-2022/.
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.
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 as debt-to-equity swaps or haircuts generally create taxable restructuring gains on the part of the debtor that might qualify as claims against the estate and that might impede the entire restructuring.
13 Restructuring of rights of creditors outside insolvency plan proceedings by majority vote was possible only for bonds governed by the German Bond Act 2009.