The Restructuring Review: Germany

The covid-19 pandemic has the world and Germany still firmly in its grip: the business model of entire industries is no longer viable, global exchange of goods and services is disrupted and international travel is restricted – all of those effects keep having a significant impact on the economy. Even though some countries such as the United States and China have begun to recover strongly and the outlook in Germany is improving, the overall situation is still challenging. The global economy is picking up pace, but is still overshadowed by the pandemic. These aspects have had a great impact on the German economy and the customers of German industry, which is very export oriented.

According to calculations, the gross domestic product (GDP) in Germany was 4.9 per cent lower in 2020 than in the previous year.² After a 10-year growth phase, the German economy thus fell into a deep recession following the coronavirus crisis, similar to the financial and economic crisis of 2008/2009. However, the German government predicts that the recession is not as severe as feared and the upturn will occur faster than expected. For 2021, the federal government expects GDP to increase by 3.5 per cent compared to the previous year and the pre-pandemic economic performance is not expected to be reached again until mid-2022.³

The numbers of insolvencies do not yet match these economic indicators: in 2020, German courts reported 15,841 corporate insolvencies. According to the Federal Statistical Office, this was 15.5 per cent lower than in 2019. The number of corporate insolvencies filed thus fell to its lowest level since the introduction of the Insolvency Code in 1999. The last time the numbers increased was in 2009, when 11.6 per cent more corporate insolvencies occurred compared to the previous year.⁴

The economic hardship caused to many companies by the coronavirus crisis thus did not result in an increase in reported corporate insolvencies. However, the absence of such an increase does not come as a surprise at the time of writing. The German government's aid measures for companies during the covid-19 pandemic prevented a rapid increase in the number of insolvency applications in the short term.⁵ These measures include, first and foremost, the temporary suspension of the obligation to file for insolvency (which has been lifted bit by bit in the meantime), regulated in the Covid Insolvency Suspension Act of 27 March 2020 as amended from time to time (see Section III.i). Experts disagree on whether the number of insolvencies will rise sharply in 2021 after the last suspension period expires or whether numbers will remain at a low level.

At the centre of restructuring efforts were two of Germany's key industries – the automotive sector, and machinery and plant engineering. In addition, the retail and entertainment industries were the scene of numerous large-scale restructuring projects. The aviation industry and the tourism sector have generally been hit hard. For the automotive and engineering industries, the already 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 aggravated by the covid-19 crisis: to contain the pandemic, many manufacturers and suppliers 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.

However, the economic collapse is currently not reflected in an increase in restructuring cases. For example, slightly more than half of the professionals in banks' workaround departments stated that the crisis had affected their loan portfolios only slightly or very slightly. At the end of 2020, only about 35 per cent of the bankers said that they had received more restructuring cases in the past six months.⁶ This may only be a snapshot and the market may turn and produce more restructuring cases in 2021 and beyond.⁷ According to a survey in early 2021, 72 per cent of experts expect the number of new restructuring cases to increase or increase significantly in the next six months.⁸

The difficult situation has also had a heavy impact on the M&A market. Following the crisis, many companies are in a financially weak position and therefore a potential target for buyers. Investors from China are showing increased interest, taking advantage of the economic upswing there. For Chinese investors, market access is an important factor when acquiring a company in Germany. Hence, Chinese buyers often pay comparatively high purchase prices even for distressed targets.⁹ In addition, US investors, especially private equity investors, are looking for targets in the German market again. Hence, experts agree that the distressed M&A market will experience a significant upswing. It is likely that there will be more transactions at the latest by the end of this year, experts believe. This will include any kind of distressed deal from small to large cap.¹⁰

Against this background, the Covid Insolvency Suspension Act has had the greatest impact on German insolvency and restructuring legislation in 2020 and 2021 (see Section III.i). In addition, newly introduced legislation transformed the existing insolvency regime encompassing changes to the principles governing illiquidity and over-indebtedness (see Section II.i). Moreover, 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) provided new features and complemented the existing mechanisms under German law (see Section III.ii).

The following provides an overview of the main features of the restructuring and insolvency framework. Individual rights and obligations are in part significantly modified by the Covid Insolvency Suspension Act (see 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 (1) three weeks if the company is illiquid or (2) six weeks if the company is over-indebted. The 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.

Illiquidity

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.

Over-indebtedness

Two concepts are relevant in this regard.

Technical over-indebtedness

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.

Continuation outlook

Even if the company is technically over-indebted, there is no obligation to file for insolvency if the company has a positive continuation prognosis. After recent legislative changes, 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 next 12 months. 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 the next 12 months. 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 negotiated at the time main proceedings are opened or even signed subject to the conditions that: (1) 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.

Creditors' committee

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.

Creditors' assembly

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.

Self-administration 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 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. Recently, the prerequisites for entering into self-administration proceedings have been further tightened, requiring the debtor, inter alia, to submit financial planning for the next six months.

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 provide that creditors' claims will 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 risks

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 a period of (generally) 24 months (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.

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 and 2021. 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 intended 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 include:

1. temporary and partly suspension of the duty of the managing directors to file for insolvency;
2. suspension of the application by creditors to open insolvency proceedings;
3. limitation of management's liability risk for prohibited payments in a financial crisis; and
4. limitation of avoidance risks and other liability risks regarding distressed lending, including the lender's liability.

The Covid Insolvency Suspension Act was amended several times and it was widely discussed whether and how certain changes should be extended and, in particular, whether the suspension of the obligation to file for insolvency for companies applying for state aid should, under certain conditions, be further prolonged. Ultimately, the suspension period ended on 30 April 2021 and was not further extended. However, the general rule that the forecast period for the going-concern prognosis (in connection with the over-indebtedness-test) is 12 months, is suspended until 31 December 2021 provided that the financial crisis of the relevant company was caused by the covid-19 pandemic – in which case a forecast period of four months applies until 31 December 2021.

It is widely believed that the Covid Insolvency Suspension Act has helped save the German economy and companies from a wave of insolvencies, as evidenced by the fact that corporate insolvencies in Germany were at an all-time low in 2020 (see Section I).

ii Directive on Preventive Restructuring Frameworks and Corporate Stabilisation and Restructuring Act (StaRUG)

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 had to be implemented by the Member States in their national legislation by 17 July 2021. The Directive was discussed by German insolvency and restructuring experts. Driven by the need for a pre-insolvency restructuring framework, especially for companies hit by the pandemic, the Directive on Preventive Restructuring Frameworks was implemented by way of the German Corporate Stabilisation and Restructuring Act (StaRUG), which entered into force on 1 January 2021. For the first time, the StaRUG introduced a new kind of restructuring scheme into German law, which can be implemented outside of formal insolvency proceedings.

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; it also allows consenting classes to overrule a whole dissenting class of creditors (cross-class cramdown). The approval of a dissenting class of creditor 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 to 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 chose between different instruments generally available under the framework (modular pick-and-choose approach), for example, a 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 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 law¹⁴ 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 (CVA). In the past, we saw German companies move their centre of main interests to the United Kingdom in order to access English law restructuring procedures. While 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 last 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). Whether the StaRUG is truly capable of limiting the impact the covid-19 pandemic had on the economy, as intended by its early introduction, remains to be seen. The regulations under the StaRUG are complex and yet untested, requiring a company in crisis to seek extensive legal advice. Hence, it may last 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.

In 2020 and so far in 2021, there have been a significant number of large-scale insolvencies as well as prominent out-of-court restructuring activities – even though the number of insolvencies and restructurings fell short of market expectations expressed at the beginning of the covid-19 pandemic.

The airline business was hit hard by insolvencies over the course of last year and remains in a turbulent state – which was mostly a result of the severe travel restrictions introduced after the start of the covid-19 pandemic. 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. Late 2020, the Court of Appeal upheld the jurisdiction of the High Court. In Germany, however, the matter has now reached the Federal Court of Justice.

Furthermore, the history of LGW Luftfahrtgesellschaft Walter came to an end after 40 years. After Eurowings terminated the wet lease contracts, the company could not recover through insolvency in self-administration and was liquidated in 2020. 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. However, Condor was able to leave the protective shield proceedings at the end of 2020 following successful restructurings and granting of state aid. The number of employees fell by around 700 to 4,200.

Last but not least, the massive impact of the covid-19 pandemic on the airline industry became apparent in two major restructurings: Germany's largest national airline, Lufthansa, was rescued with a €9 billion government rescue financing package, while travel group TUI was saved with rescue financing of around €5 billion. The insolvencies and restructuring efforts of many airlines show that the market, which was already in a consolidation phase as of 2019, imploded as a consequence of the covid-19 pandemic and the collapse of air traffic. Some companies could be rescued because the state stepped in.

The same applies to retailers and the fashion industry. In April 2020, department store chain Galeria Karstadt Kaufhof applied for protective shielding proceedings. The Local Court in Essen lifted proceedings for the department store group and some of its subsidiaries in September 2020. Creditors had previously approved the insolvency plans drawn up by the company's management, thereby waiving claims worth more than €2 billion. The restructuring plans envisages the closure of more than 40 department stores. One-hundred-and-thirty department stores and more than 16,000 jobs will be retained. Early in 2021, the hard-hit department store group was granted additional government aid of €460 million to prevent a second insolvency of the company within 12 months.

Gerry Weber filed for insolvency in 2019 and underwent a strict restructuring programme. At the beginning of 2021, it became public that the fashion chain is again in need of fresh money. The restructuring efforts continue to be difficult owing to the complex financing structure, which includes swap options for former Schuldschein-holder. Fashion company Escada filed for insolvency again in autumn 2020; the company had already gone through insolvency proceedings a few years earlier and had been sold to a US investor only one year ago. Fashion chain Hallhuber entered into protective shield proceedings in spring 2020 because of the covid-19 pandemic. The company filed an application for the initiation of protective shield proceedings in self-administration with the Munich Local Court. In May 2021, it became known publicly that the management was seeking a management buy-out and intended to acquire the chain via an insolvency plan.

The automotive sector and machinery and plant engineering also remain under pressure. In July 2020, the Local Court of Hanau opened insolvency proceedings over the assets of Veritas, a supplier to the automotive industry. At the beginning of 2021, Dutch Elastofirm acquired a subsidiary of the group. The largest proceedings in 2020 also included the insolvency of the car dealer Auto Wichert in Hamburg and the tire trading group Fintyre. The automotive supplier KSM Castings Group completed proceedings before the end of 2020. As part of the restructuring, 328 jobs are to be cut at KSM.

Clawback actions of the insolvency administrator over the Triton-controlled vehicle Galapagos, which had to file for insolvency in 2019 owning businesses in the heat exchanger and cooling power sectors, continued in 2020. The financial difficulties of Benteler, one of Europe's largest automotive suppliers, initially worsened in 2020. At the end of 2020, the ailing automotive supplier and steel tube specialist reached an agreement with its creditors to refinance its entire debt burden of €1.8 billion.

In the automotive industry, we are witnessing many carve-outs of non-profitable business units (in particular, combustion engine divisions) and the subsequent sale of those units to strategic investors or turnaround funds.

One of the most spectacular cases in 2020 was the insolvency of Wirecard, a listed German payment processor and financial services provider. Wirecard offered solutions for electronic payment transactions, risk management and the issuing and acceptance of credit cards. In June 2020, Wirecard admitted that the auditing firm Ernst & Young was unable to identify sufficient evidence of the existence of bank balances in escrow accounts amounting to €1.9 billion for 2019. This amount corresponded to around a quarter of Wirecard's total assets. Criminal charges were brought against the management. On 25 June 2020, Wirecard filed for insolvency based on imminent insolvency and over-indebtedness. The Wirecard case is already being compared to the Enron scandal. Certain subsidiaries were sold during the proceedings and also in 2021.

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 and repercussions of the introduction of the Covid Insolvency Suspension Act; and (2) the implementation of StaRUG into the national framework and practice.

With the Covid Insolvency Suspension Act, the legislator has reacted rapidly to the expected increase in corporate insolvencies as a result of the covid-19 pandemic by temporarily suspending the obligation to file for insolvency. The effects of the legislation on the liability of managers extend far beyond the suspension period provided by the Act. In particular, the Act 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 by way 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. 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. StaRUG may play a significant role in this race of different system, even though its practical use will only become apparent in the course of a few months or even years.