The main purpose of German insolvency proceedings is to provide a method for the realisation of a debtor’s assets in a manner that treats all unsecured creditors equally. Some creditors, however, are entitled to preferential treatment, including those with a right to segregation or a right to separate satisfaction.
Even though out-of-court restructurings are for many reasons still preferable and are used whenever possible, German law provides for different options of court-based insolvency procedures to either rescue the company to save businesses or where that is not possible, simply to realise their assets.
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| Peter Jark |
In late 2008, several changes were made to German statutes which had a direct influence on insolvency law.
The Act to Modernise the Law Governing Private Limited Companies and to Combat Abuses (Gesetz zur Modernisierung des GmbH-Rechts und zur Bekämpfung von Missbräuchen, or MoMiG) came into force on 1 November 2008 and led to numerous changes which affected insolvency law and the manner in which companies can be restructured in Germany. The Financial Market Stabilisation Act (Finanzmarktstabilisierungsgesetz, or FMStG) which came into force on 18 October 2008 contains further amendments of relevance to general insolvency law. The new provisions under the MoMiG and FMStG are intended to make German corporate and insolvency law more coherent and to enhance legal certainty for banks and creditors in restructuring situations.
There are several key aspects of both acts from a restructuring and insolvency law perspective:
• A mandatory insolvency request does not have to be filed in the event of over-indebtedness if, after having taken into account all relevant circumstances, the recovery of the company is likely and the odds are that the business will continue. The underlying reason for this change was the deterioration of value in shares and real estate in the wake of the financial crisis, which would have led to numerous companies being formally over-indebted and required to file for insolvency despite the fact that their financial strength is sufficient to continue trading.
• Another intention of the MoMiG is to tackle certain practices aimed at circumventing managements’ obligations in filing for insolvency. Under German law, the management
(Geschäftsführer) of a corporation (for example, a limited liability company) is obliged to file for insolvency in certain circumstances. There are, however, service providers offering company ‘burying services’ that have fraudulently circumvented this obligation by removing all managing directors of the company. According to the new law, the absence of management will now result in the shareholders being obliged to file for insolvency if the limited liability company becomes illiquid or over-indebted and the shareholder was aware of those facts. The same applies to the supervisory board members in case of a stock operation without management.
• New rules for shareholder loans and loan equivalents also apply. The rules developed by German courts with respect to the treatment of equity replacing loans and other shareholder loans no longer apply. Under the MoMiG, loans by shareholders will be treated as subordinated debt in insolvency. Prior to insolvency, the repayment of shareholder loans is no longer generally prohibited.
In accordance with the transitional rules as set out in Article 103 d Introductory Act to the
Insolvency Act (Einführungsgesetz zur Insolvenzordnung, or EGInsO), the following applies:
• Opening of insolvency proceedings and voidable transactions before 1 November 2008: Only old law is applicable.
• Opening of insolvency proceedings after 1 November 2008 and voidable transactions before that date: New law is applicable, unless the challenge pursuant to the old law is more beneficial for the shareholder/creditor. By way of example, this applies where the debtor has effected payments on a loan which is not considered as being equity substituted before 1 November 2008, but insolvency proceedings are opened after 1 November 2008. Pursuant to the new law, the shareholder would have to reimburse the payments. Since the old law was favourable because no reimbursement was necessary, the old law remains applicable.
• Opening of insolvency proceedings and voidable transactions after 1 November 2008: Only new law is applicable. The Insolvency Act provides that insolvency proceedings should satisfy a debtor’s creditors by: (i) realising its assets and distributing the proceeds; (ii) continuing the debtor’s business under formal insolvency proceedings; or (iii) instituting an insolvency plan if possible with self-administration. German insolvency proceedings consist of two key phases, namely preliminary proceedings and opened proceedings. Once a petition to open insolvency proceedings has been filed on the basis that one of the insolvency criteria exists, namely (i) illiquidity; (ii) imminent illiquidity; or (iii) over-indebtedness, the court is obliged to take all necessary steps to protect the debtor’s assets.
A company is deemed to be illiquid if it is unable to pay its debts as they fall due. Illiquidity is generally presumed when a debtor has ceased making payments.
However, the German Federal Supreme Court has specified that if a debtor can reasonably be expected to be able to pay those debts which are already due and those which are due to be paid within the next three weeks, the debtor should not be considered to be illiquid. A mere temporary interruption in payments (vorübergehende Zahlungsstockung) does not constitute illiquidity.
When determining liquidity, all liabilities which are due for payment must be taken into account, but all deferred liabilities are ignored.
The definition of ‘over-indebtedness’ has recently been amended in the context of the financial market stabilisation measures enacted in Germany. A company is deemed to be over-indebted if its assets are insufficient to meet its current liabilities. This was the definition prior to the amendment and will be the definition again after the temporary regulation expires. However, the definition has been temporarily refined by providing that even in circumstances where liabilities exceed assets, a company will not be deemed to be illiquid if circumstances indicate that it is highly probable that the business will be able to survive. This temporary regulation will only apply until 31 December 2013.
The change will inevitably lead to new questions: were the directors justified in assuming that the continuation of the business was highly probable? According to the definition of the term ‘over-indebtedness’, positively forecasting a business’ continuation merely meant that its assets may be considered by reference to their going-concern value rather than at a forced sale/liquidation value. Under the new rules, the positive prognosis is the vital criterion upon which the fate of the company will be decided. Although the new rules provide greater flexibility and scope for businesses to survive, the directors’ positive outlook must be based on economically plausible accounting, cash flow and profit forecasts that will need to stand up to scrutiny later in court.
This partial chapter is one of 15 in The Definitive Guide to Distressed Debt and Turnaround Investing: A comprehensive resource for making, managing and exiting investments in distressed companies and their securities, a new book from PEI Media.
Edited by Probitas Partners, this guide provides investors and fund managers with valuable tools and practical guides, as well as case studies and best practices. Sample contents and more information on the book are available at www.peimedia.com/books.
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