Germany’s Frankfurt District Court recently dealt with the question of whether a debtor’s lawyers’ fees arising from restructuring advice prior to insolvency could be challenged and claimed back in insolvency. The court held in the first instance (07.05.2015, Az. 2-32 O 102/13) that the lawyers of an insolvent German company in the solar industry had to repay €4.5 million after the out-of-court restructuring failed. The restructuring concept was complex as it comprised restructuring of three outstanding bonds, each of which would have to go through more than one bondholders’ vote in accordance with the German Bondholders Act. Whether the Bondholders Act was applicable at all was contested.
Claimant in the proceedings was the insolvency administrator who challenged the lawyers’ fees with the argument that, while illiquidity was imminent, the debtor intentionally put the other creditors at an undue disadvantage and that the lawyers were fully aware of this intent.
Decision of the Frankfurt District Court
A challenge for intent may be brought under section 133 of the German Insolvency Code if a transaction was made by a debtor during the last 10 years prior to filing for insolvency, or subsequent to such filing, if the debtor had intent to unduly disadvantage the insolvency creditors and the other party knew of the debtor’s intent on the date of such transaction. Thus, an intent to act to the detriment of the insolvency creditors is required.
Under established German Federal Civil Court case law, this intent is assumed if the creditor knew it was unable or likely to be unable to meet its existing obligations to pay on the maturity date but nonetheless depletes its assets by making payments. This test is usually met when lawyers are hired for a restructuring since the aim of the restructuring they advise on is to prevent illiquidity. The District Court in the present case therefore assumed intention to disadvantage.
However, according to German Federal Civil Court, the recipient of a payment standing in immediate correlation with restructuring efforts can raise an intention-to-disadvantage defense against the challenge if at the time the contested transaction was carried out there existed a coherent restructuring concept that justified the serious and reasonable prospect of success and that was at least partly implemented (“objection of restructuring rule”).
Compared to the German Federal Civil Court, the Frankfurt District Court seems to raise the requirements needed to rebut the presumption of intent. Instead of a serious and reasonable prospect, it requires the “certain expectation” at the time the contested transaction is carried out that a restructuring will soon be completed successfully.
The District Court came to the conclusion that there was no such certain expectation in the case. This followed from the fact that the debtor’s out-of-court restructuring concept was based on a legal path that had already been rejected in a similar case by the Frankfurt Higher Regional Court. The similarity had been pointed out to the defendants by the Higher Regional Court in the second instance when dealing with a challenge of bondholders. The legal issue tested by the bondholders was decided much later in favor of the debtor by the German Federal Civil Court, but due to the chronology of the events this played no role for the prospects of the out-of-court restructuring. Moreover, the District Court rejects the application of the objection of restructuring rule with the argument that a binding agreement by the bondholders confirming their support of the restructuring would have been necessary due to the imminent maturity of the bonds.
The District Court has broken new ground by applying the strict rule of section 133 of the German Insolvency Code on lawyers’ fees. The German Federal Court has only once applied this rule and rejected the restructuring defense to fees of a business consultant. Originally the objection of restructuring rule was created to alleviate pre-insolvency repayments of banks and other creditors. The strict application to restructuring consultants (lawyers as well as business consultants) has rightly been criticised with the argument that the role of a restructuring consultant commences with the evaluation and preparation of a restructuring concept and not only with its implementation. The requirement of a sound and partly implemented concept is therefore usually not met and the lawyers carry a significant risk that their fees will be challenged. When they begin the work there will be no certainty if the work will finally result in a sound restructuring concept.
On the other hand, the further the out-of-court restructuring efforts evolve, the easier it will be to better assess their likelihood of success. Insofar as the result of the District Court’s decision is not entirely unconvincing, bearing in mind that the process of restructuring was highly complex in this case and that a final success seemed extremely risky when looking at the case law of the District Court and the Higher Regional Court in a similar case.
In any case the District Court sets the hurdle for restructuring lawyers high when it demands for a legally binding agreement by the bondholders at the time the payment is made. The hurdle is too high because this agreement will usually be reached in the last moment when the facts are disclosed to the bondholders as basis for the decision or vote. Prior to this point in time many bondholders will refuse to accept confidential information since this would render them insiders and exclude them from dealing with the bonds. The District Court leaves open which majority it would have required to accept an agreement of the bondholders and we doubt that this criterion will apply to other cases at all. The decision leaves room for interpretation.
Result and Outlook
It remains to be seen if the Court of Appeal will approve the requirements established by the District Court. The defendants have already announced an appeal to the Frankfurt Higher Regional Court. If the very strict interpretation of the District Court prevails, lawyers would become more reluctant to extrajudicial restructuring and companies will be led into formal insolvency proceedings earlier.
A reasonable balance of interests would be reached if the restructuring defense were modified for lawyers’ fees. A law firm could invoke the restructuring defense as soon as it begins with the evaluation and preparation of a sound restructuring concept. As concept preparation progresses, the concept itself will increasingly need to demonstrate its validity and reasonable prospect of success. As soon as the parties recognize that a sound concept cannot be achieved, the consultants can no longer invoke the objection of restructuring.
Applied to the present case, even the modified definition of the objection of restructuring would probably not lead to a different result because the Frankfurt District Court on 15.11.2011 had already denied the chosen path to an out-of-court restructuring under the German Bondholders Act in a similar case. At this point, the debtor and his consultants should have recognized that the success of a restructuring was doubtful since two of the three bonds could only be modified with unanimous approval.