The German Insolvency Code requires the management of German limited liability companies (GmbH), stock corporations (AG) and other entities without personal liability to file for the commencement of insolvency proceedings no later than three weeks after the entity has become illiquid (zahlungsunfähig) or overindebted (überschuldet).
Illiquidity arises if a company is no longer able to pay its matured debts. By looking at whether the company has sufficient cashflow (or cash equivalents) to meet its current payment obligations, illiquidity can be determined easily.
Because of the financial crisis in 2008 and the following economic turmoil, many companies were confronted with situations where their balance sheet debts exceeded the liquidation value of the company’s assets and a specially drawn overindebtedness-balance-sheet revealed that the company was overindebted.
In order to prevent companies from filing for insolvency because of overindebtedness, in October 2008 Germany enacted a new law permitting management not to file insolvency petitions if — in management’s assessment based on the information and data available to it at that certain point in time — the company will more likely than not remain in business until the end of the next business year (going-concern prognosis). To determine whether there are sufficient grounds for a going-concern prognosis, managing directors have to analyze whether the company’s liquidity is not only sufficient at that respective point in time (as they have to do when determining illiquidity), but also whether it will be sufficient to continue the business for a reasonable period of time into the future. As a result, the overindebtedness test has become a cash flow and liquidity analysis in order to determine a going-concern prognosis and thereby avoid insolvency filings.
The purpose of this German legislation was to avoid the situation in which uncertainties as to the valuation of assets of a company would unnecessarily trigger filing obligations. Beyond that, however, it facilitates the implementation of out-of-court restructurings and prepacked insolvency plans in Germany as it relieves managing directors from the obligation of filing for insolvency, if a valid going-concern prognosis exists, unless they also face illiquidity (which can be more easily overcome by having creditors agree on a postponement of claims for the time necessary to complete the process and/ or the provision of new monies).
This closely aligns the test to the English law provisions on wrongful trading which enable the directors to continue to trade the company without personal liability, if they have a reasonable belief that there is a prospect of the company avoiding an insolvent liquidation. If constructive restructuring discussions are ongoing between the company and the creditors, it became easier for German directors to conclude that it is more likely than not that the business will continue as a going-concern, and thereby, allow for such discussions to be conducted without having to file for insolvency prematurely.
Supported by the positive results of this 2008 German law which helped significantly to avoid many insolvency filings based on a static overindebtedness test, at the end of 2010 the German legislation decided to extend the law for another three years, i.e. until the end of 2013. Like in 2010, again in 2012 there were discussions whether management in 2012 may or may not conclude that a positive going-concern prognosis exists until the end of next business year (e.g., if the business year is similar to the calendar year, until December 2013) if (a) the predicted debts for 2014 will exceed the companies’ assets measured at, as applicable, liquidation or going-concern value and, as a consequence, will create an obligation to file for insolvency in 2014 and (b) management, in 2012, cannot reasonably believe that measures to overcome the company’s overindebtedness would be available in 2014.
In order to clarify the legal situation and avoid any uncertainty but also to further facilitate out-of-court restructurings, in November 2012 both chambers of German parliament (Bundestag and Bundesrat) have passed a resolution whereby the existing law outlined above will permanently apply beyond 2013 without any further time limits. Before taking effect, the new law needs to be published in the German federal law gazette (Bundesgesetzblatt) which is expected to happen soon. Once enacted, the permanent application of the existing German law will further support the recent trend in Germany to turn the German insolvency regime into a restructuring friendly one which, among others, facilitates out-of-court restructurings and pre-packed insolvency plans in Germany.