In the wake of the recent turmoil in the financial markets the German government has agreed on a package of measures to stabilise the financial markets and to avoid adverse effects on the real economy. The draft bill as introduced on 15 October 2008 has been passed already and comes into force as from 18 October 2008. Apart from setting up a financial-market stabilisation fund to adopt measures to secure the refinancing of German financial institutions the proposal intends to amend the German Insolvency Code in relation to the definition of over-indebtedness (Überschuldung) to avoid short term insolvencies of generally healthy companies. Over-indebtedness is grounds for starting insolvency proceedings under Section 19 of the German Insolvency Code.

Under the current provision a business is over-indebted and therefore insolvent if on a given balance sheet date its liabilities exceed its assets, taking into account for the valuation of the assets the survival capacity of the business, i.e. either going concern or liquidation values. This means that if certain assets (e.g. shares in other companies, real estate) of the business have depreciated and the going-concern value of the assets and the good will of the business are not sufficient to cover its liabilities, it is over-indebted. In such case the managing director, despite the possibility that a restructuring solution is in prospect, is under the obligation to file for insolvency within 21 days after having knowledge that the business is over-indebted. A failure to file in time is a criminal offence which carries up to 3 years of imprisonment. Therefore, creditors, shareholders and management usually do not have much time to agree an out of court restructuring. This has been viewed by many practitioners as a major hindrance in achieving a restructuring outside of a formal insolvency process.

The proposed amendment to the German Insolvency Code states that no case of over-indebtedness shall exist if the circumstances are such that there is a predominant probability that the business is capable of survival, i.e. the status of the business as a going concern can be confirmed.

The main advantage and legislative rationale is that it will give businesses with short-term valuation challenges more breathing space for implementing restructuring steps and/or waiting for an upturn of the values of assets on its balance sheets. Such businesses will no longer have to file for insolvency within the previously mandatory 21 day period, provided always that the forecast for the going concern is predominantly positive. This will likely also have a positive macro-economic effect in reducing "technical" insolvencies.

From a practical perspective, existing finance documentation will need to be reviewed with respect to the wording of events of default relating to insolvency. For the most part, such clauses are likely to refer to Section 19 of the German Insolvency Code as amended from time to time. As a result, lenders will likely no longer be able to invoke an event of default based merely on a technical over-indebtedness.