On 25 August 2010, the German government published a draft of an Act for the Restructuring and Orderly Liquidation of Credit Institutions, for the Establishment of Restructuring Fund for Credit Institutions and for the Extension of the Limitation Period of Corporate Law Management Liability (Restrukturierungsgesetz, the “German Restructuring Act”). It is anticipated that the German Restructuring Act will soon be introduced to the German parliament and be passed quickly.
The proposed date for the entrance into force of this legislative package is 31 December 2010, which indicates that the German government is once again putting pressure on the EU to make progress with implementing stricter banking regulation across the EU.
2. Bank Levy
A key element of the German Restructuring Act is that it imposes an obligation on German banks to contribute to the costs of future bank crises by introducing a bank levy (Bankenabgabe) and a restructuring fund for credit institutions (Restrukturierungsfonds für Kreditinstitute, the “Restructuring Fund”). The Restructuring Fund (financed by the bank levy) shall be used as a reserve for dealing with the restructuring of systemically relevant banks.
3. Restructuring and Reorganisation Measures
The German Restructuring Act further introduces new restructuring proceedings for German credit institutions in financial difficulties. The purpose of this special regime is to allow for the possibility of a voluntary restructuring outside of the regular German insolvency proceedings. Additionally, the German Restructuring Act strengthens the authority of the German regulator (Bundesanstalt für Finanzdienstleistungsaufsicht, the “BaFin”). In specific circumstances, BaFin may even issue a transfer order forcing a German credit institution to transfer its business (in whole or in part) to an existing bank or a bridge bank established by the newly founded Restructuring Fund. Outside the draconian possibility of BaFin issuing a transfer order the Restructuring Act introduces two possible procedures where a credit institution is facing financial stress - the Restructuring procedure and the Reorganisation procedure.
4. Restructuring Procedure
The Restructuring procedure in contrast to the Reorganisation procedure is designed as a tool to be used before the onset of a full blown crisis. The Restructuring plan must be initiated by the credit institution and it must submit the plan and the name of a Restructuring adviser to BaFin. The plan cannot be used to compromise the debts of creditors or affect the rights of shareholders although as discussed below the plan may incorporate a super senior facility to enable the credit institution to raise additional funds.
The steps are as follows:
(a) Step 1
A credit institution can initiate Restructuring proceedings (Sanierungsverfahren) by notifying BaFin of its need for a restructuring (Sanierungsbedüftigkeit) and the terms of its restructuring and proposed Restructuring adviser. Note that prior involvement of a Restructuring adviser in the preparation of the plan will not be a ground by the court for rejecting the Restructuring adviser and such adviser can be an employee or director.
(b) Step 2
BaFin shall submit an application for the commencement of Restructuring proceedings to the competent higher regional court (Oberlandesgericht) without undue delay if it considers such application to be appropriate. The application shall include statements of BaFin with respect to both the prospects of a restructuring based on the Restructuring plan and the professional qualification of the proposed Restructuring adviser.
(c) Step 3
The competent higher regional court reviews the documents filed for application. If the court deems the Restructuring plan and the qualifications of the Restructuring adviser not to be evidently inappropriate, it shall give its approval to both.
(d) Step 4
The Restructuring adviser shall implement the measures set out in the Restructuring plan upon commencement of Restructuring proceedings. In order to implement such plan, the Restructuring adviser may participate in the meetings of all committees of the credit institution and give instructions to the executive board of the credit institution.
(e) Step 5
The Restructuring adviser shall inform BaFin and thereafter notify the court upon completion of the Restructuring plan. In the case of a successful restructuring the court will terminate the Restructuring proceedings. If such proceedings are not successful, the court may combine the termination order with a decision to open Reorganisation proceedings.
5. Super Senior Financing
Whilst Restructuring proceedings do not allow any interference with the rights of creditors and shareholders the Restructuring plan may provide that the credit institution raise funding in a maximum amount of 10 per cent of the credit institution’s regulatory own funds (Eigenmittel). Probably the most striking feature of the Restructuring procedure is that these funds will then rank senior to the indebtedness of the bank incurred prior to the commencement of the Restructuring proceedings.
6. Novel Features
6.1 Self Help
The ability of the bank to choose it own Restructuring adviser who may be an internal candidate may encourage banks to use the procedure because the institution’s management may feel it has a sense of control over the procedure.
6.2 Super Senior Financing
This is a radical departure from the previous position and it is hoped that the procedure may facilitate banks being able to quickly improve their liquidity position in a time of crisis.
6.3 Court Involvement
The court may, based on proposals from BaFin, make orders for further measures if necessary in the context of the restructuring or if the performance of the credit institution’s obligations, vis-à-vis its creditors, is at risk. Such measures may consist of the dismissal, or restriction of the authority, of members of the executive board, the appointment of the Restructuring adviser to the executive board, the prohibition or limitation of the credit institution’s ability to distribute its profits and the assessment and amendment of the credit institution’s bonus and remuneration schemes.
7. Critique of Restructuring Procedure
7.1 No moratorium
Probably the key weakness in the procedure is that there is no moratorium imposed as a result of the entry into the procedure so that creditors to the bank are free to take any action they are permitted to take under the terms of their documentation such as acceleration after an event of default or closing out derivative contracts.
7.2 Content of Plan
As the Restructuring plan element of the Restructuring Act does not include any procedures to force creditors to compromise their claims or reorganise the bank’s equity the efficacy of the procedure is questionable. A key element of any restructuring is likely to include either or both of these elements and hence commentators are doubtful that the procedure has sufficient utility to assist in a full scale reorganisation. Reorganisation plans have far more utility and there is a danger that the Restructuring procedure may not be used at all and credit institutions opt to go straight into a Reorganisation procedure.
7.3 Litigation risk for the super senior creditors
The Restructuring Act specifically gives junior creditors the right to claim against the super senior creditors if it can be proved that the requirements to open the proceedings have not been fulfilled. There is a danger that this will deter potential senior lenders from investing at a time of severe financial distress where their actions can be second guessed after the crisis has passed.
7.4 The Restructuring procedure is not necessarily private for public companies
The Restructuring procedure can in theory be opened in private but there is no derogation from the disclosure requirements under applicable listing rules and hence many directors of public companies may take the view that the application for the Restructuring procedure is so material that it would have to be disclosed. There is a danger that the opening of the procedure may be a signal the institution is distressed and hence there is an imminent danger the effort to restructure precipitates a loss of confidence and a possible run on the bank.
7.5 Liability for Restructuring advisers
There is an explicit provision imposing liability on negligent Restructuring advisers if they have harmed third parties. The risks involved may deter many advisers from taking appointments.
7.6 No definition of the need for restructuring (Sanierungsbedüftigkeit)
The Restructuring Act does not contain a definition of a credit institution’s need for restructuring (Sanierungsbedüftigkeit) and the management of the credit institution generally has the discretion whether or not to initiate the procedure. Given the potential negative impact of Restructuring proceedings on the management of the credit institution (such as dismissal of members of the board) the management might not be incentivised to voluntarily initiate Restructuring proceedings particularly where the trigger to use the procedure is not clear.
8. Reorganisation Procedure
Reorganisation procedures are only possible to implement if (i) the affected credit institution expects at the outset that Restructuring proceedings would be unsuccessful or (ii) Restructuring proceedings initiated by the credit institution have already failed.
The Reorganisation proceedings are commenced at the option of the affected credit institution and legal consequences may include:
- the conversion of creditors’ payment claims into equity interests (debt to equity swap);
- amendments being made to the corporate documents (e. g. articles of association) and to equity holders’ rights;
- the spin-off or hive-down of certain assets or liabilities of the credit institution or its rights and obligations with third parties to a transferee; and
- possible amendment of creditors’ rights (e. g. by deferring the maturity of certain claims and/or reducing their nominal amount), except for claims which are subject to (statutory or voluntary) deposit protection schemes which must not be prejudiced.
Implementation is split into six steps:
(a) Step 1
Either the affected credit institution itself or the Restructuring advisor (if Restructuring proceedings have been initiated but failed) initiates the Reorganisation proceedings but such proceedings are always subject to the credit institution’s consent. In both cases, notice of the intention to initiate Reorganisation proceedings to which a Reorganisation plan has been attached must be given to BaFin. Such Reorganisation plan must, inter alia, determine (i) how and to what extend third parties’ rights will be affected and (ii) set forth the different voting groups that are to be established, in particular taking into account relevant differences of affected creditors’ legal positions vis-à-vis the credit institution. The draft bill proposes that (i) creditors entitled to separate satisfaction (i.e. secured creditors), (ii) common unsecured creditors and (iii) subordinated creditors should be in different voting groups. To the extent equity holders’ rights are affected by the Reorganisation plan, they form a separate voting group.
(b) Step 2
BaFin examines in its discretion whether the situation satisfies the statutory requirements, namely that the existence of such credit institution is at risk (Bestandsgefährdung) and that the collapse of it would lead to a systemic risk for the financial system (Systemgefährdung). If BaFin deems these conditions to be fulfilled, it may apply for commencement of the Reorganisation proceedings at the competent Higher Regional Court.
(c) Step 3
The Higher Regional Court (i) examines whether the abovementioned statutory requirements relating to “systemic relevance” of the credit institution and other formal requirements relating to the Reorganisation plan are fulfilled and (ii) appoints the proposed Reorganisation adviser (who having been initially proposed by the credit institution in the first step, is subject to a veto right by BaFin who may propose other persons it deems more suitable). The court shall hear BaFin, the Bundesbank and the affected credit institution within this step.
(d) Step 4
The affected creditors and, if their rights are also affected, equity holders are invited to vote on the Reorganisation plan (taking into account the voting groups determined by such plan) by way of a particular voting scheme.
(e) Step 5
The Higher Regional Court decides whether to confirm or to reject the Reorganisation plan. In such process, it examines (i) compliance with certain compulsory statutory requirements, in particular ensuring that the legal effects of the Reorganisation plan on creditors and equity holders are adequate and (ii) whether the required consent ratios by each of the various voting groups have been reached and, if this is not the case, whether the requirements for substituting a particular voting group’s consent are fulfilled.
(f) Step 6
The court either confirms or rejects the Reorganisation plan. If the plan is confirmed by the court, the Reorganisation plan becomes effective with no further act being required (and thereby becomes binding on involved creditors/equity holders as if it were a judgment against them). If the court rejects the Reorganisation plan and does not rule otherwise, the Reorganisation proceedings end, the Reorganisation adviser’s appointment is terminated and, if the court took additional measures during such proceedings, those are repealed.
8.2 Features of the Reorganisation Plan
There are some radical features of the Reorganisation Plan:
(a) Quicker than normal insolvency procedures
Whilst Reorganisation proceedings (Reorganisationsverfahren) share some features with the insolvency plan proceedings (Insolvenzplanverfahren) contemplated by the German Insolvency Code (the latter sharing some of the features of US Chapter 11) the Reorganisation proceedings allow for fewer possibilities of judicial review. It is hoped the process will be far quicker than the Insolvenzplan process which has not been widely used.
(b) Reorganisation Plans allow for deep and comprehensive restructurings
The ability to propose a plan which converts debt into equity, amend creditors’ agreements, changes the articles or provides for a hive down makes this a very effective procedure which can implement radical changes to the credit institution’s position. Even though the general approach is that an approval requires consent by the majority of each creditor voting group (both on a per capita-basis calculated on the number of affected parties and on a nominal amount basis), there is an important exception to this basic principle: even though the majority of a voting group may have rejected the Reorganisation plan, its consent may be deemed to be given by virtue of a court order (Beschluss) if certain conditions are met. Such conditions include that the creditors of such voting group are not worse off compared to the situation lacking such Reorganisation plan, that they are adequately participating in the restructuring consideration which according to the Reorganisation plan should be distributed to all parties involved and that the majority of creditor groups has approved the Reorganisation plan with the required majority thresholds. However, in case of a debt to equity swap, the consent of each affected creditor seems to be always required. If the Reorganisation plan requires approval by the equity holders and if their required consent ratio has not been reached, there are specific and strict conditions to overcome such failure.
8.3 Critique of the Reorganisation Plan
(a) No moratorium and only day one termination stay
The initiation of the Reorganisation proceedings by the credit institution might trigger termination rights or an automatic termination with respect to certain financial transactions, in particular derivative contracts, which may have a devastating effect on the credit institution. In order to grant the bank some leeway in this respect, the statutory provisions provide that contractual relationships with the affected credit institution must not be (automatically) terminated within a certain time period. Such time period starts on (and encompasses) the day of the credit institution’s notice to BaFin until the next following “business day” (being further defined). The effectiveness of a termination is postponed until the expiry of the time period. This is by far the weakest feature of the proposed legislation. It means that termination rights or rights of acceleration if the Reorganisation procedure constitutes an event of default under existing credit documentation can be utilised after the brief moratorium period. The lack of a proper “breathing space” is a potentially fatal flaw to the procedure as the Reorganisation plan is clearly going to require some weeks at a minimum to implement.
(b) High barrier to use
The procedure is only available if the collapse of the institution would lead to a systemic risk for the financial system (Systemgefährdung). This is a high barrier to the use of the procedure and it is to be hoped that this test will be interpreted liberally otherwise the procedure will not be available to a large swathes of German banks which although important might not fall into the systemic category.
(c) Unclear international recognition
At first glance, the German Restructuring Act seems to regard both the restructuring as well reorganisation proceedings as proceedings falling within the scope of the EU Directive 2001/24/ EC of April 4th 2001 on the Reorganisation and Winding Up of Credit Institutions (the “Reorganisation and Winding Up Directive”). In fact, according to sec 46 d German Banking Act (Kreditwesengesetz) the German authorities shall inform without delay the competent authorities of other host Member State about their decision to take reorganisation measures (Art. 4 of the Reorganisation and Winding Up Directive). However, the German Restructuring Act contains no provision that clearly stipulates that both (new) Reorganisation and Restructuring proceedings shall be considered as measures falling within the scope of the Reorganisation and Winding Up Directive. Whether this was omitted intentionally or simply overseen is a matter of discussion. It cannot be left unsolved as the law governing certain aspects of both winding-up and reorganisation proceedings depend on the applicability of the Reorganisation and Winding Up Directive (Art 10 thereof) with far reaching consequences especially for creditors. The legal situation becomes even more difficult to ascertain when countries outside the EU are involved as the majority of the countries tend to apply the principle of territoriality (instead of universality) trying to ring-fence credit institutions operating within their boundaries.
9. Transfer Order
BaFin may issue a transfer order (the “Transfer Order”) (Übertragungsanordnung) pursuant to which all, or part of, the assets, contractual relationships and liabilities of an affected credit institution are to be transferred to a transferee entity (übernehmender Rechtsträger) by way of spin-off (Ausgliederung). The purpose behind the feature of the Transfer Order is to grant BaFin a tool of last resort. BaFin has been granted the power to transfer the systemically relevant part of the credit institution to a third party with the remaining rump staying within the institution and being subsequently liquidated.
Whereas the Restructuring or Reorganisation proceedings outlined above are initiated at the option of the credit institution, the German Restructuring Act allows BaFin to take control of the Restructuring/Reorganisation of the credit institution in specific circumstances even against the affected credit institution’s will. This might be necessary if the affected credit institution does not initiate voluntary proceedings or is not able to restructure itself, e. g., it cannot raise sufficient additional own funds on a timely basis.
The pre-requisites for a Transfer Order are that BaFin determines with the assistance by Deutsche Bundesbank that (a) the existence of the credit institution is at risk (Bestandsgefährdung), (b) a collapse of it would lead to a systemic risk for the financial system (Systemgefährdung) and (c) there are no means other than a Transfer Order to avoid the systemic risk in the same safe way.
The Transfer Order becomes effective with its formal notification to the transferor credit institution and the transferee entity.
9.1 No Requirement for Banking Licence
The transferee entity does not need to have a banking licence as the banking licence of the affected credit institution is deemed to be granted to the transferee by the Transfer Order. However, the transferee entity must be an existing legal entity and fulfil certain further requirements, e. g. having its registered office in Germany, two trustworthy and qualified managing directors and adequate core capital, in any case not less than EUR 5 million. The German Restructuring Act does not restrict the group of transferee entities any further. Therefore, it may be a subsidiary or a sister company of the credit institution, an unrelated private credit institution or a “bridge bank” (Brückenbank) established by the Restructuring Fund. The transferee entity needs to approve the Transfer Order. Most likely, private credit institutions will only accept such role as transferee if this is beneficial to them.
BaFin further needs to decide whether all or only part of the assets, contractual relationships and liabilities of the credit institution shall be transferred. According to the explanation of the draft bill, the Transfer Order in case of a partial transfer shall only focus on the systemically relevant and viable business units. In case of a partial transfer, BaFin determines the scope of assets and liabilities that shall be subject to the Transfer Order.
9.2 Consideration or Obligation to Compensate
As a result of the spin-off (Ausgliederung), the credit institution shall be entitled to receive consideration if the net value of the transferred assets and liabilities is positive. Such consideration can either be shares in the transferee entity or cash if (i) shares are unacceptable for the transferee entity or (ii) the envisaged purpose of the Transfer Order would be adversely affected by the fact that the credit institution becomes shareholder of the transferee entity. In order to avoid such scenario it may become necessary that the restructuring fund establishes a bridge bank. The reasonableness of the consideration will need to be confirmed by an expert opinion. Bridge banks, in contrast, can use the Restructuring Fund to finance the consideration (for details of the fund see below). If the net value of the transferred assets and liabilities is negative, the credit institution is obliged to compensate the transferee entity.
In order to avoid that the transferor credit institution misuses its influence as a shareholder of the transferee entity, BaFin is entitled to control the exercise of the voting rights by the credit institution. The transferor credit institution may dispose of its shares in the receiving company only with the consent of BaFin. BaFin further has the possibility to supervise the reorganisation measures of the receiving company and to take influence, if necessary.
9.3 Non-Applicability of the German Transformation Act
The German Transformation Act (Umwandlungsgesetz) does not apply to spin-offs (Ausgliederung) resulting from Transfer Orders. Consequently neither a spin-off agreement nor a spin-off report nor shareholder’s resolutions approving the spin-off are required. Furthermore, the transferring credit institution’s liability for the transferred liabilities is capped to an amount that a creditor would have received in a liquidation scenario in the absence of the Transfer Order.
10. Interesting Issues
10.1 Choice of assets and liabilities to be transferred
Recent bail-outs of German credit institutions have demonstrated that time is of the essence in such situations. It seems virtually impossible to have enough time to select the assets and liabilities to be transferred before issuing a Transfer Order. The more likely scenario is therefore the full transfer of all assets and liabilities and the later partial re-transfer of certain non-systemic assets and liabilities. It remains to be seen if this method will suffice to stabilize the systemic-relevant parts of the institution.
10.2 Possibility that shareholders of potential transferees reject the transfer
In cases where a private entity is looking to bid for the assets of the distressed bank through the Transfer Order process and where the transferee entity needs a capital increase in order to compensate the transferor credit institution with shares, the Transfer Order can only be made if the shareholders of the transferee have adopted final and incontestable shareholders’ resolutions for such capital increase. The latter requirement will further complicate any transfers to private credit institutions and make transfers to those less likely.
10.3 Foreign Perfection requirements
Interestingly, the German Restructuring Act contains a provision on perfection requirements for assets, contractual relationships and liabilities that are not governed by German law. To the extent creditor consent is required with respect to these to perfect transfers under a Transfer Order, it remains to be seen whether creditors will be prepared to grant their consent, e. g., thereby replacing their debtor.
10.4 Liability Cap
In contrast to the full liability of the transferee entity vis-à-vis creditors of transferred liabilities, the liability of a credit institution which is subject to a Transfer Order is capped to an amount that a creditor would have received in a liquidation scenario in the absence of a prior spin-off. This is a derogation from the treatment of spin-offs (Ausgliederungen) under the German Transformation Act (Umwandlungsgesetz), pursuant to which the liability of the transferring entity is not capped (but limited for a period of five years).
11. Restructuring Fund and Bank Levy
A core measure of the government’s proposal is the Act on the Restructuring Fund (Restrukturierungsfondsgesetz, the “Restructuring Fund Act”) which proposes to introduce the widely discussed bank levy (Bankenabgabe) into German law, which the German government has also proposed on a European and international level. The proposal may therefore also be understood as a blueprint for other governments to follow when introducing similar legislation.
The Restructuring Fund Act aims at setting up a public fund administered by the German Federal Authority for Financial Market Stabilisation (Bundesanstalt für Finanzmarktstabilisierung, the “FMSA”), which was established in 2008 to manage the bank rescue fund (Sonderfonds Finanzmarktstabilierungsfonds, the “SoFFin”).
The Restructuring Fund is to be used for overcoming imminent dangers to the financial system if the existence of such credit institution is at risk (Bestandsgefährdung) and that the collapse of it would lead to a systemic risk for the financial system (Systemgefährdung). Such dangers may not only emanate from very large banks, but also from smaller institutions, which are deemed of systemic importance based on other factors, e. g., the type and size of their obligations towards other credit institutions, their connections to other participants in the financial markets or the potential reaction of the markets to an insolvency of any such institution.
The Restructuring Fund Act provides for different measures to be taken by the FMSA, e. g. to establish, participate in or guarantee obligations of bridge banks (Brückeninstitute) in connection with transfer orders.
The Restructuring Fund will be financed by contributions from all credit institutions with a German banking license. Insurance companies and other financial institutions not covered by the Restructuring Fund Act (and which may therefore not be safeguarded by the Restructuring Fund) will not be required to contribute towards the fund. According to the draft Ordinance on Contributions to the Restructuring Fund for Credit Institutions (Verordnung über die Beiträge zum Restrukturierungsfonds für Kreditinstitute) the annual contributions of credit institutions will be calculated on the basis of a credit institution’s contribution relevant liabilities and its contribution relevant derivatives. Liabilities to customers are deducted from the contribution relevant liabilities so that investment and wholesale banks without substantial customer deposits are more affected by the bank levy. The annual contribution will be capped at 15 per cent of a credit institution’s annual profits. If a credit institution does not make a profit, however, it must still make a minimum contribution amounting to 5 per cent of the contribution calculated on the basis of the two parameters stated above.
12. Other important parts of the German Restructuring Act
Other important parts of the Restructuring Act include (i) the extension of the limitation period for management liability of board members of a credit institution from five to ten years, (ii) the introduction of stricter BaFin measures to improve a credit institution’s own funds and liquidity and the appointment of a special BaFin representative for a credit institution with specific duties and powers, as well as (iii) changes to the existing Financial Markets Stabilisation Fund Act (Finanzmarktstabilsierungsfondsgesetz, “FMStFG”) and Financial Markets Stabilisation Acceleration Act (Finanzmarktstabilisierungsbeschleunigungsgesetz, “FMStBG”), in particular with a view to establish a basis for a simplified legal termination or reduction of participations that SoFFin has acquired in German credit institutions as a result of recapitalisation measures.
The obvious benefit of the proposed legislation is that it uses a gradual approach by providing a restructuring mechanism appropriate to each stage in the possible deterioration of a credit institution’s financial position. The intensity and implications of such proceedings and measures increase as the financial situation of the relevant credit institution deteriorates but at the same time leave sufficient discretion to BaFin to react appropriately. This gradual, discretionary approach allows for substantial flexibility. As we outline above there are some significant shortcomings in this legislation and it is to be hoped the final act addresses some of the issues highlighted in our note. It is arguable that the introduction of the act with provisions which starkly deviate from the normal insolvency code procedures highlight deficiencies of the standard insolvency system.
In respect of the Restructuring Fund, compared with the amounts that were needed to stabilise German credit institutions during the recent banking crisis, there are strong doubts that the amounts collected as well as those re-allocated from the SoFFin will suffice to guarantee that the taxpayer will not again have to bear the costs of any future bail-outs. Furthermore, representatives of the German banking industry have voiced concerns that a bank levy in Germany, without corresponding measures being adopted globally (or at least across the EU) will damage the competitiveness of the German banking industry.
The general scheme of the law is to be welcomed however, whether it is fit for purpose, however, remains to be seen.