GENERAL

Legislation

What main legislation is applicable to insolvencies and reorganisations?

In principle, the Insolvency Act governs all bankruptcies and judicial reorganisations in Germany. As regards the restructuring and orderly winding up of financial institutions, the prerequisites and proceedings are primarily stipulated in the Law on Bank Restructuring and the German Act on the Recovery and Resolution of Credit Institutions (see questions 2 and 4). There are also a number of special provisions in the German Banking Act granting certain rights and responsibilities to the German Federal Financial Supervisory Agency (FSA) in the event of (threatened) insolvency of a financial institution. For example, the FSA can impose a temporary moratorium.

Excluded entities and excluded assets

What entities are excluded from customary insolvency or reorganisation proceedings and what legislation applies to them? What assets are excluded or exempt from claims of creditors?

In principle, insolvency or reorganisation proceedings may be commenced by or against any natural or legal person. An unincorporated association that otherwise has no separate legal personality will be deemed to be a legal person. Insolvency proceedings cannot, however, be commenced against any legal entity that is subject to state supervision, if the law of the respective state so provides (see also question 3).

Furthermore, the Law on Bank Restructuring and the German Act on the Recovery and Resolution of Credit Institutions (see questions 1 and 4) provide for specific rules concerning the restructuring and orderly winding up of financial institutions.

In principle, the insolvency proceedings involve all of the assets owned by the debtor on the date when the insolvency proceedings are opened and those acquired by the debtor during the insolvency proceedings. However, there are certain exceptions as regards the assets of natural persons that cannot be enforced over or form part of the insolvency. From a practical point of view, this exemption does not affect corporate insolvencies.

Public enterprises

What procedures are followed in the insolvency of a government-owned enterprise? What remedies do creditors of insolvent public enterprises have?

German insolvency law does not provide for specific procedures for government-owned enterprises. Hence, the provisions under the Insolvency Act also apply to such enterprises.

However, insolvency proceedings cannot be commenced against the federal government or a state government, or any legal entity that is subject to state supervision, if the law of the respective state so provides (see question 2).

Creditors of insolvent public enterprises have the same remedies as creditors of insolvent non-public enterprises (as to the remedies of unsecured creditors, see question 32).

Protection for large financial institutions

Has your country enacted legislation to deal with the financial difficulties of institutions that are considered ‘too big to fail’?

Following the worldwide financial crisis, the German legislator passed, among others, the Law on Bank Restructuring, which became effective on 1 January 2011. The Law on Bank Restructuring provides specific rules concerning the restructuring and orderly winding up of financial institutions. The rationale of the law is that the financial distress of a bank should primarily be rectified by its stakeholders (ie, its shareholders and creditors in particular). The German Federal Financial Supervisory Agency (FSA) may only consider an intervention if the stakeholders fail to implement adequate restructuring measures and if the stability of the financial system is otherwise at risk.

The Law on Bank Restructuring provides for two restructuring procedures, both of which can only be initiated by the financial institution itself: a recovery procedure and a restructuring procedure. Both procedures provide a framework for a collective negotiated settlement.

The management of a distressed bank can initiate the recovery procedure far in advance of a potential insolvency. The management may commence the recovery procedure after it gives notice of its need for recovery and presents a recovery plan to the FSA. Such a plan must outline the measures proposed to recover the bank, but may not impair any third-party rights.

Alternatively, a restructuring procedure may be initiated if the existence of the distressed bank is endangered and if the collapse of the bank would severely affect the stability of the financial system. The restructuring procedure is shaped along the lines of the insolvency plan procedure under the Insolvency Act (see question 8), meaning that creditors of the financial institution form different creditor groups that vote on the restructuring plan (including the possibility of a cram down). Such a restructuring plan may impair shareholder rights and may also provide for a debt-to-equity swap. Beyond this, the restructuring plan may also stipulate the spin-off of certain parts of the financial institution to an existing or a newly established affiliate.

Similar restructuring procedures are stipulated in the German Act on the Recovery and Resolution of Credit Institutions, which came into effect on 1 January 2015, in connection with the implementation of the European Recovery and Resolution Directive (2014/59/EU). Because this directive only provides for minimum harmonisation and allows the member states to maintain their national resolution procedures, the procedures of the Law on Bank Restructuring have remained unaffected and thus are still available for the FSA. In addition to the aforementioned restructuring procedures, the FSA also has the following set of resolution tools at its disposal: DAC28093581/1 PENDING-103249:

  • sale of the business or shares of the institution;
  • transfer to a ‘bridge institution’;
  • transfer to an asset management company; and
  • bail-in of shareholders and creditors (ie, converting specific loan receivables into equity by way of a debt-to-equity swap).

These tools are primarily provided by the German Act on the Recovery and Resolution of Credit Institutions.

There is no specific restructuring act for insurance companies. However, there are some special rules for insolvency proceedings over the estate of insurance companies (section 311 and following of the German Insurance Supervision Act). For instance, if an insurance company becomes insolvent, only the supervising authority may file an application for the commencement of insolvency proceedings.

Courts and appeals

What courts are involved? What are the rights of appeal from court orders? Does an appellant have an automatic right of appeal or must it obtain permission? Is there a requirement to post security to proceed with an appeal?

The lower court of the district in which a state court is located has exclusive insolvency jurisdiction for that district (insolvency court).

If the debtor’s centre of business activity is located in another district, the insolvency court of that district will have exclusive local jurisdiction. If more than one court has jurisdiction, the court in which the application for commencement of the insolvency proceeding was first filed will have exclusive jurisdiction.

Generally speaking, the competent insolvency court has jurisdiction to deal with all matters connected with the insolvency proceeding.

Orders or decisions of the insolvency court can only be appealed where the Insolvency Act expressly provides for an immediate appeal (ie, there is no automatic right of appeal). Notwithstanding this, a simple appeal is possible if the decision in question is not made by the judge, but by the clerk of the court. In any case, a creditor will only be entitled to appeal if its claim is rejected or its rights are violated by the decision.

The time limit for filing an immediate appeal is two weeks beginning upon the pronouncement or upon the service of the judgment to be challenged. The appeal must be filed by a written notice to the relevant insolvency court, which will decide if it wants to grant intermediate relief.

Pursuant to section 4 of the Insolvency Act in connection with section 574 and following of the Civil Procedure Code, an appeal on points of law can be used to challenge decisions resulting from an immediate appeal. However, such an appeal is only admissible if the appeal court has permitted the appeal on the point of law in its order following the immediate appeal. The appeal court will grant permission to file a complaint on points of law if: the legal matter is fundamentally important; or a judgment is required for the purposes of advancing the law or for ensuring consistency of court decisions.

Neither the Insolvency Act nor the Civil Procedure Code provides for requirements to post security to proceed with an appeal.

As far as reorganisation through insolvency plans is concerned, on the application of any creditor (or shareholder if applicable), the court may refuse to ratify an insolvency plan if the applicant: objects to the insolvency plan by no later than the hearing for discussion and voting (see question 33); and can demonstrate that he or she will be put in a less favourable position than he or she would have been in the absence of the insolvency plan (eg, in case the applicant can demonstrate that an asset sale or a liquidation would be more favourable).

Irrespective of such an application, the court shall ratify the insolvency plan if it provides for funds being made available for compensation in the event that a concerned party shows to the satisfaction of the court that it will be placed in a less favourable position. This is to be determined in a separate proceeding.

Furthermore, at the request of the insolvency administrator (or the debtor in self-administration proceedings), the district court may dismiss an appeal against the court order by which an insolvency plan is confirmed without delay, if it appears that the immediate effectiveness of the insolvency plan should take precedence, because the harm that would result from the delayed implementation of the insolvency plan outweighs the losses sustained by the applicant. In such a case, the appellant will be compensated out of the insolvency estate for the losses sustained by implementation of the insolvency plan.

TYPES OF LIQUIDATION AND REORGANISATION PROCESSES

Voluntary liquidations

What are the requirements for a debtor commencing a voluntary liquidation case and what are the effects?

Generally, a voluntary liquidation may only be implemented in accordance with general corporate procedures if the debtor is able to discharge all its debts or reach an out-of-court settlement with all its creditors (see question 13).

Under the Insolvency Act, the debtor may (voluntarily) initiate insolvency proceedings when illiquidity is threatened, as defined in the Insolvency Act (see question 15).

Upon the commencement under the Insolvency Act, the debtor is generally divested of the power to dispose of its assets. An insolvency administrator is then appointed by the insolvency court. In this context, however, the Insolvency Act provides for self-administration proceedings that give the debtor the opportunity to continue to manage and administer the insolvency estate, subject to the supervision of a custodian who usually is an insolvency practitioner. However, self-administration proceedings are not designed to initiate a voluntary liquidation but rather a voluntary reorganisation (either by way of an insolvency plan, a corporate reorganisation or an asset sale) (see questions 7 and 23).

Voluntary reorganisations

What are the requirements for a debtor commencing a voluntary reorganisation and what are the effects?

If the debtor is a legal entity or a (limited liability) partnership with legal entities only as (general) partners, and it is established that the debtor cannot pay its debts as they fall due or the debtor is over-indebted (as defined in the Insolvency Act (see question 15)), under German law the managing directors of the debtor must apply to commence insolvency proceedings without undue delay and, in any event, at the latest within three weeks from the date on which the company became insolvent. In addition, the Insolvency Act gives the debtor, but not the creditors, the ability to initiate a reorganisation in an insolvency proceeding when illiquidity is threatened, as defined in the Insolvency Act (see question 15). In the event of both insolvency (ie, illiquidity or over-indebtedness) or threatened illiquidity, the debtor can combine the application for the commencement of insolvency proceedings with an application for self-administration proceedings and the submission of a reorganisation plan. Such a plan is called an ‘insolvency plan’. Furthermore, if over-indebtedness or threatened illiquidity (or both) has occurred, as defined in the Insolvency Act (see question 15), section 270b of the Insolvency Act provides for an early self-administration procedure - the ‘protective shield procedure’ - which establishes a three-month moratorium. This provides the debtor with protection from creditor enforcement action and enables it to establish a reorganisation plan (see questions 21 and 23).

Aside from the debtor, only the insolvency administrator is authorised to submit a reorganisation plan (ie, an insolvency plan) to the insolvency court. However, the creditors’ meeting can instruct the insolvency administrator to prepare a reorganisation plan, which the insolvency administrator has to submit to the court within a reasonable time. The creditors’ committee (if one has been appointed - see question 34), the works council, the spokespersons’ committee of the managerial employees, and the debtor also have an advisory role in the preparation of the plan by the administrator.

As to voluntary reorganisations, the German Bond Act 2009 provides for an out-of-court restructuring procedure that allows modifications of bonds (eg, in respect of principal or value) by a majority resolution of the bondholders (75 per cent of the bondholders by amount present at a bondholders’ meeting), if the bond provides for such modifications.

In the foreseeable future, an additional voluntary reorganisation possibility will be introduced into German Law, as Germany must implement the EU Directive on Insolvency, Restructuring and Second Chance (see the European Union chapter) that forces the EU member states to implement, inter alia, a pre-insolvency restructuring procedure (see question 59).

Successful reorganisations

How are creditors classified for purposes of a reorganisation plan and how is the plan approved? Can a reorganisation plan release non-debtor parties from liability, and, if so, in what circumstances?

The Insolvency Act places very few restrictions on what may be included in a reorganisation plan (such a plan is called an ‘insolvency plan’). By approving a plan, the parties can, inter alia, agree to deviate from the statutory rules on the disposition of the debtor’s assets and the distribution of proceeds. The plan must describe the proposed measures for reorganising the debtor and how the plan affects the rights of creditors (and shareholders if applicable - see below). Typically, a plan will contain provisions for a partial waiver of claims or for deferred payments. It will also usually set out the likely outcomes for creditors in a liquidation, an asset sale, and a reorganisation of the business, so that the creditors can evaluate for themselves the advantages, whether financial or otherwise, of a reorganisation by way of an insolvency plan.

The insolvency plan must separate creditors into classes. In particular, it must distinguish between secured and unsecured creditors. The plan must be approved by each class of creditors. A class of creditors accepts the plan if a majority in number and in value in that class vote in favour of the plan. It is then up to the court to decide whether to confirm that plan (see question 12).

Furthermore, creditors who have not filed their claims with the insolvency administrator and had them included on the official table are also bound by the measures approved in the insolvency plan. Such creditors will be treated as creditors of the appropriate class if they assert a claim against the debtor after the insolvency proceedings have been terminated (see question 43).

Under the Insolvency Act, an insolvency plan cannot provide for a release of liabilities owed by third parties to creditors.

Moreover, it is explicitly regulated that an insolvency plan may not affect creditors’ rights against the debtor’s co-obligors and guarantors (section 254(2) of the Insolvency Act). In practice, this often complicates the restructuring of a corporate group if the parent company is insolvent and its subsidiaries are co-obligors or collateral providers, or both.

As the plan can provide for the disposition of the debtor’s assets, a plan may, however, create releases by the debtor in favour of third parties (eg, releasing the management, advisers or lenders of the debtor company from a potential liability). Such releases become effective upon the creditors’ consent to and the insolvency court’s approval of the plan.

Furthermore, an insolvency plan may provide for all types of (restructuring) measures permissible under corporate law, especially a debt-to-equity swap. Where a debt-to-equity swap is planned, the shareholders need to vote on the insolvency plan in addition to the creditors. Shareholders will form (at least) one separate voting class. A class of shareholders accepts the plan if a majority in value in that class votes in favour of the plan. As under corporate law, this majority is sufficient here even without a majority in number (see question 12).

As regards a debt-to-equity swap, each creditor who is to receive an equity participation must consent. It is not sufficient that the class has been consulted (ie, it is not possible to force a lender to convert a loan into equity).

Involuntary liquidations

What are the requirements for creditors placing a debtor into involuntary liquidation and what are the effects? Once the proceeding is opened, are there material differences to proceedings opened voluntarily?

Insolvency proceedings can only be commenced when an application is presented. An application may be presented by a creditor if the creditor can establish that the debtor is unable to pay its debts as they fall due or, in the case of a legal entity or a (limited liability) partnership that has only legal entities as (general) partners, that the entity is over-indebted (as defined in the Insolvency Act (see question 15)). If the creditor’s application is well founded, the insolvency court will then give the debtor an opportunity to be heard.

Once the proceedings are commenced, there are no material differences to proceedings opened voluntarily.

Upon the commencement of the insolvency proceedings, the insolvency administrator immediately takes possession of and administers all assets the insolvency estate comprises. Moreover, the debtor’s management will be subject to a positive duty to provide information.

Once the administrator has taken possession of the debtor’s assets, he or she is required to prepare a list of the assets comprising the insolvency estate, stating the value of each object. The administrator must also prepare a list of all creditors whose names appear in the debtor’s books and papers, or whose identities are revealed by other statements of the debtor, or who assert their claims in the course of the proceeding. In addition, the administrator is obliged to prepare a statement of affairs. Once all the assets of the estate have been realised and the final distribution has taken place, so that the insolvency proceedings will be closed, the legal entity or partnership will be erased from the commercial register.

Involuntary reorganisations

What are the requirements for creditors commencing an involuntary reorganisation and what are the effects? Once the proceeding is opened, are there any material differences to proceedings opened voluntarily?

As described in question 9, insolvency proceedings may be commenced by a creditor on presentation of an application if it can demonstrate that the debtor is insolvent. Once the proceedings are commenced, there are no material differences to proceedings opened voluntarily. An individual creditor does not have authority to submit a reorganisation plan. However, the creditors’ meeting may instruct the insolvency administrator to produce a reorganisation plan. If each class of creditors accepts the plan, and if the insolvency court confirms the plan, it will then come into effect (see question 8).

Expedited reorganisations

Do procedures exist for expedited reorganisations (eg, ‘prepackaged’ reorganisations)?

The Insolvency Act does not explicitly provide for any specific procedure on expedited reorganisations such as ‘pre-packaged’ reorganisations.

However, in practice, an insolvency administrator may sell the debtor’s business or key assets (see question 25) a few weeks after the insolvency proceedings are commenced. Additionally, and as stated above, the debtor is entitled to file an application for the opening of insolvency proceedings when illiquidity is threatened (see question 15). At the same time, the debtor can apply for self-administration, which would allow the debtor to continue to manage the insolvency estate under the supervision of a custodian (usually an insolvency practitioner), and also submit an insolvency plan for a reorganisation of the business as a ‘pre-packaged’ plan. In practice, a pre-packaged plan will often be discussed with the debtor’s main creditors before it is filed to ensure that they will not oppose it once insolvency proceedings have been initiated.

Unsuccessful reorganisations

How is a proposed reorganisation defeated and what is the effect of a reorganisation plan not being approved? What if the debtor fails to perform a plan?

A proposed insolvency plan (ie, reorganisation plan) must first be considered by the insolvency court. The insolvency court will reject the plan if:

  • the formalities regarding the authority to submit the plan and regarding its contents, especially regarding class constitution, have not been observed;
  • a plan submitted by the debtor clearly has no chance of being accepted by the involved participants (ie, creditors and, if involved, shareholders) or confirmed by the insolvency court; or
  • the claims to which the participants are entitled by the plan can obviously not be satisfied.

In addition, the insolvency court will reject the plan if it is submitted after the final hearing (see question 33).

If the plan is not rejected on any of these grounds, the insolvency court will set a date for a hearing at which the insolvency plan and the creditors’ (and shareholders’) voting rights can be discussed and the plan will be voted on (the ‘hearing for discussion and voting’). Each class of creditors (and shareholders) will vote separately on the plan. A majority in number and value of each class of creditors is required for a plan to be accepted. A class of shareholders accepts the plan if a majority in value in that class votes in favour.

Even if the required majority is not attained, the consent of a voting group is deemed to be given, if:

  • the members of that group are not disadvantaged to a greater extent than they would be on the liquidation of the debtor’s business and a disposal of its assets by the insolvency administrator;
  • the members of that group have a reasonable share of the economic value that was to accrue to the participants in the plan; and
  • the majority of the other voting groups has consented to the plan.

Once the creditors (and shareholders where their rights are concerned) accept the plan, it must be ratified by the insolvency court. The insolvency court will not ratify the plan if, inter alia, the acceptance of the plan by the creditors (and shareholders where their rights are concerned) is obtained in a wrongful manner, including, but not limited to, acceptance as a result of preferential treatment of a creditor.

The court may also refuse to ratify the plan if a creditor (or shareholder where its rights are concerned) successfully objects to or appeals the plan (see question 5).

Generally, a debtor’s default in performing an approved plan does not affect the validity of the plan. However, in the event that creditors’ claims are deferred or partially waived as part of the plan, that deferment or waiver ceases to bind that creditor if the debtor falls into significant arrears in the performance of the plan. The debtor will be deemed to have fallen into ‘significant arrears’ if it fails to pay a liability due, despite the creditor making a written demand and setting a minimum period of two weeks for payment.

Corporate procedures

Are there corporate procedures for the dissolution of a corporation? How do such processes contrast with bankruptcy proceedings?

German corporate law contains different procedures for the dissolution and liquidation of a corporation. The cases in which the company may or must be dissolved are set out in the relevant laws. These laws specify additional reasons, other than insolvency, for the dissolution of the company. At any time, the shareholders can resolve to dissolve the company with a qualified majority of usually 75 per cent of the votes cast.

The commencement of dissolution as such does not cause the company to cease to exist as a legal entity. It merely constitutes the commencement of the company’s liquidation by changing the purpose of the company. Once dissolved, the company can no longer pursue the business purpose defined in its articles. Its sole purpose becomes the liquidation of its business, that is, it has to: (i) terminate its current business transactions; (ii) discharge its obligations; (iii) collect its receivables; (iv) convert its assets into cash; and (v) distribute the liquidation proceeds, if any, to the shareholders.

Generally, the company is liquidated by its liquidators, who are appointed at the shareholders’ meeting, except in the case of insolvency, where the insolvency administrator liquidates the company in accordance with the provisions of the Insolvency Act.

Conclusion of case

How are liquidation and reorganisation cases formally concluded?

Liquidation and reorganisation cases are formally concluded by an order of the insolvency court. As soon as the final distribution has been made, the insolvency court will make an order terminating the insolvency proceedings. As far as reorganisation cases are concerned, the insolvency court orders the termination of the insolvency proceedings as soon as the insolvency plan has been unconditionally approved (ie, an appeal against the order confirming the plan is no longer possible) and any necessary remediation measures to cure the illiquidity or over-indebtedness, or both, have been implemented in accordance with the insolvency plan - for example, registration of the debt-to-equity swap with the competent commercial register.

If the performance of the plan is to be supervised, the court will make an order to that effect, together with the order terminating the insolvency proceedings. The insolvency court will then order the termination of supervision when: all the claims covered by the plan have been satisfied; or three years have elapsed since the termination of the insolvency proceedings and no application to commence a new insolvency proceeding has been filed.

INSOLVENCY TESTS AND FILING REQUIREMENTS

Conditions for insolvency

What is the test to determine if a debtor is insolvent?

In general, the Insolvency Act specifies two different criteria for establishing insolvency: illiquidity and, if the debtor is a legal entity (such as a limited liability company, stock corporation, etc) or a (limited liability) partnership that has solely legal entities as (general) partners, over-indebtedness.

Illiquidity

According to the Insolvency Act, a debtor is illiquid when it is unable to pay its debts as they fall due. A company is deemed to be illiquid if it has ceased making payments. The German Federal Supreme Court decision of 24 May 2005 (IX ZR 123/04) has, however, set out the following qualifications:

  • the debtor is not considered illiquid if it can reasonably be expected that it will meet its due payment obligations within no more than three weeks from their due date (including any ‘new’ obligations becoming due during the three-week period: see, German Federal Supreme Court decision of 19 December 2017 (II ZR88/16));
  • where the liquidity shortfall amounts to less than 10 per cent of all due payment obligations, the company is only considered illiquid if the shortfall is likely to increase to more than 10 per cent in the near future; and
  • where the liquidity shortfall amounts to 10 per cent or more of the due payment obligations, illiquidity is assumed, unless there is a high likelihood that the shortfall will soon be covered completely or almost completely, and the creditors can be reasonably expected to wait. Accordingly, a mere temporary interruption of payments will not constitute illiquidity.
Over-indebtedness

In general, a company will be regarded as being over-indebted whenever the company’s total liabilities (including accruals) exceed its total assets (including hidden reserves, which can be taken into account). Until 17 October 2008, where there was a predominant probability that the company’s business could be continued, then the company was permitted to have its assets evaluated on a going-concern basis, rather than on a liquidation basis. Notwithstanding the predominant probability of the continuation of its business, if a company’s valuation on a going-concern basis (considering hidden reserves) still resulted in a negative net asset value, the company had to file for insolvency. As a consequence of the financial crisis, from 18 October 2008, the Insolvency Act was modified so that a company is generally no longer regarded as being over-indebted when there is a predominant likelihood that the company’s business can continue.

Threatened illiquidity

In addition, the Insolvency Act establishes the concept of ‘threatened illiquidity’. This gives the debtor, but not the creditors, the right to initiate a reorganisation or liquidation under the Insolvency Act when the company’s illiquidity is imminent (see questions 7 and 11). The debtor is deemed to be threatened with illiquidity if it is likely to be unable to meet its existing payment obligations when they fall due. This is particularly the case when it appears that the company is more likely to become illiquid than to recover. In practice, a company threatened by illiquidity is usually also over-indebted.

Mandatory filing

Must companies commence insolvency proceedings in particular circumstances?

Each managing director, or each member of the management board, of a legal entity (limited liability company, stock corporation, etc), a (limited liability) partnership that has solely legal entities as (general) partners, or an unincorporated company is obliged to file an application for the commencement of insolvency proceedings without undue delay and, in any event, at the latest within three weeks after the date on which the company has become illiquid or over-indebted (as defined in the Insolvency Act (see question 15)). The managing directors are not obliged to apply for the commencement of insolvency proceedings immediately if they can reasonably expect that the illiquidity or over-indebtedness will be remedied within three weeks. However, each managing director is obliged to apply for the commencement of insolvency proceedings whenever it becomes clear that the illiquidity or over-indebtedness cannot be remedied. This is mandatorily deemed to be the case after the three weeks have lapsed.

The obligation to file an application for the commencement of insolvency proceedings does not only apply to the managing directors or management board members of German entities, but also to the corresponding legal representatives of foreign companies that have their centre of main interests (COMI) in Germany.

Each shareholder of a limited liability company is also obliged to file for insolvency proceedings if the company has become illiquid or is over-indebted (or both), and the company does not have, or no longer has, a managing director; unless the shareholder or member is not aware of the company’s illiquidity, over-indebtedness or that the company is without management. The same applies to each member of the supervisory board of a stock corporation if the stock corporation does not have, or no longer has, a management board.

For the consequences resulting from non-compliance with the obligation to apply for insolvency proceedings, see question 17.

DIRECTORS AND OFFICERS

Directors’ liability – failure to commence proceedings and trading while insolvent

If proceedings are not commenced, what liability can result for directors and officers? What are the consequences for directors and officers if a company carries on business while insolvent?

If the managing directors of a German limited liability company and the members of the management board of a stock corporation do not comply with the obligation to apply for insolvency proceedings (see question 16), they can be held liable for damages resulting from the delayed initiation of insolvency proceedings, and may also be liable for a fine or prison sentence of up to three years under German criminal law. Damage claims for the delayed initiation of insolvency proceedings can be asserted by the insolvency administrator, if the underlying contract from which the claim of a creditor against the debtor results was concluded prior to the insolvency of the company, or by the creditors, if the underlying contract was concluded after the insolvency of the company, but before insolvency proceedings were actually initiated.

If a shareholder of a limited liability company or a member of the supervisory board of a stock corporation does not comply with the obligation to apply for insolvency proceedings (see question 16), they may be liable for a fine or prison sentence of up to three years under German criminal law.

It is important to note that the aforementioned liabilities do not only apply in case of not filing an application for the commencement of insolvency proceedings (in due course), but also in case of an incorrect filing (eg, by missing required information).

In addition to personal and criminal liability (see question 18), if a company carries on business while insolvent, certain transactions entered into by the insolvent company might be contested by the insolvency administrator after the commencement of the insolvency proceedings (see question 47).

Directors’ liability – other sources of liability

Apart from failure to file for proceedings, are corporate officers and directors personally liable for their corporation’s obligations? Are they liable for corporate pre-insolvency or pre-reorganisation actions? Can they be subject to sanctions for other reasons?

In principle, the managing directors of a German limited liability company and the members of the management board of a stock corporation are not personally liable for their company’s obligations with regard to its creditors. Notwithstanding this, such directors can be held liable, jointly with the company, for a defective product if the defectiveness results from insufficient supervision or organisation of the production and monitoring process.

Generally, the managing directors of a German limited liability company and the members of the management board of a stock corporation are required to exercise the diligence expected of a responsible businessperson in the conduct of the affairs of the company. If they fail to do so, they will be jointly and severally liable to the company for any resulting damage. The obligation to exercise the diligence expected of a responsible businessperson also includes the duty, if a crisis threatens, to consider all possible remedial steps and, as far as possible, to initiate such measures.

They are required to call a shareholders’ meeting if it appears to be in the best interests of the company. A special meeting must be called without undue delay if it appears from the annual balance sheet, or from a balance sheet prepared during the fiscal year, that half or more of the share capital has been eroded. A managing director who fails to notify the shareholders in these circumstances may be liable to a prison term of up to three years or a fine.

Whenever the company is insolvent, the managing directors and the management board members have to ensure that the company generally ceases to make payments, unless the payments are consistent with the due care of a prudent businessperson. This may be the case particularly if the respective payments are essential to uphold the business of the company. Accordingly, they can be held personally liable for payments that result in a reduction of the insolvent estate. In addition, they may also be held personally liable for payments to a shareholder that resulted in the illiquidity of the company, unless such payments were consistent with the due care of a prudent businessperson. However, such damage claims are to be asserted by the insolvency administrator in favour of the insolvency estate and, consequently, the creditors of the company.

Apart from this, a managing director may also be liable for pre-insolvency actions that are inconsistent with an orderly management of affairs leading to a reduction of the (insolvency) estate. For instance, a prison term of up to five years or a fine may be imposed upon a managing director, who, in the event of over-indebtedness or an impending or actual illiquidity of the company:

  • conceals or removes or, in a manner inconsistent with the requirements of an orderly management of affairs, destroys, damages, or renders useless parts of the estate that would belong to the insolvency estate in the event of the institution of insolvency proceedings;
  • fails to keep commercial books that he or she is obligated to keep under the law, or keeps or changes such books, in a manner that makes the view of the financial status more difficult; or
  • contrary to the requirements of commercial law, prepares balance sheets in a manner that makes the assessment of the financial status more difficult.

A prison term of up to two years or a fine may be imposed upon a managing director who, knowing the illiquidity of the company, grants to a creditor a security or satisfies a debt to which it is not entitled or not entitled in such form or not entitled at such time, and thereby intentionally or knowingly prefers it over other creditors.

In principle, these offences are only actionable if the company has stopped its payments, or if insolvency proceedings have been commenced, or if the application for the commencement of insolvency proceedings has been rejected for lack of funds.

According to section 69 of the General Tax Code, a personal liability can arise for tax liabilities of the company, provided that such taxes have intentionally or negligently not been paid.

The managing directors can also be personally responsible for financial damages relating to fraud (section 263 of the Criminal Code), breach of trust (section 266 of the Criminal Code) and withholding and embezzlement of the employees’ contributions to the social insurance (section 266a of the Criminal Code).

Directors’ liability – defences

What defences are available to directors and officers in the context of an insolvency or reorganisation?

This mainly depends on the status of the crisis and the type of reorganisation procedure.

If a company enters a stage of (financial) crisis, but the managing directors are not (yet) obliged to file an application for the commencement of insolvency proceedings (see question 16), there are a number of potential measures that should, and partially must (see question 18), be taken by the directors and officers:

  • reviewing, and potentially increasing, the level and the quality of documentation, in particular to demonstrate that: (i) the management has properly analysed different (restructuring) options and scenarios; (ii) payments have still been made in accordance with the law (see question 18); and (iii) the management has not (yet) to file for insolvency (eg, by preparing, inter alia, a liquidity forecast to prove that the company is neither over-indebted (as there is (still) a predominant likelihood that the company’s business can be continued) nor illiquid (see question 15));
  • closely monitoring the financial situation of the company as, in case of a stock corporation and at least a larger limited liability company, the management has to ensure that an appropriate organisational set-up is in place, which enables a constant analysis and monitoring of the operational, commercial and financial situation and performance of its undertaking. This corresponds to the obligation to install ‘early detection systems’ to ensure that material risks for the company are identified at an early stage;
  • briefing the shareholders on the financial situation of the company and presenting suggestions for a financial reorganisation of the company; and
  • depending on the complexity and development of the crisis, seeking independent, professional advice (eg, to receive an opinion that the company can (still) continue its business or assess the value of assets in a due diligence review), and informing such advisers about the company’s situation.

In case a third party (such as an insolvency administrator) claims a breach of any duty by the management, the aforementioned measures can enable the directors and officers to prove that they have complied with all duties in the context of the (financial) crisis (also taking into consideration that the burden of proof is often on the director).

In this context, the need to take the aforementioned measures increases if the success or viability of the company might be endangered and an insolvency is threatening, with the result of more expansive analysis and scrutiny being required. In this case, the management generally becomes obliged to even more specifically analyse the predicted operational and financial performance, potential future threats (including their reasons) as well as potential mitigation and remediation measures. Any such analysis including results and evaluation by the management should then be documented even more detailed.

Furthermore, to a certain extent it is possible that the directors will be indemnified by the company in connection with their actions as an operating director. The scope of such potential indemnity depends on whether the company is a limited liability company or a stock corporation:

  • In case of a limited liability company, it is possible to exclude the liability for all cases without gross negligent and intentional breaches of duties. However, liability for non-compliance with the rules on the maintenance of share capital and for payments made after the company has become insolvent, and any liability under criminal law cannot be limited. Usually, the indemnity is provided by way of a shareholder’s resolution.
  • In case of stock corporation, an indemnity cannot be granted in advance. The officers can, however, ask the general meeting to approve a management decision. In case of such approval, they are not liable to the company for the consequences of the decision.

Besides, the directors (or the company) can take out directors and officers insurance (D&O insurance) which is intended to protect directors against claims for breaches of their duties.

If an insolvency proceeding has been commenced and the insolvency court has approves the self-administration, so that the management can still continue to manage the insolvency estate under the supervision of a custodian (see questions 11 and 23), the aforementioned measures are, in general, also available (except for indemnifications by the company because of the lack of power of the shareholders). In addition, it is recommendable to appoint an external restructuring expert as Chief Restructuring Officer, so that the management board can demonstrate sufficient knowledge and experience to handle a reorganisation process in self-administration.

Shift in directors’ duties

Do the duties that directors owe to the corporation shift to the creditors when an insolvency or reorganisation proceeding is likely? When?

German insolvency law does not provide for a shift of director’s duties to the creditors when an insolvency or reorganisation proceeding is likely. Instead, German law provides for:

  • a duty to apply for the opening of insolvency proceedings if the company is insolvent (illiquid or over-indebted (see question 16));
  • potential directors’ liabilities in case of non-compliance thereof (see question 17);
  • specific duties and (payment) restrictions in a crisis or (threatened) insolvency, and potential liability in case of non-compliance thereof (see question 18); and
  • rights for the insolvency administrator to contest transactions and payments of the insolvent company that prefer certain creditors (preferential transactions) (see question 47).
Directors’ powers after proceedings commence

What powers can directors and officers exercise after liquidation or reorganisation proceedings are commenced by, or against, their corporation?

This depends on whether the insolvency court appoints an insolvency administrator or approves the self-administration.

If the insolvency court appoints an insolvency administrator, the right to manage and transfer the debtor’s assets passes to the insolvency administrator after the opening of the insolvency proceedings. Therefore, if the managing directors, after the opening of the insolvency proceedings, transfer an object forming part of the insolvency estate (without the consent of the insolvency administrator), such transfer is legally invalid, subject to certain exceptions. Once the application to open insolvency proceedings has been filed, but before an order has been made opening the insolvency proceedings, the court may appoint a preliminary insolvency administrator. Usually, a preliminary insolvency administrator has fewer powers than an insolvency administrator, although the scope is similar and, if necessary, he or she can dispose of the debtor’s assets (in which case he or she is referred to as a ‘strong preliminary insolvency administrator’). However, the preliminary administrator is generally not entitled to sell the entire enterprise or one of its businesses (see question 25). The preliminary insolvency administrator’s primary role is to continue the business of the debtor and to examine whether or not the debtor is insolvent. The insolvency court is authorised to order that encumbered assets that are of particular significance for a restructuring must not be released to the secured creditors by the preliminary insolvency administrator. Rather, the secured creditors are only entitled to demand compensation for the loss of value caused by the preliminary insolvency administrator’s usage. Liabilities incurred by a strong preliminary insolvency administrator, such as where they have been authorised to dispose of the debtor’s assets, are deemed to be liabilities of the estate, provided that the insolvency proceeding will actually be opened subsequently.

In contrast, section 270 of the Insolvency Act provides for a process called ‘self-administration’, whereby the debtor may, under the supervision of a custodian (usually an insolvency practitioner), continue to manage the insolvency estate and dispose of assets (for more details see question 23).

MATTERS ARISING IN A LIQUIDATION OR REORGANISATION

Stays of proceedings and moratoria

What prohibitions against the continuation of legal proceedings or the enforcement of claims by creditors apply in liquidations and reorganisations? In what circumstances may creditors obtain relief from such prohibitions?

Pending legal proceedings

The Civil Procedure Code imposes a stay on proceedings when the court opens insolvency proceedings. If the court has appointed a ‘strong’ preliminary insolvency administrator, so that the debtor is generally prevented from selling assets already at an earlier stage (see question 21), then the stay of proceedings commences when the court appoints the preliminary insolvency administrator.

Once insolvency proceedings have been formally opened, the insolvency administrator is entitled to choose whether to continue with legal proceedings initiated by the debtor pre-insolvency.

Enforcement of claims

Once insolvency proceedings have been formally opened, creditors are prevented from enforcing their claims. In certain circumstances, the court could impose a stay on the initiation of enforcement of claims or suspend pending enforcement actions before insolvency proceedings are formally opened. Note that, as regards pending enforcement actions over immovables, only the court seized with the claim has the right to suspend such actions.

Creditors cannot, in general, apply to the court to lift this moratorium on enforcement actions. There are, however, exceptions. Creditors who can show that an asset does not belong to the estate because of a right of segregation may enforce their claim irrespective of the insolvency proceedings (see question 31). Creditors with a right to separate satisfaction are also exempted; they may claim preferential satisfaction of their claim from the respective asset.

For those financial institutions subject to the Banking Act, the FSA may temporarily suspend transactions by and against the institution to avoid its insolvency, for example by ordering a moratorium (see question 1).

Doing business

When can the debtor carry on business during a liquidation or reorganisation? Is any special treatment given to creditors who supply goods or services after the filing? What are the roles of the creditors and the court in supervising the debtor’s business activities?

As referred to in questions 7 and 21, section 270 of the Insolvency Act provides that the debtor may, under the supervision of a custodian (usually an insolvency practitioner), continue to manage the insolvency estate and dispose of assets (a process called self-administration). This is not dissimilar to the debtor-in-possession provisions of Chapter 11 of the US Bankruptcy Code. The prerequisite for the proceeding is that the insolvency court orders self-administration when the debtor applies for the opening of insolvency proceedings. The conditions for the making of such an order are: that the debtor has applied for the order; and that there are no circumstances that lead to the expectation that such an order will disadvantage creditors.

Self-administration is deemed not to be to the disadvantage of the creditors, if a preliminary creditors’ committee (see question 34) unanimously approves the debtor’s application.

If the reorganisation plan is successful and the debtor is to continue its business once the insolvency proceeding has come to an end, the plan may provide for the continued supervision of the debtor’s performance. That supervisory role is carried out by the custodian.

Furthermore, section 270b of the Insolvency Act provides for the ‘protective shield procedure’, which puts a moratorium in place on creditor enforcement for a limited period of time. The conditions for opening the protective shield procedure are that: the debtor applies for it when over-indebtedness or threatened illiquidity (or both) has occurred (as defined in the Insolvency Act (see question 15)); and the intended restructuring has reasonable prospects of success.

If these requirements are met, the insolvency court may, without opening regular preliminary insolvency proceedings, order the moratorium on creditor enforcement for a maximum of three months, during which time the debtor must, under the supervision of a custodian (usually an insolvency practitioner), establish and present a reorganisation plan. A debtor cannot apply for the protective shield procedure if it is already illiquid (as defined in the Insolvency Act (see question 15)).

As concerns the continued trading of the debtor’s business after the opening of the insolvency proceedings, creditors who supply goods or services are paid as priority creditors of the estate. Examples of priority liabilities of the estate include: liabilities incurred by the insolvency administrator or otherwise as a result of the administration, disposition, sale and distribution of the insolvency estate; and liabilities arising after the opening of the insolvency proceeding from continuing contracts (eg, employment agreements, lease agreements), and contracts that the administrator has adopted.

In this context, according to a judgment of the Federal Supreme Court (6 April 2018 - IX ZR238/17), the self-administering management shall be liable to the creditors for damages such as an insolvency administrator acting in a regular insolvency proceedings (ie, if the self-administering mangers intentionally or negligently breach the duties incumbent upon insolvency administrators under the Insolvency Code or if a priority liability created as a result of a legal act by the self-administrating debtor cannot be settled in full out of the insolvency estate, the self-administering managers can be held personally liable). This judgment is in line with the prevailing opinion in practice that considers such liability to be necessary to professionalise the self-administration.

Post-filing credit

May a debtor in a liquidation or reorganisation obtain secured or unsecured loans or credit? What priority is or can be given to such loans or credit?

Generally, the insolvency administrator may enter into loans and other credit to secure the necessary financing for a continuation of the debtor’s business. Such liabilities incurred by the insolvency administrator are treated as priority liabilities of the insolvency estate. As priority liabilities, they will be settled prior to the satisfaction of unsecured creditors, albeit only after the costs of the insolvency proceedings, which are also priority liabilities, and the secured creditors have been satisfied. The insolvency administrator must obtain the consent of the creditors’ committee or, if a creditors’ committee has not been appointed, the consent of the creditors’ meeting if a debt is to be incurred that would significantly burden the insolvency estate.

To enable a successful restructuring, a reorganisation plan can also give priority to creditors that either: make loans or give credit to the debtor or a takeover company during the period of supervision (which follows the ratification of the plan); or permit existing loans or credits to continue during this time.

Those liabilities are also priority liabilities. They will not only be paid prior to satisfaction of those unsecured creditors who already exist, but also to new creditors entering into contractual agreements with the debtor within the period of supervision, while secured creditors will still be paid first. The aggregate maximum amount of such priority credit will be fixed in the plan. Further, such preferential satisfaction requires an agreement between the debtor or takeover company and the respective creditor and written approval by the insolvency administrator.

Sale of assets

In reorganisations and liquidations, what provisions apply to the sale of specific assets out of the ordinary course of business and to the sale of the entire business of the debtor? Does the purchaser acquire the assets ‘free and clear’ of claims or do some liabilities pass with the assets?

Upon the opening of insolvency proceedings, which include either a reorganisation or liquidation, the insolvency administrator is entitled to sell the debtor’s assets. If the insolvency administrator intends to effect transactions of special significance to the insolvency proceedings, he or she requires the approval of the creditors’ committee or the creditors’ meeting. In particular, such approval is necessary if the entire enterprise, or one of its businesses, is to be transferred.

In practice, most insolvency administrators - in alignment with the major secured and unsecured creditors - aim to sell the business as a going concern as soon as possible by way of an asset sale to realise the best possible price and to preserve the greatest possible number of jobs. In general, the sale of assets is free and clear of any liability on the part of the buyer, provided that the insolvency proceedings have actually been opened. However, such asset sale does not generally affect creditors with security rights in rem to the assets. As a rule, the insolvency administrator is entitled to dispose of encumbered movable assets that are in the possession of the debtor and subsequently pay off the secured creditors with the proceeds from the sale. In practice, the insolvency administrator usually provides the acquirer of the debtor’s business (or certain parts thereof) with a release letter from the main secured creditors confirming that the security will be released upon payment of the purchase price. Apart from this, under section 613a of the Civil Code, the sale of a business (as a whole or in part) causes all employment relationships pertaining to this business (or the respective part sold) to be transferred by operation of law to the buyer (unless the employees concerned object to the transfer of their employment). However, any claims of the employees against their employer that came into existence prior to the opening of insolvency proceedings are in general considered as ordinary insolvency claims with no priority (ie, the acquirer is generally not liable for such debts of the debtor (see question 43)).

Negotiating sale of assets

Does your system allow for ‘stalking horse’ bids in sale procedures and does your system permit credit bidding in sales?

Subject to approval at the creditors’ meeting, the insolvency administrator is free to pursue ‘stalking horse’ bids in a sale procedure. In practice, however, such bids do not seem to be particularly relevant as the insolvency administrator will usually aim to dispose the debtor’s business as soon as possible, so will not focus too much on preliminary ‘stalking horse’ bids that could considerably delay the sales procedure, and could ultimately jeopardise the sale of the business as such. If the insolvency administrator expects that a number of parties might be interested in acquiring the debtor’s business, he or she will initiate an auction process to obtain the best possible price (and preserve the likelihood of a sale in a well-ordered process).

Under the Insolvency Act, a creditor may not unilaterally implement a credit bid in the sales process (unlike in a security enforcement process initiated by creditors outside of insolvency proceedings). It is possible, however, for the insolvency administrator and the acquirer of the debtor’s business, who is also a secured creditor, to agree that the consideration owed by the acquirer is (partly) paid by way of a set-off or a similar type of settlement (subject to creditors’ meeting approval) (as, for instance, in the insolvency proceedings of the German solar manufacturer SolarWorld (2017)). If the acquirer’s claims against the debtor are only unsecured insolvency claims, these claims cannot be considered at nominal value; if at all, such claims could at best be valued at a percentage equalling the insolvency quota. As to assigning a claim of a (secured) creditor, there are no restrictions under the Insolvency Act. If a creditor aims to acquire the business of the debtor (ie, the insolvent company), it is, however, more often the case that this will be achieved by a debt-to-equity-swap as part of an insolvency plan (see question 8).

Rejection and disclaimer of contracts

Can a debtor undergoing a liquidation or reorganisation reject or disclaim an unfavourable contract? Are there contracts that may not be rejected? What procedure is followed to reject a contract and what is the effect of rejection on the other party? What happens if a debtor breaches the contract after the insolvency case is opened?

Generally, any mutual contracts that have not been performed by either party in full at the time of the formal opening of the insolvency proceedings become unenforceable, unless the insolvency administrator chooses to adopt the contract. The counterparty to such a contract can require the insolvency administrator to decide without delay whether to adopt the contract. If the insolvency administrator does not make a decision, after having received such request, the insolvency administrator’s option to elect a performance of the contract falls away. Any damages incurred by the other party as a result of such avoidance of contract may be filed as an ordinary, unsecured insolvency claim.

Contracts for the sale of goods by the insolvent company that are subject to retention of title remain in place upon request of the purchaser if possession of the goods was transferred to the purchaser prior to the formal commencement of the insolvency proceedings. If, on the other hand, the insolvent company prior to the opening of the proceedings has purchased goods and received possession of such goods subject to retention of title by the seller, the insolvency administrator may postpone his or her decision on the option to maintain the contract until the date of the information hearing (see question 33).

Where the insolvent company is tenant under contracts for the lease of real estate, the insolvency administrator may terminate the lease giving the relevant statutory notice period, irrespective of the agreed contractual term. The landlord is not entitled to terminate a contract because of the insolvency of the tenant. Employment contracts where the insolvent company is the employer may be terminated by either party with a notice period of three months, irrespective of any contractual provision to the contrary. In the insolvency proceedings, employees can be made redundant with the benefit that severance payments under a social plan are capped at an aggregate maximum amount of two-and-a-half times the monthly salary per employee. However, even after the commencement of the insolvency proceedings, the Employment Protection Act still applies, which may constrain redundancies by the insolvency administrator.

In self-administrations (section 270 and following of the Insolvency Act (see questions 7 and 23)), the provisions on the performance of mutual contracts in an insolvency scenario also apply, allowing the self-administering management of the insolvent company to exercise the insolvency administrator’s rights. The self-administering management is, however, supervised by a custodian (usually an insolvency practitioner) whose consent is required for certain measures. Where an insolvency administrator (or in the event of a self-administration the debtor) breaches the (approved) mutual contract mentioned above, the other party can claim the resulting damage. Such a damages claim would be an estate claim, which would take priority over insolvency claims (see question 39). However, if the insolvency administrator, or in the event of a self-administration the debtor, has opted for the non-performance of the contract, the resulting damage may only be filed as non-preferred insolvency claim (see above).

Intellectual property assets

May an IP licensor or owner terminate the debtor’s right to use the IP when a liquidation or reorganisation is opened? To what extent may IP rights granted under an agreement with the debtor continue to be used?

There are no specific statutory provisions dealing with intellectual property rights in insolvency. In the event of the insolvency of the licensee, the insolvency administrator has the right to continue the licence agreement under its present terms or reject its continuation (any claims for damages of the licensor for non-performance being insolvency claims, see question 27). Contractual clauses providing for a right of the licensor to terminate the licence agreement upon the opening of insolvency proceedings over the estate of the licensee will, at least according to the prevailing view, be void.

In the event of the insolvency of the licensor, the different types of licences (exclusive and non-exclusive, main licences and sub-licences) and intellectual property rights (patents, trademarks, copyrights, etc) need to be reviewed individually to determine whether the licensee is still the owner of a licence and authorised to use it. Generally, the insolvency administrator over the estate of the licensor has a right to opt to continue the licence agreement. In respect of an exclusive copyright main licence (for software, films, etc), the High Court of Mannheim held that the choice of non-performance resulted in the licensee’s loss of the licence (judgment of 27 June 2003, 7 O 127/03).

A judgment of the Federal Supreme Court (17 November 2005, IX ZR 162/04) shows a possible way to ensure the continuous use of software by the licensee in the event of a licensor’s insolvency. In that case, the licence agreement allowed both parties to terminate the agreement if the continuation of the agreement was unacceptable to one party. The agreement further provided for a transfer of the source code of the software developed by the licensor to the licensee under the condition precedent of such termination, the licensee in this event being obliged to pay a one-off compensation to the licensor. In the insolvency proceedings over the estate of the licensor, the insolvency administrator chose not to continue the licence agreement. Therefore, the licensee terminated the agreement. The court held that:

  • the insolvency administrator had the right to choose not to further perform the licence agreement;
  • because of this, the licensee had the right to terminate the agreement; and
  • as the transfer of the source code was already effected before the commencement of insolvency proceedings (though under a condition precedent that was only fulfilled after the commencement of the insolvency proceedings), this transfer was not affected by the commencement of the insolvency proceedings and subsequent actions of the insolvency administrator.

In another judgment (21 October 2015, I ZR 173/14), the Federal Supreme Court also stated that, under certain circumstances, insolvency administrators shall no longer be entitled to reject or assume contracts in relation to licence buy-outs once the mutual obligations of the parties to the licence agreement have been fulfilled. According to the Regional Court of Munich (9 February 2012 - 7 O 1906/11), this shall be the case where the parties agree on an irrevocable, perpetual licence that is not subject to any royalty fees or where royalty fees have already been paid at once or at least upon the opening of insolvency proceedings, so that the licence agreement is to be qualified as a sales contract. On the contrary, the continuation of contracts, where continuing rights and obligations are foreseen, are determined by section 103 of the German Insolvency Code (ie, they are subject to the disposition of the insolvency administrator (see question 27)). Regarding secondary obligations, the Regional Court of Munich (21 August 2014 - 7 O 11811/2) decided that only such obligations that are manifestations of a functional reciprocity and are therefore agreed upon in the context of granting the licence may lead to the contract not being fulfilled by the parties in full.

Furthermore, the M2Trade (I ZR 70/10 of 19 July 2012) and Take Five (I ZR 24/11 of 19 July 2012) judgments of the Federal Supreme Court stated that even if an (insolvent) sub-licensor loses the main licence in an insolvency proceeding over its estate, any sub-licensee will still retain its sub-licence (ie, the loss of the main licence does not automatically end the sub-licence). In these judgments, the Federal Supreme Court also indicated a tendency to treat all intellectual property rights sub-licences in the same way. It remains unclear whether this will also apply to main licences.

Personal data

Where personal information or customer data collected by a company in liquidation or reorganisation is valuable, are there any restrictions in your country on the use of that information or its transfer to a purchaser?

In addition to the Federal Data Protection Act, the Insolvency Act does not provide for any specific restrictions on using customer data within an insolvency proceeding. Therefore, it is not uncommon that, in particular, the customer base of an insolvent company, which often represents an asset of significant value, is sold as part of an asset deal between the insolvency administrator and a third party (see question 25 regarding asset deals). In this context, however, in 2016, the Bavarian Data Protection Authority (DPA) imposed a significant fine (a five-figure amount) on both the seller (ie, the appointed insolvency administrator) and the purchaser in connection with the sale of customer personal data. According to the DPA, customer personal data (eg, customer email addresses, phone numbers, credit card information, etc) had been transferred unlawfully as part of an asset deal in violation of the Federal Data Protection Act, as the insolvency administrator and the purchaser failed either to obtain customer consent or, alternatively, give the customers an opportunity to object to the transfer of the personal data.

On 25 May 2018, the General Data Protection Regulation (Regulation (EU) 2016/679) of the European Parliament and of the Council of 27 April 2017 entered into force (together with a revised Federal Data Protection Act that also became effective on 25 May 2018). The Regulation raises some concerns among German insolvency practitioners, as it is questionable whether and under which condition an insolvency administrator is a controller pursuant to article 4, No. 7 of the Regulation and therefore can be held liable for non-compliance with data protection rules. Some insolvency experts reject a liability of the insolvency administrator, unless he or she has actual control over the data processing and has not released the data (carriers). However, it remains to be seen if future court decisions will follow this view and provide legal certainty.

Arbitration processes

How frequently is arbitration used in liquidation or reorganisation proceedings? Are there certain types of disputes that may not be arbitrated? Can disputes that arise after the liquidation or reorganisation case is opened be arbitrated with the consent of the parties?

There are no statistics addressing the number of arbitration proceedings in conjunction with insolvency proceedings.

After the opening of insolvency proceedings, the debtor loses its ability to be a party to a dispute in relation to the estate; instead, the insolvency administrator will be the right party. In principle, the insolvency administrator is, subject to certain exceptions, bound by an arbitration clause agreed by the debtor pre-insolvency. However, an arbitration clause agreed by the debtor prior to the opening of insolvency proceedings does not affect indispensable rights of the insolvency administrator, so that the insolvency administrator is not bound by an arbitration clause in respect of avoidance claims pursued by the insolvency administrator or proceedings related to the insolvency administrator’s right to reject the fulfilment of a contract, for example. Also, the insolvency administrator may refuse to submit to arbitration proceedings if there is insufficient money in the estate to cover the expenses of such proceedings. The insolvency court does not have the authority to direct the insolvency administrator to submit a dispute to arbitration. The insolvency administrator is, however, bound by an arbitration he or she has agreed with the other party involved.

Apart from the exclusions mentioned above, in relation to the insolvency administrator’s intrinsic rights, there are no types of insolvency disputes that may not be arbitrated. Where the insolvency administrator is willing to enter into an arbitration agreement in an insolvency proceeding, the consent of the creditors’ committee or, if a creditors’ committee has not been appointed, the consent of the creditors’ meeting has to be obtained.

Where the insolvency administrator rejects the claim, or another creditor objects to its insertion in the insolvency table, then a creditor may need to bring proceedings to have the claim recognised. This may involve having to litigate or arbitrate an underlying dispute. In such litigation or arbitration, the court or tribunal will be asked to make a declaration, rather than order specific performance. If the arbitration tribunal grants a declaration that the underlying claim is valid, the creditor would be permitted to be included in the insolvency table. Where the counterparty obtained an arbitral award prior to the opening of insolvency, they can file such a claim with the insolvency table (although the insolvency officeholder could appeal the award).

The opening of insolvency proceedings does not automatically cause arbitration proceedings to be interrupted. This depends mainly on the procedural rules applied by the arbitral tribunal. In any case, the insolvency administrator must have the chance to be heard in the arbitration proceedings. Otherwise, the arbitration award will not be recognised by German courts.

CREDITOR REMEDIES

Creditors’ enforcement

Are there processes by which some or all of the assets of a business may be seized outside of court proceedings? How are these processes carried out?

The court order opening insolvency proceedings imposes an automatic stay on unsecured creditors initiating or continuing actions against the company. Unsecured creditors can no longer enforce their rights in legal proceedings outside the insolvency proceedings.

The Insolvency Act does not impose an automatic stay on the enforcement by secured creditors (see also question 22). Creditors who claim that an asset does not belong to the estate because of a right of segregation, including retention of title creditors, are free to enforce their rights against the company. Creditors secured by charges on real estate may enforce such charges irrespective of the insolvency proceeding. The insolvency administrator may also initiate such enforcement proceedings, for example, by selling real estate in an auction and paying the proceeds to the security holder. Hence, the creditor and the insolvency administrator are both equally and independently entitled to enforcement with respect to real estate.

Creditors with a security interest in movable property will mainly be prevented from enforcement, which may then only be initiated by the insolvency administrator. Movable assets that are subject to security held by creditors and receivables, which have been assigned for security purposes, will generally be sold by the insolvency administrator free and clear of the security and the proceeds of such sale will be paid to the holders of such security, less a handling fee. This shall not affect financial collateral (as defined in section 1(17) of the Banking Act: for example, cash deposits, pledges or fiduciary transfers of securities) and collateral granted to the participant of a securities settlement system (as defined in section 1(16) of the Banking Act). The insolvency administrator is not entitled to enforcement if the creditor is still in possession of the movable asset. In this case, the creditor’s enforcement right remains unaffected by the opening of the insolvency proceedings.

Unsecured credit

What remedies are available to unsecured creditors? Are the processes difficult or time-consuming? Are pre-judgment attachments available?

An unsecured creditor must first obtain a judgment in respect of its debt. It can then initiate a judicial execution of the debtor’s personal or real property. However, these procedures can be very difficult and time-consuming, especially if the debtor contests the creditor’s claim. In principle, an attachment could be obtained in advance of a judgment or execution but only where certain strict requirements have been met. An example would be if the enforcement of the judgment would become impossible or considerably more difficult without such a court order.

CREDITOR INVOLVEMENT AND PROVING CLAIMS

Creditor participation

During the liquidation or reorganisation, what notices are given to creditors? What meetings are held and how are they called? What information regarding the administration of the estate, its assets and the claims against it is available to creditors or creditors’ committees? What are the liquidator’s reporting obligations?

In principle, all decisions of the insolvency court require notice to all the persons affected. Notwithstanding this, public notifications are sufficient for proof of service on all parties, even where the Insolvency Act provides for personal service. Thus, creditors should pay attention to all public notifications issued by the insolvency court and keep in contact with it.

The creditors have a right to be informed by the insolvency administrator about the affairs of the insolvency estate. The insolvency administrator will usually fulfil his or her duty to provide information at creditor meetings (in particular the information hearing, see below) by giving a detailed report on the financial situation of the debtor, the reasons for the insolvency, the prospects of a successful restructuring, the feasibility of an asset sale (to sell the business as a going concern) or an insolvency plan, the impacts on the satisfaction of creditors and on measures already taken by the insolvency administrator prior to the meeting.

With regard to meetings, a creditors’ meeting can only be called by the insolvency court. The most important creditors’ meetings are:

  • information hearing - at this first meeting, the creditors mainly resolve, based upon a report by the insolvency administrator, whether to continue or partially or completely shut down the debtor’s business. The creditors also resolve whether a creditors’ committee should be established (or, if applicable, the preliminary creditors’ committee should be maintained), the approval of which would be required before certain measures can be taken by the insolvency administrator; for example, significant transactions;
  • examination hearing - at this meeting, the registered claims are examined;
  • hearing for discussion and voting - at this meeting, an insolvency plan and the creditors’ (and, if applicable, shareholders’) voting rights are discussed and the plan is voted on; and
  • final hearing - the purpose of this meeting is for a discussion of the insolvency administrator’s final statement of fees, the raising of any objections against the final list of creditors and a decision by the creditors as to the assets of the insolvency estate that cannot be realised. The insolvency court also decides on the final distribution.

When the insolvency court makes the order opening the insolvency proceeding, it also sets dates for the information hearing and the examination hearing, which can take place on the same day.

Creditor representation

What committees can be formed (or representative counsel appointed) and what powers or responsibilities do they have? How are they selected and appointed? May they retain advisers and how are their expenses funded?

The insolvency court is generally obliged to appoint a preliminary creditors’ committee in conjunction with the opening of preliminary insolvency proceedings, if the debtor meets two of the three following thresholds: balance sheet total of at least €6 million; annual turnover of at least €12 million; and at least 50 full-time employees.

In all other cases, the insolvency court may appoint a preliminary creditors’ committee upon request of either the debtor, the preliminary insolvency administrator or a creditor. The preliminary creditors’ committee can require the insolvency court to appoint a certain independent person as preliminary insolvency administrator and it also has the right to suspend an early self-administration procedure (see questions 7 and 23).

In the first creditors’ meeting (ie, the information hearing - see question 33) the creditors will have to decide whether the preliminary creditors’ committee is to be maintained and, if so, whether certain members of the committee should be removed and whether additional members should be appointed. In the preliminary creditors’ committee and in the final creditors’ committee, creditors with a right to separate satisfaction (see question 22), the largest insolvency claim holders, the minority creditors and the employees shall be represented. The members of the creditors’ committee are responsible for supporting and monitoring the insolvency administrator. For this purpose, the members of the creditors’ committee have numerous powers and responsibilities. They must, primarily, keep themselves informed about the business of the debtor, examine the debtor’s books and implement a cash audit. If the insolvency administrator intends to effect transactions of special significance, he or she requires the approval of the creditors’ committee. In particular, such approval will be necessary if the entire enterprise, or one of its businesses, is to be transferred.

The members of the creditors’ committee are entitled to adequate compensation for their function as members of the creditors’ committee and to reimbursement of necessary expenses. Expenses incurred through retaining advisers will only be reimbursable if these are proportionate and necessary to properly fulfil the duties as a member of the creditors’ committee.

Enforcement of estate’s rights

If the liquidator has no assets to pursue a claim, may the creditors pursue the estate’s remedies? If so, to whom do the fruits of the remedies belong? Can they be assigned to a third party?

Once insolvency proceedings have been opened, and the insolvency court has appointed an insolvency administrator (rather than ordering ‘self-administration’), only the insolvency administrator may pursue claims belonging to the estate. The insolvency administrator cannot authorise a creditor to pursue a claim. In certain cases, the insolvency administrator may authorise the debtor or, respectively, its representatives to pursue a claim in court; however, this would not be a solution if the estate is insufficient to pursue the claim. Legal aid is available to an insolvency administrator, provided that:

  • the costs of the lawsuit are not covered by the estate;
  • the advancement of the costs by those who have an economic interest in the success of the lawsuit is unacceptable to them;
  • the lawsuit has adequate chances of success; and
  • the pursuit of the claim is not arbitrary.

Consequently, no legal aid will be granted if (certain) creditors are able to advance the costs and if such creditors benefit from the lawsuit, because of a substantial increase of their quota. In many cases, the granting of legal aid for a lawsuit of the insolvency estate is denied, because there are creditors who would benefit from the lawsuit and who could advance the costs of the lawsuit, but are unwilling to do so. In any case, the insolvency administrator is free to enter into a loan to finance the costs of the lawsuit. The repayment obligation of the loan would be an estate claim taking priority over ordinary unsecured insolvency claims (see question 39).

Generally, the insolvency administrator is entitled to sell, transfer and assign a receivable belonging to the estate (eg, to continue the business of the debtor).

Claims

How is a creditor’s claim submitted and what are the time limits? How are claims disallowed and how does a creditor appeal? Can claims for contingent or unliquidated amounts be recognised? Are there provisions on the transfer of claims and must transfers be disclosed? How are the amounts of such claims determined?

The order opening the insolvency proceeding, when sent to creditors or publicised, will include a notice to creditors requiring them to submit their claims to the insolvency administrator within a period of between two weeks and three months from the date of the order (but a delayed filing is, however, still possible for a small fee). It will also include a request to creditors to notify the administrator promptly if they claim to have security over the debtor’s chattels or immovable assets. The subject, nature and basis of the security right and the claim secured should also be stated.

Creditors are obliged to register their claims with the administrator (or the custodian in case of self-administration) in writing, stating the basis and the amount of the claim. Copies of documents supporting or evidencing the claim must be attached to the written statement by which the claim is asserted. If the amount of the claim cannot be determined exactly at the time the claim is registered, the claim has to be registered based on a fair estimate of the value as at the date of the opening of the insolvency proceeding. Claims that are subject to a condition precedent can be registered with the administrator and must be considered when proceeds are distributed. Respective amounts are, however, not distributed, but retained by the administrator either until the condition precedent is fulfilled, in which case the amount is released to the relevant insolvency creditor, or until it becomes clear that the condition precedent will not be fulfilled, in which case the proceeds are free for distribution to the other insolvency creditors. At the examination hearing (see question 33) the registered claims will be examined to determine amount and ranking. In principle, claims that are registered after the expiry of the registration period can still be examined. A claim is deemed to have been admitted where no objection has been raised by either the administrator or another creditor.

The insolvency court will then prepare a table of registered claims showing which claims have been admitted and setting out the amount and the ranking of each claim. Inclusion in the table has the effect of a final judgment as far as the administrator and the creditors are concerned. Creditors who have claims that have not been objected to by the debtor may enforce such claims after termination of the insolvency proceedings by way of execution as they can under any normal executable judgment. Thus, an objection by the debtor cannot hinder the admission of a claim but may prevent the creditor from executing his or her claim on the basis of the entry in the table.

If a creditor’s claim is disputed by the administrator or another creditor, the creditor can bring proceedings before an ordinary court for a decision as to whether its claim should be admitted.

Generally, all claims rank equally, with preferential and subordinated claims being the exception. Among the subordinated claims, shareholder loans are of particular importance. All shareholder loans made by lenders holding more than 10 per cent of the shares in the borrower (ie, a company or a partnership that has no individual persons as general partners) are generally classified as subordinated insolvency claims (see also question 48). Furthermore, a repayment of such shareholder loan made in the year prior to the opening of insolvency proceedings will generally be voidable. Prior to an insolvency, shareholder loans may, however, be repaid, provided that such repayment is not restricted by a subordination agreement or by statutory law (eg, section 64, sentence 3 of the Limited Liability Companies Act - see also question 48).

There are no specific provisions that deal with the purchase, sale or transfer of claims against the debtor and there is no general obligation to disclose such transfer of claims. However, setting off claims against the insolvency estate is not permitted if a creditor acquires his or her claim from another creditor after the opening of the insolvency proceedings, notwithstanding that the acquired claim may have originated prior to the opening of insolvency proceedings (see also question 37).

Creditors who acquire a claim at a discount are entitled to claim for its full face value (ie, they may file the full amount with the insolvency administrator).

Generally, creditors can claim interest that has accrued after the opening of insolvency proceedings. However, interest accruing on such claims from the opening of the insolvency proceedings is subordinated to other claims of insolvency creditors. They will only be paid when all other insolvency creditors’ claims have been satisfied. However, they rank higher than further subordinated claims such as the costs incurred by the insolvency creditors because of their participation in the proceedings, fines (whether regulatory fines, coercive fines or administrative fines), claims to the debtor’s gratuitous performance of a consideration and shareholder loans (subject to certain exceptions - see above).

Set-off and netting

To what extent may creditors exercise rights of set-off or netting in a liquidation or in a reorganisation? Can creditors be deprived of the right of set-off either temporarily or permanently?

As a general principle, claims by or against the insolvency estate existing as at the date of the opening of the insolvency proceedings may be set off against each other in the following circumstances: if the claim of the creditor existed and was due and payable at the time of the opening of insolvency proceedings; and if the claim of the estate against which the creditor wishes to effect set-off was also existing at the time of the commencement of insolvency proceedings.

In the event that the claim or cross-claim is contingent or not yet due at the date of the opening of insolvency proceedings, the set-off may only be effected once the claim becomes unconditional or due. A set-off will be excluded if the claim of the estate that is to be offset becomes unconditional or due prior to the time that the set-off can be effected by the creditor.

No set-off is permissible if:

  • a creditor’s claim arises after the opening of the insolvency proceedings;
  • a creditor acquires its claim from another creditor following the opening of the insolvency proceedings (even if the original creditor’s claim pre-dated the insolvency);
  • a creditor acquires the right to set off by means of a voidable transaction (see question 47); or
  • a creditor is a debtor of the insolvency estate and has a claim that has to be satisfied from the assets of the debtor that are not affected by insolvency.

These restrictions on a set-off may not affect financial services, in particular financial securities within the meaning of section 1(17) of the Banking Act.

After the validity of ‘netting arrangements’ used in the financial sector was doubted by the Federal Court of Justice in a judgment dated 9 June 2016 (IX ZR 314/14), the German legislator has passed an amendment to section 104 of the Insolvency Act providing clarity on the status of netting arrangements. Section 104(4) of the Insolvency Act allows counterparties to contractually agree on netting provisions that deviate from the statutory mechanism of termination and settlement of contracts regulated in article 104 InsO, as long as this is compatible with the basic principles of the legal provision. The law entered into force on 29 December 2016, partly retroactively.

Modifying creditors’ rights

May the court change the rank (priority) of a creditor’s claim? If so, what are the grounds for doing so and how frequently does this occur?

Under German insolvency law, the insolvency court has no competence to modify the rank (priority) of a creditor’s claim.

Priority claims

Apart from employee-related claims, what are the major privileged and priority claims in liquidations and reorganisations? Which have priority over secured creditors?

Under the Insolvency Act, in general, there are no priority claims. In particular, employee-related claims relating to a period prior to the opening of insolvency proceedings do generally not enjoy priority status.

However, employees are protected by the ‘insolvency money’, which covers wages for a period of up to three months prior to the opening of the insolvency proceedings.

The opening of insolvency proceedings does not affect creditors with proprietary claims for the return of assets that do not belong to the insolvency estate. Secured creditors may also enjoy certain superior rights. Furthermore, claims and costs arising from transactions executed by the insolvency administrator after the opening of the insolvency proceedings attract priority status (ie, they need to be paid prior to the satisfaction of unsecured creditors but after creditors with a right to separate satisfaction or a right to set-off (see also question 24)).

Employment-related liabilities

What employee claims arise where employees’ contracts are terminated during a restructuring or liquidation? What are the procedures for termination? (Are employee claims as a whole increased where large numbers of employees’ contracts are terminated or where the business ceases operations?)

Generally, the opening of insolvency proceedings over the estate of the employer does not affect the relationship with the employees. Claims of the employees against their employer that came into existence prior to the opening of insolvency proceedings are in general considered as ordinary insolvency claims with no priority; claims of the employees against their insolvent employers that come into existence after the opening of insolvency proceedings attract priority status as estate debts.

Employment contracts where the insolvent company is the employer may be terminated by either party with a notice period of three months (irrespective of any contractual provision to the contrary or an exclusion of termination). However, even after the opening of the insolvency proceedings, the Employment Protection Act still applies, which may constrain redundancies by the insolvency administrator. The German Insolvency Act contains a number of provisions that facilitate and accelerate consultation processes with the works council on operational changes that lead to redundancies and help to procure an effective termination of employment relationships. For example, protection from dismissal is limited in the event a list of employees to be made redundant has been agreed with the competent works council in a balance of interests or been approved by the labour law court in advance of issuing the notice letters. Where no works council exists, the redundancies will not trigger any severance payments under social plans. In the event that a works council had been established before a redundancy decision was taken, redundancies can be made during insolvency proceedings with the benefit that severance payments under a social plan are in any event capped at an aggregate maximum amount of two-and-a-half times the monthly salary per employee. For pension claims, see question 41.

There are no specific rules in case of terminations of large numbers of employees’ contracts or where the business ceases operations.

Pension claims

What remedies exist for pension-related claims against employers in insolvency or reorganisation proceedings and what priorities attach to such claims?

Employees’ pension claims do not enjoy priority in insolvency proceedings unless they were secured by a specific collateral in each individual case and are thereby treated preferentially compared to any other regular claim. However, pension commitments of the (insolvent) employer in relation to the employees are in general protected by the German pension insurance association. In simple terms, the German pension insurance association assumes the obligation of the insolvent employer to satisfy vested pension claims and is in turn subrogated in the insolvency as a non-prioritised creditor.

Claims for deficiencies in an external pension plan or a pension scheme do not enjoy priority in the insolvency of an employer. Where pensions are granted through a pension fund, however, the insolvency protection via the German pension insurance association is also available to the employees in the event that the assets of the external pension fund do not suffice.

Environmental problems and liabilities

Where there are environmental problems, who is responsible for controlling the environmental problem and for remediating the damage caused? Are any of these liabilities imposed on the insolvency administrator personally, secured or unsecured creditors, the debtor’s officers and directors, or on third parties?

Generally, the insolvency administrator (or in the event of self-administration, the debtor’s management board) is responsible for fulfilling the debtor’s public law obligations in the insolvency proceedings (eg, obligations resulting from environmental issues). Claims and costs arising from fulfilling such obligations attract priority status (see question 39).

However, the insolvency administrator is entitled to release objects from which public law obligations derive (such as land) from the insolvency estate so that they become part of the debtor’s assets not affected by the insolvency proceedings. In this case, the government would engage a third party to solve the environmental issues. According to case law of the Federal Administrative Court, the resulting claims of the government are either to be treated as priority claims (see question 39) or as unsecured insolvency claims. This depends on the grounds of the liability:

  • if there is a liability for the status of the object (eg, the owner exercises legal or actual control over the polluted site that contravenes the regulations), the government would have a priority claim;
  • if there is a liability for the behaviour of the debtor as polluter prior to the opening of the insolvency proceedings (eg, a debtor causes the pollution of the site through his or her actions), the government would not have a priority claim, but an unsecured claim; and
  • if there is a liability of an operator of a plant, the government would have a priority claim.
Liabilities that survive insolvency or reorganisation proceedings

Do any liabilities of a debtor survive an insolvency or a reorganisation?

Provided that the debtor is reorganised by way of an insolvency plan, debts of the debtor only survive the cessation of the insolvency proceedings if, and to the extent that, they are specified in the insolvency plan. This also applies for creditors who have not filed their claims with the insolvency administrator and had them included in the official table. Such creditors are bound by the measures approved through the insolvency plan and will be treated as creditors of the appropriate class of creditors if they assert a claim against the debtor after the insolvency proceedings have been terminated. If, following the termination of the insolvency proceedings, any enforcement by these creditors jeopardises the enforcement of the insolvency plan, the insolvency court may, upon a request by the debtor, entirely or in part unwind an enforcement or deny it for a maximum of three years. Moreover, any such claims made by these creditors shall become statute-barred after one year.

A third party that acquires the debtor’s business by way of an asset deal is generally not liable for any debts of the debtor, provided that the insolvency proceedings have actually been opened. The acquirer may, however, be held liable for the clean-up costs of polluted land acquired from the insolvency estate.

On the acquisition of the debtor’s business, whether as a whole or in part, by way of an asset deal, the employees working in the business or the respective part thereof transfer to the purchaser by operation of law, unless the employees concerned object to the transfer of their employment relationships (see section 613a of the Civil Code). A dismissal of employees for the sole reason of the transfer is not permitted, even if the acquisition of the business is made out of an insolvency estate. However, redundancies may still be made for operational reasons; for example, to make the reorganisation of the business possible (see sections 125 to 128 of the Insolvency Act). Furthermore, the transfer of the employment relationships by operation of law does not encompass the employees’ claims and pension rights arising prior to the opening of the insolvency proceedings.

Subsequent to the termination of the regular insolvency proceedings (ie, without an insolvency plan), creditors may in principle assert their remaining claims against the debtor without any insolvency-related restrictions. In this context, however, once the insolvency proceedings have been completed, any legal entity or partnership will generally cease to exist and be removed from the commercial register.

Distributions

How and when are distributions made to creditors in liquidations and reorganisations?

Distributions may be made whenever there is sufficient cash in the insolvency estate. However, the insolvency administrator has to obtain the consent of the creditors’ committee, if one has been appointed (see question 34), before each distribution. The final distribution takes place once all the assets of the estate have been realised, but only after the consent of the insolvency court has been obtained.

Distributions pursuant to an insolvency plan are not restricted by the terms of the Insolvency Act and, therefore, payments to creditors should be consistent with what has been agreed by the creditors (and shareholders if applicable) in the plan.

SECURITY

Secured lending and credit (immovables)

What principal types of security are taken on immovable (real) property?

The principal types of security devices that are taken on immovable (real) property are as follows.

Hypothek

Real property can be charged by way of a hypothek (ie, mortgage) as security for payment of a definite sum that equals the secured personal debt. It is not necessary for the creation of a hypothek that the owner of the real property is the personal debtor in respect of the claim secured by the charge. The hypothek may be certificated or non-certificated. Both forms are registered with the land register, but only the holder of a certificated hypothek receives a certificate after registration that enables him or her to transfer the hypothek externally to the register by means of written assignment and handing over the certificate.

Grundschuld

A grundschuld (ie, land charge) creates a charge on real property for the payment of a definite sum of money. It differs from a hypothek because it does not depend on an underlying personal debt and theoretically may exist without one. In practice, the parties usually agree that the grundschuld will not be transferred back to the real property owner until all outstanding sums have been repaid.

Secured lending and credit (movables)

What principal types of security are taken on movable (personal) property?

The principal types of security devices that are taken on movable (personal) property are:

  • retention of title: pursuant to section 449 of the Civil Code, the seller of personal property may retain title over the assets it is selling until the purchase price has been paid;
  • fiduciary transfer of assets: a fiduciary transfer of assets is an arrangement pursuant to which a debt is secured on personal property, possession of which is retained by the debtor;
  • fiduciary transfer of receivables: a fiduciary transfer of receivables is an arrangement whereby security is granted over receivables owed to the debtor; and
  • chattel pledge: a chattel pledge is created by pledging a chattel (or claim) as security for a debt. It is a right in rem to satisfy a claim. A chattel pledge requires that the debtor delivers up possession of the chattel.

In practice, one will often find a combination of these security devices. For instance, suppliers usually supply their products on retention of title terms. However, the terms of supply may entitle the retailer to sell the products in the ordinary course of business, provided that the (future) receivables arising from such sales to customers are assigned to the supplier in advance by fiduciary transfer.

CLAWBACK AND RELATED-PARTY TRANSACTIONS

Transactions that may be annulled

What transactions can be annulled or set aside in liquidations and reorganisations and what are the grounds? Who can attack such transactions?

Once insolvency proceedings have been commenced that include either a reorganisation or liquidation, only the insolvency administrator is entitled to contest transactions and payments of the insolvent company that prefer certain creditors (preferential transactions).

According to sections 129 to 146 of the Insolvency Act, certain actions (including the granting of collateral to a creditor) taken by the insolvent company and resulting in a direct or indirect reduction of the value of the insolvent estate, or in a complication in the enforcement of the rights of the insolvent estate, are subject to avoidance rights of the insolvency administrator (or the custodian in case of self-administration). These actions must also be taken within certain time periods prior to the filing for insolvency proceedings (suspect periods). The relevant period in which transactions and payments are voidable particularly depends on the underlying motivation of the parties involved and the value of the contingent consideration, as shown by the following examples.

Pursuant to section 130 of the Insolvency Act (congruent cover), the fulfilment of a debt or the granting of collateral, or enabling a counterparty to obtain such fulfilment or collateral, may be contested if it was made: in the three months prior to the insolvency filing, provided that at such date the company was illiquid and the other party was aware thereof; or after the insolvency filing, provided that at such date the other party was aware of the company’s illiquidity or of the fact that the company had filed for insolvency.

This provision enables the insolvency administrator to contest transactions of the insolvent company, irrespective of any right of a creditor to such fulfilment or such security at the time (eg, the right of a creditor to a specific security). Knowledge of circumstances indicating the state of illiquidity of the company, or of the company’s application to open insolvency proceedings, is deemed equivalent to actual knowledge of the illiquidity or of the filed petition.

Section 130 of the Insolvency Act does not apply if the underlying security agreement calls for an increase of financial collateral (as defined in section 1(17) of the Banking Act; for example, cash deposits, pledges or fiduciary transfers of securities) to close the gap between the value of the collateral that has already been provided, and the value of the collateral that must be provided under the security agreement (margin collateral).

Pursuant to section 131 of the Insolvency Act (incongruent cover) the fulfilment of a debt, the granting of security the counterparty could not have claimed, or not in such way or at such a time (ie, the creditor was not entitled to claim at the time), under the existing contractual arrangements may be contested if it was made:

  • in the month prior to the insolvency filing or after such filing;
  • in the second or third month prior to the insolvency filing, provided that at such date the company was illiquid; or
  • in the second or third month prior to the insolvency filing, provided that the other party was aware or should have been aware that the action was to the disadvantage of insolvency creditors. Knowledge that the granting of security is to the disadvantage of other insolvency creditors will be assumed if the creditor knows, or ought to know, at the time of the granting of the collateral, that the debtor will no longer be able to satisfy all of its other creditors in the near future because of the existing financial crisis.

Pursuant to section 133(1) of the Insolvency Act (legal acts wilfully disadvantaging the insolvency creditors), any legal actions taken by a debtor within the 10 years prior to the insolvency filing can be contested by the insolvency administrator, provided that the action was taken by the debtor with the intent of disadvantaging its creditors and the counterparty was aware that the debtor intended to disadvantage its creditors. Knowledge of the debtor’s intention will be presumed if the counterparty was aware of the debtor’s imminent illiquidity and of the disadvantageous effect of the action on the other creditors (however, see below on new rules effective as of 5 April 2017). An intention of a debtor to disadvantage its creditors does not require an actual desire of the debtor to disadvantage them. Rather, it will suffice that the debtor recognises that the satisfaction of, or the granting of security to, one creditor can cause disadvantages to its other creditors, in particular reducing the likelihood that its other creditors can be paid (whether in whole or in part) out of the remaining assets.

Pursuant to section 142 of the Insolvency Act (cash transactions), payments on the part of a debtor in return for which its property benefited directly from an equitable consideration may (only) be contested under the conditions of section 133(1) of the Insolvency Act (see also below on new rules effective as of 5 April 2017).

On 5 April 2017, a long-discussed reform of the clawback rights in German insolvency proceedings became effective. At the core of the new legislation are amendments on the aforementioned sections 133 (legal acts wilfully disadvantaging the insolvency creditors), and 142 (cash transactions) of the Insolvency Act, as well as on the suspect periods for claw-back claims.

For insolvency proceedings that have been or will be commenced after 5 April 2017, the following main amendments apply:

  • Pursuant to section 133(2) of the Insolvency Act, legal actions resulting in a satisfaction or in the provision of security are contestable if the relevant legal action took place within four years prior to the insolvency filing. In case of congruent cover (see above), the legislator has introduced further privileges:
    • the presumption of knowledge on the side of the counterparty does only apply in the event of existing (and no longer imminent) illiquidity; and
    • in the event that the creditor enters into a payment agreement with the debtor or otherwise grants the debtor a payment accommodation with subsequent (congruent) payments, it shall be presumed that the creditor did not know about the debtor’s illiquidity.
  • Section 142(2) of the Insolvency Act provides for a privilege for employees’ wages as it defines that wage payments qualify as cash transactions if made within three months after the performance of the work. The same is true if the wages are paid by a third party and it was not clear for the employee that the payment came from a party other than its employer.
  • The default interest period starts only once the insolvency administrator has put the creditor in default or upon filing suit (section 143(1)). This new interest rule also applies to insolvency proceedings that have been commenced before 5 April 2017. Before the reform, the default interest period already started once the insolvency proceedings had been opened.

In addition to the avoidance rights mentioned above, the insolvency administrator can challenge the repayment of shareholders’ loans if the repayment was made within the previous year prior to the filing for the opening of insolvency proceedings (see also question 48).

Furthermore, any security over the debtor’s assets obtained by execution of a judgment in the month prior to the application for the insolvency proceedings, or subsequent to such application, will be set aside by operation of law as at the date of the opening of the insolvency proceedings.

In order to exercise the avoidance right, an informal declaration by the insolvency administrator is sufficient. Furthermore, the insolvency administrator is entitled to close a dispute by way of an out-of-court settlement. If the creditor rejects the avoidance, the insolvency administrator has to sue the creditor before the civil courts.

Anything that was transferred, disposed of or yielded from the assets of the debtor by means of a voidable transaction has to be restored to the insolvency estate.

If no insolvency proceedings have been initiated, transactions and payments of the company may be contested by creditors under the Voidance Act, which provides rights for creditors similar to those of an insolvency administrator in insolvency proceedings.

Equitable subordination

Are there any restrictions on claims by related parties or non-arm’s length creditors (including shareholders) against corporations in insolvency or reorganisation proceedings?

All shareholder loans made by lenders holding more than 10 per cent of the shares in the borrower (ie, a company or a partnership that has no individual persons as general partners) are generally classified as subordinated insolvency claims (see also question 36). Claims resulting from legal actions that are economically comparable to a shareholder loan will also be generally classified as subordinated insolvency claims.

Furthermore, a repayment of such shareholder loan made in the year prior to the opening of insolvency proceedings will generally be voidable. Prior to an insolvency, shareholder loans may, however, be repaid, provided that such repayment is not restricted by a subordination agreement or by statutory law (eg, section 64, sentence 3 of the Limited Liability Companies Act).

Also, transactions made by the debtor with insiders or non-arm’s length creditors prior to the opening of insolvency proceedings can regularly be more easily contested, as the German Insolvency Act contains specific avoidance provisions on transactions with related parties (see sections 133(2) and 138 of the German Insolvency Act) and also turns the burden of proof partially around to their disadvantage (see sections 130(3), 131(2), 132(3), 133 (4) and 138 of the German Insolvency Act (see question 47)).

Insiders are, inter alia, the members of the body representing or supervising the debtor, as well as his or her general partners and persons holding more than one quarter of the debtor’s capital, and a person or a company that has, on the basis of a comparable association with the debtor under company law or under a service contract, the opportunity to become aware of the debtor’s financial circumstances.

GROUPS OF COMPANIES

Groups of companies

In which circumstances can a parent or affiliated corporation be responsible for the liabilities of subsidiaries or affiliates?

In principle, neither the parent nor affiliated companies can be held liable for the liabilities of subsidiaries or affiliates, unless they have given guarantees or security for the debtor’s liabilities. Generally, only the (insolvent) limited liability company is liable to fulfil its obligations unless explicitly agreed otherwise between the shareholder and the company (eg, by entering into a profit and loss transfer agreement) or the shareholder and affiliated companies with the relevant creditors (eg, by providing a guarantee), or both. There is, however, case law on ‘piercing the corporate veil’; for example, in cases of substantial undercapitalisation of the company or a misuse of the corporate form. The most important category of this case law encompasses capital maintenance requirements: ‘measures of fundamental impairment’. This means that a shareholder must not withdraw the company’s assets required for the ordinary course of business, thereby accepting a possible impairment of the company’s creditors. In the event of a measure of fundamental impairment, the shareholders - and even the shareholders of such shareholders - can be held personally liable by the insolvency administrator in an unlimited way.

At present, German insolvency law is dominated by the principle of ‘one entity, one estate, one insolvency process’. Therefore, a court cannot order a pooling of group company assets for distribution purposes.

In the course of the ongoing reform of German Insolvency law, the German parliament has passed an Act on the Facilitation of the Handling of Corporate Group Insolvencies that entered into force on 21 April 2018. This act addresses the former lack of coordination between parallel insolvency proceedings of group companies (see question 50). It does not, however, offer a consolidation of the individual insolvency proceedings. The act also contains an explicit rejection of the substantive consolidation of assets and liabilities of group companies.

In essence, the act includes the following provisions:

  • an optional common place of jurisdiction for the different insolvency proceedings;
  • the obligation on the different insolvency courts to coordinate with each other on the appointment of one joint insolvency administrator for the group-wide insolvency proceedings;
  • an obligation of the different insolvency courts, insolvency administrators and creditors’ committees to cooperate; and
  • coordination proceedings to further enhance the coordination between the different insolvency proceedings over group entities.
Combining parent and subsidiary proceedings

In proceedings involving a corporate group, are the proceedings by the parent and its subsidiaries combined for administrative purposes? May the assets and liabilities of the companies be pooled for distribution purposes?

There are not yet any provisions on combining proceedings in connection with group insolvencies. German insolvency law strictly adheres to the principle ‘one debtor, one estate, one procedure’. Therefore, a pooling of the assets and liabilities of group companies (substantive consolidation) is not permitted. Also, a combination of the procedures (joint administration or procedural consolidation) is not possible under German insolvency law. However, there is the possibility (which is often used in practice) of having the same insolvency administrator appointed for all proceedings, thereby assuring a factual coordination (see also question 49). The competent judge has discretion to appoint the same insolvency administrator for the insolvency proceedings of several group companies to optimise the coordination , or to refuse such (joint) appointments to avoid possible conflicts of interest.

As far as cross-border insolvencies of corporate groups within the EU are concerned, please see questions 55 and 56 for more details.

INTERNATIONAL CASES

Recognition of foreign judgments

Are foreign judgments or orders recognised and in what circumstances? Is your country a signatory to a treaty on international insolvency or on the recognition of foreign judgments?

As far as cross-border insolvencies within the EU are concerned, the EC Regulation on Insolvency Proceedings (Council Regulation (EC) No. 1346/2000) (the EU Insolvency Regulation), applies to procedures that have been opened before 26 June 2017.

On 26 June 2015, the Regulation (EU) 2015/848 (the EU Recast Regulation), which replaced the EU Insolvency Regulation, entered into force in all member states, except Denmark (see the European Union chapter). Cross-border insolvencies concerning non-EU member states are governed by German international insolvency law.

Within the EU, the courts of the member state in which the debtor’s COMI is situated will have jurisdiction to open main insolvency proceedings. Generally, foreign insolvency proceedings are recognised automatically and the German assets of the debtor will be subject to the foreign insolvency proceedings. Notwithstanding this, foreign insolvency proceedings will not be recognised if to do so would be incompatible with German public policy (ordre public). If, pursuant to German international law, the courts of a non-EU member state where the proceedings were commenced do not have jurisdiction over the company, such proceedings will not be recognised in Germany.

If a debtor’s COMI is located in a member state of the EU, the opening of secondary proceedings in Germany requires that the debtor has an establishment in Germany. Generally, this is also the case where insolvency proceedings of a non-member state are to be recognised in Germany. Such secondary proceedings encompass only the German assets of the debtor. If foreign insolvency proceedings have already been commenced against the debtor, proof of insolvency is not required for the commencement of the German insolvency proceedings.

Employment relationships with employees working in Germany will still be governed by German law. Creditors’ rights in rem concerning assets, whether tangible or intangible, movable or immovable, that are owned by the debtor and situated in Germany shall not be affected by the commencement of foreign insolvency proceedings.

Although any avoidance is, in principle, subject to the law that governs the underlying insolvency proceedings, a transaction that, pursuant to the general principles on conflict of laws, is governed by German law, may only be avoided by a foreign insolvency office holder if the transaction may also be avoided pursuant to German law, or is ineffective for any other reason.

The Regulation on jurisdiction and the recognition and enforcement of judgments in civil and commercial matters (Regulation of the European Parliament and the Council No. 1215/2012 (the Brussels Regulation recast)) is also relevant in relation to recognition of foreign proceedings (see the European Union chapter).

UNCITRAL Model Law

Has the UNCITRAL Model Law on Cross-Border Insolvency been adopted or is it under consideration in your country?

Germany has not adopted the UNCITRAL Model Law on Cross-Border Insolvency.

Foreign creditors

How are foreign creditors dealt with in liquidations and reorganisations?

Foreign creditors are entitled to participate in German insolvency proceedings in the same way as domestic creditors. The foreign creditor is subject to the rules of the Insolvency Act (eg, for submitting an insolvency claim - see question 36). Foreign creditors in possession of a foreign judgment would have to apply to a German court for recognition of their judgments before bringing steps to enforce it.

Cross-border transfers of assets under administration

May assets be transferred from an administration in your country to an administration of the same company or another group company in another country?

Assets belonging to the insolvency estate of the German debtor may only be transferred to an insolvency estate of a debtor in another country based on either: a supply and delivery agreement between the two debtors that has not been terminated following the insolvency; or an asset sale and purchase agreement entered into by the insolvency administrators (ie, on the basis of continuing or new contractual arrangements).

COMI

What test is used in your jurisdiction to determine the COMI (centre of main interests) of a debtor company or group of companies? Is there a test for, or any experience with, determining the COMI of a corporate group of companies in your jurisdiction?

The EU Insolvency Regulation defines COMI as the place where the debtor conducts the administration of its interests on a regular basis and that is ascertainable by third parties. For a full analysis of the test to determine COMI of a debtor under the EU Insolvency Regulation, please refer to the chapter on the European Union.

In the case of Interedil (Interedil Srl v Fallimento Interedil Srl and Intese Gestione Crediti SpA (C-396/09)) the European Court of Justice confirmed that COMI must be interpreted in a uniform way in EU member states and by reference to EU law and not national laws. Where a company’s registered office and place of central administration are in the same jurisdiction, the registered office presumption set out in the recitals to the EU Insolvency Regulation cannot be rebutted. Where a company’s central administration is not in the same place as its registered office, a comprehensive assessment of all relevant factors makes it possible to establish, in a manner that is ascertainable by third parties, that the company’s central administration is located in another EU member state.

Factors that have been held to be relevant to determine a debtor’s COMI (in addition to the rebuttable registered office presumption) are: location of internal accounting functions and treasury management, governing law of main contracts and location of business relations with clients, location of lenders and location of restructuring negotiations with creditors, location of human resources functions and employees as well as location of purchasing and contract pricing and strategic business control, location of IT systems, domicile of directors, location of board meetings and general supervision.

The rebuttable presumption that a company’s COMI is where its registered office is located has been slightly modified in the EU Recast Regulation, which states that it is not possible to rely on the rebuttable presumption where a debtor has moved its registered office in the preceding three months (see the European Union chapter).

As regards a corporate group of companies, there is no specific test to determine the COMI. Hence, in general, the parent company and each subsidiary of a corporate group is subject to an individual and entirely separate insolvency proceeding, often at different insolvency courts and under different administrators (see questions 49 and 50).

The insolvency of NIKI Luftfahrt GmbH (as part of the insolvency of the Air Berlin group in 2017 / 2018) brought up some interesting judgments dealing with the determination of the COMI (see question 59).

Cross-border cooperation

Does your country’s system provide for recognition of foreign insolvency proceedings and for cooperation between domestic and foreign courts and domestic and foreign insolvency administrators in cross-border insolvencies and restructurings? Have courts in your country refused to recognise foreign proceedings or to cooperate with foreign courts and, if so, on what grounds?

Generally, German insolvency law allows for recognition of foreign insolvency proceedings and for cooperation between domestic and foreign courts and domestic and foreign insolvency administrators.

According to article 19 of the EU Recast Regulation, any judgment opening insolvency proceedings handed down by a court of a member state that has jurisdiction pursuant to article 3 of the EU Recast Regulation (see question 55) shall be recognised in all the other member states from the time that it becomes effective in the state of the opening of proceedings. The judgment opening the proceedings shall, with no further formalities, produce the same effects in any other member state as under this law of the state of the opening of proceedings, unless the EU Recast Regulation provides otherwise. However, according to article 33 of the EU Recast Regulation, any member state may refuse to recognise insolvency proceedings opened in another member state or to enforce a judgment handed down in the context of such proceedings where the effects of such recognition or enforcement would be manifestly contrary to that state’s public policy, in particular its fundamental principles or the constitutional rights and liberties of the individual (ordre public). In 2018, the opening of insolvency proceedings over the assets of NIKI Luftfahrt GmbH in Austria (as part of the insolvency of the Air Berlin group in 2017/ 2018) raised questions about when exactly one jurisdiction had to recognise foreign openings of insolvency proceedings, as both the German insolvency court of Berlin Charlottenburg and the Austrian Higher Court of Korneuburg had assumed jurisdiction to open main insolvency proceedings (for more details, see question 59).

The concept of an automatic recognition is similarly reflected in the Insolvency Act governing international insolvency law for non-EU members. According to section 343 of the Insolvency Act, the opening of foreign insolvency proceedings shall be recognised. However, this shall not apply if the courts of the state of the opening of proceedings do not have jurisdiction in accordance with German law or where recognition leads to a result which is manifestly incompatible with major principles of German law, in particular where it is incompatible with basic rights (ordre public).

There are only a few statutory provisions governing the cooperation between domestic and foreign courts and domestic and foreign insolvency administrators. According to article 41 of the EU Recast Regulation, the administrators of main and secondary proceedings shall exchange all relevant information and shall generally cooperate with each other. The concept of article 41 of the EU Recast Regulation is reflected in section 357 of the Insolvency Act governing international insolvency law for non-EU members. Under article 41 of the EU Recast Regulation or section 357 of the Insolvency Act, the German insolvency administrator is obliged to share all relevant information and documentation with a foreign administrator to facilitate an effective and smooth process and the best possible satisfaction of creditors in the insolvency procedures. This would, inter alia, encompass the sharing of information on the insolvency estate, court actions, opportunities to realise the insolvency estate, the registration of claims and voidance rights.

Although not expressly provided for in the EU Recast Regulation or the Insolvency Act, German insolvency administrators are also allowed to enter into protocols to establish a contractual framework for the conduct of the various proceedings. Depending on their contents, such protocols require approval by the German creditors’ meeting or the creditors’ committee.

Under the EU Recast Regulation, there are now provisions governing the cooperation between domestic and foreign insolvency courts (for further information, please refer to the chapter on the European Union).

In contrast, the Insolvency Act does not contain any provisions governing cooperation between domestic and foreign insolvency courts. The UNCITRAL Model Law contains provisions on the cooperation of insolvency courts in international proceedings; these, however, have not been translated into German law. It is undisputed, however, that such cooperation between courts is allowed and some even say that insolvency courts are obliged to cooperate according to the principles established for the cooperation of insolvency administrators. The purpose of such cooperation is, principally, to share information to avoid jurisdictional conflicts and clarify the financial position of the debtor. Such cooperation is to be handled on an informal basis without formal requests for judicial assistance. Against this background, insolvency courts are also allowed to agree on protocols to establish a framework for the different proceedings.

New procedures with the aim of facilitating cross-border coordination and cooperation between multiple insolvency proceedings in different member states relating to members of the same group of companies have been introduced by the EU Recast Regulation (see the European Union chapter).

German insolvency courts have successfully cooperated with foreign insolvency courts and have thus avoided jurisdictional conflicts, in cases such as the insolvency of the PIN Group, where German and Luxembourg courts have been in close contact, or the insolvency of the BenQ Group, where German and Dutch courts have cooperated. There are no reported cases in which German insolvency courts refused to cooperate with foreign courts.

However, in a judgment dated 15 February 2012 (IV ZR 194/09), the German Federal Supreme Court refused to recognise an English scheme of arrangement between the UK-based insurance company Equitable Life Assurance Society (ELAS) and its creditors.

Given the fact that the particular scheme related to an insurance company and, therefore, specific insurance regulation had to be applied; however, the court did not decide whether the Council Regulation 44/2001 (the predecessor to the Brussels Regulation recast) could be applied for schemes of arrangements concerning non-insurance companies. However, the court indicated that there were arguments to apply Council Regulation 44/2001 as scheme of arrangements were similar to judgments in the meaning of that regulation. In this connection, a number of Germany-based companies have successfully used an English law scheme of arrangement during recent years (see question 59).

Cross-border insolvency protocols and joint court hearings

In cross-border cases, have the courts in your country entered into cross-border insolvency protocols or other arrangements to coordinate proceedings with courts in other countries? Have courts in your country communicated or held joint hearings with courts in other countries in cross-border cases? If so, with which other countries?

Although German courts have dealt with several cross-border insolvency cases, the German courts have not yet entered into any cross-border insolvency protocols or similar arrangements to coordinate proceedings with courts in other countries. The same applies to joint hearings with courts in other countries. German courts have, however, cooperated with foreign insolvency courts on an informal basis (see question 56).

With regard to cross-border group insolvency procedures, cooperation and communication between courts might occur more frequently in the future. Article 57 of the EU Recast Regulation allows the involved courts to cooperate on issues such as the appointment of the insolvency administrators, the coordination of the administration and the supervision of the insolvency estate.

Winding-up of foreign companies

What is the extent of your courts’ powers to order the winding-up of foreign companies doing business in your jurisdiction?

In Germany, insolvency proceedings are not initiated ex officio, but rather require an application for the commencement of insolvency proceedings filed either by the debtor (see question 16) or any creditor (see question 9). The obligation to file such an application in the event of an insolvency does not only apply to the managing directors or management board members of German entities, but also to the corresponding legal representatives of foreign companies that have their centre of main interests (COMI) (see question 55) in Germany (see question 16). If a company does not have its COMI in Germany, the courts lack jurisdiction to commence proceedings and, hence, to order the winding-up of that company.

As far as companies from EU-member states (except Denmark) are concerned, recognition of the order to wind up the foreign company is provided for by article 19 of the EU Recast Regulation (see question 56).

On the other hand, with regard to companies from third countries (ie, non-EU member states), international recognition depends on bilateral or multilateral agreements with the state in which the company has its registered office, or, if neither exists, on the international insolvency law provisions of the respective state.

Update and trends

Trends and reforms

Are there any emerging trends or hot topics in the law of insolvency and restructuring? Is there any new or pending legislation affecting domestic bankruptcy procedures, international bankruptcy cooperation or recognition of foreign judgments and orders?

Trends and reforms59 Are there any emerging trends or hot topics in the law of insolvency and restructuring? Is there any new or pending legislation affecting domestic bankruptcy procedures, international bankruptcy cooperation or recognition of foreign judgments and orders?

During the past years, a hot topic was the restructuring of Germany-based companies by using an English law scheme of arrangement. German companies used English law schemes of arrangements successfully to implement financial restructurings and to avoid going into German insolvency proceedings; for example, in Tele Columbus (2010), Rodenstock (2011), Primacom (2012), Apcoa (2014) and CBR Fashion GmbH (2016).

In a number of cases, the (announced) intention of German companies to use or prepare a scheme of arrangement has apparently helped to achieve a consensual solution for the restructuring of financial debts with creditors (eg, Scholz (2015/2016), HC Starck (2015)).

Schemes of arrangement are (still) in competition with the restructuring measures provided under German insolvency law that, as a consequence of the ESUG (the Further Facilitation of Restructuring Businesses Act), provides, inter alia, for the possibility of a debt-to-equity-swap as part of an insolvency plan, including the option to cram down dissenting shareholders. These restructuring measures have been well received by practitioners as a number of prominent cases have already demonstrated (eg, Pfleiderer AG (2012) and IVG Immobilien AG (2014)). Whether Brexit will make a difference to the number of German companies utilising an English law scheme of arrangement still needs to be seen.

In connection with the aforementioned ESUG, the Federal Ministry of Justice issued a research project in April 2017 that has been awarded to a consortium of leading insolvency law professors to evaluate the experiences gained in practice with the ESUG five years after its entry into force. The results of the evaluation have been set out in a report that was released by the Federal Ministry of Justice in October 2018. Generally, the report comes to the conclusion that the changes introduced by the ESUG have been largely well received in the market and that no corrections to the general orientation of the ESUG are necessary. The main findings of the report can be summarised as follows:

  • the strengthening of creditors’ rights to participate in the selection of insolvency administrators has not led to any impairment of their independence;
  • as regards the possibility of influencing shareholder rights by way of an insolvency plan, no significant impairments were found, but there is still room for improvement or clarification in some specific areas of the insolvency plan proceeding;
  • the ‘protective shield procedure’ (in the meaning of section 270b of the Insolvency Act) is rarely used, and it is not very advantageous compared to the regular ‘early self-administration procedure’; and
  • the statutory allocation of duties between judges and judicial officers has essentially proved effective.

The federal government is currently examining the results of the evaluation report in more detail to decide whether concrete legislative action is necessary. The results shall also be considered for the implementation of the ‘EU Directive on Insolvency, Restructuring and Second Chance’ (see the European Union chapter). There is currently a broad discussion among German legislators and insolvency experts how a pre-insolvency proceeding should be established without weakening the existing restructuring tools provided for in the German Insolvency Act (in particular those provided through the ESUG as described above). In principle, there are two conceivable possibilities to implement the ‘EU Directive on Insolvency, Restructuring and Second Chance’ in Germany:

  • The first arguable model contains a strict stay imposed on individual enforcement actions after the opening of proceedings following a debtor’s application. The decision of the insolvency court to open such proceedings would then have to be announced and published. The duration of this moratorium would be limited to a maximum of four months; meanwhile, the possibility to file for the commencement of formal insolvency proceedings would be suspended. In ideal circumstances, the procedure would be terminated by the conclusion of a settlement between the company and certain creditors under judicial assistance. However, in case of dissenting creditors, this model would allow a collective effect concerning all creditors, so that a strong involvement of the competent (insolvency) court would be required.
  • Another proposition provides a minimal participation of the (insolvency) court within such pre-insolvency restructuring proceedings. This approach would to a lesser extent be based on a central, judicially coordinated procedure, but rather on the idea that the debtor will negotiate independently with the creditors in case of financial distress. To secure necessary negotiations, the debtor would be able to file an application to obtain individually operating stays of enforcements with regard to individual claims or creditors. Thus, if the EU Directive will be implemented this way, the moratorium of individual enforcements will not apply erga omnes. In general, the proceeding shall be finished by a consensual settlement.

So far, no draft bill to implement the EU Directive has been published by the Ministry of Justice. However, the German Federal Ministry of Justice has already implied that it intends to implement the directive before the end of the two-year period (as provided for in the EU Directive), and it is expected that a first draft bill will be published in the first quarter of 2020.

There are also new developments in the area of the tax treatment of restructuring measures. On 11 December 2018, the German legislator passed a legislative act that is designed to establish a firm legal basis for the exemption of restructuring measures from taxation. The new regulation stipulates a suspension and a subsequent waiver of corporate income tax on cancellation of debt income resulting from loan waivers or a debt-to-equity swap (for example as part of an insolvency plan).

Also, the European Court of Justice has ruled that the ‘restructuring clause’ provided for in section 8c, paragraph 1a of the Corporation Income Tax Act, according to which loss carry-forwards are not forfeited in the event of a change of control for restructuring purposes, did not contravene European state aid law. As an immediate consequence, the German Parliament published the ruling in the Federal Law Gazette on 11 December 2018 whereby the restructuring clause was formally reinstated.

As to cross-border restructuring, the insolvency of the Air Berlin group in 2017/2018 became the first test for the EU Recast Regulation. Concerning Air Berlin’s subsidiary NIKI Luftfahrt GmbH (NIKI), the lack of clarification on the term COMI caused a conflict of competence between German and Austrian courts.

On 13 December 2017, the local court of Berlin-Charlottenburg (Germany) found it had international jurisdiction over the case and took measures (inter alia the appointment of a German preliminary insolvency administrator) to safeguard the continuation of the business. Even though NIKI had its registered office in Vienna, the court was satisfied that the company’s COMI was located in Berlin. In particular, the following considerations were highlighted by the local court:

  • NIKI was part of the Air Berlin group and indirectly controlled by Air Berlin which was already in insolvency proceedings in Germany at that time;
  • NIKI’s operational business was mainly driven from Berlin; and
  • most of the flights conducted by Niki departed from Germany.

On 8 January 2018, the Regional Court of Berlin overruled the decision of the local court, which was appealed by a creditor pursuant to article 5 of the EU Recast Regulation. The Regional Court found that, based on the following facts (among others), NIKI’s COMI should be held to be in Austria:

  • the fact that NIKI was part of the Air Berlin group could not rebut the COMI presumption;
  • the seat of NIKI’s management was irrelevant, as it had frequently travelled between Vienna and Berlin;
  • the fact that most flights departed from Germany was irrelevant, as an entity could have a number of establishments; and
  • NIKI’s employment contracts were 80 per cent governed by Austrian law.

The decision was further appealed by the appointed German preliminary insolvency administrator before the German Federal Court. Nevertheless, even before a decision was made by the German Federal Court, on 13 January 2018, the Austrian Higher Court of Korneuburg opened a (second) main insolvency proceedings in Austria, and appointed an Austrian administrator. The Austrian court took the stance that it could open the main proceedings in Austria, as the first decision of the German local court was invalid following the decision of the Regional Court and, therefore, there were, despite the pending appeal before the German Federal Court, no longer any parallel main insolvency proceedings in Germany.

In order to continue and finalise the initiated sales process of NIKI’s assets to a third party: the German main insolvency proceeding was converted into a secondary insolvency proceeding; the German insolvency administrator dropped its appeal before the German Federal Court; and both the German and the Austrian administrator agreed to cooperate closely. Ultimately, NIKI’s assets could be sold to Niki Lauda.

Consequently, the German Federal Court has neither provided further guidelines on the determination of the COMI nor made a judgment whether an insolvency proceeding continues during a pending appeal. There are, however, strong arguments in favour of the view that an insolvency proceeding continues while an appeal is pending. Accordingly, most of the German insolvency practitioners are of the opinion that the Austrian court was not allowed to open a main insolvency proceeding in Austria before the German Federal Court had decided on the appeal.

Lastly, a great majority of German scholars predict an economic downturn in Germany within the next couple of years. In particular, the automotive supplying sector is supposed to require restructuring activities in the upcoming years. Although the actual setting cannot be considered a pervasive crisis, the number of situations of financial distress is increasing. Another sector that has to be observed in the context of restructuring activities is the German retail market, especially the mid-level price segment. From a restructuring perspective, however, the aforementioned restructuring procedures (those already in place as well as those to be implemented in the near future) provide for a number of tools to achieve a turnaround or reorganisation of distressed companies impacted by a downturn.