Commencing proceedings

Litigation climate

How would you describe the general climate surrounding insolvency litigation in your jurisdiction? What are the most common sources of dispute? To what extent is litigation used as a pressure or delay tactic?

Insolvency litigation has been on the rise in Germany for quite some time and is widely expected to increase further in the future. The reasons are manifold, but the most important one arguably is the mechanism that underpins German insolvency proceedings.

During a debtor’s insolvency, unsecured creditors can no longer enforce any individual claims against the debtor. Instead, the insolvency court typically appoints an insolvency administrator to commence all promising avoidance actions and damage claims, the proceeds of which the creditors receive on a pro rata basis. Because insolvency administrators may incur personal liability for failure to ensure the best possible creditor satisfaction, they will examine all possible claims very carefully and typically err on the more litigious side to avoid accusations of not having pursued a meritorious claim.

Other factors that contribute to the recent increase of insolvency litigation include:

  • recent legislative changes that have made it easier for insolvency administrators to pursue claims against shareholders and third parties;
  • litigation funders’ entering the market with tailored solutions for insolvency administrators; and
  • legal tech applications that allow the pursuit of claims that may have been considered too small or inefficient to entertain only a few years ago.

 

Overall, insolvency administrators are more willing and better equipped than ever to pursue meritorious claims. Not all claims end up in litigation, and many reach out-of-court settlements. However, in many cases, insolvency administrators commence court proceedings, which ample and evolving case law demonstrates, especially in the critical areas of clawback claims and damage claims against the debtor’s management.

Sources of law

What key sources of law form the basis of claims arising from insolvency? How does the insolvency regime interact with other laws?

Insolvency claims stem from a variety of legal concepts, all of which essentially link to the notions of preserving or increasing the distributable estate in the creditors’ interest and preventing the preferential satisfaction of individual creditors.

  • The Insolvency Code, which serves as the primary statute with regard to insolvency proceedings, governs claims for avoidance against shareholders and third parties, as well as claims for directors’ and managers’ failure to file for insolvency in due time.
  • General corporate rules continue to bind directors, managers and shareholders when a company is approaching insolvency. An insolvency administrator may, therefore, file claims for breach of fiduciary duty, breach of the duty of care and infringement of capital maintenance regulations.
  • Insolvency claims may also arise from tort and criminal law, specifically when the management or shareholders acted with intent.

 

Creditors’ claims, on the other hand, are not very common because the insolvency administrator automatically distributes their shares upon the conclusion of insolvency proceedings. Disputes usually concern whether a creditor has sufficiently justified the claim for the insolvency administrator’s acceptance or whether the creditor has a preferred security interest.

Procedure

What procedural rules govern insolvency litigation in your jurisdiction? What common procedural hurdles arise in practice?

The Code of Civil Procedure serves as the procedural framework for insolvency litigation and applies to all civil proceedings.

Typical insolvency litigation challenges include:

  • determining when the company became insolvent, which may require economic expert evidence;
  • dealing with the frequently inadequate accounting records and scarce evidence that can make it difficult for parties to provide full proof – as a result of which very detailed and balanced case law exists on factual and legal presumptions, the necessary pleading requirements and the standard to meet the burden of proof; and
  • establishing the required subjective element on the respondent’s behalf. For example, many avoidance actions require that the opposing party had actual knowledge of the company’s insolvency or knew of circumstances pointing directly to insolvency. Abundant case law explores the required level of circumstantial evidence to prove such knowledge.
Courts

Which courts hear insolvency claims? How experienced are they with insolvency litigation?

While designated insolvency courts at the local court level handle insolvency proceedings, ordinary civil courts hear insolvency claims against directors and officers, shareholders and creditors. Each civil court often includes specialised chambers or bodies that hear insolvency litigation cases, especially in the larger district courts that handle most insolvency claims.

Jurisdiction

Through what law do the relevant courts have jurisdiction to hear insolvency claims? Does jurisdiction differ for domestic and cross-border matters?

The Code of Civil Procedure primarily governs jurisdiction to hear insolvency claims in domestic matters. Parties may bring most claims at the seat of the insolvent company or at the director’s or shareholder’s place of residence. Other venues are also possible, depending on the circumstances.

The most important legislation in cross-border matters is the EU Regulation on Insolvency Proceedings. It provides that the courts of the EU member state in which the insolvency proceedings commence will have jurisdiction for all claims that derive directly from the proceedings and are closely linked with them, such as avoidance actions or claims for failure to file for insolvency in a timely manner.

Limitation periods

What limitation periods apply to bringing insolvency-related claims? Are there any notable exceptions?

The general limitation period in Germany is three years, beginning at the end of the calendar year in which the claim arises and the claimant obtains actual knowledge of the claim or would have obtained knowledge absent gross negligence. In the context of insolvency litigation, this limitation period applies to avoidance actions and tort claims.

A five-year statute of limitations that begins when the claim first arises governs claims against directors and officers for failure to file for insolvency in a timely manner and other breaches of fiduciary duties (10 years for publicly traded companies).

There are various ways to suspend limitation, and limitation waivers in particular are common in the insolvency litigation context.

Interim remedies

What interim remedies are generally available and commonly deployed in insolvency proceedings? How are these used as part of claimants’ overall litigation strategy?

Once insolvency proceedings formally commence, the court appoints an insolvency administrator, and the insolvent debtor automatically loses its legal authority to act. In some cases, the court may also approve the debtor’s self-administration under a custodian’s supervision.

In the time between the insolvency filing and the court’s formal decision on whether to commence insolvency proceedings, the court may take any interim measures it deems necessary to preserve the insolvency estate.

The primary goal of insolvency proceedings is to preserve or increase the distributable estate in the creditors’ interest and to prevent preferential satisfaction of individual creditors. To that end, the insolvency court may:

  • appoint a preliminary insolvency administrator;
  • appoint a preliminary creditors’ committee;
  • impose a general ban of disposal on the debtor or order that debtor disposals take effect only with the consent of the preliminary insolvency administrator;
  • temporarily suspend any pending enforcement actions against the debtor; and
  • as a last resort, subpoena the debtor’s directors and detain them

 

Recent legislative changes have strengthened the role of creditors in those preliminary measures. They now have some influence on whom the court appoints as the preliminary insolvency administrator and the members of the preliminary creditors’ committee. Creditors have exerted this influence through preliminary motions in several cases.

Debtor companies may also invoke preliminary remedies, such as when a debtor company files a protective brief to prevent any interim court measures if it has reason to believe that a third party will submit an unjustified request to commence insolvency proceedings.

Evidence

What rules and procedures govern the collection and admissibility of evidence in insolvency litigation? To what extent is expert witness testimony allowed? What common evidential issues should claimants be aware of?

The Code of Civil Procedure governs evidence collection and admissibility, and the rules are the same as in any other civil proceedings. The most important ways to proffer evidence are:

  • documentary evidence;
  • witness testimony;
  • expert evidence; and
  • the court’s visual inspection.

 

Discovery and witness depositions are not part of the evidential system (ie, each party must generally rely on the documents and witnesses to which it has access); however, there are additional rules on the required pleading level and a reversal of the burden of proof to address situations in which certain facts become relevant and only one party has access.

Common evidential issues in insolvency litigation include the frequent necessity of expert evidence, often sketchy documentary evidence and the need to establish the opposing party’s knowledge of certain circumstances.

Time frame

What is the typical time frame for insolvency claims?

The average duration of first instance civil proceedings before a district court is approximately 16 months. Because of regional differences, some district courts average as quickly as 11 months and others more than 30 months; however, many insolvency claims tend to be fairly complex, and the duration of proceedings may exceed these time frames, especially in cases that require expert evidence.

In nearly all cases, an out-of-court letter precedes the initiation of court action. While no statistical data exists to predict the typical time frames of out-of-court discussions, the discussions are either fairly brief (because the parties agree on a settlement or settlement negotiations fail) or they drag on until the statute of limitations forces one party to file a claim in court. Further, in many cases, limitation waivers extend this process.

Appeals

What are the requirements to appeal insolvency-related judgments? What is the typical time frame for appeals?

A party may appeal any district court judgment to the court of appeal without first seeking permission to do so. The average time frame for appellate proceedings is 13 months, but it may range from seven to 24 months depending on different regional averages.

A party may only further appeal an appellate judgment if the court of appeal or – upon further request – the Federal Court of Justice, Germany’s highest civil court, grants leave to appeal. The duration of proceedings before the Federal Court of Justice may differ depending on whether the court of appeal has granted leave to appeal, but most cases reach a decision within six to 18 months.

Costs and litigation funding

How are costs handled and how are claims funded? Can claimants obtain third-party funding to finance the prosecution of claims?

To file a claim, the claimant must advance the court fees, which depend on the value in dispute. The current fee cap is €362,000 for claims of €30 million or more. Appeal fees are even higher.

For insolvency administrators, fees may pose a serious challenge, which is why litigation funders – albeit a more recent development – are becoming increasingly common in insolvency litigation. In addition, and more traditionally, insolvency administrators may obtain state legal aid if the estate is insufficient to cover the costs of proceedings, and the insolvency administrator has sufficient prospects of success.