An extract from The Insolvency Review, 7th Edition
Insolvency law, policy and procedurei Statutory framework and substantive law
Germany's insolvency law can be considered both old and new. It dates back to 1878, when the Bankruptcy Act established fundamental insolvency principles for the German Empire, which was founded just eight years before.
However, it can also be said to be modern because current insolvency law is mainly determined by the German Insolvency Act (GIA), which came into force in 1999 and was substantially amended in 2012. In 2017, a couple of reforms added some further nuances that are discussed in more detail later in the chapter.
Although the GIA always aimed to provide possibilities for in-court restructuring, including self-administration, besides general liquidation and post-sale creditor satisfaction, the prevailing principle was the liquidation of the insolvent company and sale of the assets. Thus, German insolvency practitioners felt that German insolvency law is not competitive to foreign insolvency laws that provide for better in-court and out-of-court restructurings.
Consequently, the GIA was amended (ESUG amendment) as of 1 March 2012. Since this amendment, the self-administration tools and influence on the appointment of insolvency administrators for debtors and creditors have improved, and an umbrella protection proceeding as a special feature of self-administration aimed at an in-court restructuring has been established. In October 2018, a review of the new regulations that was initiated by the German government concluded that the reform was successful and the overall goal to simplify in-court restructuring procedures has been reached. However, calls for the introduction of an out-of-court restructuring regime were not heard, although the discussion is continuing. The EU Council and EU Parliament adopted a new Directive (Directive (EU) 2019/1023 of 20 June 2019) for the harmonisation of restructuring frameworks in Europe. This Directive includes guidelines for out-of-court restructuring procedures and shall be implemented into German law by the end of 2021. In 2017, the powers of the insolvency administrator to set aside transactions (clawback provisions) were cut back, and completely new provisions for group insolvencies were introduced. The general perception of insolvency practitioners is that German insolvency law is now more competitive than other European and non-European insolvency legislation, and the tools for restructuring insolvent companies through an in-court proceeding have been successfully amended. According to the European Commission, Germany's insolvency regime ranks second among EU Member States as regards effectiveness.
Still, the general principle of German insolvency law is not the survival of the insolvent company at any cost, but to reach collective satisfaction of the debtor's creditors on the most attractive terms – either by keeping the company running or by selling its assets (see Section 1 of the GIA).General insolvency proceedings (liquidation)
The proceedings described in the following paragraphs cover the general insolvency proceedings. Special proceedings aimed at restructuring the debtor are discussed in Section I.iii.Preliminary insolvency proceedings
After a filing for insolvency by a debtor or creditor, the insolvency court starts to examine whether the company is actually insolvent and if there are sufficient assets to meet the expenses of the proceeding in a preliminary insolvency proceeding. The insolvency court appoints a preliminary insolvency administrator (PIA). The debtor and a preliminary creditors' committee (if established by the court subject to the fulfilment of certain thresholds) can suggest or even make a binding proposal for an individual person to be appointed. The PIA controls and limits the power of the management of the insolvent company or takes control of all actions of the debtor.
This preliminary phase is unknown to many foreign creditors and debtors and is regularly the source of legal questions such as 'Who is representing the company now?' and 'Can we continue trading with the company?' Essentially, and in very general terms, the insolvent company continues its business with its existing management but is controlled and limited by the PIA. The debtor can continue its business as long as transactions are confirmed or carried out by the PIA.
Preliminary proceedings do not usually exceed three months because during this time the debtor is released from paying its employees' wages – instead, they are paid by the German state (up to a certain amount).General insolvency proceedings
If the court is positive that the debtor is insolvent and enough assets are available, regular insolvency proceedings start and the PIA is replaced by the (final) insolvency administrator (IA). The IA is usually the same person as the PIA.
Once the general insolvency proceedings are open, the IA takes full control of all assets of the debtor. The management is still in place, but it loses control of the entity.
During the proceeding, all rights of taking decisions are with the IA, who needs the consent of the creditors' committee or the creditors' assembly for material actions.
Creditors of the company, who earned their claims before the opening of insolvency proceedings, file their claims against the insolvent estate with the IA and inform the IA about securities granted to them.
There are three classes of creditors:
a Secured creditors are entitled to separate satisfaction, including from those secured by mortgages or security assignments. They can demand priority of receipt of the money up to full satisfaction of their claim (minus a fee for the IA, which amounts to 9 per cent in many cases) when the asset is sold. If their claim is not fully satisfied, the remaining part will be treated as an unsecured claim.
b Unsecured creditors are typically suppliers or customers who dealt with the debtor prior to the opening of insolvency proceedings. They only receive the general insolvency quota at the final distribution of the insolvent estate. The average quota in corporate insolvencies is between 4 and 7 per cent of the claim.
c Subordinated creditors include those with subordination agreements by statute, such as lenders of shareholder loans or by individual contract. These creditors usually do not receive any payment on their claims.
Creditors who have a right of segregation because they are the owner of the asset – it only happens to be in the possession of the debtor – are not creditors of the insolvent estate. As a general rule, they can claim return of their assets from the IA. Typically, this can apply to suppliers with extended retention of title clauses – a concept often unknown to foreign suppliers outside Germany.
A characteristic of German insolvency law is that claims against an insolvent estate that are established during the insolvency proceedings by the PIA or IA are preferential to all unsecured insolvency claims and have to be settled first, and in full, with the insolvency court fees and fees for the IA and creditors' assembly.
With the exception of this particular feature, there are no other preferential unsecured creditors, such as tax authorities.
Once the IA has realised the assets of the company, collects outstanding claims, gives back assets that do not belong to the insolvent estate, settles preferential claims and sets aside unlawful transactions, the unsecured creditors receive the general insolvency quota and the insolvency proceedings end.
The insolvency proceedings are always supervised and led by the insolvency court, and the IA constantly reports to the insolvency court and to the creditors' assembly.Right to set aside transactions (clawback)
Another special feature of German insolvency law is the broad power of the IA to set aside transactions of the insolvent estate carried out before a filing for insolvency proceedings or during preliminary insolvency proceedings. It is a German peculiarity as compared with other insolvency law systems that there always is a high risk of clawbacks for all contract partners of an insolvent estate that dealt with that insolvent estate years before the insolvency proceedings were initiated.
In the event of a successful clawback, the contractual party of the insolvent estate has to return what was received in full (e.g., purchase price) to the insolvent estate. In return, this party receives only an unsecured counterclaim against the insolvent estate (e.g., the value of the delivered goods), which will be satisfied with the regular insolvency quota.
After much debate for many years between German insolvency practitioners, a reform of the GIA to limit the power of IAs in this regard came into force in April 2017.
While the general intent of the clawback rules was not challenged, the reform restricts the rights of IAs in scope and time. There are three aspects of particular interest.
First, before the reform, an IA could set aside transactions that were carried out for a period of up to 10 years before insolvency proceedings were initiated under Section 133 of the GIA. This period is now reduced to a maximum of four years for almost all transactions and contracts (save for some exceptions, in particular when a debtor has taken actions deliberately to harm creditors while the other party knew of that purpose).
Second, the burden of proof for an IA to set aside a transaction under Section 133 of the GIA has been increased. In particular, when the contract parties had agreed on an instalment plan for payments, before the reform it was assumed that the creditor knew about an assumed bad faith. Now, by regulation of law, instalment repayment plans are no longer an indication of bad faith – on the contrary, instalment repayment plans are an indication that the creditor acted in good faith. This is an important swing for practitioners.
Third, transactions in which both parties fulfil their obligations within a short time – a maximum of 30 days – can only be set aside if the insolvent debtor acted in 'an unfair manner'. This special variation of bad faith for short-term transactions is new to German insolvency law, and it will be up to the insolvency courts to determine the boundaries of this concept. Recent court rulings suggest that there is a change of direction for IAs when setting aside transactions. However, it is too early to tell if this is a permanent trend or just a coincidence.ii Policy
Whenever insolvency proceedings start, it is the IA's prevailing goal and obligation to seek out the best possible outcome for all creditors and present it to the creditors' assembly. It is this assembly that decides whether to liquidate, sell or restructure the debtor's business.
Liquidation, including a sale of the business assets to a buyer who continues part or all of the business, is still the most likely outcome of such a decision (approximately 90 per cent of all corporate insolvency proceedings).
In-court restructuring of the business through insolvency plans (up to 5 per cent) and self-management, including umbrella protection proceedings (3 per cent of all corporate insolvency proceedings in 2017), have become more popular and effective since 2012, and are regularly applied in large-scale insolvency cases. Some features of these restructuring tools are outlined in Section I.iii.iii Insolvency procedures
There are two main types of insolvency procedures: the general procedure, ending with liquidation and the winding up of the company, and an in-court restructuring through self-administration and an insolvency plan.Liquidation
A general corporate insolvency proceeding over a German company typically lasts for three to four years, whereas the main assets of the company that still have value are usually sold within two to six months to one or several investors.
See also See Section I.i.Self-administration and insolvency plan
Although these features have been in place since 1999, they are rarely used in practice, with rates of approximately 3 per cent of all corporate insolvencies until 2017 but amounting to 64 per cent for the top 50 corporate insolvencies in 2017.
In self-administration, a company's management remains in control when:
- the company applies for self-administration in its petition for insolvency proceedings; and
- there are no circumstances that lead to the conclusion that self-administration will be detrimental to creditors.
Instead of a PIA or an IA, the insolvency court appoints an insolvency custodian. This person supervises the debtor and has, to some extent, limited rights similar to an IA (in particular to set aside transactions prior to filing for insolvency) but does not have a direct influence on the management or power of disposal over the assets.
A special type of self-administration is the umbrella protection proceeding that was introduced in 2012. A company can apply for the umbrella protection when it is not likely that the company can be restructured. Under the umbrella, the company is granted a grace period of up to three months by the insolvency court to present an insolvency plan to creditors. The insolvency court appoints an insolvency custodian as in general self-administration; however, the company is entitled to select that individual, if the chosen person is qualified. During the grace period, creditors of the company cannot pursue their rights by legal enforcement.
When the insolvency plan is presented to creditors, a normal self-administration insolvency proceeding starts and this full insolvency proceeding can be finalised within a few weeks when everything is prepared well. The insolvent company can return from insolvency proceedings without a substantial flaw of having been insolvent as the timescale can be very short, no IA was involved, the company's management continued the business and the creditors consented to a restructuring result instead of an IA distributing the assets. Therefore, the umbrella protection proceeding has been highly marketed since 2012 as a proceeding that is not regarded as a 'real' insolvency by the public. From a legal viewpoint, however, it is an in-court insolvency proceeding.
Self-administration does not necessarily lead to a certain outcome of insolvency proceedings. Still, the assets of the company can be sold or the self-administration ends at some stage and is transformed into general insolvency proceedings (this happened in 22 per cent of proceedings that started in self-administration in 2017).
An insolvency plan is an instrument that can be used in any of the described insolvency proceedings – in a general proceeding, in general self-administration and following the umbrella protection period. As a general principle, the creditors (divided into certain groups) decide on a distribution of the insolvent estate that may differ from an outcome under statutory law in a general proceeding. The plan, drawn up by the IA or the insolvency custodian, or the management of the company in cooperation with the insolvency custodian, displays the financial situation of the company and points out measures that should be taken and their expected effects. In particular, the plan can provide for a corporate restructuring of the debtor and conversion of debt into equity. The creditors who are affected by the plan are divided into voting groups. A negative vote from one group is irrelevant if there is proof that the insolvency plan is not worse for that group than a distribution under statutory law. After the court has confirmed the plan, too, the debtor supervised by the IA or insolvency custodian has to carry out the prescribed measures.
While self-administration and insolvency plans tend to lead to better satisfaction for creditors than ordinary insolvency proceedings, and tend to be faster and more acceptable to debtors and creditors, in practice they can only be applied to substantial insolvency cases. The reason for this is that they require:
- very professional advisers, which incurs substantial costs for the debtor;
- professional management who are experienced in insolvency; and
- substantial assets and a clear going-concern perspective that favours restructuring over liquidation.
If the centre of main interest (COMI) of a debtor is outside Germany but the debtor operates a branch office in Germany, rules on international insolvency apply. As far as the COMI of the debtor is in the European Union, Regulation (EU) 2015/848 applies. Under this Regulation, a secondary insolvency proceeding can be pursued in Germany if a debtor has a branch office in Germany regarding the assets in Germany. European secondary insolvency proceedings are not seen very often in Germany. However, the discussions regarding NIKI Luftfahrt GmbH, a subsidiary of Air Berlin plc, brought the spotlight back to this topic. A German court ruled that NIKI Luftfahrt's COMI was in Germany. However, the appeal court and, at the same time, a court in Austria came to the conclusion that the COMI was in Austria. In the end, the insolvency proceedings in Germany came to a halt and new proceedings in Austria had to be initiated. This produced some chaos as the PIA in Germany had already signed a sale contract for major assets of NIKI Luftfahrt and was then forced to unwind this contract.
If the COMI of a debtor is not within the European Union, the GIA provides in Section 354 et seq. for the possibility for creditors to file for a secondary insolvency proceeding regarding the German assets. Again, this procedure is not very common.iv Starting proceedings
Essentially, the management of a company is obliged to file for insolvency in the event of illiquidity or over-indebtedness. The criteria for over-indebtedness are not met on a pure balance sheet perspective but primarily depend on the question of whether a company is likely to be prosperous in the future. Thus, companies regularly instruct accounting firms and lawyers to examine whether they are over-indebted.
Illiquidity occurs if a company is – at a certain point in time – unable to pay more than 90 per cent of its debt when due and this situation will not improve during the three weeks following that date. If illiquidity or (insolvency) over-indebtedness occurs, the management is obliged to immediately (or at least within three weeks) file for insolvency. If the management does not adhere to such an obligation, this is a criminal act and can lead to imprisonment for up to three years.
A company can opt to file for insolvency if the illiquidity is 'threatening' (impending illiquidity); in other words, if it is likely that the company will be illiquid once the debts become due.
A creditor must have a legal interest in the opening of insolvency proceedings to be entitled to file for insolvency of a debtor. That is the case if the creditor can prove its claim, and it is likely that the debtor is insolvent because, for example, legal enforcement measures against the debtor have failed. The debtor will be heard by the court before preliminary proceedings are commenced.
The competent insolvency court is the local court where the company has its COMI, which is usually the place of its registered business seat.v Control of insolvency proceedings
The power to make decisions during insolvency proceeding lies mainly with the creditors and the IA. However, insolvency proceedings are started, supervised and ended by the insolvency court, which takes a more active role than in Anglo-Saxon countries.
Besides the basic obligation of a debtor's management to file for insolvency when necessary, the members of management may also be personally liable for other violations of civil and criminal law before and during insolvency proceedings. Managing directors are more likely to be liable towards the insolvent company if they made payments out of the company even though the company was insolvent at that time from a legal perspective. After insolvency proceedings are opened, the management has to cooperate with the IA and provide him or her with the necessary information. In self-administration, the management stays in power but must coordinate certain actions with the insolvency custodian.vi Special regimes
All entities are subject to the GIA. However, some peculiarities apply to financial institutions. Under the German Bank Reorganisation Act – a reaction to the financial crisis of 2008 – only the Federal Finance Supervisory Authority (BaFin) is entitled to file for insolvency proceedings over banks. Usually, before insolvency proceedings are started, BaFin tends to support a restructuring of the bank through a moratorium. With regard to 'important' banks from a European point of view, Regulation (EU) No. 806/2014, Council Regulation (EU) No. 1024/2013 and Directive 2014/59/EU apply too (Single Resolution Mechanism). In Germany, the Restructuring and Liquidation Act 2014, in particular, incorporates the EU rules into national law. This includes the power to sell the assets of a bank or to order a compulsory bail-in of bank creditors.
Also, for insurance companies, the right to file for insolvency is limited. Again, only the supervising authority (usually BaFin) is entitled to file for insolvency. Although the proceedings are governed by the GIA, some special features of insurance law apply, such as automatic termination of insurance agreements one month after the opening of insolvency proceedings.
With regard to group companies, the GIA was amended in 2017 and now provides for the first time for special group insolvency rules. Now, under the reform, all insolvency proceedings of a group of companies can be pooled at one court. Furthermore, the possibility of a uniform appointment of one IA is provided.
The term 'group of companies' applies when one company has the possibility of exercising a dominant influence on the others or when various companies are subject to a uniform management.vii Cross-border issues
German insolvency courts acknowledge foreign insolvency proceedings under Regulation (EU) 2015/848 or under Section 343 of the GIA as being valid in Germany as well. However, the German Federal Court does not acknowledge an English scheme of arrangement as being an insolvency proceeding, whereas, for instance, the US Chapter 11 or amministrazione stradordinaria proceedings in Italy are recognised as being insolvency proceedings.
See also Section I.iii.
Overview of restructuring and insolvency activity
The number of corporate insolvencies in Germany is the lowest it has been for a long time. This is because of a strong and stable domestic economy (1.4 per cent growth in gross domestic product in 2018) and cheap terms for financing. The unemployment rate is also the lowest it has been for 28 years, and many regions of Germany profit from full employment. However, it seems that the wind is changing and some industries, such as retail, banking and automotive, are struggling with declining revenues, and unemployment rates are already rising.
Some 19,302 companies filed for insolvency in 2018 (almost 800 fewer than in 2017), which is the lowest number of insolvencies in more than 25 years. In the first quarter of 2019, 4,861 corporations became insolvent, a decrease of 3.2 per cent as compared with the same period in 2018. It is remarkable that most of the insolvent corporations are very small companies; more than 50 per cent of the insolvent companies have an annual turnover of less than €250,000. Slightly more than 83 per cent of the insolvent companies employed fewer than five people – in fact, most of them are likely to have been single-person companies. Just 0.6 per cent of the insolvent companies employed more than 100 employees.
Although all industry sectors show decreasing numbers of insolvency cases, there has been a significant drop in the manufacturing sector (of almost 12 per cent in 2018 in comparison to 2017). The service sector continues to have the most insolvencies (56.8 per cent of all corporate insolvencies). In contrast, the construction sector has one of the highest insolvency quotas in comparison with the number of companies (91 out of 10,000).
A person is most likely to be employed in an insolvent company if he or she works for a household moving company, a mail, courier or express service, or in a bar. More secure professions include being an accountant or a provider of kindergarten services.
The average insolvency quota was reduced from 62 to 59 insolvencies out of 10,000 companies in 2018 as compared with 2017.