Restructuring and insolvency law in Germany

The German Insolvency Code and the European Regulation on Insolvency Proceedings (2015/848) are the primary pieces of legislation governing insolvency proceedings in Germany. In addition, the Act on the Further Development of Restructuring and Insolvency Law (SanInsFoG) came into force in Germany on 1 January 2021. This law made several changes to the German Insolvency Code and at the same time introduced the Act on the Stabilisation and Restructuring Framework for Companies (StaRUG). The StaRUG provides a statute under German law for pre-insolvency, preventive restructuring proceedings. The aim of this law is to strengthen the out-of-court reorganisation and restructuring of companies in order to avoid insolvency proceedings. 

The initiation of insolvency proceedings always presupposes the filing of an insolvency petition. Such a petition can be filed either by the insolvent debtor or by a creditor. The insolvency petition must be based on the existence of a reason for the institution of insolvency proceedings. Otherwise the court will not initiate insolvency proceedings.

In contrast, restructuring proceedings under the StaRUG are initiated by the debtor filing a report to the restructuring court and the simultaneous existence of imminent illiquidity on the part of the company.

The following reasons for the institution of insolvency proceedings exist under German law: illiquidity, over-indebtedness and imminent illiquidity. While the petition for the institution of insolvency proceedings of a debtor can be based on any of these three reasons, a creditor’s petition for the institution of insolvency proceedings cannot be based on imminent illiquidity. 

Illiquidity 

Illiquidity occurs if a debtor is unable to meet its due payment obligations. The debtor is presumed to be illiquid if it is not able to pay at least 90% of its due obligations during the following 3 weeks. Furthermore, illiquidity is also presumed as a rule if the debtor has stopped making payments.

Over-indebtedness 

Over-indebtedness as a reason to file for insolvency applies only to legal entities (limited liability companies, stock corporations and comparable entities). Under German law over-indebtedness occurs if the debtor’s assets (based on liquidation values) no longer cover its liabilities in a winding-up scenario (balance sheet test). In addition to this, over-indebtedness requires the debtor not to have a positive going concern prognosis. On the assumption that effects from restructuring measures are likely to occur, an integrated financial plan, based on a viable restructuring concept, needs to show that the debtor will have enough liquidity to meet its payment obligations for the next 12 months.

Imminent illiquidity 

Imminent illiquidity means that it is more likely than not that the debtor will not be able to meet its due payment obligations in the near future. In order to prove imminent illiquidity the debtor needs to present a liquidity plan showing a lack of liquidity within a period that must include the next 24 months. Only the debtor may make use of imminent illiquidity as a reason to apply for insolvency as a restructuring measure.

As already mentioned above only such an imminent illiquidity is a suitable reason for opening restructuring proceedings pursuant to the StaRUG. 

Regarding the period before a possible insolvency, the preventive restructuring procedure under the StaRUG is decisive. In this case the debtor retains the right to manage and dispose of its own assets. For mediation between the debtor and its creditors in working out a restructuring solution, the debtor can apply for a restructuring moderation (Restrukturierungsmoderation). In addition, it is possible for the debtor to be assisted by a restructuring agent with special knowledge (Restrukturierungsbeauftragter), either through its own application to the restructuring court or through one submitted by the creditors.

Insolvency proceedings are generally separated into two phases – preliminary insolvency proceedings and (actual/opened) insolvency proceedings.

Preliminary insolvency proceedings

After an application for insolvency, the competent court (“Insolvency Court” at the local court) orders measures to protect the debtor’s assets (e.g. appointment of a preliminary insolvency administrator, suspension of enforcement/foreclosure, etc.). The preliminary insolvency administrator also reports to the Insolvency Court if the requirements for the opening of insolvency proceedings are met. 

The debtor usually stays in possession during the preliminary phase. If necessary, the Insolvency Court may rule that the right to manage and dispose of the debtor’s assets is transferred to the preliminary insolvency administrator. In this case, the preliminary insolvency administrator has almost the same powers as an insolvency administrator. Preliminary proceedings usually take 6 to 12 weeks and result in the opening of insolvency proceedings if the requirements are met. 

Insolvency proceedings

Once the Insolvency Court has decided to open insolvency proceedings, the right to manage and dispose of the debtor’s assets is transferred to an insolvency administrator who gains full control over the debtor’s business and assets. Enforcement/foreclosure actions remain suspended. Ongoing litigation is automatically suspended but may be continued by the insolvency administrator if appropriate for the insolvency estate. The insolvency administrator will continue the business operations of the debtor if reasonable and possible or to wind up the company. The method by which the debtor’s assets are realised (e.g. liquidation, share deal, asset deal, restructuring) needs to be coordinated between the insolvency administrator, the creditors/creditors’ committee and the Insolvency Court. The insolvency administrator is obliged to assert and enforce claims of the debtor. The insolvency administrator is bound to aim for the best possible realisation in the interest of the creditors.

Any court orders on preliminary protective measures and on opening of insolvency proceedings must be announced publicly on a database accessible via https://www.insolvenzbekanntmachungen.de. However, in exceptional cases during preliminary insolvency proceedings, the Insolvency Court may refrain from making a public announcement. 

Self-administration

Apart from the regular (preliminary) insolvency proceedings it is also possible to carry out (preliminary) insolvency proceedings in self-administration (debtor in possession). In principle, the procedure of insolvency proceedings in self-administration does not differ much from the regular proceedings described above. The main difference is that the debtor (i.e. its management) remains in charge and the Insolvency Court appoints a custodian (Sachwalter) to supervise the debtor. The right to manage and dispose of the debtor’s assets remains with the debtor. Self-administration is often used for larger companies suitable for restructuring, if the know-how of the management is necessary to continue operating the business. In such cases, an insolvency plan is frequently used to implement restructuring measures or a corporate transaction. However, insolvency plans are not limited to self-administration.

The German Insolvency Code distinguishes between: 

1. “normal” (i.e. not subordinated and unsecured) insolvency creditors
2. subordinated creditors
3. preferential creditors, and
4. secured creditors.

Unsecured insolvency creditors (i) are usually satisfied with a single-digit dividend on their claims, whereas (iii) preferential creditors’ claims (usually created by an insolvency administrator after the opening of insolvency proceedings) are satisfied in full from the insolvency estate (unless the estate is not sufficient to cover all preferential claims; in exceptional cases a preliminary insolvency administrator may also create preferential claims). Subordinated creditors (ii) only receive a dividend at all if all normal insolvency creditors (i) have been fully satisfied. Lastly, secured creditors (iv) may be satisfied partly or in full by the proceeds of their security, while their unsecured claims are only satisfied by way of a small dividend.

In the StaRUG the same type of creditors arise in principle, but these are referred to differently due to the temporal localisation of the restructuring proceedings prior to the insolvency.

Section 15a German Insolvency Code sets out a strict obligation of representative bodies of a company to file for the institution of insolvency proceedings. A prerequisite for the filing obligation is the occurrence of illiquidity or over-indebtedness (see point 3 above). If the company is only imminently illiquid, the members of the representative bodies are entitled, but not obliged, to file a petition for the institution of insolvency proceedings.

The petition has to be filed “without undue delay” but in any event within 3 weeks for illiquidity and 6 weeks for over-indebtedness. This time period can only be made use of if there is still an opportunity to eliminate the reason for insolvency with a predominant degree of probability within the period. If it turns out that attempts to “rescue” the company during the period fail, the members of the representative bodies have to file for insolvency immediately and are not allowed to wait until the period has expired.

If the representatives fail to file for insolvency in time, they face several civil and criminal law risks. Each representative can be held personally liable for damages resulting from a late filing of an application for insolvency. Furthermore, the failure to file for insolvency may be punished under the German Criminal Code. The penalty ranges from a fine to imprisonment of up to 3 years for intent and from a fine to imprisonment of up to 1 year for negligence.

The restructuring proceedings under the StaRUG are on the other hand generally voluntary proceedings to avoid insolvency and there is therefore no obligation to initiate them. Due to the advantages listed, the restructuring procedure nevertheless offers a good opportunity for the management to lead the company, strengthened again, out of the pre-insolvency crisis. 

In general, the law requires that representative bodies are fully aware of the financial situation of the company at all times, especially during financial difficulties. They have to undertake reasonable efforts to overcome the reasons for insolvency, e.g. by pursuing restructuring measures with immediate effect. 

If the registered share capital of a legal entity has been reduced to half or even less, the representative bodies are required to inform all shareholders about this fact immediately. A failure to comply with this obligation may lead to personal civil liability as well as to criminal consequences (imprisonment of up to 3 years) for the members of the representative body.

The representative bodies of a company have the duty to supervise the existence of a reason for insolvency to ensure that a petition for the institution of insolvency proceedings is filed in due time (for consequence of a belated filing see point 6 above).

In addition to this, the representative bodies can be held personally liable by the company (or its insolvency administrator) for all payments that have been made after illiquidity or over-indebtedness (see point 3 above) has occurred if the future insolvency estate has been decreased by these payments. The managing director(s) may try to exculpate themselves by arguing that the payments were made with the diligence of a prudent director. However, law and case law are very strict on exemptions and they are limited to payments that would otherwise lead to a liability of the director, e.g. for due taxes and social security contributions of the employees.

Furthermore, the legal representatives have to ensure that the company is able to fulfil the obligations that they conclude on its behalf. If they enter into agreements, in awareness of the fact that the company will probably not be able to fulfil them, without informing the other party about the financial difficulties, they risk being held personally liable for any damages. This may also constitute fraud.

In the context of a preventive restructuring procedure it is also the permanent duty of the representative bodies to fulfil their obligations regarding ongoing business monitoring, early crisis detection and crisis management according to Section 1 StaRUG.

An insolvency administrator is regularly appointed in the court order ordering the opening of insolvency proceedings. From that moment on, the debtor’s right to administer and dispose of assets belonging to the insolvency estate is transferred to the insolvency administrator. If the debtor disposes of assets after the opening of insolvency proceedings, such dispositions are invalid. The representative bodies are therefore not normally involved in the insolvency proceedings. However, they have duties of disclosure and cooperation in order to assist the insolvency administrator with the fulfilment of its duties.

Self-administration

The situation is different in self-administration proceedings: the right to administer and dispose of the insolvency estate remains with the debtor. The court appoints a custodian (Sachwalter) who merely monitors the debtor and has less control than an insolvency administrator.
In restructuring proceedings under the StaRUG, self-administration and the right of disposal also remain with the debtor and the debtor is only supported by a restructuring agent or restructuring moderation upon request. 

Shareholders are under no direct obligation to comply with the duty to file for insolvency (see above). However, if a company has no management, e.g. because all managing directors have resigned or been removed by the shareholders, each shareholder is responsible for the duty to file for insolvency. Non-compliance may lead to civil and criminal liability (see point 6 above).

Shareholders have no obligation to provide additional funding to enable the company to survive. However, if the legal structure of the company does not provide limited liability, the shareholders will be liable for losses.

Personal liability of shareholders may arise if the shareholder has deprived a company of assets that are vital to the company and if this has inevitably led to the company’s insolvency. However, the legal hurdles for such liability are rather high. Shareholders are also generally liable for repayments of shareholder loans that take place within 1 year before insolvency is filed.

In general, shareholders have no right to make decisions on the assets belonging to the insolvency estate because the debtor’s assets are economically reassigned to the creditors. The shareholders can cooperate with the management of the debtor, especially in the event of self-administration.

Nevertheless, shareholders can be involved in the restructuring process of a company when an insolvency plan is drawn up. This is a type of overall settlement with the creditors which allows for the most varied of provisions, such as determining satisfaction quotas for certain groups of creditors. As an insolvency plan is usually developed before the actual insolvency proceedings, shareholders can design specific regulations of the insolvency plan. Regulations about the rights of shareholders in particular can be part of the insolvency plan. After the plan has been drawn up, the creditors agree on it in groups. In certain circumstances individual creditor groups can, in principle, also be overruled by other groups.

Regarding restructuring proceedings under the StaRUG, shareholders must generally give their consent on whether they wish to continue the company on the basis of the restructuring plan. They therefore have the opportunity to influence the content of the plan and to shape it favourably from their point of view. 

However, the changes associated with the SanInsFoG have resulted in an alignment of the rules on plan preparation under the German Insolvency Code and the StaRUG, so that overruling by groups – a so-called “cross-class cram down” – may also occur in the preparation of restructuring plans.

In general, it is up to the shareholders whether the company is solvently liquidated or whether insolvency proceedings are opened over the assets of the company. However, there is an obligation to file for insolvency if the company is either illiquid or over-indebted. In this case, the shareholders cannot decide to voluntarily liquidate the company.

If the shareholders decide to liquidate the company even though it is solvent, they will be obliged to monitor the financial situation consistently. As soon as insolvency (i.e. illiquidity or over-indebtedness) occurs, there will be an obligation for the liquidator to file for insolvency immediately.

Yes, the StaRUG was implemented on 01.01.2021.

The creditors have to register their claims against the debtor in the list of creditors (insolvency table) and have to trust that the insolvency assets are sufficient for proportional satisfaction (insolvency dividend). With an average insolvency dividend of around 5 %, companies are able to pay comparatively small amounts to their creditors.

Usually, satisfaction rates are higher in insolvency plan proceedings.