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FAQ on particularities of labor law in insolvency proceedings

1. What forms of insolvency actually are there?

Regular insolvency proceedings are the most common type of proceedings under German insolvency law. The aim is usually to restructure the enterprise by way of transferring assets (asset deal) to another company (e.g. NewCo) or within the framework of insolvency plan proceedings (sections 217 ff. German Insolvency Statute (InsO)), in the course of which the business is not separated from its previous legal entity – unlike in the case of restructuring by way of transferring assets – but is continued within the insolvent enterprise itself.

In addition to regular insolvency, debtor-in-possession management (sections 270 ff. German Insolvency Statute) is now also common. Under certain conditions, the bodies/management of the enterprise have the option here of remaining authorised to manage and dispose of the debtor's assets under the supervision of an insolvency monitor (sections 270c, 274 ff. German Insolvency Statute). Both restructuring by way of transferring assets and insolvency plan proceedings are also restructuring instruments that can be used in debtor-in-possession management. The protective shield procedure pursuant to section 270b German Insolvency Statute as a special variation of debtor-in-possession management combines this with the insolvency plan proceedings. The primary aim is timely restructuring by way of an insolvency plan.

2. What effects does insolvency have on labor law provisions?

Insolvency proceedings are generally divided into two phases: provisional and opened insolvency proceedings. Regardless of the specific procedural variation, "normal" labor law applies initially. However, in all variations this is overshadowed by particularities of insolvency law, in some cases at the considerable expense of the employees. Under insolvency law, employees are "part of the whole group of creditors". The privileges under labor law described below are generally contingent on the opening of insolvency proceedings, which is why staff reductions privileged under insolvency law are usually only implemented in the opened proceedings.

3. Do employees receive state aid when wages are no longer paid?

In the case of employees who are only partially paid or not paid at all due to the insolvency of the employer, the Federal Employment Agency pays the outstanding remuneration claims for up to three months in the form of insolvency substitute benefits, which generally means in the amount of the lost net income. This also applies in debtor-in-possession management if the court subsequently orders the opening of insolvency proceedings or rejects the petition to open insolvency proceedings for lack of assets. If the employment relationship is not terminated, however, insolvency substitute benefits are paid only after insolvency proceedings are opened, meaning that there are no insolvency substitute benefits during the provisional insolvency proceedings. In order to be able to continue operations, the interim insolvency administrator or debtor in debtor-in-possession management must therefore regularly initiate advance financing of insolvency substitute benefits. 

4. What is the relationship between insolvency substitute benefits and short-time allowance?

Filing a petition for insolvency does not exclude the granting of short-time allowance even under the instructions of the Federal Employment Agency fleshed out in April 2020 if and insofar as the conditions for the payment of short-time allowance continue to exist (note: not in the case of a complete closure of business). In principle, it is also possible to introduce short-time work even after a petition for insolvency has been filed. In this case, however, the Federal Employment Agency will critically examine the causes of the loss of working hours and its temporary nature. 

In the case of short-time work during the period of insolvency substitute benefits, there is thus only an entitlement to insolvency substitute benefits in the amount of the remaining actual remuneration. Thus, if the conditions for receiving insolvency substitute benefits and short-time allowance are met, both forms of aid can actually be used in parallel in accordance with the instructions of the Federal Employment Agency.

5. Are there any particularities concerning termination of employment?

According to section 113 German Insolvency Statute, employment relationships in the opened proceedings can always be terminated ordinarily with a maximum notice period of three months to the end of the month, unless a shorter notice period applies. Longer notice periods, whether prescribed by statute or by individual or collective agreements, are no longer considered. This also applies to fixed-term employment relationships or in the event of prohibitions on termination or complications with termination under (collective) agreements. However, section 113 German Insolvency Statute does not exclude any existing special statutory protection against unfair dismissal for employees, such as that applicable to persons with severe disabilities. 

As a form of compensation for the "shortened" notice period resulting from insolvency, section 113 sentence 3 German Insolvency Statute grants a no-fault liability claim to compensation for the "early damage" due to premature termination of the employment relationship, meaning the remuneration from the insolvency termination date (pursuant to section 113 sentence 2 German Insolvency Statute) until expiry of the period with which the employer would have had to terminate if it had not been for the insolvency. However, the employee must file this compensation for inclusion in the list of claims as a simple insolvency claim. It is therefore often not recoverable.

6. Is there any relief in connection with the social factor test?

Pursuant to section 125 (1) German Insolvency Statute, there is a special option of concluding an agreement on reconciliation of interests with a list of names. The consequence of such a reconciliation of interests agreed in insolvency proceedings is that the dismissal is presumed to be for operational reasons and the burden of demonstration and proof is essentially shifted to the employee bringing the action. In addition, the judicial examination of the social selection of the employees is limited to gross errors. This limited criterion applies both to the social data and the formation of the comparison groups, as well as to the exemption of top performers from the social factor test. Furthermore, section 125 German Insolvency Statute not only allows the maintenance of a balanced personnel structure but also, and especially, its creation. 

7. What particularities apply to the reconciliation of interests procedure?

Pursuant to section 111 German Works Constitution Act (BetrVG), a reconciliation of interests on a planned substantial alteration to the establishment is to be negotiated with the works council if the establishment normally has more than twenty employees. This also applies in insolvency proceedings. The insolvency administrator therefore has to inform the works council of the planned measures altering the establishment and make an attempt to reconcile interests. 

If a reconciliation of interests on the planned alteration does not materialise, the insolvency administrator or the works council must submit the case to the conciliation committee pursuant to section 112 (2) sentence 2 German Works Constitution Act. The conciliation committee must then either reach an agreement with the works council or the failure of the negotiations must be declared by the conciliation committee. It is not legally permissible to implement the alteration without such an attempt to reconcile interests; if the alteration is nevertheless implemented, this leads, among other things, to claims by employees for compensation for disadvantages.

The possibility existing outside insolvency for each employer to request settlement from the executive board of the Federal Employment Agency in the absence of agreement on the reconciliation of interests and social plan is not available after insolvency proceedings have opened (section 121 German Insolvency Statute), but does not play a major role in practice anyway. 

Alternatively (and more relevant in practice), however, the insolvency administrator may also, pursuant to section 122 (1) sentence 1 German Insolvency Statute, after three weeks of fruitless negotiations or three weeks after a written request to begin negotiations on the reconciliation of interests, request the approval of the labor court to implement the alteration without prior proceedings under section 112 (2) German Insolvency Statute. The labor court will grant its approval if the economic condition of the enterprise, also taking into account the social concerns of the employees, warrants the execution of such an alteration without prior conciliation proceedings pursuant to section 112 (2) German Works Constitution Act.

8. How much should be allocated to a social plan?

The social plan volume is limited by section 123 (1) German Insolvency Statute to a maximum of two and a half monthly salaries (within the meaning of section 10 (3) German Act on Protection Against Unfair Dismissal (KSchG)) of the employees affected by dismissal. This means that the total volume of the social plan is generally limited to two and a half gross monthly salaries of all employees to be considered. In addition, no more than one third of the assets which would be available for distribution to insolvency creditors without the social plan may be used to meet the social plan requirements (section 123 (2) German Insolvency Statute). The individual distribution within the workforce is then to be agreed between the works council and the insolvency administrator/debtor in debtor-and-possession management taking into account these limits within the framework of the social plan.

9. Can the works agreements that are a burden on the assets be terminated?

Insofar as claims from a works agreement burden the assets, these can be terminated with a notice period of three months pursuant to section 120 German Insolvency Statute, irrespective of the terms and notice periods agreed. Prior consultation with the works council about agreement on a reduction of benefits should be attempted, but is not compulsory.

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FAQ on labor law aspects of insolvency
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