Restructuring and insolvency law in Germany

Restructuring 

The primary legislation governing restructuring proceedings in Germany is the Act on the Stabilisation and Restructuring Framework for Companies (“StaRUG”) which implemented the EU Directive on Restructuring and Insolvency of 20 June 2019 ((EU) 2019/1023). 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 to avoid insolvency proceedings.  

Restructuring proceedings under the StaRUG are initiated by the debtor who files a report to the restructuring court. The prerequisite for initiating the proceedings is that the debtor will be imminently illiquid. Imminent illiquidity is defined in section 18 German Insolvency Code (“InsO”) and means that a debtor is no longer able to fulfil its payment obligations as they become due over the next 24 months. This period is not fixed and can, under certain circumstances, be shorter or longer than 24 months. 

A debtor can be restructured in a preventive restructuring procedure under the StaRUG as long as it is deemed that it will be imminently illiquid, but not if it is illiquid or over-indebted within the meaning of German insolvency law. The debtor retains the right to manage and dispose of its own assets. In a restructuring procedure under the StaRUG, the debtor prepares a restructuring plan (Restrukturierungsplan), which sets out the restructuring measures that are to be implemented, such as a waiver of receivables by certain creditors, deferrals, amendments to multilateral agreements (especially financing agreements), or changes regarding shareholdings. For mediation between the debtor and its creditors when working out a restructuring solution, the debtor can apply for restructuring moderation (Restrukturierungsmoderation). In addition, it is possible for the debtor to be assisted by a restructuring agent with special knowledge (Restrukturierungsbeauftragter), either by applying to the restructuring court on its own or through an application submitted by the creditors. 

Under German law, there are three types of creditors:

• Secured creditors
• “Normal” (i.e. not subordinated and unsecured) creditors
• Subordinated creditors. 

These different types of creditors are relevant for their allocation to the different groups that vote on the restructuring plan. These groups must be formed according to reasonable and proper criteria, which means that different types of creditors can usually not be allocated to the same group. The amount of voting rights granted to each creditor depends on whether or not it is a secured creditor. A restructuring plan can be implemented even if some groups of creditors voted against it. However, a group of creditors can only be overruled if no creditor whose claim would be subordinated in insolvency proceedings obtains an economic value. 

Section 15a InsO sets out a strict obligation for 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. 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 must be filed “without undue delay”, but in any event, within 3 weeks for illiquidity and 6 weeks for over-indebtedness. This period can only be utilised 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 this period fail, the members of the representative bodies must file for insolvency immediately and are not allowed to wait until the period has expired. Up until 31 December 2023, the period of 6 weeks for filing for insolvency due to over-indebtedness had been extended to 8 weeks due to a special legislation to mitigate the effects of the current energy crisis. 

If the representatives fail to file for insolvency on time they face several civil and criminal law risks. Each representative can be held personally liable for damages resulting from the late filing of an application for insolvency. Furthermore, the failure to file for insolvency can be punished under the German Criminal Code (“StGB”). 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 generally voluntary proceedings to avoid insolvency, and there is therefore no obligation to initiate them. Due to its advantages, the restructuring procedure nevertheless offers a good opportunity for the management to lead the company, which has been strengthened again, out of a pre-insolvency crisis. 

In the context of a preventive restructuring procedure, it is 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. Although the law does not determine what exactly the representative bodies have to do in order to detect a crisis early on, experts are of the opinion that the monitoring of the liquidity is a basic element of their duty. Therefore, it is recommended to monitor the liquidity of the company regularly for the next 24 months to ensure that an (imminent) liquidity crisis can be solved at a very early stage. Furthermore, the representative bodies must ensure that the debtor conducts the restructuring proceedings under StaRUG with the due care and diligence of a prudent and conscientious business manager. Otherwise, they can be held personally liable for any damages suffered by the other creditors.

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. 

The 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 the repayment of shareholder loans that take place within 1 year before insolvency is filed and for collaterals that were granted by the debtor for a shareholder loan within 10 years before insolvency is filed. 

The StaRUG does not require shareholder approval for the initiation of restructuring proceedings. However, it is disputed among experts whether the representative bodies are nevertheless obliged to obtain the shareholders’ consent, especially if the rights of shareholders will be changed by a restructuring plan.

Insolvency

The InsO and the European Regulation on Insolvency Proceedings (2015/848) are the primary legislation governing insolvency proceedings in Germany. 

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 an existing reason for the institution of insolvency proceedings. Otherwise, the court will not initiate insolvency proceedings. 

The following reasons for the institution of insolvency proceedings exist under German law: illiquidity, over-indebtedness and imminent illiquidity. While the debtor’s petition for the institution of insolvency proceedings 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 next 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 only applies 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, over-indebtedness requires that the debtor does not have a positive going concern prognosis. On the assumption that restructuring measures are likely to have an effect, an integrated financial plan, which is 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 over the next 24 months. In order to prove imminent illiquidity, the debtor needs to present a liquidity plan showing a lack of liquidity within that period. This period is not fixed and can, under certain circumstances, be shorter or longer than 24 months. Only the debtor may make use of imminent illiquidity as a reason to apply for insolvency as a restructuring measure.

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

Preliminary insolvency proceedings

After an application for insolvency has been made, the competent court (the “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 be 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, if the requirements are met, result in the opening of insolvency proceedings.  

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 the insolvency administrator who gains full control of 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 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 the debtor’s claims. The insolvency administrator is obliged to aim for the best possible realisation in the interest of the creditors.

Any court orders on preliminary protective measures and on the opening of insolvency proceedings must be announced publicly on a database which is accessible via https://www.insolvenzbekanntmachungen.de. However, in exceptional cases during preliminary insolvency proceedings, the insolvency court can 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, insolvency proceedings in self-administration do 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 supervisor (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 InsO distinguishes between: 

• “Normal” (i.e. not subordinated and unsecured) insolvency creditors: claims usually satisfied with a single-digit dividend
• Subordinated creditors: only receive a dividend at all if all the “normal” insolvency creditors have been fully satisfied
• Preferential creditors: claims (usually created by an insolvency administrator after the opening of insolvency proceedings) satisfied in full by the insolvency estate (unless the estate cannot cover all the preferential claims; in exceptional cases a preliminary insolvency administrator may also create preferential claims)
• Secured creditors: claims 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 general, it is up to the shareholders to decide whether the company can be solvently liquidated or whether insolvency proceedings need to be 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 is an obligation for the liquidator to file for insolvency immediately. 

Financial restructuring from creditors perspective 

There is no general statutory right for a lender to supervise and/or monitor the financial situation of the debtor. German courts have, in exceptional circumstances (e.g. if the lender shows good cause that the borrower is attempting to remove assets from the creditors’ reach or is giving preferential treatment to another creditor), given the lender permission to inspect the company’s books and records. However, German bank loan agreements often include information rights which benefit the bank. If the debtor does not provide sufficient information to the bank this can be seen as an event of default that entitles the bank to terminate the loan agreement. 

In principle credit facilities may be extended and new credit granted to a company in financial difficulty. However, under certain circumstances a lender might be held liable by other creditors for immoral behaviour or for incitement to delay filing for insolvency. For example, a bank can be held liable if it grants or extends credit to a distressed company that is insufficient to restructure the company and merely delays the onset of insolvency for the benefit of the bank, thereby deceiving other creditors as to the solvency of the company, who consequently suffer losses. In such a case, the loan agreement and connected collateral agreements may be contested by the insolvency administrator, and the creditor may even be held criminally liable. However, the risk of creditor liability can be mitigated if an external expert (usually an auditor; Wirtschaftsprüfer) confirms that the proposed restructuring measures, including the credit facility, will enable the company to survive.

New security that is granted for an existing loan to prevent the lender from cancelling the loan can be contested by the insolvency administrator if it is detrimental to other creditors. The contestation risk is particularly high if new security is granted within the last 3 months before the company files for insolvency, but such security can theoretically extend to any new collateral to secure old debts within a period of 10 years before the initiation of insolvency proceedings. Security granted for new loans cannot usually be challenged. If the company becomes insolvent, any credit or other support (such as collateral for a third-party loan) granted by a shareholder of the company is automatically subordinated. Any repayments of shareholder loans or economically equivalent transactions during the period of 1 year before the filing for insolvency can be contested and clawed back by the insolvency administrator.

Non Performing Loans

In Germany, a lender wishing to transfer a non-performing loan (“NPL”) can use either an asset deal, a share deal or alternatively a synthetic model, such as a sub-participation. 

Asset deal

The lender transfers its claim for payment and the related collateral directly to the investor (Forderungsverkauf und -abtretung). 

Share deal

The lender’s claims under the NPL are, in a first step, transferred to a special purpose entity set up by the lender. This transfer can be implemented in the form of an asset deal or alternatively by way of measures under the German Transformation of Companies Act (Umwandlungsgesetz) such as spin-off (Abspaltung oder Ausgliederung). In a second step the shares in this special purpose entity are then sold by the lender to an investor by way of a share deal. A special form of a share deal would be a joint venture structure in which the shares in the special purpose entity are held by the seller and the purchaser.

Sub-participation

If a true sale of the NPL is not possible, the investor may, as an alternative to an asset deal or share deal, assume the credit risk under a sub-participation agreement. In this case, the NPL assets are not transferred to the investor but remain with the original lenders who continue to hold and service the claims in their own name but for the account of the investor. A sub-participation can also be used as an interim solution until the conditions for a true sale (such as consent from third party debtors required for a transfer) are fulfilled. 

Under German law, contractual restrictions regarding the assignability of a monetary claim are invalid pursuant to section 354a(1) German Commercial Code (“HGB”) if the underlying contractual relationship constitutes a commercial trade (Handelsgeseschäft). However, it should be noted that pursuant to section 354a (2) HGB this exception does not apply to loan agreements if the lender qualifies as a credit institution within the meaning of the German Banking Act (“KWG”). This means that an assignment of claims under loan agreements entered into with a credit institution within the meaning of the KWG is not possible without the borrower’s consent if the loan agreement restricts such assignment. A transfer of the whole contractual relationship to an investor by way of assumption of contract would in any case require the consent of the relevant borrowers. 

If a transfer or assignment of the NPL is not possible in the specific case, an alternative option could be a transfer of the credit risk to the investor. This can be achieved by way of funded or unfunded sub-participation. In this case, the selling bank remains the lender and continues to service the loans. However, the loans are held for the account of the investor who bears the economic risk. 

Also, measures under the German Transformation of Companies Act such as spin-off (Abspaltung oder Ausgliederung) may help to bypass transfer restrictions and transfer the NPL portfolio. They may therefore e.g. be used to transfer a NPL portfolio to a special purpose entity in preparation of a share deal. 

Any person who offers banking or financial services on a commercial basis in Germany needs a banking licence. If the investor, as transferee of the NPL, is only collecting receivables by means of a regular work-out of the NPL, no banking licence is required. However, if the investor intends to extend existing credit lines to borrowers of the NPL on a commercial basis, a banking licence is required. If the investor uses a third party for debt collection, respectively the collection of payments under the NPL, such third party, depending on the case, requires a licence as a payment service provider for money remittance (Finanztransfergeschäft) or a debt collection licence (Inkassolizenz).