Restructuring and insolvency law in Germany

1. What is the primary legislation governing insolvency and restructuring proceedings in your jurisdiction?

The German Insolvency Code and the European Regulation on Insolvency Proceedings (2015/848) are the primary pieces of legislation governing insolvency proceedings in Germany. So far, there are no pre-insolvency restructuring proceedings regulated by statute under German law. Restructuring proceedings outside of insolvency proceedings are basically directed by the regular corporate and labour law regulations.

2. How are insolvency proceedings or restructuring proceedings initiated?

Since there are no restructuring proceedings regulated by statute in Germany, only insolvency proceedings can be initiated. 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.

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 cannot be based on imminent illiquidity as a reason for the institution of insolvency proceedings. 

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 three 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 during the ongoing and the following financial year.

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 – according to the prevailing view in legal commentary – must include the current and the following fiscal years. Only the debtor may make use of imminent illiquidity as a reason to apply for insolvency as a restructuring measure. 

4. Which different types of restructuring / insolvency proceedings exist and what are their characteristics?

In general, insolvency proceedings are separated into two phases – preliminary insolvency proceedings and the (actual/opened) 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. 
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. 

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

5. Are there several types of creditors and what is the effect of a difference?

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 (ii) 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 (iii) 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

6. Is there any obligation to initiate restructuring / insolvency proceedings? For whom does this obligation exist and under what conditions? What are the consequences if this obligation is violated?

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 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 of the occurrence of a reason for insolvency. The period of 3 weeks 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

7. What are the main duties of the representative bodies in connection with restructuring / insolvency proceedings?

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 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 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

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 normally not involved in the insolvency proceedings. However, they have the duties of disclosure and cooperation in order to assist the insolvency administrator with the fulfilment of its duties.

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.

9. What are the main duties of shareholders in connection with restructuring / insolvency proceedings?

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 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.

10. Are the shareholders of a company involved in restructuring / insolvency proceedings?

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 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 can especially 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

11. Is a solvent liquidation of the company an alternative to regular insolvency proceedings?

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 consistently monitor the financial situation. As soon as insolvency (i.e. illiquidity or over-indebtedness) occurs, there will be an obligation for the liquidator to file for insolvency at once.

Germany does not yet have a legal framework for preventive restructuring. All restructuring measures (outside of insolvency proceedings) need to be negotiated between the company and its stakeholders. Agreements are possible within the regular legal framework, which usually requires the consent of all parties involved and often leads to hold-out situations and thus to the failure of restructuring efforts and subsequent insolvency. A possibility of binding obstructing parties, e.g. by majority vote, only exists in insolvency proceedings.

It can be expected that the EC initiative on preventive restructuring frameworks, second chance and measures to increase the efficiency of restructuring, insolvency and discharge procedures (2016/0359(COD)) will have a major impact on preventive restructuring in Germany once the Directive has been transposed into national law (approximately 2022 at the latest).

13. What is the average success rate after completed restructuring / insolvency proceedings?

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.

Alexandra Schluck-Amend
Dr. Alexandra Schluck-Amend
Partner
Stuttgart