There are limited types of insolvency proceedings in Germany. However, a petition for insolvency proceedings may lead to a restructuring procedure or liquidation of the debtor. All insolvency proceedings are governed by the Insolvency Act (Insolvenzordnung − InsO).
1. The process of standard insolvency proceedings
Insolvency proceedings will only be initiated as a result of an insolvency application. The insolvency application can be filed by the creditor or the debtor.
Insolvency proceedings are not opened right away. On the date of the insolvency application the “preliminary” proceedings (Eröffnungsverfahren) start, and usually last for two or three months.
Subsequent to the preliminary the insolvency court will open the insolvency proceedings and designate an insolvency administrator. The registry of the insolvency court publishes the order opening the insolvency proceedings immediately. Usually all important orders are published at www.insolvenzbekanntmachungen.de.
The order opening the insolvency proceedings contains the following important information:
- In the order opening the insolvency proceedings creditors are required to file their claims with the insolvency administrator within a definite period of time.
- The insolvency court docket of meetings for a creditors’ assembly.
At the creditors’ assembly the decision on how to continue with the insolvency proceedings is taken based on the insolvency administrator’s report. The creditors’ assembly decides whether a restricting procedure or a liquidation of the debtor will be initiated.
At the end of the insolvency proceedings the creditors are satisfied jointly from the proceeds generated from realizing the debtor’s assets (Quota).
Conditions for opening
Illiquidity − Section 17 German Insolvency Act: The debtor shall be deemed illiquid if he is unable to meet his obligations to pay. According to a fundamental decision by the German Federal Supreme Court (Bundesgerichtshof) the debtor’s illiquidity is presumed, if he is not able to pay at least 90 percent of his due obligations during the following three weeks.
Furthermore, pursuant to section 17 paragraph 2 sentence 2 German Insolvency Act illiquidity shall be presumed as a rule if the debtor has stopped payments.
Imminent illiquidity − Section 18 German Insolvency Act: The debtor shall be deemed to be faced with imminent illiquidity if he is likely to be unable to meet his existing obligations to pay on the date of their maturity.
This opening reason aims to protect the debtor. Hence imminent illiquidity only constitutes grounds to open insolvency proceedings, if the debtor requests that insolvency proceedings are opened.
Overindebtedness (Überschuldung) – Section 19 German Insolvency Act: Overindebtedness shall exist if the assets owed by the debtor no longer cover his existing obligations to pay unless the continuation of the enterprise as a basis with according circumstances is deemed highly likely. A status is to be prepared showing the assets and the liabilities in comparison. This status is entirely separate from the evaluation under commercial law. An overindebtedness according to the commercial balance sheet may indicate an overindebtedness as defined in Section 19 German Insolvency Act, but it alone is not proof of overindebtedness.
This reason to commence insolvency proceedings relates specifically to the form of the entity. Its aim is to encourage the owners or executive bodies of the company to engage in more far-sighted and cautious financial and earnings planning.
Duty to file − Section 15 a German Insolvency Act: According to Section 15 a German Insolvency Act, the management is obliged to file for insolvency if the debtor is either illiquid or over-indebted. This does not apply if the debtor only threatens to become illiquid. This obligation relates specifically to the form of the entity.
Insolvency plan (Insolvenzplan): Insolvency plan procedure is based on U.S. Chapter 11. The intention of the procedure is that the debtor’s business should continue. The satisfaction of the creditors entitled to separate satisfaction and of the creditors of insolvency proceedings, the deposition of the assets involved in insolvency proceedings and their distribution to the parties concerned, as well as the debtor’s liability subsequent to termination of the insolvency proceedings may be settled in an insolvency plan by way of derogation from the regulations of the German Insolvency Act. The insolvency plan enables a wide variety of different options. Only the debtor and the insolvency administrator (who may be specifically mandated by the creditors’ assembly) are authorized to submit a plan. While determining the rights held by the parties involved in the insolvency plan, groups of creditors are formed broken down by their legal status. Shareholders may build their own group and participate in the plan. The insolvency plan may include a debt-to-equity swap against the will of the shareholders. Creditors and/or shareholders may not be prejudiced as compared to a hypothetical situation.
Self-administration (Eigenverwaltung): Also based on the U.S. Chapter 11 procedure, this procedure allows for the debtor to remain in possession of the business, but requires that no facts must be known that could give rise to the assumption that creditors will be prejudiced. This may be combined with creditor protection proceedings (Schutzschirmverfahren, see below) and also follow the same rules as described in connection with the creditor protection proceedings.
Creditor protection proceedings according to § 270 b German Insolvency Act: The Law for the further facilitation of the Restructuring of Enterprises (Gesetz zur weiteren Erleichterung der Sanierung von Unternehmen, ESUG) came into force on March 1, 2012. It provides for new creditor protection proceedings that enable a debtor who filed for insolvency in self-administration to prepare a pre-packaged insolvency plan. According to § 270 b German Insolvency Act, the insolvency court may grant the debtor a period of up to three months during which the debtor may prepare and submit an insolvency plan, provided that the debtor is not yet illiquid and submits an expert opinion that restructuring by way of an insolvency plan is not evidently impossible. For the period of the creditor protection proceedings the insolvency court appoints a preliminary trustee (Sachwalter) with limited powers who mainly supervises the debtor’s management. The creditor’s interests are protected by the preliminary creditors’ committee, which is entitled to request the insolvency court to terminate the creditor protection proceedings and to appoint a preliminary administrator if the debtor-in-possession-proceeding turns out to be detrimental to the creditors.
Due to the recent changes in German insolvency law (ESUG), it is not yet possible to establish a success rate. However, even though the majority of insolvency proceedings is still treated in the traditional manner (liquidation/transfer of the business as a whole to a new entity by way of an asset deal), it has become obvious that, especially with large insolvency proceedings, debtors tend to choose for debtor-in-possession-procedures and try to enter into an insolvency plan.
Pros and cons
Creditor protection proceedings: Creditor protection proceedings provide the debtor the maximum level of self-reliance. The debtor remains in possession of the business and can restructure the business in a self-determined manner with the support of experts. The initiation of creditor protection proceedings is not published; hence creditors and especially suppliers will not be confronted with the word “insolvency”. Upon expiry of the period granted by the court, the debtor has the possibility of presenting an insolvency plan.
However, creditor protection proceedings are both complex and expensive. The debtor has to provide a report by an independent expert stating that the debtor is not yet illiquid and that restructuring by way of an insolvency plan is possible. An insolvency plan has to be prepared within a strict time-frame which again requires close coordination with the preliminary trustee, auditors, and/or a chief restructuring officer (CRO) of the debtor. Therefore, creditor protection proceedings are practical for rather large insolvency proceedings and ongoing, “cash-flow positive” businesses.
Self-administration: Regular self-administration still enables the debtor to remain in possession of the business, mostly supported by a special CRO, and to develop an insolvency plan. A trustee, appointed by the court, will only supervise the debtor’s management. This proceeding is less complex than the creditor protection proceeding and is the most convenient procedure for medium insolvency proceedings. However, practice shows that self-administered debtors often face problems in obtaining a debtor-in-possession financing (Massekredit) from banks. In such cases, the court may grant the trustee special rights to do so.
Restructuring by asset-transfer (Übertragende Sanierung): If the insolvency administrator is able to sell and transfer the business, this is indeed, in most cases, the quickest way to satisfy the creditors. However, this option is generally the least favourable with respect to the interests of the debtors. Another issue under German law is the provision of § 613a German Civil Code (Bürgerliches Gesetzbuch), “Rights and Duties in the Event of a Transfer of Business” which stipulates that the purchaser has to take over all existing employment contracts of the debtor.