A Q&A guide to restructuring and insolvency law in Germany.
The Q&A gives a high level overview of the most common forms of security granted over immovable and movable property; creditors' and shareholders' ranking on a company's insolvency; mechanisms to secure unpaid debts; mandatory set-off of mutual debts on insolvency; state support for distressed businesses; rescue and insolvency procedures; stakeholders' roles; liability for an insolvent company's debts; setting aside an insolvent company's pre-insolvency transactions; carrying on business during insolvency; additional finance; multinational cases; and proposals for reform.
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This Q&A is part of the PLC multi-jurisdictional guide to restructuring and insolvency law. For a full list of jurisdictional Q&As visit www.practicallaw.com/restructure-mjg.
Common forms of security. The most common forms of security over immovable property are:
Land charge (Grundschuld). This is a real property lien. The land charge holder does not become the owner of the property, but has a claim against the property owner for foreclosure (Zwangsvollstreckung). Foreclosure takes the form of a sale by public auction (Zwangsversteigerung) or judicial receivership (Zwangsverwaltung). The land charge holder will receive payment out of the sales proceeds. A security land charge (Sicherungsgrundschuld) is the most common form of security over immovable property.
Mortgage (Hypothek). This is similar to a land charge, but it is less flexible. A mortgage is always accessory to the secured claim.
Formalities. To create security over immovable property all of the following are required:
A session with a notary. The parties' agreements must be recorded by a German notary.
An agreement relating to the security.
Registration of the security in the Land Register (Grundbuch).
Security over immovable property is not valid until it is recorded in the Land Register. Before recording the security interest, the parties are bound by the agreement only if it was recorded by a notary or was submitted to the Land Register Office (Grundbuchamt).
Effects of non-compliance. The security is void if it is not registered in the Land Register.
Common forms of security. The most common forms of security over movable property are:
Retention of title (Eigentumsvorbehalt). A seller can reserve title to products under a purchase agreement, to the effect that the purchaser only acquires title when the purchase price is paid (see Question 3).
Security assignment (Sicherungsabtretung). This involves the securing party assigning personal property to the secured party as security for a claim. The advantage of a security assignment is that the securing party does not have to deliver the property to the secured party and can therefore continue to use the property.
Pledge right (Pfandrecht). This entitles the pledgee to satisfy a claim against the pledgor or a third party by selling the pledged property. The disadvantage of a pledge right is that the pledgor can no longer use the property as it must be delivered to the pledgee.
Formalities. There are generally no specific requirements for creating security over movable property. However:
A written agreement is recommended for evidentiary purposes.
The property must be accurately identified, to rule out any risk of confusion (for example, in a purchaser's warehouse). Lack of accurate identification frequently renders security interests invalid.
Effects of non-compliance. Non-compliance with formalities does not make the security void, although a failure to accurately identify the property may render a security interest invalid (see above). A valid agreement is also necessary (this agreement may be oral).
Once any segregation rights are executed (see Question 3, Retention of title (Eigentumsvorbehalt)) and the assets not forming the estate assets are surrendered to the entitled parties, the priority of payment is as follows:
Costs of the insolvency proceedings. These costs include court costs for the insolvency proceedings, and fees and expenses of the preliminary insolvency administrator and insolvency administrator (section 54, German Insolvency Code).
Insolvency estate creditors. These are, for example, claims resulting from new contracts signed by the insolvency administrator with third parties, such as suppliers (section 55, German Insolvency Code).
Secured creditors. If a creditor holds a security interest in a property, it is generally the insolvency administrator's responsibility to sell the property (section 166, German Insolvency Code). This is done, for example, by selling the property to a third party. The insolvency administrator is paid a standard fee of 9% of the proceeds of the sale (sections 170 and 171, German Insolvency Code). The insolvency administrator also withholds and pays value added tax (VAT). The insolvency administrator must disburse the remaining proceeds to the secured creditor (sections 50 and 51, German Insolvency Code). The secured creditor bears the risk that the proceeds collected will not fully cover his claim for payment of the purchase price.
Insolvency creditors. All unsecured creditors who have registered their claims in writing with the insolvency administrator and whose claims have seen no objection by the insolvency administrator or another insolvency creditor. Insolvency creditors receive payment on a pro rata basis. In practice, payments that insolvency creditors receive are very low in most cases.
Subordinated creditors. If the claims of all insolvency creditors have been fully paid (which is extremely rare), subordinated creditors are paid (section 39, German Insolvency Code). Subordinated claims are, for example:
claims for payment of interest that accrued after opening of the insolvency proceedings;
generally, claims for repayment of shareholder loans. Exceptions to this are where:
claims for repayment of a shareholder loan are held by a shareholder who holds 10% or less of the company's registered capital, unless the shareholder is a managing director;
a creditor acquires shares of the company for restructuring purposes after the company has become unable to make payment or is over-indebted (see Question 6) (or threatened with inability to make payment or over-indebtedness).
Claims subordinated by agreement. These claims are paid only after subordinated claims have been paid.
Shareholders. Any remaining surplus is distributed to the shareholders.
A retention of title is the mechanism most frequently used to secure unpaid debts. A retention of title prevents title to the sold goods from transferring to the purchaser before the purchaser has paid the full purchase price. If the insolvency administrator does not wish to perform the purchase agreement and pay the purchase price, the seller can demand return of the property (segregation right).
A retention of title is frequently combined with advance assignment clauses. The advance assignment clauses extend the seller's retention of title to payments due to the purchaser if the purchaser resells the goods. For example, if the purchaser sells the goods to a third party, the purchaser's claim for payment of the purchase price against the third party is, under the advance assignment clause, assigned as security to the seller that has reserved title.
A seller cannot demand surrender of the purchaser's claim for payment of the purchase price against the third party in the event of the purchaser's insolvency. However, the seller's claims are satisfied in advance from proceeds from the purchaser's claim for payment of the purchase price against the third party (in the same way as a secured creditor's claims).
A creditor can file a collection action against the debtor in a civil court. Under certain circumstances, the creditor can apply for an injunction against the debtor in a civil court. If the court enters judgment in favour of the creditor, the creditor can enforce a judgment against the debtor with the assistance of the bailiff. However, this does not apply if preliminary insolvency proceedings or insolvency proceedings have begun (sections 21 and 89, German Insolvency Code).
A creditor has a right of set-off, if that right already existed at the time the insolvency proceedings were opened (section 94, German Insolvency Code). Set-off is not permitted if the creditor acquired his claim from another creditor only after the insolvency proceedings began (section 96, German Insolvency Code).
There is no mandatory or automatic set-off of mutual claims.
There are no creditor protection proceedings under German law and German law does not provide for any other statutory non-insolvency restructuring proceedings.
Distressed businesses can receive state subsidies (subject to EU state aid control). State-owned banks can extend loans to businesses to help them out of financial difficulties if both:
The causes of a business's crisis are known.
A plan to overcome the crisis has already been developed.
If a company reduces an employee's working hours, the employee's reduced pay from the company can be supplemented by reduced working hour pay from the relevant Federal Agency for Employment, under certain circumstances. Reduced working hour pay is limited to six months.
In certain circumstances the Federal Agency for Employment pays employees' salaries for the last three months before opening of the insolvency proceedings (insolvency pay). Insolvency pay is intended to both:
Protect employees from a loss of their salaries in the event of insolvency.
Restore the insolvent company's cash flow, to facilitate a restructuring of the company.
Insolvency pay paid after opening of the insolvency proceedings is often pre-financed by a bank that purchases the salary claims.
Objective. The objective of insolvency proceedings is to liquidate the debtor's assets in an orderly fashion and pay all creditors equally (section 1, German Insolvency Code). The debtor's assets are sold and the proceeds are paid to the creditors.
Initiation. To initiate insolvency proceedings, an insolvency petition must be filed with the insolvency court (section 13, German Insolvency Code). The petition can be filed by:
The debtor (section 13, German Insolvency Code).
In the case of legal entities (for example, a limited liability company (Gesellschaft mit beschränkter Haftung) (GmbH) or stock corporation (Aktiengesellschaft) (AG)), each officer or director (for example, the managing director or a management board member) individually (section 15, German Insolvency Code).
If a legal entity has no managing director or management board, by any shareholder or, in case of an AG, any member of the supervisory board (section 15, German Insolvency Code).
A creditor, provided that the creditor has a legal interest in the opening of insolvency proceedings (sections 13 and 14, German Insolvency Code). The creditor must submit prima facie evidence of his claim and the grounds for the opening of insolvency proceedings.
If there are grounds to open insolvency proceedings (see below, Substantive tests), legal entities must file an insolvency petition (section 15a, German Insolvency Code). This must be done without undue delay, but in any case no later than three weeks from the occurrence of circumstances providing grounds for the opening of insolvency proceedings (section 15a, German Insolvency Code). Any person who fails to comply with this obligation is subject to criminal prosecution (which can result in a monetary fine or imprisonment) (section 15a, German Insolvency Code).
Insolvency proceedings can be opened in relation to the assets of any natural person or legal entity (including a GmbH, AG, general partnership (offene Handelsgesellschaft) and limited partnership (Kommanditgesellschaft)).
In most cases the insolvency court initially appoints a preliminary insolvency administrator (sections 21 and 22, German Insolvency Code). If so, the insolvency court will usually only open insolvency proceedings about two to three months after the appointment of the preliminary insolvency administrator. This is because insolvency pay may apply and be prefinanced (see Question 5, Insolvency pay).
The insolvency petition may be withdrawn until insolvency proceedings are opened or the insolvency petition is denied by a final and conclusive court judgment (section 13, German Insolvency Code).
If the debtor has filed an insolvency petition and its inability to make payment is only imminent, and it has applied for personal management but the insolvency court views the requirements for personal management to not be satisfied, the insolvency court must notify the debtor and provide an opportunity for the debtor to withdraw the petition before a decision regarding the opening of insolvency proceedings is made (section 270a, German Insolvency Code).
Substantive tests. The insolvency court will open insolvency proceedings if the debtor's assets are expected to cover the costs of the proceedings or if a third party advances funds sufficient to cover the costs, and if one of the following grounds applies:
Inability to make payment (section 17, German Insolvency Code). A debtor is unable to make payment if he is unable to meet his payment obligations when due. The following are not taken into consideration:
minor cash flow shortages. This occurs if the shortfall is less than 10% (that is, the cash available covers at least 90% of the obligations due) and if there is no apparent trend towards a larger cash flow shortage;
short-term payment problems. This occurs if the shortfall is more than the 10% cash flow shortage (see above), but is resolved within a maximum of three weeks.
Payment obligations not yet due are not taken into consideration when reviewing whether the company is unable to make payment. Payment obligations are not yet due if they:
involve deferred obligations or obligations for which existing payment deadlines have not yet passed; or
are due under civil law but the creditor has consented to deferred or subordinated payment at least de facto (that is, with or without intent to be legally bound). Whether a creditor has implicitly consented to deferred or subordinated payment of his claim should not be assumed without careful consideration.
A debtor company is generally assumed to be unable to make payment if it has already stopped making payments.
Threatened inability to make payment (section 18, German Insolvency Code). A debtor can file an insolvency petition if it is threatened with inability to make payment. In this exceptional case, failure to file an insolvency petition is not subject to criminal prosecution.
Over-indebtedness (section 19, German Insolvency Code). If a legal entity is involved, over-indebtedness can be grounds on which to open insolvency proceedings. Over-indebtedness occurs if assets no longer cover liabilities, unless the circumstances indicate that the company is more likely to survive than not (German Insolvency Code (in effect until 31 December 2013)). A probability of more than 50% is required for a company's financial strength to be sufficient for its survival. The company is "more likely to survive than not" if a forecast shows that the company's financial strength is likely to be sufficient for its survival. The time period to be examined usually covers the current fiscal year and subsequent fiscal year. The forecast for this period must be made on the basis of cash flow and earnings projections, based on facts, made in accordance with accepted business management principles.
From 1 January 2014, a new definition of over-indebtedness will apply: over-indebtedness occurs if assets no longer cover liabilities. In the assessment of the debtor's assets, the survival of the company will be taken as a basis if the circumstances indicate that the company is more likely to survive than not (German Insolvency Code (in effect from 1 January 2014)).
The insolvency court decides whether to open insolvency proceedings and whether to appoint an insolvency administrator.
Due to changes to the Insolvency Code, in force as of 1 March 2012, an insolvency administrator is no longer considered to lack independence if he is suggested to the insolvency court by the debtor or a creditor. Under certain conditions, the insolvency court will appoint a preliminary creditors' committee and provide the committee with the opportunity to state its position regarding the proposed insolvency administrator before he is appointed (unless this would result in a substantial adverse change in the debtor's financial position). If the preliminary creditors' committee makes a unanimous proposal for an insolvency administrator, the insolvency court can only ignore this if he is not suitable to serve as an insolvency administrator.
The creditors can choose a new insolvency administrator at the first creditors' meeting (section 57, German Insolvency Code), but this rarely happens.
Particularly important legal acts of the insolvency administrator (for example, a sale of the business as a whole) are subject to the consent of the creditors' committee (or, if no creditors' committee has been created, the creditors' meeting) (section 160, German Insolvency Code). If the insolvency administrator carries out important legal acts without the requisite consent, these acts still have legal effect.
At the creditors' meeting, the creditors can decide whether to shut down the company or carry on the company's business on a temporary basis (section 157, German Insolvency Code).
Supervision and control. The insolvency court supervises the insolvency administrator (section 58, German Insolvency Code). In practice, insolvency courts are reluctant to exercise their supervisory authorities. The creditors' meeting has a right to disclosure and to receive reports from the insolvency administrator (section 79, German Insolvency Code).
Supervision and control also depends on whether or not the proceedings are preliminary. In preliminary insolvency proceedings, the insolvency administrator generally has fewer powers and authorities than an insolvency administrator. A preliminary insolvency administrator generally only has the right to approve or reject asset transfers by the debtor, but no authority to manage or dispose of the debtor's assets.
However the major decisions affecting subsequent insolvency proceedings are in many cases already made during the preliminary insolvency proceedings. For example, the preliminary insolvency administrator often negotiates an agreement for the sale of the business with a prospective purchaser during the preliminary insolvency proceedings, to save time. The insolvency court usually later appoints the same person as insolvency administrator. Then, he signs the purchase agreement.
The insolvency court can decide not to appoint an insolvency administrator and instead order the company to manage and dispose of the insolvency estate under the supervision of a custodian (personal management) (section 270, German Insolvency Code). If so, the company directors continue to have full authority to manage the company. In this case, the insolvency court appoints a custodian in lieu of an insolvency administrator, but in general, this custodian has only supervisory authority.
Personal management is ordered on application, provided there are no known circumstances which are likely to disadvantage the creditors. The old presumption (which favoured the appointment of an insolvency administrator over personal management) has been reversed by changes to the Insolvency Code (which took effect on 1 March 2012).
Protection from creditors. The protections available depend on whether or not the proceedings are preliminary:
Preliminary insolvency proceedings. The insolvency court usually orders that any asset transfers by the debtor are invalid unless approved by the preliminary insolvency administrator (section 21, German Insolvency Code). In addition, the insolvency court usually prohibits or terminates any foreclosure proceedings against the debtor.
Insolvency proceedings. Creditors cannot foreclose on a debtor's assets during insolvency proceedings (section 89, German Insolvency Code). Creditors can enforce their insolvency claims only in accordance with the provisions governing insolvency proceedings (section 87, German Insolvency Code).
Length of procedure. For medium-sized or large companies, the average length of insolvency proceedings is four to eight years, but the period is not defined by law.
Conclusion. Insolvency proceedings have several effects:
Authority to manage and dispose of assets. When insolvency proceedings are opened, the authority to manage and dispose of the assets of the insolvency estate generally transfers to the insolvency administrator (sections 80 and 81, German Insolvency Code). The only exception applies in the case of personal management, where the debtor retains the authority to manage and dispose of assets (section 270, German Insolvency Code).
Survival of the company. The company is dissolved when insolvency proceedings are opened, but it does not cease to exist and the shares survive. The shareholders can continue to adopt resolutions (for example, to remove managing directors or appoint new managing directors). However, they cannot influence the insolvency administrator.
Employment agreements. Employment agreements continue to be effective when insolvency proceedings are opened. However, the insolvency administrator and the employees can terminate employment agreements at the end of each month, on three months' prior notice (unless a shorter notice period applies), regardless of any:
agreed contract term;
exclusion of the right to terminate without cause.
Employees' salary claims that accrued before opening of the insolvency proceedings are insolvency claims.
Insolvency pay. In certain circumstances, the Federal Agency for Employment pays insolvency pay (see Question 5, Insolvency pay). The insolvency estate must pay salaries for the time period after opening of insolvency proceedings.
Transfer of employment agreements. If the insolvency administrator sells the company as a whole (asset deal), the company's employment agreements transfer to the purchaser (section 613a, German Civil Law Code). There are different ways of structuring the transfer of employees with the assistance of employment services companies and job training companies (Beschäftigungs- und Qualifizierungsgesellschaften).
Bilateral contracts. A business partner of the debtor cannot terminate bilateral contracts on the grounds that insolvency proceedings have been opened. However, a business partner can demand prepayment.
After the insolvency administrator has distributed the available assets to the creditors, the insolvency court will conclude the insolvency proceedings. If the company no longer has any assets, the company will cease to exist as soon as the extinction of the company is recorded in the Commercial Register (Handelsregister).
Objective. Insolvency plan proceedings are a special type of insolvency proceeding. Insolvency plan proceedings allow for different ways of using all the debtor's assets and distributing them among the creditors (section 217, German Civil Law Code). The objective of insolvency plan proceedings is to find the best solution for all parties involved and to make that solution binding on all parties, without being subject to the rigid provisions applicable to normal insolvency proceedings (see above, Insolvency proceedings).
Insolvency plan proceedings aim for higher payments to creditors in settlement of their insolvency claims than they would receive in insolvency proceedings without an insolvency plan. Insolvency creditors may also receive payment sooner, depending on the terms of the insolvency plan.
Insolvency plan proceedings allow for:
Shares of the insolvent company to be transferred to third parties.
Debt-equity swaps, including an increase or decrease of the registered capital, payment of non-cash contributions, exclusion of subscription rights or payment of settlements to existing shareholders.
A new law that took effect on 1 March 2012 allows for an exception from the strict capitalisation provisions. If a debt-equity swap takes place in insolvency plan proceedings, the debtor cannot claim for payment against prior creditors (new shareholders) if non-cash contributions are overvalued.
Insolvency plan proceedings are particularly suitable if the company is to be preserved as a legal entity. Preservation of the legal entity is sensible if the insolvent company holds favourable contracts that a purchaser could not easily procure in an asset deal. An example of this is a favourable long-term lease agreement (if the insolvent company operates its business on leased premises, as a retail chain may do). The insolvency administrator cannot sell the lease agreement to an investor as part of an asset deal, because a transfer of the lease agreement to a different tenant is subject to the lessor's consent. The lessor cannot be forced to accept a new tenant and cannot prevent the company from continuing to perform under the lease agreements.
Preservation of the legal entity is also sensible if the insolvent company, for example, holds a securities exchange admission. The insolvency administrator cannot transfer the securities exchange admission to an investor as part of an asset deal. The insolvency administrator only has the power to sell the company's assets. It has no authority to sell the company's shares.
However, insolvency plan proceedings are rarely used in practice, because:
There are often prejudices against insolvency plan proceedings. The insolvency creditors in some cases have unjustified doubts that the shares will be able to regain commercial value after conclusion of the insolvency plan proceedings, while the insolvency creditors receive payment for their claims on the basis of quotas only. The insolvency creditors often also falsely believe that insolvency plan proceedings will take too long and that payments to the insolvency creditors will be made only from surplus cash earned by the company.
There is often not enough time to discuss and vote on the best insolvency option.
Initiation. The debtor and the insolvency administrator can submit an insolvency plan to the insolvency court (section 218, German Insolvency Code).
Because an insolvency plan is subject to the creditors' consent, it is sensible for the debtor to submit a draft insolvency plan to the insolvency court at the time the insolvency petition is filed (pre-packaged insolvency plan). The debtor should informally discuss the draft insolvency plan with the most important creditors before submitting the plan to the insolvency court. If possible, the debtor should also file an application for personal management (see above, Insolvency proceedings: Substantive tests).
The creditors cannot submit an insolvency plan to the insolvency court. The creditors at a creditors' meeting can (with a majority of the claims represented (section 76, German Insolvency Code)) request the insolvency administrator to develop an insolvency plan (section 157, German Insolvency Code).
Substantive tests. The same criteria apply as in insolvency proceedings without an insolvency plan (see above, Insolvency proceedings: Substantive tests).
The following consents and approvals apply:
The insolvency court first reviews whether the draft insolvency plan complies with applicable law (section 231, German Insolvency Code).
The creditors then vote on the insolvency plan (section 235, German Insolvency Code). The insolvency plan is subject to the creditors' consent and must be approved by a majority (in terms of the number of creditors and the amounts of their claims) of each creditor group. If one or more groups do not approve the plan, constructive approval may apply within narrowly defined limits.
The insolvency court approves the insolvency plan.
Due to amendments to the Insolvency Code, from 1 March 2012:
Shareholders can no longer prevent the transfer of the company's shares if the transfer is pursuant to an insolvency plan or implemented due to capital measures.
Individual creditors can no longer delay insolvency plan proceedings by filing appeals. If the insolvency plan places the creditor in a position less favourable than the position he would have been in the event of insolvency proceedings, and the insolvency plan makes funds available to compensate the creditor, this creditor must file a separate legal action to determine whether he is entitled to payment of these funds.
Supervision and control. The insolvency plan can provide that implementation of the insolvency plan is subject to supervision by the insolvency administrator (sections 260 and 261, German Insolvency Code).
Protection from creditors. This is the same as in insolvency proceedings without an insolvency plan (see above, Insolvency proceedings: Protection from creditors).
Length of procedure. Insolvency plan proceedings can be concluded more quickly than normal insolvency proceedings and last from a few months to a few years.
Conclusion. Insolvency plan proceedings have several effects:
Effects of the insolvency plan. The insolvency plan's effects depend on the plan's specific provisions:
in terms of paying off creditors, insolvency plans often provide for creditors to receive payment for a certain quota of their insolvency claims;
in terms of the company's restructuring, an insolvency plan may provide for:
an investor to make funds available to the company for restructuring purposes or to pay creditors; and
that investor to receive shares of the company (for example, by share transfer or capitalisation measures).
Employment agreements, insolvency pay and bilateral contracts. The same considerations apply as for normal insolvency proceedings (see above, Insolvency proceedings: Conclusion).
The insolvency proceedings are concluded when the insolvency plan is confirmed by a final and conclusive decision of the insolvency court. The plan may provide that the settlement of the creditors' claims in accordance with the insolvency plan must continue to be monitored after the insolvency proceedings are terminated.
Objective. As of 1 March 2012, the Insolvency Code now includes protective shield proceedings (section 270b, German Insolvency Code). The objective of protective shield proceedings is to offer the debtor an opportunity to develop an insolvency plan to be implemented in subsequent insolvency plan proceedings, while enjoying protection from foreclosure from creditors. Protective shield proceedings allow for development and submission of an insolvency plan (see above, Insolvency plan proceedings (Insolvenzplanverfahren)).
Initiation. Only the debtor can make an application for protective shield proceedings. In addition to the application, the debtor must submit a statement of reasons from a person experienced in insolvency matters. This person does not need to be an insolvency administrator or lawyer. The statement should confirm the debtor's inability to make payment or confirm that over-indebtedness is imminent, but also provide that a contemplated restructuring is still possible (and is not hopeless).
A protective shield proceeding also requires the creditor to file an application for personal management. In this case, the company retains the authority to manage and dispose of assets (section 270, German Insolvency Code).
Substantive tests. An application can be filed if the debtor's inability to make payment or over-indebtedness is imminent. However, the debtor will be unable to file an application if it is already unable to make payments (see above, Insolvency proceedings: substantive tests).
The insolvency court decides whether to:
Set the debtor a deadline for developing and submitting an insolvency plan.
Appoint a preliminary custodian. The insolvency court may appoint a preliminary custodian other than the one proposed by the debtor, but only if the proposed person is not suitable to serve as custodian.
Supervision and control. During protective shield proceedings, the company will manage and dispose of the insolvency estate under the supervision of a preliminary custodian. The insolvency court supervises the preliminary custodian. In practice, insolvency courts are reluctant to exercise their supervisory authorities. The members of the preliminary creditors' committee assist and supervise the debtor in the management of the company.
Protection from creditors. On receiving an application, the insolvency court will terminate any foreclosure proceedings against the debtor.
Length of proceeding. On receiving the application, the insolvency court will set a deadline for the submission of an insolvency plan. The time period for submitting the insolvency plan must not exceed three months.
Conclusion. The company retains the authority to manage and dispose of assets. The company does not cease to exist. On receiving a debtor's application, the insolvency court will also order that the debtor can 'enter into engagements' with effect for the insolvency estate. This is important because liabilities of the insolvency estate must be fully paid in the ensuing insolvency proceeding (see insolvency estate creditors,Question 2).
After cancellation or expiration of the deadline, the insolvency court will decide whether to open insolvency proceedings. The insolvency court will cancel the deadline for submission of the plan before it has passed if either:
The contemplated restructuring has become hopeless or is not possible to achieve successfully.
The preliminary creditors' committee applies for cancellation.
A creditor applies for cancellation, no preliminary creditors' committee has been appointed and there are known circumstances which make it likely that the deadline will be detrimental to the creditors.
If the insolvency court decides to open insolvency proceedings, these can take the form of either standard insolvency proceedings or insolvency plan proceedings (with or without personal management).
The insolvency court is not bound by the debtor's proposals. However, if the debtor succeeds in developing and submitting an insolvency plan before the deadline, it is likely that the insolvency court will open insolvency proceedings:
With personal management.
In the form of insolvency plan proceedings.
Non-insolvency restructuring can take many different forms. Non-insolvency restructurings are permitted if there is no obligation to file an insolvency petition.
Some examples are set out below.
Negotiation of payment deferments. In many cases, it is necessary to negotiate payment deferments and partial waivers with creditors. Negotiations are frequently informal. Non-insolvency restructuring should not be limited to finance measures. For restructuring to be economically successful, there must generally also be operational restructuring measures.
Trustee relationship. In some cases, a trustee relationship may be an alternative to insolvency. A trustee relationship requires a contract (such as a trust agreement or a restructuring agreement).
In a trustee relationship, the shares of the company in crisis are transferred to a trustee (usually called "trust GmbH"). The trustee becomes the full legal owner and can enter into transactions with third parties. The trustee holds the shares for both the (old) shareholders and the creditors (banks).
The creditors defer payment of their claims and receive rights of their own, such as:
Rights to disclosure.
Rights to share in any exit proceeds.
As a general rule, the shares are sold to the highest bidder in a structured M&A process. The trust/restructuring agreement will stipulate the following:
The dates of share sales.
Any applicable minimum sales prices.
The supervision of the trustee.
The distribution of proceeds (such as a cascade model, waterfall and so on).
The proceeds from a successful restructuring primarily flow to the creditors. The (old) shareholders may share in restructuring proceeds by collecting surplus proceeds or retaining minority shares, and through share retransfers or call options.
Normally, the insolvency administrator is the key player in insolvency proceedings.
Generally, only creditors can have certain co-determination rights (see Question 6, Insolvency proceedings: Substantive tests). Shareholders have no co-determination rights in normal insolvency proceedings.
A director, parent company or other parties can be liable for an insolvent company's debts in relation to the following:
Suretyship, guarantee and "hard" letter of comfort. Managing directors or shareholders are liable for a company's obligations if they have assumed personal liability, for example, under a suretyship contract, a guarantee, or a "hard" letter of comfort (that is a letter of comfort that is legally binding).
Intercompany agreements. If there are intercompany agreements (control and profit transfer agreements), the controlling company is liable for any net losses of the controlled company. These agreements automatically terminate if one of the parties becomes insolvent.
Special exposure to pre-insolvency liability risks. Managing directors are exposed to numerous liability risks, particularly in the period immediately preceding insolvency. In the event of insolvency, these liability risks often materialise, with:
the company no longer being able to make payments;
in many cases the insolvency administrator, rather than the former officers and directors or the shareholders of the company, being responsible for the enforcement of claims against the managing directors.
Liability for payments made after inability to make payments or over-indebtedness. A managing director is liable for any payments made by the company to third parties after the company has become unable to make payment or is over-indebted. This is subject to limited exceptions, for example if payment is absolutely necessary to prevent major losses or to pay employees' social security premiums. The insolvency administrator brings a claim against the managing director to recover the money paid.
Non-payment of social security premiums for employees. A managing director has an obligation to ensure that the company pays social security premiums for its employees.
Liability for tax obligations. A managing director is liable for any failure of the company to settle tax obligations when due.
Capital contributions. A company's shareholders are jointly and severally liable for the payment of capital contributions.
Preservation of capital. Shareholders are liable if either:
paid capital contributions are repaid to them (in the case of an AG);
assets necessary for the preservation of the registered share capital (Stammkapital) are distributed (in the case of a GmbH).
Managing directors and management board members are also subject to liability for unlawful repayments of capital. Exceptions apply if payment is:
made under a profit transfer agreement;
covered by a collectible claim for performance or repayment against the shareholder;
in respect of repayment of a shareholder loan (but other grounds for liability may apply, for example liability for payments made after inability to make payments or over-indebtedness).
Intervention jeopardising the existence of the company. Managing directors and shareholders are liable for interventions jeopardising the existence of the company (existenzvernichtender Eingriff), if the intervention results in the company's insolvency. There must be a substantial removal of assets in disregard of the interests of creditors. A managing director is also liable for payments made to shareholders if the payments would necessarily result in the company being unable to make payment.
Deception regarding inability to make payment. A managing director is liable if a contract partner (for example, a supplier) is deceived about the company's inability to make payment.
Delayed filing of insolvency petition. A managing director is liable if he fails to file an insolvency petition without undue delay, at the latest three weeks from the date the company becomes unable to make payment or over-indebted.
Embezzlement. A managing director is liable for any embezzlement of the company's assets. He is also liable if he misappropriates any assets included in the insolvency estate after the company is threatened with inability to make payments or becomes unable to make payments or over-indebted.
Duties of care. A managing director is liable if he fails to act with due care in managing the company's affairs. For example, a managing director must:
comply with applicable laws and the provisions of the memorandum and articles of association (Satzung);
ensure the proper organisation of the company;
carefully prepare all business decisions (business judgment rule).
Liability of members of the supervisory board. Members of the supervisory board may be subject to personal liability as, during company crises, they have a heightened duty to supervise the managing directors.
No limitation of partners' liability. The partners (for example, of a general partnership (offene Handelsgesellschaft)) are personally liable for the partnership's obligations (unless liability is lawfully limited, for example in limited partnerships (Kommanditgesellschaft)).
It is possible to challenge pre-insolvency transactions (section 129, German Insolvency Code). The laws governing the voidability of pre-insolvency transactions are intended to ensure that all creditors receive equal treatment. The objective is to reverse any asset transfers detrimental to insolvency creditors.
Insolvency administrator' s authority. The insolvency administrator (or, in case of personal management, the custodian) has authority to challenge pre-insolvency transactions. A legal action (for example, a collection action) must be filed with a civil court.
Detrimental legal act. Generally, pre-insolvency transactions can be challenged on the grounds that there was a legal act that is detrimental to creditors (section 129, German Insolvency Code). A legal act is detrimental if creditors would have received greater payments on their claims than if the legal act had not taken place.
Examples of voidable pre-insolvency transactions. The insolvency administrator can challenge any of the following transactions, without limitation:
Payments of due obligations made within three months of the insolvency petition, if the recipient knew that the company was unable to make payment (section 130, German Insolvency Code).
Payments that the company made to repay a shareholder loan (or equivalent claim) within one year before the insolvency petition (section 135, German Insolvency Code).
Any unpaid services that the company rendered up to four years before the insolvency petition (section 134, German Insolvency Code).
Payments made within ten years before the insolvency petition with the intent to cause detriment to creditors, provided that special subjective elements are satisfied (section 133, German Insolvency Code).
Cash transaction exception. Performance by a debtor for which the debtor directly received equivalent consideration cannot be challenged (cash transaction exception) (section 142, German Insolvency Code) (for example, a fair purchase agreement, that is, an exchange of equivalent consideration concurrently or with only minor time delay). However, this exception does not apply if the transaction is intended to cause detriment to creditors, for example if assets are sold below market value.
Limitation. The limitation period for challenging pre-insolvency transactions expires at the earliest at the end of the third calendar year after the insolvency petition was filed (section 146, German Insolvency Code and sections 195 and 199, German Civil Law Code).
Generally, an insolvency administrator can only challenge a pre-insolvency transaction in relation to the recipient of the payment or services. The insolvency administrator can only challenge a pre-insolvency transaction in relation to a recipient's legal successor in exceptional cases (for example, if the legal successor knew at the time of the purchase of the circumstances providing grounds for challenging the recipient's purchase) (section 145, German Insolvency Code).
Insolvency proceedings. When the insolvency proceedings are opened, the insolvency administrator can, among other things, sell the company's assets and litigate disputes (sections 80 and 81, German Insolvency Code). The managing directors of the company remain in office, but no longer have any powers or authorities.
The creditors can, at the creditors' meeting, decide whether the company will continue to carry on business during the insolvency proceedings. The insolvency administrator must comply with the creditors' decision (section 157, German Insolvency Code). The insolvency administrator can continue to operate the company's business only to the extent possible. For example, he cannot do so if there are no funds to pay the employees. In this case, the creditors are, by operation of law, precluded from deciding that the company's business should continue. The creditors' decision is therefore in many cases dictated by the factual circumstances.
Personal Management. If the insolvency court grants an application for personal management, a custodian (Sachverwalter) with supervisory responsibilities can be appointed (section 270, German Insolvency Code) (rather than an insolvency administrator). The company's managing directors have continued authority to manage the company. They manage the company's business.
See above, Circumstances.
The continuation of an intellectual property licence depends on which party to the licence agreement is insolvent:
Insolvency of the licensee. The license agreement will initially continue to be effective. However, the insolvency administrator has a statutory right to choose whether or not to continue to perform agreements (section 103, German Insolvency Code). The insolvency administrator also has a choice whether or not to perform license agreements. The choice of performance cannot be excluded in the license agreement.
Insolvency of the licensor. The license agreement likewise initially continues to be effective. In this case, the insolvency administrator has the right to choose whether or not to continue to perform the license agreement. The choice of performance cannot be excluded in the license agreement (except for narrowly defined exceptions). Therefore the current law is not favourable to licensees. The German legislature is expected to remedy this situation in the near future and provide that licenses are insolvency-proof during an insolvency of the licensor (see Question 13).
There is no special form of additional financing for companies that are in crisis or insolvent. In particular, there is no debtor-in-possession financing or any equivalent form of financing.
The principle of universality applies in insolvency proceedings. Therefore, insolvency proceedings relate to all of the debtor's assets (regardless of their location) and apportion the assets among all creditors (regardless of their residence) under uniform liability rules. Insolvency proceedings in other jurisdictions are therefore automatically recognised in Germany.
German courts co-operate in relation to publication and registration obligations in concurrent proceedings.
Regulation (EC) 1346/2000 on insolvency proceedings (Insolvency Regulation) applies.
Foreign creditors can participate in German insolvency proceedings in the same way as German creditors.
On 18 January 2012, the Federal Ministry of Justice submitted a draft bill (Draft Bill) for an expedited residual debt release proceeding, stronger creditor rights and insolvency-proof licenses. Under the Draft Bill:
Debtors will be released from their residual debts more quickly than before if they settle part of their debts.
Debtors will be released from their residual debts after three years (instead of six years) if they settle at least 25% of their debts and pay the costs of the proceeding. A reduction from six years to five years would also be possible, if the costs of proceedings are paid in full.
Provisions relating insolvency-proof licences will be introduced to protect the investments of licensees in the event of the licensor's insolvency (see also Question 10, Intellectual property licences). The insolvency administrator for the assets of the licensor will continue to have the right to choose whether or not to perform the licence agreement. However, the licensee would, in the future, have a right under certain conditions to enter into a new license agreement with the licensor.
The Draft Bill has yet to go through the legislative process and is expected to take effect in 2013.
At a later stage, the legislature is expected to reform both group insolvency law and the rules for selection of the insolvency administrator. The reform of group insolvency law is intended to prevent corporate groups from falling apart uncontrollably and to preserve the chances of restructuring.
Qualified. Germany, 1998
Areas of practice. Restructuring; corporate/M&A.
Qualified. Germany, 2005
Areas of practice. Restructuring; corporate/M&A.