Restructuring and insolvency in Germany: overview
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 multi-jurisdictional guide to restructuring and insolvency law. For a full list of jurisdictional Q&As visit www.practicallaw.com/restructure-mjg.
Forms of security
Common forms of security and formalities. 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.
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 and formalities. 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 (Sicherungsübereignung). 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.
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). A 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).
Creditor and contributory ranking
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 illiquid or over-indebted (see Question 6) (or illiquidity was imminent).
Claims subordinated by agreement. These claims are paid only after subordinated claims have been paid.
Shareholders. Any remaining surplus is distributed to the shareholders.
Unpaid debts and recovery
Retention of title (Eigentumsvorbehalt)
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).
Prolonged retention of title (verlängerter Eigentumsvorbehalt)
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).
Collection action and injunction
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). Set-off is also not permitted if the creditor acquired the opportunity to set off his claim by a transaction subject to challenge of a pre-insolvency transaction (section 96, German Insolvency Code).
There is no mandatory or automatic set-off of mutual claims.
Creditor protection proceedings
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.
Reduced working hours
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 is due and payable only after opening of the insolvency proceedings. Therefore, it is often pre-financed by a bank that purchases the salary claims.
Rescue and insolvency procedures
Protective shield proceeding (preparation of restructuring)
Objective. The objective of a protective shield proceeding (section 270b, German Insolvency Code) is to give the debtor an opportunity to develop an insolvency plan to be implemented in a subsequent insolvency plan proceeding, while enjoying protection from foreclosure from creditors. A protective shield proceeding allows for the development and submission of an insolvency plan (see below, Insolvency plan proceeding (Insolvenzplanverfahren)).
Initiation. Only the debtor can apply for a protective shield proceeding. 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 imminent illiquidity or the debtor's over-indebtedness.
That the debtor is not already illiquid.
That the envisaged restructuring has prospects of success.
A protective shield proceeding also requires the debtor 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 illiquidity is imminent or if the debtor is over-indebted. However, the debtor will be unable to file an application if it is already illiquid (see below, Insolvency proceeding: substantive tests).
Consent and approvals. The insolvency court decides whether to:
Set the debtor a deadline for developing and submitting an insolvency plan (though the insolvency plan can also be submitted after expiry of the deadline, when insolvency proceedings have been opened).
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.
The insolvency court must revoke the protective shield proceeding before the deadline for developing and submitting an insolvency plan expires if one of the following applies:
The envisaged restructuring no longer has prospects of success.
The provisional creditors' committee requests that the order be revoked.
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.
Supervision and control. During a protective shield proceeding, 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 proceeding 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.
Under certain circumstances (see above, Consent and approvals), the insolvency court can revoke the protective shield proceeding before the deadline for developing and submitting an insolvency plan expires.
Conclusion. The company retains the authority to manage and dispose of the 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 revoking the protective shield proceeding, or after the deadline for developing and submitting an insolvency plan has expired, the insolvency court will decide whether to open an insolvency proceeding.
If the insolvency court decides to open an insolvency proceeding, this can take the form of either a standard insolvency proceeding (see Question 7) or an insolvency plan proceeding (see below, Insolvency plan proceeding ( Insolvenzplanverfahren)) (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 (or, at least, a draft insolvency plan) before the deadline, it is likely that the insolvency court will open an insolvency proceeding:
With personal management.
In the form of an insolvency plan proceeding.
Insolvency plan proceeding (Insolvenzplanverfahren)
Objective. An insolvency plan proceeding is a special type of insolvency proceeding which allows 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 an insolvency plan proceeding 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 a regular insolvency proceeding (see Question 8, Insolvency proceeding).
An insolvency plan proceeding aims for higher payments to creditors in settlement of their insolvency claims than they would receive in a regular insolvency proceeding. Insolvency creditors may also receive payment sooner, depending on the terms of the insolvency plan.
An insolvency plan proceeding allows 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.
There is an exception from the strict capitalisation provisions. If a debt-equity swap is carried out in an insolvency plan proceeding, the debtor cannot claim for payment against prior creditors (new shareholders) arguing that non-cash contributions were overvalued.
An insolvency plan proceeding is 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. For example, in a long-term lease agreement (where the insolvent company operates its business on leased premises), 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.
Initiation. The procedure is initiated when the debtor and the insolvency administrator submit an insolvency plan to the insolvency court (section 218, German Insolvency Code). 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 Question 7, Insolvency proceeding: Initiation).
In some cases, it is recommended that the debtor submits a draft insolvency plan to the insolvency court at the time the insolvency petition is filed (pre-packaged insolvency plan).
It is also possible to submit an insolvency plan during or after a protective shield proceeding. A protective shield proceeding is no prerequisite for an insolvency plan.
The creditors cannot submit an insolvency plan to the insolvency court. The creditors at a creditors' assembly 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 substantive tests are the same as for a regular insolvency proceeding (see Question 7, Insolvency proceeding: Substantive tests).
Consent and approvals. 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.
Shareholders cannot 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 cannot delay an insolvency plan proceeding 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 an insolvency proceeding, 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 a regular insolvency proceeding (see Question 7, Insolvency proceeding: Protection from creditors).
Length of procedure. An insolvency plan proceeding can be concluded more quickly than a regular insolvency proceeding. An insolvency plan proceeding can 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 can 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 regular insolvency proceedings (see Question 7, Insolvency proceeding: Conclusion).
An insolvency proceeding is concluded when the insolvency plan is confirmed by a final and conclusive decision of the insolvency court. The insolvency plan may provide that the settlement of the creditors' claims in accordance with the insolvency plan must continue to be monitored after the insolvency proceeding is terminated.
Non-insolvency restructuring can take many different forms.
Non-insolvency restructurings are permitted provided there is no obligation to file an insolvency petition. Some examples include:
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.
Objective. The objective of an insolvency proceeding 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 an insolvency proceeding, 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 an insolvency proceeding (sections 13 and 14, German Insolvency Code). The creditor must submit prima facie evidence of his claim and the grounds for the opening of the insolvency proceeding.
If there are grounds to open the insolvency proceeding (see below, Substantive tests), the managing directors of 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 an insolvency proceeding (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) and is personal liable towards the insolvency estate for payments made by the legal entity to third parties (with limited exceptions) (Question 9).
An insolvency proceeding 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 an insolvency proceeding about two to three months after the appointment of the preliminary insolvency administrator. This is because insolvency pay may apply and be pre-financed (see Question 5, Insolvency pay).
The insolvency petition can be withdrawn until the insolvency proceeding is 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 illiquidity 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 is made regarding the opening of an insolvency proceeding (section 270a, German Insolvency Code).
Substantive tests. The insolvency court will open an insolvency proceeding if the debtor's assets are expected to cover the costs of the insolvency proceeding or if a third party advances funds sufficient to cover the costs, and if one of the following grounds applies:
Illiquidity (section 17, German Insolvency Code). A debtor is illiquid 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 illiquid. 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 consented to deferred or subordinated payment of his claim should not be assumed without careful consideration.
A debtor company is generally assumed to be illiquid if it has already stopped making payments.
Imminent illiquidity (section 18, German Insolvency Code). A debtor can file an insolvency petition if illiquidity is imminent. 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 an insolvency proceeding. Over-indebtedness occurs if assets no longer cover liabilities, unless the circumstances indicate that the company is more likely to survive than not (section 19, German Insolvency Code). 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. Section 19 of the German Insolvency Code has been amended several times in the previous years. We do not expect an amendment within the next few years.
Consent and approvals. The insolvency court decides whether to open an insolvency proceeding and whether to appoint an insolvency administrator.
Under certain conditions, the insolvency court has to 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 vote for a new insolvency administrator at the first creditors' assembly (section 57, German Insolvency Code), but this rarely happens. The new insolvency administrator must be approved by a majority (in terms of the number of creditors and the amounts of their claims).
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' assembly) (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' assembly, 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' assembly 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 insolvency proceeding is 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 a subsequent insolvency proceeding are in many cases already made during the preliminary insolvency proceeding. For example, the preliminary insolvency administrator often negotiates an agreement for the sale of the business with a prospective purchaser during the preliminary insolvency proceeding, 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.
Protection from creditors. The protections available depend on whether or not the proceedings are preliminary:
Preliminary insolvency proceeding. 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 proceeding against the debtor.
Insolvency proceeding. Creditors cannot foreclose on a debtor's assets during an insolvency proceeding (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 pre-payment.
After the insolvency administrator has distributed the available assets to the creditors, the insolvency court will conclude the insolvency proceeding. 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).
Normally, the insolvency administrator is the key player in an insolvency proceeding. Generally, only creditors can have certain co-determination rights. Shareholders have no co-determination rights in a regular insolvency proceeding.
Influence on outcome of procedure
Stakeholders can have a practical influence on the type of procedure used:
Protective shield proceeding. Since a protective shield proceeding can only be applied by the debtor, the debtor has most significant influence on the initiation of a protective shield proceeding.
Shareholders have indirect influence on the initiation of a protective shield proceeding because they can, before the insolvency court granted a protective shield proceeding, instruct the debtor's management to apply for a protective shield proceeding, or exchange the debtor's management. The stakeholders do not have to approve to the protective shield proceeding.
Insolvency plan proceeding. Since the debtor is authorised to submit an insolvency plan, the debtor can have an influence on the procedure. Although the creditors are not authorised to submit an insolvency plan, they have the most significant influence because they vote on the insolvency plan. The chances that the creditors will approve the insolvency plan increase if:
the debtor informally discusses the draft insolvency plan with the most important creditors;
amends are made to the draft insolvency plan in a constructive way.
An insolvency plan proceeding can provide for both recovery by creditors and for debtor rehabilitation. An insolvency plan will not place the creditors in a position less favourable than the position they would have been in the event of an insolvency proceeding.
Insolvency proceeding. These are usually governed by the insolvency administrator. The insolvency court is competent to decide who will become insolvency administrator. In most cases, the insolvency court will appoint an insolvency administrator who did good work in previous insolvency cases and who is well known by the insolvency court. Although the debtor can suggest an insolvency administrator, the insolvency court is not obliged to follow these suggestions.
Creditors have some influence on the insolvency administrator, and in rare cases they will succeed against the insolvency court. 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.
Also, the creditors can choose a new insolvency administrator at the first creditors' assembly.
The stakeholders do not have to approve to an insolvency proceeding.
Insolvency proceedings only provide for recovery by creditors, not for debtor rehabilitation.
If a company is insolvent, its managing director is generally not liable for the company's debts (either towards the insolvency estate or towards the creditors).
However, there are numerous liability risks for a managing director:
Suretyship, guarantee, or other contractual obligation. A managing director is liable for a company's obligations towards the insolvency estate and/or the creditors if (and as far as) he assumed personal liability contractually, for example, under a suretyship contract, or a guarantee.
Liability for payments made after illiquidity or over-indebtedness. A managing director of a company is liable to the insolvency estate for any payments made by the company to third parties after the company has become illiquid or over-indebted (section 64, German Limited Liability Companies Act; section 92, German Stock Companies Act). The insolvency administrator can bring a claim against the managing director to recover the money paid. In the event of insolvency, this liability risk often materialises, and the payments made by the company add up to a high amount to be paid by the managing director.
The background for this liability is that on illiquidity or over-indebtedness, the managing directors must file an insolvency petition without undue delay (at the latest, three weeks after the commencement of illiquidity or over-indebtedness). The liability for payments made after illiquidity or over-indebtedness is subject to limited exceptions (for example, if payment is absolutely necessary to prevent major losses or to pay tax obligations or employees' social security premiums).
Liability for payments to shareholders resulting in illiquidity or over-indebtedness. A managing director is liable to the insolvency estate for payments made to shareholders if the payments would necessarily result in the company being illiquid.
Delayed filing of insolvency petition. If a managing director fails to file an insolvency petition without undue delay, he is liable for both payments made after illiquidity or over-indebtedness and any decreases in insolvency quotas.
Preservation of capital. A managing director is liable towards the insolvency estate 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 or made in respect of repayment of a shareholder loan.
Duties of care. A managing director is liable to the insolvency estate 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, including compliance of the company with applicable laws;
carefully prepare all business decisions (business judgment rule).
Embezzlement. A managing director is liable to the insolvency estate 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 becomes imminent illiquid or becomes illiquid or becomes over-indebted.
Tort. A managing director can be liable to the insolvency estate and/or creditors for intentional damage contrary to public policy. A person who, in a manner contrary to public policy, intentionally inflicts damage on another person or company is liable to the other person or company to make compensation for the damage.
Liability for tax obligations. A managing director is liable to the tax authorities for any failure of the company to settle tax obligations when due, if he acted wilfully or through gross negligence.
Non-payment of employees' share of social security premiums. A managing director is liable towards the social insurance for any failure of the company to pay employees' share of social security premiums. Social security premiums are shared by the employee and the employer. Nevertheless, the employer has to make direct payment of the employees' share. A managing director is not liable for non-payment of employers' share.
Deception regarding illiquidity. A managing director is liable towards a contract partner if the contract partner (for example, a supplier) is deceived about the company's illiquidity.
The partners (for example, of a general partnership, or of a non-trading partnership under the German Civil Code) are personally liable for all of the partnership's obligations, unless partners' liability is lawfully limited (such as for a limited partner in a limited partnership and in a limited professional liability partnership).
Parent entity (domestic or foreign)
If a subsidiary (for example, a limited liability company or a stock corporation) is insolvent, the parent entity (domestic or foreign) is not liable for the subsidiary's debts.
However, there are some liability risks for the shareholder:
No statutory limitation of liability. A shareholder is liable for all of the company's obligations if the liability of shareholders is not limited by law. Liability of shareholders is not limited by law, for example, in the case of a general partnership, a non-trading partnership under the German Civil Code, or a limited partnership for its general partner.
Suretyship, guarantee, " hard" letter of comfort, or other contractual obligation. A shareholder is liable for a company's obligations if and as far as he assumed liability contractually (for example, under a suretyship contract, a guarantee, or a "hard" letter of comfort (that is, a letter of comfort that is legally binding)).
Capital contributions. A shareholder is liable for the payment of capital contributions. A shareholder must pay the nominal capital for his share.
Preservation of capital. Shareholders are liable if either:
in the case of an stock corporation, paid capital contributions are repaid to them; or
in the case of a limited liability company, assets necessary for the preservation of the registered share capital (Stammkapital) are distributed.
Intercompany agreements (control and/or profit and loss transfer agreements) . If there is an intercompany agreement (control and/or profit and loss transfer agreement), the controlling party is liable towards the insolvency estate of the controlled company for any net losses of the controlled company prior to opening of insolvency proceedings. These agreements usually automatically terminate if one of the parties becomes insolvent (with exceptions in case of self-administration).
The controlling party is also liable for any net losses of the controlled company prior to opening of insolvency proceedings if the financial statements are missing or void. A financial statement is void if it infringes upon provisions protecting creditors of the company (for example, valuation rules). If a financial statement is missing or void, the insolvency estate will prepare a new financial statement. Usually, this new financial statement will show higher losses than the void financial statement. Based on the new financial statement, the insolvency estate will calculate the (usually higher) net losses to be paid by the controlling party.
Setting aside transactions. A shareholder can be liable towards the insolvency administrator according to the provisions of pre-insolvency transactions, especially for repayments of shareholder loans within one year before the insolvency petition (see Question 10).
Tort. Anyone, including a shareholder and a parent entity, can be liable for intentional damage contrary to public policy. Anyone who, in a manner contrary to public policy, intentionally inflicts damage on another person or company is liable to the other person or company to make compensation for the damage. A shareholders is, for example, 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.
Liability risks for third parties include:
Suretyship, guarantee, or other contractual obligation. A third party is liable for a company's obligations if and as far as it assumed liability contractually (for example, under a suretyship contract, or a guarantee).
Setting aside transactions. A third party can be liable towards the insolvency administrator, according to the provisions of pre-insolvency transactions (see Question 10).
De facto managing director. A third party can be liable towards the insolvency estate in the same way as a managing director if the third party acts as a de facto managing director. Only natural persons can be de facto directors. A person will be considered to be a managing director if, for example, the person acts like a managing director of the company while representing the company externally.
Tort. A third party can be liable for intentional damage contrary to public policy. A person who, in a manner contrary to public policy, intentionally inflicts damage on another person or company is liable to the other person or company to make compensation for the damage.
Setting aside transactions
Challenging pre-insolvency transactions
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 illiquid (congruent coverage) (section 130, German Insolvency Code).
Payments made within three months of the insolvency petition without entitlement of the creditor to such payment, or to the kind or date of such payment, if the creditor was aware of the disadvantage to the insolvency creditors arising from such payment on its date (incongruent coverage) (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).
A shareholder, who provided a security or was liable as guarantor, shall return the benefit which was granted to the third party to the insolvency administrator, if the company paid back a loan to the third party 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 (gratuitous benefit) (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 (wilful disadvantage) (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).
Third parties' rights
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).
Carrying on business during insolvency
Insolvency proceeding. When an insolvency proceedings is 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' assembly, decide whether the company will continue to carry on business during an insolvency proceeding. 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, but only to a certain extent. For example, he cannot continue to run the business 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.
Intellectual property licences
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 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 (with a public policy exception).
German courts co-operate in relation to publication and registration obligations in concurrent proceedings.
Regulation (EC) 1346/2000 on insolvency proceedings (Insolvency Regulation) applies. There are proposals to revise the Insolvency Regulation (see Question 14, European law).
Procedures for foreign creditors
Foreign creditors can participate in German insolvency proceedings in the same way as German creditors do.
Setting aside transactions
According to the coalition agreement dated 16 December 2013, the regulations concerning actions to set aside wilful disadvantages are due to be amended. The German courts have extended the regulations concerning wilful disadvantages too far. In the view of the courts, a mere incongruency, if payments to the creditor were made without entitlement of the creditor to such payment, or to the kind or date of such payment, can be an argument for wilful disadvantage. Apart from that, the period of ten years is quite long. The repayment of revenues generated over several years can lead to subsequent insolvencies and cause widespread uncertainty for financial plannings. In an interview in INDat-Report February 2014, the German minister of justice confirmed the necessity of reform.
German group insolvency law
The German legislature is expected to reform group insolvency law. This is intended to prevent corporate groups from falling apart uncontrollably in insolvency and to preserve the chances of restructuring.
On 3 January 2013 the Federal Ministry of Justice published a draft bill for a law facilitating the management of corporate group insolvencies. The draft bill creates a new group venue for corporate group insolvencies and generally relies on co-ordination and co-operation. The draft bill has been discussed in parliament on 14 February 2014. We expect it to become law before the end of 2014.
Under the current law, separate insolvency courts may be competent for several group companies. If several affiliates of a group are insolvent, it is possible that a different insolvency administrator will be appointed for each of them. This creates a risk that different insolvency administrators can pursue different strategies or even work in opposition to one another.
The draft bill provides for the right of each group-affiliated debtor to apply for a uniform group venue. The application for uniform group venue must be distinguished from the insolvency petition. Group venue lies with the court in which the application for uniform group venue was first filed, as soon as that court has confirmed jurisdiction. If the insolvency court will grant a group venue, the group venue will also apply for group companies which otherwise would have another venue.
Insolvency plan and tax law
Recapitalisation gains upon insolvency plans can be taxable under certain circumstances. This is an obstacle for successful restructurings. In the last legislative period, a commission was installed to recommend solutions. It is expected that the commission will provide its recommendations during 2014.
The German legislature has twice tried to introduce a provision for introducing insolvency-proof licenses where the licensor becomes insolvent in a draft bill dated 22 August 2007 and a draft bill dated 18 January 2012 (both proposing to contain a new section 108a of the German Insolvency Code).
However, both attempts failed for different reasons. We still expect the legislature to try again because the issue needs to be solved for practical reasons. At present, no third bill has been drafted, though in our opinion, this is only a matter of time.
Discharge of residual debt
From 1 July 2014, new regulations concerning the discharge of residual debt will apply. As before, discharge after six years will be possible. The new regulations allow discharge after only three years provided that they pay at least 35% of their debt and the cost of the proceeding. Discharge of residual debt applies to natural persons only, not to companies.
On 12 December 2012, the European Commission presented a proposal (COM(2012)0744) to amend the Insolvency Regulation. The objective of this revision is to improve the efficiency of the European framework for resolving cross-border insolvency cases. The proposals include plans to:
Co-ordinate insolvency proceedings concerning different members of the same group of companies.
Extend the scope of the Regulation by revising the definition of "insolvency proceedings" to include:
hybrid proceedings and pre-insolvency proceedings;
debt discharge proceedings; and
other insolvency proceedings for natural persons which currently do not fit into the definition.
Clarify the jurisdiction rules and improve the procedural framework for determining jurisdiction.
Provide a more efficient administration of insolvency proceedings by enabling the court to refuse the opening of secondary proceedings where it is not necessary to protect the interests of local creditors.
Require member states to publish the relevant court decisions in cross-border insolvency cases in a publicly accessible electronic register.
On 5 February 2014, the European Parliament adopted its position at the first reading of the proposal (COM(2012)0744) and communicated it to the Council. Amendments include:
Changes for group insolvency.
Restrictions of forum shopping by suspect period (periode suspecte).
On 12 March 2014, the European Commission recommended several aspects to harmonise national insolvency law throughout the member states of the EU (C(2014)1500). According to the recommendation:
The national law should allow restructuring without formal insolvency proceedings (although a plan to restructure the debtor should be confirmed by a court).
Entrepreneurs should have the chance for a fresh start after three years.
However, under Article 288 section 5 of the Treaty of the functioning of the European Union, EU recommendations and opinions have no binding force.
German Insolvency Code (German version)
Description. Website maintained by the German ministry of justice and by juris. This website is up-to-date.
German Insolvency Code (English version)
Description. Website maintained by the German ministry of justice and by juris. This website is up-to-date. English translation is for guidance only.
Heuking Kühn Lüer Wojtek
Professional qualifications. Germany, 1998
Areas of practice. Restructuring; corporate/M&A.
Advising shareholders of distressed companies.
Advising private equity firms in connection with restructurings of the liabilities of portfolio companies.
Advising in protective shield proceedings and insolvency plan proceedings.
Advising financial investors interested in acquiring distressed companies, and strategic buyers.
Recent transactions. Advising automotive supplier Neumayer Tekfor in protective shield proceedings and insolvency plan proceedings
Languages. German, English
Lecturer for Insolvency Law and Corporate Restructurings at University of Mannheim (since 2003), Honorary Professor (2009).
Center for Insolvency Law and Restructurings of the University of Mannheim (ZIS).
Gesellschaft für Restrukturierung - TMA Deutschland e.V.
Arranging and implementing restructurings, Interview in INDat-Report, February 2014.
Protective shield proceedings in practice, newsletter 2/2012, 9th Handelsblatt Jahrestagung Restrukturierung, page 7.
Successful restructuring – Most suitable before insolvency, Der Betrieb Nr. 13, 02 April 2010, pages 31-32.
Heuking Kühn Lüer Wojtek
Professional qualifications. Germany, 2005
Areas of practice. Restructuring; corporate/M&A.
- Advising shareholders of distressed companies.
- Advising managing directors against claims of insolvency administrators.
- Advising automotive supplier Neumayer Tekfor in protective shield proceedings and insolvency plan proceedings.
Languages. German, English
- Work Group on Insolvency Law and Restructurings of the German Bar Association.
- International Bar Association (IBA).
- Insolvency-proof nature of licenses in the insolvency of the licensor, newsletter June, 2012, practice group IP, Media & Technology, page 17 ff., Streit/Bürk.
- Altered circumstances for distressed M&A by ESUG, Newsletter April 2012, Practice Group Corporate/M&A, page 2 ff., Streit/Bürk.
- Management director's liability in insolvency, Der Betrieb 2008, page 742 ff., Streit/Bürk.