Insolvency and directors' duties in Germany: overview
A Q&A guide to group insolvency and directors' duties in Germany.
The Q&A global guide provides an overview of insolvency from the perspective of companies that are operating within a domestic and/or international family of companies, and considers the various complexities that this can introduce into insolvency procedures. It also has a significant concentration on duties, liabilities, insurance, litigation, and subsequent restrictions imposed on directors and officers of an insolvent company.
To compare answers across multiple jurisdictions, visit the International Insolvency: Group Insolvency and Directors’ Duties Country Q&A tool.
This Q&A is part of the International Insolvency: Group Insolvency and Directors’ Duties Global Guide. For a full list of contents, please visit www.practicallaw.com/internationalinsolvency-guide.
Corporate insolvency proceedings
German law does not provide for specific out-of-court insolvency proceedings involving a liquidation for companies. Out-of-court proceedings to resolve insolvency or avoid insolvency proceedings are therefore limited to settlements between the debtor and its creditors.
The main insolvency proceedings available are the:
Insolvency proceeding (Regelinsolvenzverfahren), which is either supervised by an insolvency administrator or is conducted through self-administration (see Question 2, Insolvency proceeding). This is a liquidation procedure governed by the pari passu principle. It is similar to US Chapter 7 liquidations and the UK liquidation procedure under the Insolvency Act 1986.
Insolvency plan procedure (Insolvenzplanverfahren), which is executed either by an insolvency administrator or through self-administration (see Question 2, Insolvency plan procedure). The insolvency plan has similarities with US Chapter 11 reorganisations in the US and is similar to UK creditors' voluntary arrangements (sections 1 to 7b, Insolvency Act 1986) or schemes of arrangement (sections 895 et seq., Companies Act 2006). However, unlike Anglo-American rescue procedures:
a plan procedure is a largely court-driven procedure;
the debtor's insolvency must be established under either a cash flow test (section 17, Insolvency Code) or a balance sheet test (section 19, Insolvency Code). German insolvency law is therefore sometimes said to follow a "single gateway" approach;
there is always a moratorium on third party claims;
the formation of classes of creditors is mandatory.
Self-administration by the debtor is not a distinct type of insolvency proceeding but a way of conducting either regular proceedings or the plan procedure (see Question 2, Self-administration).
These insolvency proceedings can involve a complete or partial liquidation of the company's assets or a (complete/partial) restructuring/rehabilitation of the company.
German law does not provide for specific out-of-court insolvency proceedings involving a restructuring for companies. The insolvency proceeding is usually a proceeding for a liquidation of a debtor's assets. Nevertheless, an insolvency proceeding can aim for a complete/partial rehabilitation of the debtors business and debts. This is only possible by way of an insolvency plan procedure (see below, Insolvency plan procedure). This requires the consent of the (group) majority of the creditors. The main features of insolvency proceedings are outlined below.
Court-sanctioned insolvency proceedings start with the opening procedure for insolvency proceedings (Eröffnungsverfahren). During the opening procedure, insolvency courts usually order safeguards to protect the assets of the debtor, mostly by limiting the debtor's power to perform legal actions and by appointing a preliminary insolvency administrator, whose legal powers are determined by the court orders.
Alternatively, on application of the debtor (and if further requirements are fulfilled), the insolvency court can order a preliminary self-administration of the debtor (Vorläufige Eigenverwaltung). This allows the debtor (and in the case of a company, its directors) to retain most of his legal powers, and even provides the debtor with the special rights of an insolvency administrator. A trustee is appointed (instead of a preliminary insolvency administrator) to monitor and supervise the debtor (see below, Self-administration).
During the opening and main insolvency procedure, the creditors are mainly organised in the following two committees:
Creditors' meeting (Gläubigerversammlung) (section 74, Insolvency Code).
Creditors' committee (Gläubigerausschuss) (section 67, Insolvency Code).
In principle, the creditors' meeting consists of all creditors. The debtor, the administrator and the members of the creditors' committee can participate in the creditors' meetings. The powers of the creditor's meeting mainly consist of the right to:
Appoint a creditors' committee (section 68, Insolvency Code).
Request a report from the administrator (section 79, Insolvency Code).
Decide on the continuation or closure of the debtor's business (section 157, Insolvency Code).
Decide that the insolvency administrator should file an insolvency plan (section 218(2), Insolvency Code).
Prevent the sale of the debtor's enterprise to certain persons with "close interests" (section 162, Insolvency Code).
Monitor significant legal acts, if a creditor's committee has not been appointed (section 160(1) and (2), Insolvency Code).
The creditors' meeting makes decisions on the basis of a relative majority vote, although votes are weighted according to the value of the notified debts (section 76, Insolvency Code).
The creditors' committee must be heard by the court before the appointment of a preliminary insolvency administrator, and of the insolvency administrator of the main proceeding. A unanimous proposal for an insolvency administrator can only be rejected by the court if the proposed person is not suitable (section 56a, Insolvency Code). The (preliminary) creditor's committee is smaller than the creditors' meeting, and therefore likely to be more consensual. It usually consists of three, five or seven members. It is typical, but not mandatory, that at least the institutional creditors (banks), employees (if they have significant claims) and credit insurers have one representative on the creditors' committee. Decisions require a quorum of at least half of the members, and an absolute majority vote. The votes are not weighted according to the value of claims. The committee's powers are similar (although not identical) to those of the creditors' meeting (see above). The members of the committee must assist the administrator, but also monitor his work (sections 69, 261(3), 232(1) No 1 and 233, Insolvency Code). The members of the creditors' committee are liable for damages if they breach these duties (section 71, Insolvency Act). It is common for the members to enter into insurance contracts to cover such liability at the administrator's expense.
The creditors also vote on the insolvency plan (section 243, Insolvency Code). An absolute majority vote of the creditors and of the value of the claims is required (section 244, Insolvency Code). The Insolvency Code contains detailed provisions on the weighting of creditors' votes (sections 237 and 77, Insolvency Code). Creditors whose claims are not affected by the insolvency plan have no right to vote (section 237 (2), Insolvency Code). The rejection of the plan by a group of creditors can be overruled if (section 245, Insolvency Code):
They would not be worse off under the plan.
They are intended to reasonably participate in the financial proceeds of the plan.
The majority of creditors' groups have approved the plan.
The Insolvency Code also allows minority creditors to apply for the rejection of the plan if they would be disadvantaged under the plan (section 251).
Insolvency plan procedure
The insolvency plan procedure is the only way to restructure the debtor's business and debts. The debtor can prepare the insolvency plan during a moratorium ordered by the court (Schutzschirmverfahren), for which the debtor must apply. If the court orders the moratorium, the debtor must file an insolvency plan within three months and will be released from enforcement proceedings during that period.
The insolvency plan procedure differs from the regular insolvency procedure in two respects:
It aims to rescue the debtor's business.
It provides creditors a right to take initiative. Creditors can make proposals as to how the debtor's insolvency should be dealt with under certain conditions. The creditors (not the administrator) decide on the future of the debtor's company and its business. Although creditors in the regular procedure also have the opportunity to exercise some influence through the creditors' committee and the creditors' meeting, these rights are only of a supervisory nature.
Under a plan procedure, the participants in the insolvency plan can deal with the (section 217, Insolvency Code):
Satisfaction of secured and unsecured creditors.
Realisation and distribution of the assets of the insolvent estate.
Debtor's liability after the insolvency proceedings.
Since 1 January 2012, in the case of corporate debtors, the plan procedure can affect the rights of the shareholders (section 225a, Insolvency Code).
The insolvency plan can be presented to the court by the debtor or the administrator (section 228(1), Insolvency Code). The debtor can do so when filing the insolvency petition, and therefore work at an early stage towards rescue. However, the initiative is often taken by the creditors who can entrust the administrator with the preparation of the plan, which the administrator must present to the court within a reasonable period of time (section 218(2), Insolvency Code). The insolvency plan consists of a declaratory section and a constructive section:
The declaratory section must provide information about the measures that were taken after the opening of the insolvency proceeding, or still to be taken after the onset of the insolvency proceedings, in order to form the basis for the planned structuring of the participants' rights (section 220(1), Insolvency Code). In addition, it must contain any other information significant for the decision of the creditors and the court on the insolvency plan (section 220(2), Insolvency Act).
The constructive section must state how the legal position of the participants is intended to be changed by the insolvency plan (section 221, Insolvency Code). This can affect the position of both secured and unsecured creditors (section 223 et seq, Insolvency Code) (a remarkable difference from the position in a UK creditors' voluntary arrangement). Provisions on the liability of the debtor (section 227(1), Insolvency Code) and, in the case of entities without legal personality or limited partnerships, relating to the liability of partners (section 227(2), Insolvency Code) can also be included.
The court must reject the insolvency plan if it does not comply with statutory provisions or has obviously no chance of success (section 231, Insolvency Code), which is comparable to the "feasibility test" for US Chapter 11 reorganisations.
If the plan is not rejected by the court, statements on the plan will be obtained (section 232, Insolvency Code). The court will set a date for a hearing at which the creditors' voting rights will be discussed. The plan will then be voted on (section 253, Insolvency Code). To facilitate the subsequent voting on the plan, classes of creditors must be formed (section 222, Insolvency Code). Such formation is mandatory if the creditors involved have different legal positions. A further division into sub-groups is discretionary if, within a group of creditors certain creditors have equivalent economic interests. For example, tax or foreign debts can be an adequate ground for the formation of sub-groups (section 222(2), Insolvency Code). Each of the creditors' groups will vote on the insolvency plan (section 243, Insolvency Code). This considerably simplifies the achievement of consensus. Within each group, a majority vote of both the members and the amount of the claims held is required (section 244(1), Insolvency Code).
A consensus is also facilitated by the prohibition of obstruction (section 245, Insolvency Code) under which the rejection vote of a group can be declared irrelevant if it is foreseeable that the affected creditors will not be disadvantaged by the plan in comparison to a regular procedure. Additionally, a consensus is facilitated by the fact that objections of the debtor can be ignored (section 247(2), Insolvency Code).
The insolvency plan must be confirmed by the court (section 248(1), Insolvency Code). If the court, the debtor and the creditors have agreed (or if their agreement is legally deemed to be given), the insolvency plan comes into force, proceedings are terminated and the debtor regains the right to dispose of the assets (sections 254(1), 258(1) and 259(1), Insolvency Code). However, this may be subject to restrictions as the insolvency plan may require the administrator to monitor the debtor (sections 260(1) and 261(1), Insolvency Code) and the debtor's legal transactions require the administrator's approval. In such a case, the creditors will be informed of how matters are proceeding (section 261(2), Insolvency Code).
Self-administration can be used in both insolvency proceedings and the insolvency plan procedure (see above, Insolvency proceeding and Insolvency plan procedure). Self-administration allows the debtor, under the supervision of a trustee, to manage and dispose of the insolvency estate (section 270 (1), Insolvency Code). The internal company know-how is therefore used more effectively.
The debtor must apply for self-administration (section 270(2) No. 1, Insolvency Code). Self-administration is intended to encourage the debtor to file an application for insolvency proceedings as soon as illiquidity is imminent (section 18, Insolvency Code), by allowing the debtor to retain the right to dispose of the assets during the insolvency proceedings.
The debtor has no right of appeal against a court order rejecting self-administration. However, if the debtor's application is rejected, the creditors' meeting is entitled to order self-administration (section 271, Insolvency Code). In such a case, creditors can appoint the existing insolvency administrator as trustee (section 271 sentence 2, Insolvency Code).
The order of self-administration cannot lead to any delay in the proceedings or other disadvantage for the creditors (section 270(2) No. 2, Insolvency Code).
The debtor does not retain full autonomy over the assets but is supervised by an administrator (section 274, Insolvency Code). Self-administration is especially appropriate in the case of major companies, because the company's and management's assets are mostly separate and the conflicts of interests often experienced in insolvency proceedings do not arise. In addition, the debtor's management is familiar with the company structure and financial situation, which can save the time of a (preliminary) insolvency administrator becoming acquainted with the debtor's situation. Further, self-administration is a far cheaper way to conduct insolvency proceedings, as compared to regular insolvency proceedings, since the regular trustees' fees only amount to 60% of the regular insolvency administrators' fees.
The approval of the creditors is also required for significant legal acts of the debtor (section 276, Insolvency Code). The creditors' committee can apply for a court order requiring the trustee's approval for certain legal transactions.
The court will order a period within which to file and present an insolvency plan if the:
Application for the opening of insolvency proceedings was made in the context of threatened illiquidity or overindebtedness.
Debtor filed an application for self-administration.
Intended restructuring is not obviously devoid of prospect of success.
The court will also take certain measures to protect the debtor from legal claims by creditors.
Commencing insolvency proceedings requires that:
The debtor or one of its creditors must file an application for the opening of an insolvency proceeding.
There is a reason for opening the insolvency proceeding, such as illiquidity or overindebtedness (if the debtor is a legal entity). Threatened illiquidity is also a sufficient reason.
The assets of the debtor are sufficient to cover at least the costs of the insolvency proceedings. If such assets are not sufficient, the proceedings can also commence if:
a sufficient amount is paid in advance to cover the costs of proceedings; or
the costs of the proceedings are deferred.
Insolvency plan procedure
An insolvency plan procedure requires the filing of an insolvency plan by the debtor or the insolvency administrator. The plan must be accepted by a majority of the creditors (see Question 2, Insolvency plan procedure).
The general requirements are the same as for insolvency proceedings or the plan procedure (see above, Insolvency proceeding and Insolvency plan procedure), with the following two additional requirements:
The application of the debtor for self-administration must be forwarded to the competent insolvency court. The application for self-administration can be combined with an application for insolvency proceedings.
There are no circumstances giving rise to the expectation that self-administration will disadvantage creditors.
Insolvency of corporate groups
German company law is based on a doctrine comparable to that established in Salomon v Salomon in the UK. Each corporate entity is therefore dealt with in separate insolvency proceedings. German law does not recognise the concept of group insolvency.
There is a strong practical need for a group insolvency regime. To this end, a draft statute on the simplification of insolvency proceedings for company groups is pending (Gesetz zur Erleichterung der Bewältigung von Konzerninsolvenzen, BT- Drucks. 18/407). However, it cannot be predicted whether and when the German legislature will enact (or reject) the draft. In practice, insolvency practitioners have developed the principle of personal union to overcome the lack of a statutory group insolvency regime and enable a single administration of proceedings (see Question 5).
The court before which insolvency proceedings are conducted is that of the place where the debtor has the centre of its economic activity (section 3(1), Insolvency Code). The centre of the debtor's economic activity is the location from which the major part of the debtor's business is conducted.
The decisive factor is the outward conduct of the business, not internal procedures. If the operating plants and the management centre are not situated in the same place, the management centre is decisive. This is deemed to be the establishment under section 21 of the Civil Procedure Code (Zivilprozessordnung) (ZPO). Notifications (for example, notice of a business operation, entry in the Commercial Register or registered office as specified in the articles of association) are not decisive factors.
If affiliates (that is, subsidiaries, parent or sister companies) are insolvent, insolvency proceedings for these companies cannot be conducted before the same court if their management is based in different areas of court jurisdiction.
The court that has jurisdiction over the insolvency of a parent company has jurisdiction over the insolvency of subsidiaries, provided that the business of the subsidiary was managed from the management centre of the parent company.
To obtain joint insolvency proceedings for a family of companies, some legal scholars suggest that insolvent members of the family of companies should transfer their registered offices to that of the controlling company. The necessary resolutions and notifications to the Commercial Registers could then be passed and filed within a short time (see Graeber, Neue Zeitschriftfür das gesamte Insolvenzrecht [NZI] 2007, p 267).
It is a fundamental principle of German law that the insolvency of each legal entity is dealt with separately. There is therefore no requirement that all members of a group proceed under the same procedure. However, in the co-ordination of insolvency plans of several companies, the effectiveness of a plan can be made dependent on its acceptance in all other proceedings relating to the other members of the group.
The German Insolvency Code does not specifically provide for a group administrator. However, in practice, the same individual can be the administrator in various proceedings through the principle of personal union used in combination with an insolvency plan procedure (section 217 et seq, Insolvency Code) and/or self-administration (section 270 et seq, Insolvency Code).
The principle of personal union is not part of statutory law but has developed through practice. It prescribes that the same individual must be the administrator (Insolvenzverwalter) of each member of a corporate group (see Eidenmüller, ZHR 169 , p 540 et seq). This is feasible in one of the two following ways:
The relevant individual can be appointed initially as administrator of the parent company only. In this capacity, the administrator can decide how to proceed with regard to the subsidiaries (that is, whether to also file for insolvency or continue their business as a going concern if these are financially sound companies). If insolvency applications for the subsidiaries are to be filed, the administrator will request the court to be appointed as administrator of these companies.
The same individual is appointed by the court to be administrator of all the group companies. This can occur if the individual companies (possibly due to a "domino" or "rippling" effect) apply for insolvency proceedings simultaneously or almost simultaneously.
However, the application of the principle of personal union can be restricted. For example, the creditors can participate in the selection of the administrator and the court can deviate from a unanimous proposal of the provisional creditors' committee only in exceptional cases (section 56a, Insolvency Code). In addition, the creditors' committees in insolvency proceedings of groups of companies are not necessarily identical. Differing proposals can therefore be made. If the court does not appoint the same individual as insolvency administrator for each member of a group, the only hope remaining is that the various administrators will consult with each other and co-ordinate their work as far as is possible (see Hortig, Kooperation von Insolvenzverwaltern, Baden Baden: Nomos, 2008, p 34 et seq).
Further, in the absence of additional measures, the appointment of a single administrator in all group-related insolvency proceedings is likely to be subject to certain difficulties. For example, the prohibition of self-dealing in section 181 of the German Civil Code (Bürgerliches Gesetzbuch (BGB)) prevents a group administrator from dealing with the various proceedings because it is unlikely that this can take place without agreements between the individual companies. A group administrator is therefore in a continuous conflict of interests. In practice, this is resolved by the appointment of a special administrator for certain decisions (Sonderinsolvenzverwalter). Certain powers of the administrator (for example, the power to enter into agreements with members of the group) are assigned to the special administrator (see Graeber, NZI 2007, p 269).
The insolvency plan procedure is, in combination with the principle of personal union, the main instrument that makes consolidated group insolvency possible in Germany. For example, this can be achieved by integrating the various insolvency plans into the declaratory section (see Question 2, Insolvency plan procedure) and showing the possibilities and advantages of consolidation. The constructive section can then define the roles of each company in the strategy (section 221, Insolvency Code).
The weakness of this method is that the consolidation is subject to the approval of each entity's creditors, so that the procedure of agreement must be repeated for each company. This form of group insolvency is particularly dependent on agreements and therefore generates important procedural costs.
Self-administration is also a useful instrument to achieve group insolvency (section 270 et seq, Insolvency Code), since it can be combined with the plan procedure (section 284(1), Insolvency Code). On self-administration of a parent company, the unification of the management of all group companies can be attempted, without the subsidiaries being declared insolvent. If the insolvency of the subsidiaries cannot be avoided, the principle of personal union can come into effect (see above). The subsidiaries will be taken into insolvency and the court will be urged to appoint the same administrator.
While the Insolvency Code does not specifically allow a single group administrator, the same individual can be administrator in various proceedings through the principle of personal union (see Question 5). Similarly, an application for self-administration can be filed by the subsidiaries (section 270 et seq, Insolvency Code) and an administrator will be appointed to the parent company (under the regular procedure or the plan procedure). The function of the trustee (Sachwalter) who supervises the self-administration of the debtor may also be exercised by the administrator of the parent (section 279 et seq, Insolvency Code).
A further possibility is the establishment of a contractual agreement between various administrators, comparable to the protocols used in Anglo-American jurisdictions. The agreement of the creditors' committee must be sought (section 160(1), Insolvency Code) (see Eidenmüller, Zeitschrift für das gesamte Handelsrecht und Wirtschaftsrecht 169 2005, p 542). This does not result in a single group administrator, but facilitates co-ordinated action within the group.
Only a natural person can be appointed as insolvency administrator or trustee. Law firms or auditing firms cannot act as an insolvency administrator or trustee in a German insolvency proceeding.
In addition, individual advisers instructed by the company or its affiliates before the insolvency proceedings cannot act as insolvency administrators since a conflict of interests could arise. However, the fact that the insolvency administrator is proposed by the debtor or a creditor or may have advised the debtor before the application on the course of the insolvency proceedings and its consequences in general does not necessarily exclude the administrator's independence (section 56, Insolvency Code). It is common to appoint restructuring experts as managing directors of the debtor before the opening of insolvency proceedings.
Such advisers can work for all the members of a family of companies.
In principle, members of a family of companies are legally separate and distinct entities. There is therefore nothing preventing them from doing business and transferring assets to one another. However, German law restricts transfers of assets, establishing or waiving of receivables, withdrawal of capital or other comparable transactions between affiliates, where this could be to the disadvantage of creditors of the transferring company. These restrictions result from the rules on:
Piercing the corporate veil.
Setting aside certain transactions, especially insolvency contesting rights (Insolvenzanfechtung). These include preferences, transactions at an undervalue and repayments of shareholder loans. German law limits the enforceability of shareholder loans (and transactions with a similar economic effect). If a shareholder, at a time when the company was already in distress, advanced funds to the company under a loan agreement (or an agreement with a similar economic effect), the funds are deemed to be share capital (Eigenkapitalersetzendes Darlehen). Consequently, they cannot claim repayment. On insolvency, the claim to repayment is a subordinated claim (section 39, Insolvency Code). Repayments made before the commencement of insolvency proceedings must be repaid, at least if they were performed within the last year prior to the moment when the application for insolvency proceedings was delivered to court (section 135, Insolvency Code). In the absence of insolvency proceedings, shareholder loans are treated like any other third party loans. On commencement of insolvency proceedings, the claim for repayment is a subordinated claim, and repayments made within a year before the application for insolvency proceedings must be returned. Therefore, payments under cash-pooling agreements between the members of a family of companies, which are considered to be (upstream or downstream) loans under German law, may be affected by insolvency contesting rights (see Schleifenbaum/Keller, "Lost Money – How the Amendment to the GmbH Act Devalues Shareholder Loans" in: JIBFL 2008, p 555).
Prohibition on financial assistance (for public companies only). These rules are set forth in section 71a of the Stock Corporation Act (AktG) which implements Directive 77/91/EEC (Second Company Law Directive). The prohibition is similar in scope to that under section 860 of the UK Companies Act 2006.
Company groups (Konzernrecht). These rules allow the parent company to run the group by means of individual contracts between the parent and the subsidiaries, conferring on the parent company a right to give binding instructions to the directors of the subsidiary (Beherrschungsvertrag) (section 291 et seq, AktG). However, the parent must make good losses arising from the running of the business in the interests of the group (rather than in the interests of the subsidiary) (section 302, AktG). The parent company of a de facto group (as opposed to a contractually formed group under section 291 AktG) can be held liable to compensate subsidiaries which it has caused to act in a manner contrary to their own interest (section 317, AktG) (see also Ferran, Principles of Corporate Finance Law, Oxford: OUP, 2009, p. 46-7).
The validity, enforceability and ranking of contract or tort claims of related companies are not influenced by the status of a company as a parent or subsidiary. In particular, claims of a related company arising out of contract or tort rank pari passu with the claims of third party creditors. There are generally four exceptions to this rule:
Subordination of intra-group claims may be agreed individually in contractual subordination agreements (section 39(2), Insolvency Code). This is common for inter-company loan agreements.
A different treatment can be agreed in an insolvency plan (section 217 et seq, Insolvency Code).
Claims based on loans are subordinated claims (section 39(1) No 5, Insolvency Code). In Germany, a shareholder can demand repayment of a loan only after all other creditors have been satisfied (see Question 5).
Special circumstances can arise if the intra-group claims are based on transfers of assets that can be contested under insolvency law, such as preferences with the intention to disadvantage other creditors (section 133, Insolvency Code) or transactions at an undervalue (sections 39(1) No 4 and 134, Insolvency Code).
Unlike US law, German insolvency law does not recognise consolidated insolvency and, in particular, the pooling of assets (substantive consolidation). The Commission on the Reform of Insolvency Law established at the beginning of the 1990s decided not to adopt this concept for various reasons. The pari passu principle and the maintenance of the entity doctrine were decisive in making this decision. A procedure in which creditors who never dealt with the debtor and the debtor's counterparties are set against each other was not considered desirable, as the estate would be shared with creditors who were unable to foresee who their debtor(s) was at the time of concluding the contract with their business partner (unless they had obtained an overview of the entire group structure).
The only way to achieve a consolidation of the insolvent estate is through the insolvency plan procedure, under which co-ordinated insolvency plans can be achieved. However, this does not strictly result in the pooling of assets, because estates are not merged as such, but only the plans co-ordinated and individual deviations from the regular insolvency procedure agreed on (see Question 5).
The law permits group-wide security, but does not impose it. Unless otherwise agreed between the creditors and companies, therefore, personal and proprietary security of any kind is valid only against the legal entity which granted it, regardless of any involvement in a group of companies.
Secured creditors are insolvency creditors only if and to the extent that (section 52, Insolvency Code):
The debtor is also personally liable to them.
The proceeds of the realisation of the security are not sufficient to satisfy the debt completely, or the security is waived for any reason.
If a creditor has a security interest in the assets of one member of the family, and a guarantee from another member of the family, both claims are valid. The creditor can at his discretion obtain satisfaction from both claims, up to the amount of his secured debt. If the realisation of both claims is not sufficient to fully satisfy the secured debt, the creditor can only register the remaining debt as an unsecured debt in insolvency proceedings (Ausfallforderung).
Insolvency proceedings for international corporate groups
Cross-border insolvencies are governed by sections 335 to 358 of the Insolvency Code, as amended in 2003. Insolvency proceedings instituted for corporate family members in EU member states (except Denmark) are governed by Regulation (EC) 1346/2000 on insolvency proceedings (Insolvency Regulation). Both sets of rules contain similar provisions.
German courts enforce court orders from foreign jurisdictions that attempt to exercise jurisdiction over assets located in Germany if the foreign insolvency proceedings must be recognised in Germany. Such proceedings must be recognised if both (Articles 3, 16 and 26, Regulation (EC) 1346/2000 on insolvency proceedings (Insolvency Regulation); section 343, Insolvency Code):
The debtor had its centre of main interests or carried out an independent economic activity in the foreign jurisdiction (Article 3, Insolvency Regulation; section 3, Insolvency Code).
Recognition of the foreign proceedings is not incompatible with fundamental principles of German law (public order reservation).
Overlapping functions at management boards (Geschäftsführer/ Vorstand) and supervisory boards (Aufsichtsrat) levels are common and typical characteristics of groups.
There are no provisions on overlapping management board memberships. The possibility of having overlapping management boards can be deduced from section 82(1) of the German Stock Corporation Act (Aktiengesetz (AktG)), which requires supervisory board approval of double membership. This applies not only to stock companies but also to limited liability companies. Although double membership is not prohibited, it carries the risk of conflicts of interests, particularly regarding potential prohibitions to exercise voting rights. Such prohibitions have been discussed in the legal literature without a satisfactory outcome, and have only been the subject of a few judgments of lower courts (Landgericht Köln of 3 February 1992, 91 O 203/91, Die Aktiengesellschaft 1992, p 238). In any event, members cannot vote on the discharge of the controlled company's management board if they are also members of the parent company's management board (section 136 (1), AktG). In such a case, they cannot authorise a third party to vote through a power of attorney.
The qualifications for membership of a supervisory board members are set forth in the AktG (section 100(2) No 1 to 4). The provision applies to both stock corporations and limited liability companies (section 52, German Act on Limited Liability Companies (Gesetz über die Gesellschaften mit beschränkter Haftung (GmbHG)). The following persons cannot be members of a company's supervisory board:
A person who is already a member of the supervisory boards of ten companies that are statutorily required to form a supervisory board (a supervisory board must be established in stock corporations, partnerships limited by shares, limited liability companies with more than 500 employees and all investment companies). However, the legal representative of a controlling company can hold five additional positions within the group (section 100(2), sentence 2 AktG).
Legal representatives of a subsidiary.
Legal representatives of another company in which a member of the management board is also on the supervisory board.
Persons who were on the management board of the same listed company, unless his election results from a proposal of the stockholders representing more than 25% of the voting rights.
The following applies to both companies and partnerships.
Under German civil law, a shadow director is a person who carries out the functions of a director without being formally appointed as such. Such a person is subject to the range of duties that apply to directors who have been formally appointed. For example, a shadow director is subject to the obligation to file an application for insolvency proceedings (Bundesgerichtshof of 21 March 1988, II ZR 194/87, Neue Juristische Wochenschrift, NJW, 1988, p 1789). A shadow director can be liable in damages for failure to do so (section 15a, Insolvency Code; section 823(2), German Civil Code (Bürgerliches Gesetzbuch) (BGB)). The shadow director is also liable for payments that (section 64, German Act on Limited Liability Companies (GmbHG)):
Were made by the debtor company to third parties while it was unable to pay its due debts.
That foreseeably caused the company's illiquidity.
If a shareholder is a de facto director, liability can therefore lead to piercing the corporate veil.
The requirements for being a shadow director under criminal law are narrower than under civil law. Criminal liability as a shadow director (for example, for delaying making an insolvency application) requires that both the:
Appointment as managing director is void.
Individual acts as an organ of the company or controls (or at least participates in the control of) the company without having been legally effectively appointed. The actual authority exercised is decisive.
The indications of shadow management are (subject to the in dubio pro reo rule, that is, that a defendant may not be convicted by the court when doubts about his or her guilt remain):
Determination of the company policy.
Organisation of the company.
Arranging business with contractual partners.
Negotiating with lenders.
Amount of remuneration.
Deciding on tax matters.
Control of the bookkeeping.
It is disputed whether shadow management can only be established if at least six of the above eight indications are fulfilled (six-of-eight-theory).
As a general principle, officers and directors only owe duties to the company. For limited liability companies, this rule derives from the principle of limited liability itself. If directors and officers owed duties directly to creditors (for example, as employees), the principle that the creditors can only seek satisfaction by seizing the company's assets could easily be circumvented.
However, directors and officers also have direct duties to third parties, such as the duty not to give wrong information about the company, especially in prospectuses (for example, for capital market and financial products).
In addition, directors and officers must fulfil the company's public duties to the state, especially to pay tax and social security contributions. Directors and officers also owe duties to the state under criminal law.
If a company becomes insolvent, the members of the managing board must file an application for insolvency proceedings within three weeks after the insolvency occurred. If they do not fulfil this duty, they may be personally liable under both civil and criminal law.
In addition, the members of the managing board must stop all payments and can be held personally liable in damages for failure to do so. Only payments that comply with the care of a prudent director are permitted.
On the opening of the insolvency proceedings, members of the managing board lose their powers and their existing functions with regard to the insolvency estate, since they are replaced in this respect by the administrator (section 80(1), Insolvency Code), unless the court orders self-administration. The members of the managing board must generally be available for information purposes after the opening of insolvency proceedings, but do not retain their powers, except for the part of the debtor's estate that is not allocated to the insolvency estate (insolvency-free-estate) (Insolvenzfreies Vermögen).
The duties to inform and co-operate are owed to the insolvency administrator, not to individual creditors or participants in the insolvency proceedings. The insolvency administrator can enforce information and co-operation duties against the managing directors or managers with the assistance of the insolvency court, if necessary. The insolvency administrator himself owes duties to all participants in the insolvency proceedings, especially creditors (section 60 et seq, Insolvency Code).
The duties of directors or officers generally relate to each member of a family of companies and are therefore considered separately. Therefore these duties do not change when one member of a group becomes insolvent.
Officers and directors must strictly observe and pursue the interests of the company in which they hold office. A manager who has similar functions in two companies must reach a fair solution when a transaction is to be concluded between the companies. If he only pursues the interests of one company, he may breach his duties to the other company and be liable for damages. Such transactions are usually investigated by the insolvency administrator on the insolvency of one of the participating companies, who will attempt to enforce any claims which may arise against the favoured company and the director concerned.
Types of breach
Failure to take reasonable steps to minimise losses to creditors. Officers and directors are only obliged to take reasonable steps to minimise losses to the company. Officers and directors who grossly negligently fail to prevent ascertainable losses and negative effects for the company are in breach of their duty of care (that is, to act as a prudent and conscientious manager).
Misappropriation of corporate assets. Misappropriation of corporate assets is a breach of officers' and directors' duties under both civil and criminal law.
Undervaluation of corporate assets in a preference or other transaction to the detriment of creditors. This can lead to officers' and directors' personal liability for damages and criminal liability for:
Disloyalty (section 266, German Criminal Code (Strafgesetzbuch) (StGB)).
Breach of the duty of bookkeeping (section 283b, StGB).
Failure to inform creditors of insolvency. Liability for damages and criminal liability can arise if the managing director embarks on new transactions while being aware of the company's insolvency.
Preferring payment to one creditor as opposed to another when insufficient monies are available to pay both. Favouring a creditor can give rise to criminal liability (section 283c, StGB). Only German tax authorities and social insurers are entitled to bring compensation claims as prejudiced creditors.
Continuing to trade when there is little prospect of being able to pay when due. See above, Preferring payment to one creditor as opposed to another when insufficient monies are available to pay both.
All the acts of managing directors which reduce the assets of the company without adequate consideration, or which are in breach of the obligation to apply for insolvency proceedings, can give rise to compensation claims and/or criminal liability.
Directors and officers may be liable under criminal law for:
Fraud, in particular for misrepresenting the financial position of the company through falsified or opaque accounting (sections 263 or 283b, German Criminal Code(StGB)). Liability for falsified accounting applies regardless of the company's insolvency.
Negligence, in the case of accounting irregularities (section 283b(2), StGB). This requires that (section 283b(3) and 283(6), StGB):
the company discontinues payments;
insolvency proceedings are commenced; or
the commencement of insolvency proceedings is refused due to lack of assets.
Misappropriation of the company's assets (section 283, StGB).
Conducting high-risk speculative transactions (section 283, StGB).
Disposing of assets in a manner contrary to usual financial practice (section 283,StGB).
Concealing the company's financial position of the company, where the company is insolvent or insolvency results from such conduct (section 283(2) to (4), StGB).
On conviction, a director is prohibited from becoming a member of management boards of a stock corporation (section 76(3), Stock Corporation Act (AktG)) or director of a limited liability company (section 6(2), Act on Limited Liability Companies (GmbHG)) for a period of five years. This period runs from the completion of any custodial sentence. In addition, any appointment of the person as a director or member of a management board is void from the date of the criminal conviction. This applies not only to the company in respect of which the crime was committed, but to all companies in which the individual held such positions.
The above offences can also give rise to civil law liability (section 823(2), BGB; section 283 et seq, StGB).
The penalties include imprisonment for up to ten years, in cases of serious crimes. A fine can be imposed instead of imprisonment in minor cases (StGB). There are no other criminal fines or restitution.
These liability risks exist before a company becomes insolvent as well as from the moment the company becomes insolvent afterwards.
There is a tendency in Germany to make potentially premature insolvency applications to avoid compensation claims and other personal liabilities, especially in the case of outside management. In recent years, the criminal investigation authorities have increasingly concentrated on failure to file insolvency applications at the correct time.
Director and officer insurance (D&O insurance) can generally cover civil claims that arise while operating a financially distressed company. Grossly negligent and wilful breaches of obligations in crisis situations are not covered. It is extremely difficult to establish the distinction between simple and gross negligence, particularly in situations of crisis.
In exceptional cases, especially for companies with outside managers, the availability of D&O insurance can be a factor in deciding to delay entering into a formal insolvency procedure, in an attempt to overcome a crisis.
The concept of "resignation at an improper time" has developed through practice and prevents a managing director from avoiding his obligation to file an application for insolvency proceedings and criminal liability simply by resigning at an improper time.
However, a director can only resign and avoid civil liability if at least one director or officer still remains in the company. This often leads to a race between the managing directors not to be the last resigning director. If all directors have resigned, the company has no management (führungslos). In such a case, the shareholders must file an application for insolvency proceedings (section 15a, Insolvency Code). If the debtor is a public company, the members of the supervisory board must also file an application for insolvency proceedings, and may be exposed to civil compensation claims and criminal law sanctions for failure to do so.
Private litigation against officers and directors for breach of their duties after the commencement of insolvency proceedings generally only arises in cases where officers and directors have clearly breached their duty. However, compensation claims of insolvency administrators against directors and officers for breach of their duties have increased, especially for breaches of their duty to stop further payments after the company becomes illiquid or over indebted (where such payments are incompatible with the care of a prudent and conscientious manager). Such claims are not usually successful.
The creditors committee is usually asked for their consent to such litigation measures, although this consent is not mandatory.
Good faith alone is not a defence available to a managing director. A managing director must conduct the company's business with the care of a prudent and conscientious manager and examine whether the company is illiquid or overindebted.
Reliance on the valuation of assets on a due diligence or in the report of an external expert usually acts as a defence to compensation claims for breach of duty.
Reliance on outside consultants or professionals
Instructing an outside consultant or professional cannot excuse a managing director. In practice, it is the role of the consultant to precisely explain to the managing director the extent of his obligations, and the options available to comply with these obligations and prevent a breach from arising. A director will therefore have a defence where he obtains explanations and advice on his obligations from a qualified adviser and acts accordingly.
Reliance on the professional legal advice can only be a defence if the legal advice was not visibly wrong.
Exercise of reasonable judgment
In principle, directors and officers must continue the company's business for the protection of all creditors and shareholders, and to realise the "going concern" value of the enterprise. Cessation of the business and a realisation of assets or liquidation of the company must always be the last resort.
If the continuation of operations is successful and results in a higher payout, the creditors and the company suffer no loss. There are therefore no grounds for compensation claims. In addition, successful protection of the company's assets is considered to be compatible with the care of a prudent and conscientious manager (section 92(2) 2, Stock Corporation Act (AktG); section 64 S. 2, Act on Private Limited Liability Companies (GmbHG)).
If directors and officers made their decisions on the basis of intelligible and conclusive documents and information, failure to achieve the intended objective is not a breach of duty. However, it is likely that an insolvency administrator will bring a compensation claim for payments made after the illiquidity or overindebtedness of the company, and argue that such payments were incompatible with the care of a prudent and conscientious manager.
An officer or director who is convicted of a bankruptcy crime is disqualified from becoming an officer or director in another company for five years (section 76 Stock Corporation Act (AktG); section 6, Act on Private Limited Liability Companies (GmbHG)). Such a position in another company becomes invalid when the conviction becomes legal effective.
An officer or director of an insolvent company is not otherwise legally restricted from acting as an officer or director in another company.
An officer or a director who becomes personally insolvent is not restricted from continuing to act in his current company or another company. However, there is a risk that creditors (in particular lenders) lose confidence in the officer's or director's reliability, and therefore in the company itself.
See above, Current company.
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.
Dr Christoph Schotte, Partner
Professional qualifications. Germany, University of Erlangen-Nürnberg (with Noerr since 1999)
Areas of practice. Insolvency law; restructuring; corporate law; banking law.
Björn Grotebrune, Senior Associate
Professional qualifications. Germany, University of Regensburg (with Noerr since 2014)
Areas of practice. Insolvency law; restructuring; corporate law.