Changes to the German Insolvency Code - A New Frontier for Restructurings

For many years the German Insolvency Code has been criticised for its inflexibility and rigidity in relation to corporate restructurings. As such it has often been remarked that, in contrast to the US and the UK, German insolvency laws do not provide sufficient scope for distressed companies to restructure their businesses using many modern restructuring tools. This criticism largely stems from the central role that the courts play in any restructuring process. However, as a result of the Act for Further Facilitating the Restructuring of Companies (Gesetz zur weiteren Erleichterung der Sanierung von Unternehmen) which comes into force on 1 March 2012, a number of amendments have been made to the German Insolvency Code which will greatly enhance the attractiveness of Germany as a destination for financial restructurings.

Under the existing law, the insolvency administrator was normally appointed solely by the court with very little involvement from the company or its creditors. Under the new provisions, a creditors committee is able to appoint the insolvency administrator. Upon the company filing for the commencement of insolvency proceedings, the court is obliged to appoint a preliminary creditors committee if certain requirements are met (including that the company is still trading and has a minimum of fifty employees). The court will be bound by the choice of insolvency administrator appointed by the preliminary creditors’ committee unless the person is clearly inappropriate for the role.

In the past, while the concept of self-administration by an insolvent company was permitted under German law, the German insolvency courts had been reluctant to permit a company’s management to remain in control while insolvency proceedings were on foot. Under the new law however, where the company files for insolvency and applies for self-administration, the court must accept the application for self-administration under certain circumstances. Under the new regime, the company is permitted to combine the application for self administration with an application to file an insolvency plan if the company files an expert report confirming that various requirements are fulfilled - principally that the company is not cash-flow insolvent and that the restructuring is not without any prospects for success. If these requirements are satisfied, the court must accept the application and will grant the company a period of up to three months during which the court is not permitted to appoint an insolvency administrator. During this “protection” period (Schutzschirmverfahren), a preliminary adviser (Sachwalter) is appointed to monitor and support the company. In order to facilitate the restructuring, the insolvency court is able to put a quasi-moratorium in place whereby enforcement of any claims against the company is prohibited but at the same time the company can enter into preferential arrangements with various creditors.

Insolvency plan proceedings (Insolvenzplanverfahren), like self-administration, have been a key feature of German insolvency law for over a decade. However, a common criticism of insolvency plan proceedings has been the lack of participation of shareholders in the proceedings. Further, shareholder consent was required where any shareholder rights were affected by the insolvency proceeding. In practice, this resulted in a virtual inability for companies to implement debt-to-equity swaps as shareholders were effectively given the right to veto them.

Under the new law, shareholders will not be able to prevent creditors from swapping their debt into equity. Further, shareholders will be able to be crammed down to accept the restructuring of the company (i.e. capital increase or new shareholder injections) provided that a sufficient quorum of creditors have voted in favour of the insolvency plan and that shareholders will not be put in a worse position as a result of a plan.

The common consensus amongst lawyers and legal commentators is that the new amendments to the German Insolvency Code will bring it more in line with the UK and the US insolvency regimes such that Germany is likely to become a far more attractive jurisdiction in which to effect financial restructurings.