Practical implementation of Germany’s new insolvency code
November 2012 | 10QUESTIONS | BANKRUPTCY & RESTRUCTURING
financierworldwide.com
FW speaks with Joachim Englert, a partner at PwC, about the implementation of Germany’s new insolvency code.
FW: Although we are still in the early stages, what changes have you noticed in Germany’s restructuring market since the introduction of the new insolvency code (ESUG)?
Englert: All of the major new tools introduced by ESUG are now in use, and the German press and public have reacted positively, especially to the protective shield proceeding (Schutzschirmverfahren). This has helped in mitigating the stigma surrounding insolvency. Around 50 proceedings have already opened under Schutzschirmverfahren, with Solarwatt, Neumayer, Centroterm and Leiser being some of the more prominent cases. Leading insolvency practitioners are now more open to cooperating with other stakeholders, especially advisers, in insolvency proceedings. In the run up to ESUG coming into effect in March 2012, advisers made great efforts to gain an understanding of the new procedures and also to actively promote the Schutzschirmverfahren as a new Chapter 11-like procedure. Advisers now frequently encourage clients to utilise this procedure. Despite this, there remains some uncertainty about the application of the new regulations, particularly when establishing obligations of the estate by management, as well as the liability of the management and trustee.
FW: Could you outline the main advantages of ESUG from a debtor’s perspective?
Englert: ESUG provides a number of advantages from a debtor’s perspective. First, it strengthens the ‘debtor in possession’ (DIP) concept, which is attractive for management as they stay in the driver’s seat. The newly established Schutzschirmverfahren proceeding supports DIP because the mandatory supervisor (vorläufiger Sachwalter) can be chosen by management, and the court is supposed to follow management’s suggestion. The introduction of the preliminary creditor’s committee also helps management to communicate and set common goals. As a result, insolvency proceedings have become more predictable.
FW: What benefits does the new insolvency process offer to creditors?
Englert: The new process strengthens creditors’ influence when appointing an administrator. The formation of mandatory preliminary creditors’ committees, in cases where certain thresholds are met, also strengthens creditors’ influence on the insolvency process. As a result of the new process, insolvency proceedings have become more predictable due to their enhanced transparency. In addition, equity is now seen as a class within the insolvency plan proceeding, allowing for the cram down of shareholders and the limitation of their powers. Overall, the new insolvency process provides a benefit to both debtors and creditors through the encouragement of earlier proactive action being taken by management and their advisers. This serves to prevent the destruction of value which is common in uncontrolled insolvency processes and improves the chances of a successful rescue of the company.
FW: Can you describe the function of debt-to-equity swaps under ESUG? What challenges may arise when using this model?
Englert: The new insolvency law now allows for a cram down of the equity holders of a company, and allows for the conversion of creditor claims to shares in the company, with creditors’ consent. Potential over-indebtedness is thereby eliminated, so financing costs will decrease and, as a result, profitability and company creditworthiness will rise. One of the main challenges will be to exempt the shareholders from pre-emptive rights. Tax risks still remain one of the main obstacles for debt-to-equity swaps given that the German tax law was not changed in this context. In addition, ‘new’ shareholders might still be required to make an offer to buy out remaining shareholders.
FW: To what extent does the new law strengthen insolvency plan procedures?
Englert: The main strength of the new insolvency plan is the enhanced opportunity it allows for appealing insolvency plan regulations in court. It is further strengthened by having fewer administrational prerequisites. As the new Schutzschirmverfahren has been established explicitly to promote insolvency plans, with the general strengthening of DIP and now the cram down of equity claims being made possible, we do expect insolvency plan procedures to become much more common. In situations involving pre-pack plans, such as Solarwatt, the new law offers a magnificent opportunity to execute an insolvency plan within 10 weeks – Solarwatt took only seven weeks after filing to confirm a plan.
FW: Given that ESUG includes no group insolvency regime, what complications may this cause?
Englert: Up to now, insolvency procedures have only applied to single legal entities. However, in cases where several companies file as a group, it has not been ruled out that each company can appoint a different insolvency administrator and different creditors’ committee. Insolvencies of group structures still have to be well prepared, and, before filing, aligned with competent insolvency courts. Early experiences with Schutzschirmverfahren have shown that this new proceeding also helps to keep a group together, as was shown in the Neumayer Group case.
FW: Are some insolvency judges reluctant to utilise the new ESUG provisions?
Englert: One example is the Q-Cells insolvency, where the insolvency judge did not appoint the preliminary insolvency administrator proposed by management and supported by those creditor representatives present at the court at the time of the insolvency filing. He also did not involve the preliminary creditors committee in his decision of who to appoint – as is requested by ESUG – stating that “such committee has not yet been constituted and that there are doubts whether the proposed constituency would comply with the statutory requirements for such a committee”. In a subsequent insolvency case, however, the same insolvency court fully applied the new ESUG rules in accordance with the insolvency filing, which shows that there is a learning process for the parties involved.
FW: What are the preconditions necessary for a debtor to file under ESUG?
Englert: There have been no changes to the required grounds for filing for insolvency, though courts now have stricter terms regarding information requirements. Filing for Schutzschirmverfahren requires a firm to be free from illiquidity at filing but it must be over-indebted and facing illiquidity in the near-future. A firm’s restructuring plan must be reasonable and achievable, and the plan must also be confirmed by an independent third party such as an auditor, tax adviser or lawyer experienced in restructuring and insolvency.
FW: What factors are required to ensure a successful restructuring process using the new code?
Englert: Among the factors required to ensure the success of a restructuring are a sponsor, a business model suitable for insolvency and management, together with advisers and a custodian experienced in insolvency. Viable process planning is a further requirement.
FW: Do insolvency practitioners have a positive outlook for the months ahead, given the new opportunities to restructure companies under ESUG?
Englert: Restructuring and insolvency practitioners in Germany view ESUG positively and agree that, if properly applied, it will provide a useful tool kit for future restructurings and that a potential country risk has been eliminated. The new law came at the right time with the overall economic situation in Germany widely expected to become increasingly negative in the near future. In the next round of changes to the German insolvency law one hopes that group insolvency and better rules to support funding during a proceeding are introduced.
Dr Joachim Englert is a partner in PwC’s restructuring practice in Germany. He specialises in financial restructurings and operational turnarounds, IBRs and going concern analysis (Sanierungsgutachten). Mr Englert has extensive experience in the development and execution of strategic, operational, and financial improvement initiatives for comprehensive value creation, both for debtors and lenders. He can be contacted on +49 (0) 69 9585 5767 or by email: joachim.englert@de.pwc.com.
Mr Englert would like to thank Frank Girotto, a senior manager at PwC, for his input into these responses. Mr Girotto can be contacted on +49 (0) 89 5790 6456 or by email: frank.girotto@de.pwc.com.
THE RESPONDENT
Joachim Englert
PwC