One year later: Germany’s corporate insolvency law reform turns out success story
May 2013 | LEGAL & REGULATORY | BANKRUPTCY & RESTRUCTURING
Financier Worldwide Magazine
Germany has one of the strongest industries in the world, but its insolvency laws, which stem from the late 19th century, used to treat companies with multimillion euro balance sheets no different from a sole trader on the high street. Upon an insolvency filing of a debtor company, the court would, without any creditor involvement, appoint an administrator, who took control over the debtor company, sold all of its assets in a liquidation procedure, and then, usually only after a number of years, distributed the proceeds to creditors. It was not until 1999 that Germany enacted a copycat of the US Chapter 11 procedure in its ‘Insolvency Code’ (Insolvenzordnung), which allowed for a debtor-in-possession process and a creditors’ vote on a reorganisation plan. However, the process was rarely used – only in 1 percent of all insolvency cases was a plan of reorganisation proposed.
The lack of acceptance of the plan of reorganisation procedure and the criticism it attracted from restructuring practitioners resulted in the German legislator enacting, after consulting with experts, the Law for the Further Facilitation of Corporate Restructurings – Gesetz zur weiteren Erleichterung der Sanierung von Unternehmen (ESUG).
The ESUG, which amended certain provisions of the German Insolvency Code effective from 1 March 2012, was warmly welcomed by the restructuring community (though not so much by the insolvency administrators among it), and has turned out to be one of the biggest successes in legislative history so far. Even though exact figures are not available, more than 200 companies – some of them with a stock exchange listing – have successfully restructured themselves after a few months through a plan of reorganisation.
So what has happened? The ESUG strengthened creditor and debtor control over the insolvency procedure through the following key elements:
Early creditor involvement. If a company with an operating business of a size that fulfils two out of three criteria – €4.84m assets; €9.68m revenues; and an average of 50 employees, each per the prior fiscal year – files for insolvency, the court has to appoint a preliminary creditors’ committee. In addition, the court has to hear the preliminary creditors’ committee before appointing a preliminary administrator. If the court appoints a preliminary administrator before it has heard the preliminary creditors’ committee, the preliminary creditors’ committee can in its first meeting, and by unanimous resolution, elect a different preliminary administrator. The ability to partake in the election of the most influential person in the insolvency procedure from the filing (and in practice, often even before the filing), rather than having to accept whomever the court has appointed in its own discretion, has greatly strengthened creditor confidence in the German insolvency process.
Debtor-in-possession and ‘protective shield’. Even more importantly, companies have now become incentivised to seek an early restructuring ‘in court’ rather than desperately attempting to achieve an out of court solution and then only file when the business has already suffered. The incentive is two-fold. First, the management of a company in principal stays in charge of the business after filing, and will only be supervised by a trustee – under the previous law, the court would appoint an administrator who would take de facto control of the business. Second, a company may now petition for an up to three-month moratorium to draft the plan of reorganisation, during which the company’s management will continue to run the business under the supervision of a trustee which it can select, and can incur administrative expenses during that period. This is the so-called ‘Schutzschirmverfahren’, or protective shield procedure. The debtor-in-possession status will be withdrawn if the creditors’ committee unanimously petitions for it, so the balance between debtor and creditor control is preserved.
Debt-equity-swaps in court. A main driver for the reform’s success is the newly introduced potential to impair the old, out-of-money equity through the plan of reorganisation, which allows for the swapping of pre-petition debt into new equity or the issuing of new shares to a new money investor. Under the old rules, shareholders could not vote on a plan, but also could not be diluted through a plan either. Since shareholders vote in a class, only 50 percent of votes (by capital and number) are needed to approve any equity measures. German corporate law often requires a 75 percent voting threshold. If the requisite majority in a class, including the shareholders, does not consent, it can be ‘crammed down’ if the majority of classes has consented, no creditor receives a more favourable consideration under the plan than a more junior creditor, and the overall recovery for that class is better than in a liquidation. As a caveat, the plan cannot force creditors to take equity – each creditor who is supposed to swap its claims against equity has to consent. If the court confirms the plan (and no creditor appeals), the debt-equity-swap becomes effective.
These three changes have already helped dozens of German Mittelstand companies keep their business afloat and emerge with a healthy balance sheet after only a few months in insolvency. There are two prominent examples. First, the listed German solar manufacturing company Centrotherm Photovoltaics AG,emerged after only seven months in debtor-in-possession insolvency proceedings, with the creditors, through a trustee, taking control of 80 percent of the shares in return for a haircut of 70 percent of their claims. Second, the German solar module manufacturer Solarwatt AG restructured itself in six months through an insolvency plan that wiped out the old equity, gave 100 percent of the restructured equity to a new money investor, reinstated the secured bank debt, and left unsecured creditors with an immediate 16 percent dividend (with some upside) as opposed to an 11.2 percent dividend.
These examples show that the reform of the corporate restructuring rules in Germany is a step in the right direction. Restructuring practitioners are now hoping for an out-of-court process to be added to the playbook.
Sacha Lürken is a partner at Kirkland & Ellis International LLP. He can be contacted on +49 89 2030 6114 or by email: email@example.com.
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Kirkland & Ellis International LLP