What’s so special about German corporate bankruptcy cases three years after ESUG reform?
March 2015 | SPECIAL REPORT: GLOBAL RESTRUCTURING & INSOLVENCY
Financier Worldwide Magazine
March 2012 was the beginning of the end of the dark ages for German in-court restructuring. No more equity hold-outs, no more commandeering of the process by bankruptcy administrators, enhanced creditor involvement, an opportunity for meaningful in-court financial and operational restructurings. In short, just business as usual, the way an efficient in-court restructuring process should work.
In the three years since then, three fairly prominent German debtors have restructured in-court. Wood products manufacturer Pfleiderer AG restructured over €1bn in funded debt in 2012 in a single-entity bankruptcy proceeding, converting that debt to equity. Later in 2012, automobile manufacturer Neumayer-Tekfor filed for bankruptcy with three operating subsidiaries executing a going concern sale, emerging from bankruptcy several months later. Most recently, in 2014, real estate conglomerate IVG Immobilien AG emerged 12 months after filing from a single-entity proceeding, restructuring over €4bn in funded debt, handing over the keys to its secured lenders and bondholders while wiping out its stock-listed equity holders.
These cases show the extent to which the German process can be used for balance sheet restructurings. The process proved to be capable of coping with complex financial structures and myriad other creditor claims. However, for a simple right-sizing of the balance sheet, the German process cannot offer the speed and precision that a one-day English pre-pack administration, such as that carried out by A.T.U., or the slightly longer scheme, employed by Rodenstock, La Seda and Apcoa, can offer.
So what is the German Code’s competitive advantage? Among European bankruptcy instruments, Germany has a very advanced statutory scheme for effectuating not only balance sheets, but also operational restructurings in-court. But the German Code’s toolbox has remained below the radar because the thought of restructuring in German courts has only become palatable over the last three years.
Lease, labour and machinery rationalisation. Section 103 et seq. of the German Code provides extensive procedures for the rejection and assumption of contracts. Can debtors-in-possession leverage these provisions to optimise their real estate leasing obligations, similar to how firms such as Fitness First and others have relied on the English CVA? Can those same provisions be used to rationalise other contractual obligations, by downsizing a labour force, for instance, or right-sizing an aircraft fleet or other machinery leasing obligations potentially entered into during times of plenty but which will be oversized once the next crisis hits?
Automatic stay. Section 21 of the German Code and Section 240 of the German rules of civil procedure contemplate a stay of adverse action, or a moratorium, against a debtor nearly at the level at which US Chapter 11 debtors are accustomed. English procedures offer this protection only in an administration. Is this enough breathing space for a German debtor to effectuate a true operational restructuring and achieve its fresh start?
Cram-down. Section 245 of the German Code provides for cram-down provisions pursuant to which entire classes of creditors and equity holders can be forced to accept a plan, similar to US Chapter 11 and in contrast to English procedures, which do not offer true cram-down. To protect against misuse, Section 245 requires that ‘absolute priority’ and ‘best interests’ tests be met. These goals must be achieved in order to prohibit payments to out-of-the-money juniors and to ensure the plan is better than liquidation, respectively. However the procedure has barely ever been battle-tested in court. Will the sort of valuation-driven ‘confirmation fights’ that bookend US Chapter 11 proceedings become more prominent in German proceedings as well? Can senior secured debt be reinstated or even ‘crammed up’?
In-court asset sales. The German Code, even before the statutory amendments, permitted going concern ‘363’ style sales. Will the Code develop to the extent that the debtor-in-possession can carry out the process itself, without the value-draining interference that comes with administrator involvement? Equally, will ‘credit bidding’, a process which sees a creditor using a secured claim on assets being sold as currency for those assets, develop?
Pension issues. Similar to US Chapter 11, pension liabilities assumed by the German Pension Benefits Guarantee Association (PSV) are asserted by the PSV as general unsecured claims in the debtor’s bankruptcy. In contrast to Chapter 11, however, to the extent that the reorganised debtor is ‘sustainably restructured’, these PSV claims, under certain circumstances, must be paid back partially or potentially completely in full. Will over-leveraged German debtors be able to meaningfully reduce pension liabilities in a confirmed plan of reorganisation, and will the PSV emerge, similar to the Chapter 11 cases of United Airlines and American Airlines, as a major unsecured creditor in German cases?
Multiple-debtor bankruptcies. Since an enterprise’s operating subsidiaries are generally separate from its financial subsidiaries, but the operating subsidiaries provide guarantees for the financial subsidiaries’ debts, a company potentially has an interest in obtaining a discharge of liabilities for multiple debtors. In IVG, the decision not to file subsidiary-guarantors required the debtor to offer creditors an added premium to release their guarantees and liens. There’s no statutory provision for joint administration of multiple debtors in Germany, but nevertheless it is possible with careful planning and coordination. It certainly would result in a more efficient allocation of value. Will it become the norm, as in the US, or will it remain untested?
The answers to all of these questions should be an emphatic ‘yes’. However, the implementation of the German Code’s operational toolbox will be a key issue. Therefore, a final concern is whether Germany’s judiciary is up to the task. Whether German bankruptcy judges, like their English counterparts, possess the commercial savvy to shepherd a multi-billion euro enterprise through bankruptcy remains to be seen. So far some courts have stood out – Bonn (IVG), Offenburg (Neumayer-Tekfor) and Düsseldorf (Pfleiderer) come to mind. And while frowned upon, forum shopping within Germany itself is possible, with careful planning, as Pfleiderer showed.
Even though it was shaped under the influence of Chapter 11, the German Code has only slowly discovered its potential to allow debtors a second chance on the market, efficiently compromising with its creditors. Three years after bankruptcy law reform, it is obvious that debtor-in-possession and insolvency plans are an integral part of German restructuring culture. What will it take for courts and practitioners to unleash the full potential of the law for financial and operational restructurings?
Carl Pickerill and Wolfram Prusko are restructuring associates at Kirkland & Ellis International LLP. Mr Pickerill can be contacted on +49 89 2030 6066 or by email email@example.com. Mr Prusko can be contacted on +49 89 2030 6064 or by email: firstname.lastname@example.org.
© Financier Worldwide
Carl Pickerill and Wolfram Prusko
Kirkland & Ellis International LLP