First Experiences with the revised German Insolvency Code (ESUG)
As of March 1, 2012, a revised German Insolvency Code – amended by the Act for the Further Facilitation of Restructuring of Companies (Gesetz zur weiteren Erleichterung der Sanierung von Unternehmen, the so called ESUG) – went into effect. The changes brought by the ESUG have received great attention not only in Germany, but also abroad. The general view among insolvency practitioners is positive. The reform of the Insolvency Code is mostly considered a success as it has noticeably improved the possibilities to restructure companies. Cases like the restructuring of the companies Pfleiderer, SolarWatt, Leiser or centrotherm photovoltaics demonstrate this. This article provides a short overview of the main new features of the ESUG and its application in practice.
1. The Revised Insolvency Code after the ESUG
The ESUG aims to increase the chances for a successful restructuring of distressed companies. To provide an incentive for early filings for insolvency, the requirements for the debtor’s self-administration, amongst others, have been eased.
In addition, the ESUG has strengthened the rights of creditors to be involved in the insolvency proceeding, and already at an early stage. By virtue of expanded information and participation rights – in particular with respect to the court ordered self-administration and the selection of the (preliminary) trustee (Sachwalter) or the administrator – creditors now have efficient tools to influence the proceedings in their interest. The predominance of the insolvency court and the administrator over the proceedings, in particular in its early stages, is a thing of the past.
Furthermore, also from a shareholders‘ perspective the legal framework has improved since the chances for a successful restructuring (and thereby their participation in the enterprise) increase where the new creditor protection proceeding (Schutzschirm) can be used (in combination with an insolvency plan and self-administration). Because under the revised statute the insolvency plan can provide for any measure that is possible and allowed under corporate law, a great amount of restructuring options now exist.
2. First Practical Experiences and Open Questions
Under the old statute, self-administration by the debtor was actually only possible after the insolvency proceeding was formally opened. For the time period prior to such formal opening, the so called opening proceedings (i.e. the time period between the filing of the petition for the opening of insolvency proceedings and the actual opening by order of the insolvency court) only preliminary administrations were ordered, while self-administrations were the rare exception. The main argument for this practice was that it would be unjustified to let those who could not rescue the company administer their own insolvency. The preliminary administrators in the past, thus, typically recommended against ordering self-administration.
This practice has changed under the ESUG. Today, the insolvency court allows self-administration under the supervision of a trustee (Sachwalter) upon the debtor’s request. Such request can only be denied if there is a known negative impact for the creditors. As mentioned, the self-administration can already be allowed in the opening proceedings as preliminary self-administration if the petition for self-administration is not obviously without merits. If the petition for preliminary self-administration is supported by a unanimous vote of the preliminary creditors’ committee (see below under b.), the insolvency court generally must grant the petition.
Because of the chance to continue the operations of the company in self-administration (even with the involvement of the trustee), an early filing has become more attractive for the management and the shareholders. Another advantage of the self-administration is that its costs are significantly lower than in an ordinary insolvency in most cases. It is not specifically known how many preliminary self-administrations have been filed for since the ESUG has come into effect, yet we see a significant increase compared to the past.
Typically, the preliminary self-administration is an important phase, and the possibility to obtain a so called insolvency estate loan (Massekredit) is often crucial for the success of a reorganization. An insolvency estate loan is an obligation that the creditor can fully enforce against the insolvency estate after the opening of the insolvency proceeding.
In a recent decision of the German Federal Court of Justice (BGH) (Decree dated February 7, 2013 – IX ZB 43/12) the issue was whether there exists a right to appeal against a decision of the insolvency court that rejects a debtor’s motion to approve its entering into an estate loan. According to the Federal Court of Justice no such right to appeal exists because of the absence of a specific statutory provision to that effect. This decision has raised the question whether the Court has thereby indirectly expressed that the insolvency court could never approve such insolvency estate loan in a preliminary self-administration. If that were the case, no bank would provide such loans to debtors in preliminary self-administration. There have been calls for an amendment of the Insolvency Code to clarify this matter.
b) Creditor Protection Proceeding
If the company is overindebted or there exists a threatening illiquidity, the company may, upon filing for insolvency, in addition to the motion for self-administration also request that the court orders a “protective shield” for up to three months during which an insolvency plan is prepared and during which creditors cannot enforce their claims.
EThe insolvency court grants such motion, unless the restructuring is evidently hopeless. This provides the debtor with time to prepare the restructuring and submission of an insolvency plan. Under the ESUG, this new creditor protection proceeding is not an out-of-court restructuring, but a special form of the opening proceedings.
A widely watched example for the successful application of this new ESUG feature was the case of centrotherm photovoltaics AG where the insolvency court allowed the creditor protection proceeding and self-administration. The insolvency plan, which was approved by a large majority of the creditors and shareholders, provided that the unsecured creditors defer 30 % of their claims without interest and assign 70 % of their claims to an independent trustee. The trustee then contributed these claims into the company in connection with a combined capital decrease and capital increase of the company. As a result, the old shareholders reduced their share in the company to 20 %, while the trustee now holds 80 % of the shares for the benefit of the creditors. By virtue of the contribution of the creditors’ claims, these claims were extinguished and the company eliminated its debt. The trustee has the mandate to sell the new shares he received by the end of 2015 in the market and distribute the proceeds to the creditors. The creditors have, thus, the chance to receive even more than 100 % of the face value of their former claims.
c) Preliminary Creditors Committee
In order to strengthen the creditors‘ rights in the insolvency proceeding, the ESUG introduced the mandatory implementation of a preliminary creditors committee if certain criteria are met. Specifically, if two of the following three criteria are met (with respect to the previous business year), the insolvency court must set up such a committee: (i) at least EUR 4,840,000 balance sheet total (Bilanzsumme), (ii) at least EUR 9,680,000 euros revenues and (iii) on average at least 50 employees. Through the preliminary creditors committee the creditors can influence the proceeding at an early stage, in particular the selection of the (preliminary) administrator.
The insolvency court may refuse the appointment of the proposed preliminary administrator if the resulting delay has an adverse impact on the assets of the debtor.
In this context the issue arose whether creditors have a right to appeal the insolvency court’s decision not to implement a preliminary creditors committee. Several first decisions of lower courts held that such appeal right does not apply because such appeal is not one of the enumerated appeal rights in the Insolvency Code. If this will be upheld, creditors would have no action against such decisions, which means that in practice it will become crucial to discuss this matter with the insolvency court beforehand.
Another big step towards better restructuring options is the new provision introduced by the ESUG allowing altering the shareholders’ rights in an insolvency plan (Insolvenzplan) even if they do not approve. The so called constructive part (gestaltender Teil) of the insolvency plan may also provide that creditors’ claims are converted into shares in the debtor (debt-equity-swap).
Everything that is allowed under corporate law can be provided for in the insolvency plan. The Insolvency Code specifically mentions a capital decrease, capital increase, contributions in kind, exclusion of subscription rights and the payment of severance payments for shareholders. In the insolvency proceeding of Pfleiderer AG, this resulted in a combined capital decrease down to zero and subsequent capital increase under exclusion of subscription rights for the shareholders, who were, thereby, all excluded as shareholders.
The rights of shareholders to challenge a court approved insolvency plan are very limited. They can only appeal if they can show that they are significantly worse off under the plan than they were without the plan.
The ESUG Reform Act has significantly improved the predictability of German insolvency proceedings. There have been single reports that insolvency courts have not fully acknowledged the new creditors’ rights with respect to, for instance, the appointment of the insolvency administrator. Yet this seems to be a temporary problem stemming from the former legal regime that has been replaced by a restructuring friendly set of rules. What appears particularly promising is the flexibility that the insolvency plan can provide for any measure that is possible under German corporate law, and this freedom is increasingly been used in practice.