Sacha Lürken discusses new laws that could make Germany an attractive restructuring destination for troubled companies.
It is rare that lawyers and advisors in Germany so unequivocally praise new bankruptcy legislation as they have with a new draft bill published by the German Federal Ministry of Justice on September 18, 2020.
As the first real overhaul of the German restructuring framework since the restructuring laws were introduced, creating a potential template for other European jurisdictions to follow, there has rightly been much focus on this development and what it could mean for the future of distressed companies in Germany and across Europe.
Germany’s bankruptcy law, the Insolvenzordnung, of 1994, stems back to the 19th century, when a uniform civil law legislation package was passed for the newly formed German empire. It was designed as a court procedure for a liquidation of a bankrupt debtor’s assets by a court-appointed insolvency practitioner, with the proceeds going towards paying secured creditors, fees and, if anything was left, unsecured creditors.
Though reforms introduced in 1994 and expanded in 2012 made a Chapter 11-type debtor-in-possession reorganization procedure available, it was used only in very few cases – around 1% of business filings. This was mainly due to the complexity of the procedure, but also because it is a bankruptcy process that requires the inclusion of all creditors of the company, even if the company could be restructured with a rescheduling of only specified financial or similarly onerous liabilities.
Initiatives to introduce processes like the scheme of arrangement, an English procedure that was also commonly used to restructure non-English companies and is capable of Chapter 15 recognition in the U.S., were not successful, even though recoveries for unsecured creditors in Germany are remarkably low compared to other jurisdictions.
A paradigm shift occurred when the EU in June 2019 passed its directive 2019/1023 on preventive restructuring frameworks, which forces all EU member states to introduce a restructuring process for companies in financial difficulties, but before an actual insolvency, by July 2021 at the latest.
Originally aimed at facilitating a restructuring of Southern and Eastern European businesses burdened with bank debt that they would not be able to repay, this procedure will also be helpful to businesses hit by the COVID-19 pandemic as they can more effectively adapt their balance sheets.
This is potentially why Germany is now pushing to have a procedure available by Jan 1, 2021, when several of the COVID-19 related reliefs from its notoriously strict filing duties will expire.
So what are the key features of the proposed new law, with the typically long-winded name ‘Unternehmensrestrukturierungs- und -stabilisierungsgesetz?’
The draft bill proposes a shift of the fiduciary duties owed by directors from the company and its shareholders to its creditors once the company is “imminently insolvent”, which means that it is unlikely to be able to pay its liabilities due within the next 24 months.
It also proposes that a restructuring plan under which all or selected liabilities (except for employee-related liabilities) can be restructured through voting in classes with a 75% majority, taking effect with or without court confirmation.
There is also a moratorium on the enforcement of all or selected liabilities, including secured debt, for up to three months, which can be extended to up to eight months during a pending court process.
There is a proposed option to request that the court rejects onerous executory contracts, such as long-term leases. A rejection will have the effect of a termination with a three months’ notice period, notwithstanding any longer notice periods in the terms of the contract.
The bill also proposed protections for directors making payments that are beneficial to the restructuring procedure, as well as protections for creditors providing new money from an avoidance of collateral in a bankruptcy should the restructuring fail.
Perhaps most notably, the restructuring plan can be “crammed” upon non-consenting classes under tests similar to those applicable in Chapter 11. These tests include a “best interests” test, meaning that the non-consenting creditors must not be worse off than in a “relevant alternative” (which in most cases will be a bankruptcy process).
It also includes an absolute priority test, meaning junior ranking creditors or shareholders must not receive any benefit unless the senior ranking creditors are fully paid or they provide additional value), and lastly, no ‘pari passu’ creditor receiving more value under the plan than the non-consenting class.
The draft bill is open for comments from restructuring practitioners until October 2, 2020, before it will be presented to the German parliament. We expect only a few amendments to be put forward, for example to the new money protections, but that has already faced opposition from the lobby of bankruptcy practitioners in Germany, and it also remains to be seen how courts will apply the law in practice.
The new law would make Germany an attractive restructuring destination for troubled companies and could significantly stimulate the wider restructuring market. It would also pave the way for handling ‘zombie companies,’ as valuable companies can be financially restructured without the inefficiencies of insolvency proceedings.
As companies in Germany and across Europe continue to face headwinds from the COVID-19 pandemic, our hope is that the process to implement the proposed legislation will be as smooth as possible.