Germany is close to making a huge step towards international best practice for restructuring. On 19 September 2020, the German Ministry of Justice published a draft bill introducing a new stand-alone preventive restructuring process, accompanied by targeted amendments to insolvency law and related areas. The bill is currently available in draft form only, expected to be debated in and passed by Parliament and relevant committees in 2020, and — hopefully without significant changes — to enter into force on 1 January 2021. Timing is of the essence as COVID-related relief of insolvency filing duties, although very recently extended until year end with regard to balance-sheet insolvency, will end on 31 December 2020.
Preventive Restructuring Process
The preventive restructuring process combines features of well-tested restructuring proceedings, such as English schemes of arrangement and U.S. chapter 11 proceedings. Upon the occurrence of imminent cash-flow insolvency, the debtor-led process allows the implementation of tailor-made restructuring plans by majority decision and provides for an effective mechanism to bind dissenting creditors while protecting minority rights. The debtor can restructure its financial liabilities in an efficient and quick process while its business continues to operate. Court involvement is mostly optional, as is supervision by a restructuring practitioner. It remains to be seen whether the new restructuring process will be capable of restructuring leases and other non-financial liabilities. Claims of employees cannot be compromised in the restructuring process. In addition to introducing a new restructuring process, the draft bill provides for key changes to the German Insolvency Code – including provision for the release of upstream collateral and guarantees provided by the debtor’s subsidiaries; this marks a first in German restructuring and insolvency law and reduces the need for multiple proceedings.
Key elements of the restructuring process
- Court involvement is largely optional, though mandatory in the case of a moratorium or termination of executory contracts.
- Debtors are able to propose a restructuring plan. Pre-negotiated plans are possible.
- The plan is accepted with 75% majority (by value, of those voting) in each class, subject to a cross-class cram-down mechanism.
- Selective restructuring process — may, for example, involve only financial creditors.
- Plan can restructure guarantees of other group entities.
- Debtors remain in possession of their assets and day-to-day operation of their business.
- Debtors have access to the restructuring process in case of imminent cash-flow insolvency (drohende Zahlungsunfähigkeit).
- Key aspects of the procedure may be monitored by an independent restructuring officer.
Key aspects in detail
The Preventive Restructuring Process is available to all debtors (with the exception of financial institutions) with their COMI in Germany that are not yet insolvent but will more likely than not become cash-flow insolvent within the next 24 months (impending illiquidity).
The debtor can request a (general, partial or individual) moratorium for up to three months.
The moratorium can be extended to a maximum of eight months if and to the extent necessary to safeguard a restructuring plan procedure once plan confirmation by the court has been requested by the debtor. During the moratorium, the obligation to file for insolvency is suspended.
(Only) the debtor can prepare a restructuring plan. Such plan can bind the debtor's shareholders as well as secured and unsecured, financial and non-financial creditors (with the exception of employees).
Claims against, and security provided by, debtor subsidiaries can be compromised in return for adequate compensation.
Plan Acceptance and Sanction
Plan acceptance requires a 75% majority (by value, of those voting) in each class. As a minimum, secured creditors, unsecured creditors, subordinated creditors, creditors with claims against or benefitting from security provided by subsidiaries, and shareholders each need to vote in separate classes.
The plan does not need court approval but the debtor has the option to apply for court approval of the plan.
Dissenting classes can be “crammed down” if (i) a majority of classes has accepted the plan, (ii) the class members can be expected to be no worse off with the plan than without the plan, and (iii) the class members receive an adequate share in the value created by the plan.
Adequate value means (a) no other creditor receives more than par value, (b) no junior or pari passu creditor receives more value than the members of the dissenting group, and (c) neither a subordinated creditor, nor the debtor, nor a shareholder receives any additional value (subject to limited exceptions).
This also allows for senior classes to be out-voted by junior classes ("cram-up").
Discharge of Contracts
The debtor can request the court to terminate executory contracts, e.g. lease agreements, if such request is accompanied by a restructuring plan.
Debt for Equity Swap
The plan can compromise shareholders’ rights.
The court will appoint a restructuring officer if the plan is to compromise SME or micro creditors, is accompanied by a moratorium or discharge of contracts, or is expected to require a cram down of dissenting classes (unless only claims originated by financial institutions are to be compromised).
For purely financial restructurings without the above-mentioned features, the restructuring plan procedure does not require the appointment of a restructuring officer.
The role of the restructuring officer is to monitor certain ongoing eligibility requirements relating to the plan procedure and a moratorium, and to comment on the restructuring plan and on requests for a discharge.
The debtor, or a quorum of 25% of creditors of a voting class, can further request the appointment of a restructuring officer to facilitate the development and negotiation of a restructuring plan. The restructuring officer has no mandate to assert liability claims or avoidance actions.
The debtor can optionally petition the court to lead the voting on the plan or to sanction the plan. The debtor can also petition the court to opine on certain advance questions.
Court involvement is mandatory in case of a moratorium or if executory contracts are to be terminated.
Amendments to the German Insolvency Code & Related Measures
The new law provides for a shift of fiduciary duties of directors. Upon the occurrence of imminent cash-flow insolvency, directors must act in the best interests of creditors.
Directors also are now explicitly under a continuous obligation to monitor developments that could threaten the company’s going concern and to take appropriate actions if necessary.
Provided that the debtor: (i) was not cash flow insolvent on 31 December 2019; (ii) achieved positive profit from ordinary business operations in FY19; and (iii) revenue declined by more than 40% in 2020 (year-on-year), the following changes apply:
- in order to pass the going concern test and not have to file for insolvency due to balance sheet insolvency, debtors need only to demonstrate a “predominant likelihood” of subsisting as a going concern for the following four months (instead of 12 months, as per the intended change to the German Insolvency Code); and
- debtors have access to debtor-in-possession proceedings and the Preventive Restructuring Process, notwithstanding cash flow insolvency.
Release of Third Party Security
To facilitate the restructuring of groups of companies, upstream security and upstream guarantee claims against subsidiary obligors can be included in the debtor’s insolvency plan (as well as in the restructuring plan).
Voting rights will be limited to the probable recovery amount attainable from the relevant credit support and the relevant creditor is entitled to receive adequate compensation for any compromise.
Debtor in Possession in Insolvency
The draft bill provides for changes to DIP ("self-administration") insolvency proceedings.
Going forward, debtors will need to provide a self-administration plan that includes, in particular, a broad concept of how the debtor intends to overcome the difficulties leading to its insolvency and a financial plan which demonstrates going concern status for the next six months.