Chapter 11 Bankruptcy German Style
Historically, German insolvencies have been perceived as extremely unattractive, particularly because they were dominated by court-appointed bankruptcy administrators, with limited to no influence for creditors. This has, however, significantly changed over the last years. In that respect, it was the clearly expressed intention of the German legislature to make insolvencies more attractive for all parties involved. However, the available powerful features are often still unknown and hence not used, in particular by foreign investors. Outlined below are a few key features that may be utilized in German insolvencies.
Debtor-in-possession (DIP) proceedings: German insolvency law allows distressed companies to restructure themselves without losing control over their business and the restructuring process. It is no longer necessary that an insolvency administrator in the traditional German style takes over the operation of the business and exercises complete control at the expense of existing management and shareholders. Instead, the distressed company can remain in charge and operate its business, in almost all practical cases with the support of an insolvency professional as chief restructuring officer, who is trusted by the existing management. The court only appoints an insolvency professional to supervise the company (so-called Sachwalter, often translated as trustee). If planned in advance and well prepared, debtor-in-possession proceedings can allow for a complete restructuring process in less than eight months.
Insolvency plan: Another feature of German insolvency law is the so-called Insolvenzplan (often translated as insolvency plan). It is basically a proposal to the company’s creditors of how the restructured business should look and what actions need to be taken to implement the restructuring. Such proposal may even involve a total squeeze-out of existing shareholders. Only the company (or, seldomly, the trustee upon instruction of the creditors) can present such a plan. If the plan is approved by the creditors, the legal steps proposed therein take immediate effect without further documents or additional process. Creditors must approve in groups, which are set out in the plan presented by the company. There may be any number of groups, as long as creditors with a comparable economic interest are put in the same group and treated equally. The plan is approved if in each group the approving creditors have the majority in terms of headcount and volume of claims. The plan can be forced upon opposing groups, if a majority of the groups vote for the plan. The only test for a cram-down is that the opposing group must not be worse off with the plan than without, the latter normally being a liquidation scenario. A creditor cannot argue that it would be better off with a different plan.
Financing of restructuring measures: Unlike in Chapter 11 proceedings, German insolvencies do not use DIP financing because German financial institutions do not accept a reduction in the value of their collateral. Instead, German insolvencies take advantage of an element under the social security system by which employees are insured against the loss of their wages in an insolvency for up to three months. Under this concept, the payroll of the distressed company is paid for up to three months while operations continue and revenue is generated. The resulting claim of the social security agency is an unsecured claim in the insolvency, only receiving a dividend like any other unsecured creditor.
Reduction of headcount and other restructuring measures: In insolvency, labor law rules are considerably weakened making it easier for the distressed company to reduce its headcount. Long term contracts can be terminated and unprofitable leases can be returned, with any resulting claim for damages becoming an unsecured claim in the insolvency.
These instruments allow strategic investors to straighten out a venture that has proven to be more tricky than anticipated. They can be used by financial investors as an M&A tool for investments in companies that can be bought for a low price and then turned around. However, a key element for success is a coordinated and structured approach as early as possible in the process.