18 Aug 2014 05:04pm

German insolvency reforms - two years on

In 2012, after years of discussion, Germany introduced new insolvency reforms. Bringing in more control for both debtors and creditors during insolvency proceedings, the reforms helped to improve the legal framework of corporate restructuring in Germany

Two years on, the dust has settled and there are two crucial areas where the benefits have become obvious:

• Creditors now have the ability to be heard by the courts and can even nominate the insolvency administrator

• Debtors are also seeking help more quickly, before serious financial problems arise

1) Selecting an insolvency administrator

Before  the reforms it was the sole responsibility of the courts to select and appoint the insolvency administrator. The courts favoured a purely independent system, and would almost automatically reject an insolvency practitioner that had been recommended by the stakeholder.

This is because, in the court’s eyes, a recommendation would contravene the definition of being truly independent but following the reforms Germany now has greater flexibility in this area, alongside higher levels of predictability and transparency.

The purpose of this change is to increase the predictability and transparency of the proceedings, in order to facilitate the restructuring of companies and rescue of businesses.

Creditors are now able to be involved in choosing and recommending an administrator for insolvency proceedings by serving as member of a preliminary creditors committee. Once accepted, the creditors at the preliminary committee are able to put forward a practitioner whose expertise can be beneficial for insolvency proceedings, and the courts must listen to these recommendations.

Banks, normally the largest creditors and typically asked to sit on the creditors' committee, reacted slowly to the changes to start with, but have since worked to adapt to the new mechanism that allows the nomination of an insolvency administrator.

Courts can only reject recommended insolvency practitioners if they can justify that the administrator is, in their view, not suitable. Many courts have embraced this change of the law and are increasingly open to suggestion when making the decision as to which practitioner should be used. However, there do remain judges who are reluctant about embracing this change.

However, as under the old system, creditors have found ways to avoid judges who are reactionary. One such way is changing the name of the company, or moving to another area in Germany.

Businesses cannot sit on their laurels and wait out financial problems

2) Seeking financial advice earlier

There is one key aspect to Germany concerning companies operating in the zone of insolvency; businesses cannot sit on their laurels and wait out financial problems. In the UK, companies who trade but do not pay off their debt – so called zombie companies – are not encouraged to seek help early enough to prevent long-term problems. This is not the case in Germany.  

In addition to the well-established obligation of company management to file an insolvency application upon occurrence of illiquidity or over indebtedness, the reforms have made it easier for businesses to come forward. The creation of protective shield procedures, a tool that has similar characteristics to the UK’s pre-packs, allows businesses on the brink of illiquidity to apply for a three-month grace period to create a recovery plan.

Once the reforms came into effect, courts were overrun with applications from managers keen to apply this procedure to their business. It became a popular approach for debtors because the courts would no longer appoint a preliminary insolvency administrator, but rather keep the management in place under supervision from a court appointed officer if the request for the protective shield is granted.

This does however mean that the court can order any foreclosure actions to be stopped and can prevent the removal of assets that are not subjective to third party security interests.

It has taken the courts time to sift through the applications, but it has become clear that this procedure is not suitable for every business. Due to the nature of the protective shield it is an intense process that firstly requires a certified auditor to declare that the business is worth saving by providing a certificate. This process requires money and time to prepare the application, making it hard for smaller businesses to meet the requirements.

While it turns out that the protective shield procedure is not suitable for all situations, the reforms have enhanced the reputation of the insolvency laws and has resulted in businesses seeking advice faster when financial problems may arise.

German culture has also become more flexible, making it easier to embrace the need to seek professional insolvency help. Advisors are approached by companies with the idea of help via a protective shield procedure and now have the time to explain the whole palette of insolvency law based tools, recommending the right solution that might look pretty different from the first discussion.

What is important in all cases is that management – together with a business or strategy consultant – has developed a comprehensive business plan for what shall be achieved and how the business should look after insolvency. The insolvency law based tools are technical instruments, but it is important for advisers to know what direction the business will want to move in, compared to what it actually can take. Once this is clear, the insolvency practitioner can use the right tools to accomplish the new sustainable business concept.

The greater acceptance of the insolvency law instruments within Germany following the reforms is clear, benefiting both the creditors and debtors. Even though the adoption of the reforms has been occasionally rocky, they have certainly moved Germany in the right direction towards a comprehensive insolvency system.

Annerose Tashiro, partner and head of the cross border-restructuring department at leading German restructuring law firm Schultze & Braun


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