(TMA International Headquarters)
In Germany a new insolvency law, the Insolvency Code, became effective on
January 1, 1999, culminating a legislative process that began in 1978. The most
significant changes brought about by the new law are provisions regarding the
insolvency plan and the possibility of self-administration, which adopt legal
principles from Chapter 11 of the U.S. Bankruptcy Code.
The Insolvency Code does not change the conditions for the commencement of
insolvency proceedings, the first of which is filing a petition. If a debtor is
a legal entity, the petition may be filed by a creditor or the debtor for
reasons of illiquidity or overindebtedness. Illiquidity means that the debtor is
no longer able to pay its debts as they become due, which is presumed when the
debtor ceases to make payments. Overindebtedness means that a debtor’s
liabilities exceed the value of its property.
The Insolvency Code introduces the concept of “imminent illiquidity” as a new
cause for opening insolvency proceedings. It applies to a debtor who is unlikely
to be able to pay existing debts as they come due, and only the debtor may file
a petition for this reason. The measure was introduced to enable a debtor to
begin insolvency proceedings early enough to allow for reorganization.
When insolvency proceedings are opened, the insolvency court appoints an
insolvency administrator. In exceptional cases, the court may order
self-management by the debtor, under which a debtor retains its rights of
administration and disposition, subject to supervision by a creditors’ trustee.
The administrator must be a natural person who is experienced in business and
is independent of the debtor and its creditors. German insolvency courts usually
appoint lawyers to serve as insolvency administrators.
An administrator may freely manage and dispose of the insolvency estate. He
must prepare an insolvency plan if necessary and carry out a reorganization of
the debtor’s business if possible. If reorganization is not possible, the
administrator must liquidate the debtor’s business and distribute the insolvency
estate.
All of a debtor’s creditors are entitled to take part in the creditors’
meeting, at which they decide whether to shut down or continue the debtor’s
business. In addition, they can ask the insolvency administrator to draw up an
insolvency plan and can replace the administrator.
Creditors can also establish a creditors’ committee and choose its members.
Under the Insolvency Code, the committee supports and supervises the insolvency
administrator. In addition, important transactions proposed by the insolvency
administrator, such as a disposal of part or all of the debtor’s business,
require the consent of the creditors’ committee if one has been established.
The Insolvency Plan
German law provides for only one type of rescue plan—the
insolvenzplan. Under the Insolvency Code, creditors may decide to
reorganize a debtor’s enterprise based on an insolvency plan. Alternatively, the
plan may provide that an enterprise be liquidated and its assets distributed or
that the business be sold. In most cases, it makes sense to draw up an
insolvency plan only if a debtor’s enterprise will be restructured and parts of
the business sold to obtain fresh money to finance the restructuring. If the
insolvent company or the business as a whole is to be sold, an insolvency plan
is not likely to be adopted.
Only the insolvency administrator or the debtor may submit an insolvency
plan, although an insolvency administrator may do so only if the creditors’
meeting results in such a request. The Insolvency Code does not allow creditors
to draw up a plan.
The insolvency plan is divided into two parts and may have several annexes.
The first part is descriptive and is intended to provide creditors with
information about the debtor’s enterprise that will allow them to decide whether
a proposed insolvency plan is acceptable. It also includes an outline of the
current financial situation of the business and an analysis of the causes of
insolvency. It should address the conditions of the market in which the
enterprise is active.
The conclusion in the descriptive part should contain a general description
of the changes necessary to turn around the company. This can include a
recommendation to sell subsidiaries or branches of the insolvent company if
their business is no longer compatible with the principal business of the debtor
and if only a concentration on that principal business is likely to ensure a
turnaround.
The second part of the plan, the so-called constructive part, provides for
the implementation of the concept described in the first part of the proposal.
Most importantly, the plan standardizes the changes in the legal positions of
parties involved, such as secured and unsecured creditors and employees. For
example, the plan may provide for the waiver of claims or collaterals.
If the plan proposes that a debtor’s enterprise continue and that creditors
be satisfied from the revenues of the business, a balance sheet showing assets
and liabilities as of the date on which the plan will enter into force must be
attached. In addition, projected profit-and-loss statements and financial plans
must be drawn up for the period over which the creditors will be satisfied in
accordance with the plan.
Purchase Considerations
Instead of adopting an insolvency plan, the administrator, debtor, and
creditors in many cases establish a special legal entity and transfer the assets
and the operating business to it. Upon approval of the creditors’ meeting or the
creditors’ committee, the administrator sells the entity and distributes the
proceeds among the creditors. If an insolvent parent company has one or more
subsidiaries that are solvent, a special legal entity is unnecessary. The
administrator sells the subsidiary after receiving approval from the creditors’
meeting or the creditors’ committee.
An insolvency plan that provides for the sale of assets or a subsidiary
normally does not provide details of the transaction but instead fixes a minimum
purchase price.
The issues relevant to the acquisition of the business of a debtor enterprise
are generally the same, regardless of whether the sale is made in accordance
with an insolvency plan.
Employees. Because German labor law is extremely strict, it
is very difficult to dismiss employees. In general, the purchaser of an
enterprise must assume all existing employment contracts. Section 613a of the
German Civil Code prohibits a reduction in staff if a company’s assets or
business are sold and applies to both insolvent and solvent companies. The
regulation can present a major problem in the reorganization of companies.
However, certain rules applicable to insolvency proceedings permit the
dismissal of employees. The insolvency administrator may terminate employment
contracts with a notice period of three months. Under Section 113 of the
Insolvency Code, the administrator is not required to provide greater notice,
even if longer notice provisions are set out in an employment contract. Sections
125 to 128 of the code also provide for mass dismissals under specific
circumstances.
During the insolvency proceedings, a determination must be made as to how
many employees the purchaser will be required to retain and the number who will
be subject to termination or to a mass dismissal by the insolvency
administrator. Once the transaction agreement takes effect, no additional
employees may be dismissed.
Preferential Satisfaction. Creditors to whom a debtor has
transferred a chattel or a legal interest for security purposes are entitled to
separate satisfaction from the item serving as security. Creditors protected by
security interests in real property, such as mortgages, also have a right to
separate satisfaction.
In many cases, the assets or rights that are subject to separate satisfaction
are necessary for the operation of the business that a potential buyer wants to
purchase. In general, an insolvency plan may not undermine creditors’ rights to
preferential satisfaction.
An insolvency plan can provide for a waiver of such rights, however. A
potential buyer should determine whether assets subject to preferential
satisfaction are needed to operate the business and whether the insolvency plan
(if any) calls for a waiver of those rights. If not, the insolvency
administrator, the debtor (in case of self-administration), or the buyer must
attempt to negotiate a waiver with the secured creditor.
Unperformed Contracts. An insolvency administrator may
decide whether agreements entered into before insolvency proceedings were
initiated — but not performed by either party at the time of initiation —should
be completely performed. In most cases, these agreements, such as supply
contracts, are important for the uninterrupted operation of a business.
A potential purchaser of an insolvent company should determine whether
essential unperformed contracts exist and whether the administrator has decided
to continue them. The potential purchaser is not likely to find that information
in an insolvency plan. Consequently, that should be determined during special
due diligence that is usually performed regarding the debtor company.
Leases. In general, a debtor’s lease agreements on real
property remain effective, regardless of the institution of insolvency
proceedings. For property leased by a debtor, an insolvency administrator has an
extraordinary right of termination, while a lessor’s contractual rights of
termination are subject to the usual statutory restrictions, such as the right
to terminate if monthly rent is not paid in a timely manner.
An insolvency plan may provide measures for continuing leases. A potential
buyer should examine these measures carefully because the continuation of leases
may be essential for the operation of the business. For example, a hospital may
only be operated in buildings having the necessary equipment. In such cases,
termination of the lease means the business can no longer operate.
Plan Review, Approval
Approval of an insolvency plan, including the sale of assets or a subsidiary,
is subject to complex rules. After a court examination and a vote by creditors
on the plan, the insolvency court must approve the plan.
The insolvency court is required to review the lawfulness of the plan, but
not its financial or economic elements. The court will reject a plan that fails
to comply with rules regarding its submission or contents, if its defects are
incurable. For a plan submitted by a debtor, the court also determines whether
creditors will accept the plan and whether the plan is feasible. Should the
court determine that these requirements are clearly not met, it will reject the
plan to avoid delaying insolvency proceedings over a clearly inadequate plan.
If the insolvency court does not reject the plan, it is forwarded to the
creditors’ committee (if one has been appointed), the works council, and the
committee of spokespersons for officers. Under Section 232 of the Insolvency
Code, a plan submitted by the administrator is forwarded to the debtor;
conversely, a plan submitted by the debtor is forwarded to the administrator.
The insolvency plan, with its attachments and any comments, is made available to
the parties for inspection in the court’s registry, and all of these parties may
comment on the plan.
In the next phase of the process, the court schedules a creditors’ meeting at
which, in most cases, the debtor or administrator who drafted the plan gives a
short introduction regarding the plan’s purpose and contents. The creditors then
discuss the plan and vote on it. If creditor groups representing employees,
secured creditors, unsecured creditors, credit institutions, or suppliers have
been formed, each group votes separately. Approval requires a majority of
creditors representing more than half of the total monetary amount of claims for
each group.
A voting group may be deemed to have approved a plan even if a majority has
not been obtained. In particular, this measure applies if the insolvency plan
will not place the creditors of a dissenting group in a less favorable position
than they would be in without the plan and if they will participate to a
reasonable extent in the distribution of assets under the plan.
The insolvency plan is deemed approved if a majority of the groups support
it.
Under Section 248 of the Insolvency Law, any insolvency plan accepted by the
creditors requires confirmation by the insolvency court. The court must refuse
confirmation if any of the provisions of the Insolvency Code relating to the
plan were violated in either form or content, if such defect cannot be cured.
The court may also reject the insolvency plan whose acceptance was improperly
obtained, such as by favoring a particular creditor.
Court confirmation gives legal force to the modification of legal rights as
set out in the plan. Once the order confirming the plan becomes final, the plan
can create, alter, transfer, or extinguish rights and property. The confirmed
insolvency plan can be used to levy execution. Under Section 257 of the
Insolvency Act, the confirmed plan is executory to the same extent as an
enforceable judgment.