Restructuring in times of corona – legislator assists with suspending the obligation to file for insolvency

I. Legislative intervention: draft available

In our March 17, 2020 article (“Restructuring in times of corona – What companies need to know now” LINK), we reported about the COVID-19 pandemic frequently causing extreme financial difficulties for German companies. In cases of illiquity or over-indebtedness, these difficulties generally result in an obligation to file for insolvency, in particular as relates to limited liability companies (GmbH, GmbH & Co KG) and stock corporations (AG). Violations are a criminal offense. In addition, board members are subject to considerable liability risks if the obligation to file for insolvency or the ban on payments are breached after the company becomes insolvent. The legislator is now reacting to assist German businesses. A current draft law provides for mitigation of the consequences of the pandemic in civil, insolvency, and criminal procedure law. The obligation to file for insolvency is set to be suspended until September 30, 2020 initially. In addition, board members’ liability is to be limited, the granting of restructuring loans facilitated, and the risks of insolvency applications by creditors is also limited. It is expected that the relevant law will be enacted by the middle of next week with effect as of March 01, 2020.

II. Obligation to file for insolvency will be suspended until September 30, 2020

If the draft law is enacted, the obligation to file an insolvency petition pursuant to Section 15a Insolvency Code and Section 42(2) Civil Code will be suspended until September 30, 2020. This will not apply, however, in cases where the insolvency is not based on the consequences of the COVID-19 pandemic or if there are no prospects to overcome  an existing illiquidity. Unless debtors were illiquid prior to December 31, 2019, it is legally presumed that the insolvency is based on the consequences of the COVID-19 pandemic and that there are prospects of overcoming an existing illiquidity. Obviously, it will remain possible for debtors to file their own applications for the initiation of insolvency proceedings on a voluntary basis and for creditors to file third-party applications. In the event of third-party applications, however, the initiation of insolvency proceedings requires for the grounds for insolvency to already have existed prior to March 01, 2020. The suspension of the obligation to file for insolvency may be extended by decree until March 31, 2021 at the most.

Additionally, in cases covered by the extensive suspension of the obligation to file for insolvency, payments in the ordinary course of business will be deemed permissible. In particular, payments to maintain or resume business operations will not violate the prohibition of payments which would otherwise apply when there are mandatory grounds for insolvency and therefore will not lead to liability of the corporate bodies.

Correspondingly, payments to creditors during the suspended obligation to file for insolvency are to be largely excluded from insolvency challenges. In addition, credit institutions are supposed to be able to grant and collateralize restructuring loans without the risk of violating moral principles or of incurring insolvency challenges. The subordination for shareholder loans granted during the suspension period will be canceled in insolvency proceedings applied for by September 30, 2023. Their repayment until September 30, 2023 is not subject to insolvency challenges; only the collateral will remain subject to appeals.

An overview of the interaction of the new legal requirements is found below:

• Standard case: Obligation to file for insolvency is suspended until September 30, 2020
  • 1st exception: insolvency is not based on COVID-19 pandemic
  • 2nd exception: no prospect of eliminating an existing illiquidity
  • Presumption rule: Exceptions do not apply if there was solvency on December 31, 2019.
• Addition: In standard cases and where the obligation to apply is suspended, payments in the ordinary course of business do not violate the prohibition of payments after insolvency and the corporate bodies are not under threat of liability in this respect. Creditors will generally not have to anticipate later challenges of the payments received during said period. Lenders may grant new loans largely without the insolvency-specific risks otherwise existing.

III.    Consequences for practice – careful documentation recommended

The legislator is taking quick and appropriate steps to assist German businesses. Companies experiencing crisis conditions due to corona will not be forced into insolvency proceedings with the threat of consequences under penal law as a result of the pandemic. Although the legislator has failed to provide for a general temporary suspension of the obligation to file for insolvency at the height of the COVID-19 crisis, the differentiation problems relating to the issue of which companies are covered by the suspension provisions are limited. The suspension of the obligation to file for insolvency is the rule. Anyone wishing to file criminal charges or assert civil liability at a later date will have to prove the existence of the exceptions. The corporate bodies will benefit from the presumption rule if solvency was still given on December 31, 2019 or thereafter. The latter and the corona-related causes of the corporate crisis as well as prospects for rescuing the company based on discussions with financing institutions, e.g., for the purpose of obtaining KfW funds, should be carefully documented by those affected.

IV. Considerable challenges – caution with orders and cash pools, option of restructuring in insolvency and protective shielding proceedings 

The situation remains an extreme challenge for companies, general managers, management boards, and supervisory boards, not only in financial but also in legal terms. Temporary exemptions from the obligation to file for insolvency will not solve the problem of lost sales and lack of cash flows. In the event of insolvency, companies are collapsing immediately and the moratorium under civil law accompanying the suspended obligation to file for insolvency (cf. our Special Newsletter) will protect contractual relationships, but will be unable to prevent further liabilities that may accumulate to the point of unsustainability. In addition, the temporary suspension of the obligation to file for insolvency will not eliminate the general requirements under penal law. Ordering goods or services without the necessary means of payment may be considered fraud. Injecting funds into cash pools when companies are ready for insolvency is regularly considered to be embezzlement in accordance with Section 266 Penal Code. It is doubtful whether the legal classification of shareholder loans as non-discriminatory to creditors will solve this problem. For reasons of prudence alone, cash pools currently therefore need to be stopped in many groups of companies which are losing sales and cash flow due to corona and which are not receiving KfW funds due to the KfW principal bank rule and banks’ unwillingness to assume part of the risk (cf. our Special Newsletter). In many cases, despite the suspension of the obligation to file for insolvency, the step towards insolvency proceedings, possibly also by way of self-administration with plan restructuring and protective shield, will ultimately be unavoidable and sometimes even preferable. Since the 2012 Act to further facilitate the Restructuring of Companies, Germany has had a modern restructuring insolvency law. Where insolvency proceedings are used as a restructuring option, the Federal Employment Agency will grant insolvency money. These funds may be pre-financed and, according to current legislation, will relieve companies from expenses for wages and salaries for a maximum of three months. In our opinion, it would be worth considering that, in addition to suspending the obligation to file for insolvency, the legislator should also assist German businesses and employees by extending the receipt period for insolvency benefits to six months. Companies that become insolvent would then be able to virtually “survive” the crisis and reposition themselves in insolvency proceedings.

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