03-17-2020ArticleCorona

Special newsletter coronavirus

Restructuring in times of corona – What companies need to know now

I. Risk to companies from the impacts of the corona pandemic

The corona pandemic leads to a decline in sales revenues worldwide. Demand is plummeting. At the same time, supply chains in the globally networked economy are no longer reliable. Obligations to pay compensation for the inability to supply are impending, particularly in cases of no-fault supply guarantees. The liquidity and therefore the continued existence of many companies are at risk. Management and supervisory bodies must react to this crisis.

II. Duties of the management and supervisory bodies in times of crisis

Special duties exist for management bodies, in particular for general managers and management board members, in times of crisis. Monitoring duties of supervisory bodies are becoming more intensive. The duty to ensure the company’s continued existence is of utmost importance while at the same time the unlawful delaying of a filing for insolvency needs to be avoided. This requires avoidance of the occurrence of mandatory grounds for insolvency and, where this is not possible, the timely filing of an application to initiate insolvency proceedings (insolvency application).

Below are the most important legal requirements in times of crisis:

AG, GmbH and other legal forms with limited liability are obligated, if there are mandatory grounds for insolvency, to file an application to initiate insolvency proceedings with the insolvency court without delay, within three weeks at the latest. If the application is filed late, the corporate bodies are subject to criminal liability (Section 15a German Insolvency Code).
Mandatory grounds for insolvency are inability to pay (Section 17 Insolvency Code) and overindebtedness (Section 19 Insolvency Code).
Insolvency is generally given if 10 percent or more of the liabilities due cannot be settled with liquid funds (otherwise there is usually only a minor liquidity gap) and this situation persists for more than three weeks (otherwise there is only an irrelevant payment delay).
Overindebtedness is given if assets are no longer covering debts and there is no positive forecast (predominant probability) regarding the continuation of the company outside of insolvency.
If there are mandatory grounds for insolvency, there is a fundamental prohibition of making payments, the violation of which leads to liability of the members of the corporate bodies (see e.g., Section 64 German Act on Limited Liability Companies, Section 92 German Stock Corporation Act). Special rules apply, however, to employee’s contributions to social security and certain tax types.

III. Seeking advice, taking action

In view of the legal requirements that are briefly outlined above and numerous other obligations and liability risks in times of crisis, the management of companies threatened by the effects of the corona pandemic should seek independent advice from professionally qualified restructuring experts without delay and provide a comprehensive account of the situation.

Below are the main steps to respond to the crisis:

Support of liquidity through deferral agreements and working capital management (inventory reduction, factoring)
Sale of unnecessary business assets. Business assets that are material for operations may also be sold where necessary (for example, in sale-and-lease-back transactions) to gain liquidity.
Short-time work allowance: In the event of a significant loss of work, working hours and pay will be temporarily reduced. Any savings in personnel costs will reinforce liquidity. The Federal Employment Agency compensates part of the loss of remuneration for employees by paying cyclical short-time work allowance. The allowance is granted for a maximum period of 12 months. To receive the allowance, it is necessary to have a legal basis for short-time work, which may arise from collective bargaining agreements, company agreements, or employment contracts. Supply bottlenecks, in connection with the corona pandemic or officially ordered company shutdowns by the authorities generally constitute such a loss of work.

IV. Assistance from government and the legislator

The government and parliament are intervening in times of crisis for the benefit of the German economy, providing immediate assistance for threatened companies by facilitating and extending short-time work allowance, the granting of loans by KfW, and the relaxation of mandatory grounds for insolvency:

Assistance with short-time work allowance: According to the current legal situation, the loss of work is only deemed significant if at least one third of the employees are affected by a loss in gross pay in excess of 10 percent. On March 13, 2020, the legislator authorized the German government to facilitate access to short-time work allowance by means of an Ordinance. The legislator intends to lower the access threshold – it will then be sufficient if at least 10 percent of the employees are affected by a loss in gross pay in excess of 10 percent in the respective calendar month. In addition, the Federal Employment Agency is supposed to be entitled to refund some or all of the social insurance contributions that are borne solely by the employer. It is also supposed to be possible to grant short-time work allowance to temporary employees. See our FAQ Employment Law.
Assistance through emergency loans from KfW: The federal government has presented a three-stage plan. The first stage is to assist companies with unlimited loan programs and guarantees. Half a billion euros may be made available through a drastically increased guarantee framework with State-owned bank KfW. Should the financial consequences of the pandemic worsen, stage two would take effect: loans could then be made more flexible and amounts increased. The federal government could then contribute another billion euros to existing programs. Stage three provides for large-scale economic stimulus packages – in the event that companies have to cease large-scale production and are threatened with plant shutdowns. Tax deferrals are also conceivable.
Assistance through partial suspension of the obligation to file for insolvency: On March 16, 2020, the Federal Ministry of Justice and Consumer Protection announced that it was drafting statutory provisions to suspend the obligation to file for insolvency to protect companies in financial difficulties as a result of the corona pandemic. This is modeled after regulations passed on the occasion of the 2002, 2013, and 2016 floods. The obligation to file for insolvency is to be suspended until September 30, 2020 to avoid that affected companies have to file for insolvency solely because the processing of applications for public aid or financing or restructuring negotiations in the current exceptional situation cannot be completed within the three-week period to file for insolvency. It is supposed to be a requirement for such suspension that the grounds for insolvency are based on the impacts of the corona pandemic and that there are reasonable prospects of reorganization based on an application for public aid or that there are serious financing or reorganization negotiations by applicants. In addition, an authorization for the Federal Ministry of Justice and Consumer Protection to extend the measure until March 31, 2021 at the latest is to be proposed.
Our considerations: It is to be expected that the suspension of the obligation to file for insolvency will also affect liability for payments after insolvency, which should also be suspended in the relevant cases. In our view, temporary, narrowly defined general suspensions of the obligation to file for insolvency during the now imminent peak of the corona crisis would be worth considering to avoid problems of delimitation, so that insolvencies are only initiated voluntarily and creditors are protected via the prohibition of fraud. In addition, it would be worth considering extending the timeframe for the protection of employees through insolvency money, which indirectly actively promotes corporate restructuring in insolvency, from three to up to six months, thus providing an incentive in lieu of the obligation to file for insolvency. It remains a very suspenseful period while we are awaiting the development of the coming days, weeks, and months.

Addition on March 23, 2020: In view of the COVID-19 pandemic, the legislator is planning far-reaching relief soon with respect to the obligation to file for insolvency. Suspension until September 30, 2020 is to be introduced for cases where companies are expected to be rescued and the reasons for insolvency are based on the pandemic. For more information on this topic and many other related issues, see our Special Newsletter of March 23, 2020.