Implementation of the EU Restructuring Directive in Germany
December 2020 | TALKINGPOINT | BANKRUPTCY & RESTRUCTURING
Financier Worldwide Magazine
December 2020 Issue
FW discusses the implementation of the EU restructuring directive in Germany with Frank Girotto and André Bäcker at PwC Germany.
FW: Could you provide an overview of the key objectives of EU Restructuring Directive 2019/1023? What shortcomings in the previous insolvency framework does it seek to address?
Girotto: The EU Restructuring Directive 2019/1023 was introduced to harmonise the laws and procedures of EU member states with regard to preventive restructurings, insolvency and the discharge of debt. The main objectives are as follows. Companies in each EU member state should have access to a preventive restructuring framework which enables them to avoid insolvency and to continue operating. National laws must provide for the restructuring framework to be available on application by the debtor when there is a likelihood of insolvency. Furthermore, insolvent or overindebted entrepreneurs should benefit from a discharge of debt within a reasonable time period. Additionally, the efficiency of procedures involving restructuring, insolvency and discharge of debt should be improved. German restructuring practice did not include a formalised pre-insolvency restructuring framework, such as the scheme of arrangement in the UK, which is the main shortcoming that the Directive addresses.
FW: Could you describe in broad terms the core elements of Germany’s draft bill implementing the EU Restructuring Directive? What are its most notable provisions and mechanisms?
Bäcker: The most notable provision of Germany’s draft law implementing the EU Restructuring Directive is to establish a comprehensive legal framework for out-of-court restructurings which is novel to the domestic restructuring landscape. In addition, among several other legislative amendments, the draft bill contains amendments to the German insolvency code, which also stem from the results of an evaluation of the Law on Further Facilitation of Restructurings of Corporate Enterprises (ESUG), as well as amendments to the coronavirus (COVID-19) legislation. The new bill fills the gap in German restructuring law that exists between a consensual pre-insolvency restructuring and insolvency proceedings. It will allow parties to implement restructurings despite the opposition of individual parties outside of insolvency proceedings via a cram-down, including the possibility of a debt-to-equity swap. In addition, it will allow termination of contracts, if necessary, for restructuring and provides the possibility of a moratorium on individual enforcement measures. Thus, there will be an effective and practical restructuring toolkit available to German restructuring practice which will be competitive in the international market.
“The new German restructuring plan includes all conducive elements seen in international regimes and, thus, is highly competitive in the restructuring market.”
FW: Drilling down, could you explain how new tools, such as cram-downs and debt-for-equity swaps, will be available to effect restructurings?
Girotto: To overrule dissenting creditor classes by a cross-class cram-down – which in Germany has been possible within insolvency procedures since 2012 – the following conditions must be met. First, the overruled class is not worse off than without the plan. Second, the overruled class participates adequately in the economic value distributed under the plan. In particular, neither a subordinated creditor nor the debtor receives a value not fully offset by performance into the debtor’s assets, known as the absolute priority rule. Finally, the majority of voting classes has approved the plan, which must not be exclusively the shareholder and subordinated creditor classes. In case of a debt-to-equity swap, creditors may receive a cash settlement. An exception to the absolute priority rule is provided in situations where shareholders retain economic value. However, their participation is necessary for the company’s continuation or the impairment of creditors’ rights is minor. The plan may also structure the rights of creditors who are entitled to claims from a subsidiary as guarantor, co-debtor or other liability, such as group-internal third-party collateral.
FW: In what ways does the draft bill seek to enhance certain protections for creditors?
Bäcker: The bill modifies the obligations of directors, which may be subject to liability claims, in the event of imminent illiquidity. Currently, directors owe their duties to shareholders and the company until illiquidity or overindebtedness arises. The new bill leads to a paradigm shift in so far as the directors will now have to protect the interests of creditors when illiquidity is imminent but there is no overindebtedness. The bill provides that after a restructuring plan has been notified to the court, the claims arising from a breach of this obligation may be asserted by the creditors, for which the directors may be held liable.
FW: The draft bill implements a preventive restructuring framework but also proposes major changes to German insolvency law. From your point of view, do the proposed changes support restructuring within insolvency as well?
Girotto: The proposed changes are generally seen as improving the current framework, however self-administration is imposed with increased requirements. Specifically, in the present legal situation, imminent illiquidity and the going concern prognosis relevant to the overindebtedness test have been largely congruent so far. Upon imminent illiquidity, a debtor was regularly also overindebted, and therefore a greater delineation of imminent illiquidity from overindebtedness was required. This was achieved by setting the forecast period for the overindebtedness test to 12 months, and to 24 months for the imminent illiquidity test. The period to file for insolvency is extended from three to six weeks in the case of overindebtedness. In addition, the debtor must provide comprehensive documentation attached to the insolvency filing for self-administration procedures – a six month financial-plan, a restructuring plan, the state of creditor negotiations, and compliance with commercial disclosure obligations for the last three years – which may enhance the preparedness of self-administration attempts. However, some of the proposed changes will relocate decision making from creditors back to court, and we will see whether this enhances restructuring within insolvency proceedings.
“The draft law fills the gap in German restructuring practice that exists between consensual pre-insolvency restructuring and insolvency procedures.”
FW: How closely does Germany’s draft bill align with insolvency regimes elsewhere, such as Chapter 11 in the US and schemes of arrangement in the UK? Where does it differ?
Bäcker: In comparison with UK out-of-court restructuring frameworks, such as the scheme of arrangement and company voluntary arrangement, the new German restructuring plan allows for a cross-class cram-down of dissenting creditor classes. As a response to the EU Directive, the UK government introduced the new Restructuring Plan in June 2020, which also allows for cross-class cram-downs. However, no moratorium is possible within the UK frameworks. Chapter 11 procedures in the US allow for a cross-class cram-down, however Chapter 11 is a total enforcement framework where all creditors are included, not only selected creditors as in the German, Dutch and UK frameworks. In summary, the new German restructuring plan includes all conducive elements seen in international regimes and, thus, is highly competitive in the restructuring market. German companies will no longer have to use foreign tools to implement an out-of-court restructuring.
FW: To what extent do you expect Germany’s new framework to bring greater transparency, legal certainty and predictability to the restructuring process? Have any concerns or criticisms of the draft bill been raised to date?
Girotto: The draft law fills the gap in German restructuring practice that exists between consensual pre-insolvency restructuring and insolvency procedures. Pre-insolvency negotiations will be more effective because small, subordinated creditors will not be able to block restructuring solutions any longer, when the majority of creditors has come to an agreement. The new framework is also likely to reduce the number of insolvency cases because debtors can use the tools formerly reserved for insolvency procedures in pre-insolvency situations, such as financial restructuring, cram-downs and the chance to amend continuing obligations contracts, in a much shorter time frame and with less bureaucracy than in formal insolvency procedures. The majority of experts appreciated the fast and effective implementation of the EU Restructuring Directive by the German government, however minor points of criticism were raised in the draft bill, which have been largely addressed in the new draft law.
FW: Looking ahead, how might the new restructuring laws shape Germany’s restructuring market, and business in general, in the coming months and years? Do you see it as an important and effective development for Germany’s insolvency regime?
Bäcker: The new restructuring framework is an important and effective development for restructuring practice in Germany. It introduces a new tool for pre-insolvency restructurings that is competitive in the international market. It may also prevent companies from filing for insolvency, because tools reserved for insolvency processes are now available much earlier and with less bureaucracy than in formal insolvency procedures. This may prove to be particularly valuable when persisting COVID-19 restrictions negatively affect entire industries for the foreseeable future. Moreover, some shortcomings of the self-administration processes during the ESUG evaluation have been addressed in the new law, and we hope and believe that judges will appreciate this and support these well-prepared self-administration proceedings.
Dr Frank Girotto has over 20 years of work experience as an adviser for restructuring and insolvency. He has managed a multitude of engagements containing in and out of court debt to equity swaps as well as transformations. He is PwC’s representative in the committee for restructuring and insolvency of the German auditor’s institute (IDW). As such, he has closely accompanied the German efforts to implement the EU directive over the last few years and participated in various legislative hearings. He can be contacted on +49 (89) 5790 6456 or by email: frank.girotto@pwc.com.
André Bäcker works as a partner in PwC’s business recovery service. He has more than 19 years of experience in restructuring, reorganisation and insolvency. He is an auditor and tax consultant, holds a diploma in business administration and is a banker. He consults in large cross-border restructuring and insolvency situations, with particular focus on German restructuring law. Recently, Mr Bäcker and his team accompanied the German airline Condor throughout its successful self-administration proceedings. He can be contacted on +49 (69) 9585 5264 or by email: andre.baecker@pwc.com.
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