Self-administration proceedings following the legislative reform – practical impacts for self-administration and supervision

By Dr Jürgen Erbe, MBA, Attorney-at-Law in Germany and Certified Specialist in Insolvency Law, and Christoph Wehr, Bachelor of Arts (BA) in Business Administration and Master of Arts in Finance, Accounting, Corporate Law and Taxation

Among the changes introduced by the Act on the Advancement of Restructuring and Insolvency Law (Sanierungs- und Insolvenzfortentwicklungsgesetz, SanInsFoG) were a number of amendments to the Insolvency Code (Insolvenzordnung, InsO). This article focusses on the amendments to the Insolvency Code which affect self-administration, and looks in particular at select challenges relating to the practical application of these provisions.

The conditions for access to self-administration, which relate to the debtor’s past conduct, are set out in section 270b (2) Nos. 1 to 3 InsO:

  • No. 1: There must be no known circumstances indicating that there are substantial payment arrears owed to employees or other creditors specified in section 270a (2) No. 1.
  • No. 2: During the last three years prior to the application for commencement of insolvency proceedings, no enforcement or realisation prohibitions pursuant to the InsO or the Act on the Stabilisation and Restructuring Framework for Businesses (Unternehmensstabilisierungs- und -restrukturierungsgesetz, StaRUG) must have been ordered for the benefit of the debtor.
  • No. 3: The debtor must have complied with its disclosure obligations under commercial law in the last three years prior to the application for commencement of insolvency proceedings.

Based on this information, the court will draw conclusions as to whether successful self-administration is possible.

Failure to fulfil one or more of these criteria will not immediately result in refusal of the debtor’s application. A preliminary supervisor can still be appointed if the debtor is expected to be willing and able to align its management with the interests of creditors.

Much will depend on the position taken by the preliminary creditors’ committee, if one is appointed, regarding the application for self-administration. The fact that the wording of section 270b (3) InsO limits the involvement of the preliminary creditors’ committee to the situation set out in section 270b (2) has attracted criticism and is viewed in some quarters as a systematic error on the part of the legislator. Rather, it is argued, the creditors’ committee should always be involved in the decision to order self-administration, in line with the legislator’s aim of strengthening creditor involvement. Limiting participation to the cases set out in subsection (2) means that the preliminary creditors’ committee can give its view only in contentious cases. This restricts participation in comparison with the previous law – even though the intention was to extend it.

A decision pursuant to section 270b (2) InsO can be rendered without hearing the preliminary creditors’ committee only if two business days have elapsed since the application was lodged or if a decision is needed urgently because prejudicial changes in the debtor’s financial position are likely.

If the creditors’ committee is unanimously in favour of self-administration, the court will be bound by the application for self-administration in spite of any “defects” in the application as set out in section 270b (2) InsO. Self-administration may not be ordered if the creditors’ committee is unanimously opposed to the selfadministration. This is new: Prior to the reform, a resolution to reject selfadministration was not regarded as binding, but frequently served as an important guide to the court in its decision.

Pursuant to section 270b (3) sentences 3 and 4 InsO, a unanimous vote (per capita majority) by the preliminary creditors’ committee is binding on the court. However, this raises the question of what criteria the creditors’ committee can base such a decision on. In the short time available, not all creditors’ committee members will be able to examine the application requirements, notably the selfadministration strategy, and reach a decision for or against self-administration
accordingly. However, according to the strict wording of the provision, the court has no scope for review and discretion. So it remains to be seen how frequently preliminary creditors’ committees will reach unanimous decisions if these are not entirely free of liability risks for them.

From a practical perspective, the two-day limit is certainly ambitious. Because it begins to run when the application is lodged, it also encompasses the time available for the preliminary creditors’ committee to form in the case of self-administration.

The core of the application for self-administration is the self-administration strategy. This has a number of components: the financial plan, the implementation concept, an account of the status of negotiations, a description of arrangements put in place by the debtor, and the cost comparison.

Detailed requirements regarding the content of the financial plan, which must cover a period of six months and must be submitted with the application, are not provided for in statute. Instead, generally accepted standards of business management apply, with due regard for the specific demands of insolvency. Accordingly, a month-by-month financial plan will usually be sufficient, though independently of this a more precise week-by-week plan will need to be prepared for the purposes of fine-tuning liquidity in preparation for the proceedings.

The financial plan must show that it will actually be feasible to conduct the insolvency proceedings by way of self-administration as intended while also safeguarding the liquidity of the (future) insolvency estate. This forecast – as is usual – must show incomings and outgoings that are more likely than not to materialise.

This means on the one hand that it must include payments from customers, materials received and other incomings and take into account the effects on these of an application for commencement of insolvency proceedings – such as demands for advance payment and the loss of factoring as an option. The plan must also consider the effects arising from insolvency pay and insolvency estate loans (i.e. new loans granted after commencement of insolvency proceedings) and “artificial” insolvency estate loans (funds from other sources used to continue operations), assuming these are likely to come into play. On the other hand, the costs of the (preliminary) proceedings – such as consultancy fees, the supervisor’s remuneration and court costs – must also be considered.

Because the requirement is for a plan showing cash going out and coming in, from a purely practical perspective it should be derived from a monthly income statement forecast, as this will be compatible with the performance indicators used by the debtor’s financial accounting department and so enable planning to be solidly based in the debtor’s own accounting practices. Although an income statement forecast of this kind is not explicitly required, it is, together with a pro forma balance sheet, a convenient way of providing the “detailed description of [...] financing sources” required by section 270a (1) No. 1 InsO and showing how the debtor intends to continue trading without eroding the insolvency estate.

This means, for example, not disposing of any fixed assets necessary for continuation of operations or financing loss-making operations by selling off inventory.

In all cases, the plan must address and describe sources of funding. At the time the financial plan is prepared, it must be more likely than not that the sources of funding, such as an insolvency estate loan, will be available, but they do not need to be certain.

The plan must also be based on reliable and up-to-date figures. To ensure that it is, the debtor will need to look at its accounting processes, for example, to determine whether all of its invoices are being posted promptly, and review the master records of debtors and creditors from which payment due dates can be derived.

As in law the financial plan covers a period of just six months, it will not necessarily cover the entirety of the insolvency proceedings until termination and so cannot rule out a deficit arising beyond that period. In practice, therefore, the financial plan will need to show that operations are not expected to erode the insolvency estate on an ongoing basis after commencement of proceedings during the planning period, and thus that no shortfall is expected during the proceedings thereafter. On the other hand, a temporary consumption of assets (normally early on) which enables the debtor to continue to trade in a way that produces a better outcome for creditors than standard proceedings (e.g. because it will generate surpluses down the line or improve the financial condition in the event that the undertaking is sold) may be tolerated, subject to ongoing comparison with the plan or the reorganisation concept.

The reorganisation concept required pursuant to section 270a (1) No. 2 InsO must set out the causes of the crisis and describe the measures envisaged to overcome that crisis and achieve the objective of the self-administration. This is not the same thing as a recovery report to standard IDW S6 of the Institute of Public Auditors in Germany (IDW). The content and scope of this concept are not explicitly set out in law and will be determined by the size and specific circumstances of the undertaking concerned.

The reorganisation concept must also state to what extent the measures under consideration have previously been discussed with creditors. If there has not yet been any discussion with creditors, this must also be stated. The explanatory memorandum to the SanInsFoG does not mention any negative legal consequences in this latter case. Even before the legislative reform, however, it was generally agreed that self-administration against the will of key stakeholders or without their knowledge is not normally appropriate.

An application for self-administration must also include a description of any additional or lesser costs that will be incurred during self-administration in comparison with standard proceedings and in relation to the insolvency estate. This comparison must, firstly, contrast the expected procedural costs determined on the basis of a statement of assets and liabilities (supervision costs, court costs) for preliminary and commenced proceedings, i.e. supervision versus insolvency administration, and secondly, in the case of self-administration, must show the advisory costs that will be incurred for performance of standard tasks, such as insolvency advice, handling of rights to segregation and separate satisfaction, or updating the plan accounting documents. From the perspective of the court and the insolvency creditors, self-administration must ultimately be no more expensive than standard proceedings, unless continued operation of the debtor undertaking will generate value that compensates for any greater cost, or else increases the insolvency estate and thus enables higher dividends to be paid on claims.

An applicant undertaking must set out in its application how it will ensure compliance with the provisions of insolvency law and its obligations under that law. Normally – and also because the legislator has now introduced more stringent requirements – a debtor will draw on external support from an advisor experienced in insolvency matters. In its application the debtor can document its intention to work with such an advisor during self-administration and which tasks will be handled by the advisor.

If there are defects in the application which cannot be remedied even after the debtor is allowed a period to do so (section 270b (1) sentence 2 InsO), and the requirements for interim self-administration are not satisfied, the debtor will be given the opportunity to withdraw the application (section 270c (5) InsO). The InsO provides this option only where the debtor is facing imminent illiquidity. The question therefore arises of how the court can assess whether a debtor was merely facing imminent illiquidity, given that its application was deemed inadequate. In practice, this will only be possible by generous interpretation in favour of the applicant in case of doubt.

If a debtor does not withdraw an admissible application for commencement of insolvency proceedings but the requirements for interim self-administration are not satisfied, a preliminary insolvency administrator must be appointed.

The protective shield procedure has been retained as a subcategory of interim self-administration. The strict differentiation between the two has been abandoned, however. This appears appropriate, as the protective shield procedure has always been a subtype of preliminary insolvency proceedings. The fact that this was couched in rather nebulous terms in some press reports makes no difference to this.

As before, however, an application for use of the protective shield must always be accompanied by a statement that the debtor is not yet illiquid but that illiquidity is imminent. On the other hand, overindebtedness can already have occurred, but in this case it must be ensured that the planned reorganisation does not clearly lack any prospect of success (section 270d (1) InsO).

Under 270d (2) InsO, an applicant debtor can propose a particular person as preliminary supervisor, but the person who issued the statement cannot be appointed as preliminary supervisor or supervisor. The court can deviate from such a proposal only if the person proposed is clearly unsuitable for the role. The court must give written reasons for its decision. As a remedy to this decision is not explicitly provided for, this obligation to state grounds and any deviation from the debtor’s proposal are not justiciable – as was already the case in 270b (2) sentence 2 of the previous version of the InsO.

In summary, we note that the advantages of the protective shield procedure are twofold. Firstly, the debtor can “bring along” a supervisor, which in practice is a significant advantage for shareholders, who often feel that filing an application for self-administration means putting the fate of “their” company in strange´hands. Secondly, the protective shield procedure continues to be attractive from a communications perspective.

Termination of interim self-administration is governed by 270e InsO, while revocation of self-administration during the main proceedings is governed by section 272 InsO. The rules for termination/revocation during both phases of the proceedings are almost identical. The grounds for termination in section 270e InsO apply both to the protective shield procedure and to interim self-administration proceedings.

Termination of interim self-administration is new. Previously the law only provided for termination during the protective shield procedure and termination following commencement.

Pursuant to section 270e (1) InsO, a serious breach of obligations under insolvency law or unwillingness or inability on the part of the debtor to align its management with the interests of creditors are general grounds for termination of interim selfadministration. Section 270e (1) InsO lists a number of examples, but the words “in particular” make it clear that they are not to be viewed as exhaustive.

The examples are: a deficient self-administration strategy based on inaccurate facts or a breach of the duty to inform the court (section 270e (1) No. 1a InsO), incomplete or flawed bookkeeping (section 270e (1) No. 1b InsO), and hampering of enforcement of liability claims (section 270e (1) No. 1c InsO).

Interim self-administration can also be terminated if defects in the selfadministration strategy are not remedied within the period of time set (section 270e (1) No. 2 InsO) or the reorganisation sought is found to have no prospect of success (section 270e (1) No. 3 InsO).

Pursuant to section 270e (4), the preliminary creditors’ committee must be given the opportunity to make representations prior to a decision pursuant to section 270e (1) No. 1 or 3 InsO. A decision may be rendered without representations from the creditors’ committee only under the conditions set out in section 270b (3) sentence 3 InsO, as previously described.

As section 270e (1) Nos. 4 and 5 InsO provide that interim self-administration must also be terminated if applied for by the preliminary supervisor with the approval of the preliminary creditors’ committee, by the preliminary creditors’ committee, or by the debtor, it must be assumed that the grounds set out in points 1 to 3 lead to termination ex officio.

Pursuant to 270e (2) InsO, a single insolvency creditor or creditor entitled to separate satisfaction can also apply for termination of interim selfadministration. In this case, however, grounds for the application must be given, and it must be demonstrated to the satisfaction of the court that the requirements for self-administration are not met and that there is a threat of significant detriment to the creditor making the application if self-administration continues. The debtor must be heard prior to termination. An immediate appeal may be brought against the court’s decision (section 270e (2) sentence 3 InsO).

The revocation of self-administration following commencement of proceedings is governed by section 272 InsO. The grounds for revocation are essentially the same as those set out in section 270e InsO. The only addition, in section 272 (1) No. 3 InsO, is that revocation of self-administration can also be requested by the creditors’ meeting with the majority specified in section 76 (2) InsO.

In summary, the rules around ordering and termination of interim selfadministration are now much more detailed. Some of these rules could be improved, both in their wording and in terms of their practical impact. It remains to be seen how suitable they prove to be in their application.

In particular, the enhanced requirements regarding submission of documents and preparation of a financial plan will have the effect of impeding access to selfadministration in smaller proceedings. This will be due not least to the increasing advisory costs that will accompany the enhanced requirements, as a result of which self-administration proceedings will be possible only under certain circumstances.

Self-administration proceedings following the legislative reform – practical impacts for self-administration and supervision

The essay is available for download here.