Countdown has begun to the biggest overhaul of Germany's insolvency legislation, but lawyers predict more amendments are needed if the proposed reforms are to be effective.
According to Heiko Tschauner, head of business restructuring and insolvency at Hogan Lovells in Germany, the government's draft law known as ESUG (Act to facilitate restructuring of companies) doesn't go far enough on some points.
Andreas Spahlinger of Gleiss Lutz in Stuttgart agreed that more changes will be necessary to make German law fully competitive and to stop local companies moving elsewhere or using foreign restructuring laws.
Insolvency administrator
Three major amendments are set to come into force next year under ESUG. The first will make restructurings easier by enhancing the role of creditors.
"The idea is to strengthen the influence of creditors, particularly as regards the selection of an insolvency administrator" said Spahlinger.
Under existing law this is at the sole discretion of German insolvency courts. The new legislation means the court must call for a preliminary creditors committee that can put forward a specific insolvency administrator.
But the judge is only bound to appoint a practitioner of the creditors' choosing if they reach a unanimous decision in favour of one administrator.
"The first draft of the new law provided that the majority of the creditors can select the preliminary insolvency administrator but this has been amended over recent months," said Spahlinger.
Although the new law gives the creditors some degree of influence, Spahlinger said it is not sufficient and the requirement for unanimity should be replaced by a majority vote.
A candidate can be appointed notwithstanding prior involvement with the debtor, so long as they have only provided general consultation on the insolvency proceedings.
"We have to wait and see whether in practice it will be possible to create this preliminary creditors committee fast enough and to talk to them beforehand so that companies really can influence the choice of the administrator," said Tschauner. "It's still not clear in what circumstances someone will be excluded as a potential administrator due to earlier involvement in the matter."
Insolvency plan
ESUG also aims to strengthen insolvency plan procedures. This mechanism allows a company to be restructured pursuant to a court-sanctioned restructuring agreement among the creditors.
A major change is that the new code brings insolvency law and company law closer together by allowing debt-for-equity-swaps with the company creditors.
"Under the current law, if you want to do a debt-for-equity-swap, you need the consent of every single shareholder, which is virtually impossible," said Spahlinger.
The revisions mean that shareholders can be forced into debt-for-equity-swaps to facilitate restructurings.
The new law will also restrict the scope for dissenting creditors to block restructuring decisions by appealing against the plan.
Although the changes aim to facilitate insolvency plan proceedings, Spahlinger said they don't go far enough.
"The time required for insolvency plan proceedings is too long, even under the new law," he said. "I know from my English colleagues that they can complete similar proceedings in much less time: make a pre-packaged plan, prepare and discuss everything, formally file for insolvency proceedings and have the plan accepted in the same day."
A period of up to two months would be acceptable, said Spahlinger, but seven months, and sometimes even more between the filing date and the coming into force of the insolvency plan, is too long.
Self-administration
The third and most wide-reaching innovation makes self-administration more robust. This is the debtor-in-possession concept that allows the existing management, as opposed to the insolvency administrator, to remain in charge during a restructuring.
The option for a debtor to retain full responsibility for the company rescue under the supervision of a custodian has been largely neglected in insolvency proceedings to date.
"The idea is to make self-administration the rule and the insolvency administrator the exception in future," said Spahlinger. "If that is not only the written law, but also the case in reality then I think that will be a major achievement."
Under the new code, upon a debtor-in-possession application, the court will grant a three month postponement of the initiation of insolvency proceedings. During this period an insolvency plan can be submitted.
The debtor can apply for a preliminary moratorium and the company, together with its creditors, has three months to choose a custodian.
"For the first time in German history it is possible for the debtor to choose the practitioner who will act as supervisor in the preliminary self-administration and who will prepare the insolvency plan together with him," Spahlinger said. "But this will only apply in cases of imminent illiquidity or over-indebtedness. If the company is already illiquid then this is not an option."
The self-administration enhancement is not without its problems, though.
"There is one flaw in the draft," said Tschauner. "Although the draft law now resolved by the parliament has been improved against the former draft as illiquidity does not automatically stop the preparatory period, the creditors' committee can still stop this process and in this case the proceeding switches to normal insolvency proceedings."
According to Tschauner, this is a risk for the debtor initiating this process.
"The problem under the old law was that filings were made too late in most cases," he said. "The new proposals encourage companies to file for insolvency earlier, even before they are unable to pay debt."
Tschauner said that the first cases under the new insolvency law will reveal whether it will give debtors sufficient certainty so that they really file earlier.
The plans limit the court's power to approve debtor-in-possession proceedings to only those cases where there is a real sign that a procedure will impair the creditors' rights.
The new law still has to pass the upper house of the German Parliament (the Bundesrat). It is expected to come into force on March 1 2012.