German Insolvency Law, with latest reforms

German Insolvency Law, with the latest reforms: Also, a lively comparison with emboldened Indian Insolvency and Bankruptcy Code, with special reference to Committee of Creditors.

Germany introduced the Bankruptcy Act, 1877 ranking itself as one of the topmost industrial nations which allowed its industries to opt for bankruptcy, if needed. After a long period, in 1999, with twenty years of discussions, hearings and meetings, Insolvency Statute replaced the relevant acts in erstwhile West Germany as well as the East Germany. Again, due to industrial distress, the above act was reformed with an update in 2012, 2014 and 2017. The full act can be referred at the following web site:

 Name :(Insolvency Statute (Insolvenzordnung (InsO))

Website: www.gesetze-im-internet.de/englisch_inso/(German)

Let us look at the basic contour of the Insolvency Statute to have some essential understanding.

(Insolvency Code of 5 October 1994, page 2866 and last amended by article 19 of the Act of 2011, page 2854. Both pages from Federal Law Gazette)

• Part 1. General Provisions
• Part 2. Commencement of Insolvency proceedings. Assets involved and parties to the proceedings.
• Part 3. Effects of Commencement of Insolvency proceedings.
• Part 4. Management and realization of Insolvency Estate.
• Part 5. Satisfaction of the Insolvency Creditors. Discontinuation of Proceedings.
• Part 6. Insolvency plan
• Part 7. Self-administration
• Part 8. Discharge of residual debt.
• Part 9. Consumer Insolvency proceedings and other minor proceedings
• Part 10. Special types of Insolvency proceedings
• Part 11. International Insolvency Law
• Part 12. Entry into force.

There is only one primary insolvency procedure which applies to both the individuals and companies. Our discussions are meant for the procedure applicable to companies only.

What are the objectives of German Insolvency Code?

The objective of German insolvency proceedings (Insolvency Proceedings) may be summarized as under:

To satisfy creditors either by liquidation of the insolvent entity’s assets and distribution of the proceeds as per laid down norms, popularly known as “Liquidation Proceedings” or by reaching an arrangement by means of a suitable insolvency plan procedure to restructure the insolvency entity (Insolvency Plan Proceedings).

Who can initiate insolvency proceedings and on what basis?

The courts themselves cannot initiate insolvency proceedings but can act only on the basis of action initiated by the debtor or any creditor. The grounds on which application for insolvency can be filed are as under:

• Illiquidity (Incapacity to pay)
• Over- indebtedness (balance-sheet insolvency – keeping in view the latest financial crisis, the German Government has recently amended the definition of over- indebtedness to alleviate otherwise solvent corporations from adopting this step by including business forecast to explain the better future prospects in cash flow/sales/income.
• Imminent illiquidity.

Any entity or creditor can initiate insolvency proceedings on the basis of the first two reasons but the entity alone can file under imminent illiquidity reason. Further, both civil and criminal proceedings can be undertaken by government if the management of any entity fails to file applications over illiquidity or over-indebtedness.

The application has to be filed in a competent local court by any eligible person.

What happens after filing?

Insolvency Proceedings will be initiated by the competent court if it feels that the entity being studied is in fact insolvent. It usually appoints an eligible preliminary administrator who either takes over insolvent entity’s management or supervises the continued operations of the management by its directors.

Interesting but true that preliminary administrator is called as weak administrator when the court does not impose any conditions on transfer of assets on the entity, and the duties of the administrator is determined by the court.

In case, the court imposes restrictions on the management of the entity like non- selling of assets, the temporary administrator to be called as “strong administrator” has a full right to step into the shoes of the management, take possession of the assets, continue the business of the entity and sell the goods of the entity and collect the claims against others. Basically, continue the entity as a going concern. It is obvious that the administrator works under the supervision of the court and reports regularly.

Appointment of Committee of Creditors

The insolvency court is expected to set up a Committee of Creditors if the debtor satisfies two of the following three conditions:

• A balance sheet total of at least 4,840,000 Euro (after a deduction of negative equity).
• A revenue of at least 9,680,000 Euro.
• Working with a minimum of 50 employees.

Previously, this restriction was strictly imposed but however, the court can still set up the committee upon filing of an application by a creditor, the preliminary administrator or the debtor himself/herself provided that all eligible members have given their approval.

 Committee of Creditors

The members of the Committee of the Creditors (CoCe) include creditors with a right to separate satisfaction, the insolvency creditors having the maximum claims and the small sum creditors. The committee shall also include the representative of the debtor’s employees.

The creditors meeting is convened by the insolvency court. All creditors entitled to separate satisfaction, all insolvency creditors, the insolvency administrator, the members of the creditors, committee and the debtor are entitled to attend the meeting.

The time, place and agenda of the creditors meeting shall be published. Publication is not required if a creditors meeting adjourns negotiation

More information about the creditors’ committee

• The creditors may decide in their meetings whether the debtor’s business should be closed down or temporarily continued. They may also commission the insolvency administrator to draw up an insolvency plan and determine the plan’s objective. The creditors may also modify their decisions in subsequent meetings.
• Voting at creditors’ meetings is determined by a simple majority of the value of claims voting at the meeting. In the event of a tie, the majority of creditors will be decided on a poll (head count). There is no minimum requirement and a meeting is in full quorum even with one creditor’s presence.

Let us learn more about various types of creditors with the following additional details.

Preference Creditors

As the name indicates these creditors prevail over others. They are the insolvency administrator (IA)/Court itself for cost, parties who entered into contracts with IA, and social plan creditors who manage special employment law agreements.

Secured Creditors

A right to separate satisfaction grants the creditor a right for preferred satisfaction with respect to an asset which forms part of the insolvency estate. By exercising the right to separate satisfaction, the secured asset will either be realized by the secured creditor itself (who may then keep the proceeds) or IA may return the money after realization of the assets.

We may enumerate some creditors with security over real estate, others with lien over the asset which is part of the insolvency estate, other creditors with security cover over tangible movable assets/receivables and governmental authorities’ dues over custom duties.

Ordinary insolvency creditors /unsecured creditors

These are creditors who had a claim against the debtor at the time insolvency proceedings were opened, such as bond holders, unsecured loan note holders or unsecured contractual parties (Insolvenzgläubiger)

Subordinated creditors

The interests of subordinated creditors (nachrangige Gläubiger) will be addressed after all unsecured creditors have been paid in full. A debt is a subordinated one because it emanated from shareholder loan.

However, one who acquired less than 10% of registered capital and also not directors of the company (minority privilege), and restructuring privilege, an attempt by an investor to save the company by acquiring less than 10% of registered share capital and also gave loans to rescue the company from insolvency will not fall under subordinated creditors. (I would prefer to call the later investors as Samaritan for the company)

Let us continue with our narration of the insolvency company.

Lodgment of claims

Chapter 2 from InsO, the German Insolvency Code, from section 187 to 200 distills the process of accepting claims from creditors till final disposition of claims. Any one interested for finer details can refer the same. However, I have narrated in simple language the same for easy understanding.

• After opening of final insolvency proceedings, creditor should lodge his claims with the administrator indicating the circumstances under which the claim rose with full particulars of claim, date and other documentation.
• An interesting titbit – German law (Article 184 Judicature Act (Gerichtsverfassungsgesetz)) requires that the claim must be lodged in German. However, pursuant to the European Insolvency Regulation, creditors domiciled in another member state of the European Union may lodge their claims in the language of their country in EU. The only linguistic requirement is that the lodgment states at the beginning “Anmeldung einer Forderung”. (Some German words)
• The insolvency administrator must review all lodged claims and enter them in a schedule and submit to the court. In a verification meeting all relevant persons would meet to verify if their claims are disputed. All creditors or their representatives would invariably attend this meeting.
• In the verification meeting each claim will be verified and approved with the amount claimed and placed on a ranking in order of priorities. If no objection is raised, it is presumed that it has been approved. Reasons for rejecting any claim will have to be given for enabling the concerned creditor to challenge it in some other court of law.
• However, the insolvency administrator’s cost will be treated as liabilities of the insolvency estate.
• Any creditor is entitled to commence proceedings against those parties opposing the claim for the issues to be determined, within two weeks following any statement of an intended distribution. Notice of the proceedings must be given to the administrator.
• After the verification meeting the distribution can start. It follows a distribution record which is established by the administrator. As soon as the distribution of the debtor’ s assets is carried out, the court decides on the termination of the insolvency proceedings.

Insolvency Plan

An insolvency plan can be set up and submitted to the court only by the debtor or the administrator. The plan consists of two parts, namely, declaratory part and constructive part. The rehabilitation part is explained in the declaratory part while the impact of rehabilitation on the rights and claims of the creditors is dealt with in constructive part.

The most significant part of the plan is to divide the creditors into groups and how to deal with their claims.

Obviously, the plan needs the approval of the creditors who would be affected the most by its implementation and they would assemble in a meeting to decide its fate. The plan would be put to vote and a majority vote by groups is required to carry forward the plan. The debtor too is expected to approve the plan. Finally, the plan reaches the court for its final approval.

After the decision of the court gets legal binding, the plan gets an effective nod and the insolvency proceedings are terminated. The debtor recovers the power to transfer his assets. The constructive part of the insolvency plan may provide for surveillance of implementation of the plan by the administrator.

A lively comparison of Committee of Creditors between Indian Insolvency & Bankruptcy Code,2016 and German Insolvency Code (InsO):

Germany

• The creditors are appointed by the court in case of Preliminary Creditors Committee though its composition may be changed by CoCe, in its first meeting.
• The creditors entitled to separate satisfaction, the insolvency creditors with the largest claims and the minor creditors shall be represented on the creditors The court may, however, nominate any one to CoCe.
• The creditors may recommend to the court to change the administrator by unanimous vote both at pre or post stage. Generally, this does not happen unless the administrator is not a neutral person and has links with the debtor.
• The creditors have a right to look for relevant information about their dues, the details of assets available or other information at any time from the administrator.
• The members of the creditors committee shall be liable in damages to the creditors entitled to separate satisfaction and the insolvency creditors if they intentionally or negligently breach the duties incumbent upon them under this Code.
• The meeting of the CoCe is convened by 1. the insolvency administrator; 2. the creditors committee; 3. at least five creditors entitled to separate satisfaction or non-subordinated insolvency creditors whose rights to separate satisfaction and claims are equivalent to 20% of the total under this category. Even one member may become the quorum for any meeting though most of the members or their representatives generally attend the meetings to safeguard their interest.
• The court chairs the meeting. The majority votes of the members in amounts of claims of members present carries any resolution. However, the court is authorized to cancel the same if it is not in the interest of the insolvency of the entity under discussion.
• The administrator has to consult the CoCe at various stages while carrying out his duties in view of recent amendments made in 2012, 2014 and 2017. Even the insolvency plan prepared for the entity will have to carry the approval of CoCe for its implementation.

India

• Only financial creditors may become the members of CoCe. However, if there is no financial creditor at all, 18 of the largest operational creditors become the members. In case of lesser number of operational creditors all of them become the members.
• CoCE members are appointed by Insolvency Resolution Professional. Their claims are also registered by him only.
• A quorum of 33.33% of members by quantum of overdues from debtor is needed to convene the CoCe meeting.
• Minimum 66% of voting share of the committee members is required for approval of any matter at CoCe meeting. This threshold remains the same for other decisions of CoCe. The resolution professional determines the voting share of each creditor on the basis of financial debts owed to him/her by the debtor.
• The resolution professional shall give notice of each meetings of the CoCe to its members, members of the suspended Board of Directors or the partners of the corporate persons, as the case may be. Though these people may attend the meetings, they have no voting right.
• The approval of committee of creditors is to be obtained by resolution professional for various actions like raising interim finance, create security interest over the assets, change the capital structure of the debtor, giving instructions to financial institutions, transfer of debts or operational debts, etc.
• CoCe plays a vital role in case of approval of insolvency resolution plan for forwarding to Adjudicating Authority.
• CoCe meetings are organized by Insolvency Resolution Professionals on a time schedule prescribed under the insolvency code.
• The creditors may have their representatives to attend the meetings.

Conclusion

Other than the high ranking obtained consistently by Germany (4^th rank in case of insolvency by Ease of Doing business by World Bank for the year 2018), it ranks among the most powerful nation in the world in case of industrialization which has been possible due to its overall policies on establishment, nurturing, availability of man power, finance and infra structure. But as early as 1877, it thought of bankruptcy as one of the most relevant factors for its industrial growth, like India, today, which is counted among the best for its recent insolvency policies and immediate implementation. The purpose of this article is to have some interesting information about Germany which would help us in building a stronger Industrial India.

Reference:

• (Insolvency Statute (Insolvenzordnung (InsO)) – Though the original web site is in German, an English web site is also available. However, German is used in legal parlance there. English web site address is quoted in the article itself.
• Insolvency and Bankruptcy Code 2016 (India) and other updates.