GERMANY: An Introduction to Restructuring/Insolvency: Administration

Post-Covid recovery and new challenges - A Chambers Europe market overview of the 2022 insolvency and restructuring environment in Germany 

We are facing a pent-up wave of restructurings in Germany in 2022. Due to the COVID-19 pandemic, the legislator had essentially suspended the obligation to file for insolvency proceedings in 2020 and 2021. This relief was granted to companies that had run into economic difficulties as a result of the COVID-19 pandemic.

But even before that, the low level of interest rates and the extensive and readily available capital in the market had led to a significant decline in insolvency figures in recent years. Both factors contributed to companies refraining from making the necessary adjustments to their business models in response to market conditions. On the contrary, the easy availability of financing took away the pressure to implement the relevant changes. All these circumstances led to a restructuring backlog.

The wave of restructuring that will inevitably follow this congestion will be determined by three main focal points:

(i) On the one hand, the mega-trend of industrial structural change that has been emerging for some time, e.g. in the automotive industry, will continue to take hold.
(ii) Furthermore, companies will have to actively find answers to the consequences of the COVID-19 pandemic, e.g. due to the disruption of supply chains, the acute magnesium shortage, the semiconductor crisis, the extensive shortage of skilled workers and personnel exacerbated by the upcoming retirement wave among the baby boomer generation (demographic change), the whole issues of home office, remote work and short-time working, etc.
(iii) In 2022, a more recent phenomenon will be rising inflation with the resulting changes in interest rates, as can be seen, for example, from the sharp increase in energy and transport costs within a very short period of time, which is still rising. According to the German Federal Statistical Office, average natural gas prices (excluding VAT/deductible taxes) for companies have already risen by 14.2% from EUR 2.67 cents/KWh to EUR 3.05 cents/KWh in the second half of 2020 to the first half of 2021. Consumers with an annual consumption of more than 4 million giga-joules of natural gas even had to accept a price increase of 41%. This hit energy-intensive production companies particularly hard. In addition, companies are faced with rising prices for materials or precursors, provided these can be supplied in sufficient quantities at all. The key words here are, among others, computer chip shortage and magnesium shortage. Necessary price increases can often not be passed on to customers at the required speed or to the extent necessary.

While the first aspect relates more to the strategic orientation of the companies, the other two points mentioned above have a direct impact on their liquidity and P&L statement. We expect the automotive sector at supplier level, the fashion industry, retail, health care providers (hospitals) and the commercial real estate sector to be particularly affected by these challenges.

However, at the start of 2022, we do not yet see that these strong market changes are already having an impact on restructuring or insolvency cases. We had already seen corporate insolvencies at a low level in 2020. According to the German Federal Statistical Office, the number of corporate insolvencies then fell by an additional 13.5% year on year from January to October 2021. The massive government support provided in the wake of the COVID-19 pandemic (short-time working allowance, government subsidies like the so-called “November Assistance” or "Bridging Assistance I – III”, government support loans, etc) is still masking these required challenges to the business models of the companies concerned and supporting their liquidity in the short term. In addition, it has been easy for companies to compensate for any losses through favourable internal or external financing, at least in recent years. The textile retail sector, for example, was still able to compensate for these problems in 2021 by passing the losses on to its suppliers, mainly from the Far East; delivery delays were gratefully used as a reason for cancellations. On the other hand, the first government support loans (KfW loans) will fall due for repayment in the course of 2022. Refinancing these loans will become increasingly difficult. We also expect interest rates to rise in the Euro zone. Further, lending in the future will be increasingly determined not only by the ability to service the interest rate and principal, but also by other factors such as observing Environmental Social Governance (ESG) requirements. We are basically hearing the same from the private equity sector about financing through their possible participation in companies.

The restructuring and insolvency market in Germany is well positioned in regulatory terms for the upcoming wave of restructurings and is well equipped to meet the challenges ahead. In general, companies in Germany can restructure themselves using two types of procedures: a nearly out-of-court restructuring or a formal insolvency, especially in the form of debtor-in-possession proceedings.

Since January 2021, it has been possible to restructure a company's finances in Germany more or less without any court involvement comparable to a British scheme of arrangement: the so-called restructuring procedure under the new StaRUG code. This is aimed at a financial reorganisation of the balance sheet by means of a haircut of existing liabilities except for personnel and pension liabilities. The company is restructured by implementing a restructuring plan upon which the creditors vote in groups. The decisive factor here is the possibility of a cross-class cramdown to outvote obstructive creditors and to defend against their hold-out positions. However, a performance-based and thus operational restructuring of the company is not possible in the course of such a StaRuG restructuring. Nonetheless, initial experience in the market has shown that the mere threat of using this instrument can have a disciplinary effect, especially on institutional creditors.

Formal insolvency proceedings, with an increasingly pronounced form of debtor-in-possession proceedings, also offer a comprehensive toolbox for the reorganisation of a company in Germany. Above all, in addition to the regulation of existing obligations (through haircuts and the liquidation of collateral), it offers the possibility of restructuring the company in terms of performance and personnel. A complete reorganisation of the business model is thus possible. The restructuring tools include rights to intervene in contracts on the supplier and landlord side to cut costs and on the customer side to enforce necessary price increases. It also offers facilitated staff reductions through social plans/reconciliation of interests according to a so-called acquirer's concept. Both the existing shareholder with fresh money and a third-party investor can participate in the company. Both solutions can be facilitated via an asset deal or an insolvency plan. In the case of an asset deal, the investor, who can be the existing shareholder or a third party, can acquire the business free of debt with a new company and continue the business operation in a restructured form after implementing the personnel measures. If the company is restructured by means of an insolvency plan it is also possible to retain the participation of the former shareholder by injecting fresh money or by bringing in a third party as an investor. This can even be done by implementing a debt equity swap. This shows that loan-to-own strategies are also possible in Germany. The insolvency plan can even be used to issue capital market instruments in the form of shares or (convertible) bonds.