18 Loan Market Association LMA News December 2010 Significant steps towards more creditor controlled insolvency proceedings in Germany A slide up to harmonised standards in national European insolvency regimes bypassing the European lawmaker Frank Grell, Finance and Litigation Partner (Hamburg) and Chair of German Restructuring and Insolvency Practice – Latham & Watkins Dr. Ulrich Klockenbrink, Finance Associate (Hamburg) – Latham & Watkins Full harmonisation of insolvency laws in the Act of 1999. Moreover, the reform will improve European Union is still a very long way off. the creditors’ position in insolvency proceedings Forum shopping between different insolvency in general. Similar steps have either already regimes has therefore been on the agendas of been taken or are envisaged at a national level both creditors and debtors in every significant in other major European jurisdictions, such as restructuring process in the last few years. In the UK, France, Italy and Spain. Germany, debtors have been contemplating Frank Grell and implementing a shift of the place of effective Creditor influence on the appointment management to the US in order to benefit from of insolvency administrators the protection for debtor companies under Although the fundamental principle of the Chapter 11 of the US Bankruptcy Code. By German Insolvency Act is optimum creditor contrast, it has been routine for creditors to satisfaction, creditors have not had a formal consider and, in some cases implement, a say in the appointment of the insolvency shift of the debtor company’s centre of main administrators in charge of actually achieving interest (COMI) to the UK, in order to benefit such satisfaction. Instead, the insolvency from the more creditor controlled schemes of administrators are chosen and appointed by Dr. Ulrich Klockenbrink arrangement. This especially applies to UK the insolvency court. In the past, this court-led or US banks and hedge funds acting as main appointment process has posed significant creditors in major German restructurings. In uncertainties with respect to the implementation the past, such lenders perceived Germany to of pre-arranged – and therefore efficient – be a country where restructuring was hardly restructuring plans agreed between the main possible and liquidation the likely outcome creditors. While it is fair to say that 95% of the of insolvency proceedings. That perception insolvency administrators have been very has changed over the last few years, but the reasonable and commercially minded, uncertainties surrounding the rules and creditors have not been able to rely on the practice of German insolvency proceedings appointment of the particular insolvency continued to make out-of-court restructurings administrator who negotiated and consented the preferred route. Accordingly, the to the restructuring plan beforehand as the ‘insolvency threat’, i.e. the announcement courts were free to appoint another administrator. of the decision to file for insolvency, has, This will change with the insolvency reform: until now, been the inevitable part of any prior to the appointment of an insolvency German restructuring discussion. administrator, the insolvency courts will be In response to the above and ahead of any required to consult with the main creditors. harmonisation attempts at an EU level, the Under the current proposals, the court is German legislator has proposed a substantial obliged to appoint a person as administrator insolvency law reform, which hopefully will if that person is backed by a clear majority of become effective early next year. The reform the creditors. If this majority is based on the is focusing on the improvement of insolvency amount of outstanding claims and not on a plan proceedings and Chapter 11-like majority in number, lenders will have significant debtor-in-possession proceedings, which were leverage in the appointment process. In fact, initially incorporated in the German Insolvency they will be able to prepare pre-packed deals Loan Market Association LMA News December 2010 19 and install an insolvency administrator who Once the proposed insolvency reform is is willing and able to implement such a deal implemented, the exercise of all shareholders’ (providing no doubts have arisen as to rights can be made subject to plans of whether that person will act as an independent reorganisation. This includes shareholder In continental administrator). For UK readers, this may resolutions on capital reductions, capital sound like something one would expect from increases without pre-emption rights on new Europe, Germany the appointment process for an insolvency shares and contributions in kind as constructive is leading the way administrator. However in continental Europe, elements of a debt-equity-swap. Therefore, in implementing Germany is leading the way in implementing shareholders of a debtor company can be creditors’ rights creditors’ rights to a say in the appointment expropriated by majority class vote on plans of insolvency administrators. of reorganisation provided they get ‘adequate’ to a say in the compensation. Where the shareholders are appointment Debt-equity-swaps in plans of out of the money though, ‘adequate’ may of insolvency reorganisation even mean nothing. Shareholder consent is administrators. A second revolution in German insolvency law effectively not necessary for such debt-equity- will be that in the future creditors will be able to swaps since shareholders as a voting class go into equity more easily, as debt-equity-swaps can be crammed down. will be incorporated in the German Insolvency In the UK, debt-equity-swaps have been Act. In the past, share pledge enforcements an important corporate rescue tool for a long were the means by which creditors gained time. Unlike in Germany, there is no fixed corporate control over the debtor company format for debt-equity-swaps, and they may be and benefited from a turnaround economically. implemented within or outside the framework However, due to certain legal uncertainties, of a statutory procedure, depending on the share pledges were rarely enforced in Germany. terms of the finance documents and the level Instead, creditors used their share pledges as of support of the shareholders and creditors. a way of threatening shareholders into making Where the security documents require a further restructuring contributions or turning high consent threshold that is unlikely to over their shares to a trustee. be achieved by consensual negotiation, a 20 Loan Market Association LMA News December 2010 Significant steps towards more creditor controlled insolvency proceedings in Germany Continued from page 19 debt-equity-swap can be implemented via for granting self-administration will be a scheme of arrangement or a company significantly reduced. Moreover, companies voluntary arrangement. If approved by the will be able to enter into debtor-in-possession necessary majorities and, in the case of a proceedings at an earlier stage: where scheme, sanctioned by the court, they will management files for insolvency in the case bind all members or creditors of that class. of imminent, but not yet actual illiquidity An alternative means of ‘cramming down’ (i.e. earlier than in most cases in the past), dissenting creditors and shareholders may be preliminary insolvency proceedings can be the use of a pre-packaged administration sale launched as preliminary debtor-in-possession of the shares in a holding company in order to proceedings. This enables the management transfer ownership of the operating company and the creditors to prepare and negotiate to a third party or ‘in the money’ creditor class. a plan of reorganisation during the three month In France, for companies that have at least period of preliminary insolvency proceedings. 150 employees and revenues in excess of The proceedings will be overseen by a € 20 mn, a safeguard or reorganisation plan preliminary trustee, who will be appointed can provide for debt-equity-swaps subject according to a suggestion made by the to approval by three separate creditors’ management of the insolvent company. committees, one comprising the main suppliers According to the current proposal, the of the debtor, another comprising its lenders management’s request for preliminary holding bank debt and the last comprising self-administration can only be rejected by its bondholders. Spain’s insolvency regime the court where a restructuring of the debtor provides for debt-equity-swaps which often company is obviously unpromising. take the form of participative loans. In addition, These new rules will have a significant debt-equity-swaps may be proposed by impact on the economic and legal position either the debtor or the creditor as part of of creditors. On the one hand, creditors will the settlement proposal. face insolvency proceedings at an earlier stage, as the management of the debtor Improvements in chapter 11-like company is clearly incentivised to file debtor-in-possession proceedings immediately for insolvency if there is an A third goal of the German insolvency law imminent illiquidity, thereby avoiding any risk of reform is to improve the Chapter 11-like criminal charges for delayed filing. On the other debtor-in-possession proceedings that hand, creditors – especially major creditors like were incorporated into the German Insolvency the lenders – will have the chance to negotiate Code in 1999. Since then, self-administration and to finalise a plan of reorganisation during has been granted in less