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Benefits and Relaxations in German Insolvency Laws due to COVID-19: Not as generous as they may seem…

06.04.2020 Business Recovery, Restructuring & Insolvency

Christian Reinert

Christian Reinert Partner*

Daniela Pombo

Daniela Pombo Associate

It is no secret that the COVID-19 pandemic will have, or already has, negative economic effects for many companies. Most governments are working at full speed to provide financial resources to recoup the economic consequences and to facilitate keeping businesses alive in the challenging environment until the restrictive measures can be relaxed. An overview of our colleagues Alex Rogan and Julie Killip, for example, of the UK government’s measures can be found here.

But how shall the insolvency of companies be avoided until those financial resources are made available to everyone? Even worse, Germany has comparatively tough sanctions, including criminal liability, and little room for excuses for managing directors who do not comply with their duty to file for insolvency in good time. In such circumstances the COVID-19 pandemic and its impact may lead to an only temporary liquidity crunch. However, this liquidity crunch of several months may prompt an obligation to file for insolvency under the current regime and thus pose a threat to companies which are actually economically sound.

In order to avoid such unwanted effects, the German government enacted German on 27 March 2020 the COVID-19 Insolvency Suspension Act (COVID-19-Insolvenzaussetzungs-gesetz "COVInsAG"), which shall apply retroactively since 1 March 2020. This new law aims to facilitate the companies’ access to financial resources through relaxed rules to restructure existing loans or to obtain new ones before being forced to file for insolvency. 

Suspension of duty to file for insolvency proceedings

First of all, the COVInsAG suspends the general duty of the managing directors of all corporate bodies with limited liability to file for insolvency until 30 September 2020 (§ 1 COVInsAG). However, this suspension does not apply as generally as it may seem and may later prove tricky because it comes with two exceptions: The suspension shall not apply 

a) where insolvency was not caused by the effects of the COVID-19 pandemic; 

or

b) where there are no prospects to remedy the current insolvency. 

In this context, the COVInsAG contains an important presumption: If there was no insolvency by 31 December 2019, it shall be presumed that the insolvency was caused by the COVID-19 pandemic. This is helpful, if not essential, to rule out exception a) above. This means in turn that any company which was already insolvent as of 31 December 2019 in the sense of the law, cannot benefit from the privileges of the COVInsAG, the suspension to file and the further ones described below. 

Furthermore, 3 of the COVInsAG also suspends insolvency applications filed by creditors of a company during the period of 28 March and 28 June 2020 that the grounds for the debtor’s insolvency already existed as of 1 March 2020. The purpose is to avoid that companies that got into difficulties after 1 March 2020 (presumed to be caused by the COVID-19 pandemic) will be forced into insolvency proceedings by creditor’s applications. Interestingly, according to the wording of the law, the exceptions a) and b) mentioned above do not apply to the suspension of creditor’s applications. 

In summary, it is therefore of utmost importance for managing directors now to properly document that (i) the company was not insolvent as of 31 December 2019 and as of 1 March 2020 and (ii) to elaborate a plan showing a reasonable probability that the crisis can be overcome once the restrictive measures introduced due to the pandemic are lifted. 

Relaxations and privileges to creditors 

Obviously, the mere suspension of filing duties alone is not sufficient to ease the insolvency related consequences of COVID-19. The current economic situation will make it more difficult for companies to get (restructuring or bridge) loans and make the necessary measurements to keep the business afloat. 

Therefore, sec. 2 of the COVInsAG privileges certain payments, loans and shareholder loans and includes a reduced liability for the creditors granting new loans and receiving repayments and security which may otherwise be subject to a claw-back by an insolvency administrator: 

  1. Payments received in the ordinary course of business, in particular if they serve to maintain or resume business operations or to implement a restructuring concept, are deemed to have been made with the diligence of a prudent and conscientious manager and will thus not trigger liability for insolvent trading. 
  2. New loans granted during this suspension period, the payment of interest, the repayment of principal up to 30 September 2023 and the provision of related collateral (except for shareholder loans) are given more legal certainty as they not deemed to be interpreted as detrimental to the creditors. The consequence is that they cannot be clawed-back by the insolvency administrator in a potential later insolvency.
  3. Furthermore, in insolvency proceedings based on an application filed by 30 September 2023 latest, the subordination of shareholder loans and payments corresponding to these in economic terms shall not apply. Claims arising from these legal relationships will therefore increase in the ranking. 
  4. The granting of loans and collateral during the suspension period shall not be regarded as an immoral contribution to delaying insolvency. Insofar, agreements shall not be invalid according to sec. 138 of the German Civil Code (Bürgerliches Gesetzbuch “BGB”) and the common risks of such a lender to be liable for damages (sec. 826 BGB) are in fact excluded. 

However, it is important to bear in mind that the above privileges only apply in a scenario where the filing duty is suspended (see above). This means that basically only those companies benefit from such privileges, which have not been insolvent as of 31 December 2019 and who have reasonable prospects to recover.

As the above summary shows, proper documentation and a thorough check whether the privileges indeed apply are key. Otherwise shareholders, lenders and in particular managing directors may find themselves in a situation where they have relied on benefits for which their company is ultimately not eligible - with unpleasant consequences.

If your liquidity is strained and you do feel the consequences of the pandemic and the economic shutdown, feel free to contact us anytime. We are happy to help you assessing the situation and to prepare a proper strategy to overcome this crisis. Stay healthy, physically and financially, and take care!

Article authors:

Christian Reinert Daniela Pombo