Grounds to open insolvency proceedings, liability risks and available options for GmbH, GmbH & Co. KG and AG
Insolvency is part of economic life. Most company owners regard their company’s insolvency as a shortcoming and often turn a blind eye to an impending crisis.
However, insolvency is not necessarily the end of a company. Neither is it the epitome of failure. Rather, insolvency can be a true chance to reorganise and solve existing problems. To wait and hope for an improvement is usually the worse option.
As a company owner, you should not ignore how your company is doing. The earlier a crisis is detected, the better and more diverse are the options for sustainable restructuring.
It is essential that the CEO or board of management of a GmbH, GmbH & Co. KG or AG (i.e. a German public limited company) are familiar with the statutory grounds for insolvency and what actions and liabilities might follow from that. The following basic principles apply.
What are grounds to open insolvency proceedings?
Grounds to open insolvency proceedings for a company are inability to pay (“Zahlungsunfähigkeit”) and over-indebtedness (“Überschuldung”). In both cases, the company is obliged to file a request to open insolvency proceedings. According to the German Insolvency Code (Insolvenzordnung / InsO), imminent inability to pay (“drohende Zahlungsunfähigkeit”) is another ground to open insolvency proceedings. In this case, however, there is no obligation to file a request to open insolvency proceedings.
Inability to pay
Inability to pay is defined in Section 17 InsO. Debtors are deemed to be unable to pay if they are unable to meet their mature payment obligations. In German case law, these statutory provisions have been specified in several judgements. According to a judgement by the Federal Court of Justice (Bundesgerichtshof) debtors are deemed to be unable to pay if more than 10% of the liabilities are not asset-covered (“Deckungslücke”). This gap in coverage is determined by comparing the mature, non-contested liabilities at valuation date with the available liquid assets (cash, bank) as well as the liabilities that will mature within a period of three weeks with the liquidity inflows to be expected (collection of receivables, etc.).
If this comparison shows that the company will not be able to fulfil at least 90% of its liabilities within three weeks, it is deemed to be unable to pay, according to case law.
Establishing whether a company is unable to pay its due debts, requires regular careful examination and evaluation, as insolvency has significant legal consequences both for the company and its management.
Over-indebtedness
Over-indebtedness exists if the debtor’s assets no longer cover existing payment obligations, unless it is highly likely, considering the circumstances, that the company will continue to exist. This is provided for in Section 19 InsO.
The question of whether a company is over-indebted is determined by assessing the state of over-indebtedness, which does not necessarily equal the company’s balance sheet. A non-covered deficit on the balance sheet, for instance, can be an indication but is not conclusive proof of over-indebtedness. Furthermore, it is crucial whether the assets are to be assessed based on the presumption that the company will continue (going concern basis) or be liquidated (liquidation basis). In this case, the applicable criteria under commercial law differ from those that apply to a business continuation forecast (“Fortbestehensprognose”) under insolvency law.
By implication, this means that the debtor cannot be deemed to be over-indebted if there is a positive business continuation forecast. Or in other words: A continuation forecast is required to assess whether a company is over-indebted or whether its assets exceed its liabilities and to find out which accounting basis (going concern or liquidation) is applicable.
The forecast period is to be set at a minimum of 12 months from the valuation date and needs to be adjusted continually by way of a rolling forecast. Essentially, the goal is to draw up an integrated financial planning for the company, which takes new developments into account.
If the forecast shows a deficit in liquidity within 12 months, the company is deemed to be over-indebted. Consequently, assessing whether a company can be deemed to be over-indebted is to assess its ability to pay. Over-indebtedness exists from the moment that the company becomes unable to pay within the forecast period.
Since filing a request to open insolvency proceedings is obligatory in the case of over-indebtedness, it is mandatory for the management to maintain an integrated financial planning, if only to avoid their own liability. This is meant as a minimum standard and does not preclude further obligations with regard to the monitoring of the company’s economic development (e.g. in the form of an early risk detection system). Please contact me for an appointment if you need further information and advice. Over-indebtedness comes with many and varied obligations, which should not be underestimated.
Imminent inability to pay
According to Section 18 InsO, a debtor is deemed to be faced with imminent inability to pay if it is likely that it will be unable to meet existing payment obligations on the maturity date.
While an obligation to file a request to open insolvency proceedings exists in the case of an inability to pay and over-indebtedness, there is a right to file such a request in the case of an imminent inability to pay. Under this right, the company can make use of the restructuring instruments provided by the Insolvency Code at a very early stage. The scope of action is much greater at this point in time.
German law provides for a forecasting period of 24 months to evaluate whether the debtor is imminently unable to pay. This period is always to be regarded in conjunction with the 12-month forecasting period for over-indebtedness. This means that the period relevant for imminent inability to pay is the period between the twelfth and the twenty-fourth month of the financial planning period following the respective reference date. The debtor is deemed to be over-indebted if a deficit shows within 12 months. If the deficit shows between the twelfth and the twenty-fourth month, inability to pay is deemed imminent.
Therefore, a company and its management should always be advised to base their financial planning on a period of 24 instead of just 12 months in order to be able to get an overview of the company’s financial position, which provides for clarity at an early stage and more options to act accordingly. Moreover, a planning based on a period of 24 months forms the basis of an early risk detection system, which the management is obliged to implement.
What are the consequences when there are grounds to open insolvency proceedings?
Section 15a InsO stipulates that if a GmbH, GmbH & Co. KG or AG becomes unable to pay or is over-indebted, the CEO (“Geschäftsführer”) of the GmbH or the GmbH & Co. KG or the board of management (“Vorstand”) of the AG is obliged to file a request for the opening of insolvency proceedings. This obligation under Section 15a InsO does not apply to partnerships with personally liable partners (German GbR or oHG) or to freelancers. Nevertheless, such partnerships and freelancers can be held liable under criminal law where liabilities are incurred despite an existing inability to pay and a foreseeable inability to fulfil those liabilities (“Eingehungsbetrug”).
The request to open insolvency proceedings must be filed without delay and not, as is often claimed, within three weeks. According to German insolvency law, the request is to be filed at the latest within three weeks of becoming unable to pay and within six weeks of becoming over-indebted. However, those periods may be applied only if comprehensible and realistic attempts are made to end the inability to pay or over-indebtedness. The management is obliged to prove the prospect of success of such measures.
Therefore, a request to open insolvency proceedings must be filed immediately when grounds to open such proceedings occur.
Non-compliance with this obligation by the management can result in significant liability under civil and criminal law, often resulting in manager insolvency.
How can insolvency contribute to the restructuring of my company?
Insolvency is often publicly perceived as the end, i.e. liquidation, of a company.
While this may hold true for many cases, liquidation is not at all the basic intention of the German Insolvency Code. The reason why many insolvent companies are liquidated is that a lot of requests to open insolvency proceedings are filed much too late. Those companies are continued despite being unable to pay or over-indebted and the management “plugs holes” without reducing debts sustainably, thereby weakening the company in its substance. An insolvency administrator will then not find many realisable assets, which a continuation of the company could be based on. The result is the liquidation of the company. In such cases, the management is usually held liable.
This does not apply if the management has acknowledged early signs of the crisis and filed a request to open insolvency proceedings on time, which will also increase the options of the (preliminary) insolvency administrator.
If a request to open insolvency proceedings has been filed, the company can be continued, e.g. during what is called preliminary insolvency proceedings. Wage and salary payments are covered by the insolvency payments (“Insolvenzgeld”) for up to three months, with the immediate effect that costs are reduced significantly. This means that liquid assets from current payments become available and can be used in the insolvency proceedings. Moreover, liabilities accrued prior to filing the request to open insolvency proceedings do not have to be met any more. While this might be hard on creditors, it secures the company’s liquidity. Despite all disadvantages for them, business partners will usually continue to deliver products and services during preliminary insolvency proceedings, as the associated costs are covered primarily by the preliminary administrator. Advance payments are an option, too.
Preliminary insolvency proceedings include an examination by the preliminary insolvency administrator as to whether the company can be sold or maintained. There are two options:
- restructuring by transfer (“übertragende Sanierung”)
- insolvency plan (“Insolvenzplan”)
Restructuring by transfer
Restructuring by transfer means that all the assets of a company, i.e. the business operations as a whole, are sold in what is called an asset deal. The buyer is a new company. The new company buys the assets of the debtor company without being burdened by liabilities.
This means that the healthy core of the company is maintained, business operations are continued and jobs are preserved.
Such a deal follows its own rules and cannot be compared with the selling of a company outside insolvency. For further information, please refer to the paragraph on selling a company.
Insolvency plan
Unlike restructuring by transfer, an insolvency plan is aimed at maintaining the company. This means that the insolvent GmbH is not liquidated as part of insolvency but will continue to exist debt-free after the insolvency plan is approved. This insolvency plan must point out to the creditors how the company can be made fit for the future. Essentially, the plan must include a description of all restructuring measures as well as a comparative calculation (“Vergleichsrechnung”). In this calculation, restructuring by way of an insolvency plan is compared to common alternative options, i.e. discontinuation, thus liquidation. It is important to make clear that the insolvency plan will put the debtors in a better position than the alternative option would.
An insolvency plan makes sense, for instance, if a company holds licenses or permits, which are vital for business continuation but are not assignable, or if maintenance of the company itself is important for other reasons.
Restructuring can only be successful if the company is still healthy at its core. The earlier insolvency proceedings are commenced, therefore, the better the prospect of successful restructuring.
What can I do for you?
Contact me for further information on the rights and obligations of a company body or for advice on whether a request to open insolvency proceedings must/can be filed for your company.
If you are the debtor, I will assist you in preparing and conducting insolvency proceedings as well as in defending against liability claims. If your business partner is insolvent, I will help you with enforcing your claims against the debtor company or the insolvency administrator or support you in defending against possible liability claims brought against you by the insolvency administrator.