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News regarding over-indebtedness as a reason for insolvency applicable from 01 January 2021 – obligations and options of the management

  • Germany
  • Restructuring and insolvency


On 17 December 2020, the German Bundestag adopted the Act on the Further Development of the Restructuring and Insolvency Law (Gesetz zur Fortentwicklung des Sanierungs- und Insolvenzrechts, SanInsFoG) which will result in numerous changes of the restructuring and insolvency law with effect from as early as 01 January 2021. The new law inter alia contains adjustments regarding the reasons for the opening of insolvency proceedings and the obligations to file for insolvency. As any violation of these obligations may entail a personal liability, it is of utmost importance that executives are aware of the current legal situation. Moreover, a recent decision of the German Federal Finance Court (Bundesfinanzhof, BFH) has provided legal security on the tax consequences when considering the possibility to remedy an over-indebtedness by way of subordination.

1. Obligation to file for the opening of insolvency proceedings in case of illiquidity and over-indebtedness

| In principle, the German legislator maintains the previous regulation that legal entities and companies where there is no natural person with unlimited personal liability have to file for the opening of insolvency proceedings in case of illiquidity and over-indebtedness.

| The definition of illiquidity remains unchanged. A company is hence illiquid if it is unable to meet its payment obligations when due. Any obligations outstanding on the test day must be compared to the cash available to fulfil such obligations. Only minor deficits of up to approximately 10% of the outstanding liabilities are harmless, provided that they can be expected to be remedied in the near future.

| The previous definition of over-indebtedness will also basically remain the same. Pursuant to the version in effect from 01 January 2021, a company is over-indebted if the company's assets no longer cover the existing liabilities unless, considering the circumstances, it is highly likely that the enterprise will be continued over the next twelve months. For the first time in German insolvency law, the previously undetermined projection period for a continuation of the company as a going concern has now been stipulated in terms of time.

| The two-tier assessment of a company's over-indebtedness pursuant to insolvency law usually begins with an evaluation of the company's chances to be continued as a going concern. In this respect, it has to be considered how likely it is that liabilities which become due during the projection period can be fulfilled. If the continuation is likely and documentable, it is not necessary to assess an over-indebtedness on a balance sheet basis. If there are any doubts regarding the chances of continuation, however, the existing liabilities have to be compared to the company's assets on the test day to determine the state of over-indebtedness. Due to the missing projection on the continuation of the company, this comparison has to be based on liquidation values. If this test reveals a deficit in the balance sheet, over-indebtedness is established as a reason for the opening of insolvency proceedings.

| As soon as an illiquidity or over-indebtedness occurs, it is in principle no longer possible to use the newly created instrument of a restructuring outside of insolvency proceedings which will be available from 01 January 2021 pursuant to the Corporate Stabilisation and Restructuring Act (Gesetz über den Stabilisierungs- und Restrukturierungsrahmen für Unternehmen, StaRUG).

2. Deadline for the application to open insolvency proceedings and payments after a company became insolvent

| The principle that an application for the opening of insolvency proceedings has to be filed "without culpable delay" once a reason for insolvency is established will remain applicable. However, as of 01 January 2021 there will be a distinction with respect to the absolute maximum period. This deadline is

  • three weeks in case of illiquidity (as before);
  • six weeks in case of over-indebtedness.

| The managing directors of companies with limited liability have so far already been exposed to the risk of a personal liability for payments from company funds after the company became illiquid or over-indebted, unless they have acted with the care of a prudent businessman.

| The provisions on liability which have previously been covered by the corporate law statutes will be summarised in a new Sec. 15b of the German Insolvency Code (Insolvenzordnung, InsO) with effect from 01 January 2021. This new section also contains a more precise distinction between "prohibited" payments, i.e. payments establishing liability, and "permitted" payments:

  • The abstract parameter for an assessment of payments is whether they have been consistent "with the care of a diligent and prudent managing director".
  • During the period in which an application for the opening of insolvency proceedings has to be filed, payments which are made within the ordinary course of business, in particular payments aiming at maintaining the business operations of the company, are admissible provided that, at the same time, measures are taken to sustainably remedy the company's insolvency or to prepare an application for the opening of insolvency proceedings.
  • After the expiry of the respectively relevant filing period of three or six weeks, it can regularly be assumed that payments are not consistent with the required duty of care and thus trigger a liability.
  • Following the submission of an application for the opening of insolvency proceedings, managing directors can in the future rely on the fact that payments to which a court-appointed preliminary insolvency administrator has consented are deemed admissible.

| As a legal consequence of a "prohibited" payment, the managing director becomes liable to make restitutions vis-à-vis the company. This means in principle that any and all payments have to be fully refunded. The managing director can, however, prove that the damage incurred by the creditors was lower and, in such case, only has to compensate for the amount of damage.

3. Particularities in case of an over-indebtedness due to the consequences of the COVID-19 pandemic

| The suspension of the obligation to file for the opening of insolvency proceedings in effect since 01 March 2020 for companies affected by the COVID-19 pandemic will in principle also cease to apply to over-indebtedness as a reason for insolvency by 31 December 2020.

| The obligation to file for the opening of insolvency proceedings will only be suspended until 31 January 2021 for companies which applied for the granting of financial assistance in the period from 01 November 2020 until 31 December 2020 within the framework of government bailout plans to mitigate the consequences of the COVID-19 pandemic but have not yet received any payments or have not yet been able to file an application for actual or legal reasons. An additional prerequisite is that the application filed or yet to be filed has a reasonable chance of success and that the insolvency can be averted by the financial assistance applied for. These prerequisites have to be carefully assessed if they are sought to be used as a justification for the decision not to file an application for the opening of insolvency proceedings.

| If the over-indebtedness of a company (on a balance sheet basis) was caused by the COVID-19 pandemic, however, in the period from 01 January 2021 until 31 December 2021 it is sufficient that a continuation of the enterprise for a period of four (instead of twelve) months is highly likely in order to exclude an over-indebtedness under insolvency law. If the company is considered to be continued for the next four months, it is hence not required to file an application for the opening of insolvency proceedings in such cases.

| In this respect, the following criteria determine whether the company's situation has been caused by the pandemic:

  • the company was not illiquid on 31 December 2019;
  • the company generated a positive result with its ordinary business activities in the last financial year completed before 01 January 2020; and
  • the company's turnover decreased by more than 30% in the calendar year 2020 compared to the previous year.

| If, despite the fact that the company's poor situation was caused by the pandemic, the company is found to be over-indebted or illiquid as defined by insolvency law and if, due to this, insolvency proceedings have to be instigated, the generally increased requirements for access to debtor-in-possession management in effect from 01 January 2021 do not yet apply to the affected companies and their managing directors until 31 December 2021. In particular, it is not required to submit a comprehensive debtor-in-possession management plan (cf. Sec. 270a InsO) along with the application for the debtor-in-possession management. The fact that the company's poor situation was caused by the pandemic can either be proven by an attestation of a qualified person or an affirmation by the managing director that there are no liabilities which had already been due for payment on 31 December 2019 and had not been contested at that point in time.

4. Remedying an over-indebtedness by way of subordination

| If the over-indebtedness statement shows a deficit on a balance sheet basis, such deficit may be balanced by a creditor subordinating its claims against the company to other claims. If such subordination is carried out correctly, the creditor's claims do not have to be considered in the over-indebtedness statement (cf. Sec. 19 para. 2 sent. 2 InsO).

| It is, however, not intended that the claim can no longer be recorded as a liability in the balance sheet due to the subordination thus creating a taxable profit. For this purpose, a wording was designed to achieve the balancing act between a tax consideration and a non-consideration under insolvency law.

| Pursuant to prior decisions of the BFH, it must be agreed to settle a subordinated claim not only from future revenues or profits or a possible liquidation surplus but also from "other free assets".

| It was, however, not yet clear whether – as assumed by several local tax authorities – the actual circumstances of the company have to be taken into account in addition to the wording of the provision and whether a recording of the claim as a liability in the balance sheet for tax purposes is not admissible if it is highly unlikely that "other free assets" become available.

| In a current decision (file ref. XI R 32/18), the BFH has now rejected this approach and ruled that only the legal content of the subordination provision shall be relevant.

| For managing directors, this decision means that they should review any already existing consents to subordination with respect to their correct wording. Providing additional legal security, the decision also supports the instrument of subordination as a countervailing measure in times of turmoil. Especially in times when it is hard to predict the future, managing directors who can show a coverage on a balance sheet basis within the framework of the over-indebtedness statement independent of the projection on the continuation of the company are well prepared.