A. DOMESTIC FAMILY OF COMPANIES
1. If insolvency proceedings must be commenced for the family of companies, does your law permit a joint proceeding, ie, a single court file, a single judge, a single list of creditors, single notice list, or must the case for each member of the family proceed separately with no practical acknowledgement of the related proceedings?
No group insolvency in Germany
German law does not recognise group insolvency. Consolidated insolvency is provided neither in substantive or procedural law. This has the result that, in principle, each legal unit
– whether a natural or legal person – will be dealt with in separate insolvency proceedings. The fact that there may be group involvements between these legal units is ignored. This legal situation does not change the fact that there is in Germany a practical need for a consolidated insolvency regime. Logically, Germany has long since adopted the legal institution of interpreting the written insolvency law as group law in order to make up for the neglect of the legislature in this regard. The starting point in this respect is always that factual and legal coordination of the various proceedings concerning the assets of family members must be ensured. Such coordination is made possible by the more intensive application of the insolvency plan procedure (s 217 et seq Insolvency Act – InsO) and self-administration (s 270 et seq InsO). The framework thereby created is, in turn, filled out by the ‘Principle of Personal Union’.
The Principle of Personal Union
The Principle of Personal Union is not part of the written law but a development from practice. It prescribes that the same natural person be administrator-in-insolvency in the case of every member of a family of companies. This is possible in two ways, either: (1) the relevant person is appointed initially only as administrator of the parent company. As such he may then decide how to proceed with regard to the subsidiaries, whether they also make an insolvency application or whether they – as financially sound companies – should continue in business. If insolvency applications for the subsidiaries are also to be made, the administrator will urge the court to appoint him also as administrator of these companies; or
(2) the same individual is appointed from the outset as administrator of all insolvent group companies. This is applied if the individual companies – possibly due to an internal group domino effect – make insolvency applications simultaneously or almost simultaneously.
The Principle of Personal Union is not legally enforceable. If it cannot be put into practice for a factual reason such as the resistance of the insolvency court or of the creditors the only hope that remains is that the various administrators will consult and coordinate their work as far as possible.
The Insolvency Plan Procedure (‘Plan Procedure’)
The Plan Procedure is, in combination with the Principle of Personal Union, the main instrument rendering consolidated group insolvencies possible in Germany. It is modelled on Chapter 11 of the US Bankruptcy Code (‘BC’). The legal essence of the Plan Procedure is that the participants in the Insolvency Plan can deal with ‘the satisfaction of creditors entitled to separate satisfaction and of the creditors of the insolvency proceedings, the realisation of the assets in the insolvent estate and the distribution among the participants as well as the debtor’s liability after the ending of the insolvency proceedings … otherwise than as provided in this Act’ (s 217(1) InsO). Section 217(1) InsO is therefore a conclusive provision and modifications relating to matters other than those listed there are not admissible.
While the Plan Procedure, like the normal procedure, is based on the legal separation of all legally independent members of an insolvent family of companies, it is distinguished from the normal procedure in two significant respects. The Plan Procedure is directed more strongly than the normal procedure at the continuation of the debtor company. In the Plan Procedure, the creditors (not the administrator) decide the future of the debtor company. Although the creditors in the normal procedure also have a right of codetermination and the opportunity to exercise some influence through the creditors’ committee and the creditors’ meeting, these rights are of a supervisory nature. The Plan Procedure guarantees the creditors a right to take initiative. If the participants want to make their own proposal for a solution which appears to them to be favourable, they can do so in the Plan Procedure within the legal parameters which will be explained below.
Some technical issues of the Insolvency Plan: the Insolvency Plan can be presented to the court by the debtor or the administrator (s 128(1) InsO). The debtor can do this even when making the insolvency application and thereby work at an early stage towards a restructuring. The initiative, however, often comes from the creditors, who may entrust the administrator with the preparation of the Plan which the administrator must present to the court within a reasonable period (s 218(2) InsO). The Insolvency Plan consists of a ‘declaratory part’ and a ‘constructive part’. In the declaratory part, information must be given as to the measures taken or still to be taken after the opening of the insolvency proceedings and the basis for the planned structuring of the rights of the participants (s 220 (1) InsO). In addition, it should contain all other data significant for the decision of the creditors and the court on the Insolvency Plan (s 220(2) InsO). In the constructive part, it should be stated ‘how the legal position of the participants is intended to be changed by the Insolvency Plan’ (s 221 InsO). Here, the legal position of the creditors (including non-secured creditors) can be affected (s 223 et seq InsO). Provisions relating to the liability of the debtor (s 227(1) InsO) and, in the case of entities without legal personality or limited partnerships, relating to the liability of partners (s 227(2) InsO), may also be included.
The Insolvency Plan must be rejected by the court ex officio if it does not comply with legal provisions or obviously has no chance of success (s 231 InsO). If this does not happen, opinions on the Plan will be obtained (s 232 InsO). The court will fix a date for hearing, at which the creditors’ voting rights will be discussed and then the Plan will be voted on (s 253 InsO).
It is to be noted that s 222 InsO provides for the formation of groups of creditors. This group formation is obligatory in so far as creditors with different legal positions are involved. The further division into sub-groups is discretionary if, within one group of creditors with the same legal status, creditors with equivalent economic interests are combined. The question of whether a characteristic of a debt, such as that of being a tax debt or a foreign debt, can be an adequate ground for the formation of sub-groups in accordance with s 222(2) sentence 1 InsO, is disputed.
The creditors vote on the Insolvency Plan in these groups (s 243 InsO). This concept considerably simplifies the achievement of consensus. In principle, within each creditor group a majority both of members and of the amount is necessary (s 244(1) InsO). Agreement is also facilitated by the prohibition on obstruction (s 245 InsO), according to which the rejection vote of a group can be declared to be irrelevant if it is foreseeable that those affected will not be worse off than they would be in a normal procedure. An objection of the debtor can also be overcome (s 247(2) InsO). Finally, the Insolvency Plan must receive the confirmation of the court (s 248(1) InsO).
If the court, the debtor and the creditors have agreed (or if their agreement is assumed in the Act), the Insolvency Plan acquires legal effect (s 254(1) InsO). The insolvency proceeding, in which the debtor is nevertheless involved, is terminated (s 258(1) InsO), and the debtor’s right of disposal of the assets is restored (s 259(1) sentence 2 InsO). This is, however, subject to restrictions, because the Insolvency Plan may prescribe that the administrator-in-insolvency monitors the debtor (s 260(1), s 261(1) InsO) and that legal transactions require his approval. In that case, the creditors will be informed of how matters are proceeding (s 261(2) InsO).
The Plan Procedure becomes a vehicle for group insolvency when it is coordinated over a number of companies. This can be achieved by integrating the various insolvency plans into an overall group concept in the declaratory part and showing the possibilities and advantages of the consolidation of the family of companies. In the constructive part (s 221 InsO), the roles of each company in the strategy can be defined. The concept is supplemented by the Principle of Personal Union already mentioned.
The weakness of this scheme is that the overall concept must be approved for each entity. The above-described procedure of agreement of all participants must be repeated for each company, and consequently this form of group insolvency is particularly dependent on agreement and therefore procedurally costly.
Self-administration
Self-administration by the debtor can serve as an alternative in group insolvency (s 270 et seq InsO). This is all the more so because it can be linked to the Plan Procedure (s 284(1) InsO). Self-administration also has similarities to the Chapter 11 BC. It can be directed towards either the restructuring of the company or its liquidation. Self-administration permits the debtor ‘under the supervision of an administrator, to manage the insolvent estate and dispose of the same’ (s 270(1) InsO). Internal company know-how should be utilised. By self-administration initially in the group parent, uniform management of the entire group can be attempted without the subsidiaries, as far as possible, being declared insolvent. If the insolvency of the subsidiaries cannot be avoided, the Principle of Personal Union comes into play. The subsidiaries will be taken into insolvency in a planned manner and the court will be urged to appoint the same administrator. This constellation has already been described above.
Contrary to what is partially the case with Chapter 11 BC (s 1107 BC, debtor in possession), the debtor does not retain full autonomy over the assets but an administrator is imposed as his supervisor (s 274 InsO). Self-administration is especially appropriate for major companies, because company and management assets are mostly separate and the conflicts of interests often experienced in insolvency proceedings do not arise.
Self-administration is applied for by the debtor itself (s 270(2) No 1 InsO) – the existence alone of this legal institution is, in itself, an incentive for the debtor to make the application in good time – namely, as soon as inability to pay is threatened (s 18 InsO). If a creditor has made an insolvency application, that creditor’s agreement to self-administration must be obtained (s 270(2) No 2 InsO). In addition, the ordering of self-administration must not lead to any delay in the proceedings or ‘other disadvantage for the creditors’ (s 270(2) No 3 InsO). It is notable and of practical relevance that, if the debtor’s application for self-administration is refused by the court, self-administration can nevertheless be forced through if the creditors’ meeting so demands (s 271 InsO). The administrator-in-insolvency already appointed can, in this case, become the administrator (s 271 sentence 2 InsO).
For legal acts of special significance, the debtor requires the approval of the creditors’ committee (s 275 InsO). On the application of the creditors’ committee, a general requirement of the administrator’s approval for certain legal transactions can be imposed.
(a) What if the members of the family are organised under, or operate in, different locations within your country? Can a company from a distant location in your country commence its bankruptcy proceeding where its affiliate is located, if the affiliate has already commenced its bankruptcy proceeding?
The court before which insolvency proceedings are taken is provided for in s 2(1), s 3(1) InsO and ss 12–17 Code of Civil Procedure (Zivilprozessordnung – ZPO). According to s 3(1) sentence 2 InsO, the place where the debtor has ‘the centre of its independent economic activity’ is usually decisive and only exceptionally its usual place of court jurisdiction according to ss 12–17 ZPO. The ‘centre of its independent economic activity’ is the place from which the major part of the business is independently conducted. It is the outward conduct of the business, not internal procedures, which are crucial. If the operating plants and management centre are not in the same place, the management centre is decisive. This is deemed to be the ‘establishment’ under s 21 ZPO. Notifications such as notice of a business operation, entry in the Commercial Register or the registered office as specified in the articles of association, are not material. They may, however, give indications as to the actual position.
If affiliates (subsidiaries, parent or sister companies) are insolvent, the insolvency proceedings for all companies cannot be conducted before one court, if the managements – responsible for external contacts – are based in different court areas of jurisdiction. The insolvency court at the management centre of the parent has jurisdiction in the insolvency of the subsidiary – contrary to the position in the US – only if the business of the latter was also directed from the management centre of the parent.
(b) To the extent your country has different types of insolvency proceedings (such as Chapter 11 reorganisation and Chapter 7 liquidation in the US), do the members of the corporate family all have to proceed under the same type of proceeding?
Apart from the normal procedure, German law recognises, in the Plan Procedure and self-administration, two other procedures (s 217 et seq InsO and s 270 et seq InsO, cf question 1). The normal procedure is similar to that under Chapter 7 BC; the Insolvency Plan and self-administration each contain elements of Chapter 11 BC, although significant differences also exist.
As it is a fundamental principle of German law that the insolvency of each legal entity in a group is dealt with separately, and therefore a consolidated insolvency in the technical sense is not possible, there is logically no requirement that all members of a group be dealt with by the same procedure. It is at most possible that, in the coordination of insolvency plans of several companies, the effectiveness of the Plan may be made dependent on its acceptance in all other proceedings relating to all other members of the group. The comments on the Insolvency Plan are referred to (cf question 1).
2. Does your law permit, or prohibit, a single administrator/trustee/ receiver to administer the assets and the liabilities of the entire corporate family?
The Insolvency Act does not recognise a group administrator-in-insolvency, due to the individualistic philosophy of German insolvency law. However, this is subject to reservations because, while a single administrator is not technically provided for, the possibility that the same individual occupies the office of administrator-in-insolvency in various proceedings nevertheless exists through the Principle of Personal Union. Considerable potential for coordination can thereby be achieved, without officially there being a single administrator, as such.
Similarly, application for self-administration by the subsidiaries can be made (s 270 et seq InsO). At the same time, an administrator-in-insolvency will be appointed to the parent company (in the normal procedure or the Plan Procedure). The function of the administrator (Sachwalters) (s 279 et seq InsO), who supervises the self-administration by the debtor, can then also be exercised by the administrator-in-insolvency of the parent.
A further variant may be the establishment of a contractual bond between various administrators-in-insolvency. According to s 159(1) InsO, this is possible with the agreement of the creditors’ committee (s 160(1) InsO; cf the following question also). While this does not result in a single administrator either, it facilitates coordinated action within the group.
(a) If so, is there a hearing for the court to determine whether the administration by a single party is appropriate? Are secured and unsecured creditors or other parties in interest allowed to object or be heard at such hearing?
The weakness of the above-described measures is the considerable need for consensus, which is evident in various guises – on the one hand by the dependency on the decisions of the court (or courts) dealing with the proceedings (s 270(1) sentence 1 InsO) including appointing the administrator (ss 27 and 56 InsO); on the other hand, by the dependency on the approval of the creditors’ meeting or committee.
The creditors are mainly organised into two bodies. The creditors’ meeting (s 74 InsO) consists, in principle, of all creditors. The debtor, the administrator-in-insolvency and the members of the creditors’ committee can participate in the creditors’ meetings, the major powers of which consist in the appointment of a creditors’ committee (s 68 InsO), the right to demand a report from the administrator, the decision on the continuation or closure of the business, the decision on an Insolvency Plan (s 157 InsO), the prevention of the sale of the debtor to certain ‘close interests’ (s 162 InsO), and the monitoring of significant legal acts of the administrator-in-insolvency (s 161 sentence 1 InsO; important: sale of the debtor company). The creditors’ meeting decides with an absolute majority, although the votes are weighted in accordance with the debts notified (s 77 InsO). For disputed debts, a preliminary mediation and assessment procedure applies.
Secondly, the creditors are organised into a creditors’ committee (s 67 InsO). This is a smaller and more compact body than the creditors’ meeting, and therefore likely to be more consensual. The creditors with the highest claims, small creditors and a representative of the employees (in so far as they have significant claims), belong to the committee. Decisions are made by a majority of those present at each meeting, although a quorum of at least half of the members is required. The votes are not weighted in accordance with claims. The committee’s powers are similar – though not identical – to those of the creditors’ meeting. The committee participates in the decision on the closure of the business (s 158 InsO), significant transactions of the administrator (s 160 InsO), the administrator’s distribution of the assets (s 187(3) InsO) and the dividend. In addition, the members of the committee should assist the administrator, but also monitor his work (s 69, 261(3), 232(1) No 1, 233 sentence 2). The committee should serve the interests of all creditors, not of particular creditors. Its members have a right to remuneration (s 72 InsO).
In the Plan Procedure, the opinion of the creditors’ committee is required at an early stage after the Insolvency Plan has been filed with the court (s 232(1) No 1 InsO). According to s 243 InsO, all the creditors ultimately also vote on the Plan, although in the groups into which they are divided by the Plan. According to s 244 InsO, a majority of the creditors and of the amount of the claims is required. The latter is dealt with in s 237 InsO together with s 77 InsO, which provide the details as to the voting by amount and therefore the weight of the creditors’ votes. According to s 237(1) sentence 2 InsO, it is to be noted, as far as creditors entitled to separate satisfaction are concerned, that they are entitled to vote as insolvency creditors only in so far as the debtor is also personally liable to them and they waive separate satisfaction or do not receive satisfaction under that right. Section 238 InsO concerns the discussion of voting rights of the creditors entitled to separate satisfaction whose rights are affected. According to s 237(2), such creditors whose claims are not affected by the Insolvency Plan have no right to vote. In the context of the creditors’ right to reject the Insolvency Plan, the prohibition on obstruction by creditors (s 245 InsO), according to which the rejection by a creditor group can be overruled if: (1) they would not be worse off under the Plan; (2) they are intended to reasonably participate in the financial proceeds of the Plan; and (3) the majority of groups have approved the Plan, is significant. Section 251 InsO takes account of the protection of minority creditors who would be worse off under the Plan. The Plan can be rejected on their application.
Self-administration also contains hearing and co-determination elements. According to s 70(2) No 2 InsO, the consent of the creditor who has made the insolvency application must be obtained to an application by the debtor for self-administration. If the court refuses the application for self-administration, the creditors’ meeting can nevertheless force it through (s 271 sentence 1 InsO), in which case the administrator-in-insolvency can be appointed administrator to the self-administering debtor (s 271 sentence 2 InsO). The approval of the creditors is also required for especially significant legal acts of the debtor. According to s 276 InsO, the approval of the creditors’ committee is to be obtained for such acts.
(b) What about joint representation by other professionals, such as law firms or accounting or auditing firms?
Joint representation of this kind is admissible, in principle. The Lawyers’ Professional Regulations (Berufsordnung der Rechtsanwälte – BORA), however, restrict this in so far as simultaneous representation of several group companies may involve conflicts of interest. A lawyer may not, according to s 3(1) of the Lawyers’ Professional Regulations, act if he, in any function whatsoever, has advised or represented another party in the same legal matter in the opposite interest or advises or represents such party. A lawyer or other person providing legal assistance who, in relation to matters confided to him in this capacity in the same legal matter provides both parties with advice or assistance in breach of duty, shall be punished by imprisonment of between three months and five years, according to s 356 Criminal Code (Strafgesetzbuch – StGB).
It must also be noted that, under s 8 Legal Advice Act (Rechtsberatungsgesetz – RBerG), an administrative offence is committed by whoever offers legal advice professionally without having the licence prescribed by law. Auditors and tax advisors should particularly ensure that they do not cross the border between financial and legal advice when advising on restructurings. For example, according to current judgments, a contract on the basis of which a tax advisor undertook, for a company in crisis, responsibility for the restructuring negotiations with its creditors, is void.
3. Does your law encourage or discourage overlapping boards or management teams for separate members of a corporate family?
Double functions at supervisory board and management board level are common and typical characteristics of groups. German law does not provide extensively for the questions which arise. Some restrictions are placed on supervisory board members, while duplication of management board memberships is not regulated.
In s 100(1–4) of the Stock Corporation Act (Aktiengesetz – AktG), the personal requirements for supervisory board members are set down. Three reasons for exclusion are stated in s 100(2). Firstly, s 100(2) sentence 1 No1 excludes a person who is already a member of the supervisory boards in ten companies which are statutorily obliged to form a supervisory board (a supervisory board must be established in stock corporations, partnerships limited by shares, limited liability companies with more than 500 employees and all investment companies). However, s 100(2) sentence 2 AktG provides an exception for groups. The legal representative of the company controlling a group (as to the concept ‘group’ and ‘controlling company’ cf the following question) may hold five additional positions within the group, in addition to the permitted ten. ‘Legal representative’ here means the members of the management board of a stock corporation, the general partner in a partnership limited by shares, the managing director(s) in a limited liability company, the general partner in trading partnerships and limited partnerships and the partners in a civil partnership. It is also to be noted that s 100(2) sentence 3 AktG states that among the ten positions permitted in principle, the positions in which the individual is also chairman of the management board are to be counted twice. Secondly, s 100(2) sentence 1 No 2 AktG excludes supervisory board membership of legal representatives of a subsidiary. Thirdly, s 100(2) sentence 1 No 3 AktG excludes supervisory board membership of legal representatives of another company in which a member of the management board is also on the supervisory board.
The legislature has passed no comparable provisions with regard to double management board memberships, which are, as is unanimously agreed, admissible. This can also be deduced from s 82(1) sentence 2 AktG, which prescribes supervisory board approval of double membership. Although double membership is not prohibited, it carries the risk of conflicts of interests, particularly concerning possible voting rights prohibition, which is discussed for some time in the literature without a satisfactory outcome and which has been the subject of only occasional judgments of lower courts. In any event, a prohibition on voting in the meaning of s 136(1) AktG, applies if, on the occasion of the discharge of the management board of a controlled company, management board members of the parent company with double positions are in the majority. In this case also, neither is the authorising of a third party admissible.
(a) If the directors of a parent company are not directors of the subsidiary, but they either directly or indirectly manage the affairs of the subsidiary anyway, do your country’s laws render such people de facto or ‘shadow’ directors of the subsidiary?
Here, the following distinction must be made:
Sections 291 ff AktG
German law provides in s 308 et seq or s 311 et seq AktG different legal consequences linked in the case of stock corporations in some instances to contractual or de facto control of one company by another. The understanding of these provisions will be facilitated by referring to s 15 et seq AktG. The list in s 15 AktG provides the definitions: ‘Affiliated companies are legally independent entities which, in relation to each other, are in majority ownership, and majority-holding companies (s 16), controlled or controlling companies (s 17), group companies (s 18), companies with cross-shareholdings (s 19) or parties to an inter-company agreement (ss 291 and 292).’ Of particular interest here is the definition of the group in s 18 AktG, where emphasis is placed on ‘unitary management’, and on the inter-company agreement within the meaning of s 291 AktG and integration within the meaning of s 319 AktG. In addition, a rebuttable presumption of a group is applied to controlled companies.
If an inter-company agreement within the meaning of s 291 AktG exists, ss 208–310 AktG apply. While the members of the management board of the parent company are not thereby declared to be ‘de facto directors’, rights and duties are attributed to them. According to s 308(1) sentence 1 AktG, the controlling company is entitled ‘to issue orders to the management of the controlled company on the management of its business’ On the other hand, mutual duties are also provided for. The controlled company has a right to have its losses made good (s 302(1) AktG), the legal representatives of the controlling company have the duty to exercise the ‘care of a diligent and conscientious manager’ and are liable for compensation if they breach this duty (s 309(1) and (2) AktG). According to s 310(1) sentence 1 AktG, they are liable jointly and severally with the members of the management board and the supervisory board of the controlled company.
In the case of de facto groups, ie control without an inter-company agreement, ss 311–318 apply. It is to be noted that, according to s 311(1) AktG, disadvantages for the controlled company can be incurred only if they are made good. A breach of this duty also results in compensation claims (s 317(1) sentence 1 AktG). In addition, there are various reporting and auditing obligations in particular on the supervisory board (s 312 et seq AktG).
The provisions on groups in s 291 et seq AktG are substantially applied by analogy to the limited liability company (GmbH). This takes place in particular for the protection of the insolvent subsidiary GmbH.
Legal development: the de facto managing director
In principle, an individual is liable as an organ of a stock corporation or limited liability company if, although not actually holding that office, he acts as if he did. The scope of this liability is disputed. Without doubt, the liability applies on the assumption of the office but prior to the entry in the Commercial Register. The Bundesgerichtshof has so far only decided that it is not required for this liability to apply that the person acting completely supersedes the actual appointed management. It is crucial that the person concerned takes control of the fate of the company. Internal influence on the appointed managing directors does not suffice, but external action usually attributed to the managing director must be present. If these conditions are fulfilled, the de facto managing director will be treated in civil and criminal law as a genuine managing director, in particular with regard to the obligation to make an insolvency application s 64(2) Act on Limited Liability Companies (Gesetzes betreffend die Gesellschaften mit beschränkter Haftung – GmbHG) (cf question 9).
(b) Do the duties or responsibilities of officers or directors of a family of companies change when the companies become insolvent? For example does their duty shift from a responsibility to the shareholders to a responsibility to the creditors. What if only one of the companies is insolvent?
Under German law, the management by the usual management organs ends with the opening of insolvency proceedings, when they are replaced by the administrator-ininsolvency (s 80(1) InsO), who will, from that time, make the company’s decisions. The duty of the administrator is, however, in the first place to the creditors (s 60 et seq InsO). The institute of self-administration constitutes an exception to this. The comments in answer to question 1 are referred to.
4. Are there rules and do they change regarding members of the corporate family transferring assets among one another (such as by way of loans, capitalisation, other transactions) when the members are insolvent?
In principle, members of a family of companies are, in spite of group integration, legally independent entities. In principle, therefore, there is nothing against them mutually doing business in the course of which assets are transferred.
Under German law, there is an exception to this principle when restriction on the autonomy of a member of the group is indicated for purposes of creditor protection. These restrictions apply both outside and inside insolvency. Creditor protection is exercised in various forms, eg by the rejection of claims (s 30 et seq GmbHG) or the challenging of legal transactions (s 32a et seq GmbHG, s 135 InsO). As a whole, a complicated, intensively judge-driven legal development on the borders between insolvency and company law is involved. A complete account of this issue cannot be given here. Instead, two examples may be offered as illustrations.
Deemed capital shareholder loans (Eigenkapitalersetzendes Darlehen): If a member of a family of companies is a shareholder in another member of said family, and if the parent grants a loan to the subsidiary, it would, in principle, be entitled to repayment of the loan. If, however, the loan has the character of deemed capital, the situation is different. A loan has the character of deemed capital, if it is granted during a financial crisis of the company or if it is left with the company although a financial crisis commences. A financial crisis in the aforementioned sense exists, if the company due to its financial crisis would not have been granted the loan by a third party and would therefore have had to be dissolved unless the shareholder had granted the loan himself. In that event, the acknowledgement of a right to repayment of the loan would amount in fact to a circumvention of the provisions on the contribution and maintenance of capital. For this reason, the shareholder cannot demand repayment of the loan. The legal position is therefore very similar to the ‘recharacterisation’ in US law.
Interference causing insolvency (Existenzvernichtender Eingriff): If the parent withdraws so much capital from the subsidiary that the financial destruction of the latter results, the parent is liable to the creditors. This often has application to the GmbH or the limited partnership. Ultimately, this rule means that the subsidiary’s administrator-in-insolvency can claim against the parent company (cf (b) below). Whether individual creditors can make this claim by analogous application of s 93 InsO is at present disputed.
Cash management systems have been a normal and well-established element in internal group financing for a long time in Germany. Cash pooling, ie central payments through one account to which the cash surpluses of each group company are transferred and through which external liabilities are paid, is at the centre of the discussion.
Cash pooling systems are exposed to three risks in German law.
First, they may breach the capital contribution and maintenance rules of company law (ss 30, 31 GmbHG). They are therefore only admissible if (1) the loan is in the interests of the company;
(2) the loan is on arms’ length conditions; and (3) the creditworthiness of the shareholder is beyond doubt, even on the application of the most strict criteria, or the repayment of the loan is guaranteed by the provision of valuable security.
Secondly, the Bremer Vulkan judgment of the Bundesgerichtshof on liability for interference causing the insolvency of the subsidiary, resulted in restrictions on cash pooling systems. According to this judgment, parent companies or holdings are threatened with liability in the area of cash pooling if they do not take reasonable account of the interests of their subsidiaries which participate in the cash pooling system and the latter are unable, as a result, to meet their obligations, if the entire disadvantage inflicted cannot be made good in accordance with ss 30, 31 GmbHG. Apart from the liability by lifting the corporate veil because of such interference, compensation claims under s 826 Civil Code (Bürgerliches Gesetzbuch – BGB) arise against the parent company participating in the cash pooling system and its organs or those of the subsidiaries.
Thirdly, the Bundesgerichtshof recently stated that payments under a cash pooling system can be challenged, under certain circumstances, as payments without or with insufficient consideration under s 134 InsO.
5. How does your law treat claims of one member of a corporate family against other members of the corporate family?
(a) Are such claims invalid or unenforceable?
Claims of this kind are, in principle, to be dealt with like any other claims, as German law distinguishes between legal entities, ie it relies on the separate existence of companies, not on their membership of a group. The validity and enforceability of such claims have no connection to the status of a company as a parent or subsidiary. This does not mean that in a (co-ordinated) Plan Procedure within the meaning of s 217 et seq InsO, the parties cannot make other provisions for dealing with claims, so long as the affected creditors agree.
However, an exception exists if the claim concerns the repayment of a deemed capital loan (cf question 4). Claims based on loans which are deemed to be capital contributions are statutorily determined to be subordinate claims (s 39(1) No 5 InsO). In Germany, a creditor can demand repayment of deemed capital only after all other creditors have been satisfied. The legal position is therefore very similar to the ‘equitable subordination’ in US law.
(b) If not, are such claims on equal footing with those of third party creditors, or are they subordinated, or is there other treatment required or permitted under your law?
Special circumstances can, at most, arise if the group internal claims are based on transfers of assets within the group which are challengeable under insolvency law. According to s 129 et seq InsO, the administrator can challenge such inadmissible transfers of assets made in the previous ten years (s 133(1) sentence 1 InsO). Again, this is not an example of any special treatment of group debts, but rather an expression of their being treated equally.
6. Does your law allow for the pooling of assets and liabilities of all members of the corporate family, so that a creditor of one member becomes, in essence, a creditor of all members (sometimes referred to as ‘substantive consolidation’)?
The Insolvency Act does not recognise consolidated insolvency and, in particular, combination of assets, as US insolvency law does under ‘substantive consolidation’. The Commission on the Reform of Insolvency Law established at the beginning of the 1990s, and thereby the legislator itself, has decided against this concept on various grounds. The principles of equal treatment of creditors and of autonomy were crucial. A procedure in which creditors who never had a dispute with the debtor and contractual partner are suddenly set against each other was not thought to be desirable, because, in this manner, the estate would be reduced by other creditors without this danger being foreseeable for the business partner at the time of concluding a contract – unless he had obtained an overview of the entire group structure.
Therefore, in so far as a consolidation of the insolvent estate is aimed at in Germany, this is at most possible by means of the Plan Procedure, in which coordinated Insolvency Plans are worked out, their acceptance hoped for and the approval of the creditors obtained. Even then, it is not technically correct to speak of ‘pooling’, because the estates as such are not merged, but individual deviations from the normal procedure are agreed.
Outside insolvency, the assets of the individual group companies can be consolidated within the limits stated above (question 4 (b)).
Not applicable, as German law does not recognise ‘substantive consolidation’.
7. How are secured creditors treated with respect to a family of companies? For instance, if a creditor has a security interest in the assets of one member of the family, and a guarantee from another member of the family, are both such claims valid in insolvency proceedings of the entire family?
As in the case of the preceding question, the basic concept of German law must be referred to here. Security of any kind is valid, in principle, only against the legal entity by which it has been provided, irrespective of any group involvement of that company. This would not, of course, be the case if the creditors had autonomously decided to deviate from the normal case. The law permits group-wide effects, without imposing such effects (or even intending to impose them).
Section 32a(2) GmbHG provides an exception. If, at a time at which the shareholders as prudent businessmen would have contributed capital, a third party granted the company a loan instead and if a shareholder provided security for the loan or guaranteed the loan, the third party can only demand satisfaction in the insolvency proceedings of the amount which he has not been able to obtain by the realisation of the security or guarantee.
For satisfaction out of the security, s 52 InsO is to be noted. Secured creditors are insolvency creditors only if and to the extent that (1) the debtor is also personally liable to them, and (2) the proceeds of the realisation of the security are not sufficient to satisfy the debt completely or if they waive their security – for any reason whatsoever. Taking the above question, both securities are valid. The creditor can at his discretion obtain satisfaction from both securities, of course only up to the amount of his secured debt. If the realisation of both securities is not sufficient to satisfy the secured debt completely, he can only give notice of the shortfall in the insolvency proceedings (Ausfallforderung).
8. Do your laws or courts provide for post-insolvency commencement of new financing that allows continued operation of the business and provides adequate protection to the lender who made the loan? Explain.
Technically speaking, the answer to both the above questions is no.
Natural persons can, after the termination of insolvency proceedings, automatically endeavour to go back into business. German law does not contain any provision as to how such a return to business can or should be financed. German law assumes that such cases will be regulated by the market, without legislative intervention by the state. A natural person who has already been through insolvency proceedings would have to provide more security and pay higher interest for a loan than an individual who has not been subject to insolvency proceedings.
The same applies to partnerships and companies, although, of course, a further consideration arises, namely that partnerships and companies are usually dissolved in the course of insolvency proceedings. The question of how the continuation or new beginning of business can be financed does not arise, unlike in the case of natural persons. In the rare cases in which a partnership or company is not dissolved in the course of insolvency proceedings, the same applies as in the case of natural persons.
Again, the Plan Procedure constitutes a certain exception to what has just been said. The debtor and the creditors are not prevented from including financial planning in the Insolvency Plan catering for the financing of the continuation of the business. That is not, of course, obligatory. German law refrains from making express provisions and relies on market forces.
9. Are directors and officers subject to civil or criminal sanctions if:
(a) Fraud or misrepresentation of a company’s finances are discovered?
Fraud, in particular misrepresenting the financial position of the company by falsified or opaque accounting, gives rise to criminal liability of the managing director under s 263 or s 283 b StGB (the first offence – s 263 – is independent of the existence of grounds for insolvency). Negligence can, in the case of accounting irregularities, also lead to criminal responsibility under s 283b(2) StGB. This is provided, however, according to s 283b(3) and s283(4) StGB, the company discontinues payments or insolvency proceedings are opened or the opening of insolvency proceedings is refused because of lack of assets. A crime can also be committed under s 283 StGB if assets are misappropriated, high-risk speculative transactions are conducted, assets reduced in a manner contrary to usual financial practice or the financial position of the company is concealed or covered up, if grounds for insolvency exist or are brought about by this conduct: s 283(2) and (4) StGB.
A conviction carries the consequence that the responsible party or parties are prohibited for a period of five years from becoming members of management boards of an stock corporation (s 76(3) sentence 3 AktG) or managing directors of a limited liability company (s 6(2) sentence 3 GmbHG), the period of prohibition beginning only on the completion of any custodial sentence. More serious, however, and often unknown to foreign clients, is the consequence that all management board and managing director appointments become invalid ex nunc. This applies not only to the company in respect of which the crime was committed but to all companies in which the individual held such appointments.
Civil law liability in these cases follows out of s 823(2) BGB together with s 283 et seq StGB.
(b) They allow the company to continue to operate while knowing it does not have the ability to pay the debt being incurred?
Managing directors are, according to s 64(1) GmbHG, s 92(2) AktG, s 130a(1) Commercial Code (HGB), obliged to make an insolvency application within three weeks after grounds for insolvency have arisen. Breach of this duty results in liability to the creditor, s 64(2) GmbHG, s 823(2) BGB together with s 64(2) GmbHG, ss 823(2) BGB together with s 92(2) AktG, s 93(2) AktG, s 130a(1) HGB together with s 832(2) BGB, s 130a(3) HGB, or the company, s 93(2) AktG, s 43(2) GmbHG.
Breach of this duty also has criminal law implications (even in case of simple negligence) under s 84(1) No 2, (2) GmbHG, s 130b HGB, s 401 AktG.
(c) Same as (b) above but the directors believe that if some event occurs (eg chance to obtain new contract in prospect, new equity infusion, or new financing) it will be able to save the company and pay its bills?
The duty to make an insolvency application in the event of overindebtedness or inability to pay, is not relieved by the hopes or beliefs of the managing director(s) that insolvency can still be avoided by a favourable deal. Out-of-court restructuring efforts do not avoid the duty to make the application. The statutory three-week period is a maximum and begins from the acquisition of positive knowledge of the grounds for insolvency. Negligent lack of knowledge does not suffice to prolong the period. It follows that a managing director who believes that the company can avoid insolvency by the conclusion of a promising agreement must ensure that this agreement is concluded within the three-week period.
B. INTERNATIONAL FAMILY OF COMPANIES
1. If one or more members of the corporate family is incorporated under or governed by the laws of another country, does that change your answers to any of the questions set forth above?
German law applies to insolvency proceedings opened in Germany, irrespective of whether the German debtor is a member of an international family of companies or not. The answers to the above questions do not therefore change when applied to the German member of the family of companies. The answers may, however, be seen as mirror images:
2. If insolvency/restructuring proceedings are instituted for corporate family members in different countries:
In order to answer the above questions, the following distinction must be made. In principle, German international insolvency law is provided in ss 335–358 InsO. These provisions were amended in 2003. They contain the answer to the questions which arise in cross-border insolvencies. The relationship of Germany to every country in the world is regulated thereby
– with an important limitation. If states which have adopted Regulation (EC) No 1346/2000 of the Council on Insolvency (‘EuInsVO’) are concerned (all Member States of the EU except Denmark), the Regulation supersedes s 335 et seq InsO.
The following applies:
A German court may open insolvency proceedings with cross-border effect only if it has international jurisdiction. This corresponds to national local jurisdiction, and follows s 3 InsO. Reference is therefore made to question 2.
Example: the Amtsgericht (local court) Hamburg can open insolvency proceedings in the case of a debtor, assets or creditors of which are eg in the US, if the debtor has its general place of jurisdiction or the centre of its independent economic activity there.
German insolvency law is, in principle, applicable in insolvency proceedings opened in Germany, including to the effects of the proceedings abroad. If the foreign effects are restricted, because the foreign state does not recognise the German proceedings or certain of its effects, this cannot be changed.
Example: the debtor is obliged to assist the administrator in the administration or management of the assets (s 97(2) InsO). He must, therefore, grant the administrator power of attorney if the latter’s authority is not recognised abroad.
Insolvency proceedings opened abroad will be recognised in Germany, subject to two conditions (s 343(1) No 1 and 2 InsO):
The court which has opened the proceedings abroad had jurisdiction ‘according to German law’ ie reflecting German international jurisdiction abroad. The court must have jurisdiction according to s 3 InsO, if that provision were applied abroad, ie because the debtor has its general place of jurisdiction or the centre of its independent economic activity within the area of that court.
Recognition of foreign proceedings may not produce results incompatible with fundamental principles of German law (ordre public reservation).
There is very little regulation of the legal consequences of recognition. In principle, the relevant foreign law is decisive. This applies not only to the extent of seizure – it covers the assets located in Germany – but also the powers of the administrator, the rights and duties of other participants in the proceedings, the notification of debts, etc.
Independent of the foreign proceedings, insolvency proceedings can be opened in Germany limited to assets located there, ie a separate German insolvency proceeding (Particular proceeding s 354 et seq InsO).
In the area of the EuInsVO, the application is similar. A main insolvency proceeding is, in principle, effective for all Member States, if a particular proceeding is opened in each of the other Member States. The principle is formulated in Article 3(1) EuInsVO. For the opening of insolvency proceedings – as main proceedings (Art 27 sentence 1 EuInsVO) – the courts of the Member State in which the debtor has the centre of its main interests have jurisdiction. There are two judgments as to how this provision is to be interpreted, and according to them the place where the management decisions are made is decisive, as in English law. In the case of companies, this is the registered office according to the articles of association.
In a Member State in which no main proceeding is possible, particular proceedings concerning the assets of the debtor located there can be opened, if the debtor has an establishment there (Art 3(2) EuInsVO). The effects of this proceeding is limited to the assets located in that state. The insolvency estate of the main proceedings is reduced accordingly. In addition, a distinction has to be made:
Particular proceedings can be opened prior to the main proceedings.
A secondary insolvency proceeding can be opened after the main proceedings (Art 3(3), 16(2), 27 EuInsVO). This is automatically possible, but must result in the realisation of the debtor’s assets.
Question: can a particular proceeding be opened in Germany even if the debtor, while not having an establishment, has assets there? This is possible under s 354 InsO (‘other assets’), but not in the area of application of EuInsVO, ie if the main proceedings are opened in a state which adopted the EuInsVO.
