Germany: The planned changes by the ‘Act to Mitigate the Consequences of the COVID 19 Pandemic’ in insolvency law

The changes in insolvency law planned by the German government are intended to enable and facilitate the continuation of companies that have become insolvent or are experiencing financial difficulties as a result of the spread of the SARS CoV-2 virus (‘COVID 19 Pandemic‘). It is essentially what the German government wants to achieve with its proposed wording for a new ‘law to mitigate the consequences of the COVID-19 pandemic’  in insolvency law with a bouquet of measures, such as:

• Temporary suspension of the obligation to file for insolvency for companies that become insolvent in the period from 1 March to 30 September 2020 (‘Suspension Period‘);
• Liability privilege for managers in respect of payments during the Suspension Period which serve to maintain or resume business operations or to implement a restructuring plan;
• Privilege and protection against insolvency avoidance for the contractual partners and the financing creditors of the company affected by the COVID 19 Pandemic for any (legal) transactions during the Suspension Period
• Suspension of liability for the protraction of insolvency proceedings due to so-called ‘selfish’ or otherwise immoral restructuring loans;
• Protection against the avoidance of so-called congruent coverages (section 130 German Insolvency Code) during the Suspension Period;
• Protection against the avoidance of certain incongruent coverages (section 131 German Insolvency Code) during the Suspension Period;
• Protection against creditors’ insolvency applications for 3 months from the day after the promulgation of the ‘Act on Mitigation of the Consequences of the COVID 19 Pandemic’. 

1. Suspension of the obligation to file for insolvency and protection against insolvency applications by creditors

The cornerstone of the package of measures recommended by the Federal Government is a temporary suspension of the obligation to file for insolvency in the period from 1 March 2020 to initially 30 September 2020. The Federal Government can extend the Suspension Period until 31 March 2021. The retroactive effect of the suspension of the obligation to file for insolvency as early as 1 March 2020 will also benefit companies that are already insolvent today. However, the suspension does not apply to companies whose insolvency maturity is not due to the consequences of the COVID 19 pandemic or to companies that have no prospects of eliminating their insolvency. If the affected company, however, was not yet insolvent on 31 December 2019, it is assumed that these reasons for exclusion from the suspension do not apply and that there is therefore no obligation to file for insolvency for the duration of the Suspension Period. This will considerably simplify the practical application of the suspension rule.

However, it is not clear from the proposed wording what are the consequences of an insolvency maturity that has already occurred after 1 March 2020 and whether the suspension also suspends an already realised delay in insolvency. There is much to suggest that the three-week period for filing for insolvency is interrupted during the Suspension Period and therefore, in individual cases, even insolvency maturity that occurred less than three weeks before 1 March 2020 can be covered by the suspension. 

The draft legislation provides that within the first three months from the day after the announcement of the ‘Act on Mitigation of the Consequences of the COVID 19 Pandemic’, a creditor insolvency application for the assets of the company affected by the pandemic is justified if the reason for opening insolvency proceedings already existed on 1 March 2020.

2. Suspension of directors’ liability for payments after insolvency

The liability privilege for the managing directors with regard to payments in the Suspension Period, which serve to maintain or resume business operations or to implement a restructuring concept, as provided for in the draft legislation, ensures that the continuation of the (insolvent) company (permitted under the plans of the Federal Government in the Suspension Period) does not lead to personal liability of the managing director. The directors covered by this include AG management board members, GmbH management board members, cooperative management board members as well as representatives of partnerships in which no personally liable partner is a natural person. 

3. Facilitated liability-free crediting of (insolvent) companies during the Suspension Period

According to the current legal situation, the investor or the financing shareholder is exposed to considerable liability and rescission risks if it grants the company restructuring loans during the crisis. This is because, on the one hand, shareholder loans are generally subordinated in insolvency and, thus, regularly fail completely, and on the other hand there is the risk that the crediting in the crisis could trigger the offence of aiding and abetting insolvency and therefor sensitive liability consequences for the investor. To make matters worse, even a bona fide investor must expect, in the event of successful repayment (or collateralisation) of the loan, that the subsequent insolvency administrator will demand the back payment . It is precisely these risks that the German government plans to eliminate with the formulation aid ‘Law to mitigate the consequences of the COVID 19 Pandemic’: 

a) Loans from third parties outside the company

According to the scheme provided for in the draft legislation, the challenging by the insolvency administrator  of payments (or security) provided by a company up to 30 September 2023 on loans granted during the Suspension Period is per definition not (any longer) disadvantageous to creditors and thus cannot be challenged in the insolvency of the company. 

Furthermore, according to the proposed regulation, granting loans and collateral during the Suspension Period is not to be regarded as an immoral contribution to the protraction of insolvency proceedings , which is why the risk of an obligation to repay and/or liability for immoral damage to the investor no longer threatens.

b) Shareholder loans

The repayment of shareholder loans and payments on claims arising from legal acts that are economically equivalent to such a loan, are also not challengeable. However, this does not include the provision of „new“ collateral for shareholder loans already granted.

Notwithstanding para. 39, subsection 1, No. 5 and para.  44a, German Insolvency Code, shareholder loans granted during the Suspension Period will not only be satisfied subordinate in insolvency proceedings concerning the assets of the company, which are applied for by 30 September  2023, but will also be taken into account as insolvency claims in the final distribution on a pro-rata basis in the rank of para. 38 German Insolvency Code.

c) Suspension of bankruptcy challenge in free circulation 

In order to protect the other contractual partners of the company affected by the pandemic, the draft legislation also provides for a partial suspension of the insolvency challenge per se: The insolvency avoidance of congruent cover (section 130 German Insolvency Code) during the Suspension Period is excluded, unless the opponent of the avoidance was aware at that time that the debtor’s restructuring and financing efforts were not suitable to remedy an insolvency which had occurred. The same suspension effect applies to selected cases of incongruent cover (section 131 German Insolvency Code), namely

• services in lieu of or on account of performance;
• payments by a third party on the instruction of the debtor;
• the provision of security other than that originally agreed, if this is not more valuable;
• shortening of payment terms and
• granting of payment facilities.

In particular, however, the regulations on the challenge of intent (section 133 German Insolvency Code) and on the challenge of gifts (section 134 German Insolvency Code) remain largely unaffected by these changes.

4. Entry into force

The ‘Law on Mitigation of the Consequences of the COVID 19 Pandemic’ is expected to be adopted on 27 Friday March 2020 and to enter into force shortly thereafter. The changes in insolvency law described here will then apply from 1 March 2020 to 31 March 2021.