Germany Comes to Grips with Its Chapter 11
Germany enacted its current bankruptcy regime back in 1999. One of its objectives is to enhance the chances of an "in-court rehabilitation" of the debtor's business. To that end, new features have been introduced that, to a certain extent, follow the U.S. chapter 11 model. One such feature is that of debtor-in-possession (DIP) status. However, it took approximately six years for the first major bankruptcy case to use this rehabilitation procedure, with the result being that a deeply troubled business, Ihr Platz, was turned around in less than eight months.
Ihr Platz is Germany's fifth-largest drugstore chain with 800 nationwide outlets, generating an annual turnover of Û800 million and a workforce of 8,800 employees. Although the family business was successful for more than a century, one ill-minded acquisition and a few misguided internal business decisions by a new generation have burdened Ihr Platz with enormous debt and severe cash-flow problems.
Although initially the various domestic lenders remained cooperative and even waived approximately Û90 million of the company's debt, the lenders were ultimately unwilling to inject much-needed fresh money in order to turn the business around. Instead, the lenders sold off their loans, which were finally acquired by a major U.S. investment bank.
After thorough due diligence, the investor concluded that an out-of-court restructuring would be too expensive and time-consuming. Instead, it expressed its support for an "in-court reconstruction" in the hope that (1) the formal process could be used to implement both a financial and operational restructuring, and (2) at the end of the process, the investor would own the business. Finally, after coordinated preparations, the Ihr Platz's management board filed for bankruptcy in May 2005.
Traditionally, a business that is subject to formal bankruptcy proceedings is rescued by "hiving down" the viable parts of the business into a newly formed company, the shares of which are held by the bankruptcy administrator. The administrator then sells the shares to a third-party investor, often via private auction. The sale proceeds are then distributed to the creditors, and the debtor entity is dissolved.
For Ihr Platz, however, this approach was unfeasible because the real value of the company was (and still is) its widespread distribution network of stores. In order for this value to have been maintained, several hundreds of lease contracts would have had to have been assigned to the newly formed company, with the consent of each landlord. Amidst fierce competition in Germany among profitable drugstores, many, if not most, of the profitable stores might have been "hijacked" by competitors. Instead, an insolvency plan, an instrument very similar to a U.S. chapter 11 reorganization plan, was compiled that provided for a significant "haircut" to be borne by the creditors in order to improve the debtor's balance sheet.
During the process, the debtor's management ran the business under its self-administration status granted by the bankruptcy court under the German version of a DIP. In the vast majority of bankruptcy cases, a bankruptcy administrator (trustee) is appointed. However, in this particular case, the involvement at the pre-filing stage of experienced turnaround managers assisted in convincing the judge to grant self-administration. At the same time, a custodian was appointed to supervise the process.
Immediately after filing, the management board began to overhaul the operational business by closing down outlets with a negative cash flow, streamlining logistics and reducing the headcount. German bankruptcy law (which allows rejection of long-term contracts and leases, as well as labor agreements at typically much-shorter statutory termination periods) significantly facilitated the implementation of these measures.
During the very early stages of the process, the investor had started negotiations with the old shareholders regarding the "acquisition" of their worthless shares in the debtor. The German Bankruptcy Code does not provide for a debt/equity swap without shareholders' consent. However, in this case the investor had pledges over the shares that it could enforce by way of public auction. The risk that the old shareholders would be publicly blamed for obstructing the rehabilitation facilitated an amicable agreement.
The insolvency plan was only recently confirmed by the creditors' meeting, with an overwhelming majority, and was subsequently approved by the bankruptcy court. This meant that the formal bankruptcy process could be terminated. Thus, eight months later, the debtor has emerged in an excellent position for future growth.
In retrospect, Ihr Platz was by no means the model candidate for an "in-court restructuring" process because, inter alia, with an outlet network spread throughout Germany, in practice it remained difficult to control the bankruptcy process. Also, the business was heavily dependent on an uninterrupted supply chain to be maintained with several hundred suppliers, and it faced vigorous market competition.
Nonetheless, the restructuring was achieved. This was, above all, due to the willingness of the investor to embark on the adventure and financially support the process. Also, the ownership of the entire outstanding bank debt by a single investor significantly contributed to its success. More importantly, the investor provided additional financing from day one and even guaranteed that the unsecured creditors would receive the dividend quota laid down in the insolvency plan. At the same time, a well-prepared public relations campaign was launched that sent a strong message to the market and helped maintain support from suppliers and customers.
Investors now know that there is an alternative to an out-of-court restructuring, but they must take into account that the law is still developing, and surprises must still be anticipated. Whether the Ihr Platz case will be a breakthrough for the new German bankruptcy law remains to be seen.
The Italian Insolvency Law Reform
A new insolvency law was approved on Dec. 22, 2005, following the recent partial reform of Italian Insolvency Law, which set out new provisions for (1) claw-back actions (azioni revocatorie), (2) creditor composition procedures (concordato preventivo) and (iii) out-of-court debt restructuring (accordi di ristrutturazione del debito). The new insolvency law will come into force on July 16, 2006, and will be applicable to any preventive measures or bankruptcy proceedings commenced on or after that date.
The first objective of the reform is to improve the situation of those debtors that are not insolvent according to the Italian test of inability to pay debts as they fall due, but still face difficulties that mean that they may be unable to pay their debts in the near future. In particular, the new insolvency law aims to simplify insolvency proceedings and maximise return for creditors as a whole when it is impossible to save the debtor. It aims to achieve this by (1) amending the rules governing the carrying on of business during the reorganisation process and strengthening the powers of the creditors' committee; (2) accelerating and simplifying the verification procedure for the creditors' list; (3) providing that, within 60 days from the completion of the inventories, the receiver shall prepare a liquidation plan to be presented to the creditors' committee for its approval; (4) regulating the disposal of the insolvent debtor's assets and providing that the creditors' committee may suggest amendments to the plan prepared by the receiver; (5) providing a fair and equitable system for the ranking of the claims that divide the creditors into classes; and (6) providing that, after the completion of the insolvency proceedings, the insolvent debtor will, under certain conditions, be released from all of the debts that arose prior to the declaration of insolvency (esdebitazione).
The most important provisions introduced by the new insolvency law are (1) clawback actions (which have been in force since July 2005), (2) the rules on judicial composition with creditors and out-of-court arrangements with creditors based on debt restructuring plans and intended to safeguard the company's business and its assets, (3) the powers and the role of the creditors' committee and (4) the liquidation and disposal of debtor's assets.
Judicial Composition with Creditors
The rules on judicial composition with creditors (concordato preventivo), which came into force in July 2005, are one of the most significant amendments provided for by the new insolvency law. In fact, the debtor's proposal to its creditors may now provide for a wider range of arrangements, including a debt-restructuring plan and the payment of creditors by assignment of the debtor's assets, assignment by assumption (accollo), and transfer of shares, bonds or other financial instruments to creditors or assignment of the company's business to a third party (assuntore).
In addition, an important amendment contained in the new insolvency law concerns the provision of various different classes of creditors, which receive different treatment. In light of this new provision, the quorum for the approval of the plan has also been amended: the plan now has to be approved by the majority of each class of creditors. However, courts may approve the composition with creditors notwithstanding the disapproval of one or more classes of creditors, provided that the majority of all of the recognised creditors have approved the plan. Once the scheme of arrangement has been approved, it becomes binding upon all creditors.
Debt Restructuring Agreements
The new insolvency law provides for arrangements with creditors by way of debt-restructuring plans between the debtor and its creditors whose aggregate credits equate to 60 percent of the debt. A report by an expert is also required to assess the feasibility of the restructuring agreement and to determine whether it will be able to ensure that the creditors participating in the agreement are paid.
The debt-restructuring plan has to take into account the following main points:
- current net debt of disinvestment;
- level of indebtedness deemed acceptable by the creditors; and
- financial flow generated by the management of the company. Moreover, the debt-restructuring plan must specify which restructuring mechanisms are envisaged. They may involve:
- corporate capital (i.e., any reduction thereof or the share composition);
- the restructuring of the debt in terms of imports, expiry dates and transformation of contracts;
- new loans for the company; and
- guarantees for the creditors.
The Creditors' Committee
The creditors' committee is an important innovation introduced by the new insolvency law. The courts have much less power and flexibility than in the past, since they now merely ascertain whether the receiver's acts are in compliance with the law. However, they give the creditors' committee an increased role during insolvency proceedings in that they now have the power to supervise all deeds carried out by the receiver in managing the proceedings. In particular, the creditors' committee (1) approves the receiver's acts, (2) expresses a binding opinion when so required by law or by the court and (3) may also ask the court to replace the receiver. In particular, within the judicial composition with creditors procedure, the creditors' committee approves the arrangement with creditors proposed by the debtor.
The new insolvency law has introduced significant amendments to the rules governing clawback actions. They are intended to protect the so-called par condicio creditorum (i.e., equal treatment of creditors) by declaring that certain transactions carried out by the debtors before the declaration of insolvency are ineffective. Those amendments are as follows:
- the reduction of the so-called "suspect period" (the period of time prior to the declaration of insolvency during which the transactions took place) to one year before the declaration of bankruptcy for any non-arm's-length obligation (anormale) and six months prior to the declaration of insolvency for any arms-length obligation (normali);
- a transaction is defined as 'non-arm's-length' when the difference between what is given or promised by the bankrupt party and what is obtained as consideration is more than a quarter; and
- a list of transactions that cannot be clawed back:
- payments for goods and services supplied by the debtor in the ordinary course of business
- remittances in bank accounts, provided that they reduced the debtor's exposure with the bank in a significant and permanent manner
- agreements for the sale of real estate properties used by the purchaser for residential purposes
- deeds, payments and securities made or granted for implementing judicial composition with creditors or debt-rescheduling agreements or for implementing a restructuring plan
- payments of salaries to the debtor's employees and payments of outstanding debts carried out as consideration for services related to the filing of application for judicial composition with creditors.
At present, a winding-up procedure of a company may take years to be complete. The aim of the new insolvency law is to accelerate the liquidation process. In particular, the new rules governing liquidation provide that, inter alia, following the commencement of winding-up proceedings, the receiver has to draw up a winding-up plan, which then has to be approved by the court with the compulsory opinion of the creditors' committee. The receiver will immediately assess whether it is economically viable to carry on business on a temporary basis, which may be authorised if it is to the creditors' and company's advantage to do so.
Furthermore, the plan will specify the claims for damages and clawback actions that will be proposed, and whether it is appropriate to sell the whole business or individual assets of the company.
In the event that a going concern is sold, the new insolvency law provides that claims lodged in the course of lease agreements may not be paid within the winding-up procedure, since the lessor is liable for any debts that accrued until the termination of the lease.
The new insolvency law provides that the receiver is expected to fulfill his duties, whether statutory or arising from the winding-up plan, with the professional due diligence required by his mandate. Therefore, the new rules clearly provide that the receiver is directly accountable for the fulfilment of the winding-up plan that he or she prepared.
Further amendments introduced by the new insolvency law include an additional type of special lien upon movable assets and the abrogation of the judicial moratorium procedure, which has now been replaced by the new judicial composition with creditors.
1 Contributing authors are Lars Westpfahl and Jochen Wilkens, Hamburg; Raffaele Lener and Giuseppina Ivone; Rome.