Daniel Kress and Torsten Göcke discuss restructuring tools and analyse current trends and developments in the German insolvency market.
1. What trends, in terms of activity levels, affected industries or investor focus, have you seen in the restructuring and insolvency market in your jurisdiction over the last 12 months?
There has been a continued interest in German distressed debt and asset investments by national and international investors, due to the current low interest rate environment, a strong German economy and continuous investor appetite for German assets. However, there have been fewer restructurings in and out of court than in the past as borrowers have been able to refinance in the market.
Against this background, investors look into potential targets very closely, and while pricing has become competitive, many deals appear less attractive.
Despite an overall decrease in the number of restructurings, investor commitments have nevertheless led to a number of successful restructurings outside formal insolvency procedures by silently implementing consensual restructuring concepts or by applying third-party driven trust structures. Thanks to the booming M&A market, a number of troubled situations have been solved through asset disposals/break-ups. In addition, there have been successful court-governed restructurings by means of a sale of the debtor's business as a going concern and by applying tools such as the insolvency plan (Insolvenzplan) (e.g. IVG Immobilien).
Affected industries include the automotive industry, building and systems technology (Imtech), retailers (Weltbild Verlag, Kettler, Strauss Innovation, Hein Gericke), the renewable energy sector (Prokon, AC Biogas), the German "Mittelstand" fashion industry (Escada, Strenesse, Mexx Deutschland) and banks, e.g. balance sheet clean-up by means of non-performing loan deals. In addition, we have seen restructurings in the relatively new SME bond segment, i.e. the “Mittelstandsanleihen” (Laurèl, Singulus Technologies, Rena Lange).
Following the implementation of an insolvency law reform in early 2012, there has been further internationalisation of German restructuring practice, evidenced by an early involvement of key (financial and commercial) creditors, more focus on self-administration (Eigenverwaltung) and "debtor-driven" insolvency procedures, more complex and innovative structures, cross-border restructurings, pre-packed insolvency plans to implement operational and financial restructurings, the use of bond restructuring tools, appointments of CROs to govern insolvency procedures and the availability of professional restructuring advice on the market.
2. What is the market view on prospects for the coming year?
If the interest rate environment does not change, or if the world economy – on which Germany as a major exporter relies heavily – does not cool down significantly, the overall number of restructurings will most likely remain low. A pick-up in 2016 may, however, be triggered by uncertainties such as the development in China, uncertainty of the interest rate changes in the US, lack of stability of the Euro, a potential "Brexit" and the (again) higher leverage used in an increasing number of M&A transactions and for the refinancing of legacy deals.
Against this background, we expect to see further consolidation of the German insolvency and corporate restructuring market combined with a constant interest of institutional and strategic investors in distressed debt and assets. The re-vitalisation of tools such as the German insolvency plan will continue to produce innovative restructuring concepts. On the other hand, we expect to see clear-cut business sales by insolvency administrators to achieve cost effective and speedy restructurings in the SME segment. In cases where only a financial restructuring is necessary, we would also expect a continuous drive to the London market given the greater flexibility of English out-of-court restructurings and a greater familiarity with English law concepts of the international investor base that is primarily based in the city.
3. What are the key tools available in your jurisdiction to achieve a corporate restructuring – are they primarily formal, court-driven processes, or are informal out-of-court restructurings possible? Do you feel that the tools you have available are effective in terms of providing speedy, fair and predictable outcomes?
Traditionally, German insolvency law and the restructuring practice focussed on formal, court-driven processes. However, this does not mean that out-of-court restructurings are unprecedented or impracticable. Today, professionally advised debtors regularly present consensual restructuring concepts or exercise out-of-court tools, e.g. by seeking to amend bond terms by a majority vote in accordance with the German Bond Act 2009 (Schuldverschreibungsgesetz 2009). Practice has shown, however, that out-of-court procedures may be easily challenged in court by individual stakeholders assuming hold-out positions. Thus, it is expected that in-court workouts remain important.
The outcome of German insolvency proceedings is, generally, reasonably predictable if a conclusive restructuring case is prepared, sufficiently organised and pre-discussed with important stakeholders (including the insolvency court). In a distressed situation, the major challenge is to secure sufficient time to develop the restructuring concept and take preparatory work prior to the actual filing. The predictability of insolvency proceedings becomes an issue if preparations are insufficient or if the insolvency court lacks trust in key individuals. However, there is a growing willingness of insolvency judges to enter into informal pre-discussions with the debtor and its advisers.
4. In terms of intercreditor dynamics, where does the balance of power lie as between shareholders and creditors, and as between senior lenders and junior/mezzanine lenders? In particular, how do valuation disputes between different stakeholders tend to play out?
In the past years, the balance of power has clearly shifted from the shareholders to the creditors. Shareholders traditionally had a strong position in restructuring situations which they exercised mainly by insisting on formal positions to block corporate measures. Following the insolvency law reform in 2012, the potential for shareholders to act obstructively is limited. As creditors have the option to initiate and implement a creditor-supported insolvency plan (developed by the insolvency administrator) under which the shareholders can be crammed down, negotiations with shareholders have been facilitated from the outset.
The balance between different groups of lenders and the outcome of valuation disputes are largely determined by individual facts of the case. General statements are not possible. Valuation disputes have so far not played a significant role as the in-court restructurings are typically run as an open investor process. Also, German insolvency law makes it difficult to bring valuation challenges as a creditor.
5. Have there been any changes in the capital structures of companies based in your jurisdiction over recent years caused by the retreat of banks from loan origination? In particular, have you found that capital structures now increasingly comprise debt governed by different laws (such as New York law governed high yield bonds)? If so, how do you expect these changes to impact on restructurings in the future?
In the recent past, Germany has experienced increasing influence of alternative investors such that bought NPL portfolios from deleveraging banks, as well as debt in the secondary market. However, the presence of alternative lenders in the field of loan origination still lags behind activities seen in other national markets, such as the UK. The market development is still away from the level one would have expected at the end of the financial crisis. As regards governing laws, it is common practice to have UK- or US-law instruments sitting within more complex financial structures of larger businesses; this is, however, not a recent development, in particular the high yield market has been, for a long time, dominated by New York law governed bonds, whereas English law has a role to play in corporate lending and structured financings.
6. Is there significant activity on the part of distressed debt funds in your jurisdiction? How successful have they been in entering the market, and how much has market practice (or law) evolved in response? If funds have not successfully entered the market, can you identify reasons why?
In recent years, distressed debt funds and investors have become increasingly active in Germany. Most players are US- and UK-based funds which have shown interest in investment opportunities in high yield bonds, senior debt and convertibles, but also attempted to take advantage of newly introduced and/or reformed restructuring tools, such as bond restructurings by majority vote pursuant to the renewed German Bond Act 2009 or, since 2012, the opportunities associated with flexible insolvency plan proceedings.
Notwithstanding today's visibility of debt funds in large-scale restructurings, the German distressed debt market is still not fully penetrated. Investments tend to concentrate on large companies with international dimension. The main reason for hesitation of external distressed debt funds to invest in the German SME market is that some early lighthouse restructurings have proven difficult and time-consuming compared to, e.g., a typical financial restructuring governed by UK laws. Also, many investors are chasing the same type of assets that are relatively rare and therefore often deemed too expensive. In addition, debt investors tend to distrust the German claw-back regime (Anfechtungsrecht) which is executed by the court appointed insolvency administrator (who is not under creditor control).
7. Are there any unusual features of your insolvency or restructuring law that an external investor should be aware of (such as equitable subordination, or substantive consolidation)?
German insolvency law has several features which may be considered new or unusual by external investors.
Even senior secured external creditors are immediately subordinated if they – directly or indirectly – acquire an equity stake in the company exceeding 10%. At the same time, security rights for such loan will become contestable, unless such security was granted more than ten years prior to the filing for insolvency. Repayments received within a period of one year prior to the filing for insolvency will be subject to claw-back, most likely also if the creditor has become shareholder only after the repayment occurred, or depending on circumstances, a new loan was granted after the previous loan had been paid back. Subordinated claims generally have no economic value in a distressed situation. If an insolvency plan is adopted, subordinated claims are deemed to be released, unless the plan explicitly provides otherwise. Details on the treatment of shareholder loans are complex and subject to dispute in German legal literature and the judiciary.
8. Are there any proposals for reform of the legal framework that governs insolvency and restructurings in your jurisdiction?
German restructuring law is subject to constant reform. Most prominently, and in reaction to complaints in particular from SME, the German federal government initiated an initiative to amend the German insolvency claw-back regime. The latest proposals aim towards a cut-back of perceived excess claw-back rights of insolvency administrators and to increase the predictability for companies doing business with financially distressed counterparts. In particular, payments following a customary deferral of payment (Zahlungsaufschub) granted along the chain of suppliers and employees' claims shall receive better protection. The reform proposal is flanked by a limitation of claw-back rights in case of congruent coverage (kongruente Deckung). The various issues are highly disputed among insolvency administrators, pressure groups and legal practitioners. We do not expect the reform to be implemented – if at all – before the end of 2016.
Furthermore, the legislator currently considers the development of German rules governing the insolvency of groups of companies (Konzerninsolvenzen). Currently, the insolvency of each of the companies is dealt with separately without effective means to coordinate such proceedings. In addition, the European Commission has published an Action Plan to boost business funding and investment financing and announced to issue a legislative proposal for harmonisation in the area of insolvency law until the end of 2016. Such harmonisation shall include an obligation of member states to implement a pre-insolvency restructuring procedure.
9. If it was up to you, what changes would you make?
It is common ground among restructuring practitioners to ask for efficient, speedy procedures with a high level of predictability, at best with little interruption of the affected business.
Against this background, German current legal insolvency framework seems well-established for operational restructurings. However, the outcome of insolvency proceedings still largely depends on the effort and expertise of a few individuals, including the insolvency judge and the court-appointed insolvency administrator.
Having said that, following the changes in 2012, German insolvency law has become more open for increased creditor influence. It may be considered to take further steps in this respect and to grant creditors even stronger and more decisive influence on major decisions.
In addition, the development of a well-functioning pre-insolvency restructuring procedure, limited to financial restructurings and accompanied by an ex-post court review with financial settlement only, should be on the agenda list, as suggested by the European Commission and as successfully established in the national laws of other jurisdictions such as the Netherlands or Spain.
The case law regarding claw-back rules and an increased aggressiveness by receivers to go after directors and advisors in case of a failure of an out-of-court restructuring has also created a significant level of uncertainty and should be re-adjusted by the legislator more comprehensively than the proposed legislation regarding the claw-back rules. In particular, when the main purpose of a restructuring is to re-adjust the liability side of the balance sheet, there is no evidence that in-court restructurings are more effective, rather to the contrary, the recovery rates of creditors in insolvency proceedings remain consistently low.