Newsflash: Bundestag passes law suspending the obligation to file for insolvency

(Last update: 26 March)

Yesterday (25 March 2020), the German Parliament [Bundestag] passed the so-called Gesetz zur Abmilderung der Folgen der COVID-19-Pandemie im Zivil-, Insolvenz- und Strafverfahrensrecht [Act Mitigating the Civil, Insolvency and Criminal Procedural Law Consequences of the COVID-19 Pandemic]. The changes to insolvency law provided for therein through the COVID-Insolvenz-Aussetzungsgesetz - COVInsAG [COVID Insolvency Suspension Act] are far-reaching. Managers of enterprises which have gotten into difficulties due to the COVID-19 pandemic are being released from the obligation to file for insolvency until 30 September 2020. During this period, the payment prohibitions which otherwise apply when a company becomes insolvent are also being suspended. In addition, for a transitional period of three months, the right of creditors to file for insolvency is being suspended. These measures are accompanied by a privileged treatment of restructuring loans (“fresh money”) - including shareholder loans - and the protection of business partners against legal challenges. The regulations apply retroactively from 1 March 2020.

1. Objective of the COVInsAG

The aim of the COVInsAG is to enable and facilitate the continuation of companies that have become insolvent or are experiencing economic difficulties as a result of the COVID-19 pandemic. The affected companies and their representatives on the corporate bodies are to be given time to take the necessary steps to remedy the company’s factual and material insolvency, in particular to take advantage of state aid for this purpose or to make financing or restructuring arrangements with creditors and investors. The limitation of liability and risks of legal challenges is also intended to create the conditions under which such companies can be granted restructuring loans and to prevent business relations with business partners from being broken off.

2. Suspension of the obligation to file for insolvency

As soon as a company becomes illiquid or over-indebted, an application for the opening of insolvency proceedings has to be filed without undue delay. If this obligation, which is regulated in Section 15a para 1 of the German Insolvency Code [Insolvenzordnung, InsO] (or for associations [Vereine] in Section 42 para 2 of the German Civil Code [Bürgerliches Gesetzbuch, BGB]), is not fulfilled, this can lead to both civil law obligations to pay damages and criminal law sanctions for the relevant members of the representative bodies.

The COVInsAG is suspending the obligation to file for insolvency until 30 September 2020. This is not applicable only if the factual and material insolvency is not based on the effects of the COVID-19 pandemic or if there are no prospects of remedying the company’s existing illiquidity.

It is presumed that a company’s factual and material insolvency is based on the effects of the COVID-19 pandemic and that the prospects of remedying its existing illiquidity do exist if the company was not illiquid on 31 December 2019. Admittedly, the presumption is rebuttable. However, in view of the presumption’s purpose of effectively relieving the applicant from the difficulties of proving and forecasting this situation, the legislator is of the opinion that a rebuttal should only come into consideration in those cases in which there can be no doubt that the COVID-19 pandemic was not the cause of the factual and material insolvency and that there are no prospects of successfully remedying an existing factual and material insolvency at the company.

3. No payment prohibitions in the event of factual and material insolvency

Once a company becomes illiquid or over-indebted, managers of such affected companies may only make payments that are also reconcilable with the diligence of a prudent businessman after this point in time. Accordingly, payments were only possible to a very limited extent to date. It was a requirement that the payments served to maintain realistic restructuring chances in the interests of the creditors. This was the case, for example, in case of payments for water, electricity and heating as well as wages and salaries.

According to the COVInsAG, all management measures in the ordinary course of business are now deemed reconcilable with the diligence of a prudent and conscientious manager. Hence, both measures to maintain or resume business operations and measures to implement a restructuring concept are permissible. This should enable the managers of affected companies to take all necessary measures to continue the company in the ordinary course of business.

4. Insolvency proceedings in case of applications by third parties

In addition to the suspension of the obligation to file for insolvency, the opening of insolvency proceedings by third-party application, i.e. applications for insolvency filed by creditors, is being suspended for a period of three months from the entry into force of the COVInsAG. In this case, the opening of insolvency proceedings by way of third-party application filed after the entry into force of the Act will only be possible if the reason for the insolvency already existed on 1 March 2020. For a period of three months, the new regulation on third-party applications will prevent companies affected by the COVID-19 pandemic, which were not yet insolvent on 1 March 2020, from being forced into insolvency proceedings by third-party application.

The suspension of the obligation to file an application also includes the otherwise upheld obligations of the Federal Financial Supervisory Authority [Bundesanstalt für Finanzdienstleistungsaufsicht - BaFin] or the competent supervisory authorities to exercise their right to file an application in accordance with Section 46b para 1 of the German Banking Act [Kreditwesengesetz - KWG], Section 43 para 1 of the German Capital Investment Code [Kapitalanlagegesetzbuch - KAGB] in conjunction with Section 46b para 1 KWG, Section 21 para 4 and 5 of the German Payment Services Supervision Act [Zahlungsdiensteaufsichtsgesetz - ZAG] and Section 312 of the German Insurance Supervision Act [Versicherungsaufsichtsgesetz - VAG].

5. Privileged treatment of restructuring loans (including shareholder loans)

The COVInsAG also provides for the privileged treatment of new restructuring loans in respect of legal challenges and liability. For example, the granting of credit and collateral during the suspension period is not considered unethical; any claims, e.g. arising from § 826 BGB within the scope of the so-called lender liability, are excluded accordingly.

In addition, the repayment by 30 September 2023 of a new loan granted during the suspension period and the provision of collateral to secure such loans during the suspension period cannot be legally challenged in insolvency proceedings. The scheme protects lenders of new loans, including goods credit and other forms of performance on deferred payment terms. They should not have to fear that they will be obliged to repay interim payments or lose access to the collateral provided when the new loans were granted if efforts to rescue the borrower's business fail and insolvency proceedings are opened after all. It is imperative that the loan is a new loan (“fresh money”). In the case of a mere novation, prolongation or economically comparable circumstances, tantamount to a back and forth payment, the privileged treatment of legal challenges shall not apply.

The COVInsAG also wants to create incentives for shareholders to provide additional liquidity to companies in the crisis. Therefore, the repayment of shareholder loans is also being protected under the same conditions as the repayment of third-party financing. The suspension of the subordination of shareholder loans under insolvency law serves the same purpose. When shareholder loans are granted, these also have to be new loans in the sense of additional liquidity. For this reason, a prolongation or new issue of a previously subordinated shareholder loan for the purpose of or with the effect of an upgrade in rank is not covered. The collateralization of shareholder loans from the assets of the company is explicitly not privileged.

The above privileges apply for an unlimited period of time to financing within the framework of state aid programs granted by the Kreditanstalt für Wiederaufbau (KfW) and its financing partners or other institutions due to the COVID-19 pandemic. This applies not only to the parts of the financing made available by the KfW, but also to the parts to be provided by third parties.

6. Protection against legal challenges for business partners

In addition, the COVInsAG also grants protection against legal challenges in certain cases which do not involve the granting of restructuring loans. This applies, for example, to contractual partners of continuing obligations such as landlords and lessors, but also to suppliers. Were such contracting parties to fear that they would have to return payments received if the restructuring efforts of the crisis company fail on grounds of a legal challenge brought within the framework of the insolvency, they would be inclined to terminate the contractual relationship by the quickest possible means, which in turn would frustrate the restructuring efforts.

Therefore, the COVInsAG stipulates that the legal challenge of congruent payments – i.e. those made or provided exactly as agreed – is excluded during the suspension period if the recipient was not positively aware that the restructuring and financing efforts of the company affected were not suitable to remedy the illiquidity situation existing at the company. Explicit protection is also afforded to performance in full discharge of the obligation or by way of provisional performance, to assignments of claims in lieu of cash payments and to payments by third parties on the instructions of the company affected, because such payments are economically equivalent to performance by the debtor. The exchange of a security without increasing the security value is also protected so as not to hinder the economically sensible use of security. The protection is extended to the granting of accommodations for payment, because such accommodations strengthen the company’s liquidity and in this respect have a similar effect to the granting of new loans. The protection of a shortening of payment targets, on the other hand, is intended to offer contractual partners a further incentive to continue contractual relations. If, for example, a supplier of vital business components is only prepared to continue supplying the debtor company if the payment periods previously agreed in a framework agreement are shortened, he should not be forced to terminate the contract in its entirety simply because the adjustment of the contract would expose him to risks of legal challenges.

7. Entry into force and duration

The COVInsAG comes into force with effect from 1 March 2020. As it is not foreseeable whether the situation will have stabilized sufficiently in the coming months, the measures in the COVInsAG can be extended by the Federal Ministry of Justice and Consumer Protection [Bundesministerium der Justiz und für Verbraucherschutz - BMJV] by statutory ordinance without the approval of the German Federal Council [Bundesrat] until 31 March 2021 if this appears to be necessary due to the continuing demand for available public aid, ongoing financing difficulties or other circumstances.

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