Local Court of Cologne: "Essential" creditors may prevent a debtor-in-possession proceeding

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1. Recent Decision by the Local Court of Cologne

Under § 270 (2) no. 2 of the German Insolvency Code ("InsO") a German insolvency court may only grant an order to open insolvency proceedings as debtor-in-possession proceeding (Eigenverwaltung) if the insolvency court finds "that no circumstances are known which lead to the expectation that the order will place the creditors at a disadvantage". In its decision dated 1 July 2013 (case no. 72 IN 211/13), the Local Court (Amtsgericht) of Cologne issued some guidance on how to assess whether there are such disadvantages that would justify the rejection of a debtor's petition to open insolvency proceedings over its assets as a debtor-in-possession proceeding.

The court held that such a disadvantage as contemplated by § 270 (2) no. 2 InsO exists "if essential creditors sincerely declare that they will not participate in a cooperative restructuring under the present management of the company." In consequence, the court denied the debtor's petition to open the insolvency proceedings as a debtor-in-possession proceeding and eventually opened a regular insolvency proceeding over the assets of the debtor with an insolvency administrator (Insolvenzverwalter) in place.

2. Legal Context

§ 270 (2) no. 2 InsO is a crucial provision when it comes to the question of whether the management of a company that filed for insolvency may continue to be in control during the opened insolvency proceedings (so called debtor-in-possession). As of 1 March 2012, this provision was considerably revised by the "Act for the Further Facilitation of the Restructuring of Corporations" (abbr. as "ESUG" in German), increasing the threshold to reject a debtor-in-possession proceeding by requiring a concrete showing of disadvantageous circumstances.

Under the revised provision, it is now to be developed by case law what kind of facts would count as "disadvantages" of a debtor-in-possession proceeding and how these purported disadvantages for the creditors need to be credibly shown to the satisfaction of the insolvency court.

The Cologne court developed the following test in order to discern relevant disadvantages:

  • "Disadvantages" that are sufficient to reject a debtor-in-possession proceeding exist if the opening of a debtor-in-possession proceeding would diminish the chances of the restructuring of the debtor in comparison to the rejection of the debtor-in-possession proceeding, which would for instance be the case if a vendor, a trade creditor or a finance creditor is unwilling to participate in a cooperative restructuring under the present management of the company and does not want to provide a restructuring contribution or does not even want to continue delivering supplies.
  • Furthermore, the respective creditor also has to issue a sincere declaration that it would not participate in a cooperative restructuring if the petition for the opening of a debtor-in-possession proceeding was granted.
  • Conversely, it would not be sufficient if this creditor simply states its scepticism concerning the debtor-in-possession proceeding.
  • Under these conditions, and only in the event that the rejecting creditor is essential for the company and the success of the restructuring, then the insolvency court has to refrain from granting the opening of a debtor-in-possession proceeding.

The court added in an obiter dictum that another way to bring such potential disadvantages to the attention of the court would be a decision of the preliminary creditors' committee as long as the reasons of the preliminary creditors' committee's decision are specific enough. However, a simple decision of the preliminary creditors' committee to reject the debtor in possession proceeding would be insufficient if it contains no reasons, even if the decision were unanimous.

3. Legal Importance of the Decision by the Cologne Court

The Cologne insolvency court's decision is one of the first decisions in this regard under the reformed German insolvency law, as revised by ESUG in 2012, and will in all likelihood serve as persuasive precedent in similar cases throughout Germany.

While there is no isolated right of appeal, at least the court is now explicitly obliged by § 270 (4) InsO to state the reasons for denying a petition to grant a debtor-in-possession proceeding, especially in the event that the preliminary creditors' committee voted in favour of the debtor-in-possession proceeding.

As a result of these practical and procedural circumstances, the published decision of the Cologne insolvency court will be among the best available persuasive precedents concerning this issue.

It must be noted though, that, instead of an appellate procedure, the creditor's assembly (Gläubigerversammlung) can later, under certain circumstances and with the appropriate majority, order the insolvency court to open or terminate the debtor-in-possession proceeding, as the case may be. However, while this is legally an option, opening the debtor-in-possession proceeding via such a decision of the creditors' assembly would often not be so relevant anymore as it would often come too late, at a stage when all major economic decisions have in all likelihood already been made in the meantime by the insolvency administrator.

4. How Can Debtors and Creditors Handle This Legal Issue?

  • Before filing a petition to open insolvency proceedings as a debtor-in-possession proceeding, the debtor has to take the considerable risk into account that the insolvency court may in the end reject only the part of the petition that concerns the request for a debtor-in-possession proceeding and will instead subject the debtor to a regular insolvency proceeding under a regular insolvency administrator. As the debtor cannot file an isolated appeal to this decision, it is advisable to assess - before the filing for insolvency - whether there are any such conceivable disadvantages and whether there are any essential creditors who would be inclined to withhold their support for the debtor-in-possession proceeding and capable to convince the court of the respective disadvantages.
  • Essential creditors now have increased leverage over the management of a debtor, as this decision hands them a powerful tool to remove the management at the beginning of the insolvency proceedings and, prior to that, to threaten the attempt of such an removal during the restructuring negotiations preceding an insolvency filing. However, it must be noted that this is not a nuanced tool: While it can possibly be used to put pressure on the management, the removal of the management and the appointment of an insolvency administrator might not necessarily be in the best interest of such essential creditors, hence this option should only be carefully pursued.

5. Factual Background of the Decision

According to the Cologne court, the debtor's efforts from 2011 on to launch a promising restructuring failed. At first, far-reaching agreements with the essential creditors were reached and a restructuring concept was devised. As a consequence of this restructuring concept, a key issues paper was signed in mid-February 2013, which initially was supported by all essential creditors. However, the key issues paper contained several conditions precedent that were supposed to be fulfilled by the end of March 2013 but which did not occur on time. That deadline was mutually extended up until early May 2013. After this deadline lapsed, the largest creditor terminated the agreement and also terminated and accelerated the granted loans, leading to the eventual failure of the out-of-court restructuring. This way the largest creditor already expressed that it was not willing to continue the restructuring efforts with the present management of the company. The creditor then underscored its views in several court filings in May 2013, arguing against the petition of the debtor to open the insolvency proceeding as a debtor-in-possession proceeding, stating that it was unlikely that the restructuring would succeed in a debtor-in-possession proceeding because no promising restructuring had been initiated in the previous six months. In addition, two further essential creditors also informed the court of their opposition against the envisaged debtor-in-possession proceeding.

6. Reasoning of the Court

The court held that the undefined criterion of "disadvantages" for the creditors in § 270 (2) no. 2 InsO, which is a condition for the rejection of a debtor-in-possession proceeding, needs to be interpreted "broadly" for the purpose of taking into account the complete interest of all parties to the proceedings. Such disadvantages will be the result of a debtor-in-possession proceeding in the event it is already known or can be expected with reasonable likelihood after an overall evaluation of all known information based on the circumstances that the opening of a debtor-in-possession proceeding would diminish the chances of the restructuring of the debtor in comparison to the rejection of the debtor-in-possession proceeding. The court gave as examples of such disadvantages cases where the vendors, trade creditors and loan creditors are unwilling to participate in a cooperative restructuring under the present management of the company and (i) do not want to provide a restructuring contribution; or (ii) do not even want to continue delivering supplies.

The court stated that way to bring such disadvantages to the attention of the court would be a decision of the preliminary creditors' committee in a preliminary insolvency proceeding, as long as the reasons of the preliminary creditors' committee's decision either (i) demonstrate specific circumstances pursuant to which it can be expected that the debtor-in-possession proceeding would place the creditors at a disadvantage; or (ii) show that essential creditors are unwilling to participate in a cooperative restructuring within a debtor-in-possession proceeding. However, the court noted that it would not be a sufficient demonstration of such disadvantages for the creditors if the decision of the preliminary creditors' committee does not contain any reasons, even if the decision is unanimous.

The court also pointed out in this regard that the insolvency court would in any event only be bound by a unanimous decision of the preliminary creditors' committee pursuant to § 270 (3) se. 2 InsO that is in favour of the petition to grant a debtor-in-possession proceeding, as such a decision would by law show that the debtor-in-possession proceeding would not place the creditors at a disadvantage.