Germany’s Insolvency Reform Enables Loan-To-Own Strategies

by Latham & Watkins LLP
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Frank Grell is a partner at Latham & Watkins who chairs the firm’s German Restructuring and Insolvency Practice. Grell reflects on some of the major changes brought about by Germany’s 2012 Insolvency Act (Insolvenzordnung), including an increase in the rights of creditors in the proceedings over the assets of German companies, the introduction of “protective shield” proceedings and a reduction in the negative stigma previously associated with restructuring and insolvency.

Looking at the next six months, Grell expects to see more distressed M&A deals and an increasing number of people using the new regime. “They will still always test whether they can handle the insolvency out of court, but then we will also have the in-court route to go, and we will see more of that,” he said.

Does the insolvency process in Germany now more closely resemble the chapter 11 process in the United States?

Grell: In Germany, we now have a debtor in possession regime that really works. Unlike before, management does not lose its power over the company, which means the other stakeholders, including customers and suppliers can work with the same people they did before and will not automatically lose faith in the company due to the insolvency filing. Prior to the March 2012 reform, insolvency was the ultimate threat in Germany, and now it’s viewed as a viable tool that can be used in restructurings. Now stakeholders accept that insolvency may not be such a bad thing. At Latham, we have seen examples of companies where more people continue to do business with them during the insolvency process because they now know that it is a safe and supervised process — instead of shying away from the company.

What were some of the driving forces behind the movement to reform the insolvency code in Germany?

Grell: We saw companies changing their center of main interest because they wanted to make use of the existing UK or US insolvency regimes. In response the restructuring community in Germany — including law, accounting and advisory firms — began pushing years ago for a reform of the domestic insolvency regime. Then came the Lehman Brothers bankruptcy in 2008 and suddenly insolvency was on the political agenda. Normally, changing the insolvency court was not something that you could get interest behind.

What does the timeline now look like for restructurings in Germany?

Grell: Restructurings in Germany now can take much less time. Latham was involved in the largest protective shield regime case to date — in seven months the company was fully restructured with a new shareholder on board. Nobody lost their jobs and all the suppliers stayed on board — in an amount of time that was considered a record for a process that would normally have taken years in Germany.

How are private equity investors responding to Germany’s new insolvency regime?

Grell: We are also now seeing more private equity investors that are pursuing loan-to-own strategies in Germany. Before the new regime was in place, the lack of predictability was a major roadblock that made many shy away. So we see money flowing into distressed situations in Germany. Given the economic situation and the legal predictability, now Germany seems to be top of the agenda for many UK and US private equity and hedge funds.

Has Germany’s new insolvency regime address tax issues associated with insolvencies?

Grell: The tax regulations for restructurings have not yet been modernized so there is still work to be done. Unfortunately, given the recent elections in Germany, there are other issues on the political agenda now. The existing tax regulations are more cumbersome than they would be had the insolvency reform also covered the tax side. But we do have solutions for these tax questions around the so-called cancellation of debt income taxation in restructuring situations.

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DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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