As the economic effects of the coronavirus (COVID-19) pandemic continue to be felt, Germany’s protective shield proceeding under Section 270b of the Insolvency Code is a way for companies to restructure under the direction of management.
Despite the temporary suspension of the obligation to file for insolvency under a March 25 amendment law to the Germany Insolvency Code, aimed at mitigating the economic consequences of the COVID-19 pandemic (see our prior LawFlash on this topic), the pandemic is expected to cause an increase in corporate insolvencies in Germany in the second half of 2020. Companies having economic difficulties may therefore seek efficient options to implement restructuring measures and avoid liquidation through an insolvency proceeding.
Since the outbreak of COVID-19, a number of well-known German corporates such as Galeria Kaufhof, Hallhuber, and Esprit have applied for a so-called protective shield proceeding (Schutzschirmverfahren) under Section 270b of the Insolvency Code, which is aimed at restructuring the company under the direction of its management. In this LawFlash, we explain the basic procedural steps of a protective shield proceeding and its main advantages in comparison to a classical insolvency procedure.
The protective shield proceeding is mainly a reorganization proceeding that can be used by a debtor between the time of the application to open insolvency proceedings and the time of opening of the self-administrated insolvency proceedings. During the protective shield proceeding, the debtor shall prepare the restructuring of its business under the protection of insolvency law. The protective shield proceeding was introduced to German insolvency law in 2012 in order to provide companies with an early restructuring option without losing control over the operations of the company. It is sometimes referred to as the “German Chapter 11 proceeding.”
The protective shield proceeding can be used by companies that are either over-indebted (überschuldet) or in a situation where their inability to pay debts when due is threatening. Companies that are already in a situation where they cannot pay their debts when due (zahlungsunfähig) are not eligible for this proceeding. However, if a company becomes unable to pay its debts during a protective shield proceeding, this has no effect on the pending proceeding.
The initiation of a protective shield proceeding requires an application from the debtor. The debtor must apply for (1) a self-administrated insolvency proceeding and (2) a protective shield proceeding. Together with this application, the debtor has to provide a certificate of an independent expert confirming that the company is not in a status of existing illiquidity and has the prospect of a successful restructuring. The independent expert can be selected and appointed by the company and must be an attorney, auditor, tax adviser, or similar consultant who has experience in insolvency matters. The certificate must be reasoned and up to date at the time of filing the application.
The insolvency court will typically rely on the certificate if it is provided by a sufficiently qualified expert and not conduct its own substantive investigations. If it opens the protective shield proceeding, the debtor will be given a certain period of time (maximum three months) to provide an insolvency plan that contains the envisioned restructuring steps. In addition, the court can order certain interim protective measures such as the prohibition of enforcement measures of creditors against the debtor during the protective shield proceeding, or entitle the debtor to dispose of assets that are subject to security rights.
The court may also entitle the debtor to enter into transactions that have a preferred ranking in a later insolvency, i.e., so-called obligations incumbent on the assets of the debtor (Masseverbindlichkeiten). The court may (and in some larger cases, must) establish a preliminary creditors’ committee. Further, it will appoint a preliminary custodian (Sachwalter) to monitor and supervise the activities of the debtor and to notify the insolvency court and the creditors’ committee of any activities that may have negative consequences for the creditors. The debtor can propose a custodian but it must be different from the expert who issues the restructuring certificate. The court will usually follow the proposal of the debtor as long as the proposed custodian can act independently. The custodian has a mainly supervisory role and does not replace or take over the management of the debtor.
The protective shield proceeding should end with the submission of the insolvency plan to the court. The court then decides on the opening of self-administrated insolvency proceedings, during which the insolvency plan shall be approved by the creditors and implemented. However, it is also possible to restructure the company during the protective shield proceeding so that no insolvency proceeding needs to be opened.
The protective shield proceeding is a way for a company in a crisis to use certain legal privileges applicable under the Insolvency Code in order to prepare and implement a restructuring of the company. The main advantage of the protective shield procedure is that control over the business operations of the company does not transfer to an external insolvency administrator but remains with the company’s management.
The company also controls the proceeding, as it determines the timing of the proceeding and has the right to select the expert who issues the restructuring certificate as well as the custodian. Certain privileges of insolvency law such as the enforcement moratorium, the possibility to stop performance under unfavorable contracts, and simplified options to terminate employment contracts are available to the company’s management and can be used to increase liquidity of the company.
Using the protective shield procedure requires careful preparation and management and the help of experienced advisers, as a successful restructuring in a protective shield proceeding involves substantial concessions from the company’s creditors, which need to be brought on board at an early stage of the proceeding.
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