Investing in distressed assets across the eurozone is perceived as a key opportunity on the private equity landscape, and has experienced a substantial increase in the number of potential investors.
Distressed investing in Europe has traditionally been perceived as riskier and more challenging than US distressed investing due to the eurozone legal systems.
In contrast to Chapter 11 reorganisations in the US, many insolvency regimes in Europe are predisposed toward liquidation of troubled companies rather than restructuring them and preserving going-concern values. In recent years, some eurozone countries have updated or amended their insolvency regimes; for example, amendments to the German insolvency code, which came into effect on 1 March, 2012.
The German amendments add predictability to the treatment of distressed investments by allowing debt-for-equity swaps in restructuring plans without requiring approval of existing shareholders and by giving a preliminary creditors’ committee broader influence over the direction of insolvency proceedings in a way that is protective of going-concern value.
Updates to the German Insolvency Law
Previously, German insolvency law provided no mechanism for any changes to shareholders’ rights without their formal consent. However, such swaps can now be accomplished via an insolvency plan, which can be used to implement a dilutive investment without shareholder approval in certain cases.
Furthermore, a new mechanism (akin to a US “cram down” restructuring) would allow the plan to be implemented without consent in certain circumstances. The recent reforms significantly improve the mechanisms by which creditors can convert their debt claims into equity, thereby increasing the attractiveness of control investing in German companies.
Preliminary Creditors’ Committee
Historically, creditors in a German insolvency proceeding have not had a meaningful mechanism to influence restructuring matters in the period between the insolvency filing and the initial creditors’ meeting, which may be a few months later. The reform addresses this problem by allowing the debtor, its preliminary administrator or a creditor to request the establishment of a “Preliminary Creditor’s Committee” (vorläufiger Gläubigerausschuss), in the early stages of an insolvency filing.
Strengthening of Self-administration
Previously, when an insolvency proceeding was initiated, the court would typically appoint a preliminary insolvency administrator to take control of all the company’s business and the existing management team would remain in place where, in the court’s opinion, it would not delay the insolvency process or adversely affect creditors.
The new law contains a presumption in favor of self-administration: the court can only reject the application for self-administration if it concludes that creditors would be negatively affected. In reaching its conclusion, the court is required to hear submissions from the Preliminary Creditors’ Committee ((vorläufiger) Insolvenzverwalter), if one has been appointed, thus significant creditors can influence the restructuring outcome. If there is a unanimous support for self-administration (Eigenverwaltung), the court will follow that recommendation.
A debtor is permitted to seek a “protective shield” period of up to three months in which the debtor may negotiate with key constituents in an effort to prepare a pre-packaged insolvency plan. Such a procedure is only permitted where the debtor is not illiquid, the debtor has elected self-administration, and the intended restructuring doesn’t appear to be obviously futile. During a protective shield period, investors benefit as the debtor’s business operates free of enforcement proceedings, thereby minimising the negative impact of the restructuring on the business while the creditors and debtor negotiate the terms of a restructuring.
Appointment of Insolvency Administrators
Where self-administration is not chosen, the new law permits the Preliminary Creditors’ Committee to comment on the court’s proposed insolvency administrator, before appointment. If the committee makes a unanimous recommendation of an administrator, the court is bound to appoint that individual unless the candidate is not eligible for some extrinsic reason. Previously, only the court could appoint a preliminary administrator.
The full impact of the new German insolvency law will not be known until the courts have applied the new provisions in a fair number of cases. In principle, however, the reform presents very intriguing possibilities for distressed investors. It allows for flexibility in designing a restructuring that can “cram down” existing equity by granting new equity to creditors or new-money investors without old equity’s consent.
The new law also appears to be a strong message to investors that the German insolvency regime will no longer favor liquidation, but rather will permit creditors a significant voice in a process that permits management to continue business operations while a restructuring plan is negotiated.
Thomas Schürrle is a partner and Peter Wand is international counsel in the Frankfurt office of Debevoise & Plimpton LLP. Natasha Labovitz is a partner in the firm’s New York office.