32	1  Introduction

given, where the balance of total assets minus the liabilities of the debtor is negative. The assets have to be valued at a fair market value, i.e., the net value likely to be achieved if the assets were to be sold at the time of calculation in a regular course of business (estimated sale price minus sale costs). On the negative side of the net asset status (Überschuldungsstatus), all claims by third party creditors have to be taken into account, e.g., loans, provisions for contingent liabilities or loss compensation obligations vis-à-vis subsidiaries.An exception applies to such liabilities that have been subordinated and thus are ranked behind the claims of all other debtors by way of a subordination agreement (Rangrücktrittsvereinbarung) or a debtor’s warrant (Besserungsschein).

1.4.2.3  Imminent Illiquidity

Finally, insolvency proceedings may be filed in case of imminent illiquidity (drohende Zahlungsunfähigkeit). A situation of imminent illiquidity is given, when a liquidity forecast shows that a company will become illiquid within the current or subsequent fiscal year. The insolvency reason of imminent illiquidity was introduced by the legislature in 2002 and had no equivalent in the Bankruptcy Code in force until this date. By introducing the concept of ‘imminent illiquidity,’ the legislature aimed at more insolvency proceedings to be opened in a timely manner to increase creditor protection, as well as to improve the chances of successful restructuring. For this purpose companies are given the option of filing insolvency proceedings voluntarily at a time prior to actual incapability to pay their debts, i.e., when more assets and liquidity are available, as a foundation for rehabilitation or reorganization efforts. Therefore, the insolvency reason of imminent liquidity (a) constitutes a right, not an obligation to file insolvency proceedings and (b) does so only in favor of the company, not for its creditors.

1.4.3  Insolvency Proceedings—Steps and Options

1.4.3.1  Petition to Open Insolvency Proceedings

Insolvency proceedings shall only be opened upon written petition. Such petition for insolvency proceedings (Insolvenzantrag) may generally be filed either by the insolvent company itself or by its creditors.41 The petition is to be filed with the Municipal Court (Amtsgericht) competent for the debtor’s place of residence

indebtedness was temporarily narrowed. According to the amendment, a negative net asset position only constituted a situation of over-indebtedness in the absence of a substantial likelihood for a continuation of the business. This permitted managers not to file insolvency proceedings if the company was more likely than not to remain in the business in the medium-term. The amendment was limited in time and expired on 31 December 2010. Since 1 January 2011 the old definition of over-indebtedness applies again.

41  In the case of imminent illiquidity, only the company is entitled to file a petition.

1.4  A Brief Introduction into German Insolvency Law	33

(if the debtor is a consumer42) or the debtor’s place of business (in case the debtor is a businessperson, sole proprietor or company).

In the case of illiquidity or over-indebtedness, the company is obliged to file the petition.43 If the company becomes insolvent, the managing director of the company is personally responsible for filing the petition for insolvency proceedings without undue delay (ohne schuldhaftes Zögern), but not later than three weeks following the date the insolvency becomes identifiable to the director.44

A managing director failing to meet this requirement risks personal liability under civil law and under criminal law:

•First, pursuant to Secs. 15a para. 1 InsO and 823 para. 2 BGB, the managing director will be held personally liable for such damages caused to the company and its creditors by a delayed filing for insolvency proceedings. In case of more than one managing director, all directors are held jointly and severally liable.45

•Second, pursuant to Secs. 64 GmbHG, 92 para. 2AktG, the managing director is obliged to reimburse the company for any payments made to the shareholders or to third parties after the company has become illiquid or after its over-indebted- ness has been established.

•Third, deliberately delaying a necessary filing for insolvency is a criminal offense under Sec. 15 para. 4 InsO, which is punishable with imprisonment of up to three years. Depending on the facts of the case, other criminal charges (e.g. bankruptcy) may apply as well.Any conviction on these grounds will lead to the offender’s being generally disqualified from taking the office of a managing director of any other corporation for a period of five years, see Sec. 6 para. 2 no. 3 GmbHG.

1.4.3.2  Preliminary Proceedings

Insolvency proceedings will not be opened because of the petition alone, but, in addition, require a formal decision to open insolvency proceedings by the local court. Until such decision is made, the court will order preliminary measures to prevent detrimental changes to the company’s assets. Usually it appoints a preliminary administrator (vorläufiger Insolvenzverwalter). Such a preliminary administrator may—depending on the scope of the court order—either have the right to comprehensively take over the company’s management or be limited to supervision of the existing management and to take only clearly defined actions.

42  Different from other insolvency regimes, the German Insolvency Code applies both to natural persons not running a business, as well as to businessmen, merchants and companies.

43  In the case of imminent illiquidity the company is entitled, not obliged, to file a petition.

44 As the filing has to be made without undue delay, the director may, depending on the individual circumstances, be required to file for insolvency proceedings before the lapse of the three-week period. This may be the case where within the three weeks timeframe reorganization or restructuring measures cannot be taken or are more likely than not to remain unsuccessful.

45  Since it may be difficult for creditors to retrospectively establish details regarding the financial situation of the company in order to prove that on a given date the company was illiquid, the burden of proof lies with the directors.

34	1  Introduction

1.4.3.3  Regular Insolvency Proceedings

If the court holds that an insolvency reason does exist and the remaining assets of the company are sufficient to cover the costs of the proceedings (court fees, expenses, and remuneration of the insolvency administrators), it will formally initiate insolvency proceedings by appointing a (regular) insolvency administrator.46 The insolvency administrator acts as the sole representative of the insolvency estate and as such has the sole right to manage the company and to dispose of its assets during the proceedings.

Any claims against the insolvent company may only be pursued under the rules of the insolvency proceedings. Creditors have to file their claims with the administrator. Their claims will fall into one of three categories:

•preferential claims (Masseverbindlichkeiten);

•regular claims (Insolvenzverbindlichkeiten); or

•subordinated claims (nachrangige Verbindlichkeiten).

Creditors whose claims arise only after the opening of the insolvency proceedings (Massegläubiger) enjoy preferential treatment insofar as they have to be fully satisfied by the proceeds of an enforcement of the assets by the insolvency administrator before any regular insolvency creditor (Insolvenzgläubiger) receives any payment from such proceeds. Creditors of subordinated claims (e.g. a claim for repayment arising from a shareholder’s loan) will be satisfied even after the insolvency creditors and will typically leave empty-handed. In contrast, a preferred ranking usually assures that the creditor will be paid in full. Within each category, the insolvency administrator is obliged to treat all creditors equally.

Secured creditors who have a security interest over assets in the insolvency estate may, depending on the type and scope of their security right, be entitled to a separation right (Aussonderungsrecht) or may demand separate disposition of the asset concerned (Absonderungsrecht). Creditors who have a separation right (e.g., owners of an asset under a retention-of-title agreement) do not fall in one of the above-mentioned categories but have an in-rem claim for return of the asset, which is enforceable individually, independently from the insolvency proceedings. Creditors who may demand separate disposition (e.g. creditors whose claims are secured by a land charge) are privileged in that they may demand that the asset be disposed of separately and that the proceeds from this particular disposition are preferentially used to satisfy their claims.

With regard to pending contracts, i.e. contracts, which have not yet been executed by either party in full, the insolvency administrator has the right to choose between performance and immediate termination. Damages suffered by the counterparty from choosing termination constitute non-preferential insolvency claims. Moreover, the insolvency administrator has the right to set aside certain transactions (Anfechtungsrecht) which have been made by the company prior to filing for insolvency or the opening of the insolvency proceedings on grounds that the transaction has reduced the value of the insolvency estate.

46  If, however, the court rejects the opening on grounds of the remaining assets being insufficient to cover the costs of proceedings, the company will be dissolved.