Companies in crisis: Examine reorganization options at an early stage.

 StaRUG provides no relief in terms of labor law – short-time working allowance extended.

Axel Höselbarth / Rechtsanwalt

Companies in crisis: Examine reorganization options at an early stage

If companies are threatened by liquidity problems as a consequence of rising energy prices and high inflation, they need to examine reorganization and restructuring options ahead of time. The possible options include insolvency under self-administration or pre-insolvency restructuring proceedings. Why good preparation and sufficient lead time are essential.

The Insolvency Trend from the Leibniz Institute for Economic Research in Halle (IWH) has recorded a slight increase in the number of insolvencies among unlimited companies and corporations in November in comparison with October. The insolvency rate is 23 percent higher when compared with the same month last year. In addition, the number of employees affected is also significantly higher than in the previous twelve months. According to a recent survey carried out by the National Association of German Cooperative Banks (Bundesverband der Deutschen Volksbanken und Raiffeisenbanken – BVR), high electricity and gas costs and an economic downturn are causing increasing levels of concern among German SMEs.

Examine worst-case options ahead of time

German lawmakers have created two options designed to intervene ahead of time before a regular insolvency occurs if earnings diminish as a result of expensive energy, high inflation and rising lending rates, for example: Since 2012, the Act to Further Facilitate the Restructuring of Companies (ESUG) has offered company managers the chance to remain in control of the company even after filing for insolvency. Unlike regular insolvency proceedings, the responsible court does not appoint an insolvency administrator, but rather only an administrator who assumes a control and supervisory role. Insolvency under self-administration is primarily an option for companies with a functioning business model which run into temporary and unexpected difficulties. The timely coordination of the restructuring concept with the most important creditors is a key prerequisite for success. It is also important to allow sufficient time for the self-administration application. If the management waits too long, they do more than simply waste valuable time. In the worst case, the company even faces the risk of delaying insolvency.

StaRUG enables reorganization without insolvency proceedings

The Act on the Stabilization and Restructuring Framework for Companies (StaRUG) came into force in 2021 and aims to address matters at an even earlier stage: Companies facing the threat of insolvency in the near future despite having a viable business model are offered the opportunity to reorganize without insolvency proceedings. The restructuring plan forms the central element and enables companies to reorganize their liabilities if a 75 percent majority of each creditor group agrees. The options here can range from suspended repayment, deferrals or waivers of claims, for example. In each case, the proceedings require sufficient lead time.

No relief for employee claims

The instrument is especially suitable for financial restructuring proceedings, as the Act on the Stabilization and Restructuring Framework for Companies (StaRUG) does not provide any labor law-related relief for the reorganization. Rather, claims by employees arising from or in connection with their employment relationship are explicitly excluded from the options offered by the Act. The same also applies to rights arising from commitments involving company pension schemes. In contrast, insolvency proceedings provide employers with easy access to liquidity via the insolvency allowance.

Whereas StaRUG stipulates that the general principles of labor law apply to layoffs, employment relationships are easy to terminate in the course of insolvency proceedings due to the shorter notice periods. The regulations governing the transfer of a business also remain unaffected according to StaRUG. These regulations very frequently create an obstacle to reorganization. If companies aim to restructure their staff during the course of a pre-insolvency reorganization process, they are forced to fall back on the classic instruments: Measures to provide greater flexibility with regard to working hours, short-time work, voluntary programs, reconciliation of interests and social plans, transfer companies or mass layoffs. Against this background, the Government’s decision to extend easier access to short-time working benefits until June 30, 2023, due to the energy crisis and the high burdens on the economy comes as good news.

Employee representatives’ participation rights

The StaRUG explicitly has no influence on the participation rights of employee representatives. However, the decision to utilize the pre-insolvency reorganization procedure does not give rise to any participation rights on the part of the works council as this does not represent an operational change.

Forecast period for over-indebtedness test shortened

To prevent fundamentally healthy companies from being forced into insolvency, the German government has shortened the forecast period of the over-indebtedness test as part of the third relief package: A company is only considered to be over-indebted if it is unlikely that the company will remain a going concern beyond a period of four months. Previously, this period was twelve months. This regulation is currently scheduled to remain in force until December 31, 2023.

Given the numerous current crises ranging from the Covid-19 pandemic to the drastic rise in energy prices, together with rising interest rates on loans, the fact that the number of insolvencies is lower than expected according to the IWH is a promising sign. According to the study conducted by the BVR, there are grounds to hope for improvement in the near future: Fewer companies were concerned about a gas shortage than they were a few months ago. Furthermore, many SMEs have already begun investing in renewable energies. Nevertheless, the last three years have demonstrated how important it is to prepare for worst-case scenarios. That is why companies threatened by liquidity problems need to analyze the opportunities and risks of various restructuring and reorganization options at an early stage. Labor law issues need to be a particular focus in view of the StaRUG. Good preparation and sufficient lead time are also important for success. If managers have developed a comprehensive restructuring plan ahead of time, this not only emphasizes the need for action but also improves the probability of finding mutually agreeable solutions.