The current turbulent times—marked by the COVID-19 pandemic and the war in Ukraine—are having a significant impact on the German economy. Many companies are facing financial difficulties due to supply chain bottlenecks, import and export restrictions, and rising prices. This makes it all the more important for business owners to know how to act in a legally compliant manner when their company is in crisis.
I. Legal Framework
The obligation to file for insolvency applies to all legal entities and partnerships without legal personality where no personally liable partner is a natural person.
There are two grounds for insolvency that trigger a management’s obligation to file for insolvency: insolvency and over-indebtedness. In cases of merely imminent insolvency, there is no obligation to file, but the debtor has the right to do so.
While at the start of the COVID-19 pandemic, the cumbersome COVID-19 Insolvency Suspension Act (COVInsAG) provided for legal measures to mitigate the economic impact of the pandemic by temporarily suspending the obligation to file for insolvency (in cases of insolvency resulting from the pandemic), it is important to note that the suspensions of the obligation to file for insolvency expired completely as of September 30, 2020, with respect to insolvency, and as of December 31, 2020, with respect to over-indebtedness (extended in exceptional cases until April 30, 2021, for both) the scope of application of this Act has completely expired. Since then, the strict liability and penalty-based regulations regarding the obligation to file for insolvency in cases of insolvency have once again applied without restriction.
II. Over-indebtedness
Over-indebtedness exists when the debtor’s assets do not cover existing liabilities (both due and not yet due), unless the continuation of the business over the next twelve months is, under the circumstances, highly probable (so-called positive going-concern prognosis). For the period from January 1, 2021, to December 31, 2021, the legislature had shortened the forecast period from twelve to just four months in cases of pandemic-related over-indebtedness, in order to account for the uncertain overall circumstances.
According to prevailing opinion, the going-concern forecast is essentially a liquidity forecast—that is, whether it is highly probable that liabilities due or becoming due in the next twelve months will be covered by sufficient liquidity when they fall due. If the forecast is positive, there is no over-indebtedness. In such cases, balance sheet overindebtedness has no relevance under insolvency law. If the forecast is negative, a balance sheet overindebtedness test must be conducted.
The starting point for this is the company’s commercial balance sheet; however, capitalized assets must be valued based on a liquidation scenario rather than going-concern values. The assets are then compared with the liabilities and provisions. If the assets do not cover the debts, the company is also overindebted from a balance sheet perspective and is therefore required to file for insolvency.
In the event of over-indebtedness, the insolvency petition must be filed “without culpable delay,” no later than six weeks after the onset of over-indebtedness. The six-week period is a maximum deadline and may only be utilized as long as a promising restructuring effort to eliminate the over-indebtedness is still being pursued; however, this effort must be completed within the filing deadline. If there is no prospect of resolving the over-indebtedness or if such a prospect ceases to exist, an insolvency petition must be filed immediately.
III. Insolvency
Insolvency exists when a debtor no longer has sufficient liquidity to settle its due liabilities. The Federal Court of Justice (BGH) still permits a liquidity shortfall of less than 10 percent as a tolerance threshold and to distinguish it from payment delays that are not considered problematic under insolvency law. Insolvency is assessed based on a liquidity status (a list of currently due liabilities and the liquid funds available on the same day) as of a specific cutoff date.
If a shortfall of 10 percent or more exists as of the reference date, the liquidity status is updated on a daily basis starting from that date using a liquidity forecast that includes expected cash inflows and outflows over the next three weeks, as well as liabilities that have been repaid and those that are becoming due. If the shortfall is not reduced to below 10% within the three-week period, the company is insolvent. The petition for insolvency due to insolvency must be filed “without culpable delay,” in accordance with the principles outlined above, and no later than within three weeks.
IV. Insolvency Often Discovered Too Late
If, as is often observed in practice, insolvency is discovered too late, an insolvency petition must generally be filed immediately. The three-week deadline has then already expired. According to the Federal Court of Justice (BGH), once insolvency has occurred, it can only be remedied if the debtor “generally resumes making payments.” If this is achieved, an insolvency petition need not be filed. However, this requires that all due liabilities be paid in full and that all future due liabilities be paid on time and in full in the near future. There are no more specific requirements. To demonstrate a “sustainable” resumption of payments, one should avoid at all costs falling back into a liquidity shortfall in the near future.
Typically, resuming payments is only possible if new liquidity is provided by an investor or shareholder, or if a significant payment from a project is received. However, a cash injection from a shareholder is sufficient only if it can actually be used to pay all due liabilities and if it is not merely promised but also disbursed immediately. The proverbial drop in the bucket, combined with a promise of further payments, is by no means sufficient for this purpose.
