Economic Shutdown: More and More Companies Are Facing Bankruptcy Due to the Coronavirus Crisis
On March 27, 2020, the German Bundestag passed the “Act on the Temporary Suspension of the Obligation to File for Insolvency and on the Limitation of Director Liability in the Event of Insolvency Caused by the COVID-19 Pandemic (COVInsAG).”
The aim is to prevent companies from having to file for insolvency en masse due to the effects of the COVID-19 pandemic and to ensure that restructuring measures are taken to avert insolvency, rather than companies refraining from such measures out of fear of being held liable by a subsequent insolvency administrator. However, the COVInsAG is not intended as a remedy for companies that were already in economic crisis prior to the COVID-19 pandemic.
Corporate Insolvency: Suspension of the Obligation to File for Insolvency
The COVID-19 pandemic has plunged many companies into a deep economic crisis. If the company is insolvent (i.e., its liquid assets are insufficient to settle its due liabilities) or overindebted (i.e., its assets do not cover its liabilities and there is no positive going-concern prognosis), then, pursuant to Section 15a of the Insolvency Code (InsO), an insolvency petition must be filed. Otherwise, management is personally liable to criminal prosecution and is liable for payments ordered after the company became insolvent.
The legislature now intends to suspend these obligations and liability risks retroactively for the period from March 1, 2020, through September 30, 2020 (with an option to extend until March 31, 2021) if the insolvency was triggered by the COVID-19 pandemic.
First, during the suspension period pursuant to Section 1 of the COVInsAG, the obligation to file for insolvency is suspended, unless the insolvency is not attributable to the consequences of the COVID-19 pandemic or there is no prospect of remedying the insolvency that has occurred.
If the company was not insolvent as of December 31, 2019, it is presumed in its favor that the insolvency is attributable to the effects of the COVID-19 pandemic and that there is a prospect of resolving the insolvency. However, this presumption is rebuttable.
Thus, if insolvency proceedings are subsequently initiated, an insolvency administrator would continue to investigate—even if the company was solvent as of the end of 2019—whether insolvency or over-indebtedness existed prior to March 1, 2020 (i.e., the start of the suspension period). If insolvency is subsequently determined to have existed at an earlier date, the specific circumstances of the case will ultimately determine whether the insolvency administrator can successfully assert liability claims against the managing directors.
However, if the state of insolvency was triggered solely by the COVID-19 pandemic, the managing directors’ personal liability for payments made after the onset of the state of insolvency is waived, at least to the extent that such payments are made in the ordinary course of business, in particular to maintain or resume business operations or to implement a restructuring plan (see Section 2(1)(1) of the COVInsAG).
For insolvency petitions filed by creditors (typically tax authorities and social security agencies), the following applies during the suspension period: a ground for opening insolvency proceedings must have already existed as of March 1, 2020.
COVID-19 Insolvency Suspension Act: Repayment Claims, Payments, and Collateral
As part of the COVInsAG’s additional measures, the risk of avoidance actions against shareholders, lenders, and other creditors is also to be limited in order to encourage them to support distressed companies. This limitation on avoidance actions is intended to apply regardless of whether the company is actually insolvent (whether due to COVID-19 or not).
Thus, repayment claims for shareholder loans granted during the suspension period are to be exempted from the subordination provided for in the Insolvency Code, and their repayment—if made by September 30, 2023—will not be deemed to disadvantage creditors. Since they do not disadvantage creditors, these repayments are also not subject to avoidance in subsequent insolvency proceedings.
Furthermore, payments and security provided during the suspension period in favor of creditors will also be exempt from avoidance if they are made as contractually agreed. Certain payments that deviate from the contractual terms—such as payments made in lieu of performance or by third parties at the debtor’s instruction—are also not subject to avoidance (see § 2(1)(4) COVInsAG).
It is easy to see that the provisions of the COVInsAG are legally complex and difficult for a business manager without legal training to implement as a guideline for action.
Is the Company Facing Insolvency Due to the COVID-19 Crisis?
If an acute risk of insolvency has arisen as a result of the COVID-19 pandemic, the managing director should urgently seek legal advice to best avoid liability risks and, if necessary, to continue to comply with any existing obligations to file for insolvency.
Merely referring to the provisions of the COVInsAG as explained above does not satisfy a managing director’s duties of care and conduct, even during the COVID-19 pandemic.
