When the new German Insolvency Code became law 10 years ago, carrying out insolvency proceedings without an insolvency administrator, i.e. on the basis of self-administration (U.S. law equivalent: debtor in possession), became possible. The aim of self-administration by the debtor under the oversight of a supervisor is to speed the proceedings up and reduce costs. The debtor retains the right to administer and dispose of its assets. Like the insolvency administrator in the general proceedings, the debtor acts in the self-administration proceedings as an official administrator with rights and duties defined by law.

Also in Germany, self-administration is growing in importance in actual practice. In the insolvency proceedings Babcock Borsig, Kirch Media, IhrPlatz and SinnLeffers, such order was passed subject to the following special conditions: Ahead of institution of insolvency proceedings, the executive bodies of the indebted companies were replaced or augmented by third parties that possess expertise in the fields of insolvency and restructuring. Self-administration also applies to the secondary insolvency proceedings.

Detlef Specovius, who is a lawyer with Schultze & Braun, specialising in insolvency law and CRO of SinnLeffers GmbH, was asked whether an insolvency company should restructure itself on the basis of self-administration and whether, for example, such a solution would be a possibility for the ailing Opel car maker.

Question: What is self-administration?

Specovius: When a business files an application for insolvency, the court decides whether the business in question is to be subject to the decisions of an insolvency administrator or whether it can carry out its restructuring itself on the basis of self-administration. In other words, self-administration places the restructuring process under the conduct of management.

Question: Does it make sense to give management this responsibility, is it actually in a position to carry it out responsibly and, above all, in the interests of the creditors?

Specovius: That’s a good question. And it can clearly be answered in the affirmative. The law clearly states that self-administration can only be prescribed by the court if it is not to be expected that this will delay the proceedings or disadvantage the creditors. In other words, the court examines the position in advance. As a rule, the enterprises have already called in one or more experts when the application for insolvency is filed, and the experts work alongside management in the self-administration proceedings. This was the way it was in my case at SinnLeffers.

Question: So this is to say management brings the necessary know-how on board and then does restructuring itself?

Specovius: In a nutshell, yes.

Question: Does this mean that actually only large enterprises can afford this, and therefore self-administration is only an option for them?

Specovius: No, smaller businesses have also been successfully restructured on the basis of self-administration, but, of course, it is easier for larger enterprises to obtain the necessary know-how; ultimately it’s a question of the funds that are available. The insolvency proceedings are, as a rule, so complex that they won’t work without the necessary expertise. This has been true in the case of SinnLeffers. It is not easy to take such a large company with a large number of branches and is one of the leading fashion store chains in Germany out of crisis. A very positive aspect is that a financially strong partner has been found who is prepared to inject fresh capital.

Question: What are the advantages of self-administration?

Specovius: The enterprise can negotiate directly, in particular with customers and suppliers. The continuity of business relationship is maintained. In this way the enterprise can appeal for a “vote of confidence” and negotiate with prospective investors. In the case of self-administration, management retains control over all activities itself.

Question: Where would self-administration make sense in the case of enterprises in crisis, taking the crisis currently facing the Opel car maker as a case in point?

Specovius: This is always difficult to judge from the outside, but on the basis of my many years of experience I would say that an application for self-administration should be filed if management still has the confidence of the parties involved in the insolvency proceedings and it is believed to be capable of carrying out restructuring successfully. This could speak in favour of self-administration at Opel, in particular if Opel is drawn into the downward spiral by the crisis at GM – in other words not by its own mistakes – and there is confidence that German management will be capable of steering Opel back to less troubled waters.

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According to reports by AFP and the L.A. Times, 1,300 Chinese businesses located in the Pearl River delta went out of business in the first nine months of the year as a result of the financial crisis. According to the above sources, as many as 30 per cent of the firms with foreign participation in Guangdong Province suffered losses. Now is the first major test of the new Chinese bankruptcy legislation that came into effect on 01 June 2007. The advantages it has in comparison with the old law will also benefit business partners, suppliers and customers.

The major change is the possibility to apply for orderly restructuring of a company on the application of the entrepreneur,  without official permission first having to be sought. This was not an option under previous Chinese Insolvency Law. However, this change has not only strengthened the position of the entrepreneurs,  but also that of creditors, in other words suppliers and customers. The new legislation gives them the right to file an application for insolvency on behalf of the Chinese company in question if it is no longer able to meet payments that are due. The creditors can also have a say in the proceedings, for example in decisions on the provisions of a restructuring plan. Creditors that have security interests will also have preferential claims now that the new legislation has been passed. Until the change in the law, the 1986 Bankruptcy Act had admittedly given priority rights to secured creditors, albeit only in the case of state-owned firms. However, this was undermined by various Special Regulations of the State Council on the handling of bankruptcy proceedings that came into force starting in 1994. These regulations gave employee claims priority over secured claims in order to prevent social unrest.

Foreign shareholders can file an application for restructuring, insofar as they own at least 10 per cent of the shares. Shareholders can also join forces in order to achieve the required percentage of shares. In restructuring proceedings they can decide on the restructuring plan as a single group, insofar as the plan affects their legal interests. All in all, the new Chinese insolvency legislation provides greater legal certainty; many of the legal provisions are based on Western legal systems – including the German Insolvency Code. Albeit there are still points to be clarified with regard to the criteria for proof of insolvency, so that an application for insolvency can be filed by the creditors,  and regarding the time window for an application for restructuring. The months ahead will show how this is interpreted in actual legal practice.

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Germany’s reaction to the credit crunch, the so called Act on the Implementation of a package of measures to stabilize the financial market (Gesetz zur Umsetzung eines Maßnahmenpakets zur Stabilisierung des Finanzmarktes) – an unprecedented tour de force of the legislative procedure from its proposal by 11 and 12 October to its entry into force by 18 October 2008 – includes an unexpected change in the German Insolvency Act.

Besides a number of measures intended to enhance the stabilization of the financial market, the Bailout Act weakens significantly the German over-indebtedness test and therefore the duty to file for insolvency for limited liability companies and corporations. Under the current law these legal entities were obliged to file for insolvency either in the case of illiquidity, i.e. if they are unable to meet their mature obligations to pay or in the case of over-indebtedness, i.e. if the assets owned by the debtor no longer cover his existing obligations to pay. The directors of companies meeting either the illiquidity or the over-indebtedness test incurred even criminal liability if they failed to file for insolvency within three week time spread.

According to the new over-indebtedness test a company is over-indebted if its assets no longer cover its existing obligations to pay, unless the company has a positive prognosis as to its going concern. With this weakening of the over-indebtedness test – applicable not only to financial institutions, but every company in Germany – the legislator intended to avoid that a company due to the financial crisis situation and the decrease in value of its assets would be obliged to file for insolvency even it is liquid and has a positive prognosis as to its going concern.

Curiously the “new” over-indebtedness test corresponds to the case law definition of the German Federal Court prior to the enactment of the “Insolvenzordnung” in 1999 which had emphatically overruled the existing case law. The Credit Crunch exemption for over indebted companies from the requirement to file for insolvency will therefore be a interlude: by the beginning of 2011 the classic over-indebtedness test will be re-entered into force.
Nevertheless until this “back to future” experience the current over-indebtedness test will enhance companies with a positive going concern prognosis – who are still subject to the unchanged illiquidity test - to undertake out of court restructuring where the classic test would have forced the directors to file for insolvency. However, the practical impact of this new test should not be over estimated: an over-indebted company is in nearly every case meeting the illiquidity test.

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