The current restrictions and reductions to public life in the aftermath of the corona virus outbreak have led to a direct and immediate economic crisis. Federal and state governments, as well as city governments, are working hard to provide rescue packages and measures intended to prevent a wave of insolvencies. This brings up memories of floods in Germany and the financial crisis of 2008/2009. This time as well, as soon as the aid measures come to an end, investors will be looking for buy and sell opportunities. The number of M&A transactions will rise, and those investors pursuing loan-to-own strategies will be seeking more opportunities.
A bust for business
It may sound a bit crass, but the fact is that it is appropriate to talk about the opportunity that this crisis is bringing to the market for distressed M&A. The survival of many companies, and the fates of many people, are now in question, and an end to the carnage is not in sight. Entire industries have no customers anymore. Tourism succumbed to the virus, large conventions and conferences have been cancelled, and small events suffered the same fate. In those industries that produce goods, trade has been impacted by supply shortages. In many industries, demand is still present, and in a few cases, demand has risen, such as in pharmaceuticals, food retail and technology.
Sometimes companies cannot meet the increased production demand because of missing components and inputs from abroad, first and foremost from China and other low-wage countries in Asia. Even if business in Germany is not impacted completely, companies increasingly cannot work as they do normally, due to employees in quarantine or employees who are absent to care for a child or elder. In the next days, we’ll understand more about the impact of having schools and kindergartens closed for so long. In many families, both parents work. And since people are being asked to stay at home, general consumption is already collapsing. Retail shop owners and restaurant owners are having to cope with far fewer or no customers at all.
If income declines from one day to the next, no matter what the reason, liquidity becomes a serious problem. This doesn’t just impact those companies that were having trouble before the coronavirus crisis and are therefore in a more difficult situation. Small and mid-sized companies, as well as freelancers, rarely have extra liquidity because their overall turnover is low anyway. In many cases, they have no cushion to protect them from a long-term lack of income. Even large companies are being tested by the situation, depending on the capital structure they chose during the good times of the past. Those decisions about how much capital to retain on the balance sheet, how much should be paid out, and how much debt to take to keep investors interested will bear consequences.
The measures that local, state and federal authorities are offering in the aftermath of the coronavirus crisis are also focused on liquidity.1For instance, the government quickly passed laws that made it far easier for companies to apply for short-term unemployment benefits for their own employees, in order to avoid laying them off.2 It seems lawmakers were able to learn from the experience of the financial crisis in 2008 and 2009 and quickly roll out this important option to keep the labor market intact. Several measures are already helping companies: They include looser requirements about the number of employees in a company who are eligible for help; easier access to these measures for temporary workers; and refunds from the federal employment office of social benefits paid to employees.
In addition, tax-related measures were passed to help individual companies faced with problems of liquidity. The state is allowing companies and individuals to defer the payment of their taxes. The tax authorities must allow this in cases when paying the taxes would lead to hardship, and the definition of hardship in this case seems lenient. Tax pre-payments are to be reduced quickly and easily if income in the current year is expected to be lower than in the past year. For those tax bills already due, tax authorities will not charge late fees or demand payment in cases when the company or taxpayer has been impacted by the coronavirus.
For companies that are exporting goods, the federal government is providing export credit guarantees like it did in the years after the financial crisis. Primarily, however, there are liquidity loan programs through the KfW, Germany’s state-owned development bank. A billion-euro economic shield is meant to help companies of all sizes in all industries overcome the crisis.3 The bank is setting up special programs for companies that have short-term and acute liquidity problems. To make it easier and faster for loans to be given, the federal and state governments are guaranteeing loans. If necessary, the guarantees already defined in the federal budget of roughly 460 billion euros can be increased to 930 billion euros.4
Moratorium on insolvency filings
Even when rescue packages are prepared quickly and companies can directly ask for aid, some companies will still face insolvency. That’s because incorporated businesses and atypical business forms such as certain partnerships are required to file for insolvency within a very short period of three weeks after becoming illiquid or over-indebted. In its communication with the public about the coronavirus crisis, authorities avoided using the word insolvent, in part because policymakers have been working hard for years to remove the stigma associated with the term.
Managers and directors should not close their eyes to the “sword of Damocles” that may be hanging over their heads in the aftermath of the coronavirus crisis. Not only is the period for filing very short, but filing for insolvency may also bring with it personal liability or criminal charges. In the current situation, companies should not have to file for insolvency if one of the credit programs could help the company get through the crisis. In this case, the debtor and creditors need to allow enough time for the aid programs to help. If companies rush to file insolvency, creditors and house banks in particular will have a flood of applications to deal with at a time when they lack personnel to process them.
As a result of the financial crisis, the ratio of liabilities to assets allowed in terms of insolvency law was adapted for the situation almost overnight, and the definition of when indebtedness constitutes insolvency was changed. The rules were relaxed for companies that suddenly had devalued assets but still had operational income. The financial crisis was different than the current crisis because the devaluation of assets caused financial statements to be out of whack. Considering the change in definition of over-indebtedness over-indebtedness, however, companies in this crisis do not have to file for insolvency as long as they can show a positive prognosis for the current and following business year.
After the definition of over-indebtedness was loosened until the end of 2010 (in the aftermath of the financial crisis as part of the Financial Market Stabilization Act), lawmakers voted for an extension to 2013. In 2012, they voted for the definition to become permanent. However, the problem remains the financial solvency of the company when it is over-indebted. In the current crisis, the main question right now is how to bridge the uncertain economic time and avoid insolvency. In this situation, the changes to rules about when to file for insolvency made in the aftermath of the financial crisis don’t help much.
Providing a moratorium on insolvency filings is nothing new. The federal government did this in 2002, 2013 and 2016 for companies financially impacted by floods. First the moratorium was for six months, and then it was extended. The idea was to help companies get through the impact of the natural disaster. Those companies affected were given time to go through the process of refinancing and restructuring.
In the end, the goal then and the goal in the current crisis is to gain enough time to let the aid measures work to bridge the exceptional period before a company must file for insolvency. If a company was not able to get back on its feet even within the extended period by claiming insurance proceeds or damages or by restructuring or renegotiating with creditors, then indeed it must file for insolvency within three weeks from that point.
In the coronavirus crisis as well, it’s imperative that a short-term moratorium on insolvencies be provided. Such a law was prepared as a broader part of the coronavirus aid package to make sure the aid package is effective.5
Lawmakers allowed a temporary moratorium on insolvencies until September 30, 2020, that can be extended until March 31, 2021, at the latest. To take advantage of the moratorium, the reason for the insolvency has to be related to the coronavirus pandemic. In addition, it is only available to those applicants that have a chance of a successful restructuring through refinancing, aid or negotiations.
Criteria for the “worthiness of self-management in insolvencies” were recently developed as part of the review of a law that went into effect in 2012. The criteria are designed to make it easier for companies to manage their own restructuring in cases of insolvency by self-administration. These are criteria that lawmakers could also consider to help limit fraud with state aid that costs creditors money.6
Managers and directors are not necessarily out of trouble just because rules have been loosened about filing for insolvency. Even if they will not be accused of failing to file for insolvency in a timely manner or a company takes part in a moratorium, the other parts of insolvency law still apply. Creditors can take legal action to ensure communication about the financial situation of the company during the crisis period. And, what’s more, companies may not proceed with payments after they have become illiquid and over-indebted (§ 64 Satz 1 GmbHG, § 92 Absatz 2 AktG, § 130a HGB). In cases when this is not respected, the management and directors may be liable to make restitution.
When insolvency is managed by an insolvency administrator, large sums can come together because the goal is not to make restitution for a damage but to recover funds that flowed through the organization. The idea is not that these norms keep a company from resuming or continuing its business during the crisis, but to avoid economies to be run at the ultimate expense of creditors. The justice system is engaged in a delicate balancing act for this complex matter and is still answering the question of where the border is. Without knowing the landscape, it’s highly risky to maneuver through it. And it’s important to keep in mind that according to the latest rulings, D&O insurance does not necessarily automatically cover managers in cases of personal liability.7
Even in cases when short-term insolvency is avoided due to new, low-cost loans, companies must get back to the place where they can pay for the bridge financing. Depending on how long the crisis lasts, which is something no one can say with certainty, this can be a problem. In any case, it’s a good thing that a long discussion took place at the EU level about the necessity of a pre-insolvency restructuring tool in the national laws of member states. This nudged member states in the right direction.8
The new preventive restructuring measures made available under EU law are now being implemented by member states. Germany, for instance, has already begun doing so. The laws should be designed to give companies that have an operationally viable business a tool for avoiding insolvency when there is a likelihood of it. In this case, when companies just need to restructure the passive sides of their balance sheets, it would no longer be necessary to have a process in which all creditors participate, which can be lengthy and has specific consequences. This opportunity to avoid a mediation and enforcement of insolvency laws in favor of a quicker, more effective and legal process for reducing debt should only be available for those companies that begin negotiations with their creditors before they become illiquid.
If German lawmakers were to give companies in a crisis due to the coronavirus a tool for preventive restructuring and to link that tool to a viability test, companies who were hit by the corona crisis would have far more options. This is something we can recommend. For these companies it will be typical that there is no need for insolvency restructuring instruments, including measuring debt from all creditors against operative business or the passive side of the balance sheet. Even if a good law does need time to be developed, which of course is no guarantee of its effectiveness, this process should be sped up in order to harmonize new rules with a temporary moratorium on insolvency filings.
The EU has been calling for a process for companies – and natural people – to have a means of deleveraging or debt relief. This is the way it should be. If a company is doing poorly, many jobs are at risk of being lost. Lobbyists and interested parties submitted a draft bill on February 13, 2020, that would shorten the time to three years in which debt forgiveness must take place.9
Crisis as an opportunity
The idea that crisis is also an opportunity should not be lost, even when the crisis is as big as the current one. In the end, the crisis makes it clear what many already know – that certain dependencies make parties vulnerable. It’s well known that in the relatively new and ambitious solar energy industry, almost all parts are built in Asia. Other industries are in a similar situation, but it was much less known. Now the situation is more visible. It’s also known that the company that has the cheapest offering is the one that wins, no matter where that company is headquartered. In most cases, other providers have no chance against that kind of competition. This is something that can change and would benefit not only jobs but also the environment, the climate and sustainability. When companies do their due diligence and decide whether to make an acquisition, we expect them to put these factors in stronger focus. Diversification will become a central criteria for purchase decisions.
Calling the gods
That our economy needed immediate help from lawmakers to ensure survival and protect wealth is not being debated. But a glance back at recent crises shows us that we will be dealing with the consequences of the rescues for a long time.
Ever since the new economy bubble burst in 2000, non-performing loans (NPLs) have been a financial instrument of interest.10
One of the EU’s restructuring directives passed last year has the aim of eliminating NPLs as a financial instrument, as they have become objects of speculation and were one reason for the financial crisis. Now there’s a new crisis and many companies will become further indebted. It is unclear when these new loans can be repaid and whether they may end up being non-performing loans as well. As we saw with the change of the definition for over-indebtedness in the aftermath of the financial crisis it is hard to turn the wheel back.
A functioning economy that is based on supplier credits is also based on businesses being able to trust that their partners will pay their invoices on time. This trust would be harmed if rules about applying for insolvency are loosened too much.
When the coronavirus crisis is behind us, at the latest, the market for M&A will grow again. Many companies will be more heavily indebted and need partners with strong balance sheets. In addition, the market for NPLs will continue to grow and lead to more room for investors that have the intent to take over companies via debt to equity. A discussion is underway about whether and under what circumstances further preventive restructuring measures shall enable interference in the rights of shareholders.11 Loan-to-own strategies as part of insolvency proceedings and insolvency plans have been pursued more since it was allowed in 2013. Due to the current crisis, they will be pursued even more. Since it became possible through the ESUG-law for the rights of shareholders to be impacted against their will, companies have been converting debt claims into shares as a way to deleverage. At the same time, that step can lead to a takeover. Lawmakers made debt-equity swaps possible as part of insolvency proceedings in the new law § 225a Absatz 2 InsO, and they also made them practical by ruling out claims about discrepancies by creditors in § 254 Abs. 4 InsO. If valuations for non-performing claims are too high during a debt-to-equity swap and takeover, this has no further consequences for the creditors.
- https://rsw.beck.de/aktuell/meldung/regierung-beschliesst-massnahmenpaket-gegen-corona-krise ↩
- Entwurf eines Gesetzes zur krisenbedingten Verbesserung beim Kurzarbeitergeld ↩
- https://www.bundesfinanzministerium.de/Content/DE/Standardartikel/Themen/Oeffentliche_Finanzen/2020-03-13-Schutzschild-Beschaeftigte-Unternehmen.html ↩
- https://www.bundesfinanzministerium.de/Content/DE/Standardartikel/Themen/Oeffentliche_Finanzen/2020-03-13-Schutzschild-Beschaeftigte-Unternehmen.html ↩
- https://rsw.beck.de/aktuell/meldung/insolvenzantragspflicht-fuer-durch-corona-epidemie-insolvente-unternehmen-soll-ausgesetzt-werden ↩
- https://www.bmjv.de/SharedDocs/Downloads/DE/News/Artikel/, Seite 71 ↩
- OLG Düsseldorf, Urt. v. 20.7.2018 – I-4 U 93/16 beim BGH anhängig unter Az. IV ZR 186/18; zur anderen Auffassung vgl. bspw. Markgraf/Henrich, NZG 2018, 1290 ↩
- Richtlinie (EU) 2019/1023 über präventive Restrukturierungsrahmen, über Entschuldung und über Tätigkeitsverbote sowie über Maßnahmen zur Steigerung der Effizienz von Restrukturierungs-, Insolvenz- und Entschuldungsverfahren und zur Änderung der Richtlinie (EU) 2017/1132 ↩
- https://www.zvi-online.de/heft-3-2020/zvi-2020-79-reform-2020-die-weitere-verkuerzung-des-restschuldbefreiungsverfahrens/ ↩
- https://www.bankingsupervision.europa.eu/ecb/pub/pdf/guidance_on_npl.de.pdf ↩
- Heckschen/Weitbrecht, Überfremdungsschutz im GmbH- und Aktienrecht, NZG 2019, 721; Schäfer, Einbeziehung der Gesellschafter in ein vorinsolvenzliches Restrukturierungsverfahren?, ZIP 2019, 1645 ↩