German insolvency laws are considered unsympathetic to companies going bust, with the result that insolvency proceedings are often kicked off in the UK, as Annerose Tashiro reports

When UK Conservative Party leader David Cameron stood in front of the Confederation of British Industry on 15 July and proclaimed that "we cannot – and should not – save all companies that fail" as a result of the credit crisis, he promised to investigate replicating the better parts of the US Chapter 11 system of liquidation. While this is a laudable suggestion, the process of administration in the UK is already less painful than virtually anywhere else in Europe. The credit crisis has hit whole economies – and hit them hard. The problem is further compounded in manufacturing industries, where rising energy prices are especially troublesome. Collectively, this spells a time of extreme worry for the German economy in particular.

Insolvency is a predictably stressful time for all the parties involved – once-powerful directors are suddenly impotent bystanders while their company faces restructuring or worse in front of their eyes. Creditors fret about whether or not they will recover their money. It is perhaps most unfortunate that, in the midst of these unavoidable conditions, German legislation appears unsympathetic if companies go into insolvency. It is not surprising that in such situations one or more parties often try to start insolvency proceedings in the UK.

European legislation stipulates that a company heading into insolvency should do so wherever its head of operations is, provided it is within the European Union. The ambiguity of this statement enables parties involved to try to start the proceedings wherever the legislation is most beneficial to their own cause, justifying it accordingly. Both Schefenacker and DNick, patently German companies, were restructured under a guise of British organisational leadership. This can lead to a race to declare insolvency among parties, further endangering companies which could yet pull through.

Few countries could have more disparate legislation for insolvency than Germany and England. In English law, there is provision for out-of-court settlements, such as the company voluntary agreement (CVA), with the possibility of the debtor or creditor appointing an insolvency administrator.

German legislation is more severe. Here the insolvency judge acts unilaterally and often irrespective of the desires of either party, who are routinely denied any input into the proceedings. It is no surprise that there are likely to be English stakeholders in German companies and vice-versa, and this can often be met with resentment from English parties, critical of the perceived lack of representation and transparency in the German system. When compounded with the German requirement of directors to file for insolvency within three weeks of unsustainable indebtedness, or else face civil and criminal liability, the German system seems positively daunting.

To stem the tide of companies racing to the most favourable legislation for insolvency, legislators throughout Europe have realised the importance of these manoeuverings and engaged in thorough research into different legal frameworks. The German Parliament is now trying to recover Germany's credibility in such circumstances.

As of this summer, the requirements on German directors regarding insolvency have broadened. Most significantly, German entities may now relocate their seat anywhere else in the European Community, enabling companies to predict their lex forum concursus, while remaining an entity governed by German corporate law. Such requirements now apply to the directors of all companies with their centre of main interest in Germany. By the same token, shareholder loans are always subject to equitable subordination.

More flexibility will be injected by the option to transfer authority to investors who specialise in crisis and restructuring, with the expectation that they will withdraw their interests shortly after. This can be enacted through special loans, the familiar equity mechanism, or acquiring distressed debt engagement. The German legislator is hoped to provide the flexibility of the CVA with the security of a well-defined legislative framework.

The strident efforts made by Germany are likely to be criticised as long overdue. However, it is symptomatic of the fact that European legislation is gradually gaining a homogenous approach, without any central interference. Such integration, sped on by difficult times, should help to pave the way towards a Europe that is fitter for the challenges to come.

While a consistent attitude may be brought about in the near future, homogenous legislation may take years, particularly if English law adopts the Chapter 11 system just as Germany begins to catch up. Perhaps in the very long term we will see (in addition to the European procedural regulation on insolvency proceedings) some kind of homogenous substantive European law on handling multinational distressed situations, led by the idea that all parties are treated equally and with more predictability. Until then, a pilgrimage of German companies limping to England is likely to continue.

Annerose Tashiro is head of cross-border insolvency at Schultze & Braun.

GermanyJuly2008