Distressed M&A in Germany
Insolvencies in Germany were at a record low in 2019 and insolvency administrators were feeling underworked. And along came a virus that changed economic reality in a heartbeat. Whilst the German legislative has done its utmost to mitigate the economic consequences, it does not take the magical talent of the future-teller to realize: there will be numerous insolvencies in 2020 and 2021, and with that bargains for investors. Obviously, there are not only opportunities, but also risks in acquiring a company out of bankruptcy. Most, often all, risks can be eliminated by a careful examination in the run-up to the acquisition (due diligence) as well as by a careful drafting of the contract. The range of legal issues to be considered touches on a number of legal areas. In the foreground are insolvency, corporate, labour and tax law issues, in individual cases also antitrust law issues. We will highlight a few of the more general legal issues.
1. Share deal or asset deal?
The acquisition of the insolvent company by way of a share deal initially leaves the reason for insolvency of the over-indebtedness or illiquidity unaffected and therefore regularly does not correspond to the interests of the purchaser. The situation is different in particular if the purchaser is prepared to contribute fresh equity capital to the company. He will be prepared to do so in particular if the company's creditors waive their claims – if necessary against the issue of a debtor warrant. In particular, the insolvency plan procedure (§§ 217 et seq. of the German Insolvency Code, Insolvenzordnung, InsO) offers the possibility of agreeing corresponding provisions with the company's creditors. A purchaser will choose this route above all if he attaches particular importance to the acquisition of assets of the company which the company cannot transfer individually. These may be goodwill, certain non-transferable permits or valuable contractual relationships such as a large number of rental agreements. Often, such deal will require a close cooperation with the insolvency administrator and the creditors, to structure proceedings in a way that minimise risk exposure.
In practice, however, the asset deal from insolvency discussed below is of much greater significance than the share deal discussed here. The following explanations therefore focus on the asset deal.
2. When is the right time to buy in the crisis of the target company?
Under German law, three stages offer involvement of a purchaser.
At the stage before an application for insolvency is filed, difficult questions regarding the competencies of a (provisional) insolvency administrator, the insolvency court and the creditors of the seller do not arise. However, both the seller and the purchaser run considerable risks. In terms of civil law, liability risks from the continuation of the company name (§ 25 German Commercial Code, Handelsgesetzbuch, HGB), the legal transfer of employment relationships (§ 613a German Civil Code, Bürgerliches Gesetzbuch, BGB) and the liability for tax liabilities of the legal predecessor (§ 75 German Tax Code, Abgabenordnung, AO) without the exclusions or restrictions applicable in insolvency proceedings are just as much in the foreground as the risk of an appeal by the insolvency administrator under §§ 129 et seq. InsO. As a rule, a purchase shortly before an insolvency application is filed is only worthwhile if a thorough due diligence has been carried out and the target company is sustainably financed immediately after the takeover. The investor will also need to brace for litigation with an administrator, who in all likelihood will question the validity of the acquisition.
An acquisition of the company after an insolvency application has been filed but prior to the opening of insolvency proceedings by the assigned insolvency court is usually not advisable because the advantages of the purchase from the insolvency cannot yet be used at this stage. According to the German Insolvency Code, a sale of the company in the opening proceedings is generally not permitted as the rights of disposal of the preliminary insolvency administrator do not provide for this. Therefore, unless there are strong arguments for an acquisition prior to the opening, the acquisition process (which may have been started before!) will only be completed at that stage. It should be noted that in almost all cases there will be a three month period between the application for the opening of insolvency proceedings and the insolvency court’s decision on the opening of the actual proceedings.
3. Transferring restructuring after opening of proceedings
The acquisition of all or at least the essential active assets (asset deal) of an insolvent company is often referred to as a transferring restructuring. In this case, it is not the company itself that is restructured but the company's business operations. The way to restructure is to transfer the company's business operations to another, "healthy" legal entity, usually without liabilities. The proceeds from the sale are used to satisfy creditors. The insolvent and, after the transfer of its business, former entity is eventually liquidated.
A transferring restructuring requires the consent of the creditors' committee (usually on larger insolvencies) or, if no such committee has been appointed, the creditors' meeting. In the event of a sale of a business to particularly interested parties, this provision always requires the consent of the creditors' meeting.
Violations by the insolvency administrator of the participation rights of the creditors' committee or the creditors' meeting do not lead to the ineffectiveness of the measures taken. The insolvency administrator may, however, be held personally liable as a result.
4. Questions of liability
The structuring of the transferring restructuring as an asset deal enables the purchaser in particular to shed the seller's liabilities. The purchaser is therefore generally only liable for the debts expressly assumed by the seller. In this case, the risks of a statutory liability extension to the acquiring liability are effectively excluded. The same applies to the risk posed by the Transfer of Undertakings regulations, with the caveats outlined below.
5. Labour law
A wide range of labour law issues arise in connection with the acquisition of a company from insolvency. Of fundamental importance for the labour law treatment of the transferred restructuring is that § 613a BGB is generally applicable – with certain restrictions in the legal consequences (see below). Thus, a transfer of employment relationships pursuant to § 613a BGB also occurs in the event of a transfer of business from insolvency. Social vested rights are generally preserved. The purchaser also takes over – to a limited extent, and immediately – the following commitments of the seller concerning a company pension scheme for employees.
The transfer of employment relationships, including a possible company pension scheme, is often an obstacle to reorganisation. However, § 613a BGB is limited by established case law with regard to the legal consequences of the provision. Accordingly, the purchaser is only liable for the seller's obligations arising from the employment relationship after the opening of proceedings. Accordingly, the purchaser only owes that part of a company pension scheme established with the seller which the respective employee has earned after the opening of proceedings.
However, the restrictive application of § 613a BGB alone often does not do justice to the interests of a business purchaser from insolvency. Rather, his reorganisation objective can often only be achieved by personnel adjustment measures. The contact person of the potential business purchaser in this respect is the insolvency administrator, who performs all employer functions in the insolvency proceedings. The provisions of the German Works Constitution Act (Betriebsverfassungsgesetz, BetrVG) are also generally applicable in insolvency. The participation rights of the works council are of particular importance, especially with regard to changes in operations (especially reconciliation of interests, social plan). However, the special labour law provisions of the German Insolvency Code create certain simplifications for the insolvency administrator. Incidentally, these provisions do not apply either directly or by analogy in the opening proceedings – a further argument in favour of not carrying out the company acquisition from the insolvency until after the opening decision, if possible.
The labour law peculiarities of the acquisition of a business from insolvency cannot be dealt with exhaustively at this point. Rather, only a few particularly important aspects should be highlighted. These aspects include the possibility of termination by the insolvency administrator with a shortened notice period of three months (§ 113 InsO).
§ 128 InsO facilitates the sale of businesses from insolvency. Accordingly, it is harmless if the changes of business, which is the subject of a reconciliation of interests, is only to be carried out by the purchaser after the business has been sold. In addition, according to § 128 InsO, in the case of a termination in connection with a transfer of business, there is the presumption that this termination does not occur because of the transfer of business, i.e. it does not constitute a violation of the corresponding prohibition of termination in § 613a, para. 4, Sentence 1 BGB.
For a more far-reaching adjustment of the personnel structure to the needs and expectations of the purchaser, insolvency administrators and potential purchasers will often talk about measures which can only be implemented with the participation of the employees respectively the works council.
6. Tax law
In terms of tax law, the avoidance of liability for the seller's business taxes in accordance with § 75 para. 1 AO is regularly of major importance for the purchaser of a business from insolvency. In this respect, an exception applies by law for "Acquisitions from an insolvency estate" (§ 75 para. 2 AO). This exception applies both in the period after the opening of the insolvency proceedings and already between the insolvency application and the opening of the proceedings. This case law is justified with the aim of achieving the best possible liquidation of the debtor's assets in the interest of the creditors. This liquidation would be made more difficult if the purchaser had to take into account the business liabilities covered by § 75 AO.
From a tax point of view, the question of whether the sale of the business is subject to VAT is still frequently relevant. Whether a business sale fulfils the requirements of a business sale as a whole (§ 1 para. 1a German Value Added Tax Act, Umsatzsteuergesetz, UStG) may be doubtful in individual cases. However, in view of the particular time pressure under which acquisitions from insolvency frequently occur, there is often no time to obtain binding information in accordance with § 89 para. 2 AO.
7. Representations and warranties
Claims from an asset purchase agreement concluded by the insolvency administrator after the commencement of the insolvency proceedings are based on a legal act of the insolvency administrator and are therefore liabilities the administrator must satisfy in full. In addition, the insolvency administrator may be personally liable for the corresponding liabilities. This liability may arise under the conditions of § 61 InsO. This is the case if a debt incumbent on the estate created by a legal transaction of the insolvency administrator cannot be fully satisfied from the insolvency estate. The insolvency administrator may, however, relieve himself by proving that he could not be aware of the probable insufficiency of the insolvency estate for performance. However, the burden of proof for this circumstance lies with the insolvency administrator.
In order to exclude both a liability of the assets involved in the insolvency proceedings and his own liability, the insolvency administrator will generally exclude warranty and not want to make any guarantee promises when selling the company from insolvency. Typically, warranties and purchase price influence each other. In any case, apart from finding insurance products to cover the lack of warranties by the administrator, it is of utmost importance to carry out a fast but thorough due diligence process,
In our experience it is also helpful to understand how far the administrator is willing to go and to define leverage one may have. That leverage may be price, a voluntary assumption of employment contracts or a rapid close of any transaction.
We assume a comeback of Distressed M&A activity in the next months. Rapid delivery, quick decisions and a thorough diligence are the keys to take advantage of opportunities that will surface.
Prof. Dr Hans-Josef Vogel