German insolvency reform to boost turnarounds

Marred by a spate of high profile insolvency cases, including retail chain Schlecker, the German government seems determined to get failing businesses back on track. ESUG introduces a range of measures to make it easier to do just that.

A preliminary creditors' committee will give creditors more power, a protected reorganisation process, equivalent to Article 11 of the US law, should help businesses reorganise themselves without the interference of the courts. Enhanced rights for creditors, allowing them to choose the preliminary insolvency administrator and debt equity swaps will further aid in restructuring, the German government claims. But the industry is uncertain of how investors will react to the changes and whether the law will have any real impact on private equity at all.

"ESUG certainly sends out a psychological signal but I cannot see any real opportunities to do things that one could not do before," says Dr Sven-Holger Undritz, adviser at White & Case Insolvenz GbR.

Despite this scepticism, he believes the changes are for the better: "I think it's good. The signal is pro restructuring and pro participation and one has to listen to the creditors and also give the indebted business a second chance. Unfortunately in Germany, insolvency is still stigmatised and I hope that this old way of thinking will slowly be overhauled. Businesses should be able to announce insolvency sooner. Then it will be more interesting for investors too as more businesses come onto the distressed market."

Although historically only about 1% of company insolvencies entered self-administration according to Undritz, ESUG seeks to give more power to creditors and management to elect self-administered proceedings. That may offer a distinct advantage for investors, says Dr Henrik Fastrich, founding partner at Orlando Management: "When creditors decide before proceedings that the business can function without an insolvency administrator, the administrator loses power and the management can continue in self-administration. This offers the possibility for investors to invest in the business early on and directly approach the creditors together with management to find a solution."

To make the restructuring process easier once a solution has been found, ESUG provides a new legal framework that prevents rogue debtors and creditors from obstructing the process, unless they can demonstrate that the plan puts them at a distinct disadvantage.

ESUG could also enhance the market for distressed company sales in Germany. Debt-equity swaps have been rare in Germany over the last few years but could grow in use in the future, says Undritz, as the legal framework for them has improved considerably.

"The theoretical base for debt-equity swaps has been established but some banks aren't interested in obtaining equity. It could be interesting for PE firms to buy discounted debt and swap it for equity when such special situations arise and they will come. Up until now debt-equity swaps have been in the shadows and everyone here is asking themselves whether this will really change."

The turn-around market has been lacklustre in Germany recently and industry players are asking themselves whether ESUG is really doing enough to change that. After all, "the opportunity to invest and buy cheap business out of insolvency, has already existed in the past," says Undritz.

ESUG has been in force since 1 March and its impact will be reviewed by the German government after five years.

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• Topics
• DACH
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• Germany