Corona – suspension of obligation to file for insolvency: liability risks and other problems for managers and directors

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Managers and directors must thoroughly check whether the suspension of the obligation to file for insolvency is relevant to their company, otherwise there are imminent and substantial liability risks. Restructuring in the course of insolvency proceedings can be the better alternative.

After a unprecedented fast-track legislative procedure, the “law for the temporary suspension of the obligation to file for insolvency and for the limitation of D&O liability where insolvency was caused by the COVID-19 pandemic” (COVID-19-Insolvenz-Aussetzungsgesetz – COVInsAG) was published in the Federal Law Gazette on 27 March 2020 and became retrospectively effective as of 1 March 2020. In light of the severe impact of the measures taken to slow the spread of the COVID-19 pandemic, both on the economy as a whole, but especially on the direct economic situation of individual companies as well, the speed of the legislative procedure was urgently necessary. It was the only way to avoid that healthy companies were forced to file for insolvency from one day to the other. At the same time, it was impossible to create a law on such short notice which considers all eventualities. Therefore, no manager or director should rely on the maxim stated by Peter Altmaier, Federal Minister for Economic Affairs and Energy, that “ideally no company in Germany will become insolvent solely due to the Coronavirus epidemic”. Even if the difficulties were caused primarily by the Coronavirus epidemic, substantial liability risks remain imminent. Managers and directors are facing problems based both in the prerequisites for the suspension of the obligation to file for insolvency as well as in the attached legal consequences, and also unexpected problems from a factual point of view.

I. Prerequisites for the suspension of the obligation to file for insolvency

The suspension of the obligation to file for insolvency firstly prerequisites that the insolvency is based on the impacts of the Coronavirus spread. At first glance, that may be easily demonstrated when a company had to close due to officially ordered measures or is a travel operator. Here, the manager profits from the presumption that any insolvency is based on the impact of the Covid-19 pandemic if the company was not insolvent on 31 December 2019. Yet any manager must keep in mind that this presumption is rebuttable. In later insolvency proceedings, any insolvency administrator will try to prove the opposite. It is therefore essential to document that there was no insolvency at the end of 2019 and that the insolvency was caused by the spread of the Coronavirus.

The second prerequisite for the suspension of the obligation to file for insolvency is far more dangerous, as well as surprising in light of the statement by Peter Altmaier. If there are no prospects to resolve the insolvency, the obligation to immediately file for insolvency remains effective. So, the manager must not only consider the cause for the insolvency, but he must also make a prognosis as to whether it can be resolved. The COVInsAG does not state a period in which the solvency must be presumably restored, but there are many reasons to assume that it will be the same as the period of suspension until 30 September 2020. Should the insolvency not be resolved by then, an insolvency application must be immediately filed on 1 October 2020. It would then be easy for any insolvency administrator to demonstrate that there were no prospects to resolve the insolvency from the beginning. In that case, the rebuttable presumption in his favour will no longer help the manager.

Yet how is a manager supposed to make an even close to reliable prognosis in the current situation as to whether there are prospects to resolve the insolvency? What should he base such a prognosis on? Nobody knows how the situation will develop, when the ordered restrictions will end or even be loosened. It is just as unclear how the economy will develop after the restrictions have ended. One can hardly assume that business will reach “pre-Corona-levels” again instantly or will do so at all. For their own protection, the prognosis made should therefore at best be substantiated and documented by an external expert.

Independent of the legal prerequisites, there is often a factual problem: If a company has become insolvent, it requires new liquidity fast to maintain its operations. The legislator intends to provide such liquidity by means of a government aid programme, which offers loans from the Kreditanstalt für Wiederaufbau (KfW), Germany’s promotional bank, and assumes 90 % of the risk. These credits can be applied for through the respective local banks. As short previous experience shows, many applicants suffer a nasty surprise there. Particularly those companies that were already experiencing difficulties previously are not granted those loans by the local banks, as those are unwilling to bear the remaining risk of 10 %, doubting that there are prospects to resolve the insolvency. If it is impossible to gain fresh liquidity to at least cover the absolutely necessary costs, the suspension of the obligation to file for insolvency does not provide help. Operations will immediately collapse completely. Insolvency proceedings, which allow for the non-payment of old liabilities and during which the state bears the personnel costs for three months through insolvency benefits, may be the better alternative in such a situation.

The Federal Ministry for Economic Affairs and Energy recognized that problem and offered a fast readjustment: It announced KfW instant loans for medium-sized companies on 6 April. Companies with 11 to 249 employees that have at least been on the market since January 2019, can receive loans of up to EUR 800,000, for which the state will assume 100 % of the risk. There will be no additional risk assessment by the local bank.

Finally, it should not be forgotten that any new loan constitutes a new liability and will have to be paid back at some point. Before any new loans are taken out, the company should review whether it will presumably be in a position to pay it back. If it does not, the situation could worsen during the suspension period. In a worst-case scenario, the bank demanded even the company’s silverware as security for extending the loan. In that case, the prospects for restructuring during later insolvency proceedings could possibly be hopeless.

Even if the temptation is huge, the decision to use the suspension of the obligation to file for insolvency and maybe take out an additional bank loan should under no circumstances be taken easily. There is not only the fact to consider that restructuring is more promising when insolvency proceedings are initiated early on. If the decision is made based on false or uncertain assumption, managers and directors also risk personal liability.

II. Legal consequences of the suspension of the obligation to file for insolvency

The limitations of D&O liability granted by the COVInsAG may at first glance seem tempting and facilitating to the decision not to file for insolvency. Payments made in the ordinary course of business, in particular for the continuity or resumption of business or the implementation of restructuring concepts, are deemed compatible with the due care of a prudent and diligent businessman. Liabilities resulting from Sec. 64 Limited Liability Companies Act or comparable regulations on other company forms seem thereby excluded and not filing for insolvency seems risk-free. But the exemption from liability only applies when the obligation to file for insolvency is suspended. In other words: The exemption from liability does not apply if the insolvency was not based on the impact of the Coronavirus epidemic or there were not prospects to resolve it. That is why a critical review of these prerequisites and the according documentation is so important. If theses tasks are not completed, there may be a nasty surprise when realization dawns.

Even if the prerequisites for the suspension of the obligation to file for insolvency are presumed with justification, there are liability risks, as the exemption only applies for payments made in the ordinary course of business. Therefore, if there is the slightest risk for later insolvency proceedings, the manager should, for his own protection, currently refrain from making any investments not absolutely necessary and move them to a later time.

Additionally, the COVInsAG does not limit D&O liability based on other claims. For example, if a manger incurs new debt to continue operations, which cannot be paid back later, he may be subject to criminal or civil liability due to fraudulent inducement to contract, irrespective of whether the prerequisites for the suspension of the obligation to file for insolvency have been fulfilled.

Regarding legal consequences, it should also be mentioned to managers and directors that shareholder loans granted during the suspension period do not have a lower-ranking status, at least not in insolvency proceedings applied for until 30 September 2023. That may increase the shareholders’ willingness to grand additional liquidity for the preservation of their company. Thus, shareholder loans may be a worthwhile alternative to bank loans, as the shareholder does not have to accept the lower-ranking status. In addition, it will usually be easier to talk about the ranking status or the deferral of a loan with a shareholder than with an external bank during a later crisis.

III.  Conclusion

The current situation is not easy for managers and directors and the regulations introduced by the COVInsAG only improve the situation under strict conditions. No manager should be advised to play for time by using the offered possibility for not filing for insolvency despite the company’s insolvency. The company’s long-term prospects would decrease and the manager’s own liability risk would increase.

Instead, the manager must regard the restructuring during the suspension period to resolve the insolvency without filing for it and the restructuring within insolvency proceedings applied for at an early stage as equal alternatives. Each individual case must be reviewed as to which alternative is better for a company.

If he chooses to use the suspension of the obligation to file for insolvency, the presence of the prerequisites must be documented to secure against later claims resulting from his liability.

The determination and procurement of liquidity necessary during the suspension period is an integral part of making that decision. Furthermore, it must be secured that any loans can be paid back later. Here, the possibility of shareholder loans as an alternative to bank loans should definitely be considered.

Your contact person:
Johannes Landry, Partner
+49 172 5315 261
johannes.landry@arqis.com

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