Effects of the self-administration proceedings on the company’s liquidity and balance sheet
Some features of German insolvency law are unique and not found in any other insolvency code. Self-administration enhances these unique features.
The Federal Employment Agency takes over wages and salaries retroactively for the three months prior to the opening of the proceedings in both self-administration proceedings and standard insolvency proceedings. For a company with fifty employees and a gross monthly payroll of approx. 150 TEUR, including social security contributions, this can mean a liquidity advantage totalling 450 TEUR. Of course, for larger companies that advantage is correspondingly higher. Moreover, in the period between the filing of the application for insolvency proceedings and the opening of the proceedings the company is not burdened with sales tax on its earnings. However, this applies only to self-administration and not to standard insolvency proceedings. All unsecured liabilities at the time the application is filed are considered simple insolvency claims.
Only a part or pro rata share will be paid on these claims in the future. This pro rata share rarely exceeds twenty percent, which means that this generates a significant liquidity advantage. However, this advantage only has an impact some time later when the claims ultimately come due. Moreover, during the proceedings, the company does not pay interest or make repayments to banks, and pays only those claims for goods and/or services that are incurred after the application to open insolvency proceedings was filed.
As a result of not making these payments and accumulating continued normal deposits from sales, the company builds up significant liquidity, and we mention here only its most important sources. Savvy consultants know still many more ways to generate liquidity during the proceedings. While consulting fees and court costs reduce liquidity, these costs, if planned and structured reasonably by the consultant, usually amount to only one-third of the total liquidity advantage. Thus, the enterprise retains significant liquidity, and additional bank loans for crisis management are normally unnecessary.
Building up liquidity
Something very similar takes place on the financial side. Because old liabilities are not paid, that is, only a fraction of the unsecured claims are being paid and secondary liabilities are completely eliminated (for example, mezzanine claims, which are not considered at all in insolvency proceedings), a very substantial restructuring gain is generated and significantly strengthens the company’s equity position. This is because in a self-administered insolvency plan the original legal entity, namely the company, is preserved. That is, the company is not broken up and its assets are not sold to a third party via an asset deal. The result is that the asset side of the balance sheet during the proceedings remains mostly unchanged, while the liability side is strengthened by the fact that the creditors’ significant waivers greatly reduce total liabilities and thus lead directly to an increase in equity. It is not uncommon for these proceedings to bring about improvements in the equity ratio of seventy percent or more.
The resulting restructuring-related profit is tax-free with respect to both trade and income tax. However, this must be clarified in advance by obtaining binding information from the competent municipality regarding trade tax and from the competent local tax authority regarding corporate tax if the company is a stock corporation or regarding income tax if the company is a partnership. The relevant legal provision must still be approved by the EU Commission. However, approval is expected shortly. Still, considerable errors can be made with respect to binding information issued. Without professional advisory support, there is a great risk that taxes will be collected nevertheless and that the restructuring will then fail because of the tax burden.
Impact on equity
Using an example, the following chart summarises the impact of balance sheet restructuring. The figures are the result of negotiations with creditors and therefore depend on the facts of the individual case:
- Equity amounted to EUR 4,135 million before the balance sheet restructuring and through financial measures grows to EUR 12,290 million. The equity ratio increases from 18.7 to 70.4 percent.
- Mezzanine capital is deemed subordinate capital. The mezzanine creditor is completely eliminated.
- In the example, only ten percent of the pension provisions remain, and these are assumed by the company as existing remaining provisions. The remaining 90 percent are assumed by Pensionssicherungsverein (PSV, mutual pen- sion assurance association), which in exchange receives a pro rata share in cash of 10 percent of the waived provisions. This means the insured employees suffer no disadvantages, as the PSV will pay the secured pensions in the future.
- In the example, only 85 TEUR remain of the other provisions, and the rest is waived.
- Bank liabilities are secured by fixed assets and current assets and thus remain unchanged with respect to collateral. However, this must be agreed upon with the banks. Because no payments are made, liquidity is preserved.
- The suppliers with interests secured by a right of retention of title are fully satisfied.
- The unsecured suppliers are serviced with 365 TEUR and must waive 90 percent of their claims.
- The unsecured bond creditors are serviced with 366 TEUR and must waive 95 percent of their claims.
- The Federal Employment Agency has accrued a claim of 286 TEUR during the proceedings and receives only ten percent of that (28 TEUR). It waives its claim to the rest.
The unsecured creditors are willing to accept waiving such significant amounts of their claims after they have been shown that they would receive significantly less if the company were liquidated. The proceedings end with the company’s liquidity situation and balance sheet significantly strengthened and the company ready to start into the future with new momentum.