Promptly file the insolvency application or risk liability for the delay

Insolvency always requires an insolvency application. The same applies to a self-administered insolvency plan in. Generally, it is not up to the debtor to decide if and when to file such an application. German insolvency law recognises three reasons for filing an insolvency application: insolvency, overindebtedness and imminent insolvency.

 If compelling reasons exist to file for insolvency, the debtor must file an application. Only in cases of so-called imminent insolvency is it left to the debtor’s discretion to file the application. However, the debtor must file the application for insolvency at the latest when the company becomes actually insolvent. When applying insolvency law in German insolvency practice, the only reason for insolvency that really plays a role is imminent insolvency. At any rate, the other reason for insolvency, which is overindebtedness, is of no significance when the company can show a positive prognosis for continuation as a going concern. The company can have this positive prognosis certified by a third party, such as a consultant. Given such a positive prognosis for continuation, a company’s overindebtedness, which is defined as liabilities outweighing assets even after the release of dormant reserves, is no longer relevant in practice because in response to the banking crisis and the overindebtedness of many financial institutions the legislature enacted the Financial Market Stabilisation Act. Due to the great value impairments caused by the so-called “toxic securities” on their books, many banks would have been overindebted and thus obliged to file an insolvency application. In order to prevent this and the resulting economic collapse, the definition of overindebtedness was weakened drastically. Accordingly, a company’s overindebtedness obligates it to file an insolvency application only if the company cannot be continued sustainably or if it is highly unlikely that the company can continue as a going concern.

Reason for insolvency: Inability to pay

The situation is different when the reason for insolvency is the company’s inability to pay. Here, the governing bodies of a legal entity or a GmbH & Co. KG always have a duty to file an insolvency application without undue delay no later than three weeks after the company has become insolvent, and failure to comply is punishable. The three-week period is intended to 

give the corporate bodies the opportunity to implement restructuring measures to sustainably remove the reason for insolvency. However, if it is obvious that this cannot realistically be expected, then the application must be filed promptly, that is, well before the three-week period expires. The reasons for insolvency are normally determined for the company in crisis on the basis of its so-called insolvency status, the results of which must be verifiable and stand up to being challenged – if only for reasons of liability.

The important reason for filing an insolvency application is the debtor’s inability to meet its payment obligations as they come due. According to the Federal Court of Justice's 2005 landmark decision on the matter, this is the case if within a period of three weeks the debtor cannot meet at least ten percent of its total liabilities due unless, in exceptional cases, it can be expected with a probability bordering on certainty that the liquidity gap will be completely or almost completely eliminated in the near future and it is reasonable to expect the creditors to wait based on the particular circumstances of the individual case. It is very difficult for laypersons to determine if and when this is the case, and that is why they should call on expert help. If the debtor fails to file an insolvency application despite its inability to pay the corporate bodies of the debtor become liable to prosecution. This can also have grave implications on future career opportunities of the responsible agents and can lead to personal civil liability risks for the company organs that are obliged to file the insolvency application.

Filing the insolvency application early provides more room to manoeuvre

The insolvency reason of imminent insolvency is present when it is expected that the debtor will not be able to meet its existing payment obligations. The earlier an insolvency application is filed, the greater is the company's room to manoeuvre. If at the time the application is filed there is still sufficient liquidity, the usually necessary advance payments that become due with the filing of the application can be made.

 The advantages of insolvency proceedings, e. g., the non-payment of wages and liabilities or portions of sales tax, take effect only after some time. In contrast, suppliers will almost always immediately demand advance payment for new orders. Filing the insolvency application early therefore guarantees an effective and successful restructuring of the company through insolvency. For this reason, companies in crisis should make much greater use of imminent insolvency as a reason for filing for insolvency, for example, by demonstrating in a liquidity plan that in a few days, weeks or months they will be obligated to file an insolvency application. This is sufficient to begin insolvency proceedings. However, self-administration that does not lead to protective shield proceedings is also possible when actual insolvency has occurred, that is, without the reason of imminent insolvency. Nevertheless, it makes sense not to wait until the company is de facto insolvent because in that case, its possible courses of action are significantly limited.

Reward for early application

The ESUG created incentives for the early filing of an insolvency application. The sooner the application is made and the more cash the company has available, the greater are the chances of successful restructuring under insolvency protection. It may seem surprising, but by naming imminent insolvency as a reason for filing an insolvency application the legislature wanted to reward companies that decide to apply for insolvency early on. The legislature clearly intended for the new law to make insolvency a strategic option.