The German Federal Government’s various aid measures for employees, self-employed persons, small, medium and large enterprises are suitable for alleviating personal hardships, reducing the economic costs of insolvencies and plant closures and supporting the economy. In addition, it is important that the German Federal Government will play also a constructive role in overcoming the crisis on a European level, to avoid the COVID19 pandemic leading to a European sovereign debt crisis.

Notwithstanding this, the obligation for distressed German entities to file for insolvency is suspended until September 30, 2020, but this will not apply, in cases where the insolvency is not based on the consequences of the COVID-19 pandemic or if there is no prospects of overcoming an existing illiquidity.

It will remain possible for debtors to file their own applications to initiate insolvency proceedings on a voluntary basis and for creditors to file third-party applications. However, for a creditor to file a third-party application, grounds for insolvency must have existed prior to March 01, 2020. The suspension of the obligation to file for insolvency may be extended by decree until March 31, 2021 at the most.

Overall, the situation remains an extreme challenge for companies, general managers, management boards, and supervisory boards, not only in financial but also in legal terms. Temporary exemptions from the obligation to file for insolvency will not solve all the problems, in particular lost sales and lack of cash flows. In the event of an insolvency, companies are collapsing immediately and the moratorium under civil law accompanying the suspended obligation to file for insolvency will protect contractual relationships, but does not prevent further liabilities that may accumulate to the point of unsustainability.

Further, the temporary suspension of the obligation to file for insolvency does not eliminate the general requirements under German criminal law. For instance, ordering goods or services without the necessary means of payment may be considered at a later stage as fraud. In many cases, despite the legally permissible suspension of the obligation to file for insolvency, initiating insolvency proceedings, possibly also by way of self-administration with planned restructuring and protective shield, will ultimately be unavoidable, and sometimes even preferable, to avoid further risks and measures.

The Economic Council to the Federal Ministry of Economics and Energy (Wissenschaftlicher Beirat beim Bundesministerium für Wirtschaft und Energie (BMWi)) (“Economic Council”) has provided further thoughts, remarks and conclusions to the German Federal Government in a letter that addresses various aspects of the envisaged aid measures regarding the COVID-19 pandemic, in particular the following set out below.

While solo self-employed persons and small enterprises have received non-repayable grants to help to reduce operating costs the Economic Council, suggest that in addition there ought to be additional income replacement, independent of the basic provision.

Also, whilst guarantees and loans have been provided for medium-sized enterprises and the initial problems of co-financing by banks has been solved, the longer the lockdown and the crisis, the more that the liquidity problems of the companies will turn into solvency problems. Loans to secure liquidity issues will postpone payment problems into the future. For many companies this is sufficient to enable those companies to cope with the effects of the crisis, but for many it is not. There is the risk that, at the end of the crisis, many companies will be faced with a debt overhang that will burden their further development or drive them into insolvency.

Tackling these problems through insolvency proceedings involves some risks of a special kind:

• the long duration of proceedings, which can be even longer when many insolvencies occur at the same,
• the impairment of the functionality of the companies during the insolvency proceedings,
• the stigma of the insolvency application for companies and entrepreneurs, and
• the risk of chain reactions that burden the financial system.

As such, the Economic Council suggest that it is necessary for the government to develop procedures that enable debt relief for companies, whether by converting liquidity loans into grants, or loans into equity.

Notably, the new established Economic Stabilization Fund is aimed to support large companies and is intended to stabilize companies in the economy by overcoming liquidity bottlenecks and by creating the framework conditions for strengthening the capital base of companies whose existence would be threatened if they were to have a significant impact on the economy, technological sovereignty, security of supply, critical infrastructures or the labor market.

Under section 16 clasue 2 of the Economic Stabilization Fund Act (Wirtschaftsstabilisierungsfonds – Act), to qualify for such support a company must meet at least two of the below criteria:

• a balance sheet total of more than EUR 43 million;
• a turnover of more than EUR 50 million; or
• have employed an average of more than 249 workers.

Financial sector enterprises and credit institutions are excluded from these measures.

The specific details about the legal and economic conditions of the stabilizing measures will be addressed in a separate statutory order (Rechtsverordnung) to be enacted by German Ministry of Finance and the BMWi in the coming days. Such stabilization measures include pursuant to section 22 clause 1 of the Act:

• Mezzanine instruments like the provision of subordinated debt, hybrid bonds, profit participation rights, silent partnerships, convertible bonds; and

• Equity instruments by the acquisition of shares or the assumption of other components of the equity of the company.

In view of the Economic Council, section 22 clause 2 of the Act is quite vague and does not define in detail, which companies shall be supported and which financial instruments and conditions shall be used for such support. Its view is that such criteria are required to enable the Federal Ministry of Finance to select the right support. Accordingly, the Economic Council outlines that clear criteria are important to enable the Federal Ministry of Finance to select which companies should be supported and which are not. Examples of such criteria and conditions could be:

• State subsidies should not be granted if profits have been distributed after a key date (e.g. 15 March 2020);

• No dividend payments, share buybacks (except by the state) and bonus payments to the management board before government loans are repaid; and

• The company must prove that it has been placed in the distressed situation without its own fault.

In the case of companies that fulfil the aforesaid thresholds of the Act, there is the possibility that the state participates with equity. However, this possibility should be applied restrictively, because such companies might have considerable equity reserves, so that solvency problems are less urgent. The Economic Council points out that section 25 clause 1 of the Act requires “a clear perspective for continuation after overcoming the pandemic.” Further, there should be no other financing possibilities, like the possibility of an equity contribution from the owners. According to the experience of the Corporate Finance Steering Committee 2009/2010 in many cases, the owners reject capital increases because the owner position would be “diluted”. However, such statements would just reflect above all the interests of the former owners.

Overall, it is the understanding of the Economic Council that the criteria set out in the Act are too vague for a relevant examination procedure. Section 16 clause 1 of the Act speaks of assistance for enterprises “whose continued existence as a going concern has considerable effects on the economy, the technological sovereignty, security of supply, critical infrastructure, or labor market.” The criteria given to the Corporate Finance Steering Committee in 2009 were specified in more detail. With a slight modification of these criteria one could imagine that the expert committee named in the Act would have a better check list to proceed (changes since 2009 bold):

1. It is foreseeable that the company will operate after a calming of the economic crisis without state aid, and the funding requested is therefore only of a temporary nature and not permanent and no serious distortions of competition are to be feared. The industry in which the company is operating has unpredictable massive drops in sales, unit prices, deliveries and prices affected by intermediate products, which are the result of the corona crisis.

2. It is also a prerequisite that all other financing options are exhausted in particular through banks, but also through capital increases.

3. In addition, there is a special economic eligibility to prove, i.e. amongst other things:

(a) Importance in the value chain: A rejection would mean that numerous upstream and downstream companies in the value chain or end users also encounter considerable difficulties and may become insolvent;

(b) Employment policy meaning: A rejection would become one lead to intolerably high job losses. The amount of state aid and the number of jobs secured should be reasonable in relation;

(c) Innovation policy significance: A rejection would turn into a massive Impairment of the technological performance in the concerned lead sector; or

(d) Regional political significance: The company has a special significance for the region as a major client of the regional economy.

The stabilization measures of the Economic Stabilization Fund are available until 31 December 2021 in accordance with section 26 clause 1 of the Act. After the Economic Stabilization Fund has completed its task, it will be unwound and dissolved. That the participations existing on that date continue to exist beyond that date is probably unavoidable. However, the wording of section 26 clause 2 of the Act does not state that this interpretation of the decision on this is solely up to the Economic Stabilization Fund. There should be a mechanism for the most rapid termination of state equity investments. It would be particularly important, to be concluded in the contracts with the undertakings, that the undertakings themselves have the possibility of terminating the contracts.