RECENT changes in the German Insolvency Code ('InsO') draw the attention of the German (distressed) M&A community to the debt-to equity swap. The German Insolvency Code was amended as at 1 March 2012 by the bill to further facilitate corporate restructurings (Gesetzzur weiteren Erleichterung der Sanierung von Unternehmen) ('ESUG'). The changes introduced by ESUG included, inter alia, the improvement of the prerequisites for the purposes of out-of-court restructuring by way of an insolvency plan ('Plan'). In particular, the debt-to-equity swap was added to the catalogue of possible restructuring measures in a Plan procedure. The Plan is the 'road map' for an intended restructuring of the debtor and if confirmed by the insolvency court, the debtor is released from the 'in-court' insolvency procedure. Already in 1999 a reform of the German insolvency law introduced the option of out-of-court restructuring by way of an Plan, however, from 1999 until 2010 only 1 to 2% of the companies which filed for insolvency made use of this option.
§ 225 a InsO now allows for a debt-to-equity swap to be included in the Plan against the will of the existing shareholders. In general, there a two ways to structure a debt-to-equity swap: (i) the debtor's capital is decreased followed by a capital increase in which only the creditor takes part (DES) or (ii) the debtor's shares are acquired in a share deal and the creditor's claims waived in return (fake debt-to-equity swap).
LEGAL FRAMEWORK FOR A DES AS PART OF AN INSOLVENCY PLAN
§ 254 a InsO stipulates that any corporate measures included in the Plan, are considered having been made in statutory form once the Plan becomes legally binding. This also includes capital measures to be taken for a DES, whereas, normally, a notarization would be required.
For the purposes of a DES the share capital of the debtor is first decreased by way of a simplified capital reduction in order to compensate value reductions or losses. Subsequently, the share capital is increased again by an amount equal to the fair value of the creditor's claims to be contributed. The creditor then transfers its claim to the debtor in order to fulfill its payment obligations by way of a contribution in kind. The capita lcan, however, only be reduced to an amount below the statutory minimum capital – EUR 25,000 for a limited liability company (GmbH) and EUR50,000 for a public company (AG) – if the minimum capital is contributed, respectively, filled-up in cash and only the exceeding amount by way of a contribution in kind. The fair value of the claims to be contributed has to be determined by way of a prognosis for the day of the application for registration of the capital increase with the commercial register. The capital measures have to be registered with the commercial register in order to become effective.
The Plan itself has to be adopted by the creditors and confirmed by the competent insolvency court. For the vote on the Plan creditors are divided into different creditor groups to be formed pursuant to certain legal and factual criteria. For the adoption of the Plan it is necessary that the majority of the creditors in each group and the majority of the sum of claims of each group vote in favor of the Plan. The existing shareholders form an independent group and their voting rights within the group depend solely on their shareholding in the debtor. The consent of single creditor groups canin principle be replaced in case the majority of creditor groups has voted in favor of the plan.
Unfortunately, ESUG did not come hand in hand with a revision of the German restructuring tax law. A DES leads to an increase of the taxable profit of the debtor. The profit is, however, only increased by the amount of the claim which is not of value (recoverable) and, therefore, not converted into equity. The creditor, on the other hand, cannot use the write-off to reduce his tax burden. The tax to be paid on the increased profit may be deferred and later on (once no further changes to the basis of decision are to be expected) waived by the competent tax authorities according to the Restructuring Decree. Nevertheless, this only applies to corporate and income tax but not to trade tax. Furthermore, a change in ownership due to a DES of more than 25% but not exceeding 50%leads to a pro rata denial of tax loss carry forwards. If the DES leads to a change in ownership of more than50%, tax loss carry forwards cease to exist completely. This is because the application of a restructuring clause in the German Corporate Tax Act was suspended due to a decision by the European Commission. According to a very recent ruling of the German Federal Tax Court, profits realized during a fiscal year before the change in ownership took place can, however, be offset against any tax loss carry forwards. The German Ministry of Finance has not yet commented on this federal court ruling; they took the view in their 2008 circular, that a profit could not be offset in case of a change of control during a fiscal year.
ADVANTAGES OF A DES AS PART OF AN INSOLVENCY PLAN
One of the main advantages of a DES as part of a Plan is that it can be implemented against the will of the existing shareholders. Moreover, the existing shareholders of the debtor as well as other minority creditors have very limited means to prevent or appeal against the adoption of the Plan.
In addition, ESUG introduced further provisions which shall facilitate a DES, namely, the over valuation of creditor claims does not lead to a liability under German capital maintenance rules and change-of control clauses are not triggered by a DES. Finally, incase the creditor has not converted all of his claims into equity, § 39 para. 4 InsO provides for an exception of the rule of the general subordination of shareholder loans in this context.
OUTLOOK
In summary, the DES is a restructuring and acquisition instrument which allows the parties involved not to lose all of their capital invested in the debtor but to stay invested and to possibly establish the basis for an effective turn-around in relatively short time. Furthermore, a DES is an interesting acquisition tool for hedge-funds and investment firms with a loan-to-own strategy. Banks will most likely be reluctant to make use of DES since they would have to consolidate the debtor in their balance sheet. Ultimately, it remains to be seen whether the relevance of the Plan and therewith of the DES will actually increase due to the changes introduced by ESUG.
Authors:
Dr. Jan Wildberger
Phone: +49 (69) 247047-19
Fax: +49 (69) 247047-35
E-mail: jan.wildberger@pplaw.com
