In Germany insolvency law becomes financialised

by Ida Ince | 26 Oct 2012

The Amendment of the German Bankruptcy Act,¹ which came into effect six months ago, has opened the door to widespread abuse alleges the industry association VID, which claims to represent more than half of liquidators.

“A few influential and wealthy creditors now threaten to dominate proceedings”, the VID chairman Christoph Niering said in Berlin. “In addition, many debtors and their advisors disregard the fundamental requirements of bankruptcy law for their own benefit and manipulate the decision-making process.”²Above all, this is a decisive disadvantage for small creditors, including the employees of companies in crisis.

The CDU-FDP coalition government reformed the Bankruptcy Act with the stated aim of saving more ailing companies than before. All parties were to receive for this purpose greater incentives to initiate administration and recovery proceedings. In particular, rights of creditors have been expanded to choose a specific administrator. Also, management have a greater chance to remain at the helm and plan the process.

But in the opinion of liquidators since the coming into force of the reform, so-called professional creditors have yanked the rudder hard in their direction. They have had the time, money, and professional advisors, to impose their own interests, Niering lamented. In particular, banks, credit insurers, and even public bodies, have made a mockery of the VID. Increasingly financial actors are exploring bankruptcy as an unregulated hedge fund secondary market and buy in there.

Niering claimed his principal concern was the equal treatment of creditors and that saving the business was paramount. He finds it extremely worrying that large creditors can now, behind closed doors, select an “appointed manager” who represents their own best interests. This tactical advantage has perhaps been noticed by some prominent creditors already. Medium and small creditors are often left behind. Niering cited the example of the East German solar company Sovello that had to lay off thousands of employees when it closed.

The concerns of the VID with respect to specific German reforms are however a very focused beam of critique. The market for bad debt has been around for years, varying with the risk appetite of investors (a function of the availability of capital). Already before the reform, those German companies that had taken on huge amounts of debt in the boom years were potentially beholden to their major creditors come trouble.

A significant feature of finance law is the endeavour to provide a raft of structural proposals which intervene in a company’s affairs long before insolvency protection is sought in the courts. By finance law I mean the international law of finance which operates as a modern lex mercatoria parallel to the states in which it must “touch down” on occasion. This is a particular feature also of pre-emptive contractual drafting — to avoid becoming tied-up in local proceedings, and if possible, to avoid them or even escape them with a restructuring.

By way of example, when Schefenacker AG, a German car-parts maker, faced a default on its bonds in 2006, it fled the country where it was founded in 1935, moved its headquarters to England & Wales and filed for insolvency protection in London. The move allowed Schefenacker to complete a 500 million-euro restructuring that company lawyers said would have been impossible under Germany’s more stringent insolvency law. Jurisdiction shopping in insolvency cases is very much on the rise. In this case, the move allowed the company’s current management to escape threats by a group of creditors to bring it down in Germany, shocking banks everywhere with the speed and audacity with which it bolted from the stable, and causing banks to quickly tighten conditions of credit.

“In a market for restructuring, some jurisdictions work better than others’,’ said Tony Horspool, a London partner at Cadwalader, Wickersham & Taft. “Things like Schefenacker create an incentive for countries to continue to improve their systems.” ³

The German insolvency reforms must be seen in this light — in the desire to “improve” a local legal system to attract insolvency proceedings, even if, as the VID claims, this results in handing over the process to the biggest beasts and their friendly advisors. Indeed, Germany was already open to a kind of internal forum shopping in any event. German insolvency proceedings can be commenced in any small district court — German industry being relatively well spread across the country — but the view for some time amongst the larger creditors is that district judges are too “inexperienced” and “tied to local stakeholder concerns” to understand the merit of restructuring proposals dreamt up in New York, London, or Frankfurt. Accordingly, “sensible and experienced” judges in Düsseldorf and Heidelberg became the go-to arbiters as lawyers developed various ruses to explain why these bigger courts had jurisdiction for a small factory further east.

Compare how U.S. insolvency protection can be obtained by having the smallest presence in a State. It is common practice to advise non-U.S. resident corporates who foresee the need for protection in the U.S. to open up a bank account with US$10 in Delaware or New York state, as this is enough to obtain a “business presence”.

Thus, when we say that german insolvency law has become financialised, the market in distressed debt and the bending of the law to preferred creditors is but a subset of the wider financialisation of the law itself as financial law. It is a question of law as another commodity on offer at the lowest cost to globally mobile actors.

The VID’s belief that principles of equal treatment etc. have been pushed aside in favour of professional creditors fails to understand that such a debate is reduced to the question of how many varieties of tomato are used to flavour baked beans — a question secondary to the representational promotion of that fact to the consumer of global law. The German insolvency reform was made not with Germans as its principal objects or “beneficiaries”, but with a specific section of a wider market in mind. Small creditors and employees become subjects of laws in which they have no interest — a law about them but not for them.