Regular insolvency: The exact procedure

Insolvency procedures may differ from country to country. As a reference, in Germany, normally, a three-month preliminary insolvency phase is initiated with the application for creditor protection, which leads to regular insolvency proceedings at the end of this period. What should you expect now?

Depending on the size of the company, the court-appointed insolvency administrator will come to your company with a team of specialist insolvency lawyers and assistants. He will initially take over the accounts and cash management. Your accounting department will assist him in this process.

The next step is for the insolvency administrator’s team to work with your operational team to ensure that the business continues to operate as long as it can in order to build up insolvency assets. This is a very painstaking process that nevertheless needs to be implemented quickly. Suppliers must be persuaded to continue to deliver even though they have likely not been paid for the last deliveries made and will not be paid again. Many suppliers will want to switch to prepayment, which the team will try to prevent in order to remain solvent during the first phase of pre-insolvency, when, after all, there is no liquidity. Customers are expected to pay in advance so that future deliveries of goods from suppliers can be paid on time.

In Germany, wages will be paid by the state employment agency for the three months of the pre-insolvency period. There will be losses for employees whose contracted pay is above an assessment threshold. However, the employment agency needs time to review the insolvent company’s payment requirements and the individual employee cases. To ensure that employees receive insolvency pay as seamlessly as possible, the insolvency administrator will engage a pre-financier to advance insolvency pay to employees. The employees must assign their wage claims to this pre-financier, which the pre-financier uses as collateral for refinancing. Your HR department will be severely challenged to provide all the required information in the shortest possible time. In practice, the first payment will be somewhat delayed despite the fastest processing. This deprives the workforce of further motivation, which is needed right now. The employees’ displeasure and, in some cases, distress must be absorbed. Leadership is needed.

Entering the pre-insolvency phase requires a complete inventory, because the insolvency administrator must secure the existing assets. An inventory during ongoing business operations with only partial motivation is a special challenge. At the same time, the insolvency administrator must ensure that no suppliers collect delivered and unpaid goods. These goods must also be secured. The law provides for this.

Customers have received bank guarantees for any advance payments that may have been made. This is standard practice in the mechanical and plant engineering sector. However, the insolvency administrator will not deliver the input materials and components procured for this purpose to the customers, but will insist that the customers make use of the guarantee. In this way, insolvency administrators have the goods paid for several times over. This is also covered by law and contract.

With all these options, the insolvency administrator’s team will build up as much liquidity as possible in order to continue managing the company for as long as possible, even after the pre-insolvency phase has expired, when personnel costs must also be paid in full again. Incidentally, employees can be released after the end of the pre-insolvency phase without receiving severance pay. So don’t be surprised if the insolvency administrator waits until the end of the pre-insolvency phase to make personnel changes. In the meantime, some employees are likely to leave the company voluntarily, and almost certainly not the worst ones.

The insolvency administrator must generate the highest value for the creditors. With this in mind, he will consider whether transferring the business to a new shareholder or breaking up and liquidating the assets (equipment, inventory) is the best solution for creditors.

The most important thing during the pre-insolvency phase is to use the time to prepare a coherent restructuring concept, leading to an integrated business plan.

Since the period of financial support and enforcement protection is limited, focus your strategic activities on selected development projects that you complete during this time. Insolvency administrators, who from now on will scrutinize every assignment and payment for release, are inclined, in the interest of creditors, to allow only those activities that will generate deposits and income in the short term. Keep in mind, however, that specialist insolvency lawyers do not know your markets. They depend on your reasoning if they are to approve forward-looking projects.

Example 1: In the case of an insolvent automotive supplier in Baden-Württemberg, the insolvency administrator’s team stopped any orders for material that was not to be processed to order within three months. In the supplier industry, orders exist in the form of ongoing call-ups. Due to the nature of the business processes, such call-ups were not available for the period after three months, but delivery times, especially for semiconductor components, are well in excess of three months. If orders were not placed now, it was then clear that future call-ups could not be processed.

Example 2: At an insolvent automotive supplier, product development projects were in progress. It is customary to carry out product developments for upcoming vehicle models together with the customer in advance. In this case, a product was 98% developed. A final development loop was still to be carried out, which would have cost a few thousand euros. The insolvency administrator did not release the comparatively small amount for this processing. His reasoning was that it was not at all clear whether the company would even achieve the start-up of the new vehicle model, which was still 6 months in the future. He could not expect the creditors to spend money now, the possibility of repayment of which lay in an uncertain future. With this decision, the insolvency administrator took away a piece of the company’s future. The company also lost its attractiveness for potential investors as a result of this decision.

Several such short-sighted decisions by the insolvency administrator made the company unattractive to potential strategic buyers. The business operations eventually had to be closed down.

Of course, the insolvency administrator also pursues his own economic goals in addition to his public appointment. As long as he administers a company, he earns money from the insolvency case.

Two more tips for shareholders: If the company is not able to fully service shareholder loans on an ongoing basis in times of crisis, shareholders should pay themselves the interest from the company, but not the redemption portion. Insolvency administrators can demand that shareholders repay repayment amounts paid into the company. Interest payments cannot be contested by insolvency administrators.

If a sale of the business is a better option for creditors than breaking it up, the insolvency administrator will initiate a bidding process. As the existing shareholders, you can of course bid on the business operation, which will then be discharged from debt. However, there is a risk that you will be outbid by third parties. If you want to avoid this at all costs, you should aim for insolvency proceedings in self-administration instead of regular proceedings. However, you must meet certain requirements for this.

In each country, local regulations should be applied.


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