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Insolvency Proceedings

Definition, Explanation

Insolvency and the corresponding legal procedure are regulated in the Insolvenzordnung InsO (insolvency code). It applies mainly the company types of GmbH, AG, eingetragener Kaufmann (e.K.), Einzelunternehmen, OHG, KG, BGB-Gesellschaft, Partnerschaft and the so-called European Economic Interest Grouping (EEIG). Unlike private individuals with no entrepreneurial activity to which the Verbraucherinsolvenzverfahren (consumers insolvency proceedings) apply, those companies must go through the Regelinsolvenzverfahren. Natural persons or partnerships such as sole proprietors, GbR, KG, Freiberufler (Freelancers) can request an insolvency procedure, but are not obliged to.

To protect employees from the effects of insolvencies, the labour agency pays them insolvency money.

Reasons for insolvency of companies and self-employed

• Products cannot be marketed any longer because demands decreased due to technical or fashion novations or prices are no longer competitive
• Deficient controlling or cash-management
• Too high indebtedness to banks or suppliers
• No more liquidity to pay due money (wages and salaries, credits, rents)
• For self-employed and Freiberufler: private insolvency results in occupational insolvency for non-separated assets
• Too low owner’s equity, especially for business starters
• Unknown or neglected tax burdens and dues

Law knows three reasons to start an insolvency procedure:

• Illiquidity acc. to § 17 InsO
  Indications are:
  • due payment to suppliers
  • due wages, salaries and social insurance contributions
  • making out of uncovered cheques
  • exequaturs have been applied for
• Expected illiquidity acc. to § 18 InsO
  Illiquidity is foreseeable but there are chances of successful reorganization
• Over-indebtedness acc. to § 19 InsO
  which comes into question only for artificial persons as GmbH, GmbH & Co. KG, AG. Criterion is that the debts exceed the debtor’s assets

Insolvency procedure for artificial and natural persons:

• Insolvency is ‘applied for’ at the insolvency court of the responsible county court
• Creditor or debtor can file the written application. The right to apply for opening an insolvency procedure is reserved for the managing director and personally liable shareholders. Within 4 to 8 weeks, the allowing is decided. An application must be handed in with documents proving the reasons
• Required documents include application forms, list of assets and a list of creditors and debtors
• The application for insolvency must be filed within 21 days since illiquidity or over-indebtedness of the company. Otherwise it is regarded insolvency procrastination and penal. Managing director or board members will be personally liable to damages and prosecution
• After an insolvency application has been filed, it is examined whether there are reasons justifying insolvency. The application is valid if there is given illiquidity or expected illiquidity or over-indebtedness, and the insolvency assets cover the procedural costs. If costs are not covered by the insolvency assets, respite can be applied for. The considering of the application is often done by a commissioned expert who becomes a temporary insolvency practitioner
• The expert also takes security measurements to protect the future insolvency assets from continued losses of the debtor
• If the insolvency application is rejected due to lack of mass, then artificial persons are deleted from the trade register – natural persons are added to the debtors list from which they will be deleted 5 years later
• The insolvency order by the court includes:
  • the date to open the procedure
  • the naming of a insolvency practitioner
  • requesting the creditors to report their debts within a determined period of 2 weeks to 3 months
  • requesting the debtors to no longer pay anything to anyone but the insolvency practitioner
  • the interdicting of single foreclosure measurements
  • determining the due date of a report about the company and a decision regarding its future which can be liquidation of the assets, sale or partial sale, or reorganization
  • determining a date for consideration of the application and evaluation of the debts
• The procedure-opening order is published
• After the insolvency application has been considered, the public prosecution department is informed. They can investigate regarding acts of bankruptcy, violation of accounting- or balancing-duties as well as defraud or infidelity. This includes false pretences for obtaining credits and fiscal evasion if turnover tax has been deducted late
• After the opening of the insolvency procedure, an insolvency practitioner is constituted which is normally the already active temporary practitioner takes control of the assets. His job is to maintain the company, to make lists of existing assets components, to list debts and to collect debts. By insolvency rescission, the practitioner can correct unjustified transfers of assets
• In the meeting at the date of report, respective in the first meeting of creditors, a decision regarding the further handling of the company is made:
  • Liquidation: The assets are sold / auctioned. The creditors are proportionally indemnified out of the receipts
  • Reorganization: The company continues to exist. the creditors receive payment from the profits made
  • Sale: the company is sold. Creditors receive payment from the receipt
• In the examination meeting, the creditors’ claimed debts are evaluated
• The receipts first are used to pay the court and practitioner. After that, creditors are indemnified, also with progress payments
• After the final distribution, the insolvency procedure is cancelled by court decision. Unindemnified creditors can assert their claims by foreclosure
• The debtor can apply for discharge of residual debt, after 6 years

Besides the regular insolvency procedure, there is the ‘insolvency plan procedure’ which is mainly aimed at maintaining the company. A plan can be filed along with the application for the insolvency procedure.

Employees are protected in case of insolvency of the employer by the insolvency money. Additionally, there are regulations concerning e.g. vacation, parental leave and cancellation during insolvency of the employer.

Tips, Checklist

• As an entrepreneur, by all means pay social insurance contributions in time
• In case of expected insolvency that is when you are certain that the company can be successfully reorganized, you should file an insolvency plan along with the application for insolvency
• Make up a debts balance. Use the actual present values
• As an insolvent entrepreneur you are entitled to withdraw the capital from the insolvency assets that you need for a modest living
• Apply for discharge from residual debts if there remain high debts after the insolvency procedure. You will be freed of your debts after a 6 years period of “well-trying” (Wohlverhaltensperiode) in which you must have been gainfully employed and trying to indemnify your creditors partly

Last update: 07/20/2010