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Insolvency rules in Germany – general liability of the managing director and constant challenges by the insolvency administrator?

Insolvency rules in Germany – general liability of the managing director and constant challenges by the insolvency administrator?

I’d like to start this article by answering the question raised in the title. Under German law, the managing director of a GmbH (limited company) has no general liability in the event of insolvency. Nor is it the case that all administrators in all insolvencies exercise the right to challenge the insolvency. German insolvency legislation certainly should not deter business owners from establishing a GmbH in Germany. Nonetheless, in our practice we often encounter two groups of Dutch business owners. The one group assumes that, in the event of a GmbH’s insolvency, the managing director is automatically liable, with his entire assets. The other group forges blindly ahead, entirely ignorant of what happens in the event of insolvency.

Newspaper articles essentially convey an accurate picture of insolvency law in Germany. A prime example is the FD on Tuesday last week (14-10-2014) in its article “Schippers verstrikt in Duits faillissementsrecht“ (Skippers get entangled in German insolvency law) http://lgl.kn/7295f), which talks about insolvency administrators’ rights to challenge insolvency. Sometimes, however, the explanations are a little simplistic from a legal perspective and, of course, cannot be generalised.  The article in FD, however, sends the right message to its readers: If you are properly informed and seek proper advice beforehand, you have nothing to fear from insolvency law in Germany. The problem is not German law, but the complacency with which we rely on our Dutch legal perspective. The German legal system is so similar to the Dutch system that we are too quick to set caution to the wind and carry on regardless, without heeding the small but significant differences.

So, to give you a head start on German insolvency law, we will now take a quick look at the managing director’s liability in insolvency and challenges by the insolvency administrator.

1. The managing director’s liability in insolvency

One of the motives for establishing a company with share capital is to limit personal liability. If the managing director were always liable in the event of insolvency, this purpose would be negated. After all, it’s usually in times of adversity that you need an exclusion of liability, not when everything’s going well.

German law, however, does not provide for the managing director’s general liability in the event of insolvency. Akin to the Netherlands, there are always grounds for liability if there has been a breach of obligations. German law, however, is more likely to attribute the insolvency of a limited company to a breach of obligations by the managing director, which explains why the first group of Dutch business owners are so wary.

Specifically, the managing director is obliged to apply for insolvency sufficiently early on and refrain from disposing of the assets or entering into further commitments if there are grounds for the commencement of insolvency proceedings. The managing director of a GmbH is bound by law to apply for insolvency without delay – i.e. as swiftly as possible – once there are grounds for insolvency.  Sometimes, a delay of one to two weeks is deemed sufficient to assume that the petition was filed too late. This is compounded by the fact that the grounds for insolvency are more readily established in German than in Dutch law.

There are three grounds for the insolvency of a GmbH:  overindebtedness, inability to pay or imminent insolvency. The first two grounds are imperative grounds for insolvency, which means that, if they arise, an application must be made for insolvency proceedings.

Overindebtedness occurs when the company’s assets no longer cover its liabilities, i.e. when all the assets combined are less than all the payment obligations.

Inability to pay, or insolvency, occurs when a company is unable to make the necessary and due payments. Intermittent payment delays do not constitute insolvency.

The third reason, imminent insolvency, is not an imperative ground. It occurs when the company is likely to be unable to meet its payment obligations at the time they fall due. In this case, the business owner is not compelled to immediately file for the commencement of insolvency proceedings, but he may choose to do so in order to devise a restructuring plan and avert the imminent insolvency.

If the managing director does not apply for insolvency in good time, as already discussed, he has breached his obligations and this may also constitute grounds for the managing director to be held liable with his personal assets. However, this liability applies only to damages suffered by third parties as a result of the breach of obligation. The managing director is therefore not liable for the GmbH’s entire, existing liabilities, but only for the damage suffered by creditors as a result of assets being disposed of despite the existence of a ground for insolvency and for newly assumed liabilities.

In principle, therefore, if a GmbH’s managing director remains clued-up about the company’s financial situation and takes action as soon as things start to go awry, he will not normally be held liable. The law does, of course, allow a few other ways of proactively reducing the risk of liability.

2. Challenges by the insolvency administrator

Dutch companies that do business with German companies will probably have come across situations in which the insolvency is challenged by the insolvency administrator. The right to bring challenges is a tool used by the insolvency administrator to reverse disposals of assets prior to or during the insolvency proceedings.  It protects the interests of the creditors in the insolvency proceedings, who frequently only get back a small portion of their claim on the insolvency assets.

It is, however, highly unusual for payments made 10 years ago to be challenged, like the situation cited in the aforementioned FD article. Payments made this long ago can only be challenged if deliberately prejudicial legal transactions were effected, which means the parties accepted that creditors in insolvency proceedings would be disadvantaged and both parties were aware of the existence of a ground for insolvency. Nonetheless, business owners should take this arrangement seriously, as the mere fact that the Dutch business owner was aware that the contracting party making payment was facing imminent insolvency and other creditors may be disadvantaged by the payment is sufficient. Particularly with large-scale insolvencies and big payments, it is best not to assume that an insolvency administrator will not attempt to challenge a payment. The moot point is, of course, exactly how long ago a contracting party became aware of the imminent insolvency.

Irrespective of whether the party was aware of a ground for insolvency, the insolvency administrator may challenge disposals effected three months prior to and following the commencement of insolvency proceedings.

The 3-month rule in itself has major implications in practice. It’s not just the insolvent debtor who is affected by the challenges but more especially, of course, the contracting parties who repeatedly grant a company a deferment of payment. If the cash-strapped business partner is granted a deferment of payment or allowed to pay a due debt in instalments, payment by instalments may be challenged in subsequent insolvency proceedings. The understanding Dutch business owner must then refund payments to the insolvency administrator and the only option left to him is to have his claim entered in the insolvency register.

Conclusion:

German insolvency law contains a number of rules of which business owners should be aware before collaborating with German contracting parties or establishing a GmbH in Germany. After all, particularly during periods of financial crisis, you never know how long your own business or the contracting party will withstand payment defaults and dwindling orders.

Susanne Hermsen

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