Looking back at the last few months, the COVID-19 pandemic has hit many companies hard and amplified disruptive trends in various sectors. In addition to other measures to address COVID-19 impact on businesses, Germany has made significant progress toward international best practices for restructuring: StaRUG — known as the German scheme — came into effect on 1 January 2021, as one of the most modern restructuring laws in the world. But how will StaRUG help German companies survive the crisis and what if insolvency is unavoidable?
- What does the German market currently look like?
Frank Grell: When we look back at the last few months, the COVID-19 pandemic has created a truly unprecedented set of challenges for the economy and society at large. Despite the drastic policy responses in financial aid, the crisis has hit many companies hard. For example, in the automotive and engineering industries, the COVID-19 crisis has exacerbated the already tense situation that arose from the diesel crisis and the government’s lack of a coherent and sustainable mobility strategy.
Nils Röver: COVID-19 has also amplified disruptive trends in other sectors. The fashion and retail industry, for example, faced changes in consumer behavior before the pandemic. The number of restructurings in these industries has risen throughout the year. However, we are far from seeing the wave of restructurings and insolvencies some commentators expected. The temporary suspension of the obligation to file for insolvency until January 2021, coupled with financial aid, has helped fashion and retail companies stay afloat.
- What is the significance of the Law on the Stabilization and Restructuring Framework for Enterprises (StaRUG)?
Grell: Germany has achieved a huge step towards international best practice for restructuring. The German scheme , which came into effect on 1 January 2021, is one of the most modern restructuring laws in the world. Companies in Germany have been waiting a long time for efficient restructuring tools outside of insolvency proceedings — which they can use in particular in cases in which a company has a small group of dissenting creditors. Had the draft legislation been deferred or further diluted, it could have forced large companies, in particular, to resort to proceedings in other jurisdictions, for example using the English or Dutch schemes, or to file for insolvency, with significant economic impacts. Now, they have the tools in their home jurisdiction.
- How will the StaRUG help German companies through the crisis?
Grell: Many of the companies currently in distress actually only face liquidity or over-indebtedness problems; their core business is intact and will remain so after the crisis. With the StaRUG, restructuring can be carried out in a minimally invasive manner instead of the major open-heart surgery that insolvency proceedings entail. And under the StaRUG, potential investors need not fear hold-out value creditors when it comes to financial restructuring.
- Why are the new developments in Germany important?
Röver: We believe the distressed M&A market will be one of the drivers in M&A for the next few years. Activists will increasingly focus on capital structure imbalances, vulnerabilities, and management responses to the pandemic. So far, activist investors have been relatively quiet, limiting disruption to boards at this challenging time, thus avoiding any perceptions of aggressive behavior.
Grell: We have, however, seen activists quietly accumulate equity positions, and larger corporates continue to be seen as value plays. Activists will increasingly scrutinize companies continuing to meet the challenges of second-wave COVID-19 infection risks to both their organizations and revenue streams.
- What other coping mechanisms are appearing in the market?
Grell: We may see an acceleration of corporate divestments. In the past, we have seen companies use economic downturns as catalysts to transform their businesses and emerge stronger. Companies will be looking to streamline their businesses, reduce debt, and respond to shifts in industries from this market event. Divestment of non-core assets will become more important as boards look to further stabilize performance and focus on their strongest business lines.
- There will also be situations where insolvency is unavoidable. What will companies face in that case?
Grell: If filing for insolvency is unavoidable, companies should carefully consider whether debtor-in-possession (Eigenverwaltung) proceedings provide an option for an in-court restructuring.
Irrespective of whether companies pursue debtor-in-possession or not, an increased number of insolvency proceedings will likely also result in an increase in insolvency-related litigation matters. Two newer developments enable insolvency administrators to pursue significantly more claims than just a few years ago. On the one hand, legal tech tools allow plaintiffs to conduct mass actions and enforce a large number of similar claims. We are on the forefront of that development. On the other hand, more litigation finance providers have entered the German market with a focus on litigation initiated by insolvency administrators.
Never before have insolvency administrators had more inclination or capability to claim liability or repayment in insolvency proceedings. While this is an opportunity for plaintiff insolvency administrators, it clearly is a challenge for management, shareholders, and other stakeholders who must be mindful of the litigation risk long before an insolvency arises. We expect contentious dispute over clawbacks and damages. Latham stands ready to represent clients in such claims.