One year ago when the German out-of-court restructuring regime, StaRUG, came into force, people hoped for it to be the beginning of a new viable rescue culture in Germany.
Whilst generally not public, it appears there have been substantially more professional articles covering StaRUG than cases themselves (believed to be around 10-20 for the year).
In our view, this is not solely due to a generally solid financial and economic situation and substantial state-aid measures, but also due to certain weaknesses of the StaRUG itself (which we hope will be remedied either by case law or addressed by the legislator soon).
It is therefore worth reviewing the “lessons learned” from the tested, and untested, experience of StaRUG over the last year.
1. Recap – StaRUG as German out-of-court restructuring regime
Prior to StaRUG, German law did not provide for any scheme for a debt restructuring absent the full consent of all creditors involved or formal insolvency proceedings, In addition to traditional strict and mandatory insolvency filing obligations under German law, this posed a risk for out-of-court restructuring efforts. As stated in our article last year, the StaRUG has the potential to be a helpful restructuring tool for companies which are imminently illiquid, i.e. on a more likely than not basis are not fully funded for 24 months, without yet being insolvent. Comparisons have been drawn to U.S. Chapter 11 proceedings or a UK Scheme of Arrangement, mainly due to the possibility of a cram down of certain creditors, even cross-class, and limited court involvement.
2. StaRUG does not (yet) qualify for automatic recognition in international group restructurings
Following the traditional German approach of dealing with each entity on an individual basis in insolvency, the StaRUG also focuses on the individual entity. However, as a break away from that principle, StaRUG allows for the restructuring of collateral granted by affiliates for the debt subject to the restructuring.
It is typical in a major restructuring that both the debtor entity has granted security over foreign assets (e.g. by way of a security transfer agreement) and foreign subsidiary entities have provided (upstream) collateral themselves (e.g. by way of assignment of its receivables or bank account pledges). Therefore, cross-border recognition of the StaRUG is crucial but is currently not straightforward:
a. Within the EU, international recognition of StaRUG proceedings is still not automatic (and requires a country-by-country analysis). Whilst “die öffentliche Restrukturierungssache” (a publicly heard StaRUG case) was included in Annex A of the EU Insolvency Regulation on 15 December 2021, the possibility to have a case heard publicly will only be available in Germany from 7 July 2022. In any event, having to hear a case publicly means StaRUG would lose one of its advantages;
b. Additionally, the ability of StaRUG to effectively deal with in rem collateral provided by the debtor entity over its foreign assets, such as share pledges over foreign subsidiaries or foreign mortgages remains in doubt because, generally, the opening of a StaRUG (as with insolvency proceedings) shall not affect in rem collateral in other EU countries. This means that any release of collateral through StaRUG would not be recognized in those EU member states and enforcement by creditors would remain possible;
c. Collateral granted by foreign subsidiaries is unlikely to be eligible for a restructuring under the StaRUG, and would need to be restructured pursuant to local restructuring law. An exception may apply where, in accordance with such local law, the restructuring of the primary claim in Germany leads to the extinguishing of the accessory collateral; and
d. Recognition under U.S. Chapter 15 has not yet been tested.
3. StaRUG majorities may interfere with intercreditor provisions
Another reason why StaRUG is unlikely suited for major restructurings is a potential conflict of the voting majorities required under the restructuring plan with consent provisions in intercreditor agreements. Where financial creditors are organized by way of an intercreditor agreement or otherwise binding provisions in the loan facility, such provisions usually contain certain majority requirements for amending the facilities. These majorities – at least for a debt haircut – are typically higher than those under StaRUG where the consent of a certain class is given when 75 % in value approve the plan.
Thus, and this has not played a role yet, the cram-down of a dissenting creditor within one class may imply a violation of the duties owed under the intercreditor provisions towards other creditors. While the court’s confirmation of the StaRUG proceedings is likely to give effect to the voting and supersede intercreditor restrictions, the breach of contractual duties may remain. It would then be a logical next step for the dissenting creditor to go after the majority creditors and request compensation; this would leave the restructuring result ad absurdum.
Against that background, it is noteworthy that the StaRUG explicitly allows for the restructuring of individual provisions in the intercreditor agreements (and, potentially, the decreasing of majority requirements thereunder). However, it remains to be seen whether a German court will take that into account in a potential purely contractual litigation between creditors.
4. Only remote protection for new money, if at all
Most surprisingly, one of the key disadvantages of the StaRUG is the limited protection, if any, for new money:
i. Firstly and unlike in insolvency proceedings, the StaRUG does not allow for a super senior or a specific bridge loan concept. The time limitations and other requirements under German law for bridge loans are equally strict in- or outside a StaRUG proceeding. Absent this, the company must finance itself on the way to and during the restructuring from already available means.
ii. Secondly, new money provided for under the StaRUG plan is hardly ring-fenced against the claw-back in a potential later insolvency. A creditor can obtain protection by a so-called S6 restructuring opinion which shows, in broad terms, that the company is worth and capable of restructuring and the creditor did not act in bad faith, and thereby provides a crucial defense in any potential litigation. However, preparation of such opinion by an independent expert (often: auditors at the Big Four) takes several weeks, at least, in which the debtor must be funded and no bridge loan protection exists, as mentioned. One of the odd parts of the StaRUG is that the legislator has excluded clawing back of the granting of the loan by the new creditor but not a claw-back of its repayment – whereas only a repayment of the debt by the company can generally be subject to a claw-back.
5. No restructuring against the shareholder
In usual circumstances where an entity is financially solvent, the managing directors owe their fiduciary duties to the company and ultimately to the shareholders. Upon filing for the StaRUG, the law provides for a shift of duties to the creditors.
It was one of the last minute changes before the implementation of the StaRUG that such shift of duties does not occur upon imminent illiquidity but only upon the voluntary filing – which requires the company to be imminently illiquid.
Therefore, it now seems common ground that the filing for StaRUG requires prior approval by the shareholder(s). This holds true at least for limited liability companies (GmbH) and is discussed for stock corporations (AG) where the board can act more independently. Absent such approval, the filing by a managing director of a GmbH would still be legally effective but could give rise to personal liability (and, thus, will unlikely be seen in practice).
Given the likely requirement for shareholder approval, a cross-class cram down of the entire shareholder class is therefore unlikely to be seen in practice.
However, what has been seen, is the cramming down of a minority shareholder by the majority shareholder. This cannot be prevented by a mandatory prior shareholder resolution because the majority in the articles of association required for such fundamental decisions is usually 75 % and therefore, minority shareholders should negotiate articles of association and shareholder agreements with this in mind.
6. Scenarios where a StaRUG will be seen going forward
In light of the above and reflecting the StaRUG cases which we are aware have been closed, it seems that StaRUG will have the ability to organize an amorphous and unorganized group of creditors, i.e.
- several non-organized local saving banks; or
- holders of German Schuldscheine which do not typically enter into an intercreditor agreement; or
- holders of bonds when a restructuring under the German Bond Act is not possible because the required quorums are not met (this has been the case for German retailer Eterna most recently).
It is also possible that the German state bank KfW (which has provided loan support during the Covid- pandemic) will sooner or later be one of the stakeholders in a StaRUG.
Once used, case law has shown that the restructuring plan can be implemented quickly, i.e. within a couple of weeks. Undoubtedly, however, the StaRUG can be (and, certainly has been) used as an instrument to discipline creditors even without the initiation of formal proceedings, simply because of its inherent possibilities of a cram down.
More from the Weil European Restructuring Blog
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