German Debt Restructuring: Recent Trends And Developments
In 2009, the German economy was hit hard by the worldwide economic and financial crisis. Like most other industrial economies it suffered the biggest economic downturn for decades. However, the German economy was able to recover relatively quickly. Short-time work, the ‘cash-for-clunkers-program’, a strong export market and increased private consumption driven by low interest rates have supported this recovery. As a result, in 2010 Germany enjoyed its highest level of economic growth since the reunification. By Q2 of 2011 however, this growth trajectory had stalled. Due to the ongoing sovereign debt crisis, the outlook for 2011 and 2012 is currently very uncertain (current GDP growth predictions for Germany are c. 2-3% in 2011 and only c. 1 % in 2012).
Despite the decline in the number and volume of restructuring cases especially in the first half of 2011, the next wave of financial restructurings is already impending. Almost €100 billion of leveraged debt outstanding in Europe – with a substantial portion in Germany – is set to mature by 2016 (the ‘maturity wall’). Better quality debt may be refinanced over the bond and loan markets. However, according to Standard & Poor’s, c. 90 percent of the debt maturing by 2016 is rated 'B+' or worse and these borrowers may struggle to refinance through conventional means. The peak in the maturity profile for total European leveraged debt is scheduled to occur in 2015 and it is unclear whether there will be sufficient liquidity in the market to refinance all of this debt at acceptable prices as it matures.
Additional refinancing requirements for the German market will occur from upcoming maturities of standard mezzanine programs. In total, €4.4bn of mezzanine debt is scheduled to mature between 2011 and 2014. According to a current study by PwC, 10-20 percent of the mezzanine financed companies will face serious refinancing problems and are likely to become restructuring cases – almost €1.0bn of total mezzanine debt. In the meantime, the first standard mezzanine program (PREPS 2004-1) reached its maturity in May 2011 – the rate of return for the investors of around 6-7% was less than expected.
In light of these upcoming refinancing challenges, we highlight some of the latest developments in the German debt restructuring environment below:
Financial restructurings in Germany are usually accompanied by a Restructuring Opinion ("Sanierungsgutachten") from an independent expert reflecting on the feasibility of the proposed restructuring. This mitigates the risk for lenders (collaterals and claw-backs) and is typically required before a final decision on possible restructuring options is made. IDW S6, published by the Institute of Chartered Accountants in Germany, is the established standard for Restructuring Opinions. Currently, the Institute is working on an amended version, integrating some of the feedback received by practitioners. The main amendments include: highlighting that elements of the German Supreme Court ("BGH") ruling are included; incorporation of a statement that there is no risk of insolvency within the completion period of the Restructuring Opinion; and the necessity of a statement that the company has the ability to be restructured. It is expected that this new version (IDW S6 N.F.) will be published by the end of this year.
Only in very rare occasions, German insolvency law has been viewed as an alternative instrument to an out-of-court restructuring in the past and has therefore attracted criticism, in particular during the economic crisis. Points of criticism are, inter alia, the lack of influence on the appointment of insolvency administrators by creditors and the impossibility of debt-to-equity swaps without the cooperation of the existing shareholders (only via enforcement).
In February 2011, the German Federal Government published the first draft of a new Act Serving the further Facilitation of the restructuring and the reorganisation of enterprises ("ESUG"). The purpose of the draft act is, among others, to involve the creditors in the selection process of the (preliminary) insolvency administrator and hence to improve the reliability and predictability of insolvency proceedings. The draft act also attempts to expand the opportunities for the reorganisation of an insolvent debtor in so-called insolvency plan proceedings. Currently, the rights of the existing shareholders of an insolvent company remain unaffected by a recapitalisation of the company in connection with an insolvency plan. Thus, debt-to equity swaps in order to recapitalise the company are not possible without the cooperation of the existing shareholders. This separation of insolvency law and corporate law shall be abandoned and insolvency plans shall provide the debt-to-equity swap as an instrument to recapitalise insolvent companies. This bill of the German Federal Government (ESUG) is estimated to come into effect at the beginning of 2012.
The ESUG is clearly perceived among practitioners as a step forward in the right direction. However, how big the step really is remains to be seen as insolvency in Germany might continue to attract a significant level of stigma.
In addition, with the options of a double-sided trusteeship, the applicability of the UK Scheme of Arrangement if specific criteria are fulfilled (e.g. legal documents according to UK LMA standard) – recent examples include Telecolumbus and Rodenstock; and the possibility of enforcement procedures also regarding German legal entities (e.g. Primacom, Walter Services), the German toolkit for Financial Restructuring has been extended. Nevertheless, it is most likely that Germany will remain a relatively difficult jurisdiction for restructurings. Furthermore, there is clearly no "one size fits all" solution, especially also due to tax reasons.
The European Commission has recently ruled (26 January 2011) that the bail out clause ("Sanierungsklausel") constitutes unlawful state aid. This clause covers the offsetting of losses carried forward against future profits. In the case of illiquid or over-indebted companies (subject to certain conditions), this offsetting could occur despite a detrimental change in ownership if the share transfer occurred with the aim of restructuring the company.
Following the decision on the "Sanierungsklausel", a discussion has arisen as to whether the German recapitalisation decree ("Sanierungserlass") may also constitute unlawful state aid. The recapitalisation decree is currently the only possibility to offset carried forward tax losses against recapitalisation gains without the requirements of German minimum taxation, for instance as a result of debt waiver or debt-to-equity swap. According to these rules, taxable income of up to €1 million can be offset entirely, while amounts exceeding this level can be offset by losses carried forward at a rate of 60 percent. Therefore, only roughly 40 percent of recapitalization gains (covered by losses) remain taxable at a rate of c. 30 percent. In addition, the recapitalisation decree allows for the deferral and abatement of tax on recapitalisation gains to the extent such gains exceed the existing losses carried forward. Should this rule be deemed to constitute unlawful state aid, it would significantly influence future debt restructurings as certain restructuring options would be replaced by others, such as a debt waiver by e.g. a debt-pull-up.
Our recent practical experiences in leading large and complex German debt restructurings has shown that understanding the specific jurisdictional issues as well as the varying different stakeholder mindsets even within a specific lender's syndicate is critical to reach a successful outcome and that innovative solutions can be found to deal with many of the challenges they present.
PwC's restructuring practice is one of the largest in Europe and worldwide, enabling us to bring unrivalled knowledge, experience and expertise in restructuring advice and implementation to every case. The German branch with over 50 dedicated restructuring professionals has completed over 50 restructuring deals in 2010 including some of the key recent German financial restructuring cases.
Patrick Ziechmann is a Partner of PwC Business Recovery Services and he is leading our expert team in our Dusseldorf office. He has extensive consultancy practice in the area of corporate finance. He is specialized in developing and implementing concepts for reorganizations and business recoveries in different industries with particular focus on mechanical engineering, construction, chemistry, telecommunication and media. In this context, he focuses on strategic, operational and financial restructuring, business planning, cash management and insolvency advice. Patrick Ziechmann can be contacted on +49 211-981-7518 or by email at email@example.com.
Stefan Schwertel is a Senior Manager with PwC. He is part of PwC's Business Recovery Services leadership team and focusing on financial restructuring and debt advisory services. Before working with PwC, he gained comprehensive strategy and operational consulting experience during his eight years with McKinsey & Company. Stefan holds a Master degree of Mathematics as well as a Master of Business Administration (MBA) of the University of Southern California, Los Angeles. Stefan Schwertel can be contacted on +49 69-9585-6057 or by email at firstname.lastname@example.org.