COVID-19 (Coronavirus): How the COVID-19 Relief Act Can Help Rescue German Companies

On March 25, 2020, the German parliament adopted a package of measures to mitigate the effects of the COVID-19 pandemic (“COVID-19 Relief Act”). This article contains an overview of the key measures for German companies, which are:

• Suspension of insolvency filing obligations and insolvency-related payment restrictions;
• Facilitation of new debt financings; and
• Prohibition on termination of real estate leases for payment defaults.

Although not covered by this alert, we note that the COVID-19 Relief Act also contains further relevant measures, including a moratorium on payment claims against consumer lenders (which can be extended to companies by governmental decree); a moratorium on payment claims against micro-enterprises for utilities; tax payment deferrals; special loan facilities offered by the state-owned Kreditanstalt für Wiederaufbau (KfW); and an economy stabilization fund of EUR 600 billion.

The COVID-19 Relief Act is expected to come into effect as soon as possible after it is endorsed at the German federal council meeting scheduled for March 27, 2020.

This alert is relevant to investors, management and directors of German companies, as well as wider stakeholders.

SUSPENSION OF INSOLVENCY FILING OBLIGATIONS AND INSOLVENCY-RELATED PAYMENT RESTRICTIONS

The COVID-19 Relief Act limits the situations in which it is necessary or possible to file for insolvency. It does this by (1) suspending the directors’ duty to file for insolvency in an insolvency situation (together with their related duties); and
(2) restricting the situations in which a creditor can file against a debtor.

(1) Suspension of directors’ duty to file for insolvency and related duties

Under German insolvency law, directors must file for insolvency no later than three weeks after the occurrence of an insolvency event, which occurs when a company becomes over-indebted or illiquid. The COVID-19 Relief Act effectively suspends the obligation to file for insolvency until September 30, 2020 where: (i) the insolvency is caused by the pandemic and (ii) there is a realistic prospect that the illiquidity can be cured. 

Presumption of pandemic-induced insolvency

Both conditions are presumed to be met if the company was not illiquid on December 31, 2019. This presumption can be rebutted only if there is no doubt that either (i) the pandemic did not cause the insolvency or (ii) it will be virtually impossible to cure the illiquidity.

However, the extent to which directors can rely on the presumption remains to be seen, in particular in cases where a company was already distressed or struggling to obtain financing. This will be especially pressing where that company is unlikely to qualify for state relief programs intended to mitigate the economic effects of the pandemic, such as those provided by the KfW. In any case, boards must monitor the situation, including whether the conditions for the filing suspension are met on an ongoing basis. If they are no longer met, the obligation to file for insolvency is revived.

Suspension period

The suspension is effective from March 1, 2020 until September 30, 2020 (or such later date up until March 31, 2021 as the government may decide). After this period, the usual rules will apply, and companies that have not remedied existing insolvency events will lose the ability to achieve a restructuring outside an insolvency proceeding.

Reduced liability risk for directors

Generally, in addition to failure to file, directors can become personally liable if they make payments following the occurrence of an insolvency event. The COVID-19 Relief Act also amends the rules on directors’ liability for wrongful trading to match the suspension of the obligation to file for insolvency. However, under the COVID-19 Relief Act, as long as the conditions for the filing suspension apply, a deeming provision makes payments in the ordinary course of business prudent. 

(2) Restriction of creditors’ ability to file for insolvency

For the three-month period after the date the COVID-19 Relief Act is officially announced, insolvency proceedings can only be opened if grounds of insolvency existed before March 1, 2020. However, the COVID-19 Relief Act does not affect insolvency proceedings initiated prior to the announcement date, and so insolvency proceedings might be opened irrespective of whether the insolvency was triggered by the pandemic.

DEBT FUNDING FOR COMPANIES IN FINANCIAL DISTRESS

In normal times, providing a company in financial difficulty with further liquidity may give rise to lender liability. Granting loans or security for loans might be qualified as unconscionable and trigger damages claims from other creditors if the company becomes insolvent. Repayments or the proceeds from enforcement of security under such loans might also be re-claimed or avoided, respectively, by the insolvency administrator. Such risks are typically mitigated by an auditor's validation of the restructuring concept. The Covid Relief Act introduces the following supportive measures:

• If repayment of loans granted during the suspension period is completed by September 30, 2023, or security for such loans is granted within the suspension period, lender liability will not be triggered for claims based on creditor disadvantage. This also applies to the repayment of shareholder loans or measures with corresponding economic effects, although not to security granted to shareholders. This measure applies without limitation in time to all loans granted by KfW or its financing partners under state aid programs initiated to remedy the economic effects of the pandemic.
• In the case of insolvency proceedings initiated prior to September 30, 2023, claims under shareholder loans granted during the suspension period are not subordinated by law but rank equally with third party claims.
• Granting of loans or security during the suspension period does not qualify as an unconscionable contribution to delay a compulsory insolvency filing, and therefore the risk of such loans being void and the risk of lender liability for damages claims of third parties does not apply.

Note that such measures will apply regardless of whether the company’s business was impaired by the pandemic, as long as the related funding or payments were made during the suspension period.

MORATORIUM FOR LEASE PAYMENTS

The COVID-19 Relief Act provides that tenants who cannot pay rent between April 1, 2020 and June 30, 2020 due to the effects of the pandemic will not have their lease terminated. For this moratorium to apply, the tenant has to provide reasonable proof that the default is related to the pandemic. This can be shown by public orders relating to the pandemic which prohibited or extensively restricted the tenant from doing business. It is not wholly clear how strong the connection between payment default and the pandemic is required to be. In light of the purpose of the termination moratorium, we are of the view that a significant impact on a business caused by the pandemic and a prudent business judgment not to use liquidity for rent payments but to use it elsewhere would be sufficient for the termination moratorium to apply.

Regardless of any extension to this period, tenants have two years to pay outstanding rent, until June 30, 2022. However, the moratorium does not exclude the landlord’s right to terminate on other grounds, nor does it affect the obligation of the tenant to pay default interest.