Montag, 14. Oktober 2019

The Different Kinds Of Creditors In German Bankruptcies

Some creditors are created more equal than others in German bankruptcies.
Creditors are differentiated between preferential creditors, unsecured creditors and secured creditors. 
I. Preferential Claims
Preferential claims are claims that arise after the debtor has filed for bankruptcy. They are fees for the court, the administrator, the creditors' committee and basically every contract that administrator enters into for the company after bankruptcy. Preferential claims have the highest priority, meaning they are paid first buy whatever money is available. This might seem unfair for other creditors who have had claims outstanding for several years. And it is. But the reason is that if this was not the case the debtor would basically say: "Do business with us now although we are in bankruptcy and guarantee you that you will only get back 5% of your money." Noone would do that, the company could not continue to operate in the market and would have to be liquidated. That is why the law basically states that everyone who does business with the debtor after the formal bankruptcy filing will be paid business as usual after he has sent his invoice.

As a rule of thumb: Claims that arise after the filing of bankruptcy, but before proceedings are formally openend are not preferential claims. Of course, every file is different. If the court orders that the preliminary administrator may make preferential claims – he can do just that.
II. Unsecured Claims

Regular (unsecured) claims are those claims that arose before the company entered into formal bankruptcy proceedings. These creditors must must file their claims for registration with the administrator, who either rejects the claim or registers it with the bankruptcy schedule. In case of a rejection the creditor must bring a legal action to enforce the acceptance of the claim. If he does not, his claim is not filed with the schedule and will not be considered for any payments.

 III. Secured Claims
Secured creditors are legally not bankruptcy creditors, because they have a direct claim against the estate to surrender their collateral or payment of the proceeds thereof. To the extent the security was not sufficient to cover the total amount of the secured claim, the remaining claim will be treated as an unsecured bankruptcy claim.

Mittwoch, 9. Oktober 2019

How Does A Typical German Bankruptcy Proeedure Look Like?

One of the main difficulties in the European Union considering bankruptcies is that there are not only 28 (soon to be 27) legal systems, but also 24 official languages. This is why we are looking for an AI-solution that helps you translate every court order automatically. You will hopefully see our first drafting within the next couple of weeks. 
Meanwhile, let us start by going through a simple case of a bankruptcy proceeding in Germany. I will link actual filings from First-Data as examples for relevant court dockets. 

I. The Bankruptcy Filing And Preliminary Bankruptcy Proceedings

Bankruptcy proceedings can basically be divided into the preliminary bankruptcy proceedings and the actual, formal, bankruptcy proceedings. Both stages are supervised by the bankruptcy court.

A bankruptcy must be filed by management as soon as any bankruptcy reason exists. If the filing is late (as are 80% of filings), this can lead to criminal prosecution. As matter of law, every bankruptcy filing has to be filed with the state prosecutors (see MiZI).

It is the job of management to know whether a bankruptcy reason exists. But: Bankruptcy can also be filed by creditors and – if necessary – by shareholders. I even know of a case where a court found that the supervisory board had to file, because management refused to do so.

However, the court does not automatically open bankruptcy proceedings after a filing. First, preliminary proceedings are opened: the court determines whether a bankruptcy ground actually exists. The court will therefore appoint a preliminary creditors’ committee and a preliminary bankruptcy administrator. For example, see the filing for Beate Uhse AG, where both was ordered by the court in Flensburg:

The court ordered Dr. Sven-Holger Undritz (White & Case) as preliminary administrator. Among his tasks were

a) to examine the jurisdiction of the court for proceedings (centre of the debtor's economic activity);

b) to examine whether there is grounds for opening formal bankruptcy proceedings;

c) to find out whether the debtor's assets will cover the costs of the proceedings;

d) see, if the prerequisites for self-administration are met (this is usually only done if management files and asks for self-administration).

A preliminary creditors’ committee was also established. Its most important right at this stage is to oversee the administrator and exchange him, if neccessary, after formal proceedings are opened.

II. Formal Opening And Creditor Meeting

Formal bankruptcy proceedings are opened by the court if, based on the assessment of the preliminary administrator, it arrives at the conclusion that bankruptcy grounds do in fact exist and there are sufficient assets to cover the costs of the proceedings. See here for a court order of a formal opening: 

If there are no bankruptcy reasons, the filing will be rejected. If there are, but the debtor does not have sufficient assets, the company will be liquidated. The court will order the necessary steps for that. For an example of insufficient funds, see here: 

Otherwise, the bankruptcy process is formally opened. Creditors now can no longer enforce their claims outside the bankruptcy proceedings (although this might already be the case after the preliminary filing). A (final) bankruptcy administrator will be appointed which in most cases will be same person as the preliminary one. He is now in charge of the debtor, unless self-administration is granted.
The first creditors’ meeting is no later than three months after the opening of the formal proceedings. There, the creditors decide how to proceed with the company. It can also instruct the administrator to prepare a bankruptcy plan. In a bankruptcy process, the creditors meeting is about the equivalent of the shareholders meeting outside the bankruptcy process. The creditors can influence the process, especially by confirming or exchanging the administrator.

Depending on the circumstances, a solution for the debtor is sought out, which can be anything from finding an investor, a sale of the company, a sale of the assets or simply a liquidation. Every case is different, which is why it is very important to have an administrator who has good business judgement.

III. Closing

If a solution is found and/or the (majority of the) creditors agree, the company will be released from administration and is basically a “normal” company again.

Samstag, 5. Oktober 2019

Why do corporations file for bankruptcy?

The question seems easy enough, because in 99% of cases, the answer is clear: they ran out of cash. But: the German insolvency statute actually has 3 reasons for opening a bankruptcy-proceeding: 

1. The debtor is insolvent, which means he is unable to pay its creditors;
2. the company is over-indebted, meaning the debtor's assets no longer cover his obligations to pay, unless it is highly likely, considering the circumstances, that the enterprise will continue to exist;
3. (only if the if the debtor files for bankruptcy himself):  the debtor is imminently insolvent.

So logically, it makes sense to differentiate between cases where the company has to file for bankruptcy and cases where it makes sense to file. I would argue that lots of cases include both. But the latter usually occurs only when there are new stakeholders involved. Not only do they look with a different angel – they also bought into the securities at different (cheaper) prices. 
I. The company has to file for bankruptcy/ creditors file for bankruptcy

As I wrote earlier, in reality, 99% of all bankruptcies are filed because of insolvency (reason 1.). Companies usually do not go to court and say "My assets probably won't cover my liabilites." That is because management is in a very precarious role: file to early and your stockholders sue you. File to late and the creditors (in the form of the administrator) do. 
Also, over-indebtedness (reason 2.) is also very loosely defined, as companies are not required to file, if it is "very likely that the enterprise will continue to exist." As long as management is in some talks over stretching loans, getting a new investor or not having to pay its employees for, they can – and must! – argue that it was likely that the enterprise will continue to exist. If you do a simple test and check for openings of cases on First Data, you will see that the overwhelming majority of cases is opened on the grounds of both insolvency and over-indebtedness, because once you are insolvent, your assets usually do not cover your liabilites (otherwise you would have sold them and paid off your liabilites). 
II. It makes sense for the company to file for bankruptcy

This is relatively new in Germany. It is usually done, because there is new management installed which sees an advantage in taking a bath and restrucutre the whole company. You see, usually the creditor threatens with “filing for bankruptcy”. But of course, management can make the same threat. If you read through the case study of how Buffett took the reign at Salomon, this is basically what he did. He told regulators 

“These are all the solutions I have. If you don’t help us … well, I do not know what else to do. Here are the keys. You take over.”

That worked, because they knew the only worse outcome for the country than having a misbehaving Salomon, is a dead Salomon. They gave Buffett what he needed and the bank was ultimately saved. But it goes both ways and there are all kinds of stories and wild legal battles and I myself have been involved in a case, where creditors wanted to file for bankruptcy in order to get rid of management, because they happened to have 30% of the shares outstanding and they were a simple joke (I will write about that case study in-depth in another post, as it makes a great illustration of the possibilities of bankruptcy if you understand the tools it can provide to you).

But in general, the upside of filing for bankruptcy is that it puts an automatic stay on all stakeholders: every lawsuit is legally required to halt, every foreclosure is put on halt and employees get paid for three months from the government. Basically, the creditors are forced to stop attacking the debtor and sit on the table to work out a plan. If they do not find a solution, the company will be liquidated, which is almost always a worse outcome for all stakeholders, especially employees, suppliers and customers. You can see a liquidation scenario versus a bancruptcy plan in the cases of Beate Uhse and SKW Stahl AG on Debenture Research.

There is another great thing about a structured bankruptcy-plan: it is not necessary to have every creditor to agree, but simply the majority of creditors. That’s what makes a bankruptcy so powerful, if used properly: the company can enforce things against the will of major stakeholders, if it serves the general good. It is why I call it “Bankruptcy protection”. It is neither good nor bad, but just a tool that can be used. It depends on how it is used and handled. 

We will talk more about that in the next post.

Freitag, 4. Oktober 2019

Welcome to Debenture – and a starter on German bankruptcies

Over the last couple of weeks, we have gotten an enormous amount of positive feedback for our product First Data, which saves and indexes every bankruptcy case in Germany. It updates users automatically on any news on the case. 

As always, we found out a lot of things about our users that we did not know before. For example: we thought our users would only be distressed-debt-professionals. Interestingly, there are also lots of people such as small business owners who are using our website. As you can imagine, most of them did not know how to proceed after their debtor has filed for bankruptcy. Which is why we started to create a solution for that. You will see a first draft in a couple of days.

We now also know that we have lots of people outside Germany following debtors in Germany. Here is some really good news for all you people out there: it has always been one of our goals to make the bankruptcy market more efficient and therefore available to foreign professionals. A huge pain – obviously – is the different language. We are working on a solution for that, too.

Until then, let me start on some basics about the bankruptcy process in Germany and why so many distressed-debt-professionals are active in this field. This is not just a playing field in the US. It happens here in Germany. A LOT!

In order to understand why, you have to know the basic idea behind bankruptcies: in many cases, the business is actually a very good business. It simply did not have enough cash to pay its creditors in the short term. So they had to file for bankruptcy, even though it is a very good business.

It is hard to understand this at first. You have to go through many case studies (preferably by reading only) and then some more. I recommend reading Marty Whitman, Seth Klarman and Leucadia for starters, if you really want to get a hold of it. But Carl Icahn and Warren Buffett also did some of those and you can really learn a lot about the economics of reorganizing a company through bankruptcies by going through these case studies. 

Now: Germany used to be very different. The ideal bankruptcy here was often described something like this:

In an ideal case, the debtor files for bankruptcy just in that moment, where, after the bankruptcy process is completed, every creditor of the company gets what he is owed. 

In Germany, and actually most European countries, traditionally the idea was to liquidate the company after bankruptcy and sell the assets to pay the creditors, because the business does not work. If all goes well, creditors get their money back. It is a huge, huge drag on the economy to operate this way, even if all the creditors were to get back their money in full. But that, of course, almost never happens. For example: in bankruptcy cases that started in 2010 and ended in 2017, creditors got back 6.2% on average (I am only talking about corporate bankruptcies). The numbers vary from year to year, but in the end, you are not far of by assuming a number around this range.

But: as with any statistic, this is the average across 22.000 corporate bankruptcies each year. In some cases, creditors go empty-pocketed. In others, you might get back as much as 50% of your claim, sometimes even the full amount. The trick is to find out where. And this is what hedge funds try to do. They find out where they can buy debt and trade claims for less than they think they can get out after the bankruptcy is completed. I know fund managers who actually just do that: they calculate what they think is the market value of the assets and see if they can get the debt cheaper. Some advanced form of arbitrage.

But what the big funds, such as Cerberus, Oaktree and Apollo, do, is to buy the debt cheaply, actively influence the bankruptcy process so that the company is not liquidated, then reorganize it in the bankruptcy process and profit from the business itself, once it is restructured. Many times, they exchange their debt into common stock so that the company is no longer indebted after the bankruptcy. This happened in the cases of Beate Uhse, SKW Stahl and will also happen with Gerry Weber. We covered those reorganizations on Debenture-Research.

This shift from liquidation towards reorganization will continue in the future. According to a recent Financial Times article, several hedge fund managers are creating new funds for distress-debt-opportunities, many of them because they see huge opportunities in Europe. Plus: the EU has passed a law that orders EU-members to legislate preventive restructurings. Basically, this will allow companies to reorganize their liabilities before they have to file for bankruptcies. 

So, you see, distressed companies can provide lots of opportunities. Most of all: if it helps keeping the company alive – what’s the downside? It can be a much better outcome for the parties involved. But the first step must be to make data available to the players involved. Which is exactly why we built Debenture. See you soon.