Downsizing & Unwinding
How companies can adjust size
and structures
Various industries such as the automotive or steel sector are heavily under pressure. When capacity utilisation drops drastically and losses increase, owners and managers are confronted with the question of what options they can take: downsizing, liquidation, insolvency or dormancy.
An overpriced acquisition has led to high indebtedness, a major project failed or demand has plummeted – the reasons for a corporate crisis can be very different. However, what all distressed companies have in common are the financial symptoms: losses have melt away the equity, owners helped out through shareholder loans or equity injections. If the company has accepted bank loans and infringes contractually agreed financial ratios by way of a so called covenant breach, the lenders are allowed to terminate and demand immediate repayment. At the same time, liquidity often becomes scarce so that due invoices can no longer be paid; insolvency is imminent or has already occurred.
Self-administration as a restructuring solution
The fate of the distressed company depends on what is happening and what is feasible: what are the causes of the crisis, is the business model still suitable, will the company be profitable on a smaller scale? Does it help to get through the crisis in the long term if legacy sites are cut off? What goals do the owners have, what can and do they want to contribute financially? What restructuring solutions does the law provide for in the respective country and is there state aid available? With the latter, Germany has a locational advantage for renovation. “If a company is restructured under self-administration, the Federal Employment Agency continues to pay the majority of the salaries for three months from a fund financed by all companies. In addition, there are certain liquidity reliefs for the payment of wage and sales tax as well as social security contributions, and the company is given the option of extraordinary termination of long-term obligations such as unprofitable orders, rent or leasing instalments. This allows the company to take a financial start for the restructuring,” explains Dr. Alexander Verhoeven, lawyer and restructuring expert at horizon-re in Frankfurt. After about six to eight months, the company can leave the legacy behind by means of a so-called insolvency plan. The decisive advantage over classic insolvency is that management and shareholders retain control over their company. The power of administration will remain with the previous management, which will only be supervised by a so called Sachwalter as a trustee appointed by the insolvency court.
Germany has an international advantage
With such advantages, Germany is alone internationally. In the Netherlands, for example, a protective shield procedure called WHOA was also introduced during the Covid19 pandemic. However, there is no financial insolvency benefit there. In Chapter 11 proceedings in the United States, there are also no public dollars available to support liquidity for the continuation during the restructuring efforts. However, German self-administration is not a sure-fire success either. “The owner must always be willing and able to make a financial contribution to the restructuring of the company, or there must be a core that can be restructured that gives the company the necessary medium to long-term profitability. Because the insolvency plan must not put the creditors in a worse position than they would be if the company were broken up or otherwise continued,” says Verhoeven. If the owner himself is insolvent or short of cash, self-administration proceedings are often ruled out. Recent example: the German department store group Galeria Karstadt Kaufhof with its insolvent shareholder Signa, where only regular insolvency proceedings were feasible. It is also impossible to argue away that self-administration is still an insolvency procedure. Even though many companies have now gone down this path, the insolvency stigma still clings to it. In addition, there are risks for the owner that payments from the time before the insolvency application are contested and have to be refunded. In addition, during the ongoing restructuring efforts, there is always the risk that self-administration will be transferred to regular insolvency proceedings – which is the case if there are indications that self-administration is not suitable in an individual case or that the restructuring no longer has sufficient prospects of success.
Out-of-court restructuring proceedings without insolvency
If there are some major creditors such as banks or landlords and a deal is to be concluded with them, out-of-court restructuring proceedings are the means of choice. For example, the aforementioned Dutch WHOA makes it possible to meet liabilities privately by means of an out-of-court settlement – whereby the settlement is also binding for those creditors who do not agree to the settlement. In order to decide on the settlement, creditor groups are formed to vote on the settlement. In the end, a court confirms the settlement. However, the WHOA procedure itself is not suitable for the dismissal of employees during restructuring. To this end, the WHOA would have to be combined with a social plan and negotiated with the works council and the trade union which is also expensive in the Netherlands. In case of a WHOA, the owner of the company in crisis must ensure that all running costs still incurred are met from the day of the application. Only then can the settlement be reached.
Orderly withdrawal by means of liquidation
Another solution is liquidation, which takes at least a year in most countries – and requires owners to finance all of the company’s liabilities. In addition, numerous formalities must be fulfilled. In Hong Kong, for example, an official procedure of the Companies Registry must be undergone based on five resolutions and three forms. The authority publishes in the local gazette that the owners have decided to liquidate. If there are no objections within three months, the Companies Registry will declare the company liquidated. Until then, any balances from the company account should also be transferred; otherwise, the amount will be vested in the government. In Germany, too, it is no less formal: on the basis of a notarial shareholders’ resolution, a liquidator is appointed who dispatches the liquidation via the Federal Gazette. This is followed by a so-called blocking year, in which everyone who still has something to get from the company can get in touch. Once the 12 months have passed, the liquidator draws up a final liquidation balance sheet, lets the shareholders vote on it and discharges. This is followed by the final account and a distribution of the remaining assets to the shareholder(s). Last but not least, the register court makes sure at the responsible tax office that there are no longer any tax liabilities – if no concerns are expressed there, the register court finally deletes the company from the commercial register.
The Dormant Mode
One type of liquidation is the so-called dormant mode. This puts the distressed company into a state of sleep, so to speak, by cutting all employees and discontinuing operational business with the aim of being able to use the existing assets such as trade marks or patents and take advantage of tax loss carry-forwards later on. In Hong Kong, for example, a “Declaration for Dormancy” is needed for this. On the basis of a Board Written Resolution, a General Written Resolution and a Special Resolution, the shareholders use paper and ink to decide on the dormancy, which is recorded by the Companies Registry. This is associated with considerable relief in terms of accounting and taxes – but also financing of all obligations by the owners. As soon as the company is to wake up again, it needs a special decision again.
Whichever solution is used in the individual case – all managed restructuring options require a financial injection from the shareholders or a core that can be restructured, which gives the company the necessary profitability in the medium and long term. Otherwise, the only option is the regular insolvency procedure with all the associated risks and side effects.