I. Introduction

Due to the current corona crisis and the therewith associated tense economic situation, many managing directors (Geschäftsführer) are faced with the question of a possible, punitive obligation to file for insolvency as well as other duties that must be observed in the context of a crisis.

The following provides an overview of the obligation to file for insolvency, payment prohibitions in a crisis as well as the facilitations introduced under the German COVID-19 legislation.

II. The Obligation to file for Insolvency

According to Section 15a German Insolvency Code (Insolvenzordnung, "InsO"), managing directors of a German limited liability company (Gesellschaft mit beschränkter Haftung) are obliged to file for the opening of insolvency proceedings if the company is illiquid (zahlungsunfähig), or over-indebted (überschuldet).

To the extent several managing directors have been appointed for the company, each of these managing directors is subject to the obligation to file for insolvency. A possible division of responsibilities within the management does not release the co-director from the duty to supervise the other director and, especially in a crisis, to get an idea of the financial situation of the company.

The filing must be made without undue delay, at the latest, however, within three weeks of the occurrence of the illiquidity or over-indebtedness. In this context, it is irrelevant whether the managing director had actual knowledge of the reason for insolvency or not. For this reason alone, especially at the first signs of a crisis, a managing director is urgently advised to continuously evaluate the financial situation of the company and to document this accordingly.

1. Illiquidity

The general reason for the opening of insolvency proceedings is first of all illiquidity (Section 17 InsO). This is given, if the company is unable to pay its debts, when they fall due. In case, the company has suspended payments, illiquidity is reputably presumed.

On the other hand, mere temporary liquidity bottleneck does not constitute illiquidity. According to German case law, such an insignificant payment hold-up exists if it can be eliminated within three weeks.

From a quantitative point of view, case law also generally assumes that a shortfall of less than 10% does not lead to illiquidity, unless it is already foreseeable that the liquidity gap will exceed the 10% threshold. Although this is not a rigid threshold, an exceedance of the 10% threshold serves as a rebuttable presumption for illiquidity. This assumption can be rebutted, e.g. if the company can demonstrate that the liquidity gap will be completely or at least almost completely eliminated with almost certainty within a reasonable period of time that is acceptable for the creditors.

Ultimately, a managing director will have to draw up a liquidity balance sheet in order to establish whether the company is illiquid. After abandoning the so-called bow-wave theory, according to which liabilities falling due in the short term (liabilities II) were not to be taken into account, this balance sheet now compares not only the liquid funds available on the record date (assets I), but also assets realizable in the short term (assets II) with liabilities already due (liabilities I) and liabilities II.

While illiquidity is a mandatory reason to file for insolvency, managing directors may also voluntarily file for the opening of insolvency proceedings if there is an imminent inability to pay (drohende Zahlungsunfähigkeit). In accordance with Section 18 InsO, imminent illiquidity is given if the company will likely not be in a position to fulfil its existing payment obligations at the time they fall due in the future. In general, a period of two years is examined in this respect.

2. Over-indebtedness

In addition and according to Section 19 InsO, over-indebtedness is also a mandatory reason for the opening of insolvency proceedings. Over-indebtedness exists if the company's assets are not sufficient to cover the company's liabilities, unless the continuation of the company is predominantly likely.

Whether the company's assets are sufficient to cover its liabilities is determined by comparing the company's assets and liabilities. While the assets are stated at their liquidation values, all current liabilities, regardless of their maturity, are to be taken into account on the liabilities side.

Therefore, in many cases the decisive factor of whether the company is over-indebted within the meaning of the InsO is whether there is a positive business continuation forecast (positive Fortführungsprognose). In addition to the necessary intention to continue the business on the part of the company or its executive bodies, a meaningful and plausible business concept and a financial concept that can be derived from it, according to which the company is solvent at least in the current and the following financial year, is required. The relevant period of time may be longer, depending on the specific circumstances. This is particularly the case if it can only be foreseen in the longer term whether the liquidity of the company can be restored in the long term.

3. Legal consequences

If the company is illiquid or over-indebted and the managing director does not file for the opening of insolvency proceedings, or does not do so on time or correctly, he is committing a crime. A violation of the obligation to file for insolvency can be punished with a fine or imprisonment of up to three years.

In addition, the managing director may be liable for damages vis-à-vis the company as well as its creditors by violating the obligation to file for insolvency.

A person who has within the last five years committed a criminal offence by failing to file for the opening of insolvency proceedings, cannot be appointed managing director of a limited liability company or stock corporation. At the same time, the violation of the obligation to file for insolvency will generally justify the immediate removal of the managing director from office and an extraordinary termination of his employment contract.

III. Prohibition of Payments

In addition to the obligation to file for insolvency, the managing director is within a crisis also faced with other obligations that give rise to a potential liability. For example, the managing director is obliged to compensate the company for payments made after the company became illiquid or was found to be over-indebted, provided however these payments were not compatible with the diligence of a prudent businessman. This includes not only cash payments but also other, comparable benefits which are detrimental to the assets of the company.

The prohibition of making payments takes effect with the occurrence of illiquidity or over-indebtedness, irrespective of any actual knowledge of the managing director. The culpability of the managing director which is required for the liability is presumed. Accordingly, a managing director will only be able to discharge himself in exceptional cases, for example, if he could not recognize the reason for insolvency despite taking sufficient precautions.

Excluded from the prohibition of payment are only those payments which a managing director who exercises the diligent care of a prudent businessman would have made. This is intended to enable the managing director to continue operations if such continuation is more advantageous for the assets involved in the insolvency proceedings than the immediate discontinuation of the business or if there are serious chances of restructuring within the three-week period for filing a petition for the opening of insolvency proceedings.

IV. COVID 19 Legislation

In order to make it possible and easier for companies that have become insolvent or are experiencing financial difficulties as a result of the COVID-19 pandemic to continue their business operations, the German Parliament has enacted the law on the temporary suspension of the obligation to file an insolvency petition and to limit the liability of executive bodies in the event of insolvency caused by the COVID-19 pandemic (Gesetz zur vorübergehenden Aussetzung der Insolvenzantragspflicht und zur Begrenzung der Organhaftung bei einer durch die COVID-19-Pandemie bedingten Insolvenz), as part of the law to mitigate the consequences of the COVID-19 pandemic in civil, insolvency and criminal procedure law (Gesetzes zur Abmilderung der Folgen der COVID-19-Pandemie im Zivil-, Insolvenz- und Strafverfahrensrecht).

This includes a temporary suspension of the obligation to file for insolvency until 30 September 2020 with the option of an extension until 31 March 2021 at the latest, in order to give the concerned companies time to eliminate the reason for insolvency, for example by taking advantage of state aids or by making financing or restructuring arrangements.

The suspension of the obligation to file for insolvency is subject to the reason for insolvency being based on the consequences of the COVID-19 pandemic and that there is a prospect of eliminating the existing inability to pay, e.g. through recourse to state aid. If the company was not insolvent on 31 December 2019, it is assumed that these conditions are met. It is to be expected that this presumption can only be rebutted in exceptional cases, such as in cases where the insolvency maturity is obviously not based on the consequences of the COVID-19 pandemic.

If the suspension of the obligation to file for insolvency applies, a further presumption in favor of the managing directors applies also. It is assumed that all payments made in the ordinary course of business, in particular payments which serve to maintain or resume business operations or to implement a restructuring concept, are compatible with the due care of a prudent and conscientious businessman. This enables the managing director to make payments without being exposed to the risk of liability.