Protective shield proceedings or provisional self-administration

People still often associate the concept of protective shield proceedings with the new insolvency law. Moreover, the misconception is still widespread that initiating self-administration proceedings and successfully concluding them is possible only if the company is not yet insolvent but is only overindebted or threatens to become insolvent. We will explain briefly below how protective shield proceedings differ from normal provisional self-administration, why protective shield proceedings are actually less desirable than provisional self-administration, and why a company’s insolvency does not necessarily matter in this context.

The porcess of a sel-administered insolvency plan

insolvency proceedings have two parts. The first part, the so- called opening of insolvency proceedings, covers the period of time between the filing of the insolvency application and the opening of the insolvency itself. Usually this period last for two to three months. The duration of this period depends largely on whether or not wages and salaries have been paid by the time the insolvency application is filed. The Federal Employment Agency regularly pays wages and salaries retroactively for the three months prior to the opening of insolvency proceedings. This applies regardless of whether the proceedings are standard insolvency proceedings or self-administered insolvency proceedings.

Example of insolvency benefit payments

To illustrate this, we offer the following example: The insolvency application is filed on 01 February 2017. The Federal Employment Agency will take on payment of wages and salaries retroactively for the three months prior to the date the proceedings were opened. Thus, if the January wages have not been paid, then the proceedings will open on 01 April because then the Federal Employment Agency will cover the wage and salary payments for March, February and January 2017. If the January wages have already been paid when the company files for insolvency, then the opening of the proceedings will be moved to 01 May 2017 in order to allow the company to utilise the entire three-month insolvency benefit period. The opening of the insolvency proceedings is followed directly by the insolvency thus initiated. In the period following the opening of insolvency proceedings the company is again solely responsible for paying wages and salaries. As a rule, self-administered insolvency involves an insolvency plan. If the creditors approve the plan with the necessary major- ities, the insolvency court will usually confirm the plan at the voting date and conclude the proceedings about two to four weeks after that. So-called protective shield proceedings (§ 270b Insolvency Code) and provisional self-administration (§ 270a Insolvency Code) take place exclusively in the period between the filing of the insolvency application and the opening of the insolvency proceedings, that is, only during the insolvency opening proceedings. In both types of proceedings only a provisional trustee is appointed. This trustee has only control rights, but does not have the rights of an insolvency administrator (except for the right to appeal/challenge transactions). The other rights of an insolvency administrator are taken on by the self-administering debtor, and the latter is thus placed in a dual role as both debtor-in-possession and insolvency administrator at the same time.

Advantages and disadvantages of the proceedings

When insolvency is opened, both the protective shield proceedings and provisional self-administration come to an end. Both types of proceedings lead to self-administration, and this self-administration is the same regardless of which type of proceedings preceded it. The main difference between the two types of proceedings is that protective shield proceedings can be used only if the company is not insolvent. However, provisional self-administration is possible even in the case of insolvency. Protective shield proceedings give debtors some additional rights that are not granted in provisional self-administration. Among these is the debtor’s right to freely select its trustee and that the court must always allow debts incumbent on the insolvency assets. Of course, we do not recommend selecting a trustee without consulting the court and the main creditors and obtaining their agreement to the choice. Otherwise the court would have numerous opportunities to derail the proceedings. Likewise, the debtor’s right to enter into debts incumbent on the insolvency assets is usually just as insignificant because even in provisional self-administration this debtor’s right is usually granted by the court on request.

The advantage of entering into debts incumbent on the insolvency assets is that suppliers may possibly be more willing to agree to payment terms because their new claims are debts incumbent on the insolvency assets and would therefore have to be paid before all other claims. There are no other major differences between protective shield proceedings and provisional self-administration. In lay discussions the term “protective shield proceedings” is often mentioned because it sounds much better than provisional self-administration. However, the disadvantages of protective shield proceedings can be quite serious. In particular, the court must be notified if the company becomes insolvent in the course of the proceedings. Although this has no direct consequences, the information will be communicated to the creditors, and negative reactions on their part cannot be ruled out. Moreover, whether the debtor is permitted to make payments then or whether such payments would collide with § 64 (1) of the German Limited Liability Company Act (GmbHG) is an open question. Under the latter law, the managing director is liable for any payments he makes after the company becomes insolvent. Whether this also applies during protective shield proceedings or whether insolvency law supersedes company law is an open question. Protective shield proceedings may be initiated only when insolvency is imminent, and therefore a neutral third party must first confirm and certify that insolvency is only imminent but not yet present. This certification process requires additional expenditure of time and money.

Moreover, there are still several unresolved legal issues regarding protective shield proceedings. The problem posed by § 64 (1) GmbHG has already been pointed out. However, in protective shield proceedings, an insolvency plan must be submitted within no more than three months. If this does not happen, the fate of the proceedings is completely open, and it is even possible that a standard insolvency will be ordered in the opened proceedings. With provisional self-administration, there is no obligation to submit an insolvency plan within a specified period. In protective shield proceedings, the provisional creditors’ committee can end the protective shield proceedings by a simple majority vote (§ 270b (4) of the German Insolvency Code (InsO)). The committee has no such right in provisional self-administration. Thus, the real advantage of protective shield proceedings lies in their name and not in any actual advantages, particularly because in provisional self-administration it is also possible for companies to impose the trustee of their choice as long as they have the provisional creditors’ committee unanimous agreement.

Both proceedings are insolvency proceedings

Both the protective shield proceedings and provisional self-administration are insolvency proceedings. In both cases, filing an application to open insolvency proceedings is mandatory. Thus, in the context of protective shield proceedings it would be detrimental to convey that the proceedings do not concern the opening of insolvency, but are rather independent restructuring proceedings. As in any standard opening of insolvency proceedings, the trustee will ask the creditors to submit their claims no later than at the opening of the insolvency proceedings and before the start of the actual self-administration proceedings. If creditors had been told prior to this that the proceedings are allegedly not insolvency proceedings, they might be very annoyed and confused because the information the trustee will communicate to the creditors is precisely that the company is now opening insolvency proceedings. Like provisional self-administration, protective shield proceedings end upon the opening of the insolvency proceedings and both lead directly to standard self-administration. From this point on, there is de facto no difference anymore between the two types of proceedings. In any case, the legislature’s original aim of creating independent restructuring proceedings in the form of the protective shield proceedings has not been achieved.

Practice dictates that protective shield proceedings should be used only in very exceptional cases. In any case, it may be noted here that if the respective company is already insolvent, the only path to insolvency protection is provisional self-administration. Moreover, provisional self-administration has no serious drawbacks when compared to protective shield proceedings —on the contrary, it offers significant advantages. This view has by now become established in practice, and only about five percent of all self-administration proceedings are protective shield proceedings.