Hightex and the conundrum of Debtor in Possession

Debtor in Possession
While German insolvency law already provides for debtor-in-possession proceedings there are only very few cases in which insolvency courts have approved such option. This is due to a number of reasons, namely a combination of very restrictive requirements for such debtor in possession and a deeply rooted distrust of the management of insolvent companies by German insolvency courts.

The new regulation will substantially reduce any legal hurdles for such debtor-in-possession proceedings:

• Currently, the burden of proof is on the insolvent company to demonstrate that a debtor in possession would not cause any adverse effects to the creditors, making it easy for the insolvency courts to turn down any such application by just saying "no." The new regulation will shift the burden of proof from the debtor to the insolvency court. In addition, the insolvency court will need to produce a detailed written court ruling when denying a debtor-in-possession proceeding, whereas it can avoid such paperwork by granting the application.
• A debtor-in-possession application cannot be turned down on grounds of adversely affecting creditor rights when the preliminary creditors' committee has passed a unanimous resolution. Similar to the appointment of the (preliminary) insolvency administrator, the insolvency court shall consult the preliminary creditors' committee before ruling on a debtor-in-possession application.
• To avoid any negative prejudice against debtor-in-possession proceedings the new regulation provides that the insolvency court shall not appoint a preliminary insolvency administrator for the insolvency opening proceedings unless it is obvious that the application of the debtor will not be granted. Instead, it shall appoint a trustee who mainly has a monitoring role.
• To give the management of a corporation time to present a pre-packaged plan to the insolvency court, the new rules allow the insolvency court to issue an up to 3 month moratorium during which the debtor is protected against any enforcement actions by its creditors. When applying for such moratorium the management of the debtor needs to submit an opinion by an accounting firm, tax advisor or law firm which certifies that the debtor is imminently but not actually illiquid yet and that a restructuring is not obviously hopeless. A debtor-in-possession proceeding is still possible if the debtor actually becomes illiquid during the three month moratorium.
• Upon the debtor's application, the insolvency court has to grant priority to all who become a creditor during the up to three months moratorium. This will substantially improve debtor's chances to obtain DIP financing necessary to continue its business.
• By passing a resolution to that effect the creditors' meeting can even enforce a debtor-in-possession proceeding and thus overrule a prior contrary court ruling. However, this will only be a theoretical option given that any voting of the creditors' meeting will come too late to determine the course of events when it comes to allowing debtor-in-possession proceedings.

While German insolvency law already provides for debtor-in-possession proceedings there are only very few cases in which insolvency courts have approved such option. This is due to a number of reasons, namely a combination of very restrictive requirements for such debtor in possession and a deeply rooted distrust of the management of insolvent companies by German insolvency courts.

The new regulation will substantially reduce any legal hurdles for such debtor-in-possession proceedings:

• Currently, the burden of proof is on the insolvent company to demonstrate that a debtor in possession would not cause any adverse effects to the creditors, making it easy for the insolvency courts to turn down any such application by just saying "no." The new regulation will shift the burden of proof from the debtor to the insolvency court. In addition, the insolvency court will need to produce a detailed written court ruling when denying a debtor-in-possession proceeding, whereas it can avoid such paperwork by granting the application.
• A debtor-in-possession application cannot be turned down on grounds of adversely affecting creditor rights when the preliminary creditors' committee has passed a unanimous resolution. Similar to the appointment of the (preliminary) insolvency administrator, the insolvency court shall consult the preliminary creditors' committee before ruling on a debtor-in-possession application.
• To avoid any negative prejudice against debtor-in-possession proceedings the new regulation provides that the insolvency court shall not appoint a preliminary insolvency administrator for the insolvency opening proceedings unless it is obvious that the application of the debtor will not be granted. Instead, it shall appoint a trustee who mainly has a monitoring role.
• To give the management of a corporation time to present a pre-packaged plan to the insolvency court, the new rules allow the insolvency court to issue an up to 3 month moratorium during which the debtor is protected against any enforcement actions by its creditors. When applying for such moratorium the management of the debtor needs to submit an opinion by an accounting firm, tax advisor or law firm which certifies that the debtor is imminently but not actually illiquid yet and that a restructuring is not obviously hopeless. A debtor-in-possession proceeding is still possible if the debtor actually becomes illiquid during the three month moratorium.
• Upon the debtor's application, the insolvency court has to grant priority to all who become a creditor during the up to three months moratorium. This will substantially improve debtor's chances to obtain DIP financing necessary to continue its business.
• By passing a resolution to that effect the creditors' meeting can even enforce a debtor-in-possession proceeding and thus overrule a prior contrary court ruling. However, this will only be a theoretical option given that any voting of the creditors' meeting will come too late to determine the course of events when it comes to allowing debtor-in-possession proceedings.

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A relatively high proportion of larger companies that attempt to reorganize under Chapter 11 emerge as independent going concerns. At the same time, one study showed that for public companies of all sizes, only between 26 and 45 percent each year from 1990 to 2002 emerged with their reorganization plans confirmed by the courts. These statistics include many companies with multiple filings for various of their subsidiaries.