Introduction to Insolvency Law
Insolvency law in Germany forms the basis for dealing with financial crises of companies and individuals. It regulates how to handle debts and obligations when a debtor – whether a legal entity like a corporation or a natural person – becomes insolvent. The insolvency proceedings serve to protect the interests of creditors and to provide the debtor with a way out of over-indebtedness. Insolvency courts play a central role: they supervise the course of the proceedings and ensure that legal requirements are met. The Federal Court of Justice (BGH) in Karlsruhe, as the highest civil court, ensures uniformity in insolvency law jurisprudence and decides on fundamental issues of great importance for the practice of insolvency proceedings. For companies and their executives, it is therefore indispensable to follow current developments in insolvency law and the decisions of the Federal Court of Justice to respond timely to new requirements.
BGH Strengthens Powers of Insolvency Administrators Regarding Compensation Adjustments in Insolvency Proceedings
When insolvency proceedings are opened over a stock corporation (AG), the right to reduce the compensation of the management board lies with the insolvency administrator and not with the supervisory board. The BGH clarified this with its ruling dated October 22, 2024 (Ref. II ZR 97/23). The management board has a special responsibility during the economic crisis, especially with regard to compliance with due diligence obligations.
As a rule, the supervisory board determines the compensation of the management board. When setting the total remuneration of the management board, the supervisory board is advised to consider factors such as the size of the company, business expectations, and the economic situation of the company. The effects of insolvency on business operations may require significant adjustments during ongoing operations. Efficient organization of the insolvency proceedings and close cooperation between insolvency administrator, supervisory board, and creditors are crucial to ensure a smooth process and the legality of the proceedings. Therefore, the insolvency administrator is also responsible for reducing the compensation of the management board. An exception applies, however, if insolvency proceedings have been opened over the AG. According to the BGH decision, the insolvency administrator then holds the right to reduce the management board’s compensation, as stated by the law firm MTR Legal Attorneys, which advises, among other things, in insolvency law.
Insolvency Administrator Cuts Management Board’s Compensation
In the underlying case, insolvency proceedings had been opened over a stock corporation, which had significant impacts on operations and business processes. The insolvency administrator reduced the compensation of one management board member. However, this member insisted on full payment of his contractually agreed compensation. He argued that only the supervisory board is authorized to decide on salary adjustments. The insolvency administrator insisted on the reduction, arguing that the company’s economic situation had deteriorated significantly, making continued payment of the contractually agreed compensation unreasonable. The dispute ultimately reached the Federal Court of Justice.
The BGH sided with the insolvency administrator and clarified with its ruling that after the opening of insolvency proceedings, the decision-making authority over reducing the management board’s compensation lies with the insolvency administrator. According to § 80 of the Insolvency Code (InsO), as of the opening of the proceedings, the administration and disposal authority over the company’s assets transfers exclusively to the insolvency administrator, stated the BGH. This is intended to ensure that the insolvency estate is managed in an orderly manner and used in the interest of all creditors. Within the framework of the insolvency proceedings, it is particularly important to consider the company’s payment obligations towards creditors and the management board to ensure an orderly settlement. Securing funds and liquidity plays a central role, especially regarding the continuation of operations and adjustment of the management board’s compensation. While the supervisory board does not lose all its functions, it is no longer responsible for compensation adjustments.
Who Can File an Application?
An insolvency application can be filed by various persons and institutions as soon as there are signs of insolvency or over-indebtedness. In practice, it is often the debtors themselves who file an insolvency application with the responsible insolvency court to enable an orderly settlement of their obligations. However, creditors with outstanding claims against the debtor can also file an application if they fear that their claims will no longer be met in the normal course of business. Furthermore, for legal entities such as a GmbH or an AG, managing directors or board members are obliged to file an insolvency application without delay in case of insolvency or over-indebtedness to avoid personal liability risks. Authorities such as the tax office or social insurance carriers can also act as creditors and file an application if they assert claims against the debtor. The application must always be filed with the insolvency court at the debtor’s registered office. Contact details of the responsible insolvency court can be easily found via the Federal Court of Justice’s website or through a targeted internet search.
The responsibility of the executive board for the economic crisis is not decisive
The judges in Karlsruhe further commented on the so-called fairness review. The basis for this is § 87 para. 2 of the German Stock Corporation Act (AktG), which allows an adjustment of the executive board’s compensation if the company’s economic situation has significantly deteriorated. The Federal Court of Justice (BGH) emphasized that all circumstances of the individual case must be considered in this decision. Primarily decisive is the objective economic situation of the company. For a well-founded assessment, evaluating economic and financial data is crucial to objectively appraise the actual situation of the company. While the personal responsibility of the executive board for the crisis may also play a role, this is not a mandatory requirement for a reduction. Therefore, the executive board’s compensation can be reduced even if it is not culpable for the insolvency and continuing full payment of its remuneration would be inappropriate, whereby various approaches to managing the crisis and adjusting the executive board’s compensation can be considered.
Procedural costs and financing
The conduct of insolvency proceedings involves various costs that may affect both the debtor and the creditors. The main procedural costs include the fees of the insolvency court, the remuneration of the insolvency administrator, and the expenses for managing and realizing the insolvency estate. In many cases, the question arises as to how these costs can be financed, especially if the debtor’s assets are insufficient. Insolvency law offers several options here: The court may defer procedural costs upon request, initially releasing the debtor from the payment obligation. Alternatively, creditors may provide an advance on estate costs to enable the proceedings and safeguard their chances of satisfying their claims. It is advisable to consult an experienced lawyer or insolvency administrator early on to find the optimal solution for each individual case and best protect the interests of all parties involved.
Protection of the insolvency estate
The BGH emphasized that reducing the executive board’s compensation does not serve to punish the board but to protect the insolvency estate. According to the model of the Insolvency Code, these funds belong collectively to all creditors and must not be diminished by inappropriate remuneration of individual corporate officers, whereby the creditors’ claims on the insolvency estate are of central importance.
The insolvency administrator is, in this function, to be regarded as a trustee for the collective body of creditors, the BGH further explained. Their task is to secure, manage, and achieve the best possible satisfaction of creditors. Insolvency administrators bear the responsibility to properly realize the estate and conduct the proceedings in accordance with the law. High executive salaries, which are no longer in any proportion to the company’s condition, would contradict this objective.
Note: Corporate officers and creditors should ensure that their claims are properly registered and that the legal requirements for protecting the insolvency estate are observed.
The creditors’ perspective
Creditors hold a central position in insolvency proceedings as they significantly influence the realization of the insolvency estate and distribution of proceeds. They are entitled to register their claims with the insolvency administrator and participate in the creditors’ meeting, where important decisions regarding the further course of the proceedings are made. Furthermore, creditors have the right to be informed about the use of the insolvency estate and may challenge the insolvency court’s decisions in case of disagreements. Active involvement of creditors is essential to enforce their claims within the insolvency proceedings and to achieve the highest possible payout ratio. If a creditor disagrees with a decision of the insolvency court, there is the possibility to appeal to the Federal Court of Justice to seek a review of the decision. Knowing one’s rights and obligations in insolvency proceedings is therefore indispensable for creditors to effectively represent their interests and increase the chances of successful claim enforcement.
Insolvency administrators empowered in their authority
The judgment has significant practical implications. It shows that executive board members must be prepared for the fact that their contractually guaranteed compensation is not untouchable in the event of insolvency. Even with honest conduct of office, reductions in remuneration can occur if the company’s financial situation requires it.
In contrast, insolvency administrators are strengthened in their powers by this decision. They can independently examine and decide whether and to what extent an adjustment of compensation is necessary, without having to involve the supervisory board.
Overall, the BGH has again demonstrated with its decision that the protection of the insolvency estate takes precedence over the individual interests of corporate officers.
Insolvency law – a complex system with a balanced reconciliation of interests
Insolvency law covers numerous legal issues that are of great importance to all parties involved – especially creditors, debtors, banks, and their families. In insolvency proceedings, motions, particularly the insolvency petition, play a central role as they determine the course of the procedure. Creditors and banks can file motions to secure their claims, with the insolvency schedule serving to register and assess these claims. The insolvency plan procedure and the creation of an insolvency plan make it possible to restructure companies and claims without a complete liquidation. Enforcement and executions are important tools for enforcing claims but are subject to special legal frameworks within insolvency proceedings. The protection of the debtor’s family is also considered to ensure necessary maintenance. Overall, insolvency law is a complex field that offers comprehensive legal solutions for all affected parties.
MTR Legal attorneys provide comprehensive advice on insolvency law.
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