Best Practice: Protective Statements in German StaRUG and insolvency proceedings

Introduction

In a distressed debt scenario, a negotiated, out-of-court, consensual solution is invariably the best outcome for the debtor and its creditors. Where negotiations fail, debtors will often be forced into pursuing in-court restructuring or insolvency proceedings. Faced with the prospect of a potentially value-destructive formal process, lenders must consider how to effectively preserve their rights.

In the complex landscape of German restructuring and insolvency law, the concept of the so-called Schutzschrift, which translates as “protective statement”, plays a pivotal role in safeguarding creditors' interests. This article explores the legal background, function, and strategic importance of protective statements - particularly from the perspective of creditors seeking to influence the outcome of formal proceedings.

The protective statement: legal basis and function

Although not expressly legislated for in insolvency proceedings, the practice of protective statements has evolved through customary law and "best practice" guidelines. The instrument stems from Sec. 945a of the German Code of Civil Procedure (Zivilprozessordnung, ZPO), which concerns interim injunction proceedings, rather than insolvency proceedings.

Interim injunctions are, for example, frequently pertinent in disputes concerning intellectual property rights. Trademark owners may use such injunctions to temporarily prevent alleged infringers from distributing goods that have potentially been introduced to the market. This procedural tool aims to provisionally protect the rights of the trademark owner, recognising that civil law disputes in Germany can often last several years. In contrast, an interim injunction can be obtained within a few days or weeks, and it can avoid unreasonable and potentially irreversible harm being inflicted pending the final resolution of the legal dispute.

The protective statement functions as a pre-emptive legal brief submitted to the court. Its purpose is to safeguard the submitter's interests in anticipation of an application for an interim injunction. The Respondent may submit the protective statement and set out its view on the underlying facts and legal implications in an attempt to convince the court that the application for an interim injunction is unjustified. As the commercial and legal impacts of an interim injunction can be quite significant for the respondent, the protective statement has been created so that the respondent can ensure the court considers any aspects favourable to the respondent, which otherwise it may potentially overlook.

As becoming a respondent to an interim injunction and knowing which court it will be filed in is not always predictable, Germany has created a centralised register of protective statements (Zentrales Schutzschriftenregister). The register is maintained at the State Administration of Justice in the state of Hesse (Hessen). Any protective statement submitted for registration must be considered in any interim injunction proceedings before all German courts.

Protective statements and their strategic importance in insolvency proceedings

Insolvency courts often recognise protective statements filed by creditors, as the consequences and implications of an order to initiate (preliminary) insolvency proceedings is analogous to an interim injunction. There are similar interests at play in both interim injunctions and insolvency proceedings, which becomes clear if one considers the following four examples:

• Forum shopping:
  Debtors may deliberately file for insolvency with an insolvency court which does not have jurisdiction or they may relocate their registered place of business or their centre of main interests in order to establish the jurisdiction of a different insolvency court (so called forum shopping). While the practice of forum shopping is not objectionable in principle, this practice may also be abused as an illicit manoeuvre to harm “chasing” creditors. Creditors can use protective statements to set out their view on the facts relevant for establishing jurisdiction and therefore avoid the initiation of insolvency proceedings in a foreign or distant insolvency court with no plausible connection to the debtor’s business operations.
• Debtor-in-possession:
  German insolvency law allows, under certain circumstances, to opt for debtor-in-possession insolvency proceedings (Eigenverwaltung) under the supervision of a trustee (Sachwalter). This can be a tool to facilitate the continuation of business as a going-concern in an attempt to restructure. However, where creditors have lost confidence that the current management is willing or able to conduct such proceedings diligently and in the best interests of its creditors, the latter are typically unwilling to further support any restructuring efforts. By way of a protective statement, creditors can inform the insolvency court early on that and why they do not support a potential application for a self-administered insolvency proceeding. The more commercially and financially crucial a specific creditor’s position is, e.g. due to its large amount of claims, extensive security/senior position or its relevance to the debtor’s business operations, the more likely it is that the insolvency courts will be influenced by their views.
• Preliminary measures:
  In order to secure the debtor’s estate, the insolvency court may order pre-emptive measures for the preliminary insolvency proceedings, effectively meaning the period between the insolvency petition and the order to commence formal proceedings. This period typically lasts up to three months. Such pre-emptive measures may include extended competences of the provisional insolvency administrator, freezing of assets, or the appointment of a provisional creditors’ committee. If creditors see indications that such preliminary measures are in their best interests, they may use a protective statement to argue their position early on so that it can be considered by the court.
• Choice of insolvency administrator or trustee
  In principle, the considerations of whether a potential candidate is suitable as the (preliminary) insolvency administrator is a matter to be decided on a case-by-case basis by the insolvency court, with only a few restrictive regulations. However, in the interests of the creditors and the debtor, it is important that the insolvency court selects a candidate appropriate for the specific proceedings. This should be someone with relevant industry knowledge and experience in similar cases, or if applicable, with the ability to handle large-scale cases. Although the creditors' preferred candidate may conflict with the administrator’s interest in being appointed, the creditors' interests always take precedence over those of the insolvency administrators. Creditors may submit a well-reasoned suggestion of their preferred candidate within a protective statement. However, judges are not bound by such suggestions and may decide on the candidate independently.

Creditors essentially use protective statements to ensure that the insolvency court takes their arguments into account in case an insolvency petition is submitted, highlighting the analogy with an interim injunction. A protective statement enables creditors to provide arguments and evidence at an early stage, which then must be considered by the insolvency court. However, consideration by the court must not be a mere favour to the relevant creditor or jeopardise the (prospective) insolvency estate. Any decisions made by the insolvency court are made at the sole, independent discretion of the relevant judge and need to be in line with the applicable insolvency law provisions.

The creditor's explanations and presentation of their arguments in a protective statement are relevant manifestations of their constitutional “right to be heard”, as stipulated in Article 103 of the German Constitution (Anspruch auf rechtliches Gehör). This provision guarantees that an affected party has the chance to comment on the matter before any decision potentially disadvantageous to them is made. However, in the case of an insolvency petition, the court typically must render decisions expeditiously, making it impractical to consult with all creditors in advance. Protective statements therefore provide a reasonable compromise for the creditors to voice their views prior to any dispositions.

Protective statements are particularly valuable in scenarios with potential unlawful activities connected to the debtor´s insolvency. Such incidences may be deliberately delayed insolvency petitions or adverse actions by the debtor´s management, such as asset stripping or shifting registered offices to the detriment of creditors or the insolvency estate. Such scenarios often involve complex factors. These may include:

• Influence of problematic shareholders who pressure or threaten the debtor’s management;
• Uncertainties regarding debtor´s legal representation;
• Suspicious asset transfers;
• Sudden termination of negotiations with major financiers despite covenant breaches or termination triggers;
• General mistrust in current management and a lack of support for self-administration;
• Potential domino-effects of a collapse of legal entities in the parent / holding not being met with appropriate precautions to ringfence the relevant subsidiary.

Structure and Content of a Schutzschrift

A well-crafted protective statement is essential for effectively communicating a creditor's position to the insolvency court. Despite the lack of requirements required by law, according to established best-practice guidelines the document generally follows a structured format, akin to a legal complaint, especially:

• Rubrum: Identifying the parties involved, particularly the submitting creditor, the potential insolvency debtor and its legal representatives, as well as any associated group companies.
• Applications: Requests by the submitting creditor may include, for example, the rejection of applications for debtor-in-possession proceedings, appointment of a preliminary insolvency administrator with certain powers and competences, imposition of general prohibitions on dispositions and transactions by the debtor (asset freezing) or the appointment of a preliminary creditors’ committee.
• Facts & Background: Detailed presentation of the debtor's corporate structure, its representatives, information on branch offices or production facilities, information on workforce, relevant assets, other crucial creditors / stakeholders, indications for unlawful or criminal behaviour, relevant status quo of negotiations etc. Generally, the court should be provided with as much information as possible, ideally substantiated by relevant documents / evidence (Glaubhaftmachung, Sec. 294 (1) ZPO) in a structured and compact form which allows for fast processing.
• Rationale: Legal arguments supporting the applications made, supported by citations of relevant case law and/or relevant legal literature.
• Insolvency Administrator / Trustee: Depending on the strategy, creditor may suggest a potential (preliminary) insolvency administrator or trustee.
• Declarations of consent: If the appointment of a provisional creditor committee is requested, declarations of consent to participate as a member in such committee a should be submitted in respect of as many potential members as possible.

Importantly, there is no legal requirement to file a protective statement in the centralised register. Instead, it may be directly submitted to the relevant insolvency court. It may be appropriate to submit the protective statement to the register and to the insolvency court which would most likely have jurisdiction. This makes it more likely that the protective statement is available to as many courts as possible in the event the debtor engages in forum shopping before filing the insolvency petition. However, while many judges choose to do so, there is no legal obligation for insolvency courts to consult the centralised register prior to making any orders in insolvency proceedings. Such obligations only exist with respect to applications for interim injunctions.

Use Cases in StaRUG restructuring proceedings

Creditors should always bear in mind that protective statements can be used in connection with StaRUG proceedings. In an application for the initiation of StaRUG proceedings, generally aimed at the implementation of a restructuring plan, the debtor may simultaneously apply for a moratorium (Stabilisierungsanordnung). This is intended to obtain a freezing order with respect to enforcement and realisation actions by certain or all creditors. In most cases and if the relevant conditions are met, the restructuring court will make its respective decision immediately after receiving such applications. However, if a protective statement was filed, the court has an obligation to take into account the creditor’s remarks and arguments. This is particularly of interest to creditors who expect to be affected by the anticipated moratorium and who seek to uphold their ability to enforce their security.

In this context, the pivotal criterion is that the issuance of a moratorium must be essential to protect the restructuring process. This may not be the case if the relevant asset, which is subject to the creditor’s enforcement interest, is not required to uphold the debtor’s business operations. In cases in which all relevant creditors as part of a standstill agreement have already voluntarily agreed not to pursue their outstanding claims or enforce their security interests for a specified period, a freeze on enforcement or realisation would not offer any additional benefit and thus could be denied.

Where a substantial number of creditors, who by virtue of their security rights or aggregated claim amounts have the potential to collectively impede the acceptance of a restructuring plan, have explicitly stated that they neither intend to initiate nor continue negotiations regarding a restructuring plan, a moratorium would likely be redundant, as the likelihood of a restructuring plan being approved is marginal. Hence, it may be useful to deploy a protective statement to require the court to carefully evaluate whether or not a moratorium would actually facilitate a successful restructuring.

Conclusion

In German insolvency proceedings as well as StaRUG-restructurings, protective statements serve as a crucial tool for creditors to assert and voice their interests proactively. By meticulously preparing and strategically filing a protective statement, creditors can potentially influence the course of insolvency and restructuring processes, mitigate risks, and enhance the likelihood of favourable outcomes.

As insolvency law continues to evolve, the practice of submitting protective statements underscores the dynamic interplay between legal strategy and financial prudence in safeguarding creditors’ interests.