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Liquidity assistance or protective shield procedures?

Many companies/entrepreneurs have been hit by the corona crisis. Since the shutdown at least, many companies have seen a more or less severe slump in sales, depending on the sector, and now face acute liquidity problems.

Although the German government suspended the obligation to file for insolvency and thereby eased direct pressure on companies to file for insolvency within a maximum of three weeks after insolvency occurs, this is, however, in principle only the case if the company has reasonable prospects of restoring its liquidity within a foreseeable period of time, for instance, by using liquidity assistance from the KfW programme, and if insolvency is due to the impact of the corona pandemic.

However, practical experience shows that after a few days there will already be a significant number of cases in which house banks will be very reluctant to approve loan applications (one example of this being the Karstadt/Kaufhof case). The reasons for this include, on the one hand, the fact that banks are unable to collateralise their own liability risk. On the other hand, however, companies that were already in difficulty before the corona crisis (even if they were not obliged to file for insolvency) face the problem of not being able to convince the banks that they are capable of repaying their debts to the required extent (usually 5 years).

In cases like these, a situation arises where lending decisions will first be delayed and then finally rejected. Companies who realise that their house banks will be reluctant to support and positively accompany them through the crisis should therefore develop a plan B in time in order to be prepared for the day when the loan is not granted.

Companies should therefore examine whether the implementation of a so-called protective shielding procedure could provide a viable way out of the crisis. With this procedure, insolvency law provides a tried-and-tested set of instruments for a company’s thorough restructuring without having to take on further debt capital. The fact that a very large number of companies are currently threatened by insolvency risks is likely to significantly reduce the stigmatisation of insolvency, which is still prevalent in Germany. In the current situation, the disadvantage of insolvency proceedings becoming known should not necessarily lead to customers, suppliers and other parties turning away from the company. On the contrary, the company can instead hope for sympathy and support.

The debtor company can apply for protective shield proceedings if the reason for insolvency is imminent inability to pay and if plans exist to reorganise the company by means of an insolvency plan. In this case, the insolvency court orders so-called self-administration and instead of a (provisional) insolvency administrator a so-called insolvency monitor is appointed, whose powers are limited to monitoring management in the execution of the insolvency plan proceedings in order to avoid – intentional or unintentional – actions that could disadvantage creditors.

The company has a right of proposal in the selection of the insolvency monitor and can also influence the composition of the creditors’ committee. However, experience shows that an insolvency expert should join management before the company files for insolvency in order to assure the court that management has sufficient expertise in insolvency proceedings, in particular, in the planning procedure. Detailed knowledge of insolvency and procedural law is also vital when preparing to file for insolvency. For example, a certificate issued by an auditor must be submitted in order to show that insolvency has not yet occurred and that the intended restructuring programme is not obviously hopeless. It is precisely at this point that a significant number of applications fail.

If, on the other hand, insolvency has already occurred, the company can, as an alternative to the ‘genuine’ protective shield procedure, still file for insolvency, combined with an application for self-administration. In this case, however, the company has no right of co-determination when it comes to selecting the insolvency monitor and/or the creditors’ committee. In real life, however, it is at least possible to exert some influence here too by contacting the insolvency court.

One major advantage of the protective shield procedure, besides management’s continued power of disposition, is the possibility for the company to apply for insolvency payments for its employees for a period of three months. In contrast to short-time benefits, employees continue to receive their full salary (up to the contribution assessment ceiling) for three months, and any collectively agreed obligations to top up short-time benefits no longer apply for the company. Depending on the total payroll volume, this gives the company a certain degree of leeway for restructuring. Furthermore, the company can also make use of tax advantages, for instance, with regard to VAT, during the insolvency filing phase.

Exemption from pension burdens or unfavourable lease contracts can also be successfully and cost-effectively achieved in this way.

The insolvency plan consists of three parts, i.e. the descriptive and formative parts as well as the annexes to the plan. The descriptive part provides a comprehensive description of the reorganisation measures, with the annexes to the plan presenting an integrated finance plan. The formative part addresses the legal steps necessary for restructuring. When the plan is accepted by the creditors and becomes legally effective, the legal consequences also come into immediate effect.

After the insolvency plan procedure has been completed, the company presents itself as sustainably debt-free. Had government assistance been used, the company, through no fault of its own, would end up having to pay off corona-related debts for years.

The protective shield procedure is certainly not the solution for all companies due to the extensive procedural regulations, but it should at least be included as an option in the entrepreneurial calculation for the strategic management of this crisis.


For more information, go to:

Corona crisis – First aid from PKF

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