Impact of EU "Pre-pack proceedings" directive in Germany: pre-pack proceeding vs pre-pack plan

The EU Commission has presented a draft directive on the mandatory inclusion of a "pre-pack proceeding" in national insolvency laws.

On 7 December 2022, the European Commission published a draft directive harmonising certain aspects of insolvency law with the aim of facilitating distressed M&A by reducing legal uncertainties in cross-border transactions.

There is little doubt that the draft directive will actually be adopted, but what form it will take and, above all, when it will be adopted remains to be seen and may not occur until after European elections in June 2024.

The "pre-pack proceeding" under the draft directive

A "pre-pack proceeding" means "an expedited liquidation proceeding that allows for the sale of the business of the debtor, in whole or in part, as a going-concern to the best bidder, with a view to liquidating the assets of the debtor as a result of the established insolvency of the debtor."

The pre-pack proceeding will consist of two successive phases:

• the "preparation phase", in which an attempt is made to find an appropriate buyer for the debtor’s business (or part of it) who will basically acquire the company free of debts and liabilities;
• the "liquidation phase", in which the sale of the debtor company is approved, completed and the proceeds distributed to the creditors.

Preparation phase

The preparation phase begins with the appointment of a monitor by the court at the debtor's request. The monitor has the task of:

• documenting the sale process;
• ensuring that the process is competitive, fair and transparent;
• proposing the best bidder; and
• justifying why the bid meets the creditor interest criterion.

Only those who meet all the eligibility criteria for insolvency practitioners in the relevant member state and who can actually be appointed as insolvency practitioners in the liquidation phase can be appointed monitors.

During the preparation phase, the debtor retains control over its assets and the daily operation of the business.

The suspension of individual enforcement measures may also be invoked.

The sale process carried out during the preparation phase should be competitive, transparent and fair, as well as in line with market standards in order to avoid the risk of abuse (especially in the form of 'fire sales'). The procedure must comply with the recognised rules and practices of M&A transactions in the respective member state. In particular, these include:

• inviting potential investors to participate in the sales process;
• passing on the same information to them;
• allowing due diligence to be carried out; and
• soliciting bids and recommending the best one.

These principles may only be waived if a member state chooses to require the court to conduct a rapid public auction after the opening of the liquidation phase. In this case, member states are obliged to use the best bid received in the preparation phase as a "stalking horse bid" (i.e. as initial bid acting as a purchase price floor so that other bidders can not underbid the purchase price).

The criterion for selecting the best bid should be the in the creditors’ best interests. The "best-interest-of-creditors test" means "the test whereby no creditor would be worse off under a liquidation in pre-pack proceedings than such a creditor would be if the normal ranking of liquidation priorities were applied in the event of a piecemeal liquidation".

In the event that only one binding offer is received in the sale process, it will be the offer corresponding to the market price of the company.

Where interim financing is required, member states must ensure, for the protection of the financier, the following:

• the most favourable possible interim financing is sought;
• the providers of interim financing receive priority for payments in subsequent insolvency proceedings even if other creditors have claims of higher or equal priority;
• the providers of interim financing may be granted security interests over the sale proceeds in order secure reimbursement.

Secured creditors should be able to participate in the bidding process in pre-pack proceedings by offering the amount of their secured claims as consideration for the purchase of the assets over which they hold a security. (This is known as "credit bidding").

Creditors as well as holders of equity of the debtor’s business have the right to be heard by the court before the authorisation or the execution of the sale of the debtor’s business or part of it.

Liquidation phase

With the opening of the liquidation phase, the sale of the debtor company to the buyer proposed by the monitor is approved by the court and the monitor is appointed as insolvency practitioner.

The liquidation phase is considered to be insolvency proceedings as defined in Article 2, point (4) EU Insolvency Regulation. The Centre of Main Interest (COMI) applies.

In the liquidation phase, it is possible for an "executory contract" (i.e. a contract between a debtor and one or more counterparties under which the parties still have obligations to perform at the time of the opening of insolvency proceedings in the liquidation phase) to be assigned to the purchaser of the company even without the consent of the other party.

"Pre-pack" in German insolvency law

German insolvency law does not provide for a legally regulated independent "pre-pack" proceeding in the sense of the draft directive. Common practice, on the other hand, is:

• reorganisation by transferring company assets, in which the sale of the debtor company is prepared in a first phase (preliminary insolvency proceedings) and completed in a second phase (opening of insolvency);
• the pre-packed plan (or pre-packaged plan), which is usually drafted in the context of an out-of-court restructuring attempt (in the shape of an insolvency plan). If the out-of-court solution fails, the pre-packaged plan can be filed with the court at the same time as the application for insolvency. When the insolvency plan becomes legally valid, the insolvency proceedings are terminated as a matter of principle.

The main differences or similarities are as follows:

Conclusion and outlook

According to the opinion expressed here, the "pre-pack proceeding" cannot easily be integrated into one of the procedures described above, especially since the preparation phase presupposes the "insolvency" of the debtor but is not yet intended to be formal insolvency proceedings. This new "pre-pre-proceeding" could serve as an additional restructuring instrument. If no appropriate buyer has been found in the preparation phase, it is possible to restructure the company by means of an insolvency plan and then sell it. In this way, brochures and data rooms can be reused so that the costs spent on the "pre-pack proceeding" are not lost.

It would be desirable to have creditor participation in the form of a mandatory creditors' committee instead of a right to be heard.

It is doubtful that the German legislator will implement the provision on "executory contracts". This is because such a right would be incompatible with the German concept of "negative freedom of contract". Contracting parties cannot be forced to accept clauses to which they never agreed.

For more information on the impact of this directive on German law and business, contact your CMS client partner or local CMS experts.

This article is part of our Law-Now blog series "Harmonisation of Insolvency Laws in the EU", which will provide an overview of the EU Commission's draft directive, including the most important objectives and planned measures. The series itself will deal with the two exciting topics of the draft directive, "pre-pack proceedings" and "insolvency avoidance actions" and show how these topics are being discussed in the Member States and what the situation is like in individual non-Member States.