RESCUING

COMPANIES IN
ENGLAND AND
GERMANY

REINHARD BORK

Translated from the German by

CHRISTOPHER SCHULLER

OXFORD
UNIVERSITY PRESS
 14
CURTAILING CREDITORS' RIGHTS

A. Unsecured Creditors 14.02 1. Germany 14.20

1. Germany 14.03 II. England 14.21
II. England 14.14 C. Overall Picture 14.25
B. Secured Creditors 14.19

Aparrfrom the necessary structural changes, a central restructuring instrument is 14.01

the curtailment or reduction of the rights of creditors. If the company which holds
the business is to be restructured, it must at the very least get its current debts in
order-it must restructure the liabilities side of the business. 1 This discussion mainly
concerns unsecured, pre-restructuring creditors (Section A), but the extent to which
it applies to secured creditors must also be considered (Section B).2

A. Unsecured Creditors

Against unsecured creditors, the arsenal of measures spans the range from bare 14.02
forbearance, to partial forgiveness in combination with forbearance, to complete
forgiveness of the debt. It is also possible to capitalize debt in the form of a debt-
equity swap, though this will be the subject of a separate, subsequent discussion. 3
These measures are all possible under contract law when they are done consensually.
But restructuring law must deal with the question of whether it wants to make it
possible to enforce such measures even against the will of all or some of the
creditors. 4 In addition, the other end of the spectrum must not be forgotten, in
which a debtor abuses the protections of restructuring proceedings in order to

1 cfpara4.13.
2 Types of creditors are dealt with above at paras 3.09 if.
3 See paras 15.20 if.
4 See paras 1.34, 5.03.

209
 Procedural Issues
-----------------------------
escape his creditors. 51he power to curtail creditors' rights must always come with
a means of preventing abuse.

I. Germany

14.03 German law does not have any particular difficulties with this issue. Even indepen-
dent of insolvency, § 5 Sch VG permits the claims of lenders to be reduced on a
majority vote among them, as long as such a reduction is provided for in the condi-
tions of the loan. Otherwise, the following applies.

1. Standard insolvency proceedings

14.04 Since all of the restructuring procedures on offer in Germany require illsolvency,
restructuring in Germany essentially entails the assumption that because of the
insolvency, the claims of the creditors no longer have their full value. 'Ihe nominal
value of their claims is economically reduced to the value of the fractional repay-
ment (quota) they stand to receive under the insolvency. In the standard insolvency
procedure, this value is determined by taking the assets of the debtor available for
payout after the insolvency creditors have been paid off (the Soli-Masse or 'balance
mass') and dividing it among the claims listed in the table of established creditors'
demands (cf§§ 188 S 3, 195 1nsO). This divvying-up does not change the claims'
nominal value and is not a mandatory reduction of the claim to the quota by force
oflaw, but it is an articulation of the economic interest of the creditors that remains
against the debtor.

14.05 The approach is the same for restructurings planned to be accomplished via asset
deal. The insolvency professional can sell the business and divide the remaining
proceeds by quota among the creditors once the restructuring creditors and secured
creditors have been satisfied. As set out in § 20 I InsO, the creditors maintain the
balance of their claims against the debtor outstanding after this payout, but the
claim is generally worthless as the debtor company is struck off the register and
ceases to exist.

14.06 The same is not true when both the business and its holding company are to be
restructured. 6 Since the debtor continues to exist, the debtor continues to be liable
for the balance of the claims still outstanding after the payout. ']11is situation has to
be rectified by some sort of arrangement with the creditors, bur the specific forms
of the agreement can vary quite considerably. Creditors will as a rule insist on receiv-
ing at least as much as they would have been paid under a liquidatioll, and the
statute guarantees as much for insolvency plan proceedings under §§ Abs I
Nr 1 and 255 Abs 1 Nr 2 1n50. It is also possible that they will demand to see a
share of any restructuring success in the form of a promise to be repaid out of future

5 Previously discussed at paras 2.()3, 3.16.

6 Previously discussed at para 5.10.

2]0
 Curtailing Creditors' Rights

profits, or that they will demand a premiui'n in exchange for forbearance. It is also
conceivable that they might forego repayment entirely-including even the
quota-if the amount they would expect to receive is marginal and overshadowed
by transaction costs or if they wish to preserve a business relationship with the
7
restructured debtor by agreeing to special contributions to the restructuring.
In practice, such agreements regularly prove to be difficult. One reason is that unse- 14.07
cured creditors are by no means a homogenous group-they pursue quite varied
interests and cannot all be satisfied in one fell swoop.s Instead, different creditors'
interests will have to be dealt with in different ways; creditors wishing to continue
to do business with the restructured firm, for example, can be asked to forego their
claims entirely, whereas others will only settle for at least what they would expect to
receive in a liquidation, or perhaps even more. Another difficulty is that dissenters
may attempt to use their blockade position to force a better offer or secure special
advantages for themselves.

2. Insolvency plan proceedings

German law provides the insolvency plan procedure for these very situations. It 14.08
permits the division of unsecured creditors into groups (§ 222 Abs 2 InsO) with
different legal consequences applying to each (§§ 222 Abs 1 S 1, 224 InsO), and
dissenter creditors can be bound by means of a voting procedure (§§ 235 ffInsO).
The details of the procedure are discussed later on,9 but here it is enough to point
out that, if it is necessary for the restructuring, German law enables any arrange-
ment about debt to be made via a majority vote of the creditors. The necessary
controls to prevent abuse are provided throughout, starting with the pre-examina-
tion of the insolvency plan presented by the debtor (§ 231 InsO),lO continuing with
the checks on group composition,11 and ending in the previously discussed 'expro-
priation protection of§§ 245 Abs 1 Nr 1, 251 Abs 1 Nr 21nsO,12 which is designed
to prevent creditors being placed against their will in a worse position under the
insolvency plan than they would have been in the standard procedure.
It merits brief mention that the insolvency plan procedure is also available for 14.09
cases of mere likely inability to pay debts, especially under the restructuring prepar-
ation procedure contained in the ESUG.13 Setting aside for the moment the fact
that likely inability to pay debts almost always goes hand in hand with balance-
sheet insolvency,14 the question in these cases becomes how to justify curtailing the

7 See para3.14.
8 See para 3.15.
9 Further discussed at paras 17.01 ff.
10 cf BGH ZIP 2011, 340 Rdnr 3.
11 cfBGHZ 185, 206 Rdnr 35; 163,344,347 ff.
12 Most recently BGH ZIP 2010, 1499 Rdnr 17 ff; 2010, 292 Rdnr 6; NZI 2007,522 Rdnr 9 ff.
13 At para 10.23.
14 Details can be found at para 8.14.

211
 Procedural Issues

creditors' rights without the debtor having entered substantive insolvency. But the
intrusion is justified--likely inability to pay debts arises under § 18 Abs 2 1n50
when the debtor will probably not be in a position to satisfY the claims of creditors
at the time when they come due. Once this likely inability has been established in
respect of a debtor, the creditor may no longer hold his claim on his own books at
face value: he is instead obligated under the 'caution principle' in § 252 Abs 1 Nr 4
HGB to reduce it to the likely value in liquidation. 15 1be claim loses its full value in
economic terms because of the manifest risk ofinsolvency. Once this has happened,
the insolvency plan may be enforced along these lines against the will of the minor-
ity creditors by changing the legal value of the claim to match its economic one.

3. Reorganization
14.10 'TI1e provisions on the reorganization procedure in the KredReorgG are particularly
illuminating in this context. The KredReorgG permits curtailment of creditor
rights under its § 8 Abs 3 by means of a reorganization plan, in respect of which
three important observations can be made.

14.11 First, there is no equivalent provision for restructuring plans under the KredReorgG
(§ 2 Abs 2). This is no accident, since restructuring under the KredReorgG is lim-
ited to measures internal to the bank (§ 2 Abs 2 S 2 KredReorgG), nor is it wrong,
since the justification for curtailing the rights of creditors evaporates for a proce-
dure that does not require that the debtor even be approaching insolvency. Claims
during this phase remain of their full value, making compulsory reduction for the
purposes of restructuring an act of illegal expropriation.

14.12 Secondly, curtailment of creditors' rights through a reorganization plan is permit-

ted as early as an 'danger to existence with systematic consequences' arises
(§ 7 Abs 2 KredReorgG), which is defined as 'looming insolvency' by means of a
cross-reference to § 48b KWG.16 The statute thus permits compulsory intrusions
into creditors' rights at a point when the debtor is not yet substantively insolvent
but is expected to become so in the absence of countermeasures. In these situations,
as with likely inability to pay debts,17 the caution principle prohibits creditors'
claims being booked at their full nominal value. Instead, the possibility must be
considered that the bank will become insolvent failing restructuring action being

15 Events which are justified and foreseeable, such as insolvency proceedings in the case of a debtor
in financial difficulties on the accounting date in question, are to be considered in valuation. Doubtful
claims are to be carried on balance sheets at their likely value, and unrecoverable claims are to be writ-
ten off See Hope-Merkt in Adolph Baumbach and Klaus Jilrgen Hope, HGB (34th cdn, Munich,
20lO), § 252 Rdnr 11, § 253 Rdnr 23; Ellrott and Roscher in BeckScher Bilanzkommentar, § 253 Rdm
567,569 if; Winkeljohann and Biissow in BeckScher Bilartzlwmmerttar, § 252 Rdnr 38; Ballwieser ill
Munchener Kommentar zum Handelsgesetzbuch, § 253 Rdnr 63; Wirtschajisprufir-Handbuch heraus-
gegeben vom Institut der Wirtschaftsprufir in Deutschland e. v., Bd. l, (13th edn, DLisseldorf, 20(6),
E Rdnr 435.
16 Details call be found at para 8.16.
17 See para 14.09 and n 15 above.

212
 Curtailing Creditors' Rights
,.J
18
taken, and claims can only be protected at their liquidation value. This theory
justifies curtailment of creditors' rights not just in an insolvency plan, but also in a
reorganization plan (which parallels the rules on the insolvency plan procedure).
Thirdly, § 8 Abs 3 KredReorgG does not distinguish between secured and unse- 14.13
cured creditors in dealing with intrusions into their rights. But the overall concept
of the procedure, especially in light of § 12 Abs 2 KredReorgG,19 makes clear that
there is no provision whatsoever for making inroads into the rights of secured credi-
tors: 'creditor' in the sense of the statute appears only to mean unsecured creditor.

II. England
English law also provides for curtailment of creditors' rights in each of the three 14.14
restructuring procedures discussed in this investigation.

1. Scheme ofarrangement
The significant instrument contained in the scheme of arrangement is the binding 14.15
of (unsecured2Q ) creditors.21 The binding is not compulsory, since the proceedings
can be confined to the company-law side if needed (s 895(l)(b), CA 2006). But the
company can also alternatively or additionally provide for the creditors' rights to be
curtailed by their restructuring plan and put these intrusions to a vote of the credi-
tors' meeting (s 895(1)(a), CA2006). The plan must explicitly detail its consequences
for the creditors' claims (s 897(2)(a), CA2006). Sections 895(1)(a) and 899(1), CA
2006 permit the division of creditors into separate groups according to their various
interests, with different consequences permissible for each,22 although before the
creditors' meeting, the correctness of the division will be examined by the court,23
and the confirmation of the results of each vote by the court will be conditional on
the respective arrangements' being fair and reasonable. 24 The main concern is that
the creditors are not put in a worse position under the scheme than they would have
been in liquidation. 25
Since there are no special requirements for beginning the scheme of arrangement 14.16
procedure, and especially since insolvency is not a requirement, creditors must
be protected from the debtor's abuse of the process to escape his commitments.

18 This does not apply as long as the claims are guaranteed by deposit guarantee. ban
on curtailing rights secured in this way is therefore intentional (§ 12Abs 2 KredReorgG).
19 See n 18 above.
20 For secured creditors, see para 14.22.
21 Discussed at para 9.17.
22 Roy M. Goode, The Principles o/Corporate Insolvency Law (4th edn, London, 2011), 12-17.

23 cf para 9.30.
24 See para 17.64.
25 Re My Travel Group pic [2004] EWCA Civ 1734; Re Telewest Communications ptc [2004] EWHC
924 (Ch).

213
 Procedural Issues
-------"--------
The protection here is threefold: 26 in the court's approval of the application for the
setting of a creditors' meeting; in the three-fourths majority necessary for decisions
in that meeting; and in the court's examination of the results of the meeting before
it confirms them. The company will therefore have to convince its creditors and the
court that the intrusions into the rights of the creditors are necessary, fair, and rea-
sonable in view of the current or expected situation in which the company finds
itself. If the debtor fails to do so, it will reach neither the necessary majorities nor
gain the approval of the court.

2. Company voluntary arrangement

14.17 Unlike the scheme of arrangement, the eVA is explicitly limited to dealing with
legal relationships between debtor and unsecured creditor (s 1 (l), IA 1986),27 and
there is only one creditor group as a rule, meaning that a division of the creditors
into different classes is almost always out of the question. 28 Neither is the opening
of eVA proceedings dependent on the company's insolvency, so particular abuse
prevention controls are again important. 'Illese come ex ante from the nominee's
scrutiny of the restructuring plan and his duty to advise the court of his opinion of
it (s 2(2), IA 1986), and ex post from the court's scrutiny, although only on the
request of an overruled creditor, alleging that he has been unfairly treated differ-
ently (s 6(l)(b), IA 1986).29 This channel opens the possibility of subjecting the
majority vote of the creditors' meeting to screening for abuse of process.

3. Administration
14.18 1be starting position in administration is shifted, since substantive insolvency is a
precondition (para 11 (a), 27(2) (a) of Sch B 1, IA 1986) and the restructuring pro-
posal is laid forth by the administrator (para 49(1) ofSch Bl, IA 1986), creating
two significant choke points against abuse of process. If the administrator decides
to pursue an asset deal, his decision is usually followed by quota-based repayments
to the creditors from the proceeds ofliquidation. 3o Here, there is no curtailment
stricto sensu of the creditors' rights, bur rather a realization of the actual economic
value of the claims. If, on the other hand, the debtor is to be restructured, the
restructuring plan can, and most often will, include reductions of the rights of
unsecured creditors. In order to bring this about, the administrator has to use a
scheme of arrangement or a eVA (para 49(3) ofSch Bl, IA 1986), for which the
previous paragraphs apply, including the points on abuse prevention. It is not pos-
sible to include a reduction of the claims directly into the proposal and submit it to

26 Summarized in Re My Travel Group pIc [2004] EWCA Civ 1734; details at Louise Gullifcr and
Jennifer Payne, Corporate Finance Law: Principles and Policy (Oxford, 2011), 13.3.
27 cfpara 6.05 If, also as pertains to the following.
28 cfpara 9.18.
29 cfpara 17.65.
30 cf para 6.15.

214
 Curtailing Creditors'Rights

a vote at the creditors meeting (paras 50 ff of Sch B1, IA 1986 and rules 2.34 ff, IR
,#
1986), as in the German insolvency plan procedure, since the creditors' meeting
only has power to approve or reject the administrator's measures, and not to make
broadly binding constitutive declarations that curtail the rights of creditors.

B. Secured Creditors

The binding of secured creditors is much more problematic. Proceeding from the 14.19
working hypothesis that the security will be enough for the complete repayment of
the secured creditor's claim, then the secured creditor stands to have his claim paid
in full even in a liquidation. He thus has neither an economic incentive to waive his
right to the security or the secured claim, nor an economic incentive to involve
himself in the restructuring effort at all-his primary interest is in realizing the
security as quickly as possible. Things may look different, however, if the security-
holder is interested in a continuing business relationship with the (restructured)
31
debtor and is therefore willing to contribute to the restructuring. At the same
time, the economic sustainability of the secured creditor's legal position forbids his
rights being curtailed, set aside, or placed at the mercy of a majority vote. Any
system of restructuring law must keep this in mind.

I. Germany
In Germany, secured creditors need not fear for the economic value of their securi- 14.20
ties in the face of the insolvency professional or the majority will of the creditors'
meeting.32 This position comes partially from rules on separated satisfaction in
open insolvency proceedings,33 which protect the secured creditor under the so-
called value-preservation principle by providing him with a claim against the
proceeds, a substitute security, or repayment for the face value even when he is
forced to give up his security in substance. 34 It also comes from the provisions on
the insolvency plan, which prohibits forcing security-holders to provide restructur-
ing contributions; such contributions must be negotiated. No creditor whose
security maintains its value can be forced to waive his secured claim or give up his
security, in whole or in part. Hence the assumption of § 223 Abs 1 S 1 InsO that
securities remain untouched, and of § 222 Abs 1 S 2 Nr 1 InsO, which permits a
special grouping of creditors with separation rights only if their rights stand to be

31 On the various interests in play, ef para 3.13.

32 The situation is different under § 5 Abs 3 S 1 Nr 6 SchVG only for bond creditors and only
insofar as the bond terms so provide. For these situations, § 5 Abs 4 SehVG sets out that a majoriry
decision is enough.
33 See further paras 13.10 ff.
34 ef§ 172 Abs 2 InsO and para 13.12 f.

215
 Procedural Issues

curtailed;35 this proposal must in turn be discussed in detail at the voting hearing
(§ 238 Abs 1 S 1 1nsO). Majority decisions and obstruction bans do not apply to
security-holding dissenters, since they can usually automatically present prima focie
evidence that they will be placed in a worse position through the curtailment of
their rights than they would have been without the plan (§§ 245 Abs 1 Nr 1, 251
Abs 2 1nsO).

II. England
14.21 English law has different rules for secured creditors 36 111 each of its three
procedures.

1. Scheme ofarrangement
14.22 1he general view at present is that the scheme of arrangement can also curtail the
rights of secured creditors. The statute permits arrangements for 'creditors' gener-
ally (s 895(l)(a), CA 2006), and in doing so does not differentiate between secured
and unsecured ones. Unlike the CVN7 and administration,38 it does not specif-ically
exclude secured creditors,39 and the courts decided early on that this meant that
secured creditors could also have their rights compromised by a scheme of arrange-
ment. But a close review of the key cases quickly reveals that the door has not been
opened to the reduction of securities with sustainable value for the purpose of
boosting the restructuring mass. Instead, the purpose is for securities to be valued
realisticaUyLl° and to be able to be exchanged for other assets of at least equal value---
especially shares of the rescue company. When it comes to the question of whether
the restructuring decision is fair and reasonable, courts look principally at whether
the secured creditors' prospects of being repaid have deteriorated or not--even in a
scheme of arrangement, intrusions into the rights of secured creditors must respect:
the principle of preservation of value. Within this boundary, there is no objection
to a curtailment of their rights for the purposes of restructuring. 41

35 For example, BGHZ 163,344.

36 Ihe term is defined by s 248, IA 1986.
37 cf para 14.23.
38 cf para 14.24.
39 The fonndation is laid by Re Empire Mining C(J (1890) 44 Ch D 402; Re Ale/barna, New Orleans,
Texas and PacificJunction Railway Co [1891] 1 Ch 213; for delimitation purposes cf Lehman Brothers
International Europe (In Administration) {No2} [2009J EWCA eiv 1161; Re Bluebrook Ltd [2009]
EWHC2114 (Ch).
40 In the leading case, Re Empire Mining Co (1890) 44 Ch D 402, for example, the securities had
proven to be largely worthless since they were over assets abroad and other creditors had priority over
the secured creditors according to the local law.
41 '1he field of interests is not different here than it is in German law, for example, where the insol-
vency professional can usc transactional assets over which securities are held in the production process
as long as the security-holders arc offered replacement securities of equal value (§ 172 Abs 2 1nsO;
cf para 13.12).

f'
216
 Curtailing Creditors'Rights

2. Company voluntary arrangement )I

If the CVA is chosen as the restructuring instrument, the legal situation is relatively 14.23
clear:42 s 4(3), IA 198 and para 31 (4) ofSchAl, IA 1986 explicitly forbid intrusions
into the rights of secured creditors without their consent. Thus the High Court has
held43 that a CVA does not bar a secured creditor from realizing his security as long
45
as he has not surrendered his security rights 44 or a moratorium is not in force. The
management is thus compelled to discuss the restructuring proposal in advance
with the (major) secured creditors and negotiate in contract any concessions they
are seeking. 46

3. Administration
None of that changes when the CVA takes place within an administration, for 14.24
administration proceedings are also not capable of reducing the rights of secured
creditors without their consent (para 73(1)(a)-(2) (a) ofSch Bl, IA 1986). When
administration is combined with a CVA, the situation under para 73(2)(b) ofSch
B 1, IA 1986 is the same because of s 4(3), IA 1986. The moratorium prevents
secured creditors from exercising their rights,47 but if that constitutes an unreason-
able infringement of their rights, secured creditors can apply to the court for the
necessary protection. 48 The administrator, too, will have to consult the secured
creditors ifhe wants to restructure the business.

C. Overall Picture

Overall, it is possible to say that the issue of curtailing creditors' rights is dealt with 14.25
in both legal systems comparably and with comparable propriety. Unsecured credit-
ors must make due with the real economic value-the liquidation value--of their
claims, since the legal quantum of their claims can be reduced to their real eco-
nomic value by majority votes of the creditors' meetings in all of the proceedings
being examined here, even against the will of a dissenting minority. Protection
from abuse of process is guaranteed but comes from different places: partially
through qualified majorities, but in every case through the opportunity to seek an
examination of the majority's decision by the court.

42 On the following, see also Geoffrey M. Weisgard, Michael Griffiths, and Louis Doyle, Company
Voluntary Arrangements and Administrations (2nd edn, Bristol, 2010), 6.23 ff, 6.46 ff.
43 Rey v FNCB Ltd [2006] EWHC 1386 (Ch).
44 Such waivers cannot be rescinded, Khan v Permayer [2001] BPIR 95.

45 See para 13.26.

46 Weisgard, Griffiths, and Doyle (n 42 above), 6.40.
47 This is a key difference between administration and winding up. See Cosco Bulk Carrier Co Ltd v
Armada Shipping SA & STX Pan Ocean Co Ltd [2011] EWHC 216 (Ch).
48 cf para 13.28, as well as Goode (n 22 above), 11-20.

217
 Procedural Issues

14.26 So too are the rights of the secured creditor guaranteed. They cannot, as a rule, be
curtailed by majority vote against the will of security-holders, with the exception of
the English scheme of arrangement, in which the courts play the critical role in
confirming the decision of the creditors' meeting, thereby ensuring that the justi ..
fied interest of the secured creditors in the full amount of their claims is preserved.
Practitioners may see it as a hindrance that securities must be respected, since it
compels restructurers to agree the restructuring plan with the secured creditors and
to make appropriate room for their demands. But it is an unavoidable consequence
of securities law, which permits the debtor to transfer his ownership powers to a
creditor as security-holder in whole or in part. In restructuring, the rights thus
transferred to the creditor must be respected-at the very least in the form of a value
guarantee. They cannot be reduced or voided for the purposes of restructuring: they
must retain their full force in the very situation for which they were created.

218
 Procedural Issues

The transformation is always undertaken within a scheme of arrangement, IOi

which special rules apply under ss 920 If, CA 2006. Demerger, known as division,
is regulated in S5 919 If, CA 2006, the necessary three-fourths majority in s 922, CA
2006, and the joint and several liability in s 940, CA 2006. There are no simplified
rules for restructuring elforts.

15.18 These rules do not apply to the private companies being discussed here; for them,
there is no structure equivalent to the German demerger. Practitioners thus make
use of general provisions in the scheme of arrangement. 34 In s 900(l)(a), CA 2006,
the statue explicitly mentions amalgamation, and permits the transfer of an entire
business or individual parts of it under s 900(l)(b), CA 2006, generally to a new
company founded explicitly for this purpose. Doing so permits English practition-
ers to simulate a number of the features of German transformation, including
demerger by division. Depending on the content of the scheme, both assets and
liabilities are transferred. However, even during crisis and insolvency a separate
decision of a three-fourths value majority and a simple numerical majority of the
creditors' meeting (s 899( 1), CA 2006)35 and shareholders' meeting for each action
are required, plus the explicit order of the court under s 900, CA 2006.

15.19 'I11e transfer of contractual obligations is not possible on this basis because of the
applicable general law36 discussed aboveY External business partners are often
given the contractual right to terminate or force through new conditions and the
court's confirmation of the scheme is not able to change that. 38 "n1is is one of the
reasons that transformation measures are only seldom included in schemes of
arrangement. 39

c. Debt-equity Swap

15.20 Creditors will be more willing to forego part or all of their claims if they receive a
share of the debtor company in need of restructuring, perhaps as a particular form
of earn-out repayment. They thereby get a chance to participate in the profits of the
successfully restructured company and earn interest on the capital they have con-
tributed. The conversion of creditor claims into shares of the company, the so-called
debt-equity swap, makes sense as a restructuring instrument in this light. 40

34 cfGullifer and Payne (n22 above), 13.2.2.

35 As long as their interests are afrecrcd and to be protected; to that extent, the discussion above ill
nn24 and 25 applies here.
36 cf para 12.30.
37 Gullifer and Payne (n 22 above), 13.2.2.
38 Gower and Davies (n 18 above), 29-9; Gullifer and Payne (n22 above), 13.2.2.
39 Ai; above.
40 For more detail, sec Horst Eidenmtiller and Andreas Engert, 'Refonnperspektiven einer
Umwandlung von Fremd- in Eigcnlcapital (Debt-Equity Swap) im Insolvenzplanverfahrcll', ZIP

226
 Company Law Measures

Technically, the debt-equity swap is a,form of capital decrease combined with cap-
ital increase in which the purchase rights of current shareholders are excluded and
the claims of the creditors are added to the capital at their objective value. 41 For
restructuring, this has the helpful effect of combating both balance-sheet insol-
vency and inability to pay debts, since the creditor claims are no longer carried on
the liabilities side and repayment and interest obligations disappear,42 freeing up
liquidity for other purposes. 43

If this transformation of debt capital into share capital outside insolvency law 15.21
requires the cooperation of the current shareholders, value is divided between cur-
rent shareholders and creditors according to a company-law distribution rule. 44 An
insolvency-law distribution can be substituted if substantive insolvency has arisen ,45
since the capital brought in by the current shareholders has been lost and their
shares are essentially worthless, a fact which the creditors' vote to convert their
claims into share capital cannot change. It is then enough to give the present share-
holders a procedural value preservation guarantee-the right to prevent the court
approval or to challenge the vote of the creditors if they can prove that their shares
indeed have residual value and the debt-equity swap puts them in a worse position

2009,541 ff and notes; Lars Westpfahl, 'Debt Equity Swap', in Stephan Eilers, Matthias Koflka, and
Marcus Mackensen (eds) Private Equity (Munich, 2009), 24 Rdnt 1 ff; see also the notes to Spetzler
(n 5 above), 435 fn 10.
41 See for example, Stefan A. Wirsch, 'Debt Equity Swap und Risiko der Insolvenzanfechtung',
NZG 2010,1131 £
42 cfAllg Begr RegE ESUG, BR-Drs. 127/11,23.
43 Pape (n 5 above), 2158.
44 Details, also on the follOWing, can be found in Eidenmiiller and Engert (n 40 above), 543 ff.
45 The purpose here is only to mention a connected alternative solution that is known in the
economic analysis of law as 'Bebchuk's scheme'. Lucian Bebchuk ('A New Approach to Corporate
Reorganization', Harvard Law Review 101 [1988], 775 ff) had suggested, roughly, that in insolvency,
the secured credirors should split up the shares between them and give the unsecured creditors and
present shareholders options over them that new investors could buy at the nominal worth of their
original (and meanwhile dissolved) claims, such that once all of the options were exercised, the debt
would have been replaced with share capital and the owners alone would decide on the fate of the busi-
ness. This model, refined primarily by Philippe Aghion, Oliver Hart, and John Moore, The Economics
ofBankruptcy Reform, Journal of Law, Economics and Organization 8 (1992), 523 ff), has been heavily
criticized, with the criticism most recently consolidated and developed by Alexander Dilger, 'Forced
to make mistakes: Reasons for complaining about Bebchuk's scheme and other market-oriented insol-
vency procedures', European Journal of Law and Economics 21 (2006),79,79 ff). It is not discussed
further here, since although it may be suitable in theory, in practice it could not be implemented
in the context of insolvency law which has been conceived on a fundamentally different basis. See
Jochen Bigus and 1bomas Eger, 'Insolvenzrecht zwischen privatautonomer Gestaltung und iiffentli-
cher Regulierung', Perspektiven der Wirtschaftspolitik 5 (2004), 193, 200 ff; Horst Eidenmiiller,
Finanzkrise, Wirtschaftskrise und das deutsche Insolvenzrecht (Berlin, 2009), 164 ff; Horst Eidenmiiller,
'Unternehmenssanierung zwischen Markt und Gesetz' (Cologne, 1999), 96 ff; Madaus (n 12 above),
443 ff; Hans-Bernd Schafer and Claus Ott, 'Lehrbuch der iikonomischen Analyse des Zivilrechts'
(4th edn, Berlin, 2005), 597 f; Peter Weise, 'Kommentar' in Claus Ott and Hans- Bernd Schafer (eds) ,
Efjiziente VerhaltenssteuerungundKooperation im Zivilrecht (Tiibingen, 1997), 176 ff; and the sources
below in n 67.

227
 Procedural Issues

than they would have been in under an insolvency proceeding oriented toward
liquidation. 46

15.22 Such a rule is not possible in a pre-insolvency restructuring. FortheAktiengesellschajt,

one has to keep in mind that the ECJ47 has rejected making any exception for
restructuring outside of an insolvency proceeding with enforcement characteristics
to Art 25(1)(1) of the Second Company Law Directive (77/91/EEC).48 Under this
rule, the general meeting is always required to approve a capital increase, with which
a debt-equity swap is necessarily connected. Nor for the GmbH can a special rule
for pre-insolvency restructuring procedure be justified. It should be remembered
that such proceedings are done on a voluntary basis and are initiated by the man-
agement ultimately in the (moderated) interest of the shareholders, with which a
pushing-out of these shareholders by means of a debt-equity swap is fundamentally
incompatible. 'This restructuring instrument can only be taken advantage of in
substantive insolvency.49

I. Germany
15.23 German law is still somewhat badly positioned on this issue. 50 Neither current
company law nor current insolvency law handle the debt-equity swap explicitly.
Instead, the necessary company law measures (capital increase with purchase exclu-
sion; possibly also capital decrease) require a three-quarters majority at a general
meeting, even for insolvency plan proceedings. 51 The only aspect that can be regu-
lated by an insolvency plan under current law is the modification to the debtors'
rights that a debt-equity swap necessarily entails. The law, however, assumes under
§ 230 Abs 2 InsO that the consent of every individual creditor affected is required.
There are explicit deviations only under § 5 Abs 3 S 1 Nr 5 SchVG for bond holders
if the loan conditions state otherwise; in these cases, a simple majority is sufficient
(§ 5 Abs 4 SdiVG).

15.24 The reorganization of financial institutions again represents an exception from the
general consent requirement. § 9 KredReorgG permits creditor claims to be con-
verted into shares of the financial institution at the centre of the reorganization

46 cf the corresponding discussion of pre-insolvency creditors in para 14.8 and the sources in
n 56.
47 cfegEuGHSlg 1996, 1-1347 Rdnr 38 If, 42; 1992,1-2111 Rdnr 27 If, 32f; 1991,1-2691, Rdnr
20,25 f.
48 Second Company Law Directive 77/91/EEC ofl3.12.1976, Gazette L 26 of31.1.l977, p I If.
49 Echoed by Andreas Piekenbrock, 'Empfiehlt sich angesichts der Wirtschaftskrise die Einfuhrung
cines gesonderten Restrukturierungsverfahrens?', ZVglRWiss 108 (2009),242,269.
50 More optimistically Michael Sinhart, 'Debt/Equity Swaps in Germany', 1CR 2009,282 If; details
of practice in Winifried Carli et ai, 'Debt-ro-Equity-Swaps in der aI(tuellen Transaktionspraxis', ZIP
2010,1737 If; Westpfahl (n 40 above), Rdnr 1 If.
51 cf paras 15.05, 15.08 and Carli et al (n 50 ab'5ve), 1739 f!l741; on the non-insolvency debt-
equity swap see .lens Ekkenga, 'Sachkapitalerhohung gegen Schuldbefreiung', ZGR 2009, 581 If.

228
 Company Law Measures

plan. The plan is then subject t9 the procedure as set out in para 15.7: the reorgan-
ization plan and the debt-equity swap are agreed by the general meeting under § 18
Abs 1 and 3 KredReorgG bya simple majority. 52 lfit cannot be reached, the obstruc-
tion ban under § 19 Abs 4 KredReorgG may apply. There are some modifications,
however, mainly from § 9 KredReorgG: the constitution's freedom of association
operates negatively as well, and a creditor in a debt-equity swap cannot be forced
into a majority decision if it would result in his automatically becoming a share-
holder, since Art 9 Abs 1 GG permits individuals to be forced into associations only
in exceptional circumstances. 53 § 9 Abs 1 5 2 KredReorgG respects this by giving
individual creditors an opt-out: the right to remain in their creditor position,
although there is no comparable right for current shareholders. 54 On the other side,
the statute also has an eye on the rights of the shareholders in that it obligates the
financial institution 55 under § 9 Abs 2 KredReorgG to pay the current shareholders
reasonable compensation (for the 'watering-down' of their shares that were not
worth much anyway56). There are additional provisions for restructuring privileges
in § 9 Abs 1 54 and Abs 3 KredReorgGY
Under the recent reform, following an urgent appeal 58 by practitioners,59 the debt- 15.25
equity swap has been included in the statute. § 225a Abs 2 InsO explicitly permits
the constitutive part of an insolvency plan to provide for the conversion of creditor
claims into shares or membership rights, again in exchange for compensation to the

52 The exception of an accompanying capital increase without putchase exclusion is dealt wilh at
para 15.07.
53 cfEidenmliller and Engert (n 40 above), 547.
54 Criticism from Spetzler (n 5 above), 452.
55 Criticism of passive legitimation in Spetzler (n 5 above), 459 f.
56 In the statement oflegislative putpose on the White Paper, Begr RegE § 9 KredReorgG (BT- Drs
17/3024, p 51), value is calculated generally with reference to the value of the financial institution
as a going concern. This is incorrect. The value of the shares has to be based on the value at the
moment of the creditors' decision without taking into account the planned restructuring measures,
not on the value after the restructuring (even if the new shareholders are included). Value increases
that depend on restructuring must remain outside the scope of the value calculation, since they deal
with restructuring contributions of other parties that have yet to be made. This view is echoed by
Obermliller and Kuder (n 31 above), 2019; Sven Schelo, 'Neue Restrukturierungsregeln fUr Banken',
NJW 2011, 186, 188; Spetzler (n 5 above), 446 If, 459; criticism also from Obermuller (n 30 above),
89; Jasmin Urlaub, 'Notwendige Anderungen im Gesetz zur weiteren Erleichterung der Sanierung
von Unternehmen (ESUG) zur Verhinderung von Missbrauchen', ZIP 2011,1040, 1044 f.
57 For more detail, see para 16.06.
58 A collection of the corresponding statements can be found in Spetzler (n 5 above), 435
fn 10; but criticism from Jurgen Wallner, Erwin Gerster, and Rudiger Weig, 'Steuerbarkeit von
Sanierungsprozessen trotz Insolvenz', ZInsO 2011, 16,20 f; and reservation expressed by Roman
Paulus, 'Die auslandische Sanierung uber einen Debt-Equity-Swap als Angrilf auf das deutsche
Insolvenzrecht?', DZWIR2008, 6 If.
59 For more detail see Gerrit Holzle (n 11 above); Kresser (n 12 above), 1409 If; Stefan Simon, 'Der
Debt Equity Swap nach dem Gesecz zur weiteren Erleichcerung der Sanierung von Unternehmen
(ESUG)', CFLlOI0, 448 If.

229
 Procedural Issues
-------------
current shareholders.60 111e opt-out for affected creditors is in § 225a Abs 2 S 2
In50. 61 The procedure is the same as that described in para 15.9: the decision is
taken not by the general meeting but by a voting class consisting of the shareholders
(§ 222 Abs 1 S 2 Nr 4 In50) that decides with a simple value majority (§ 244 Abs
3 rnsO) and subject to minority protection (§ 251 En50) and obstruction bans in
the event of rejection (§ 245 Abs 1 and 3 1nsO).62 'TI1ere is no rule, however, for the
application of restructuring privileges along the lines of § 9 Abs 1 S 4 and Abs 3
KredReorgG.63 There is also no provision addressing the eventuality of a conflict
between the debt-equity swap and a contractual change of control clause giving the
co u nterparty the right to terminate the co ntract. Ifsuch cl a uses are no tto be blocked
by § 119 InsO,64 there is a risk that a debt--equity swap could retroactively miss its
target: the preservation of entitlements 65 specific to the identity of the company.66

II. England

15.26 In England, the debt-equity swap is a standard instrument of restructuring. In the

literature, it usually merits mention only at the margins. 67 As far as creditor rights
stand to be converted into share capital, general company-law measures have to
be applied; there is no special regime for administration. 68 However, the debt-
equity swap can be contained in a scheme of arrangement 69 or a CVA70 even inside

60 See above and n 12. The statement of purpose correctly assumes that the shares of the company
will usually be worthless. See n 16 above.
61 Criticism from Frank Frind, 'Problemanalyse Zllm RetE "ESUC"'---'I;;ill, ZlnsO 2011, 373;
T;;il2, ZInsO 2011, 656, 657.
62 Criticism from Moritz Brinkmann, 'Wege aus der InsolvcllZ cines Unternehmens----oder: Die
Ccsellscbafter als Salliertlngshindernis', WM 2011, '),7, 100 r
63 Discussed critically in Svcn Schclo, 'Reform dcr UIltcrnebmenssanicrung', DB 20lO, 2209,
2210. 13Ilt cf BGHZ 165, 106 ZIP 2006, 279 and the comment in Rainer Himmelsbach and Jan
Achsnick, 'Jnvestments in Krisenllnternehmen im Wege sanienmgsprivilegiertcr debt-equity-swaps',
NZI 2006, 561 If.
64 See Hiilzle (n II above), 129.
65 c[ para 1.29.
66 Fittingly Brinkmann (n62 above), 101 f.

67 cf Roy M. Goode, the Principles (1Corporate Insolvency Law (4th edn, London, 201l), 11-17
and 12-6; Cullifer and Payne (n 22 abovc), 13.2.4.1, 13.2.4.2; in more detail Adrian Cohen andJohn
Maclennan, 'Ultimate turnaround: debt to cquity swaps', CRI 2009, 91 If; Karen Kemp and David
Harris, 'Debt to equity conversions' [August 19931 PLC 19 ffi Charles Wilsoll, 'Debt equity swaps:
an alternativc form of corporate rcscue', CRI 2009, 10.3 f; de lege firendrl with a Illore thorough disclls-
sion of the theoretical model, see Aghion, Han, and Moore (n 45 above), Alice Belcher, Corporate
Rescue (Sweet & Maxwell, 1997), 120 f; David Brown, Corporate Rescue (Chichester, 1996), 20~58
ft; Andrew Campbell, 'Ihe equity for debt proposal: rhe way forward?', 11,&P 1996, H If; Vanessa
Finch, Corporate Insolvency Law (2nd edn, Cambridge, 20(9),321 If, 422 If.
68 cf para 6.1 0 and Goode (n 67 above), ] 1-17.
69 cf Re McCarthy and Stone pIc [2009] EWI-IC 1]]6 (eh); Nt' li:lewestCommunicationsplc 120041
EWHC 924 (Ch), 120041 EWCA Civ 728,120041 EWI-lC 1466 (Ch).
70 An example is the Schefinaker case; cf Cohen and Maclennan (n 67 above), 93 and para 1.07.

230
 Company Law Measures

administration 71 and put to the crsditors' meeting for a vote which requires a major-
ity of three fourths to succeed.

Interestingly, the accompanying consequences for the rights of the current share- 15.27
holders under the swap have not been the subject of academic or judicial discussion,
and there do not seem to be any particular difficulties here in practice. Although it
is recognized that the current shareholders must approve the swap,72 and that the
rules on capital increases and capital decreases may need to be respected,73 the pre-
cise procedural integration is discussed neither in the literature nor particularly in
the case-Iaw. 74 If the swap of the claims is integrated into a scheme of arrangement,
there are no further difficulties, since schemes permit the shareholders' rights to be
modified under s 895(1)(b), eA2006. evAs do not work the same way. The incon-
sistency seems to be tacitly tolerated because the proposal for the eVA has to come
from the company (s 1(1), IA 1986) and the eVA also has to be agreed by the share-
holders (cf 2(2) (aa) , IA 1986), meaning that the eVA can be used as a means for
obtaining the necessary company-law legitimation indirectly. For this reason alone,
the scheme of arrangement is the instrument preferred by practitioners for imple-
menting a debt-equity swap. But if massive resistance is expected from the
shareholders and it seems less than certain that the required thfee-fourths majority75
will be achieved, an alternative is the founding of a new company (the jargon is
'newco') whose shares are distributed to the creditors of the debtor company and
which receives the assets of the debtor company in an asset deal.

D. Overall Picture

The overall picture is not a unified one. Both systems address the necessary com- 15.28
pany law measures, but German law does so with far greater attentiveness. Whereas
England regulates the topics being discussed here rather cursorily and discusses
them only in passing, German law expends considerably more energy.

Most noticeably, English law provides no special rules for company law measures in 15.29
insolvency. The most convincing explanation is that the leading 76 instrument for
these measures, the scheme of arrangement, is not exclusively an insolvency instru-
ment but is also available in a pre-insolvency stage where special rules for curtailing

71 cfthe proposed action in Re Colt Telecom Group pic (No 2) [2002] EWHC 2815 (Ch).
72 Finch (n 67 above), 322.
73 cf generally para 15.11; in detail Kemp and Harris (n 67 above), 24 ff; Wilson (n 67 above), 103;
hints also in Finch (n 67 above), 322.
74 This may be because the key cases have usually featured the conversion into shares of a newly
founded receiver company, meaning that there was no curtailment of the rights of the current share-
holders. See the citations in n 69.
75 On capital reduction, cf para 15.10.
76 cfpara 15.12.

231
 Procedural Issues

shareholder rights cannot be legitimated. 77 The provisions of the scheme ofarrange-

ment allow them, but only with an enormously high 75 per cent majority, meaning
that the instrument only provides advantages over general company law where
company law does not permit majority decisions (such as in the exchange of shares
of the company for shares of a receiver company).

15.30 By comparison, the German provisions such as the company-law modification

powers under the new § 225a Abs 3 1nsO go much further, to the point of seeming
almost revolutionary. But whereas the German law spends considerable energy on
minority protection for current shareholders, this is at most a marginal theme in
English law. The debt-equity swap is perhaps the central example of this, a con-
struction that is handled in English discussion mainly as a modification of creditor
rather than shareholder rights without thereby giving rise to any practical
problems.

77 cf para 15.22.

232