Relaxed over-indebtedness test extended permanently

In response to the financial crisis, the German legislator introduced in October 2008 a new-over-indebtedness test pursuant to which limited liability companies and other legal entities are not considered over-indebted in case of a positive going concern prognosis. What was initially a temporary amendment has now been declared permanent.

The German Insolvency Code requires the management of limited liability companies or other legal entities to file for insolvency without undue delay if the company is over-indebted or unable to pay its debts. In the absence of a positive going concern prognosis, a company is considered to be over-indebted if its assets no longer cover its existing liabilities. Consequently, a company with a positive going concern prognosis will not be deemed to be over-indebted, regardless of whether or not company debt exceeds the value of the company’s assets. 

The underlying legislation for this over-indebtedness test was adopted initially for an interim period ending 31 December 2010, was later extended to 31 December 2013 and has now been declared permanent. Therefore, in future it will remain to be essential to ask under which circumstances the management may assume a positive going concern prognosis.

In order to make this prognosis, the management has to assess whether there is a sufficient degree of probability that the company will be able to carry on its business in the near future (at least until the end of the following fiscal year of the respective company). To this end, the management has to evaluate primarily whether the future cash flow of the company is likely to cover future payment obligations. In addition, according to some legal commentators and recent German case law, it will be necessary to show that the company is able to generate profits in the near future.

In practice, the now permanent over-indebtedness test introduced in 2008 avoids early filings for insolvency and therefore enables companies to implement out-of-court restructurings. However, the management should be aware that the going concern prognosis may be scrutinized by the courts. To avoid personal liability of the management, external advisors should be engaged to evaluate the management’s prognosis and, in addition, the underlying assumptions should be documented properly.

Dr Lars Weber