"Pre-pack" – New proceedings for the distressed M&A market?

Among other things, the proposed directive provides for the introduction of "pre-pack proceedings". Such pre-pack proceedings make it possible to negotiate the sale of a company with a third party prior to the commencement of an insolvency proceeding and to prepare the takeover in a binding manner so that a given transaction can be completed in shortened proceedings swiftly thereafter. The market already knows such pre-pack proceedings from other countries. At least since the judgements of the Court of Justice of the European Union (CJEU) on the transfer of employment relationships to a transferee as part of Dutch "pre-pack proceedings", pre-pack has caught on as a term. Furthermore, such proceedings had already been implemented in other Member States, such as France and Spain, before the proposed directive was published. Taking these proceedings as a basis, the directive proposal now provides for such regulations for all Member States. The explanatory memorandum to the draft directive states that the pre-pack proceedings are intended to ensure that these proceedings, considered effective for value recovery for creditors, are available in a structured manner in the insolvency regimes of all Member States.

The big question for the German distressed M&A market and insolvency practitioners is therefore whether – assuming the directive proposal is adopted – this will mean the introduction of a completely new distressed M&A procedure. Do these proceedings open up new opportunities for investors and companies in crisis or are they merely a modification rather than a new restructuring instrument? If you read through the regulations in the draft directive unbiased and detach yourself from the terminology, in the planned processes you can at least recognise the practice that is already in place in German insolvency proceedings, namely in preliminary insolvency proceedings.

The draft directive provides for a two-phase distressed M&A process. Article 19 et seq. of the proposal for a directive contains provisions on the "preparation phase", intended to find an appropriate buyer. This phase takes place before the start of the insolvency proceedings and is supervised and accompanied by a "monitor", who is appointed by the court at the debtor's request and is later also appointed as the insolvency administrator. 

The aim is to start the bidding process and identify a buyer whose offer is likely to ensure the best possible recovery rates for the creditors. Furthermore, it should also be possible to apply for enforcement protection during this phase. 

The preparation phase should be followed by the second phase, the "liquidation phase", which aims at approving and executing the sale and takeover of the assets and which is implemented following the opening of insolvency proceedings. This phase also encompasses carrying out the remaining proceedings and distributing the proceeds to the creditors. 

When comparing this two-phase procedure proposed in the draft directive with distressed M&A practice, it can be seen that a professional M&A process is usually set up immediately after the application is submitted and, if successful, the contract is already negotiated and the transfer prepared so that the sale can be implemented on the day the insolvency proceedings are opened and the corresponding approval of the creditors' meeting / creditors' committee can be obtained. What possibly distinguishes the two procedures is that the draft directive does not necessarily require formal insolvency proceedings. Therefore, a procedure similar to that under the Corporate Stabilisation and Restructuring Act (StaRUG) could be considered before the actual insolvency proceedings are implemented. However, if such preliminary proceedings are not pursued and are made part of the regulations of provisional insolvency administration, the draft directive suggests that the directive will probably only have an impact on implementation with regard to proceedings to the extent that the current practice will now also be governed by law.

As regards the individual regulations of the draft directive, however, some provisions are new for the process of a distressed M&A transaction of a German target, and legal practitioners are asking themselves whether and to what extent this can and should be implemented in German insolvency law at all. Article 27 of the Directive provides for the assignment to the acquirer of the debtor's executory contracts which are necessary for the continuation of the debtor's business and the suspension of which would lead to a business standstill. The assignment shall not require the consent of the debtor’s counterparty or counterparties. At this point at the latest, every legal practitioner has probably paused reading. Detached from any legal doctrine and constitutionally anchored principles, such a possibility of forcing the counterparty to change the counterparty would be an advantage in insolvency law practice. Many restructuring cases involving a transfer have already failed in the past, as it was in fact not possible or could not realistically be expected that all counterparties of the insolvent company would agree to a takeover of the contracts by the acquirer on the same terms. As a result, potential acquirers withdrew from the transaction already beforehand. 

Under German legal doctrine, however, this is incompatible with freedom of contract. Freedom of contract as a fundamental principle of civil law and a core element of private autonomy, which is guaranteed by Article 2 sec. 1 of the Basic Law, ensures that everyone is free to decide whether, how and with whom they wish to conclude a contract. However, if a new counterparty can be forced onto the counterparty as part of pre-pack proceedings, this is precisely incompatible with freedom of contract as a core principle of German law. 

It therefore remains to be seen whether these concerns will be reflected in the final wording of the directive and how the regulations as a whole will be implemented in the German insolvency regulations.

With regard to the implementation of the proceedings and the structure of the transfer of assets, it remains to be seen whether the proposed regulations will be retained and how they will ultimately be implemented in the German Insolvency Code.