Last month, SinnLeffers came out of insolvency substantially slimmed
down but otherwise intact. That's quite a victory, considering that
since the financial crisis last September, most German insolvencies
have led to liquidations.
With SinnLeffers, the whole exercise took less than a year, which in
a German insolvency timetable is blazingly fast. More than two-thirds
of the employees kept their jobs.
"This is a success story," says Annerose Tashiro, an Achern, Germany-based lawyer at Schultze & Braun GmbH,
the restructuring firm responsible for the SinnLeffers
self-administration. "As of now, there should be a better reception,
since we can prove [self-administration] works and works proficiently."
However successful, this doesn't mean a Chapter 11-style
debtor-in-possession insolvency will now sweep through Germany,
according to several legal specialists in German restructuring. For the
foreseeable future, self-administered insolvent companies will remain
relatively rare, for reasons that range from court preferences and
public perception to creditor rights. "Courts are still quite reluctant
to have a company in the hands of people who ran it into the ground,"
says Andreas Böhme, counsel in King & Spalding LLP's Frankfurt office. "Companies routinely apply for self-administration, and just as routinely, courts turn them down."
In Germany, insolvencies are the domain of a special chamber of
commercial court. As Martin Rolf Trayer, a lawyer with the Frankfurt
office of Faegre & Benson LLP, explains, insolvency judges
in Germany have enormous latitude in deciding which administrator gets
the call. "It's in the court's discretion who is given the mandate for
administration," Trayer says.
Volker Beissenhirtz, also a Schultze & Braun attorney, believes
there will bemore self-administration cases but that it may take
another five to 10 years to really gain momentum.
"This can be seen as a trend, perhaps not in terms of a particular
head count, but what can happen in [the future]," says Beissenhirtz,
who was responsible for the back-office coordination of the
administration.
Under the terms of the SinnLeffers restructuring, pre-insolvency shareholder Deutsche Industrie-Holding GmbH,
or DIH, retained ownership, but lost about €100 million ($139 million)
in outstanding loans it had extended to the company. DIH purchased the
chain in 2005 along with a Palm Beach, Fla., private equity firm, HMD Partners.
In June 2008 DIH bought out its partner. Neither the original sale
price nor the subsequent acquisition cost was ever made public. DIH is
a Frankfurt private equity firm that specializes in middle-market,
distressed companies.
SinnLeffers and Hertie were at one time both owned by the troubled
European department store and mail-order conglomerate KarstadtQuelle.
Much as Macy's Inc. subsumed various brands into its name after
acquisition, so, too, did KarstadtQuelle attempt to gobble up in the
1990s all sorts of department store and apparel chains and turn them
into one retail behemoth. For example, Hertie, a group of smaller
department stores, was rechristened Karstadt Kompakt GmbH & Co KG.
The aggressive expansion strategy didn't work. In 2005,
KarstatdtQuelle teetered on insolvency. To stay afloat, it had to
unload four of its acquired chains.
No acquirer succeeded in a successful turnaround of the various
properties. As the economy soured, all four retail entities filed for
insolvency. Apparel retailer Wehmeyer GmbH & Co. KG filed last
July, as did Hertie. SinnLeffers filed a month later. Men's clothes
chain Pohland-Herrenkleidung GmbH & Co. KG filed in March.
Pohland is still in preliminary administration. In December, apparel sourcing company Techno Lifestyle GmbH & Co. KG
acquired Wehmeyer, a 43-store chain, out of administration for an
undisclosed amount. Techno Lifestyle managing director Rajive Ranjan
told an Indian newspaper that his company would invest €15 million into
expansion and open a branch of Wehmeyer in his native India next year.
Hertie failed to find any such savior. On May 20, the
court-appointed administrator for Hertie announced all 54 stores would
be shuttered. More than 80% of the creditors voted for liquidation,
which came after negotiations broke down between potential new
investors and the old owner, a distressed U.K. investment fund that
also holds the leases to the properties. The British property and
financial investment company, Dawnay, Day International Ltd., is also in receivership.
Hertie's administrator, White & Case LLP partner Biner
Bähr, faults Dawnay Day for poor operational management while in charge
and intransigence during restructuring negotiations.
"They were financial investors [interested] in property. They didn't
have the expertise for running a retail business," Bähr says.
Hilco UK Ltd., a subsidiary of the U.S.-based Hilco Group, was a 15% minority shareholder in Hertie. "They were supposed to bring retail expertise, but they failed also," he says.
The Düsseldorf-based lawyer, one of Germany's best-known insolvency
administrators, added that reduced rentals were absolutely essential
for continued operation. Potential investors "needed new lease
contracts. They couldn't possibly run the business with the old ones."
According to Bähr, Dawnay Day also failed to consider a critical
element of German insolvency law. Under normal circumstances, the
landlord would have priority as a creditor. But in this case, the
landlord is also the shareholder. So rights are subordinated, even
though the operating company and the property companies may be
separately incorporated. "That was a crucial point of law," says Bähr,
which Dawnay Day representatives didn't appear to understand. "Let's
call it a clash of cultures."
SinnLeffers avoided being broken up, although it didn't escape some
contraction. It applied for insolvency in August 2008. While in
administration, the chain cut 22 of 47 stores. Roughly 1,300 workers,
or about 35% of the workforce, lost their jobs.
German societal dictates lean heavily toward corporate restructuring
and rehabilitation whenever possible. "Liquidation is a second choice
to restructuring. It has always been and will always be," says Detlef
Hass, a Munich-based partner at Lovells LLP. "A majority of
insolvencies are small businesses, and a majority of those result in
liquidation. A normal-sized business would not be liquidated as long as
there was a chance to be restructured." However, there's a paradox at
work. Society may favor restructuring, but directors must contend with
enormous legal pressure to file for insolvency administration.
They can face both civil and criminal liability if they allow a corporation to continue operating while insolvent.
Under the law, directors have just 21 days to declare the company
insolvent if they determine the company is illiquid. Until last
November, directors also were required to file if they determined that
debts are greater than assets if liquidated, the so-called balance
sheet test. The law was amended to make the determination less
absolute. Directors could be exempt from filing if they determine that
the outweighing of the asset value by debt is a temporary phenomenon
and the company will remain liquid for the next 18 to 24 months.
That gives directors some latitude. But lawyers say corporate
officers will still likely err on the side of caution to avoid any
potential liability.
Under German law, insolvency is a two-step process. After directors
declare their company insolvent, the court appoints a provisional
administrator, a process that could take three to six months. That
individual is a specialized lawyer drawn from a small list supplied to
each court.
During the preliminary period, an administrator attempts to
determine what course insolvency should take. There is some breathing
room. The state pays the wages of workers for up to 90 days. It's one
of the most generous interpretations in Europe of a European Union
directive mandating some kind of government assistance for workers of
newly insolvent companies.
"If you don't have to pay for 4,000 employees, you can really make money. You can't not make money," Beissenhirtz says.
The actual insolvency kicks in, usually after three months, but
sometimes longer, depending on the size and complexity of the company.
Typically, the provisional administrator also becomes permanent,
with wide-ranging powers over the company and its future. "It's much
more like a manager's job," Trayer says.
However, the administrator can also pretty much dictate what course
of action to take. "Insolvency allows administrators to liquidate, run
or sell the company," says Hass. "That's the beauty. It can be a
tailor-made proceeding."
In the case of SinnLeffers, a district court in Hagen, Germany,
appointed Horst Piepenburg provisional administrator. Düsseldorf-based
Piepenburg is one of the country's most experienced administrators. He
has worked more than 1,000 insolvency cases, including Babcock Borsig
AG and companies related to the Axel Springer AG group.
A few months before the provisional insolvency, however, SinnLeffers
had hired Schultze & Braun, the country's largest specialist
restructuring firm, to consult on restructuring options. One Schultze
& Braun partner, Detlef Specovius, functioned as a chief
restructuring officer and assumed the title of managing director in
August. The plan, says Beissenhirtz, was for Specovius and Schultze
& Braun to lead the company toward self-administration.
Piepenburg agreed with the self-administration arrangement. The
court approved the proposal on Nov. 1. Piepenburg became a trustee,
with supervisory powers. Specovius became self-administrator, while
other management remained in place.
His firm filed a plan to the court in December. The court approved
the plan, as did creditors, in March. After a mandatory appeal period,
the court formally discharged the insolvency on May 4.
SinnLeffers benefited from some special circumstances. That included a simple share structure and only one major creditor.
Under German law, shareholders must approve any restructuring plan.
As the sole shareholder, DIH was obviously on board. DIH also was the
only creditor, save some trade creditors, which were paid off in full
under the plan.
Under German law, suppliers have the right to regain their goods
even in an insolvency if they aren't fully paid, says Tashiro, who
heads Schultze & Braun's cross-border insolvency and restructuring
group. An administrator has the right to either assume or reject all
other contracts.
Since DIH agreed to forgo its entire loan, there were no creditor
disputes, which could have derailed the plan. "If this were an LBO and
there were 70 banks, you'd go crazy trying to do a business rescue,"
Beissenhirtz says.
One reason the notion of a SinnLeffers self-administration gained
traction, Beissenhirtz believes, is that neither the judge nor the
wider public blamed management for the company's woes. Instead, there
was an understanding that DIH inherited problems from KarstadtQuelle.
"Management came to power in 2005 and tried to rescue the company ever since," he says.
By contrast, management is normally considered a major part of the problem and immediately removed in most German insolvencies.
What's more, many administrators are loath to cede power.
These circumstances are not easily replicated. While
self-administration has been legally possible since the country's
insolvency laws were updated a decade ago, few cases have been logged.
Even then, it's not exactly the same as an American
debtor-in-possession. "Just looking at the black-and-white law,
management can stay in place," says Hass. "In reality, management gets
a chief restructuring officer-type in place who essentially acts as a
CEO.
"Then the courts might appoint him as administrator."
Particulars of the SinnLeffers case notwithstanding, Tashiro
believes other companies and other turnaround specialists in Germany
will now be tempted to at least try self-administration, and companies
and courts alike will be more predisposed to sign off on the process.
"It gives me confidence," she says.
"Those who have a good understanding of the way it works will be
supportive. Those who never liked the concept will not support it. This
won't change their minds."
Self-administration is a "pretty Germanic clone" of American
debtor-in-possession, and "it's complex," adds Kolja von Bismarck, a
Frankfurt-based partner at Clifford Chance LLP, speaking at a Turnaround Management Association Webinar, or Web seminar.
But "it works."
Comments
Retailing in Germany is in a deep funk. More and more retail chains are going bust as unemployment rises, consumers cut back on spending and distressed banks refuse to lend more money. Woolworth Deutschland GmbH & Co. KG went into preliminary receivership in April; many stores are expected to shut down. Arcandor AG, one of Germany's two biggest department stores, is desperately trying to 
Mr Bahr was simply dragging out his process with the stores and pretending someone would by the dog of the business in the hope the he could get his hands on the property companies too and thus increase his fees. He failed and is now blaming everyone but himself.