Claims for the recovery of payments made to creditors after the company should have filed for insolvency are attractive from the perspective of the illiquidity administrator: The law generally holds company directors liable for all payments made by the company after insovlency maturity. Such claims can quickly accumulate into significant amounts. Moreover, according to the case law of the German Federal Supreme Court (Bundesgerichtshof, „BGH“), these claims are typically covered by directors & officers (D&O) insurance policies.[1] It is therefore unsurprising that legal violations related to delayed insolvency filings account for a substantial portion of manager liability cases. As a result, our blog will occasionally explore practical aspects of § 15b of the German Insolvency Code (Insolvenzordnung; „InsO“) that may become relevant in court or settlement discussions. This article represents the third forray in our series of forrays into this area and, like the second forray, focuses on the definition of illiquidity pursuant to § 17 para. 2 sentence 1 InsO.
In fact, the BGH’s IXth Senate for Civil Matters issued a landmark ruling in 2005[2], establishing that illiquidity should be assumed if (1) a liquidity gap exists on the relevant date, (2) the gap is not foreseeably bridgeable within the following three weeks, and (3) 10% or more of the debtor’s total due liabilities remain unpaid. In 2017, the BGH’s IInd Senate for Civil Matters confirmed[3] that illiquidity is determined by combining the static figures from a balance sheet as of the relevant date with dynamic figures from a financial projection over the three-week period. However, in more recent rulings, the BGH has indicated that under certain conditions, a series of financial status may suffice to demonstrate illiquidity. Does this shift in the method of proof alter the concept of illiquidity itself? This question has both legal and computational significance. Calculating the liquidity gap solely based on financial status reports leads to significantly different outcomes.
The new standard on the determination of illiquidity issued by the German Institute of Accountants (Institut der Wirtschaftsprüfer; „IDW“), IDW Standard S 11, now also relies on financial status reports for illiquidity calculations, increases the percentage threshold for the liquidity gap compared to the BGH standard, and warns that using the BGH method may entail liability risks. In contrast, our second forray dated October 6, 2024, argued that the BGH’s easing of evidentiary requirements does not represent a departure from the detailed reasoning in the BGH rulings of 2005 and 2017, which require a liquidity plan covering the three-week period following the relevant date. This interpretation is supported not only by the procedural context of these rulings but also by the substantive considerations underpinning the 2005 and 2017 decisions. Accordingly, IDW S 11 should not be followed. This article will elaborate on these points, building on the second forray from October 6, 2024.
- § 15b InsO: Starting Points
[Refer to the first forray dated 20 August 2024.]
- Questions Concerning Insolvency: Legal „Tomographies“
[The significance of the term “illiquidity” and its interpretation by the BGH in the aforementioned 2005 and 2017 rulings were discussed in the second forray dated 06 October 2024.]
- Differences in the Methods for Calculating the “Liquidity Balance” on the One Hand and IDW S 11 as well as Methods (2) and (39) on the Other Hand
- Differences in Calculation Method and Outcome
- Differences in the Methods for Calculating the “Liquidity Balance” on the One Hand and IDW S 11 as well as Methods (2) and (39) on the Other Hand
According to IDW S 11, the liquidity gap in the liquidity balance should be calculated solely based on financial status reports, without any projection. This approach differs from the BGH rulings of 2005 and 2017, which include a forecast.[4] Following the IDW approach entails risks:
As outlined in the second forray, the BGH calculates the liquidity balance by including on the asset side both available cash on the relevant date (Assets I) and funds expected to flow in or become liquid within the next three weeks (Assets II). The BGH then compares this sum to the liabilities due on the relevant date (Liabilities I) and those becoming due within the next three weeks (Liabilities II), using the following formula: Assets I + II : Liabilities I + II [5]
This is a fraction. Expressed in percent, the result is as follows:
Coverage portion in %=AI+AIILI+LII . 100%
The coverage gap then amounts to: 100% - Coverage portion.
As a simple numerical example, let us assume: Assets I = 5, Assets II = 4, Liabilities I = 6, and Liabilities II = 4. Based on the financial status report, there is an initial liquidity gap of , which, relative to Liabilities I, corresponds to a gap of (rounded). During the subsequent three-week period, the additional inflows (Assets II = 6) match the additional outflows (Liabilities II = 6). Thus, the absolute liquidity gap remains unchanged at . However, according to the BGH formula, the relative coverage ratio improves because the denominator (Liabilities I + Liabilities II) increases. Consequently, the coverage ratio becomes:
Coverage portion in %=5+46+4 . 100 = 90%.
The liquidity gap then decreases to (100% - coverage portion =) 10%, compared to the initial 16.6%. Despite the unchanged absolute liquidity gap of -1, the percentage liquidity gap decreases due to the larger reference base.
IDW S 11, paras. 51, 25, rejects this “volume effect” derived from BGH case law on computational grounds, arguing that it tends to produce smaller liquidity gaps and thus results in a later recognition of insolvency. Instead, IDW S 11 proposes calculating the coverage gap initially as an absolute figure (AI + AII – LI – LII) (in our example: –1) and then comparing it (not to LI + LII, but only) to PI. According to IDW S 11, this results in a coverage gap of (1 : 6 =) 16.6%. This approach seems to be supported by the fact that the sums formed by the BGH in the formula Assets I + II : Liabilities I + II do not account for the fact that, during the three-week period, Assets I (fully or partially) are quickly collected, and Liabilities I (fully or partially) are quickly settled.[6] As a result, the reference base decreases. Even in planning terms, therefore, in a financial status calculated for the last day of the three-week period, the available Assets I and Liabilities I will be lower than the sum of AI + AII and LI + LII calculated at the initial reference date. As mentioned, IDW S 11, in line with the BGH rulings presented in the second installment from October 6, 2024, instead proposes a series of financial status reports presented in a “meaningful number.” This approach is intended to apply to both ex-ante forecasts and retrospective analyses.[7]
- Legal Superiority of the “Liquidity Balance” Method
Which calculation method is correct? The IDW overlooks that this is not merely a computational issue but a legal question. Legally, the BGH’s approach should prevail.
- 2006 BGH Ruling
In its 2006 ruling (see the second forray from October 6, 2024), the BGH (IXth Senate for Civil Matters) stated in the context of an avoidance action that, for the purposes of § 17 para. 2 sentence 1 InsO, “the funds available at the relevant date and those expected to become liquid within three weeks must be compared to the liabilities due and payable on the same date.”[8] Although the wording is not entirely clear, since it refers to “the same date” while also mentioning funds expected to become liquid within three weeks, it appears that the BGH was referring to the last day of the three-week period.
In the IInd Senate for Civil Matters’s 2017 ruling, which referenced this 2006 decision, the calculation method was explicitly specified as AI + A II : LI + LII.[9]
- Significance of Methods (2) and (3)
For further details on the BGH-approved methods (2) and (3) for proving illiquidity, see the second forray dated October 6, 2024.
Nothing different arises from the decisions of the IXth and IInd Senate for Civil Matterss, further explained in detail in forray 2 dated 06 October 2024, regarding the methods (2) and (3) permitted for verification purposes in addition to the "liquidity balance" (method (1)), that is,:
Method (2): A liquidity status as of the key date combined with a register covering the following three weeks, showing the actual daily inflows and outflows, where the liquidity gap is significant on every day of this period (in the case in dispute, not less than 77% on any day).
Method (3): Several liquidity statuses presented on a daily basis in a "meaningful number," where, starting from a status indicating a significant shortfall on the key date, the liquidity gap cannot be materially closed on any of the forecast period's[10] recorded dates.
Methods (2) and (3) are both retrospective and show little difference between them. However, these methods neither sum AI + AII nor LI + LII. They do not encompass a cash flow calculation for the three-week period but merely several financial statuses. Accordingly, they avoid the volume effect criticized by IDW S 11, as the statuses on each series' key date disregard liabilities that have already been paid by the relevant key date. Nevertheless, as elaborated in forray 2 dated 06 October 2024, the newer decisions serve to ease procedural proof without challenging the foundation of the outlined BGH decisions of 2005 and 2017.
- Substantive Situation
In this analysis of case law, it is important to note that illiquidity and the timing of its occurrence are legal evaluations. The criteria that inform this evaluation and led the BGH to the 10% threshold value outlined in forray 2 are presented in the BGH’s landmark decision of 2005.[11] There, the BGH explains in detail the reasons why a financial shortfall on a single day does not result in illiquidity, how long the timeframe for remedying a shortfall is, and up to what threshold levels shortfalls are tolerated by the legal system. The BGH explicitly rejects the view that was previously held, according to which a debtor would generally be considered insolvent if they are unable to meet their due liabilities in full (100%) within the three-week period.[12]
The justification for a tolerance threshold is derived from: (1) Legislative materials, (2) the disadvantages of premature insolvency filings, which also negatively affect creditors, (3) the interference with constitutionally protected rights of the debtor associated with an illiquidity proceeding (Articles 12, 14 of the German Basic Law), and (4) macroeconomic considerations. The BGH also derives the 10% threshold from legal considerations:
"A higher threshold would be difficult to reconcile with the legislator’s intent to lower the requirements for assuming illiquidity. Conversely, a lower threshold—such as 5%—would come too close to the rigorous 'zero-tolerance principle' to have any practical effect."[13]
Thus, the BGH's legal guidelines are based on legal evaluations. This also applies to the formula introduced in 2017 (AI + AII : LI + LII)[14]. Moreover, "illiquidity" is not to be determined by an absolute EUR amount. This is evident from the 10% threshold, which results in company-specific metrics. However, only the metrics AII and LII reflect the extent of the actual cash flows of the affected company. The cash flow calculation over the three-week period more realistically represents the financial means moved by the company in real life than a status review or a series of mere status reviews.
Additionally, only a three-week forecast accounts for the financial reserves that can be activated during this period, which may not yet be utilized as of the key date or even over a series of key dates—such as inventory or other working capital components that the debtor may not yet deem ready to be realized. Furthermore, key dates (and series of key dates) may be more distorted by random fluctuations in payment flows than continuous cash flow analyses. From a legal perspective, therefore, the formula AI + AII : LI + LII cannot be invalidated by referencing business accounting systems alone.
Consequently, the caution expressed in IDW S 11 regarding the liability risks associated with using the formula AI + AII : LI + LII must itself be viewed with caution: not only can a delayed illiquidity filing cause harm, but so too can a premature one. The differentiation must instead be made according to the outlined legal evaluations. Legal evaluations take precedence over business-oriented guidelines.[15] To the extent that IDW S 11 deviates from the legal situation[16], its capability to excuse experts, auditors, or consultants who rely on it, is limited.
[1] German Federal Court of Justice (BGH), judgment dated November 18, 2020 - Case No. IV ZR 217/19.
[2] BGH judgment dated May 24, 2005 - Case No. IX ZR 123/04, Section II 3 of the reasoning.
[3] Judgment dated December 19, 2017 – Case No. II ZR 88/16
[4] IDW S 11, Paragraphs 51, 24 (Footnote 59).
[5] BGH judgment dated December 19, 2017 – Case No. II ZR 88/16, Paragraphs 34, 41 et seq., 62.
[6] See also IDW S 11, Paragraph 25, Footnote 11, which notes that the BGH does not consider “payments made on due and maturing liabilities.”
[7] Paragraphs 51 et seq., 25; similarly, Philipp/Säuberlich, ZinsO FOKUS 2022, 677, 679, who criticize that this deviation by the IDW from BGH case law creates significant legal uncertainty.
[8] BGH, judgment dated October 12, 2006, Case No. IX ZR 228/03, Paragraph 28.
[9] BGH, judgment dated December 19, 2017 – Case No. II ZR 88/16, Paragraphs 34, 41 et seq., 62.
[10] In this case as well, the submitted financial status reports represented the actual figures of the past within the relevant three-week period; the term “forecast period” is evidently not intended to imply a projection made from an ex ante perspective, but merely denotes the three-week assessment period.
[11] BGH judgment dated May 24, 2005 - Case No. IX ZR 123/04, Section II 2 b of the reasoning.
[12] BGH judgment dated May 24, 2005 - Case No. IX ZR 123/04, Section II 3 of the reasoning.
[13] Ibid.
[14] BGH, judgment dated December 19, 2017 – Case No. II ZR 88/16, Paragraphs 34, 41 et seq., 62.
[15] See generally Spindler, in: Goette/Habersack (eds.), Munich Commentary on Stock Corporation Law, 6th edition 2023, Section 93, Paragraph 37; Grundei/Reuter, “Agile” Organizational Structures: Entrepreneurial Necessity or Organized Irresponsibility?, DB 2024, 2309, 2314 et seq.
[16] Also critical of the IDW’s deviation from BGH case law: Philipp/Säuberlich, ZinsO FOKUS 2022, 677, 679.