When a corporation has spent all its equity through the accumulation of losses, thus showing a negative equity in its balance sheet, Section 225 (1) of the Business Enterprise Code (UGB) prescribes that its management must explain in the notes to the annual accounts whether the debt level is high enough to be of relevance under insolvency law. This would be the case if a negative continuity forecast were added to the debts on the books.
Same as when it is unable to pay, the company needs to file for insolvency proceedings as otherwise the management could be made liable under the relevant rules of civil and company law and might expect to suffer consequences under criminal law.
Yet tools to counter a crisis in good time before insolvency proceedings need to be instituted do exist and are explained below:
Eliminating an excessive calculatory debt by waiver of priority
If no new (equity) capital is contributed, a typical remedy is to reduce the priority of debts in order to eliminate excessive debts from the books.
This remedy must involve a so-called qualified waiver (“Nachrangabrede”) which complies with the requirements of Section 67 (3) of the Insolvency Act (IO). According to this provision, a debt need not be posted in the balance sheet when the creditor states that it wants to be satisfied only after a (possible) negative equity is made good (Section 225 (1) UGB) or, in the case of liquidation, after all other creditors have been satisfied, so that no insolvency proceedings need to be filed because of this debt. All three conditions (satisfaction after elimination of the negative equity, after all other creditors in the event of liquidation, and no need to institute insolvency proceedings because of this debt) need to be stated cumulatively so that the obligation to carry the debt as a liability on the balance sheet can be waived.
If the management is able to remove the excessive (calculatory) debt from its books, it has found a loophole to escape the crisis because such a debt is ignored when looking at the company from an insolvency law point of view. Thus: if debts deprioritised by qualified waivers exceed the negative equity, the company is not deemed to be in excessive debt and the crisis is over (at least for the time being).
This approach involving a waiver of priority applies not just to claims by shareholders but also to (outside) capital claims by banks, where such outside capital becomes functionally similar to equity and is typically known as mezzanine capital. Such a waiver may even allow a company to take out a loan on the market.
In a group context, the crisis may be overcome by obtaining a so-called “binding letter of comfort” from other group companies, typically the parent. However, this requires the unit issuing such a letter to have adequate financial means to actually satisfy the debts of the distressed unit.
Positive continuity forecast
If priority waivers do not help to ensure a company’s survival, the management is required to carry out a continuity forecast in order to establish that the excessive debt on the books does not oblige it to file for insolvency. It is only when the forecast arrives at a positive result that this condition is satisfied; if not, insolvency proceedings must be instituted. Basically, such a forecast needs to reason whether the company is likely to be able to continue its business activities while meeting its payment obligations. To this end, a primary forecast looks at the company’s ability to pay in the next six to twelve months, based on a financial schedule. A secondary forecast, which extends for a longer period of about three years, comprises planned profit and planned loss accounts, planned balance sheets and cash flows. Together, these figures need to show a sustainable reversal of the company’s fortunes in order to constitute a positive continuity forecast.
Preparing the continuity forecast is the duty of the management. Practical experience has shown that particular care should be lavished on it, given the liability risks noted above.
Legal support
When in distress, a company should quickly obtain the advice of insolvency and restructurisation experts so as to ensure that ways and means of coping with the crisis are used in a targeted and timely manner.
Summary
Once a crisis has solidified and the company’s equity has been spent on covering losses, a qualified waiver of priority may help eliminate excessive debts from the books, always providing that this method complies with the strict provisions of Section 67 (3) IO. If this should fail, a continuity forecast must be performed, which needs to be positive in order to avoid the obligation to file for insolvency proceedings, i.e. it must confirm that the company has a high probability of survival.
For further information on this topic please contact Matthias Schmidt at Preslmayr Attorneys at Law by telephone (+43 1 533 16 95) or email (schmidt@preslmayr.at). The Preslmayr Attorneys at Law website can be accessed at www.preslmayr.at.
