By: Lena Fleischmann, a German law student and a Referendarin at Phillips Nizer LLP.
The coronavirus pandemic has taken a particularly harsh toll on many fashion brands and retailers. Since stay-at-home orders were enacted in mid-March, the pandemic has accelerated the demise of major companies that were already in trouble as Germans (and their wallets) stayed home. More and more companies have been filing for bankruptcy, key among them fashion brands and retailers—most notably brands that had little to counter the remarkable advance of online retailing and the success of fast fashion providers such as H&M and Zara.
From the country’s largest chain of department stores, Galeria Karstadt Kaufhof, which filed for insolvency under a plan to close dozens of stores, to Tom Tailor, which received a bailout from the German federal government, well-known German names in the fashion industry are facing the twin challenges of changing shopping patterns and public-health lockdowns with the same mixed success of American brands. In April, the popular women’s fashion company Hallhuber sought rescue in what is known in Germany as a protective shield procedure. (That proceeding, which also was used by Galeria Karstadt Kaufhof, is approximately the same as a Chapter 11 proceeding in the USA.) The Esprit fashion group announced at the beginning of July that it would close around half of its approximately one-hundred branches in Germany as part of its realignment. Around 1,100 jobs were to be cut.
According to a current industry survey, sales of products in Germany in the fashion trade from January to June were thirty-five percent below those in 2019. The online sales of retailers with large physical operations were typically less than ten percent of their total turnover—a presence too lean (even after accelerated expansion) to provide complete relief for many of them in the current crisis. There is an expectation of a further wave of insolvency proceedings and bankruptcies in the German fashion industry in the coming months.
There are cultural and lifestyle consequences to all this. Until the pandemic, major German cities had retained lively central shopping districts that had formed a core strength of retail sales.[1] Major store closings have raised concerns about city centers growing deserted. “We run the great risk that traditional shopping malls that have shaped our inner cities for many decades will go bankrupt” warned Josef Sankjohanser, the president of the German Trade Association.
To determine if an insolvency filing is required, a struggling company must examine its liquid funds and its current liabilities on a certain key date. Liquid funds include available cash, credit lines and receivables. Which of those non-cash items may still be so included in the calculation of assets, and at what point the collection of a receivable may no longer be expected with certainty, are difficult to determine in a generalized matter; much depends on the facts of the individual case. The one constant is that, if a German company cannot demonstrate that it can meet ten percent or more of its current liabilities within three weeks, it is deemed insolvent. According to the applicable statute (§ 15a I 1 InsO), entities that meet that test must file for insolvency. It is important to understand, however, that they are not considered bankrupt, which is distinguished from insolvency in Germany. Although bankruptcy denotes a final end to business activity and is a procedure (with criminal liabilities for certain wrongdoings), insolvency in the economic sector is a declaration of a precarious business status.
According to § 15a I 1 InsO of the insolvency statute, entities must file for insolvency if they fail the statutory indebtedness test. The rule is universally applicable whether a company is organized as GmbH (limited liability company), AG (public limited company), registered cooperative, or UG (small limited liability company). If the company has met the threshold inability to pay its debts, the directors could be liable to prosecution for delay in filing for insolvency, § 15a InsO i.V.m. §§ 17, 18, 19 InsO. In Germany, such delays in filing cases are about 11.5% of all white-collar criminal cases.
In view of the crisis, the Covid-19 Insolvency Suspension Act (COVInsAG), an emergency federal law, provided changes in German insolvency law through March 31, 2021, giving companies facing financial problems due to the pandemic greater leeway in avoiding forced insolvency filings.
The future of the fashion business in Germany remains as uncertain as it does in the rest of the world. The key questions will be the same: When will it all end? And when it does end, how will things be different? After all, the suspension of the obligation to file for insolvency is only a temporary measure to combat a global crisis, not a long-term solution to the changes in retailing that have challenged stores throughout the world.
[1] Many German cities have pedestrian zones where people can leisurely walk through the city center, strolling from one shop window to the next without having to deal with automobile traffic. These zones aim to provide better accessibility for pedestrians, to enhance the amount of shopping and other business activities, and to improve the overall urban experience.
