Companies paying high price as Austrian insolvencies continue to rise

A number of crisis factors – such as COVID, the Russian invasion of Ukraine, and Israel's war against Hamas – have influenced the Austrian restructuring and insolvency environment in the past few years. There are now initial signs of the economic pressure easing (such as a decreasing base rate), although the economic effects of these various crisis factors have yet to fully reach the real economy.

After the number of insolvency proceedings decreased massively during the pandemic, insolvencies returned to the pre-crisis level in 2022, with around 5,000 proceedings. In 2023, this trend continued. The number of corporate insolvencies rose by around 13% to 5,380 compared with 2022, which corresponds to the level ten years ago. Compared with the pre-pandemic year of 2019, 7% more bankruptcies were recorded in 2023. The real estate and construction sectors, as well as the industry sector in general, continue to be massively affected by the above factors.

In addition to the number of company insolvencies, provisional liabilities also skyrocketed, by 534% to around €13.999 billion. This was mainly due to the Signa insolvencies. The number of employees affected also increased by 53%, while the number of creditors rose by 46%.

A declining business landscape, a downward trend in turnover, and a shrinking order situation at around one in two companies speak for themselves. The issue of costs is still the key factor with regard to internal developments.

With 988 insolvent companies, an increase of 15%, the retail sector recorded the highest number of bankruptcies in several years. The main reasons for this, in addition to the high demand for energy and the associated high energy costs, are a failure to recover from the pandemic, a recent structural change, and a decline in private purchasing power.

In this context, there is a need for a modern restructuring and insolvency law able to address these negative developments, and the reform efforts of the European legislator with a directive harmonising certain aspects of insolvency law with common regulations, especially for pre-pack procedures, are highly welcomed.

In Austria, there are two basic approaches to restructuring and insolvency:

• Restructuring by way of out-of-court restructuring or in reorganisation proceedings; and

• Liquidation in an out-of-court liquidation or in bankruptcy proceedings.

Out-of-court restructuring or liquidation is carried out on the basis of the general legal framework provided by Austrian law, as well as international standards that have developed in this area (such as the INSOL principles). The Austrian Insolvency Act provides for special legal regulations for restructuring or bankruptcy proceedings (as sub-forms of insolvency proceedings). Another option is restructuring in restructuring proceedings under the Austrian Restructuring Act, which is a hybrid form of in-court and out-of-court restructuring.

There has been a significant increase in the demand for restructuring in the past year.

On the first signs of a crisis, especially a ‘likelihood of insolvency’, the debtor has to take restructuring measures. If a company is confronted with these first signs and the legal representatives fail to take reasonable actions, the legal representatives expose themselves to possible civil and criminal charges. A likelihood of insolvency is defined in the Austrian Restructuring Act as:

• Imminent insolvency; or

• When the equity ratio falls below 8% and the notional debt repayment period exceeds 15 years.

In such case in Austria, the following informal and formal restructuring procedures are available for business entities.

The aim of this type of restructuring is voluntary debt relief and the continuation of the debtor’s business, all in accordance with the provisions of private law based on a restructuring agreement (Restrukturierungsvereinbarung). In addition to debt relief, the restructuring agreement may contain other restructuring measures, including the subordination of loans, an injection of ‘fresh money’ (new loans or private equity), an M&A process (accompanied by a restructuring trust), or a (partial) liquidation concept (for assets not necessary for operations or real estate).

Since the restructuring agreement is governed by contract law, the restructuring, including each restructuring measure, requires the consent of all the creditors involved. The advantage of an out-of-court restructuring is that it takes place behind closed doors and thus negative effects such as damage to the company's reputation and changed customer and supplier behaviour can be prevented.

These proceedings aim at a discharge of debt through a restructuring plan (Restrukturierungsplan) and at the continuation of the debtor’s business. Only the debtor can apply for this restructuring proceeding to avert insolvency and ensure the viability of its company (Sicherstellung der Bestandfähigkeit).

The creditors are grouped into classes to vote on the restructuring plan. Adoption of the restructuring plan generally requires that a majority of the affected creditors present in each class approve the plan and that the sum of the claims of the consenting creditors in each class amounts to at least 75% of the total sum of the claims. The restructuring plan is binding once it has been confirmed by the court. Restructuring measures can thus be implemented by majority decision.

Besides the options provided by the Restructuring Act, entities that are not insolvent but that are having financial difficulties can apply for statutory restructuring of their business under the Business Reorganisation Act (Unternehmensreorganisationsgesetz). In practice, however, the Business Reorganisation Act is ‘dead law’, since entities do not make use of it.

The legal framework for court-based restructuring and insolvency in Austria is codified in the Austrian Insolvency Act. In principle, the Insolvency Act provides for two types of proceedings: reorganisation and bankruptcy (liquidation).

A reorganisation proceeding enables the debtor to discharge debt while continuing its business. As part of these proceedings, debt is discharged on the basis of a reorganisation plan in which the creditors are offered a quota of 20% (in reorganisation proceedings without a debtor in possession) and 30% (in reorganisation proceedings with a debtor in possession), payable within two years. At the same time, the debtor is able to continue its business or parts thereof. The difference between these two types of proceedings is whether the debtor retains control over the company’s assets and a court-appointed insolvency administrator takes over control or is only involved in important matters.

In order for the insolvency proceedings to be opened as reorganisation proceedings, a reorganisation plan must be submitted.

Insolvency proceedings in the form of bankruptcy (liquidation) proceedings are opened if the company is no longer viable. ‘No longer viable’ means that the company cannot meet its liquidity needs and is not generating sufficient income. In these proceedings, the court appoints an insolvency administrator who takes on the task of liquidating the company and distributing the proceeds of the liquidation proportionately to the creditors, without any minimum quota.

The following requirements must be met for insolvency proceedings to be opened:

• An application for the opening of insolvency proceedings;

• Cost-covering assets (kostendeckendes Vermögen);

• A reason for the opening of insolvency proceedings (illiquidity or over-indebtedness); and

• An insolvency claim or a claim arising from an equity-substituting performance.

With the Recovery and Resolution Act, a special regime in accordance with Directive 2014/59/EU for the reorganisation and insolvency of financial institutions (banks) is available in Austria. If deemed necessary, the competent authority (the Financial Market Authority) may put in place early intervention measures, such as the removal of senior management or the appointment of a temporary administrator. If an institution is failing, or likely to fail, the bank will be dissolved (wound up).

Four kinds of tools are provided to the competent authority for the dissolution:

• Sale of business;

• Bridge institution;

• Asset separation; and

• Bail-in.

While a sale of business is the sale of shares or part of the operations of a bank to a third party, the bridge institution and asset separation tools are used to set up a new institution controlled by the competent authority, which takes over part of the operations of the bank. The difference between the two lies in the objective of the measure, being either continuation (bridge institution) or liquidation (asset separation) of the separated part.

The bail-in tool may be used by the competent authority to decrease in part or full the outstanding liabilities of the bank, if there is a justified reason to expect that the measure – together with all other measures – will restore the financial situation of the bank.

The most notable developments and transactions, with the exception of the insolvency of the Signa Group, have been in the area of out-of-court restructuring. As mentioned above, the real estate sector, in particular, has run into massive difficulties, but the industrial sector also has a considerable requirement for consolidation.

Particularly in out-of-court restructuring, based on the differentiation between lender-led restructuring and shareholder-led restructuring, various new restructuring instruments have been developed and existing restructuring instruments have proven their worth.

One restructuring instrument that has proven itself in this context and continues to bring forth new elements is the debt-equity swap. In the tense relationship between existing owners and potential new owners, the restructuring trust is also gaining popularity as a restructuring instrument.

However, there are currently, and will continue to be, also major distressed transactions in the real estate and industrial sectors. In the real estate sector, larger transactions are still rare at present, as the real estate market is expected to recover. Therefore, a large number of stabilisation measures are required in this area. In the industrial sector, the first major transactions are already taking place, as some companies have to consolidate.

In Austria, the EU Insolvency Regulation (the EU Regulation) is an integral part of Austrian insolvency law. For example, in May 2022, secondary insolvency proceedings pursuant to the EU Regulation were opened concerning a branch of the German company Ausbau Bohn GmbH in Austria.

The EU Regulation is applicable if the centre of main interest of the debtor is located in an EU member state. The regulation includes proceedings due to the occurrence of material insolvency and preliminary proceedings under insolvency law. According to Article 7 of the EU Regulation, the law of the state in which insolvency proceedings are opened applies, although special provisions also apply, for example, in the case of employment contracts or retention of title.

The EU Regulation provides that the opening of insolvency proceedings in one member state is automatically recognised in all the others. The only case in which this does not occur is if the recognition is contrary to the ordre public of the respective member state. If no territorial or secondary proceedings have been opened in the recognising member state, the insolvency proceedings have the same effect there as in the country in which they were opened.

Territorially restricted proceedings can also be conducted. The precondition is that the debtor has a branch in this state. A distinction is made in the designation as follows: if there are no main proceedings pending, these are referred to as ‘particular proceedings’, otherwise as ‘secondary proceedings’. These proceedings are always conducted in accordance with the national law of the state in which the proceedings were opened.

The EU Regulation also provides for a cooperation mechanism for insolvency administrators and insolvency courts for group insolvencies. In any case, this cooperation mechanism must be questioned, as the insolvency of the Signa Group has shown that it could not be applied effectively due to strong individual interests in the respective insolvency proceedings and that no cooperation mechanism is provided for the creditors, who also have similar interests in central points.

The UNCITRAL Model Law on Cross-Border Insolvency is largely overlaid by the EU Regulation, which contains clearer, but also more, regulations.

In December 2022, the EU published a proposal for a directive harmonising certain aspects of (material) insolvency law (the Proposed Directive).

The Proposed Directive lays down common rules on:

• Avoidance actions;

• The tracing of assets belonging to the insolvent estate;

• Pre-pack proceedings;

• The duty of directors to submit a request for the opening of insolvency proceedings;

• Simplified winding-up proceedings for micro-enterprises;

• Creditors’ committees; and

• The drawing up of a key information factsheet by member states on certain elements of their national law on insolvency proceedings.

With respect to avoidance actions, it shall be ensured that legal acts that have been perfected prior to the opening of insolvency proceedings to the detriment of the general body of creditors can be declared void. The Proposed Directive provides three types of avoidance:

• Avoidance due to preferential treatment;

• Avoidance due to lack of, or inadequate, consideration; and

• Avoidance due to legal acts that intentionally disadvantage creditors.

The implementation of so-called pre-pack proceedings is also part of the Proposed Directive. Pre-pack proceedings are a special form of sales process. This sales process is divided into two subsequent phases: the preparation phase and the liquidation phase.

The preparation phase aims at finding an appropriate buyer for the debtor’s business or part thereof before the formal opening of the insolvency proceedings, and the liquidation phase aims at approving and executing the sale of the debtor’s business or part thereof and at distributing the proceeds to the creditors shortly after opening the formal insolvency proceedings.

With regard to the obligation of managing directors to file for insolvency, the Proposed Directive stipulates that the management must submit a request for the opening of insolvency proceedings within three months of becoming aware, or within three months from the point at which they could reasonably have been expected to have been aware, that the respective legal entity is insolvent.

In Austria, there is little requirement to implement the Proposed Directive in this form, as a large part of the planned harmonisation is already covered by Austrian insolvency law. The only major innovation is the pre-pack proceeding. The sales process, which is already provided for in Austrian insolvency law and takes place after the formal opening of insolvency proceedings, is already well structured. Nevertheless, a sales process that is started before the opening of insolvency proceedings could have the potential to lead to even higher sales proceeds. In Austria, to be able to use this restructuring instrument effectively, it will be crucial that the buyer's liability for the debts and liabilities of the seller is excluded accordingly.

In June 2024, the European Central Bank initiated a turnaround with regard to the base rate and reduced the base rate by 0.25 percentage points for the first time in almost five years. It remains to be seen how sustainable the turnaround in the base rate will be, although this will have a significant influence on whether the requirement for restructuring and insolvency remains at a high level in Austria.

Since out-of-court restructuring, in particular, has proven itself in recent years as an extremely flexible instrument for restructuring companies, even economically difficult conditions can be overcome and companies can be put back on a successful path.

Nevertheless, any shortcomings in Austrian restructuring and insolvency law should be taken into account and it should continue to be constantly adapted to new developments.