Debt-to-Equity Swap in Germany

A debt-to-equity swap in Germany is a restructuring mechanism that converts outstanding creditor claims into equity participation in the debtor company. It is one of the most powerful tools available under the German insolvency framework, enabling businesses to shed unsustainable debt burdens while giving creditors a meaningful stake in the reorganised entity. This guide covers the legal basis, procedural steps, shareholder rights, valuation requirements, tax implications, and practical considerations for both creditors and debtors navigating this process in Germany.

The primary statutory foundation is the Insolvenzordnung (InsO), Germany';s Insolvency Code, which was substantially reformed to introduce the insolvency plan procedure (Insolvenzplan) as a flexible restructuring instrument. The debt-to-equity swap became a formally recognised tool within the Insolvenzplan following the ESUG reform - the Act to Further Facilitate the Restructuring of Companies - which came into force in the early part of the last decade. ESUG amended the InsO to allow creditors to receive shares or equity interests in the debtor company as satisfaction of their claims, even without the consent of existing shareholders in certain circumstances.

Beyond the InsO, the StaRUG - the Act on the Stabilisation and Restructuring Framework for Businesses - introduced a pre-insolvency restructuring regime that also accommodates debt-to-equity conversions. StaRUG allows financially distressed but not yet insolvent companies to restructure their liabilities through a court-confirmed restructuring plan, avoiding formal insolvency proceedings entirely. This dual-track system gives German law a degree of flexibility that is broadly comparable to Chapter 11 in the United States or the Scheme of Arrangement in England and Wales.

The Aktiengesetz (AktG) and the GmbHG (GmbH-Gesetz) govern the corporate law mechanics of issuing new shares or equity interests to creditors. These statutes impose specific requirements on capital increases, shareholder pre-emption rights, and the valuation of non-cash contributions - all of which are directly relevant when a creditor';s claim is contributed as a non-cash asset in exchange for equity.

A debt-to-equity swap typically becomes relevant when a company faces one of the three statutory grounds for insolvency under the InsO: illiquidity (Zahlungsunfähigkeit), imminent illiquidity (drohende Zahlungsunfähigkeit), or over-indebtedness (Überschuldung). Over-indebtedness, in particular, is a common trigger in leveraged structures where a company';s liabilities exceed its assets on a going-concern basis.

In practice, two scenarios illustrate when this tool is most useful. First, consider a mid-sized German GmbH that has taken on significant bank debt to finance an acquisition. A downturn in its sector causes revenues to fall sharply, and the company can no longer service interest payments. The bank, rather than forcing a liquidation that would yield little recovery, agrees to convert part of its loan into a minority equity stake. The company';s balance sheet is repaired, and the bank retains upside if the business recovers. Second, consider a German AG with a complex capital structure involving multiple bond tranches. Bondholders, acting through a creditors'; committee, negotiate an insolvency plan under which their claims are converted into new ordinary shares, effectively wiping out existing shareholders and giving bondholders full ownership of the reorganised company.

A common mistake is to treat the debt-to-equity swap as a purely financial transaction without appreciating its corporate law consequences. The conversion creates new shareholders with voting rights, dividend entitlements, and statutory information rights. Existing shareholders may find their stakes diluted to near zero. Management should engage restructuring counsel early to map out these consequences before any plan is filed.

The insolvency plan (Insolvenzplan) is the primary procedural vehicle for a debt-to-equity swap within formal insolvency proceedings. The process unfolds in several distinct stages, each with its own timeline and requirements.

The insolvency administrator or the debtor itself (in debtor-in-possession proceedings under § 270 InsO) drafts the plan. The plan must contain a descriptive part (darstellender Teil) setting out the current situation of the debtor and the proposed measures, and a shaping part (gestaltender Teil) specifying the legal consequences, including the terms of the equity conversion. The plan must identify the classes of creditors affected, the conversion ratio, and the valuation basis for the claims being converted.

Creditors are grouped into voting classes based on the nature and rank of their claims. Secured creditors, unsecured creditors, and subordinated creditors typically form separate classes. Each class votes on the plan, and approval requires a majority by headcount and a majority by value of claims within each class. Under the cram-down mechanism introduced by ESUG, a dissenting class can be overridden if the plan does not leave any class worse off than it would be in a liquidation scenario - the so-called "no worse off" test.

Existing shareholders vote separately. Under ESUG, the court can confirm a plan even if shareholders reject it, provided the company is over-indebted and shareholders would receive nothing in a liquidation. This override of shareholder veto rights was a landmark change in German restructuring law and significantly increased the practical utility of the debt-to-equity swap.

Once the plan is approved by the required majorities and confirmed by the insolvency court, the corporate law steps are executed. For a GmbH, this means a resolution to increase share capital by way of non-cash contribution, with the creditor';s claim serving as the contributed asset. For an AG, a capital increase against non-cash contributions requires compliance with the AktG, including a report by the management board and, in some cases, an auditor';s review of the contribution value.

The timeline from filing an insolvency application to plan confirmation typically ranges from three to nine months, depending on the complexity of the capital structure and the degree of creditor cooperation. Expedited proceedings are possible where the debtor files a pre-packaged plan alongside the insolvency application.

StaRUG offers a distinct pathway for companies that are not yet insolvent but face imminent illiquidity. The restructuring plan under StaRUG can include a debt-to-equity swap as one of its measures, subject to court confirmation. The key advantage is confidentiality: StaRUG proceedings can be conducted largely out of court and without public disclosure, preserving the company';s reputation and customer relationships during the restructuring.

Under StaRUG, the debtor prepares a restructuring plan and submits it to affected creditors for a vote. The plan can be confirmed by the court even if a minority of creditors dissent, provided the majority thresholds are met and the dissenting creditors are not worse off than in the counterfactual scenario. Shareholders can also be included in the plan if their interests are affected, though StaRUG gives the debtor considerable flexibility in designing the scope of the plan.

A non-obvious requirement under StaRUG is that the debtor must not be over-indebted at the time of filing. If over-indebtedness exists, the company is technically required to file for insolvency under the InsO, and StaRUG is no longer available. In practice, this means the timing of a StaRUG filing is critical, and advisers must carefully assess the balance sheet position before committing to this route.

Many foreign investors underestimate the importance of the restructuring plan';s feasibility analysis. StaRUG requires the debtor to demonstrate that the plan is likely to restore the company';s ability to service its obligations. Courts have rejected plans where the underlying business case was not sufficiently substantiated. Engaging financial advisers to prepare a robust integrated financial model is therefore not optional - it is a practical prerequisite.

If you are considering a debt-to-equity swap under StaRUG or the InsO insolvency plan route, early legal structuring is essential. Contact info@vlolawfirm.com - we can help structure the setup correctly the first time.

The valuation of the claims being converted into equity is one of the most contested aspects of any debt-to-equity swap in Germany. Under German corporate law, a non-cash contribution to a capital increase must be valued at its actual economic value. For a creditor';s claim, this is typically its fair market value rather than its nominal value. If a loan is trading at a significant discount in the secondary market, the equity issued to the creditor should reflect that discounted value, not the full face amount of the debt.

This valuation principle has important consequences. If the claim is overvalued, the capital increase may be challenged, and the creditor may be required to make an additional cash payment to cover the shortfall. Conversely, if the claim is undervalued, existing shareholders may argue that their interests have been improperly diluted. In insolvency plan proceedings, the court and the insolvency administrator provide a degree of oversight that reduces this risk, but disputes over valuation remain common.

Existing shareholders retain pre-emption rights (Bezugsrechte) under the AktG and GmbHG unless those rights are formally excluded. In an insolvency plan, pre-emption rights can be excluded by the plan itself, subject to the court';s confirmation. Outside of formal insolvency, excluding pre-emption rights requires a shareholder resolution with a qualified majority and a written justification from the management board demonstrating that the exclusion is in the company';s interest.

A practical scenario illustrates the complexity: a foreign private equity fund holds a controlling stake in a German AG and has also extended a shareholder loan to the company. The company becomes over-indebted. The fund wishes to convert its shareholder loan into additional equity to repair the balance sheet. However, shareholder loans are subordinated under § 39 InsO in insolvency proceedings, meaning they rank behind all other creditors. Converting a subordinated claim into equity does not require the same valuation rigour as a senior claim, but it also provides no benefit to other creditors and may be challenged as a transaction to the detriment of the creditor body if done shortly before insolvency.

The tax treatment of a debt-to-equity swap in Germany is complex and depends on the perspective of both the debtor company and the creditor. Errors in tax planning can significantly reduce the economic benefit of the restructuring.

From the debtor';s perspective, the conversion of a liability into equity generally gives rise to a debt forgiveness gain (Sanierungsgewinn). Under § 3a of the Einkommensteuergesetz (EStG) and the corresponding provision in the Körperschaftsteuergesetz (KStG), a debt forgiveness gain is exempt from income and corporate tax if the restructuring meets the statutory conditions for a "Sanierung" - a genuine restructuring aimed at restoring the company';s viability. The exemption is not automatic; the company must demonstrate that the restructuring is necessary, suitable, and intended to restore solvency. Tax advisers must prepare a detailed Sanierungskonzept (restructuring concept) to support the exemption claim.

A common mistake is to assume that the tax exemption applies in all cases. If the restructuring is not genuine - for example, if the company is converted into equity only to extract value for related parties - the exemption will be denied, and the full debt forgiveness gain will be taxable. This can create a significant tax liability at precisely the moment when the company has the least capacity to pay.

From the creditor';s perspective, converting a loan into equity at a value below the loan';s book value crystallises a loss. For a German tax-resident creditor, this loss is generally deductible, subject to the general rules on loss utilisation and the specific rules on write-downs of equity investments under § 8b KStG, which restricts the deductibility of losses on equity participations for corporate creditors. Foreign creditors must assess the tax treatment in their home jurisdiction, which may differ significantly from the German rules.

The interaction between the Sanierungsgewinn exemption and the minimum taxation rules (Mindestbesteuerung) under German law adds another layer of complexity. Even where the exemption applies, the company may still face a residual tax liability if it has other taxable income in the same period. Coordinating the timing of the swap with the company';s overall tax position is therefore an important planning consideration.

What happens to existing shareholders when a debt-to-equity swap is implemented in Germany?

Existing shareholders face dilution, potentially to near zero, when a debt-to-equity swap is implemented through an insolvency plan. Under the ESUG reforms to the InsO, shareholders can be overridden if the company is over-indebted and they would receive nothing in a liquidation. Outside of formal insolvency, shareholders retain pre-emption rights unless those rights are formally excluded by a qualified majority resolution. In a StaRUG restructuring, shareholders can be included in the plan if their interests are affected, but the debtor has flexibility in designing the plan';s scope. Shareholders who believe the plan undervalues their interests can challenge it before the insolvency court, though such challenges are subject to strict procedural requirements and time limits.

How long does a debt-to-equity swap take in Germany, and what does it cost?

The timeline depends heavily on the procedural route chosen. A StaRUG restructuring, conducted largely out of court, can be completed in as little as two to four months if creditor cooperation is strong. A formal insolvency plan proceeding typically takes three to nine months from the filing of the insolvency application to plan confirmation and implementation. Professional fees - covering legal counsel, financial advisers, insolvency administrators, and tax advisers - represent the largest cost component and can run into the mid-to-high six figures for complex restructurings. Court fees and registration costs add to the total but are generally a smaller proportion. Companies with simpler capital structures and cooperative creditors tend to complete the process faster and at lower cost.

Can a debt-to-equity swap be done outside of formal insolvency proceedings in Germany?

Yes, a debt-to-equity swap can be implemented outside of formal insolvency through a consensual out-of-court restructuring or through the StaRUG pre-insolvency framework. In a purely consensual restructuring, the debtor and creditors agree on the terms of the conversion without court involvement, and the corporate law steps - capital increase, share issuance - are carried out under the AktG or GmbHG. This approach requires unanimous or near-unanimous creditor consent, which is difficult to achieve in complex capital structures. StaRUG provides a middle ground, allowing a court-confirmed plan to bind dissenting minority creditors without triggering full insolvency proceedings. The choice between routes depends on the degree of creditor consensus, the urgency of the situation, and the need for confidentiality.

A debt-to-equity swap in Germany is a sophisticated restructuring tool that sits at the intersection of insolvency law, corporate law, and tax law. Used correctly, it can transform an unsustainable debt burden into a viable capital structure, preserving jobs and enterprise value. The legal framework - combining the InsO insolvency plan, the StaRUG pre-insolvency regime, and the corporate law requirements of the AktG and GmbHG - provides multiple pathways, each with distinct advantages and risks. Careful planning, early engagement of advisers, and a clear understanding of valuation and tax consequences are essential to a successful outcome.

VLO Law Firms advises international clients on bankruptcy and restructuring matters in Germany. We can assist with insolvency plan preparation, StaRUG restructuring plans, debt-to-equity conversion mechanics, shareholder rights analysis, and coordination with tax advisers. To request a consultation, contact: info@vlolawfirm.com