Restructuring of Listed Companies Using Insolvency Plan Procedures

– The Case of Senator Entertainment AG –

Christian Köhler-Ma, MPA, attorney-at-law, Marc Fritze, M.A., attorney-at-law

I. Introduction

In most cases insolvency proceedings are to satisfy the creditors by liquidation of the assets of
the debtor (cf. - for Germany - Section l sentence 1 1st Alternative Insolvency Code).
However, as a rule this causes considerable losses: In nearly all cases, the liquidation value is
below the going-concern value, goodwill is destroyed irretrievably, employment is lost.

Therefore, the Insolvency Code (Insolvenzordnung, abbreviated InsO) which came into effect
in 1999 intends to promote restructurings in the hope to avoid such losses. Modelled on
chapter 11 of the U.S. bankruptcy code, the “insolvency plan” proceedings were meant to be a
flexible tool for restructurings. However, this has been used less than originally hoped for.
Restructurings by means of an insolvency plan are still relatively rare. Partly this is due to the
complex legal rules applicable to plan proceedings; partly it is caused by debtors who often
file for insolvency only when the business has already collapsed and restructuring is no longer
possible.

The standard – and frequently used - alternative to an insolvency plan is a restructuring

through an asset deal. However, this is impossible if there are assets that cannot be transferred
to a new entity. This was the case regarding Senator Entertainment AG, the central holding of
an international group of companies primarily active in the fields of film licensing and film
production.

II. Senator Entertainment AG

1. The Group

Having been founded in 1979, Senator had developed into a group of companies for
international and German film productions, film distribution and film licence trading. It had
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acquired a large film library containing thousands of films, i.e. various licenses to show or
sublicense films worldwide, in Europe or in Germany. It operated worldwide and was a
leading company in its area in Germany. The company went public in 1999 at the height of
the dot-com stockmarket boom. The combination of a familiar product and the dynamic of the
media industry made it a star on the tech sector of the German stock exchange, the so-called
“Neuer Markt”. At its peak, the Senator Group was valued at over 800 million euros and had
films such as LOLA RENNT and GOOD BYE LENIN to its name.

When the dot-com bubble burst Senator was severely affected. While the volume of bank
loans had previously been low, it quickly increased to a total of € 170 millionsecured by
pledges of shares in the holding’s subsidiaries and participations and of the film library. At
the same time, sales of the associated companies fell and investments (films) did not produce
the expected returns. Management changed. The new CEO had the value of the film library
re-assessed and as a result found that liabilities clearly exceeded the value of the assets
(“Überschuldung”, overindebtedness). After negotiations with the lenders´ consortium broke
down balances in Senator’s accounts were frozen. Then, as required by German companies
law and criminal law, the board of directors of Senator Entertainment AG and the managing
directors of a number of subsidiaries (which had guaranteed the parent’s debt) filed for
insolvency.

2. Legal Questions

The film business is interesting to many for its connections with art and glamour. In addition,
interesting legal questions abound. For example, the group acquired film exploitation rights
via its subsidiaries, Senator Film Verleih GmbH, Senator Film Produktion GmbH, Eurofilm
& Media Ltd. (Ireland) and Senator US-Holding GmbH. Copyright lies with the author of the
work, sec. 7 German Copyright Act. Copyright can be licensed for exploitation purposes. This
licence is to be treated as a lease in German insolvency proceedings and the relevant statutory
rules for leases (Section 581 para. 2 German Civil Code - BGB, Sections 111 sequ., 119
Insolvency Code) apply. However, under German law leases cannot be transferred without
specific agreement of the lessor which owing to the large number of licenses would have been
impossible to obtain. Termination clauses owing to an insolvency are invalid (Section 119
Insolvency Code), but special rights of termination can exist or be excluded (Sections 103,
109 sequ., 112 Insolvency Code). In addition most of the license contracts were governed by
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English or Californian law with obvious conflict of law issues with regard to the effects of
German insolvency law.

Furthermore films produced and distributed in Germany receive considerable subsidies.

Public funding is first given for a specific film if it is produced here. Producers and
distributors of successful films are entitled to further funding. The subsidies have to be repaid
if the original conditions for paying them no longer exist, for example if new films cannot be
financed. The liquidation of a production company therefore results in additional debt –
subsidies repayable - and destroys entitlements to future subsidies.

III. The Insolvency Plan Proceedings

Initially the consortium banks planned to liquidate their collateral leading to a winding up of
the group. However, it became evident that national players from the film industry as well as
some international players and financial investors were interested in the group as a going
concern. Therefore, the decision was taken to find an investor that would either acquire the
majority of shares in the holding after a restructuring or who would buy the operating
companies, leaving only the holding company to be wound up. As the holding company
continued to be listed on the Frankfurt stock exchange the former alternative proved to be
more attractive because it offered investors an additional exit alternative, and to this end an
insolvency plan was drafted.

This insolvency plan combined debt forgiveness and capital increases to achieve the desired
restructuring of the balance sheet. Originally the plan proposed full debt forgiveness in
exchange for a payment of € 10 million to be provided by an outside investor who was to
acquire a 75% majority of the shares through a 90% write-off of the existing equity and a
capital increase of the same amount (€ 10 million). Some collateral deemed not essential for
the business – shares in a chain of cinemas and shares in U.S. film projects – were to be
liquidated and the proceeds paid to the banks as well. The unsecured creditors - a much
smaller group - were to receive a quota of 10% which was substantially higher than what they
could have expected in liquidation. Claims between member companies of the group were to
be forgiven in full without any payments.
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To enable the takeover by a potential investor an extraordinary meeting of shareholders had to

be convened at the beginning of insolvency proceedings in order to comply with statutory
requirements. This meeting was held and resolutions were adopted to initially decrease the
nominal capital to 10 percent of its value (a 10 to 1 writedown of capital) and then to carry
out a capital increase by € 10.364 million. After a short period in which the existing
shareholders could subscribe to the new shares these were available for issue to an investor.

Talks with several bidders were proceeding when the original lenders sold their loans to a
London-based investment bank. This led to a change of strategy as the buyers saw this as a
medium-term investment and did not wish to immediately seek a new industry owner. Instead
they wanted to convert the acquired debt into shares which under German companies law is
subject to narrow restrictions. Hence the investment bank made use of the capital increase
initiated by the insolvency administrator and subscribed to shares in an amount of approx. 9.9
million euros. In addition the provisions of the insolvency plan were changed to accommodate
the interests of the new bank creditor. The bank debt was not any more forgiven in full but
instead reduced from more than € 170 million to € 21 million, € 11 million of which were
subordinated debt. In addition that part of the debt that was found by an independent audit to
be covered by the current value of the groups’ assets was also changed into equity. All debt
exceeding these amounts was forgiven. The collateral which concerned the core business –
the film library and shares in the German subsidiaries - remained as security for the debt that
was not forgiven. Those assets that did not concern the core business – mostly shares in a
cinema chain, U.S. subsidiaries and claims for damages against third parties - were transferred
to the bank for liquidation.

The creditors unanimously accepted this insolvency plan at a special meeting convened for
this purpose. As a consequence, the subsidiaries were released from their co-liability as
envisaged in the plan and their insolvency applications could be withdrawn.

During the whole process normal operations were maintained in cooperation between
management and insolvency administrator. Films previously acquired or produced were
released into cinemas and various film production projects were continued. Specifically,
production of the French-English-Romanian-German co-production MERRY CHRISTMAS (later
nominated for an Academy Award) could be completed. The film had its world premiere
during the insolvency proceedings. By cutting back on personnel costs and rental expenses
further restructuring measures were carried out and the cost structure reorganised.
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IV. Conclusion and outlook

The Senator insolvency shows that a group of companies with international operations can be
successfully restructured through German insolvency proceedings. It also illustrates that de
facto a debt-equity-swap can be achieved if both shareholder measures and insolvency plan
proceedings are combined. Changing the name of a company and shifting its seat outside the
German jurisdiction – as in the case of Deutsche Nickel AG / DENIC – is not necessary to
achieve equivalent results.