The Illiquidity Test Under § 17 InsO

What the illiquidity test asks

The illiquidity test determines whether a German company has reached the general ground for opening insolvency proceedings: illiquidity (Zahlungsunfähigkeit). A debtor is illiquid if it is unable to meet its payment obligations that have fallen due; illiquidity is generally to be assumed if the debtor has stopped making payments (§ 17(2) InsO).

The illiquidity test is therefore a liquidity test, not a balance sheet test: a profitable company with valuable assets can be illiquid, and a loss-making company with ample cash may not be. For the management of a corporation, the result has immediate consequences, because the duty to file for insolvency arises without culpable delay and at the latest three weeks after illiquidity occurs (§ 15a(1) InsO), and payments after that point can trigger personal liability (§ 15b InsO).

The statutory definition is short. The details of the illiquidity test have been developed by the Federal Court of Justice (BGH), which distinguishes genuine illiquidity from a mere temporary payment stoppage and has set quantitative guidelines for the size of the liquidity gap and the time horizon within which it must be closed.

The BGH's 10 per cent gap and three-week horizon

The BGH's standard dates back to its judgment of 24 May 2005 – IX ZR 123/04 and has been confirmed repeatedly.

In its judgment of 19 December 2017, the BGH summarised it as follows (BGH, judgment of 19 December 2017 – II ZR 88/16): illiquidity, rather than a mere temporary payment stoppage, exists if the debtor is unable within three weeks to obtain the funds needed to pay its due liabilities and to reduce the liquidity gap to below 10 per cent.

Where the gap is 10 per cent or more, illiquidity is regularly to be assumed, unless it is exceptionally to be expected with near certainty that the gap will soon be closed completely or almost completely and creditors can reasonably be expected to wait in the particular circumstances. The assessment is made solely on the basis of objective circumstances.

A gap of less than 10 per cent does not automatically mean solvency either: if it is foreseeable that the gap will soon exceed 10 per cent, illiquidity may already exist. The three-week horizon mirrors the maximum filing period of § 15a(1) InsO and reflects the time a debtor can reasonably use to obtain new funds, for example through a bridge loan, an equity injection or the sale of assets.

Applying the illiquidity test: liquidity status and Passiva II

The illiquidity test is carried out in two steps. First, a liquidity status (Liquiditätsstatus) on a reference date compares available liquid funds, including cash, bank balances and unused credit lines that can be drawn, with liabilities that are due and payable. A liability is due when the creditor can demand payment and has done so; liabilities whose payment the creditor has effectively deferred are not counted. Second, where the status shows a gap, a liquidity balance (Liquiditätsbilanz) or a short-term liquidity forecast determines whether the gap can be closed within three weeks.

In its 2017 judgment, the BGH clarified a long-debated point: when the liquidity balance is drawn up, the liabilities that fall due and are demanded within three weeks after the reference date, the so-called Passiva II, must be included alongside the funds expected to become available in that period. A debtor cannot therefore count incoming payments over the next three weeks without also counting the liabilities that fall due in the same period.

The Court also held that a managing director sued by the administrator cannot simply dispute a liquidity status based on the company's accounts by claiming the books were not properly kept; he must show in detail which liabilities were not due or not demanded.

Common errors in the illiquidity test

Experience from liability and contestation disputes shows recurring errors when companies apply the illiquidity test themselves. The most frequent is counting funds that are not actually available: credit lines that the bank has already frozen or is entitled to cancel, receivables from customers who are themselves in difficulty, or proceeds from an asset sale that has not been signed. Only funds that the company can realistically obtain within three weeks may be taken into account.

A second error is leaving out liabilities. Liabilities are due when payment can be demanded and the creditor has demanded it, which includes invoices due under agreed terms. Informal "understandings" with creditors that they will wait are counted only if they amount to a genuine deferral, ideally documented. Tax and social security liabilities, wages and rents are frequently overlooked in forecasts prepared under time pressure.

A third error is ignoring the dynamic perspective. A snapshot on a single date may show a small gap, while the forecast for the following weeks shows a widening shortfall. The BGH's approach requires both the reference-date status and the three-week balance including Passiva II. Finally, companies sometimes treat the three weeks as a grace period for doing nothing. The period is available only for serious efforts to close the gap or to prepare an orderly filing, and those efforts should be documented in board minutes and correspondence with financiers.

The illiquidity test in groups and with intra-group financing

The illiquidity test is applied separately to each legal entity. In a group, a subsidiary may be illiquid even though the group as a whole has sufficient cash, if the subsidiary cannot access that cash. Claims under a cash pool agreement or intra-group loans count as available funds only if they can actually be called and paid within three weeks; in the 2017 case, the parties argued about a loan to a sister company that was repayable on demand. Comfort letters and parent guarantees help only if they give the subsidiary an enforceable claim to liquidity that can be realised in time.

Group treasury should therefore be able to produce entity-level liquidity forecasts quickly, and directors of subsidiaries must form their own view rather than rely on group assurances. Where a parent decides to stop funding a subsidiary, the subsidiary's directors may have to file within three weeks. Our insight on the insolvency of a German subsidiary explains the parent's exposure.

Payment stoppage and its indicators

Under § 17(2) sentence 2 InsO, illiquidity is generally to be assumed if the debtor has stopped making payments (Zahlungseinstellung). A payment stoppage is the outward manifestation of illiquidity: conduct of the debtor indicating to the relevant circles that it is unable to pay its due liabilities in substantial part. Courts infer a payment stoppage from indicators such as the debtor's own statements that it cannot pay, the non-payment of wages, social security contributions or taxes over several months, returned direct debits, enforcement measures by several creditors, payment only under pressure of enforcement, or requests for deferral combined with a failure to pay agreed instalments.

A payment stoppage, once established, is presumed to continue until the debtor has resumed paying its creditors generally. In insolvency contestation cases, the BGH has emphasised that a declaration by the debtor that it cannot pay for lack of funds is a particularly significant indicator and that other indicators must carry comparable weight if there is no such declaration; see our insight on insolvency contestation under § 133 InsO.

Illiquidity, imminent illiquidity and over-indebtedness

Illiquidity must be distinguished from the other insolvency grounds. Imminent illiquidity exists if the debtor is likely to be unable to meet its existing payment obligations when they fall due, generally over a forecast period of 24 months (§ 18(2) InsO). It entitles the debtor to file, opens access to the StaRUG and protective shield proceedings and triggers the early-warning duties of management, but it does not create a filing obligation. Over-indebtedness is a balance sheet test combined with a 12-month going-concern forecast and applies to legal entities (§ 19 InsO); see our insight on going-concern forecasts and over-indebtedness.

The distinction matters for the choice of restructuring tools. Debtors that are only imminently illiquid can use the StaRUG or protective shield proceedings, while actual illiquidity closes both routes and requires a filing. Testing illiquidity accurately and early therefore keeps strategic options open.

Consequences for directors and creditors

Once illiquidity occurs, directors must file without culpable delay and at the latest within three weeks; using the period is permitted only while realistic restructuring efforts are pursued with due care. Payments after illiquidity are permitted only if compatible with the care of a prudent manager (§ 15b(1) InsO), with payments in the ordinary course that maintain the business generally permitted during the filing period while restructuring or filing preparations are pursued diligently (§ 15b(2) InsO). Late filing is a criminal offence and can lead to personal liability towards creditors. Our page on directors' duties in a crisis explains these duties.

For creditors, the illiquidity test matters in insolvency contestation, in decisions to continue supplying a customer and in assessing whether to file a creditor's petition. Creditors who know of illiquidity face a higher risk that payments they receive will be avoided. Our insight on customer insolvency and supplier strategies discusses practical responses.

How TRW & Co helps

We advise managing directors, supervisory boards, shareholders, lenders and administrators on the illiquidity test and its consequences. We review liquidity status and forecast methodology with financial advisers, assess filing obligations, structure bridge financing and standstill agreements to avoid illiquidity, and defend or pursue liability and contestation claims in which the timing of illiquidity is disputed. This page is general information, not legal advice. If you need to assess a company's position, please contact us.