Insolvency Employment Law: Employees in Insolvency

How insolvency employment law works

Insolvency employment law is the set of rules that modify German employment and works constitution law when an employer becomes insolvent. Employment relationships do not end with the insolvency of the employer; they continue with effect for the estate, and the administrator, or the debtor in self-administration, steps into the employer's role. Protection against dismissal, works council rights and the rules on business transfers continue to apply. Insolvency employment law, however, shortens notice periods, simplifies the negotiation of operational changes, caps social plans and provides insolvency money for unpaid wages. These tools are a major reason why companies restructure through insolvency proceedings rather than out of court.

For employees, insolvency means uncertainty but also protection: wages for the three months before the insolvency event are secured by the Federal Employment Agency, pension rights are protected by the statutory insolvency insurance, and dismissals still require a social justification under the Protection Against Dismissal Act. For investors and buyers, insolvency employment law determines how quickly a business can be adapted and which liabilities transfer with it.

Insolvency money for unpaid wages

Employees who worked in Germany are entitled to insolvency money (Insolvenzgeld) if they still have claims to wages for the three months of the employment relationship preceding the insolvency event (§ 165(1) SGB III). The insolvency event is the opening of insolvency proceedings, the rejection of the petition for lack of assets or the complete cessation of business in Germany where no petition has been filed and proceedings are obviously out of the question. Insolvency money is paid by the Federal Employment Agency and is financed by an employer levy; it covers net wages up to a ceiling linked to the contribution assessment ceiling.

In practice, insolvency money is pre-financed. Before the proceedings are opened, a bank buys employees' wage claims with the consent of the Employment Agency and pays the wages on the normal dates; it is later reimbursed by the Agency. This allows the business to continue in the preliminary proceedings without paying wages from its own liquidity for up to three months, which is often the single most important source of liquidity in an insolvency restructuring. Timing the opening of proceedings to make full use of the three-month period is therefore a standard planning step.

Insolvency employment law on notice: § 113 InsO

Employment relationships can be terminated by the administrator, and by the employee, regardless of an agreed fixed term or an agreed exclusion of ordinary termination; the notice period is three months to the end of a month unless a shorter period applies (§ 113 InsO). This overrides longer contractual, collective or statutory notice periods. If the administrator terminates, the employee can claim damages for the early termination as an ordinary insolvency creditor.

The shortened notice period does not remove the need for a valid reason. In establishments covered by the Protection Against Dismissal Act, dismissals must still be socially justified, usually on operational grounds, with a correct social selection. Special protection for works council members, pregnant employees, employees on parental leave and severely disabled employees continues to apply, with the required consents of authorities. The mass layoff notification rules of § 17 KSchG also apply in insolvency; errors in the consultation or notification can render dismissals invalid. Our insight on mass layoff notifications under § 17 KSchG explains the requirements.

Operational changes and the works council in insolvency

Works council rights continue in insolvency. A planned operational change, such as a closure or major headcount reduction, requires negotiations on a reconciliation of interests and a social plan under §§ 111 and 112 of the Works Constitution Act. Insolvency employment law accelerates this. If no reconciliation of interests is reached within three weeks of the start of negotiations or a written request to negotiate, although the administrator informed the works council in good time and comprehensively, the administrator can apply to the labour court for consent to implement the change without the conciliation procedure (§ 122 InsO).

If the administrator and the works council agree a reconciliation of interests that names the employees to be dismissed, it is presumed that the dismissals are justified by urgent operational requirements, and the social selection can be reviewed only for gross errors with regard to length of service, age and maintenance obligations (§ 125(1) InsO). This "list of names" reconciliation is the key tool for workforce reductions in insolvency, because it greatly reduces litigation risk. Where no works council exists or no agreement is reached, the administrator can ask the labour court to determine that the dismissals of specified employees are socially justified (§ 126 InsO).

Works agreements and social plans

Works agreements that impose obligations burdening the estate can be terminated with three months' notice even if a longer period was agreed (§ 120(1) InsO).

A social plan agreed after opening may provide a total volume of up to two and a half months' earnings of the employees affected by dismissal; social plan claims are administrative expenses, but unless an insolvency plan is agreed, no more than one third of the estate otherwise available for distribution may be used for them (§ 123 InsO). Social plans drawn up in the three months before the petition can be revoked by the administrator or the works council (§ 124 InsO). Our insight on social plans and reconciliation of interests covers the general rules.

Employee transfers in asset deals

When an administrator sells the business or part of it, the buyer takes over the employment relationships under § 613a BGB, as in any business transfer. The employees must be informed and can object to the transfer. In insolvency, however, the buyer's liability is limited: according to established case law of the Federal Labour Court, the buyer is not liable for claims that arose before the opening of insolvency proceedings, because they are part of the distribution to all creditors; liability for pre-opening pension entitlements is restricted accordingly. This makes asset deals from an administrator considerably more attractive than share deals in a crisis.

Restructuring before a transfer is supported by § 128 InsO: a reconciliation of interests with a list of names or a court determination remains available even if the operational change is to be implemented only after the sale, the buyer participates in the procedure, and the presumption extends to the question whether dismissals were made because of the transfer (§ 128 InsO).

Transfer models through a transfer company (Transfergesellschaft), in which employees conclude new contracts with a separate entity and receive transfer short-time work benefits, are also used to reduce the workforce taken over by a buyer. Our insights on business transfers under § 613a BGB and buying assets from an insolvency administrator explain the transaction side.

Using insolvency employment law in a restructuring strategy

Insolvency employment law is most effective when it is built into the overall restructuring plan from the start. Before filing, management and advisers should identify the target organisation, the functions and sites to be closed or reduced, and the expected number of dismissals. This analysis determines whether a reconciliation of interests with a list of names is realistic, how much a social plan will cost within the statutory caps and how long the process will take. It also affects the comparative calculation in an insolvency plan, because personnel costs are often the largest item in the continuation scenario.

Early dialogue with the works council and, where relevant, the trade union is essential. Works councils know that insolvency employment law gives the administrator considerable leverage, but they also know that a negotiated solution is faster and more predictable than labour court proceedings. Packages that combine a list-of-names reconciliation with a transfer company, qualification measures and a social plan using the available volume often achieve broad acceptance. Collective agreements on pay and working time may need to be renegotiated with the union in parallel, as insolvency does not suspend them.

Communication with employees requires care. Employees need clear information about insolvency money, the timetable and their rights, including the possibility of objecting to a transfer in an asset deal. Key employees whose departure would endanger the restructuring may need retention arrangements, which must be agreed with the custodian or administrator and documented as administrative expenses within the financial plan.

Pensions, managing directors and other issues

Occupational pension entitlements are protected by the statutory insolvency insurance of the Pension Security Association (Pensions-Sicherungs-Verein): beneficiaries whose claims under a direct pension promise are not met because insolvency proceedings have been opened receive benefits from the insurer within the statutory limits (§ 7 BetrAVG).

Vested expectancies of active employees are also protected. Managing directors' service contracts can be terminated under § 113 InsO as well, but managing directors who are not employees for social security purposes, such as controlling shareholder-managers, do not receive insolvency money. Employee claims for the period after opening are administrative expenses, while arrears from before opening are ordinary insolvency claims to the extent not covered by insolvency money.

In self-administration, the debtor exercises the employer's rights under insolvency employment law in agreement with the custodian, and certain rights, such as applying to the labour court under §§ 122 and 126 InsO or terminating works agreements, are effective only with the custodian's consent (§ 279 InsO). Our page on dismissals and workforce restructuring gives the general employment law framework.

How TRW & Co helps

We advise companies in self-administration, administrators, investors and buyers on insolvency employment law. We plan workforce measures and timetables, negotiate reconciliations of interests with lists of names and social plans with works councils, prepare mass layoff notifications, structure transfer companies and advise on § 613a BGB in asset deals. We also represent employers in labour court proceedings arising from restructurings, working with our insolvency team. This page is general information, not legal advice. To discuss a restructuring, please contact us.