German automotive supplier bankruptcies expected to rise

To the surprise of many, and despite the coronavirus crisis, the number of corporate insolvencies in the first half of 2020 has been stable in the German manufacturing sector and even declined in other sectors, compared to the first half of 2019.

This is part of a series, find out more about how to manage supply chain distress in the manufacturing sector.

Only 8,900 cases of business insolvencies have been filed in Germany in the first half of 2020, which is a decrease by 8.2 % compared to the number of corporate insolvencies during first half of 2019. One could say that the insolvency situation has thus detached itself from the fundamental economical situation of German businesses.

However this may be an effect of policies enacted when the crisis began rather than a sign of a healthy industry. The actual effects of the Covid-19-pandemic on the German economy and especially on the distressed automotive industry will start to manifest themselves in autumn.

The German economy is experiencing the calm before the storm. As the German government has lifted the duty to file for insolvency until the end of September, a lot of cases where an insolvency would have been appropriate were postponed.  

The suspension of the duty to file for insolvency within a three-week-period was intended to protect companies from the immediate impact of Covid-19-caused lockdown, so they would not have to file for insolvency just because the aid provided by the German federal government could not reach them in time.

The Association of Insolvency Administrators in Germany (VID) expects that the suspension of the obligation to file for insolvency will not be extended beyond September 30 by the lawmakers. Accordingly, an increase of business insolvencies may be seen this autumn. Starting from 1 October 2020, the real impact of the pandemic and lockdown on German businesses will become visible in terms of numbers of insolvency proceedings. A sharp rise in corporate insolvencies will take its toll on the automotive industry and its suppliers, a sector which has been under pressure and has shown signs of slowdown before the Covid-19-crisis hit the industry.

Avoiding a massive increase of insolvencies in autumn could be possible if the companies affected by Covid-19 were able to overcome the crisis within the next months. But such a fast recovery can not be expected in most of the cases, in particular not in the automotive industry, given the severity of the recession and the fact that the situation in this sector had already been instable before Covid-19.

Challenges before Covid-19

In recent years, the German and global automotive sector had already shown signs of crisis, resulting in significantly increased supply chain risks. We expect to see the situation to worsen significantly from October 2020 onwards.

For some years now, the German automotive industry has been under pressure: sales figures have been falling in relevant markets such as the USA and China, the reasons for which cannot be solely attributed to the Diesel crisis or increased demand for car sharing and more bicycle sales.

According to the Association of the German Automotive Industry (VDA), in 2019 both production and exports declined due to weaker international demand: 4.7 million passenger cars were produced in Germany, which is 9 % less than in 2018. German car manufacturers exported almost 3.5 million passenger cars, which is 13 % less than in 2018.

While the automotive industry has been under pressure long before the Covid-19 pandemic hit the world, the manufacturers reacted to rise up to the challenge. Instead of talking about a crisis, politics, unions and businesses were calling it 'structural change', implying the necessary changes could be achieved with commitment and innovation.

Unprecedented market collapse

The coronavirus pandemic caused a world wide collapse of the automotive markets, and thus brought forth the worst crisis in decades in the European and German automotive industry. The collapse of markets is unprecedented.

In the first half of 2020 there were 1.21 million new passenger car registrations in Germany, a drop of 35 % compared to the first half of 2019. According to the VDA, this is the lowest figure for a first half year in Germany since German reunification. On the international markets, the situation is similar: the European passenger car market fell by 43 % in the period up to May, the US market fell by 23 % and the Chinese market fell by 27 %.

In the first half of the year the passenger car production in Germany also fell to its lowest level in 45 years, due to the drop of demand, the disruption of supply chains and production stoppages. From January to June, 40 % less vehicles were produced at the German locations than in the same period last year.

Commercial vehicle markets are hit even harder. However, the impact on employment in the German automotive industry is not yet as strong as one might expect – a circumstance that is mostly owed to the instrument of short-time work (Kurzarbeit), which allows employers to lower the staffing costs during crises while keeping their workforce employed.

Nevertheless, the massively lowered production numbers have serious implications not only for global corporations such as Volkswagen, Daimler or BMW, but also and even more so for the many small and medium-sized businesses in the automotive supplier industry, which have fewer capital resources and for which the insolvency risk is therefore higher. The endemic risk for the industry's entire value chain is apparent: an increase in supplier insolvencies may disrupt the entire supply chain and thus threaten the entire industry.

There have been signs of a slight recovery on the markets in the second half of the year 2020. As an example, German manufacturers have received significantly more orders in June than in May, even though the demand is still lower than in June 2019. Still, even if demand recovered again to pre-crisis levels, it will take years to compensate the losses suffered during the lockdown period. We expect that not all suppliers will be able to last long enough to see this day.

The sector will suffer from increased costs related to health measures for the protection of employees' health, while unsolved challenges , such as the customs dispute between the USA and China and costs related to the transformation to electro-mobility remain.

The German automobile industry will not prosper unless the entire supply chain is stable, from original equipment manufacturers (OEM) to the midsized and small automotive suppliers.

How will the sector react

We expect to see a wave of consolidation in the automotive industry, in particular in the supplier sector. This will include a lot of businesses leave the market entirely, but this will provide a chance to strengthen and expand for others, who will look for new strategic partnerships and for acquisition targets from a strategic perspective in order to secure supply chains. Other investors – competitors or private equity funders with liquidity – may use the  fallout of the pandemic as an opportunity for acquiring distressed businesses as a means of expansion, in order to gain access to new markets and innovative technologies.

Restructuring under German insolvency law

When a Germany-based business becomes insolvent, the insolvency proceedings fall under the framework of German insolvency law. Everyone who is doing business with a German automotive supplier will therefore, in the event that supplier is threatened by insolvency, be affected by the provisions of German insolvency law.

This is a vital aspect, since in particular any contractual agreements made by the parties are superseded by the provisions of the German insolvency code. One prime example for this are contractual termination clauses which define insolvency proceedings as an event of default; such clauses are invalid under German insolvency law.

Another important aspect of German insolvency law is how the different types of insolvency proceedings focus on restructuring an insolvent entity or aim for selling the business in distress. Opting for insolvency proceedings without an administrator allowing the management to remain in charge (self administration proceedings, or Eigenverwaltung) under the supervision of a court-appointed custodian (Sachwalter) is the way forward for a business in distress which aims to reorganize itself in order to reenter the market. Others may find the protective shield proceeding (Schutzschirm) appealing, suitable only for an insolvent business which aims for an arrangement with its creditors in order to reorganize. Last but not least, there is the regular insolvency proceeding with court appointed administrator in charge, which is the most attractive scenario for investors which are looking to acquire an entire business debt-free by means of an asset deal.

Competitors, investors or customers who know precisely what their position and their options under the applicable law are in the upcoming wave of insolvencies in the German automotive sector will be able to reduce their exposure and possibly use these special circumstances as an opportunity for themselves.