Major Fraudulent Insolvencies in Germany For 2006 and 2007

The term “fraudulent insolvency” needs explaining before we go any further: It is an insolvency either caused by or involving criminal acts. “Pure fraudulent insolvency” caused only by criminal acts—generally by fraudulent misrepresentation—is a form of insolvency practiced by suppliers of financial services or other intermediaries.
 
The more frequent form of fraudulent insolvency is the so-called mixed variety—caused by a combination of commercial crises and criminal acts. This form of insolvency is generally associated with large-scale false accounting in the annual financial statement designed to mask the company's commercial plight. In recent years in Germany, at least one group or two major nonconsolidated companies per year have been seen to fall foul of fraudulent insolvencies.
           
Table 1: 
Major fraudulent insolvencies in Germany from 2005-2007

The most significant of these insolvencies in 2006 and 2007 are set out below.

Heros Group
Time and again, cash-transit companies are making off with the money that they transport. The news broke in February 2006 that a cash-transit company had built up its business by embezzling the cash it was carrying for customers.
 
With a market share of approximately 50 percent, the Heros Group was the biggest cash transit company in Germany. Its customers were all major banks in Germany and numerous large food chains. In operation for about 25 years, Heros had gone from strength to strength.
 
On Feb. 20, 2006, applications for insolvency proceedings were made against 27 Group companies in Germany and the European Union. These insolvency applications came in the wake of investigations by the state prosecution service. The managing partner and other senior figures were arrested. The managing partners and other staff were suspected of having helped themselves to their customers' money.

The system of deception at Heros was simple. Any money collected from a customer was not delivered immediately to the customer or central bank; there was a delay of a few days. This made it possible for them to use part of the money in transit for their own purposes. Part of this misappropriated money was used to fund the operation of the business, which was in the red, and a further part was simply pocketed by the managing partner and other complicit staff. The loss to customers was approximately EUR 400 million. About half of this was used to plug the operating losses of the Group and the other half was for the personal benefit of the culprits.

Customers did not begrudge delays in the delivery of cash because Heros then became liable for high interest payments as a result. Customers were completely unaware of the real reasons for the delivery delays—apart from one customer with an employee in a responsible position who knew what was going on. For it to work, this snowball system was dependent—as are all snowball systems—on continuous expansion. Heros expanded its business by undercutting competitors and buying them out.

But this expansion, fuelled by rock-bottom prices, attracted attention, including that of the state prosecution service. The insolvency proceedings were marked by some special features and characteristics.

A single insolvency administrator was appointed for all the companies in the Heros Group in Germany and in the European Union. For Germany, far from being a regular thing, this is astonishing, because German insolvency law does not cover consolidated and group insolvencies. A regulation covering “administrative consolidation,” allowed for under American insolvency law, is unknown in Germany.

Insolvency proceedings were also opened against the assets of the main culprit, the managing partner, on whom sentence has now been passed. However, the administrator appointed for these proceedings was not the one appointed for the Heros Group.

The administrator for the Heros Group was faced with two tasks. On the one hand, the actual business operation needed to be sold—although it was not profitable. An appropriate investor was soon found—a U.S. financial investor.

On the other hand, a search needed to be made for the assets that the main culprit, and others, had embezzled from the group. To conduct this search, the insolvency administrator took unusual action. A reward amounting to 20 percent of any assets recovered was offered, with the promise of anonymity to the potential informant through representation by a lawyer—rather like a whistleblower hotline.

NICI AG

In the next fraudulent insolvency to be considered, although money was involved, it was more about soft cuddly toy animals. The mascot of the 2006 World Football Championship in Germany was a scantily-clad lion manufactured as a cuddly toy by NICI. NICI was well-known in Germany because of this cuddly toy animal. Apart from that, NICI produces mainly smaller cuddly animals in Hong Kong and the People's Republic of China, used for such items as key ring fobs.

Before the World Football Championship began, the chairman of the board management and main shareholder of NICI AG admitted to the Supervisory Board that he had been doctoring the annual financial statements of the company for years by inventing the sales figures. The sales figures for 2006 had been declared as EUR 100 million, but 38 million of this was fictitious. This manipulation of the figures had started years earlier. For example, in 2003 the fictitious sales totaled EUR 6 million. But this falsification of the sales figures masked the fact that business was in fact at a standstill. The company was making losses but was reporting profits because the sales figures were made up. Because of the reported profits and an apparently expanding business, it had proved possible to attract financiers who provided the AG with EUR 40 million by way of mezzanine capital. Also, outstanding but nonexistent receivables were built into the asset-backed securities structure as a result of the fictitious sales.

Overall, the company's indebtedness had spiraled downwards to almost EUR 200 million—in just a few years. It still looks as though the main culprit—who has now been sentenced—used the finance to prop up the company and not to line his own pockets. For this reason, the insolvency administrator decided not to proceed against the assets of the main culprit. About six months after service of the insolvency application by the administrator, it proved possible— once again—to dispose of the business to a U.S. financial investor.

Wohnungsbaugesellschaft Leipzig West AG

The application for insolvency proceedings in respect of Wohnungsbaugesellschaft Leipzig West AG was made on July 19, 2006. Wohnungsbaugesellschaft Leipzig West AG had funded itself with loans from private individuals (owner partial debentures), which attracted an annual interest of 7 percent. Before instigation of insolvency proceedings, the cash raised through such loans totaled approximately EUR 250 million. The raising of loans began in 1999. Of this sum of EUR 250 million, the main culprit (not yet sentenced because the case against him is currently stayed) had transferred almost half to himself. The operation of a housing association (Wohnungsbaugesellschaft) was merely a front to enable finances to be raised. So far, the insolvency administrator has only been able to trace the fate of a small proportion of the assets that the main culprit had misappropriated.

Erich Rohde KG

Erich Rohde KG is a shoe manufacturer with production sites in Germany and Portugal, an annual sales turnover of EUR 170 million and a workforce of 510. As in NICI AG, in Rohde KG the sales figures were also an invention. It is interesting that, just as in the case of NICI AG, the company was financed by mezzanine capital to the tune of EUR 40 million. This funding grew only in recent years. There are no indications that the unlimited partner of the KG had in fact benefited personally. In the meantime, the insolvency administrator has been able to dispose of the business—once again to a financial investor.

Scheider Group

The Schieder Group produces furniture and has a turnover of approximately EUR 1 billion. An attempt to restructure the business management of the company revealed that in recent years the commercial position of the Group had been doctored, once again by fictitious sales figures. In the Schieder Group as well, the funding needs of the company had in recent years been supplied to an extent by mezzanine capital. The restructuring extraneous to the insolvency was stopped and insolvency applications were made for a number of Group companies. Various members of a law firm were appointed as insolvency administrators. Meanwhile, the business operations of the most important companies have been disposed of, but not to a financial investor this time.

Conclusion

There are some features common to the companies under consideration: The insolvent companies were not funded or not exclusively funded in the conventional way, by bank credits, but by new forms of finance, such a mezzanine capital, ABS structures or loans made by private individuals. In cases of fraudulent insolvency, the group or consolidated structures are generally best dealt with by a single insolvency administrator appointed for several companies or at least by the appointment of several administrators who all work out of the same office.

It is usually possible to dispose quickly of the business operations of these insolvent companies—often to U.S. financial investors. Often, less success attends the search for the assets misappropriated by the culprit from the company.