Draft IDW Standard on Early Crisis Detection and Crisis Management

Preventing is better than curing; this is not only true in medicine. Also in business management, incorporating measures for the early detection and management of crises forms an essential part of the management’s duties. But how must modern corporate governance be organised in order to sufficiently “prevent” and thus avoid personal liability risks as a managing director? Statutory provisions such as section 1 of the German Act on the Stabilisation and Restructuring Framework for Companies (Gesetz über den Stabilisierungs- und Restrukturierungsrahmen für Unternehmen – StaRUG), which came into force in 2021, provide only abstract answers, which we have already outlined in a previous Newsroom article: Geschäftsleiterpflichten: Pflicht zur Krisenfrüherkennung und Krisenmanagement nach § 1 StaRUG (German).

The Institute of Public Auditors in Germany (Institut der Wirtschaftsprüfer in Deutschland e.V. – IDW) now offers guidance with its “Draft of an IDW Standard: Design of early crisis detection and crisis management according to Section 1 StaRUG (IDW ES 16)”. According to its own statements, it is primarily addressed to managers of companies with limited liability. Although IDW ES 16 is not legally binding for managing directors, it can provide valuable guidance for management bodies and their advisors, as it reflects the IDW's opinion on how the requirements of section 1 StaRUG should be specified. Comments on the draft could be submitted to the IDW until 12 May 2025. Its final adoption is still pending.

I.  Key elements of IDW ES 16

IDW ES 16 specifies two central legal terms of early crisis detection: developments that threaten the company’s continued existence (Fortbestandsgefährdende Entwicklungen) and corporate planning (Unternehmensplanung).

1. Developments that threaten the company’s continued existence

According to section 1 (1) StaRUG, the members of the managing board are obliged to continuously monitor developments that could threaten the company’s continued existence. If such developments are recognised, the managing board must take appropriate countermeasures and inform its supervisory bodies. To be able to fulfil these duties, it is essential to be aware of the criteria under which a development can be said to threaten the continued existence of the company.

IDW ES 16 approaches this by using established definitions, referring to such developments which, without suitable countermeasures, can lead to significant negative changes in the company’s net assets, financial position and results of operations and thus significantly increase the risk of insolvency. They can occur at all stages of a crisis and therefore well before grounds for initiating insolvency proceedings exist. Developments that threaten the company’s continued existence can be of financial, operational or other origin.

2. Corporate planning for at least 12 months

Pursuant to IDW ES 16, corporate planning is the central component of an early crisis detection system. The level of detail in the planning depends on the specific circumstances of the company concerned. The establishment of corporate planning as such is one of the duties of care of every prudent managing director, regardless of a crisis. Corporate planning must in particular describe the expected liquidity development of the company and be based on plausible, i.e. consistent, comprehensible and consistent assumptions from an ex-ante perspective.

IDW ES 16 assumes a planning horizon of at least 12 months, mirroring the period for the going concern prognosis under section 19 (2) sentence 2 of the German Insolvency Code (InsO). The IDW considers a period of 24 months to be appropriate. Depending on the complexity of the business model and ongoing projects, even longer planning may be necessary. The exact length of the planning period depends on the individual circumstances of the company concerned.

II. Ongoing evaluation and review

Once established, corporate planning must be continuously reviewed and compared with actual results in order to make any necessary adjustments. IDW ES 16 justifies this by stating that a continuous comparison of the planned and the actual development of the company helps identify developments that could threaten the company’s continued existence at an early stage and enables countermeasures to be taken in good time. The documentation of this review process is of particular importance for legal protection.

III. Instruments for early crisis detection

According to the IDW, the managing board has access to the following tools and measures to design an effective early crisis detection system; the question of how these measures are to be implemented specifically is being left up to the individual circumstances of the company concerned:

• Risk Culture: Establishing a risk culture as part of the corporate culture to foster risk awareness;
• Risk-Bearing Capacity: Determining the maximum impact of risk that the company can sustain without threatening its existence;
• Risk Organisation: Defining responsibilities within the planning process and clearly allocating the necessary resources and skills. Ideally, this includes a central organisational unit;
• Risk Identification: Systematically detecting risks through comprehensively analysing all areas and processes within the company;
• Risk Assessment: Evaluating identified risks in terms of their probability and impact, focusing primarily on the most likely scenario;
• Risk Management: Developing strategies to mitigate or manage identified risks, such as optimising the product or service portfolio or negotiating prices with suppliers and customers;
• Risk Communication: Ensuring effective internal communication to facilitate the dissemination of risk reports;
• Risk Monitoring: Conducting continuous comparisons between expected and actual outcomes, allowing for necessary adjustments and improvements to the early crisis detection instruments.

IV. Crisis management

As developments that threaten the company’s continued existence intensify, the measures taken for early crisis detection may no longer be sufficient to avert the actual occurrence of a crisis. In this case, the obligation to recognise a crisis at an early stage according to section 1 (1) sentence 1 StaRUG becomes an obligation to manage the crisis. According to IDW ES 16, this next stage of crisis management may already have been reached if the occurrence of the specific risk factor is not predominantly likely but would have a significant negative impact on the company if it were to occur.

Regarding the measures to be taken to overcome such an advanced risk situation, IDW ES 16 refers to the separate IDW standard on restructuring concepts (IDW S 6) and explicitly names the following measures:

• Analysing the economic and legal initial situation (including asset, financial, and earnings position);
• Analysing the crisis stage and causes as well as whether an insolvency risk exists;
• Developing a vision of the business model post-restructuring;
• Identifying measures to avert insolvency risk and to manage the crisis;
• Creating an integrated corporate plan.

Again, there is a continuous obligation to evaluate, review and, if necessary, readjust the precise measures taken. If the managing board realises that there are grounds for insolvency, they must file for insolvency without undue delay, but at the latest after three weeks (in the event of illiquidity, section 17 InsO) or six weeks (in the event of over-indebtedness, section 19 InsO) and in the meantime switch to so-called emergency management; further details can be found in the standard for assessing the existence of grounds for opening insolvency proceedings (IDW S 11). If the company only faces imminent illiquidity (section 18 InsO), depending on the individual case, pre-insolvency restructuring proceedings in accordance with the StaRUG may be considered instead of (voluntarily) filing for insolvency.

V. Conclusion and significance

IDW ES 16 provides a guideline for managing directors to recognise potential crises in good time and to appropriately react to first signs thereof. The draft fits in with the other existing IDW standards and therefore repeatedly refers to IDW S 6 and IDW S 11.

Naturally, the IDW ES 16 cannot resolve the uncertainties linked to the open wording of section 1 StaRUG. Instead, the standard provides flexible guidelines to consider the specific circumstances of the company concerned. It would be desirable for the final version to include additional concrete examples in order to offer further value, as experience has shown that the early warning tools listed above are difficult to grasp, especially when the company is performing well.

To avoid liability risks, managing directors should look into the requirements for early crisis detection and management, implement meaningful corporate planning that takes into account the identified risk factors, and establish suitable early crisis detection systems in day-to-day operations. Such measures must be documented to be able to prove compliance with good corporate governance retrospectively as well.

If there are signs of a crisis, it will depend on the individual case whether the requirements for restructuring concepts according to IDW S 6 must in fact be complied with (as recommended by IDW ES 16). In any case, the same applies here as in medicine: the earlier professional advice is sought, the more promising it is to take countermeasures. In the words of the start-up platform of the German Federal Ministry for Economic Affairs and Energy (Existenzgründungsportal des Bundesministeriums für Wirtschaft und Energie): "In any case: advice".