Shareholder loans under German insolvency law
March 2014 | SPECIAL REPORT: GLOBAL RESTRUCTURING & INSOLVENCY
Financier Worldwide Magazine
The statutory provisions of German insolvency law concerning the subordination of shareholder loans were subject to a fundamental reform in 2008. Following the reform, a number of questions concerning the scope and range of the new provisions became controversial and have been subject to lengthy discussions in literature and jurisdiction. By now, some of those questions have been decided by the German Federal Court of Justice (Bundesgerichtshof, abbr. BGH). In its judgments, the Court took the opportunity to generally maintain its rigorous line of preventing shareholders from withdrawing shareholder loans in connection with an insolvency of the company.
The following article provides an overview of the German statutory law of equitable subordination and the case law of the German Federal Court of Justice evolving from the reformed provisions.
Subordination of shareholder loans under German insolvency law
Through the reform of 2008, the statutes concerning the subordination of shareholder loans were transferred from company to insolvency law. They now apply to all companies which have no individual person as a direct or indirect personally liable shareholder irrespective of the legal form of the company. As a result, the reformed statutes apply not only to companies organised under German law but also to companies organised under foreign law if German insolvency law is applicable, i.e., if the centre of main interests of the company is in Germany.
Subordination of all shareholder loans and comparable claims
One of the key provisions of the law of equitable subordination is sec. 39 para 1 no. 5 of the German Insolvency Code. According to that provision, all claims for the repayment of a shareholder loan are subordinated in the insolvency of the company. ‘Subordination’ means that the subordinated claim may only be satisfied after the claims of all other unsecured creditors of the company have been fulfilled completely.
The subordination also applies to claims resulting from legal transactions which are comparable to a shareholder loan in economic terms. As a result, subordination will basically apply to all claims resulting from circumstances in which a shareholder gave credit to its company in any form.
Exceptions from subordination
To allow the restructuring of distressed companies and to protect minority shareholders, two exceptions are made from subordination: first, no subordination applies to the claims of a creditor that acquires shares of the company in the case of imminent or existing illiquidity or over-indebtedness in order to reorganise the company, as long as a sustainable reorganisation has not been reached (sec. 39 para 4 sentence 2 of the German Insolvency Code). Secondly, no subordination applies to shareholders that own 10 percent or less of the shares in the company and that do not act as managing directors (sec. 39 para 5 of the German Insolvency Code). Yet, the applicability of those exemption clauses is limited because of uncertainties concerning the factual and legal scope of the provisions.
Claw-back rules concerning the repayment and the collateralisation of shareholder loans
Another key rule is sec. 135 of the German Insolvency Code, which contains (inter alia) two important claw-back rules: first, in order to prevent a circumvention of the equitable subordination by repayments of shareholder loans prior to the opening of the insolvency proceedings, sec. 135 allows an insolvency administrator to claw-back payments made under a shareholder loan (or comparable claim) that were made within one year prior to the filing for insolvency. Secondly, insolvency administrators are entitled to challenge any security which the company granted to the shareholder to secure a shareholder loan (or any comparable claim) as long as the security had been granted within 10 years prior to the insolvency filing.
The judgments of the German Federal Court of Justice
As mentioned above, the German Federal Court of Justice had the opportunity to decide several questions concerning the scope of the aforementioned provisions. In those decisions the Court maintained its strict line concerning the subordination of shareholder loans and its willingness to apply the statutory rules on attempts and arrangements that are designed to circumvent the applicability of the statutory rules.
The definition of a ‘shareholder’
One question the Court dealt with was which parties are considered to be ‘shareholders’ in the sense of the statutory law.
In accordance with its former case law, the Court found that loans given by an affiliated company, which is (directly or indirectly) controlled by the shareholder, are to be treated as shareholder loans (BGH 21.2.2013 IX ZR 32/12; BGH 18.7.2013 IX ZR 219/11). Accordingly, if lender and company are connected through a common (direct or indirect) shareholder and the shareholder is able to control the lender, the loan will be treated as a shareholder loan. The same applies if the loan is granted by an indirect shareholder of the company which is able to exert a dominating influence on the direct shareholder. As a consequence, the subordination of a shareholder loan cannot be avoided by using another entity as lender if that other entity is controlled by the shareholder.
Assignment of a shareholder loan and/or transfer of the shares of the company
Another crucial question decided by the Court is whether and how the applicability of the law of equitable subordination is influenced or changed if the shareholder that granted the shareholder loan transfers its shares in the company and/or assigns the loan to a (neutral) third party afterwards.
In the first case the Court considered, a shareholder transferred its shares to a third party but kept the loan it had previously given to the company (BGH 15.11.2011 II ZR 6/11).
The Court found that a loan given by a former shareholder is subordinated if the lender had been a shareholder of the company at any point within the one-year period defined in sec. 135 of the German Insolvency Code. Hence, if a transfer of shares and a repayment of a shareholder loan take place within the one-year period, the insolvency administrator can claw-back the repayment from the former shareholder.
In a second case, the shareholder assigned its shareholder loan to a (neutral) third party, but kept its shares in the company (BGH 21.2.2013 IX ZR 32/12). The Court found that the respective claim remains subordinated if the assignment took place within the one-year period set out in sec. 135 of the German Insolvency Code. Also, since the company repaid the loan to the assignee within the one-year period, the Court found the insolvency administrator to be entitled to claw-back the repayment from the assignee as well as from the shareholder. Thus, the Court found the assignee and the shareholder liable as joint and several debtors. A shareholder might therefore be liable for the repayment of a loan to an assignee even though the shareholder did not take part in the repayment and essentially did not gain any (direct or indirect) advantage from it.
The realisation of security assigned for a shareholder’s loan
As mentioned above, not only can the repayment of a shareholder loan be voidable; the same may also apply – within a 10-year period – to the assignment of a security for the benefit of the shareholder.
In a recent decision, the Court decided a case in which the company had transferred receivables by way of security to the shareholder to secure a shareholder loan. The shareholder then satisfied its repayment claim by realising the assigned receivables (BGH 18.7.2013 IX ZR 219/11).
The Court found that the insolvency administrator was entitled to claw-back the realisation proceeds of the security granted by the company to its shareholder, if the assignment of the respective security itself was voidable because it took place within the 10-year period set out in sec. 135 of the German Insolvency Code. The Court also found that the right to claw-back the proceeds is not limited by the fact that a direct repayment of the loan at the date of the realisation of the security would not have been voidable because of the expiration of the one-year-period defined in sec. 135 para 1 no. 2 of the German Insolvency Code. Only if the assignment of the security itself was no longer voidable because the 10-year-period had elapsed, would an insolvency administrator no longer be entitled to claw-back the proceeds gained from realising the security. And consequently, if the assignment of the security itself is no longer voidable, the satisfaction of the repayment claim within the one-year period prior to the application for the opening of the insolvency proceedings cannot be challenged by the insolvency administrator.
The recent decisions of the German Federal Court of Justice show that German judicature maintains its rigorous line concerning shareholder loans and comparable claims. As a rule of thumb, one must be aware that almost any shareholder loan (or comparable claim) will be subordinated in the event of insolvency. Furthermore, any repayment of such claim is voidable within a one-year period and securities granted to shareholders are voidable within a 10-year period prior to the application of the opening of the insolvency proceedings. However, other than prior to the reform of 2008, shareholder loans are subordinated and repayments are voidable only in the case of an insolvency of the company. Generally speaking, as long as a company is not insolvent, a shareholder loan will basically be treated like any other loan.
Heiko Tschauner is a partner and Christine Ede is an associate at Hogan Lovells. Mr Tschauner can be contacted on +49 89 290 12 0 or by email: email@example.com. Ms Ede can be contacted on +49 89 290 12 0 or by email: firstname.lastname@example.org.
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Heiko Tschauner and Christine Ede