Germany's Federal Court of Justice strengthens banks' role as lenders in restructuring cases

In its judgment of 25 June 2020 (case no. IX ZR 243/18), the Federal Court of Justice provided banks with legal clarity and certainty in the field of restructuring loans. In its guiding decision, the Insolvency Panel harmonises the indeterminate legal concepts of the economically shareholder-equivalent status within the meaning of section 39(1)(5) Insolvency Code with the requirements of banking supervisory law, while at the same time taking into account the credit institutions’ normally greater interest in securing loans in restructuring cases. Prior to this decision, banks were exposed to increased risks in restructuring cases when they monitored the implementation of the recovery plan and the impact of the measures, alongside the bank’s usual credit protection interest through covenants in line with the MaRisk requirements. Some opinions in legal literature considered that, as a result of the (factual) influence on debtors in need of restructuring, banks held a shareholder-equivalent position within the meaning of section 39(1)(5) of the Insolvency Code. As a result, it was said that banks are only subordinate insolvency creditors and exposed to simplified contestation options under section 135(1) of the German Insolvency Code. The Federal Court of Justice has now rejected this in principle.

I. Background (simplified)

A banking consortium granted a restructuring loan to the debtor. The banking consortium secured this restructuring loan both through collateral from the insolvency debtor (the debtor) and from the parent company, a German company in the form of a GmbH & Co. KG, i.e. a partnership with a limited liability company as its general partner, (the defendant), and through a ‘bilateral trust’. In this particular case, the trust involves a fiduciary transfer of the shares in the defendant’s general partner to a trust company which is not bound by instructions but is subject only to the trust agreement. The banking consortium was directly entitled as the privileged beneficiary of the trust agreement and pursuant to section 328(1) of the Civil Code.

The insolvency administrator in respect of the debtor’s assets (the claimant) claimed against the defendant in respect of the repayment of the debtor’s loan to the banking consortium within the last year prior to the date of filing for insolvency under section 135(2) of the Insolvency Code. According to Section 135(2) of the Insolvency Code, legal actions of the debtor company which satisfy claims of a third party other than a shareholder are subject to avoidance by the insolvency administrator vis-à-vis the shareholder if that shareholder obtains release of a piece of collateral. The Regional Court dismissed the action on the ground of the banking consortium’s shareholder-equivalent status and its primary liability under section 135(1)(2) Insolvency Code. However, the appellate court, i.e. Frankfurt Higher Regional Court, in its judgment of 8 August 2018 (4 U 49/17, NZI 2018, 891), amended the decision and declared the action to be justified on the merits saying that the banking consortium was not a quasi-shareholder within the meaning of section 39(1)(5) Insolvency Code.

II. Key content of the decision

The Federal Court of Justice confirms the decision of the appellate court and classifies the banking consortium as a third party not equivalent to a shareholder within the meaning of sections 39(1)(5) and 135(2) of the German Insolvency Code.

The court said that a lender was a third party equivalent to a shareholder only if the rights it was entitled to under the trust agreement and other arrangements where applicable, met the triple criteria of participation in the proceeds, rights equal to those of a shareholder and participation in the management, in an overall assessment of the form of the company in question, in such a way that its legal position corresponded to that of a regular shareholder. Those conditions were not met in the case under consideration.

• No particularly large participation in the company’s profits: If the lender’s participation in the distribution of proceeds is essentially limited to a securing function, i.e. in order to secure the lender’s rights to (re)payment of interest and principal, the Federal Court of Justice qualifies this as only an indirect participation in profit and thus only a weak indication of equality with a shareholder. The scope of such agreements corresponds to the claims in the case of an external loan, the court says.
  
  
• Lack of participation in management (impact on management): Mere economic bargaining power on the part of the lender or its ability to have a merely de facto influence on the decisions of the management of the debtor is not sufficient. Rather, it is necessary for the relevant players to be subject to instructions from the lender or for the decision-makers to be dependent on them in a legally secured form or in a legally established way. Nor do the lender’s rights to terminate give rise to a legally established influence on the management.
  
  
• No rights equivalent to shareholders’: What is required is a legally secure influence, which means that the activity of the debtor in question is to be regarded as a business activity of the lender. It is not sufficient that the lender is favoured by a bilateral trust, that the financing commitment depends on the commissioning, observation of and compliance with a restructuring plan, obligations for retention of profit, that the lender’s consent is required for profit distributions or withdrawals in favour of limited partners or obligations to report to and inform the lender. Contrary to what the Federal Court of Justice pointed out in its judgment of 13 July 1992 (II ZR 251/91, BGHZ 119, 191, 198) regarding the right to substitute equity, in order for a lender to be treated as a shareholder, it is not sufficient for the shareholders to be no longer able to take decisions on matters of principle on their own responsibility. What matters instead is who the decision-making power is allocated to, even if only in the form of reservations of consent. In this case, the trustee was exclusively bound by the trust agreement.
  
  
• Overall balancing consideration: As a whole, the legally possible influence of the lender must achieve the legal status of that of a shareholder. At the same time, the banks’ must have a share of profits comparable to that of a shareholder. In the absence of a sufficient legal basis giving the lender sufficient influence, the debtor’s activity cannot be regarded as the lender’s own business activity.

III. Conclusion and impact in practice

In its guiding decision, the Federal Court of Justice harmonises the indeterminate legal concepts of shareholder-equivalent status within the meaning of section 39(1)(5) Insolvency Code with the requirements of banking supervision, while at the same time taking into account the usually increased interest of institutionalised lenders in securing loans in restructuring cases. At the same time, with the triple criteria and its final overall assessment the Federal Court of Justice creates a sufficiently solid legal framework for practice in order to be able to meet, in particular, the requirements of banking supervision law, in particular those laid down in Circular 09/2017 (BA) – Minimum requirements for risk management (MaRisk), in particular BTO 1.2.5 (treatment of problem loans). As a result, credit institutions should no longer realistically face the risk of their claims being placed under the subordination according to section 39(1)(5) Insolvency Code, provided that by way of corresponding contractual provisions they primarily pursue their loan-securing interest and compliance with bank supervision requirements in restructuring cases.

In addition, the rule of section 135(2) Insolvency Code, which is crucial to the dispute in the present case, is of considerable importance in the context of actions against banks contesting insolvency. If shareholder collateral is released in the event of a contestable loan repayment, not only third-party notice should be required on one’s own initiative because of a possible revival of such collateral. On the contrary, third-party notices pursuant to section 426(1) Civil Code and section 426(2)(1) Civil Code in conjunction with section 135(2) and 143(3) Insolvency Code often appear to be called for, based on the insolvency administrator’s own right and based on the right transferred to the insolvency administrator.