German Federal Court decides on ‘clawback’ risks for lenders

In a recently published ruling, the Federal Court of Justice (Bundesgerichtshof) decided on a claim brought by an insolvency administrator against a consortium of banks. The administrator sought a judgment that various security agreements between the debtor and the banks be declared invalid.

The relevant security agreements had been entered into one year before the opening of insolvency proceedings in relation to a standstill and prolongation agreement. At the time when the security agreements were concluded, the parties had been provided with an expert opinion which stated that the debtor’s illiquidity could be avoided under the assumption that the banks agreed to a prolongation of the loans for 28 months, that the debtor’s turnover would be increased and that a subsidiary of the debtor would repay its intercompany debt to the debtor. Even though the banks merely agreed to initially prolong the loans for eight months, the debtor provided additional security to the banks by way of assignments of receivables, stocks and IP rights.

The court decided that the security agreements were subject to clawback provisions under German insolvency law. The court held that the debtor had entered into the agreements with the intent to disadvantage its creditors and that the banks were aware of the debtor’s intent, leading to a clawback claim by the administrator against the banks under Section 133 of the German Insolvency Code. Under this section the administrator may set aside a transaction by the debtor if the debtor intended to disadvantage its creditors and if the receiving party knew this. Against creditors, this clawback claim applies for a period of four years prior to the application for opening of insolvency proceedings.

Attila Bangha-Szabo, expert in insolvency law at Pinsent Masons in Munich, commented on the ruling: “Lenders should be aware that under German insolvency law there are high clawback risks with respect to the granting of additional security at a time when the debtor’s solvency is uncertain.”

For its decision, the court relied on its previous case law according to which the administrator’s burden of proof is eased if a lender receives security to which the lender had no directly enforceable claims, if the lender does not provide additional loans as consideration, and when the borrower’s liquidity is doubtful at the time when the security is provided. The court held that all three conditions were met in the case at hand.

The banks, on the other hand, failed to sufficiently demonstrate that the debtor’s intent when entering into the security agreements was not to disadvantage its creditors but to comply with a reorganisation plan with a view to avert its insolvency.

Bangha-Szabo said: “The outcome of the case might have been different if it was not for the reorganisation plan’s major flaws.” In particular, the court decided that there were substantial flaws in the reorganisation plan because there was no reasonable explanation for the assumptions that turnover could be increased or that the debtor’s subsidiary would be able and willing to pay the intercompany debt.

“Ultimately, the banks’ position as secured creditors was compromised because not only did they receive security without an enforceable claim thereon, they also did not agree to prolong the loans as required under the reorganisation plan,” Bangha-Szabo said.