On 3 July 2009, the German Federal Council (Bundesrat) accepted the so-called Bad Bank Act (Gesetz zur Fortentwicklung der Finanmarktstabilisierung (Act) and it is expected that the Federal Council will consent to the Act in its plenary session on 10 July 2009. The Act aims at stabilising the position of banks and other financial institutions by allowing them to offload specific "toxic" assets and thus relieving future pressures on their equity.

The first "bad bank" concept set out in the Act allows credit institutions and financial holding companies, as well as their domestic and foreign subsidiaries (banks), to transfer specific "toxic" assets to bad bank special purpose vehicles (SPVs). Such assets include:

Any structured securities to be transferred must have been acquired by the bank on or before 31 December 2008.

In consideration for the transfer of those assets, the bad banks will issue bonds to the transferring entity which will be backed by those assets. These bonds are eligible for guarantees from the German Financial Market Stabilisation Fund (SoFFin) if all the following criteria are satisfied:

The banks will be obligated to make annual compensation payments to the bad bank during the term of the SoFFin guarantee. Those payments will be calculated as the difference between the transfer value of the toxic assets and the underlying value determined by SoFFin, divided by the number of years making up the term of the guarantee and may only be made from future distributable profits.

Moreover, in return for guaranteeing the bonds, the bad bank must pay fair market remuneration to SoFFin over the term of the guarantee. In addition, if the annual compensation paid to the bad bank over the term of the SoFFin guarantee is not sufficient to compensate for losses from the transferred assets, any unsettled losses (including those incurred after the maximum term of the SoFFin guarantee of 20 years), must continue to be discharged from distributable profits of the transferring entity on a preferred basis.

In addition to the SPV bad bank concept, the Act also allows banks to apply to SoFFin for the creation of a so-called "liquidation institution" (Anstalt in der Anstalt (AIDA)) to which not only toxic assets, but all forms of illiquid securities as well as non-strategic business units, can be transferred (in all cases, provided that the bank had already acquired those assets on or before 31 December 2008). Transfers can take the form of spin-offs (Abspaltung or Ausgliederung) and asset deals. Apart from an actual transfer, AIDAs can also guarantee, acquire sub-participations in, enter into trust arrangements or issue derivative securities in respect of toxic assets, other illiquid securities and non-strategic business units.

The shareholders/members of the bank, or, where the bank is an SPV or a subsidiary, the shareholders of the SPV or the subsidiary are generally jointly and severally liable (gesamtschuldnerisch) for any losses incurred by an AIDA. This does not apply where one or more of the banks is a Land or where a bank is a listed company; in the former instances, there will be no joint and several liability while in the latter instance, the transferring entity is required to balance losses from the distributable profits (that is, money reserved for dividends to its shareholders). The AIDAs may additionally demand adequate compensation from the Banks.

It is additionally necessary that the Banks have a sound business model and adequate financial gearing. Responsibility for personnel, pensions and other employment benefits remains with the Banks.

Finally, when applying for the creation of an AIDA, the Bank must set up a liquidation plan in re-spect of the “toxic” assets, other illiquid securities and business units and any expected liquidation proceeds must at least cover the estimated new liabilities, administrative expenses and taxes.