Lending and taking security in Germany: overview
A Q&A guide to finance in Germany. The Q&A gives a high level overview of the lending market, forms of security over assets, special purpose vehicles in secured lending, quasi-security, negative pledge clauses, guarantees, and loan agreements. It covers creation and registration requirements for security interests; problem assets over which security is difficult to grant; risk areas for lenders; structuring the priority of debt; debt trading and transfer mechanisms; agent and trust concepts; enforcement of security interests and borrower insolvency; cross-border issues on loans; taxes; and proposals for reform.
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Overview of the lending market
M&A activity has considerably increased over the last 12 months and has lead to a higher demand of acquisition financings. The German acquisition finance market has become more competitive (not least due to an increased appetite for risk and the market entry of new direct lending funds) and offered more liquidity. This has lead to more favourable terms for borrowers, including lower margins and arrangement fees, stretched leverage and a looser covenant package, including a few covenant-lite deals for large cap financings. Larger credits were able to tap the high yield bond market or to benefit from US style structures, such as term loan B financings. The midmarket segment has continued to be dominated by club deals and has offered to a certain extent more borrower-friendly terms and conditions (for example, larger headrooms). In addition, there has been a significant number of dividend recapitalisations, amend-to-extends and refinancings, but it is expected that this number will decrease throughout 2015.
Although there are no significant constraints on bank liquidity in the German market, private debt funds have managed to capture a larger market share in the mid-cap market segment than in the previous year, not only offering financings for assets that were not attractive or bankable for bank lenders but increasingly competing with banks throughout the entire market by offering more flexibility than traditional bank financing.
The Schuldschein market has further expanded by attracting foreign issuers as well as international investors and including US dollar tranches in certain cases. However, the mid-cap bond market continues to be under pressure, as a considerable number of issuers have been downgraded or have defaulted on their payment obligations. The first mid-cap bond market places have already been closed.
Forms of security over assets
Real estate is a distinctly confined part of the surface of the earth recorded as a plot of land in the land register (Grundbuch) maintained with the competent local court. Accessory assets that serve the economic purpose of the real property (Zubehör) (for example, machinery) generally share the same legal treatment as the land.
Essential parts of the property which are permanently fixed to it (wesentliche Bestandteile) (for example, buildings) are not subject to separate ownership, but belong to the owner of the land. It is, however, possible to grant heritable building rights (Erbbaurechte) over real estate, thereby assigning the beneficiary the right to construct a building on the land, which is subject to separate ownership. The heritable building right is transferable and can be encumbered independently from the underlying land.
Common forms of security
Security over real estate or heritable building rights can be taken in the form of a:
Land charge (Grundschuld).
A mortgage is an accessory security interest. This means that it:
Only arises for the benefit of a particular mortgagee (and its assignee/transferee) that is also a creditor of the secured claim.
Will cease to exist if the secured claim ceases to exist.
Can only be enforced if, and to the extent that, the secured claim is due and payable.
Cannot be assigned without simultaneously assigning the secured claim to the assignee.
A land charge is a non-accessory security instrument which itself is independent from the secured claim. The security purpose of a land charge is typically set forth in a separate security purpose agreement (Sicherungszweckvereinbarung) which can be amended between the parties without releasing and retaking the security. Due to its flexibility, it is the most common form of collateral over real estate in practice.
A mortgage and land charge can be granted with a certificate (Briefhypothek/- grundschuld) or without a certificate (Buchhypothek/ - grundschuld), and can be created in a comprehensive way so that they encumber various plots of land (Gesamthypothek/- grundschuld), and can be enforced in one single enforcement process.
While neither a mortgage nor a land charge require notarisation, the application to the land register for registration of the security interest must be signed by the property owner and certified (beglaubigt) by a notary. There is no form requirement for the conclusion of a security purpose agreement.
The security grantor is usually requested to submit to immediate enforcement in relation to the real estate security, which requires notarial form.
The security right comes into existence on registration, and, in the case of a certificated form, on issuing the certificate. The rank of the security right depends on the date of the registration if not otherwise agreed with a prior ranking creditor. As registration might take several weeks, or, even months, it is common practice to request a notarial confirmation that based upon inspection of the register, the security will be registered with the agreed rank.
Tangible movable property
Tangible movable property
Tangible movable assets are physical objects which are neither an essential part of a plot of land nor an accessory asset (see Question 2), for example, machinery, inventory, raw materials and (un)finished products.
Common forms of security
Security over tangible movable assets can be taken either in the form of a:
Transfer of title for security purposes (Sicherungsübereignung).
A pledge as an accessory security interest is dependent on the underlying secured claim (see Question 2, Common forms of security). In order to perfect a pledge over movable assets, the beneficiary of the pledge must become the possessor (Besitzer) of the relevant asset, that is, the security grantor would no longer be able to employ the asset in its business. Therefore, the most common security over movable assets is a security transfer.
A security transfer creates a non-accessory security interest which is independent from the secured claim. The transferor transfers legal title (Eigentum) of the assets to the transferee who is contractually bound not to make use of its legal title until a defined trigger event occurs. The security transfer allows the transferor to keep physical possession of the asset and to use it for its business.
There are no form or registration requirements for a pledge or a security transfer regarding movable assets.
It is crucial to clearly identify the transferred assets in the security agreement. This can be accomplished by providing asset lists, labelling the assets or precisely defining a security area and thereby transferring all assets in that area (coupled with an undertaking to place all relevant assets in the security area).
Movable assets transferred under a security transfer agreement may be subject to:
Statutory liens, such as those in favour of commission agents (Kommissionäre), carrier/forwarding agents (Frachtführer/Spediteure), landlords (Vermieter/Verpächter), warehouse owners (Lagerhalter) or contractors for work (Werkunternehmer).
Public dues on imported or exported goods (Einfuhr- und Ausfuhrabgaben) or excise taxes (Verbrauchssteuern).
These may provide the beneficiary of that lien or creditor of those public dues with certain priority rights over those movable assets.
The German Banking Code (KWG) provides a general definition of financial instruments, which includes among others:
Shares in a company.
Money market instruments.
The financial instruments over which security is most commonly granted are shares and, in certain cases, debt securities (including bonds, notes and commercial paper).
Common forms of security
Security over financial instruments can be taken in the form of either a:
Assignment for security purposes (Sicherungsabtretung).
A security assignment is a non-accessory security instrument which is independent from the secured claim. As it leads to a transfer of legal title, it is not considered appropriate for, for example, taking security over shares, as it would lead to the beneficiary becoming a shareholder with all related unwanted consequences.
In case of a pledge over shares, the membership rights, including the voting rights, remain with the pledgor of the shares. A pledge does not automatically capture any dividend and other payment rights originating from the shares, so it is necessary to pledge these along with the shares.
The form and perfection requirements depend on the type of financial instrument over which security is to be taken:
In the case of shares, form and perfection requirements vary further, depending on the corporate form of the entity whose shares are being pledged and the form in which they have been issued:
Shares in a limited liability company (Gesellschaft mit beschränkter Haftung (GmbH)). These cannot be certified. A pledge requires notarial form triggering non-negotiable notarial costs based on the transaction value, which is calculated as the lower of the equity value of the shares and the amount of the secured obligations, but capped at EUR60 million. If the security agreement is notarised in the English language, there are mandatory surcharges of 30% of the notary fees;
Shares in a limited partnership (Kommanditgesellschaft (KG)). These are not certified either and can be pledged in private written form without involving a notary. It is advisable to choose notarial form if the general partner is a German limited liability company (see above) and the shares in the general partner are pledged at the same time;
Shares in a stock corporation (Aktiengesellschaft (AG)). These may be issued in bearer (Inhaberaktie) or registered (Namensaktie) form and may be certified or not. The pledge agreement does not need to be notarised, but in the case of share certificates, additional perfection requirements apply. The beneficiary of the pledge must obtain at least indirect possession of the share certificate. If the share certificates are deposited with a depository, the delivery to the pledgee can be substituted by an instruction to the depository to possess the certificate for the pledgee rather than the pledgor. The technicalities of obtaining indirect possession vary depending on the type and custody of the certificates (for example, a global certificate deposited with a central custodian).
Articles of association of the company whose shares are being pledged may contain restrictions on encumbering or transferring shares by requiring the consent of shareholders and/or the company for any encumbrance or transfer. These restrictions may need to be removed to create an enforceable pledge and, if required, the consent of the shareholders or the company needs to be obtained.
A pledge over shares does not require notification, but pledges over receivables such as dividends must be notified to the respective company in order to perfect these pledges.
In the case of debt securities, the perfection requirements depend on the type of financial instrument and whether they are held through Euroclear or any other clearing system. If they are certified, the above considerations for certified shares apply.
Claims and receivables
Claims and receivables
Under German law, a claim (Anspruch) is the right of a person to demand that another person acts in a particular way or refrains from acting. Receivables (Forderungen) are claims resulting from a contractual agreement or from a statutory obligation (for example, tort and unjust enrichment). The most common types of claims and receivables over which security is granted in Germany are:
Receivables arising from inter-company loan agreements.
In acquisition financings: purchase price receivables and claims against report providers.
Common forms of security
Security over receivables can be taken in the form of a pledge (Pfandrecht) or a security assignment (Sicherungsabtretung).
A pledge as an accessory security instrument is dependent on the secured claim (see Question 2, Common forms of security). A security assignment is a non-accessory security instrument which can exist independently from the secured claim.
A decision for either form of security is generally driven by the following considerations:
In order to perfect the pledge, it is necessary to notify the debtor. Therefore, a pledge is generally considered more appropriate for intra-group receivables or for receivables against debtors who can be notified as a practical matter without negative consequences for the business. A security assignment, by contrast, does not need to be disclosed to the debtor and is therefore the common form for security over receivables against trade debtors.
On the opening of insolvency proceedings, an assignee under a security assignment only has a claim against the insolvency administrator for preferential satisfaction (abgesonderteBefriedigung) in respect of the assigned rights, but has no right to enforce its security interest outside the insolvency proceedings. The insolvency administrator will deduct contributory charges of around 9% (plus VAT, if applicable) of the enforcement proceeds before disbursing them to the assignee. A pledge, by contrast, may be enforced directly by the pledgee without paying contributory charges to the insolvency estate.
In the German market, extended retention of title arrangements (verlängerte Eigentumsvorbehalte) are frequently used. Under these arrangements, a supplier authorises a buyer to resell or manufacture the delivered goods before being paid, provided that the buyer assigns the resulting customer receivable to the supplier. Given that German courts treat a security assignment as void if it also captures receivables subject to extended retention of title arrangements, such receivables must be carved out from the scope of the security assignment.
Perfection of a pledge requires notification of the relevant debtor of the receivables, whereas a security assignment does not need to be notified. However, absent a notification a debtor can continue to make payment to the assignor with full discharging effect. Therefore, debtors under inter-company loan agreements, hedging agreements, insurance companies, sellers under a share purchase agreement and report providers are usually notified from day one, whereas customers will usually only receive notification after the occurrence of a defined event of default or enforcement event.
The general terms and conditions governing insurance contracts and policies often stipulate that the assignment of claims against an insurance company must be notified to the insurance company or that the insurance company must grant its consent for the assignment to become effective. Any assignment of a claim against an insurance company arising from a third party liability insurance (Haftpflichtversicherung) is not valid in relation to that third party.
Common forms of security
Under German law, the subject of security is not the cash deposit itself, but rather the receivable against the account bank to withdraw the balance on the account.
The most common form of security over cash deposits is an account pledge agreement in which the pledgor pledges all its present and future claims and receivables against the account banks arising under or in connection with the underlying account arrangement.
Technically, it would also be possible to take security by way of a security assignment. As account banks are familiar with bank accounts being subject to third party security and an enforcement of a pledge can be made without triggering any contributory charges, security over bank accounts is usually granted by way of account pledges.
The perfection of the pledge requires notification of the relevant account bank.
Under their general terms and conditions, German banks usually benefit from a pledge over bank accounts which ranks prior to any subsequent pledge and have a right of set-off and retention. In order to establish a prior ranking pledge, the account bank must waive its pre-existing pledge and its set-off and retention rights. Alternatively, the parties can agree with the account bank to treat the pledge with priority over the pledge established for the benefit of the account bank. This arrangement does not alter the ranking of the pledges in rem, but only takes effect as between the parties.
The most common types of intellectual property over which security is granted are:
Trade marks (Marken), either as European community trade mark or national trade mark.
Designs/utility models (Geschmacksmuster).
Copyrights (Urheberrechte) are not transferable under German law and as such cannot be employed as collateral. It is, however, possible to take security over rights under a licence to use a copyright or any other intellectual property.
Common forms of security
The common forms of security granted over intellectual property rights are the:
Security assignment (Sicherungsabtretung).
A pledge, as an accessory security interest, is dependent on the secured claim (see Question 2, Common forms of security). A security assignment is a non-accessory security instrument which can exist independently from the secured claim.
While both forms are used in the German market, there appears to be a preference for the security assignment because it allows the beneficiary to enforce the collateral through a straightforward sale. The enforcement of a pledge requires carrying out an auction process unless the collateral has a determined market value, which will rarely be the case for intellectual property rights. However, the assignee assumes in this case all payment obligations towards relevant public registries and authorities, as well as in relation to claims from third parties for an infringement of intellectual property rights. It is therefore advisable to include an appropriate indemnity in the security agreement.
There are no particular formality requirements for a pledge or for a security assignment regarding intellectual property rights.
A security assignment and a pledge of patents, trade marks, designs and utility models can be registered with the German Trade Mark and Patent Office (Deutsches Patent und Markenamt (DPMA)). However, registration is not required to perfect the security interest. Frequently, registration will only be made after the occurrence of a defined trigger event. Without a registration of that transfer, the assignee is not entitled to act towards the DPMA or receive declarations from the DPMA and has no right of action (Prozessführungsbefugnis).
A security assignment or pledge relating to a community design or community trade mark can be registered with the Office for Harmonization in the Internal Market (Trade Marks and Designs). Absent such a registration, a third party can acquire the intellectual property right from the registered holder bona fide (gutgläubig) unless the acquirer is aware of the security assignment.
It is generally possible to grant security over future assets without an amendment each time a future asset comes into existence. In order to create an effective security interest, German law requires, however, that the assets are described in a non-ambiguous manner so that it can be clearly determined on the basis of the security agreement alone which items will be part of the collateral.
Under German insolvency laws, the authority to dispose over an asset ends with the opening of insolvency procedures over a German debtor so that as from this time no future assets or receivables will become part of the security.
Under German law, it is not possible to grant a security interest over any and all assets of an enterprise by a single instrument, such as a floating charge. A similar effect can, however, be achieved if security is being taken over (substantially) all assets by individual security agreements (that is, over shares, bank accounts, receivables, fixed and current assets, IP rights and land).
A pledge or a security assignment cannot be established if the underlying asset is not transferable. This applies, for example, as a matter of law to copyrights, a limited personal servitude (beschränkte persönliche Dienstbarkeit) and certain pre-emption rights (Vorkaufsrechte).
Multi-layered collateral structures with different ranks in rem for the same asset can only be established for security interests over real estate, ships and aircraft (where the ranking is apparent from the public register) and pledges. For non-accessory security, such structures can only be achieved economically by contractually agreeing on a "waterfall", that is, a structure according to which enforcement proceeds are distributed amongst various creditors with different priorities (see Question 15, Inter-creditor arrangements).
Release of security over assets
Accessory security rights such as a mortgage (Hypothek) or pledge (Pfandrecht) which are linked to the secured claim will automatically lapse by operation of mandatory German law as and when the underlying secured obligations have been discharged in full. There are no further formalities required, but it is advisable to confirm that the security interests have indeed been released.
Non-accessory security rights such as a land charge (Grundschuld), security assignment (Sicherungsabtretung) or security transfer (Sicherungsübereignung) need to be released and the assigned or transferred assets need to be re-assigned or re-transferred by way of an agreement between the security grantor and the security holder. It is also possible (and in the case of land charges also common) to leave non-accessory collateral in place and change the underlying secured obligations or to assign the collateral to a third party so that the collateral can be used for, for example, a subsequent financing.
It is possible to release non-registered collateral under a condition precedent (aufschiebende Bedingung) so that it will be effective only on occurrence of an agreed trigger event (for example, on receipt of the full amount of the secured claim).
Special purpose vehicles (SPVs) in secured lending
It is common to take security over the shares of an SPV borrower, but usually lenders also take security over the SPV's assets with a view to avoiding structural subordination and access of third party creditors to those assets. However, in leveraged finance and other non-recourse financing structures, it should be assessed on a case-by-case basis whether it is appropriate to take share security over the shares in the parent company.
Under German law, there is a broad range of arrangements which are not strictly speaking security but have a similar economic function and enable the creditor to obtain a better position on the debtor's insolvency. The most popular are the following:
Finance leasing allows financing the purchase of an asset without taking a loan. The lessor purchases the asset and leases it to the lessee in consideration for the payment of lease instalments. During the lease period the lessee does not own the asset, but at the end of the lease period has the option to purchase the asset from the lessor for its residual value, if any. In an insolvency of the lessee, the leased asset does not fall into the insolvency estate, but the lessor may segregate the leased asset (provided the lease agreement has been terminated prior to the filing for insolvency or the insolvency administrator has elected not to fulfil the contract). If the administrator chooses to continue the lease agreement, any future lease payments become super senior liabilities of the insolvency estate and take priority. Finance leasing is not recharacterised as security.
Sale and leaseback
A sale and leaseback transaction is similar to finance leasing. The difference in the structure is that the lessee buys the asset, sells it to the lessor (lender) and then leases it back again. In the case of the lessee's insolvency, the lessor as legal owner is entitled to segregate the asset from the insolvency estate (see above, Finance leasing). Sale and leaseback transactions are not being recharacterised as security.
In a factoring transaction the factor buys receivables arising from supplies and services from a company. Factoring can either take the form of a recourse financing (unechtes Factoring) or non-recourse financing (echtes Factoring) under which the factor assumes the default risk on the acquired receivables. The factor in a non-recourse factoring has a segregation right in the case of an insolvency of the seller. By contrast, recourse factoring in an insolvency of the seller is reclassified as a secured loan, and therefore the factor can only demand preferential satisfaction in relation to the acquired receivables.
A hire purchase agreement is a type of lease arrangement with an option for the lessee to acquire title to the asset at the end of the hire period whereby the paid lease is given full or partial credit against the purchase price. In an insolvency of the lessee, the same situation as for finance leasing applies (see above, Finance leasing).
Retention of title
If an asset is being sold subject to a retention of title (Eigentumsvorbehalt) arrangement, title to the asset remains with the seller or supplier until the purchase price has been paid in full. Until title passes to the purchaser, it only has an inchoate right (Anwartschaftsrecht) in respect of the transferred asset that can itself be subject to security. In an insolvency of the purchaser prior to the full payment of the purchase price, the seller or supplier (as the legal owner of the asset) can demand segregation of the asset from the insolvency estate. Retention of title arrangements are not recharacterised as security.
Guarantees are commonly used in Germany and can be created by an agreement, which is made:
Between the guarantor and the beneficiary.
Between the guarantor and the debtor (in favour of the beneficiary).
Unilaterally by the guarantor.
A surety (Bürgschaft) is similar to a guarantee but has an accessory nature and is less common in finance transactions.
A guarantee can be structured as a first demand guarantee (Garantie auf erstes Anfordern) under which the guarantor has to make payment upon a demand meeting the pre-agreed formalities only. Objections of the guarantor can, unless they are obvious or can be demonstrated by readily available evidence (liquide beweisbar), only be brought forward in separate court proceedings after the payment under the guarantee has been made. Since this structure imposes a significant risk on the guarantor, such a guarantee may be invalid if it is contained in general business conditions. Irrespective of whether the guarantee qualifies as standard terms, German courts have held that it can only be validly given by financial institutions, or companies experienced in international finance transactions.
Risk areas for lenders
Specific rules apply to the following business types:
Stock corporations. A German stock corporation (Aktiengesellschaft) must not grant financial assistance either in the form of a loan or credit support by giving a guarantee or other security for the purpose of acquiring its shares. This prohibition also extends to the stock corporation's subsidiaries.
In addition, a stock corporation must not grant any guarantee or security in order to secure obligations of its direct or indirect shareholders (or their subsidiaries) unless it has:
entered into a domination or profit and loss pooling agreement;
a fully recoverable indemnity or claim for refund following payment under the guarantee or enforcement of the security.
Limited liability companies/limited partnerships. The granting of financial assistance by a limited liability company or a limited partnership is generally permissible, subject to certain rules regarding the preservation of the company's (or in the case of a partnership with a limited liability company as its general partner, the general partner's) stated share capital.
A German limited liability company must not grant up-/cross-stream guarantees and security if and to the extent payments under or enforcement of that security would cause the amount of the company's net assets to fall below the amount of its registered share capital (Stammkapital), or to increase an existing shortfall of its net assets in relation to its registered share capital, unless it has:
entered into a domination or profit and loss pooling agreement;
a fully recoverable indemnity or claim for refund following payment under the guarantee or enforcement of the security.
In addition, managers of a limited liability company or a stock corporation can become personally liable for any payment to shareholders (which may include enforcement of guarantees and security) resulting in an illiquidity (Zahlungsunfähigkeit) of the company unless the managing directors could not have discovered this even if they applied the due care of a businessman (Sorgfalt eines ordentlichen Geschäftsmanns). This is an unsettled area of law subject to further development.
For this reason, it is market practice to include limitation language in any up-/cross-stream guarantee and security. It is necessary to strike an appropriate balance between the interests of management to avoid any personal liability on the one hand and the interests of secured parties to receive meaningful credit support on the other hand. The exact scope of the limitation language is subject to individual negotiation on a case-by-case basis.
Finally, even though a breach of capital maintenance rules does generally not render the relevant security invalid, the courts have held that an up-/cross-stream security interest (including a guarantee) may be invalid if:
At the time of the creation of the security interest, the enforcement of the security interest would impair the protected share capital of the company.
The third party creditor and the shareholder have acted in fraudulent conveyance (kollusives Zusammenwirken) to the detriment of the company or other third party creditors.
A fraudulent conveyance exists, in particular, when third party creditors and shareholders are, at the time of the creation of the security interest, aware (or should be aware when applying due diligence) of a threatened insolvency or other material adverse financial condition of the company and intentionally (or acting with gross negligence) ignore this threatened insolvency or other material adverse financial condition of the company.
The directors of a German company are subject to a general obligation to act in the interest of that company in relation to all their actions on behalf of the company, including when granting security for the benefit of third parties.
Loans to directors
A limited liability company or a limited partnership with a limited liability company as general partner cannot make loans to its directors or the directors of its general partner from funds that are required to preserve its stated capital. A stock corporation must not make a loan to its directors without approval of the supervisory board.
Usury means the offer of a performance in exchange for monetary advantages which are clearly disproportionate to the performance by exploiting the weakness, predicament or inexperience of the contracting party. Usurious loans are void and can result in criminal liability.
In the event of a material over-collateralisation at the time when a security interest is granted, the security interest may be held invalid. There are no strict rules as to when exactly German courts will assume initial over-collateralisation.
In the case of over-collateralisation at any later point in time (for example, after a partial repayment), the validity of the collateral is not affected, but the collateral may have to be released, under general principles of German law, to the extent that its value exceeds the value of the secured claims by a significant amount. The relevant threshold commonly applied is 110% or, if there are some uncertainties as to valuation, 150%.
In the case of insolvency of a company, all shareholder loans or claims considered economically equivalent to shareholder loans will by operation of law be subordinated to the repayment claims of any other creditor. In addition, an insolvency administrator may challenge the repayment of shareholder loans within one year, and the granting of collateral for such a loan within a period of up to ten years, prior to the filing of an insolvency petition. Under certain circumstances, these principles may apply to a third party, such as a lender, if it has a degree of control over the business of the borrower comparable to the influence of a shareholder. A German court may infer such a level of control from the extent and scope of the covenant package in the credit agreement and the existence of a pledge over the shares in the company.
Structuring the priority of debts
Contractual subordination of debt is possible and common in Germany with the use of an inter-creditor or a subordination agreement (see below, Inter-creditor arrangements).
Structural subordination is possible and used to be very common in mezzanine or high yield structures. Currently, however, there are many structures in the market where mezzanine debt or high yield bonds rank pari passu with the senior debt and the parties only rely on contractual subordination.
An inter-creditor agreement usually sets forth the ranking of various layers of debt, rules for the enforcement of collateral and the distribution of proceeds among various classes of creditors. Parties to an inter-creditor agreement are typically the creditors of the various debt instruments (including hedge counterparties), relevant agents and security trustee(s), the borrower, the guarantors and other security grantors. Inter-creditor arrangements are very common in the market, but an insolvency administrator would not be bound by the waterfall provisions when distributing enforcement proceeds (see Question 8, Other assets).
Debt trading and transfer mechanisms
Debt is usually traded by way of assumption of contract (Vertragsübernahme), which essentially combines an assignment of rights and transfer of obligations. The other available option is a mere assignment, which however does not lead to a transfer of an existing lender's obligations under a credit agreement. A novation is very unusual and should be avoided as any accessory security would fall away.
Non-accessory security is commonly held by a security trustee for the benefit of a syndicate of lenders (including future lenders). Accessory collateral such as a pledge is usually held by the secured parties and, by way of a parallel debt arrangement, a security agent, and automatically transfers along with the underlying secured claim. A parallel debt takes the form of an abstract acknowledgement of debt in order to create a claim for the security trustee equal to the aggregate amount of all claims outstanding in connection with the secured documents from time to time. The parallel debt concept is widely used in the German market, even though it has never been tested in court.
Agent and trust concepts
German law does not have a concept equivalent to a common law trust. However, it is possible to appoint a security trustee to whom any non-accessory security is being granted (for example, a land charge, a security assignment or transfer) to hold that security on trust for the benefit of the finance parties. For accessory security (such as a pledge), it is mandatory under German law that the beneficiary also be a creditor of the underlying secured obligation. If it is intended to grant that type of security also to the security trustee (and not to the lenders only), it is necessary to establish a parallel debt claim, thereby making the security trustee itself a creditor of the secured claims (see Question 16).
Enforcement of security interests and borrower insolvency
The relevant circumstances in which a lender can enforce its loan depend on the individual contractual arrangements. It is usually agreed that a lender can accelerate a loan at any time after an event of default has occurred, unless it is remedied or waived within a specified grace period. However, a court may hold an acceleration invalid, for example, where the lenders have not taken into consideration the legitimate interests of the borrower.
A German law guarantee used in a finance transaction is usually enforceable if the secured claim has not been fully paid by the borrower. It is common to exclude certain defences the guarantor or the borrower may have or any right of revocation or set-off. In the case of a first demand guarantee (see Question 12), the guarantee is even enforceable on issuing a payment demand.
The requirements for enforcing a security interest depend on the type of collateral:
Pledges cannot be enforced until the secured obligation has become due and payable (Pfandreife). The mere occurrence of an event of default is not sufficient.
For non-accessory security, there is no statutory requirement that the secured claim has fallen due, but the enforcement triggers will often be aligned with accessory security granted in the same transaction.
Apart from a mortgage or a land charge, it is not mandatory that an enforceable instrument (vollstreckbarer Titel) be obtained in advance, rather it is common that the parties waive such a requirement where applicable. Enforcement of a security interest over real estate requires a special legal title (for example, a court order), but lenders usually request the security grantor to submit to immediate foreclosure (Unterwerfung unter die sofortige Zwangsvollstreckung).
In each case, the lender must give the relevant security grantor reasonable prior written notice of an intended enforcement; the minimum period which is usually agreed is one week. This notice and grace period is not required if the security grantor has ceased or refused to make payments or has filed an application to commence insolvency proceedings or such proceedings have commenced.
With respect to a land charge (Grundschuld) not only the secured obligations but also the land charge must be due and payable before it can be enforced. For land charges created after 19 August 2008, the land charge must be terminated and declared due and payable with six months' written notice prior to enforcement. The security purpose agreements often provide that the beneficiary is entitled to terminate the land charge at any time irrespective of a right to accelerate the secured obligations. However, no case law exists in this regard and it is disputed among legal commentators whether termination of land charges is valid in the absence of an acceleration event in relation to the secured obligations.
Methods of enforcement
The enforcement methods depend on the type of asset. A private sale of pledged assets not having a market or stock exchange price is only possible if the pledgor agrees to that private sale after the enforcement trigger has occurred.
Real estate. The realisation of security over real estate usually occurs by way of forced sale (Zwangsversteigerung) and/or judicially realised receivership (Zwangsverwaltung).
Movable assets. Movable assets that have been transferred for security purposes can be enforced either by way of auction or private sale. The security holder is under a fiduciary duty to maximise the sales proceeds.
Receivables. The lender usually realises the collateral by collecting the receivables from the third party debtor.
Bank accounts. Pledges over accounts are usually realised by collecting any amounts standing to the credit of the pledged account.
Intellectual property rights. Intellectual property rights assigned to the security holder can be enforced by way of sale. In the case of a pledge, the enforcement occurs by public auction.
Shares and partnership interests. In the absence of a market or stock exchange price, pledges over shares can only be enforced by public auction.
Rescue, reorganisation and insolvency
Under German law, no statutory pre-insolvency rescue or reorganisation procedure is available that can be used to restructure loans. The new protective umbrella proceeding (Schutzschirmverfahren) is a special insolvency proceeding which is available if the debtor is imminently (but not actually) illiquid (for further details, see Question 22).
On filing of an insolvency petition, the insolvency court can take preliminary protective measures to secure the assets of the debtor during preliminary insolvency proceedings. This may include a suspension of any enforcement measures.
The insolvency court can also determine a protection period not exceeding three months during which the debtor can work out an insolvency plan, provided that both:
The debtor files for insolvency on grounds of imminent illiquidity (drohende Zahlungsunfähigkeit) or over-indebtedness (Überschuldung) and applies for self-administration.
A third party insolvency expert has certified that the debtor is at the time of application still able to pay its debts as and when they fall due (zahlungsfähig), and its reorganisation is not obviously without any prospect of success.
Under such protective shield proceedings (Schutzschirmverfahren), a stay on enforcement is mandatory if applied for by the debtor.
On the opening of main insolvency proceedings, any judicial enforcement action brought against the debtor by any of its creditors is subject to an automatic stay. Whether or not a secured creditor remains entitled to enforce collateral depends on the type of collateral:
Movable assets in the possession of the insolvency administrator and receivables and other claims that have been assigned for security purposes can be freely disposed of and collected by the administrator notwithstanding any security rights over such assets. The secured creditor only has a claim for preferential satisfaction (abgesonderte Befriedigung) from the enforcement proceeds, subject to a deduction of contributory charges of up to 9% plus VAT for the benefit of the insolvency estate.
Pledged movable assets and receivables can be enforced by the pledgee itself.
In relation to shares and IP rights, it is controversial whether the creditor has the right to realise its security interest or whether only the administrator is entitled to do so.
As regards real estate the preliminary insolvency administrator may apply for a stay of enforcement if this is required to prevent any negative effects on the financial condition of the debtor. The main insolvency administrator has the same option if and as long as:
the so-called "report meeting" (Berichtstermin), a special creditors' meeting in the course of the insolvency proceedings, has not taken place; and
the real estate is required for the conduct of the debtor's business or a subsequent sale of the business, the enforcement would jeopardise an insolvency plan, or the enforcement would have a negative impact on the realisation.
In addition, irrespective of any security interest over the land, the administrator is entitled to initiate court action or sequestration of the real estate during insolvency proceedings.
Any repayment of a loan and any guarantee or security interest acquired may be subject to challenge by the insolvency administrator if they are deemed detrimental to other creditors and were effected within certain periods prior to the filing of the insolvency petition. The most relevant hardening periods range from one month to ten years and depend on various factors, such as whether:
The debtor was illiquid at the time of the transaction.
The creditor had knowledge that the debtor was illiquid.
The creditor was aware that the transaction would be disadvantageous to other creditors.
The debtor had the intent to prejudice its creditors.
The security interest or guarantee was granted gratuitously.
If any transaction is successfully avoided, the relevant secured creditor is obliged to repay any amounts received or to waive the benefit of any security interest granted to it.
In the absence of an insolvency proceeding, a third-party creditor who has obtained an enforcement order but has failed to obtain satisfaction of its enforceable claims has, under certain circumstances, the right to challenge certain transactions such as the payment of debt and the granting of security pursuant to the German Act on Avoidance (Anfechtungsgesetz). The relevant hardening periods are substantially similar to the ones described above.
The following order applies:
Creditors who have a segregation right (Aussonderungsrecht) with respect to an individual asset (for example, based on ownership) can demand that this asset be segregated from the insolvency estate.
Secured creditors who benefit from a pledge, mortgage or land charge as well as creditors to whom the debtor has transferred a movable asset or has assigned a receivable for security purposes have a right to separate satisfaction (Absonderungsrecht), that is, they can either enforce the security directly or demand preferential satisfaction from liquidation proceeds of the secured assets. In the case of pledges or security over real estate, the ranking of several creditors with respect to the same asset depends on the point in time when the security interest has been created (for example, in the case of land charges, their registration) (see Question 2). The senior ranking security holder will accordingly be satisfied before the subordinated beneficiaries. With respect to security assignments and transfers, it is not possible to grant security with different ranks (see Question 4). If a security interest has not been validly perfected, the creditor is treated as an unsecured creditor.
Priority creditors must be satisfied first out of the insolvency estate. This includes most notably court fees and the remuneration of the insolvency administrator and other creditors with respect to agreements concluded with the consent of the insolvency administrator (for example, loans to provide liquidity during the proceedings).
Ordinary unsecured creditors are paid from the remaining insolvency estate, if any.
If all other creditors are satisfied, the subordinated creditors (including shareholder lenders) finally receive payment of their debts.
Cross-border issues on loans
There are no particular restrictions on the making of loans by foreign lenders or the granting of security or guarantees to foreign lenders. However, any person engaged in banking business or financial services in Germany may be required to obtain the relevant banking licence, unless this activity is permitted to be conducted in Germany on the basis of a European passport.
There are no exchange controls that restrict payments to a foreign lender under a security document, guarantee or loan agreement under German law. However, on the basis of the International Monetary Fund Agreement, an obligation that is contrary to the exchange control regulations of a member state of the International Monetary Fund may not be enforceable in Germany. As regards payments (other than specific de minimis payments) made by a German resident to, or received from a non-resident, a notification must be made to the Deutsche Bundesbank and filed by the relevant German resident. Any omission of this notification may trigger an administrative fine.
Taxes and fees on loans, guarantees and security interests
No stamp or documentary taxes are payable in Germany in connection with the execution and performance of the obligations under a loan, guarantee or security agreement.
The granting of security over real estate located in Germany may trigger withholding taxes payable in Germany for foreign non-treaty lenders. The enforcement of a land charge will trigger real estate transfer tax (Grunderwerbsteuer) levied on the purchase price which is to be paid by the person acquiring the real estate at a rate between 3.5% to 6.5%, depending on the location of the property. This also applies to the enforcement of a share pledge if the sale of the pledged shares results in the buyer acquiring (in)directly at least 95% of the shares in a company owning German real estate or heritable building rights (Erbbaurechte).
Registration fees are payable in Germany in respect of the registration of mortgages and land charges in the relevant land register. The registration costs are linked to the value of the relevant security interest.
Notaries' fees are payable in respect of a pledge over the shares of a limited liability company (GmbH) or a limited partnership with a limited liability company as general partner (GmbH & Co. KG), a submission to immediate foreclosure with respect to real estate and the creation of security rights over real estate. The notary costs are linked to the transaction value (Geschäftswert), which is capped at EUR60 million.
Until some years ago, it was common practice to save costs by notarising pledges over shares in a German limited liability company in certain parts of Switzerland. However, subsequent changes in Swiss and German law had cast significant doubts on whether a Swiss notarisation of pledges over shares in a German limited liability company would still be regarded as equivalent and therefore valid. As a consequence, the market has over the last years no longer considered a Swiss notarisation of German GmbH share pledges to be satisfactory. There has been a recent decision by the German Federal High Court of Justice (Bundesgerichtshof) that seems to indicate that notarisations of share pledges in certain areas of Switzerland may be considered equivalent to a notarisation in Germany, but it remains to be seen how the market will react to the judgment in the absence of a clear statement by the court.
The fees for a perfection notice sent by a German notary to a pledged company regarding the pledge of its shares have increased significantly since the reform of the German notary fees effective from 1 August 2013. To avoid such fees, the notice could be included in the share pledge agreement.
There are various techniques to save notarial costs for a submission to immediate foreclosure as required when real estate security is granted (see Question 2, Formalities). It is possible to limit the submission to a partial amount or to grant an irrevocable power of attorney to the beneficiary to declare that submission on behalf of the security grantor prior to enforcement.
German Federal Ministry of Justice
Description. Official website of the German Federal Ministry of Justice (Bundesjustizministerium) that provides the German statutes. English translations of German legislation are provided on the following website for guidance only: www.gesetze-im-internet.de/Teilliste_translations.html
The Federal Court of Justice
Description. Official website of the German Federal Court of Justice (Bundesgerichtshof).
Description. Unofficial websites that provide the judgments of the German Federal Supreme Court and the verdicts of certain lower courts.
Winfried M Carli, Partner
Shearman & Sterling LLP
Professional qualifications. Admitted as Rechtsanwalt (Germany), 1999; LL.M. (New York University), 2000
Areas of practice. Domestic and cross-border bank financing, restructuring and regulatory matters, with a focus on acquisition financings, bank/bond financings, project financings, real estate financings and general banking matters.
Languages. German, English
Esther Jansen, Partner
Shearman & Sterling LLP
Professional qualifications. Admitted as Rechtsanwältin (Germany), 1998; Dr. jur. (University of Heidelberg), 1999
Areas of practice. Cross-border and domestic bank finance and restructurings with a focus on acquisition financings, bank/bond financings, real estate financings, asset based lending and corporate lending.
Languages. German, English.
Matthias Weissinger, Counsel
Shearman & Sterling LLP
Professional qualifications. Admitted as Rechtsanwalt (Germany), 2007; Attorney-at-Law (New York), 2004; Dr. jur. (University of Bayreuth), 2006; LL.M. (University of Pennsylvania Law School), 2003
Areas of practice. Domestic and cross-border financings and restructurings with a focus on out-of-court and in-court restructuring solutions, leveraged buyouts, bank/bond financings, real estate financings and corporate lending for large- and mid-cap companies.
Languages. German, English.
Debt fund on the unitranche financing of the acquisition of Duran Group by One Equity Partners (OEP).
Deutsche Beteiligungs AG and funds advised by Deutsche Beteiligungs AG on the financing of the acquisition of Pfaudler Process Solutions Group.
Spheros on the financing of the acquisition of Automotive Climate Control Inc. (ACC).
Debt fund on the unitranche financing of the acquisition of Rademacher Group by private equity firms Cross Equity Partners and PINOVA Capital.
Silverfleet Capital in the acquisition financing for Competence Call Center Holding GmbH, jobs in time holding GmbH, Orizon AG as well as in connection with the recapitalisation of Kalle Group and creatrade-Group.
J.P. Morgan Securities plc and UniCredit Bank AG as the initial purchasers in connection with the offering by HP Pelzer Holding GmbH of EUR230 million senior secured notes.
JP Morgan and Commerzbank on a comprehensive refinancing of Stabilus Group including a revolving credit facility and a EUR315 million high yield bond.
Alstria office REIT-AG in its EUR544 million real estate refinancing.
Commerzbank, Deutsche Postbank, KfW-Ipex on the EUR310 million refinancing of a cavern portfolio by IVG Institutional Funds GmbH.
AXA Private Equity in the unitranche financing of the acquisition of Industrial Parts Holding.
Adidas on a EUR500 million revolving credit facility and in the establishment of its worldwide cash pool.
Ardagh in a EUR150 million multi-jurisdictional receivables financing (including, among others, English, German and Italian receivables).
Deutsche Bank and others on a EUR1.5 billion high yield bond issued by Schaeffler Holding Finance B.V. and the initial purchasers in several offerings of high yield bonds by Schaeffler AG in the aggregate amount of about EUR2.3 billion.
Barclays Bank and J.P. Morgan Securities in connection with a covenant-lite US$2.875 billion Term Loan B term facility for INEOS AG.
Elster Group SE on the EUR840 million refinancing by a syndicated senior loan facility and a high yield bond.
Citigroup Global Markets, The Royal Bank of Scotland and Deutsche Bank AG in several secured bond offerings by Continental in an aggregate amount of EUR3 billion.