Parent guarantees in the insolvency of a German subsidiary – claw back risks
A recent ruling of the German Federal Civil Court (Bundesgerichtshof (“BGH”)) is a reminder of the risks which shareholders of a German company can face in an insolvency of their German subsidiary.
Under the German Insolvency Code (“InsO”), claims for repayment of a loan granted by a shareholder who holds more than 10% of the shares in the debtor are subordinated and rank behind the insolvency claims of unsecured creditors (Sections 39 para. 1 no. 5, para. 5 InsO). Furthermore, pursuant to Section 135 para. 1 InsO, if the debtor has given the shareholder security for or satisfied such a shareholder loan within the 12 months immediately prior to the filing of insolvency, such security or repayment is subject to challenge by the insolvency administrator. If the challenge is successful, the shareholder will need to return such security or payments to the insolvency estate (Section 143 para. 1 InsO).
However, shareholders are not only at risk in providing direct shareholder loans, but also if they provide collateral to a third party lender who grants a loan to a subsidiary. In a case decided by the BGH on 13 July 2017 (IX ZR 173/16), a German company (the “Debtor”) obtained a working credit facility from a bank. The facility was secured by a global assignment of the Debtor’s receivables as well as a parent guarantee issued by its sole shareholder. In the 12 months prior to the insolvency filing, the sum outstanding under the working capital facility was reduced by collections from customer payments. After insolvency proceedings were opened over the Debtor, the insolvency administrator requested from the shareholder a payment equivalent to the reduction of the working capital facility in the last 12 months prior to insolvency.
The shareholder refused to pay and argued that the insolvency creditors were not detrimentally affected by the fact that the customer payments were used to repay the bank. Given the global assignment, the bank was entitled to receive the customer payments anyway based on its security/ownership rights. However, the BGH ruled that despite the existing global assignment, the insolvency creditors were detrimentally affected. The BGH found that by giving the parent guarantee, the shareholder was obliged to settle the Debtor’s obligations to the bank. The Debtor satisfying the claims of the bank through other means meant that the shareholder was released from this obligation and this release, according to the BGH, constituted a disadvantage for the insolvency creditors and was therefore subject to challenge and claw back by the insolvency administrator. The BGH held that the shareholder’s obligation under the parent guarantee should have primarily been used to repay the bank, in which case the customer payments would have been available for the Debtor for the benefit of the unsecured creditors.
This BGH ruling was not surprising for German insolvency professionals. It is in line with Sections 135 para. (2), 143 para. (3) InsO and follows previous rulings of the BGH in comparable situations. However, non-German shareholders will often be surprised if they suddenly find themselves subject to a claw back request from the insolvency administrator of their subsidiary, even if they have not received any payments, where they have provided a security for the Debtor’s obligations to a third party which has been settled within the last year prior to the Debtor’s insolvency. Therefore, the case is a reminder about the risks of providing collateral for a German subsidiary. The insolvency administrator will not only review whether he can recover direct payments received by the parent from the Debtor prior to insolvency, but also where the parent has been released from an obligation under a parent guarantee or other security provided by the parent. Shareholders who are aware of the risk at the time when asked to provide a parent guarantee to third parties should take it into account in their decision process. Furthermore, when shareholders consider putting their German subsidiaries into insolvency, they should carefully review all intra-group relationships to identify in advance potential avoidance claims and claw back risks, so that they avoid unpleasant surprises after insolvency proceedings have been opened.