A key objective of the current German coalition government is the reform of the clawback provisions in the German Insolvency Act (Insolvenzordnung - InsO). To address this, the German Federal Ministry of Justice and Consumer Protection recently published a draft bill for discussion.
The German government is expected to remain in office until 2017, making it highly likely that this reform will become law, in the course of 2015-2016.
Background and objective of the reform
The principal aim of the reform is to offer a higher degree of predictability to economic transactions and to lower the risk of clawbacks. Existing German clawback provisions date to 1994 and have come under increasing criticism by both the German business community and German unions, in particular section 133, paragraph 1 InsO., which allows an insolvency administrator appointed to a company to contest transactions with that company for “willful disadvantage” (Vorsatzanfechtung) to the detriment of all of that company’s creditors. This means that any transaction undertaken with the company during the ten years prior to its application for the opening of insolvency proceedings, or subsequent to such application entered into by the company, with the intention of disadvantaging its creditors upon its insolvency, can be contested if the creditor in such a transaction was aware of the company’s intention on the date of the transaction. In addition, there has been criticism due to increased attempts by some insolvency administrators to challenge the payments of salaries to the company’s employees.
Envisaged limitation of clawback actions for willful disadvantage
According to the reform, the general provision for such clawbacks for willful disadvantage shall remain unaffected. However, the revised rules will make a distinction between so-called coverage actions, i.e. actions which provide security or satisfaction to a creditor, and other legal actions, such as the selling of assets under market value. The new rules will significantly shorten the clawback period for coverage actions in cases of willful disadvantage from ten to four years prior to the application for insolvency proceedings.
In addition, the draft bill makes a distinction between the congruent actions of granting of security or other rights in favour of a creditor who is contractually entitled to such security or rights, and the granting or facilitating of security or other rights in favour of a creditor who is not contractually entitled to such security or rights. Clawback actions in respect of coverage provided to the former class of creditor (i.e. pursuant to a contractual entitlement) shall only be admitted if the debtor who granted the coverage acted in the knowledge of its inability to pay its debts and the creditor was on notice of such inability.
For other cases of willful disadvantage, in particular the displacement of assets or bankruptcy actions, the existing provisions shall remain in place. This means that the clawback period of 10 years prior to the application for insolvency proceedings and the respective case law will still apply.
Hence, the reform would lead to the following system for clawback actions for willful disadvantage:
Re-shifting the burden of proof
Furthermore, the draft bill contains legal clarifications which intend to provide more predictability regarding the interpretation and practical application of the legislation. Crucially, this would reverse some longstanding case law of the Federal Court of Justice (Bundesgerichtshof - BGH), Germany’s highest civil court, which had considerably shifted the burden of proof for the benefit of the insolvency administrator. This case law is now the subject of criticism and the BGH appears to be retreating from it.
The new reform aims to clarify several issues including the following:
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A simple request by the debtor for a customary easing of payment terms (verkehrsübliche Zahlungserleichterung) may by itself no longer count as evidence for the intent to willfully disadvantage the creditors.
The same shall apply in the course of enforcement measures with regard to amicable settlement efforts that are reached between the debtor and the creditor via settlement negotiations conducted by the court’s enforcement officers.
Similarly, the new rules would also eliminate legal uncertainty with regard to clawback actions in cases in which the creditor supports restructuring measures of the debtor or in which equivalent transactions by which the market value of an asset is paid in a timely manner according to standard market practice shall ensure the continuation of the debtor’s business.
Specification of the privilege for cash transactions
According to the current section 142 InsO, payments by the debtor in return for which it benefited directly from a consideration of equal value are so-called “cash transactions” (Bargeschäft), and may only be challenged under the conditions of section 133 InsO (see above).
With regard to clawback actions regarding employee salaries, the reform clarifies that if the period between the performance of work by the employee and the employee’s compensation for this work does not exceed three months, then such employee payment is regarded as a cash transaction and thus cannot be clawed back.
Privileged status of creditor satisfaction through enforcement measures
According to the new law, coverage which has been achieved through enforcement measures on the basis of an enforcement resulting in title being obtained through court proceedings may only be challenged under the conditions of section 130 InsO, i.e. if the enforcing creditor knows about the debtor’s inability to pay its debts. The respective changes to section 131 InsO are, in particular, intended to protect employees and small and mid-sized companies which have incurred procedural and cost risks in order to obtain a court order.
New rules on interest rates of clawback claims
Section 143 InsO which deals with the legal consequences of clawbacks shall be amended with regard to the interest to be paid for clawback claims. In the future, clawback actions shall only bear interest according to the general rules on interest for default and section 291 of the German Civil Code (Bürgerliches Gesetzbuch - BGB). This new interest rule aims to eliminate wrong incentives for a slow enforcement of clawback claims and excessive interest charges. Until now, there was a perception in the market that insolvency administrators would be dragging their feet in prosecuting these clawback claims because the statutory interest rate under current market conditions is much higher than any market rate.
Reactions to date
The German business community and German unions have welcomed the reform bill. As mentioned previously, the draft seems to have caused the highest German court to retreat from the current administrator-friendly case law. The German legal literature is varied on the reform: dogmatic supporters of general insolvency law principles are highly critical, whereas others welcome the idea of limiting clawback actions.
Practical consequences of the new regime
Despite the reform containing a number of positive changes, the German clawback regime will remain an uncertain area of German insolvency law for some time.
Although this reform would clearly lower the clawback risks in certain cases, unfortunately a high degree of unpredictability will remain as the new provisions contain numerous new terms which will need to be tested and clarified in court. This may take a decade or more, as with the current provisions that were enacted in 1994 and came into force in 1999.
As a result, once this reform is enacted, those undertaking business in Germany will still need to seriously consider the clawback risks before entering into any significant transactions due to the potential financial ramifications.
Furthermore, businesses and their creditors should continue to operate with caution because the continuing unpredictability will result in insolvency administrators continuing to exploit this uncertainty in order to maximise the assets available to insolvency companies by seeking to obtain settlements with creditors.