August 30 2019 Frolicking in the (cash)pool? Hesitant embrace of state-of-the-art cash management Schima Mayer Starlinger | Banking & Financial Services - Austria Banking & Financial Services IntroductionFactsDecisionCommentIntroductionAlthough the benefits of cash management are unquestioned in Austria, Austrian corporate, regulatory and tax laws – contrary to those in (for example) Germany – cannot provide a stable legal basis for establishing a cash pool in Austria or even for including an Austrian corporate subsidiary into a group-wide (ie, cross-border) cash pool arrangement.The most important legal obstacle is the Austrian capital maintenance rules. Save for certain exceptions, these rules prohibit upstream and side-stream financial assistance and are protected by the statutory invalidity of any violating arrangements (for further details please see "Capital maintenance rules and voidance of third-party security"). Under certain conditions, such nullity may also affect banks which operate the cash pool accounts by voiding security instruments granted by Austrian participants and triggering repayment obligations.When entering into such agreements, banks regularly rely on representations and warranties by the master company and security granted by group members. However, in insolvency scenarios, Austrian insolvency administrators have recognised the potential invalidity of cash pool arrangements as a worthwhile goal and regularly challenge these arrangements and payments made.In a recent decision,(1) the Supreme Court dismissed an insolvency administrator's complaint challenging the enforcement of an account pledge provided to a bank as security for a notional cash pool arrangement.(2)FactsThe Austrian insolvent limited liability company (the debtor) was a subsidiary of a wholesale group based in Australia. The debtor's direct majority shareholder, a Dutch private company (the master company), coordinated a notional cash pooling arranged by a Dutch bank.Pursuant to the cash pooling agreement governed by Dutch law, the debtor was not obliged to maintain a minimum amount on its participating account and could terminate the agreement at any time. Further, the debtor pledged all of its claims against the bank out of or in connection with its participating account as a security for the total liabilities of all participants of the cash pool. The master company's core obligation was to ensure that at the end of each business day, the total balance of all participating accounts was not negative (ie, had a credit balance or was at least zero).During the first years, the debtor mostly received money from the cash pool. Following an intragroup transaction in June 2014, the debtor's account had a positive balance of approximately €2 million, which remained essentially at this level even though the financial situation of the group deteriorated significantly. The debtor terminated the cash pooling agreement as of 14 April 2015. On the same day, the bank enforced the account pledge by setting off the credit in the debtor's participating account against the secured obligations. Deprived of its liquid funds, insolvency proceedings were opened against the debtor within 14 days of the enforcement of the pledge.Internally, the debtor was subject to instructions by the master company. Pursuant to these instructions, the excess liquidity achieved by the debtor was to be made available to the cash pool. While the debtor transferred such amounts to the participating account independently, it had to apply to the master company to receive money from the cash pool. Interestingly, the courts were unable able to ascertain whether the bank had been aware of these internal restrictions. Further, there were no judicial findings as to whether:the master company's financial situation had been disclosed to the debtor when entering into the cash pooling agreement; orthe debtor had adequate insight and information rights as regards the master company's financial situation.DecisionBased on these facts and (lack of) findings, the Supreme Court assessed the complaint by the debtor's insolvency administrator of the debtor based on a violation of the maintenance of capital rules and held as follows:From a maintenance of capital point of view, the risks arising from a notional cash pooling arrangement are typically less critical than those arising from cash concentration or zero balancing arrangements. Adequate interest allocation and compensation risks must be considered if the Austrian participant could negotiate better conditions on a standalone basis. In any case, the debtor's assumption of liability for default by the granting of security would likely violate the principles of capital maintenance.The arm'slength principle,(3) as applied by the lower-instance courts, is not a decisive criterion because notional cash pooling agreements are unlikely to be concluded with third parties. Accordingly, the only relevant test is whether participating in the cash pool and providing security had a corporate benefit for the debtor, also taking into account the advantages for the debtor arising from being part of the group of companies financed by the cash pool.The fact that the debtor had received funds from the cash pool must be considered and may outweigh the risks arising from granting security, unless the risk of a default was probable at the time of entering into the cash pooling agreement. To that end, the Supreme Court explicitly held that "the corporate benefit cannot be invalidated by merely referring to the potential risk of an insolvency".Summarising aspects of cash pool arrangements that have been previously developed by doctrine and were basically reflected in the cash pooling agreement, the Supreme Court held that no findings to the contrary had been made by the courts.The Supreme Court refrained from rendering a final verdict on the admissibility of the notional cash pool arrangement, as amended by the master company's internal instructions. In its reasoning, the court emphasised that the maintenance of capital rules are essentially aimed at corporations, their shareholders and the management. Except for collusive conduct, a third party such as a bank may become subject to such rules only in the event of gross negligence (ie, if the abusive nature of the arrangement is 'virtually obvious'). In such cases, the third party must investigate the transaction in detail in order to ascertain whether it can participate in such a transaction.The Supreme Court held that, contrary to upstream and side-stream security or funding transactions, in cash pooling scenarios, the corporate benefit may appear plausible for the bank and, in any case, cannot be ruled out. With respect to the case at hand, the court referred to the fact that following the judicial findings of the lower-instance courts, the internal instructions altering the terms of the cash pooling arrangement may not have been disclosed to the bank. Based on these findings, the bank had been safe to assume that the debtor could terminate the contract at any time and decide for itself what amount would be paid into the cash pool and thus be subject to the risk of loss in case of an enforcement of the account pledge.Based on this reasoning, the Supreme Court concluded that a potential nullity of the cash pool arrangement in the relationship between the master company and the debtor did not affect the effectiveness of the debtor's contractual obligations towards the bank. Accordingly, the court dismissed the complaint.CommentEven though this first decision of the Supreme Court on cash pooling arrangements dealt with the least invasive form of a cash pool, it is remarkable that the court did not grant a clean bill of health. In any case, the court's guidance on the advantages of cash pooling arrangements, as well as on contractual minimum requirements, must be considered when structuring new or reviewing existing cash pool arrangements of any kind.Further, a more cautious approach is advisable with respect to cash concentration arrangements, particularly with respect to:the Austrian participant's information and termination rights;the level of information provided on the financial situation of the master company; andthe advantages and risks arising from participating in the cash pool.Termination rights must be tailored in a way that settlement payments (ie, credit or debit) are calculated and made as of the effective date of the termination. Further, such payments must be secured in a way that the Austrian participant has a first ranking right to receive and retain repayment (eg, security in rem or right of segregation). In order to avoid jeopardising such structure, the security instruments provided by the Austrian participant must also be terminated with immediate effect. It remains to be seen whether banking practice allows for this special treatment of Austrian participants in cross-border scenarios.Further, with a view to banks involved in cash pool arrangements, this decision is significant as the Supreme Court held that even if the arrangement should be void between the Austrian participant and its shareholder (respectively, the master company), this may not backfire if the bank did not act grossly negligent (ie, it has not or could not have been aware of the violation of the maintenance of capital rules).Banks may rely on a prima facie assumption of a corporate benefit, provided that the terms and conditions of the cash pooling arrangement are materially in line with the guidance provided by the Supreme Court. However, this comfort must not be seen as a basis for failing to apply adequate due diligence, as the Supreme Court explicitly held that the principles of capital maintenance as developed on upstream and side-stream intragroup loans and security will be applied on cash pooling arrangements.In a highly disputed decision,(4) the Supreme Court developed the so-called 'overall planning' criterion, which requires banks to duly review all individual legal acts entered into in connection with a transaction. It remains to be seen whether this criterion may also be applied to banks in (notional) cash pooling scenarios (eg, by requiring them to monitor whether the actual conduct of a participant is in line with contractual rights). Applying this to the case at hand, the debtor's discretionary keeping of a credit balance of €2 million on a pledged account despite the financial difficulties of the group could arguably have been considered an existential risk in favour of its shareholder and thus an infringement of the capital maintenance rules. A cautious approach may be advisable, as the extent to which a court will apply the 'overall planning' criterion is not always foreseeable.Banks involved in cash pooling arrangements may derive some comfort from this decision, but there is still no legal certainty and careful tailoring of the cash pooling agreements is crucial in order to allow an Austrian corporation to legally participate in a cash pool and to avoid a nullification of cash pool agreements and ancillary security documentation.For further information on this topic please contact Stephan Schmalzl at Schima Mayer Starlinger by telephone (+43 1 383 60) or email ([email protected]). The Schima Mayer Starlinger website can be accessed at www.sms.law.Endnotes(1) OGH 02.05.2019, 17 Ob 5/19p.(2) Contrary to a cash concentration (zero or target balancing) arrangement, a notional pooling does not require a physical transfer of cash to a centralised master account. The balances of the pool accounts are netted daily on a purely arithmetical basis for the purpose of optimising interest.(3) In order to comply with the principles of capital maintenance, any business relationship between an Austrian corporation and its shareholder must be set up at arm's length (ie, in a manner as if such business relationship would have been concluded with an external third party).(4) OGH 6 Ob 48/12w, as unrestrictedly confirmed in 1 Ob 28/15x, irrespective of heavy criticism by legal doctrine.