According to a recent judgment of the German Federal Supreme Court (Bundesgerichtshof) in February 2007, banks can enforceably assign loan receivables, even if such assignment conflicts with banking confidentiality and/or the German Data Protection Act (Bundesdatenschutzgesetz). This decision is likely to encourage banks which are considering refinancing options to enter into structured finance transactions such as asset backed financings. This memorandum analyses the court decision. Introduction
The market for structured finance transactions in Germany is underdeveloped when compared with other European jurisdictions and especially when compared with the United States. German banks have traditionally been hesitant to use structured finance transactions, such as securitisations or other asset backed financings, to refinance outstanding loans despite considerable advantages inherent within such structures including the transfer of any collection risk to the assignee. From an accounting point of view, the equity reserve funds of the Bank are improved which is valuable in view of the requirements as set forth under Basel II. This hesitation is due in large part to the legal uncertainty as to the validity of transfers of loan receivables discussed below. However, the recent judgment of the German Federal Supreme Court has clarified the validity of transfers of loan receivables in favour of asset backed financings.
Previous Legal Situation
Legal uncertainty as to the validity of transfers of loan receivables was initially caused by a judgment of the Higher Regional Court (Oberlandesgericht) of Frankfurt am Main dated May 25, 2004. At issue in this decision was whether the assigning bank must comply with all applicable banking confidentiality obligations (i.e., obtaining the debtor’s consent prior to the disclosure and transfer of customer data to the purchaser of the loan receivables) in order to have a valid and enforceable assignment of loan receivables. The Higher Regional Court ruled that the assignment of loan receivables by banks without compliance with all banking confidentiality obligations is invalid, and therefore the consent of each debtor was required to assign any loan receivable. However, the decision in this case was not followed by other lower German courts which added to the market uncertainty as to the validity of transfers of loan receivables. Consequently, various refinancing transactions requiring assignments of loan receivables seemed doubtful. For example, even transactions as simple as factoring were argued to be impossible as obtaining consent of each debtor was not practical and any alleged breach of banking confidentiality and/or the German Data Protection Act could have invalidated the underlying assignments.
The decision of the German Federal Court of Justice
In its decision dated February 27, 2007 the Federal Supreme Court ruled that there can be a valid and enforceable assignment of loan receivables without regard to compliance with all applicable banking confidentiality obligations. Unlike the Higher Regional Court of Frankfurt, the Federal Supreme Court relied on German law principles to honour the assignment of loan receivables unless there are exceptional circumstances which may lead to its invalidity. Consequently, the Federal Supreme Court held that violations of banking confidentiality and/or the Data Protection Act do not render the assignment of receivables invalid under German law.
However, the Federal Supreme Court stated that there is a minor liability risk for failure to comply with all applicable banking confidentiality obligations, noting that under very special circumstances the bank may be fined for a violation of the Data Protection Act or may be liable to a particular borrower for damages. As quantifiable losses due to such violations will be hard to prove, transferring banks may not consider this liability risk a deal concern.
By providing more legal certainty as to the assignability of existing loan receivables, the recent decision of the German Federal Supreme Court is an important step in outlining the legal framework for structured finance transactions. While the decision is of particular importance for existing loan agreements, loan agreements to be concluded should include a prior approval of the debtor to a possible future assignment so as to avoid any potential liability by the individual borrowers.