Rules on Financial Assistance in Germany
German law provides strict rules regarding the ability of a company and its subsidiaries to provide financial assistance for the acquisition of its own shares. In particular, the grant of security interests over the company’s or its subsidiaries’ assets as collateral to a third party (i.e. pledging of bank accounts, security transfer of assets, share pledges over the subsidiaries’ shares, etc.) is regarded as financial assistance.
Generally, such financial assistance is permissible only in the context of a limited liability company (Gesell-schaft mit beschränkter Haftung, GmbH), and then only to the extent that the assets may not be reduced below the stated share capital (non-freely available equity of the company). Therefore, security documents usually contain so-called “limitation language” which seek to maintain the stated share capital by limiting the grant of security to a permissible level.
For German stock corporations (Aktiengesellschaften, AG), applicable financial assistance rules are even stricter: For AGs, regardless of the stated share capital, it is prohibited to grant any of the company’s and its subsidiaries assets as collateral. Therefore, a stock corporation is unable to provide collateral for the acquisition of its own shares.
Consequences of violations of financial assistance rules
Following such restrictions, under German law advance payments, loans, guarantees or other collateral granted by an AG for the purpose of acquisition of its own shares are void. For financing the acquisitions, options other than using collateral from the target AG and its subsidiaries have to be considered.
There have been cases in which the target company was converted from being an AG into a GmbH in order to be able to provide (limited) collateral to the financing banks. Alternatively, if the debt is pushed down from the acquisition vehicle to entities below the stock corporation, the subsidiaries would be in a position to provide collateral for the debt (e.g. by way of a merger).
Consequences on securities in case of an IPO in Germany
What are the effects of the financial assistance rules in an initial public offering? Prior to an IPO, an entity unfit for listing (e.g. a GmbH) must be converted into a stock corporation. As a consequence of the conversion, the grant of securities over assets as collateral for the acquisition loan will become void due to the financial assistance rules. The lenders will be left without security between the change in form and the actual listing. If the IPO fails, the lenders are left without security until a reconversion has taken place and the GmbH may grant the identical security anew.
Decision by Higher Regional Court Munich
A part of the financial community now is hoping for relief in light of a judgment rendered by the Higher Regional Court in Munich (Oberlandesgericht) on May 10, 2012. In the case at hand, a stock corporation sold a subsidiary below market value to one of its shareholders and later fell into insolvency. The administrator claimed that the transfer constituted forbidden financial assistance and therefore would be void. While the court agreed on the qualification as financial assistance, it rejected the conclusion and treated the transfer as valid. It ruled that the shareholder is entitled to keep the shares in the subsidiary. However, according to special stock corporation provisions requiring a shareholder to return monies received outside of profit distribution, the shareholder is required to repay the difference between the true market value and the purchase price.
While this case at first glance seems to be unrelated to the grant of collateral, some legal advisers are claiming that the court after treating the transfer of shares as valid also – despite the change of form – treat the granting of collateral as valid. Obviously, this would be a major break-through – especially for lenders. The cited decision has been challenged and now is pending with the Federal Court of Justice (BGH).
It however remains unsure whether the Federal Court of Justice will uphold the cited decision. Even if the judgment were upheld, it will remain doubtful whether the case at hand will be deemed comparable to the granting of security and the change of form prior to an IPO. Therefore, lenders are strongly advised not to rely on the decision, at this time.
For the time being, for the period prior to an IPO lenders should seek independent security from the shareholders and request an undertaking to grant the collateral anew if the IPO is not completed in a specified time frame. Recent precedents in our own practice prove that shareholders are open to such requests, as the consent of the financing banks is a precondition to an IPO.