The German Federal Court of Justice (Bundesgerichtshof - BGH) in its decision of 17 February 2011 (IX ZR 131/10) has been dealing with the issue which – since the Act to Modernise the Law Governing Private Limited Companies and to Combat Abuses (Gesetz zur Modernisierung des GmbH-Rechts und zur Bekämpfung von Missbrauchen - MoMiG) came into effect – is being controversially discussed as to whether loans by family members (in particular the shareholder’s siblings, spouse and children) in insolvency proceedings will be given subordinate ranking. The Court rejected a general equal ranking of such (unsecured) loans with shareholders’ loans which – subject to the exceptions defined in section 39 (4) and (5) of the German Insolvency Code (Insolvenzordnung - InsO) – are undoubtedly of subordinate ranking. It has also rejected a reversal of the burden of proof to be borne by family members with regard to grounds for subordinate ranking. The Federal Court of Justice has thus clearly rejected a model which “is tantamount to joint liability for the debts of close family members”.

Insolvency creditors with subordinate ranking

The basis for the decision was the provision in section 39 (1) no. 5 of the InsO. According to this provision, not only claims for repayment of loans granted by a shareholder but also “claims arising from legal transactions which in economic terms correspond to such a loan” rank behind other claims in insolvency proceedings. The Federal Court of Justice ruled that a family connection between the lender and the shareholder does not alone justify giving the claim equal ranking to a shareholder loan. As the rigid principles for the subordinate ranking of shareholder loans have been controversial since the MoMiG came into effect, this issue was unclear prior to this decision of the Federal Court of Justice.

Contestation

As loan claims from one of the shareholder’s family members are not automatically subordinate pursuant to section 39 (1) no. 5 of the InsO, any payments of the company in connection with such loans which were made one year before or after filing for insolvency are not subject to the (simplified) contestation for shareholder loans and “equal-ranking claims” pursuant to section 135 (1) no. 2 of the InsO.

Reversal of burden of proof

Finally, the Federal Court of Justice rejected relief from the burden of proof with regard to the subordinate ranking circumstances solely based on the fact that the loan is granted (unsecured) by a family member of the shareholder. In this context, the Federal Court of Justice has expressly rejected application of section 138 of the InsO which regulates relief from the burden of proof on certain grounds for contestation in the event of participation by shareholder’s family members. The Federal Court of Justice, however, has left open the issue of whether it will abide by its rulings prior to the MoMiG, in which third-party loans are put on an equal footing with shareholder loans if the shareholder has provided the third party with the funds for loan extension or if the third party has a right for indemnification towards the shareholder (the latter case should already result from section 44a of the InsO). In all other respects, it is highly likely that the current ruling will continue to apply.