The most important principle of the German insolvency law is the equal treatment of the creditors of the insolvency debtor. To satisfy their claims, the creditors are entitled to the debtor’s insolvency estate. The insolvency estate consists of the entire assets of the debtor which belong to him at the time the insolvency proceeding is opened and which he obtains during the proceeding. The insolvency challenge rights give the insolvency administrator, under certain prerequisites, access to assets which the debtor disposed of to the detriment of the creditors prior to the filing for insolvency, thus increasing the insolvency estate. The challenge of transactions in particular takes into account that it is often attempted in pre-insolvency phases to deprive the creditors of access to the debtor’s assets by way of objectively unjustified transfers of assets or to put individual creditors in a better position. The challenge rights can only be exercised by the insolvency administrator or – in case of self-administration proceedings – by the insolvency trustee (Sachwalter).
BASIC PRINCIPLES The insolvency administrator is entitled to challenge transactions entered into prior to the filing for insolvency and which place the creditors at a disadvantage. Transaction The term “transaction” has to be interpreted broadly. It includes any action which has a legal effect, e.g. promissory contracts, contractual obligations, real acts (Realakte), acts of legal procedure, resolutions taken by corporate bodies, but also omissions. Placing Creditors at a Disadvantage The placement of creditors at a disadvantage must be assumed where the assets that are meant to satisfy the creditors were reduced from an economic point of view. Therefore, a disadvantage can be given in case of a decrease in assets, an increase of liabilities, an aggravation of access possibilities or an aggravation or a delay of enforceability. The challenge rights partly differentiate between direct and indirect disadvantages. A direct disadvantage is given where the disadvantages relating to a transaction occur in the debtor’s assets without further circumstances, e.g. the sale of an asset below value. In contrast, it is sufficient for an indirect disadvantage, if beside the transaction itself additional circumstances arise that cause the adverse effect on the creditors. For example, this is the case where the debtor in fact receives an equivalent consideration which, however, is irrecoverable.
Cash Transaction The contemporaneous exchange of equivalent value, a so-called cash transaction (Bargeschäft), is privileged. In such case, a challenge of the transaction is explicitly excluded by law, with the exception of a challenge based on a willful prejudice or an incongruent coverage. The burden of proof for any placement of the creditors at a disadvantage is with the insolvency administrator. In this regard, however, the law provides for several alleviations of the burden of proof. Related Parties In the event that the transaction was concluded between the debtor and a related party (nahestehende Person), less stringent requirements for a challenge apply. These parties normally have better opportunities to be informed about the financial circumstances of the debtor and are, by experience, more likely willing to collaborate with the latter to the detriment of the creditors. If the debtor is a natural person, related parties are, inter alia, spouses, husbands or relatives. Related parties of a corporate entity are, in particular, members of the management or supervisory board and personally liable shareholders. Furthermore, persons who have the opportunity to inform themselves about the financial circumstances of the debtor due to a relation under corporate law or a service contract are related parties to the respective corporate entity, as well.
ChALLENGE RIGhTS AND ThEIR PREREqUISITES The challenge rights can be ordered according to the time periods during which the challenged transaction took place prior to the insolvency filing. The period of the last three months prior to the insolvency filing is generally viewed as particularly critical: As a rule, the shorter the time period between the transaction and the insolvency filing, the lower are the prerequisites for the challenge. Congruent Coverage The insolvency administrator can challenge any transaction that the addressee of the challenge (creditor) was entitled to at such time and which granted a security (Sicherung) or satisfied his claims (Befriedigung) (kongruente Deckung), Section 130 German Insolvency Code (InsO). In case the transaction subject to challenge takes place within the last three months prior to the insolvency filing, then a challenge is possible, if at the time the transaction took place the creditor was illiquid and the creditor had knowledge of such illiquidity. Regarding the
period following the insolvency filing, knowledge of either the illiquidity or the insolvency filing is sufficient. Hence, from a subjective point of view, the knowledge of the creditor of the illiquidity of the debtor is required. Illiquidity is given when the debtor is not able to pay his debt when due. The addressee of the challenge is deemed to have knowledge of such illiquidity if he has knowledge of the circumstances underlying the illiquidity and in light of common experience had to assume that the debtor will not be able to pay a material portion of his debt. It is assumed that related parties do have knowledge as to the illiquidity. It should be noted that with regard to transactions taking place after the insolvency filing, a challenge is generally even possible if the legal act took place with the knowledge or even the consent of the preliminary insolvency administrator. In such case, however, a challenge by the later insolvency administrator may be precluded for reasons of legitimate expectation and legal certainty. Incongruent Coverage An incongruent coverage (Section 131 InsO) occurs when the creditor obtains security or satisfaction of his claim without being entitled to such security or satisfaction, or to a security or satisfaction of this kind or at that time (inkongruente Deckung). A non-claimable satisfaction of a claim is given, e.g., in case of the satisfaction of a time-barred claim. A satisfaction of this kind is not to be claimed, if it deviates from the performance owed pursuant to the underlying contractual obligation. A creditor must not claim a satisfaction of his claim at that time, if it is not due or limited in time. An incongruent coverage, however, is also present where the debtor non-voluntarily satisfies a claim due, such as in case of pressure or threat, in order to prevent the filing for insolvency or the initiation of enforcement proceedings.
Such transactions can be challenged per se, if they take place within one month prior to the filing for insolvency. If the transaction occurs in the second or third month prior to the insolvency filing, then the transaction can be challenged if the debtor was illiquid at the time the transaction was effected, or if the creditor was aware at that time that the transaction places the other insolvency creditors at a disadvantage. The creditor is deemed to have such knowledge if, based on his information on the economic situation of the debtor, he could not assume that the debtor’s assets were sufficient to pay off all creditors in the foreseeable future. It is assumed that related parties have knowledge of the placement of creditors at a disadvantage. Directly Disadvantageous Transaction A transaction entered into by the debtor that places the insolvency creditors at a direct disadvantage can be challenged, if it was transacted within three months prior to the insolvency filing and if, at the time the transaction was made, the debtor was illiquid and the other party to the transaction had knowledge thereof (Section 132 InsO). In this regard, transactions directly disadvantaging creditors also include transactions entered into by the debtor by which the debtor waives or loses a right or is deprived of asserting such right, or by which a pecuniary claim against the debtor is facilitated or becomes enforceable. The creditor’s knowledge of the debtor’s illiquidity is presumed if he has knowledge of circumstances that necessarily imply the debtor’s illiquidity. Willful Disadvantage A transaction entered into by the debtor within ten years prior to the insolvency filing with the intention to disadvantage his creditors can be challenged if the other party to the transaction has knowledge of such intent at the time of the transaction (Section 133 para. 1 InsO). Such knowledge of the debtor’s intent to disadvantage his creditors is presumed if the other party knows at that time about the debtor’s imminent illiquidity and the placement
of creditors at a disadvantage. For instance, any conduct leading to an incongruent coverage is a strong sign of evidence for the other party’s knowledge of the debtor’s intent. Furthermore, the case law provides the insolvency administrator with several generous alleviations of the burden of proof regarding the knowledge of the addressee of the challenge of the debtor’s intent to disadvantage his creditors. For example, a subsequently concluded standstill agreement or a subsequent agreement to pay in installments can already establish the subjective prerequisites for a challenge. A contract for pecuniary interest between the debtor and a related party can be challenged (Section 133 para. 2 InsO) if it is directly disadvantageous to the insolvency creditors, i.e. the transaction directly diminishes the insolvency estate, and if it was carried out within two years prior to the insolvency filing. While, again, the debtor must have the intention to place his creditors at a disadvantage, this intention is presumed by law and must be rebutted by the related party. The related party’s knowledge of the debtor’s intention to disadvantage his creditors is also presumed by law. Currently, the legislator is discussing adjustments to the prerequisites for a challenge pursuant to Section 133 InsO. Gratuitous Benefits Gratuitous transactions (including partially gratuitous transactions) (Section 134 InsO) entered into during the last four years prior to the filing for insolvency proceedings can also be challenged, unless the object of these transactions were ad hoc gifts of little value in accordance with common practice.
Shareholder Loan and Contributions by Silent Partners The insolvency administrator can also challenge the repayment or the collateralization of a shareholder loan or an equivalent claim (Section 135 InsO). A collateralization, for instance, would be the provision of a surety by the shareholder for a loan granted by third parties. Repayments can be challenged if they occurred within one year prior to the insolvency filing. The providing of security can be challenged if such transaction was effected within ten years prior to the insolvency filing. Furthermore, the insolvency administrator can challenge the satisfaction of a third party’s claim for repayment of a loan if such claim was secured with a security granted by a shareholder of the debtor and if such transaction was transacted within one year prior to the insolvency filing; the same applies for claims which are economically equivalent to loans. Finally, a transaction can be challenged, by which a silent partner (stiller Gesellschafter) is paid back in full or in part his silent partner contribution (Einlage) or by which his share in the loss incurred is waived in full or in part, if the underlying agreement was entered into within one year prior to the insolvency filing (Section 136 InsO). Challenge against Legal Successors A transaction may also be challenged and enforced against legal successors. This challenge right refers to universal succession (Gesamtrechtsnachfolge) as well as to singular legal succession (Einzelrechtsnachfolge). Hence, a transaction may be contested against the heir or another universal successor, and also against any other legal successor, if such legal successor (i) was, at the time of his acquisition, aware of the circumstances giving rise to the contestability of his predecessor’s acquisition, or (ii) was, at the time of his acquisition, a related party, unless he was at that time unaware of the circumstances giving rise to the contestability of his predecessor’s acquisition, or, (iii) obtained the object of contestability by way of a gratuitous transfer.
Legal Consequences The aforementioned challenge rights basically have an equal, independent status, i.e. they do not exclude each other and can be fulfilled simultaneously. Any assets of the debtor sold, transferred or relinquished under the transaction subject to the challenge must be restituted to the insolvency estate. Also, this claim is subject to interest-bearing. The claim for restitution becomes due when the insolvency proceedings are opened. The restitution has to be made in kind. Where a restitution is not possible, compensation of value has to be paid. Claims of the Addressee of a Challenge If the creditor restitutes to the insolvency estate what he has obtained, his original claim will revive. Due to the principle that a challenge must not result in an unjustified enrichment of the insolvency estate, the creditor’s consideration has to be refunded from the insolvency estate as far as it is still a distinguishable part of the insolvency estate. Otherwise, the recipient of a challengeable benefit can only assert his refund claim as an ordinary unsecured insolvency claim against the insolvency estate which is the usual case. Prescription Period The prescription period for claiming the challenge rights is three years, beginning with the opening of the insolvency proceeding and the insolvency administrator’s knowledge of the circumstances on which the respective challenge right is based and of the person of the addressee of the challenge. Upon the insolvency administrator initiating legal proceedings regarding the challenged transaction, the period of limitation is suspended.