Within German contract law, the principle of being bound by a contract (pacta sunt servanda), i.e. the obligation to fulfill agreements, applies. In case of the insolvency of one of the contractual parties, however, exceptions are made. Upon the opening of the insolvency proceedings, the principle of being bound by a contract is modified.
The insolvency provisions concerning the fulfillment of mutual contracts (Sec. 103 et seq. German Insolvency Code (Insolvenzordnung, InsO)) grant the insolvency administrator an option right as to whether agreements which had been concluded prior to the opening of proceedings and which have not yet been fully performed by both parties shall be fulfilled. The opening of an insolvency proceeding does not lead to a substantive transformation of the agreements, however, any outstanding claims arising from the mutually unperformed agreement are no longer enforceable. The purpose of these rules is to allow the insolvency administrator to maintain or to increase the insolvency estate, enable restructuring attempts and to prevent the contractual partner of the debtor from terminating an agreement which was favorable for the insolvency estate due to the insolvency of the latter.
The most important stipulations are explained below.
The Insolvency Administrator’s Option Right, Sec. 103 Inso
The prerequisites for exercising the insolvency administrator’s option right (Insolvenzverwalterwahlrecht) is the mutuality of the claims which have not or not fully been performed by both parties at the time of the opening of insolvency proceedings. Types of agreements which are often subject to the administrator’s option right are purchase agreements, contracts for works and services, license agreements and loan agreements. However, the option right does not apply, for example, in the context of mutual agreements which have been fully performed by one party, agreements with a valid termination clause or shareholder agreements.
The administrator has to declare demand for performance to the contracting party. For this declaration, he is not bound to any time periods. However, the contracting party may ask the administrator to exercise his option right and to issue a corresponding declaration. In this case, the administrator has to issue his declaration “promptly” which means acting without undue delay. Thus, the insolvency administrator is allowed to assess the consequences of exercising his option right within a time period reasonable under the circumstances of the individual case in question, e.g., after obtaining the consent of the creditors’ committee, after a final review of possible restructuring options or after the first report meeting to the creditors (Berichtstermin).
Consequences and Effects
Opting for Performance: In case the administrator decides to perform a not or not fully performed agreement, he assumes the rights and obligations of the debtor arising from the agreement. The declaration of the administrator has an effect only for the future (ex nunc), i.e. the performance owed by the debtor becomes a preferential obligation (Masseverbindlichkeit) and the performance owed by the counterparty becomes a preferential claim (Masseforderung). The initially agreed contractual conditions remain unchanged. Claims of the contractor which incurred prior to the opening of the insolvency proceeding are not affected by the administrator’s election to choose performance. Such claims are to be filed as ordinary, unsecured insolvency claims (Insolvenzforderung).
Opting for Non-Performance: In cases where the insolvency administrator rejects the performance of a contract, this is only of declaratory nature, since as described above, upon opening of insolvency proceedings the reciprocal claims are no longer enforceable. The contractual claim of the contracting party is replaced by a compensation claim for non-performance. The contracting party may file such compensation claim as an ordinary, unsecured insolvency claim with the insolvency claims schedule. The amount of the damage claim is calculated based on the principles of the so-called theory of difference (Differenztheorie) pursuant to which the mutual claims arising from the non-performance of the agreement are netted against each other. If the result is a positive balance in favor of the contracting party, the latter can claim this balance as an insolvency claim. Satisfaction of such claim will be subject to the insolvency dividend quota.
Separable Performances, Sec. 105 InsO
For agreements containing separable performances, Sec. 105 InsO contains special provisions regarding the administrator’s option right. In particular, this pertains to so-called agreements for continuing obligations, e.g. agreements for the continuous supply of goods or energy. In this context, and regardless of whether the insolvency administrator is opting for performance or not, all counterclaims for partial performances rendered prior to the opening of insolvency proceedings can only be filed as ordinary unsecured insolvency claims. If the administrator decides in favor of the continuance of the agreement, the contracting party becomes a preferential creditor for all future claims arising from the continued supplies or services. Partial performances already rendered prior to the opening of the insolvency proceeding cannot be reclaimed.
The fact that services rendered prior to the opening of insolvency proceedings may only be asserted as ordinary unsecured insolvency claims serves mainly the purpose of avoiding an exposure of the insolvency estate. Such exposure could in particular result from the fact that the administrator would otherwise need to first reject the further performance of the contract to avoid preferential claims against the insolvency estate and would then have to conclude the same agreement at potentially worse conditions.
Invalidity of Termination Clauses, Sec. 119 InsO
Contractual agreements excluding or limiting the applicability of the insolvency administrator’s option right under Sec. 103 et seq. InsO are invalid. In its judgment dated 15 November 2012, the Federal Court of Justice (Bundesgerichtshof, BGH) has, with regard to agreements regarding continuing obligations, clarified that termination clauses linked to an insolvency event (insolvenzabhängige Lösungsklausel) jeopardize the administrator’s right to choose between performance or non-performance and, thus, are invalid. This applies in particular to clauses which grant the parties the right to terminate an agreement for cause if the respective other party has filed for insolvency or if (preliminary) insolvency proceedings have been opened over the respective party’s assets. On the other hand, termination clauses linked to non-insolvency events (insolvenzunabhängige Lösungsklausel), e.g. termination rights for default of obligations, initiation of enforcement measures in the assets of the other party, breach of essential contractual obligations or the occurrence of a significant deterioration of the financial situation of the other party, are usually deemed to be in line with legal regulations.
Exceptional provisions for different types of agreements
The insolvency laws provide for special provisions regarding certain types of agreements, which supersede or modify the administrator’s option right:
Expiry of Agreements, Sec. 115 – 117 InsO
Save for very limited exceptions, assignments, agency agreements or powers of attorney relating to the insolvency estate terminate upon opening of insolvency proceedings by operation of law. Claims regarding an agreed remuneration or reimbursement of expenses can only be filed as non-preferential claims with the insolvency schedule.
Withdrawal of the Right of Choice, Sec. 106, 107 InsO
Subject to any avoidance rights, regarding priority notices (Vormerkung) registered prior to the opening of insolvency proceedings the administrator is deprived of his option right, Sec 106 InsO. Hence, such priority notices are insolvency-resistant (insolvenzfest). Any claims secured by a priority notice must be fully compensated from the insolvency estate. The insolvency-remoteness further applies to the purchaser’s expectant right (Anwartschaftsrecht) in the event of the insolvency of the seller, if the parties have agreed on a retention of title (Eigentumsvorbehalt), Sec. 107 InsO.
Continuance of Certain Agreements – Special Termination and Rescission Rights, Sec. 108 InsO
By law, lease agreements on immovable property as well as employment and service agreements are continued despite the opening of insolvency proceedings, Sec. 108 InsO. Any claims which arose prior to the opening of insolvency proceedings from such agreement have to be filed as ordinary unsecured insolvency claims. Claims which arise after the opening of insolvency proceedings, however, are preferential claims. Instead of the option right, the insolvency administrator is granted special termination and rescission rights for these types of agreements.
The law on lease agreements grants the insolvency administrator a special termination right providing for a notice period of three months to the end of the month, irrespective of the contractual termination provisions. In case of the insolvency of the lessee, both the administrator and the lessor may withdraw from the agreement, if the rental property has not already been handed over at the time of the opening of the proceedings. If the administrator withdraws from the agreement, the lessor may request damage claims for the premature termination as an ordinary unsecured creditor. During the lessee’s insolvency, the lessor cannot terminate the lease agreement based on pre-insolvency default of rental payments or because of a deterioration in the financial situation of the lessee, so called termination lock (Kündigungssperre), Sec. 112 InsO.
With regard to the laws on employment and service agreements, the administrator is also granted the right to terminate the underlying agreement at three months’ notice to the end of the month, regardless of any agreed or applicable statutory notice period. Employees who would be subject to longer notice periods or are irredeemable under their employment or labor agreements may assert damage claims as ordinary unsecured creditors in the amount of the remuneration and fringe benefits they would have received if regular notice periods had been applicable. For employees whose employment agreements are irredeemable the amount of the damage claim is, however, limited to the amount calculated on the basis of the longest notice period applicable under statutory law.