German Insolvency Reform – Claw-back Due to Willful Disadvantage
By Dr. Christian Mock
I. Executive Summary
The reform (which has come into force and effect on 5 April 2017 ("Reform")) is aiming at increasing legal certainty in cases of rescission inside and outside of insolvency proceedings regarding insolvency rescissions due to willful disadvantages (Vorsatzanfechtung) for creditors.
However, it has to be highlighted that the Reform has solely introduced very limited changes without overhauling the general concept of German claw-back law or rescissions due to willful disadvantages in particular. As a consequence, the German insolvency rescission law remains one of the most complex legal fields of law in Germany which still provides for widespread opportunities for the insolvency administrators to put pressure on creditors.
Therefore, (foreign) investors and business partners should always (i.e., not only in stressed/distressed situations) take into consideration the legal implications of the German claw-back law to avoid unpleasant surprises.
II. Legal Situation Before the Introduction of the Reform
The German legislator has implemented a very complex system by way of which an insolvency administrator/trustee can claw-back payments from a creditor.
The ultimate weapon of the insolvency administrator/trustee in this respect is a rescission due to willful disadvantage (Vorsatzanfechtung) pursuant to section 133 of the German Insolvency Code ("InsO").
According to paragraph 1 of said provision, a transaction made by the debtor during the last 10 years prior to the application to open insolvency proceedings (or subsequent to such request) with the intention to disadvantage its creditors may be contested if the other party was aware of the debtor’s intention on the date of such transaction. Such awareness is presumed by law if the other party knew (i) the debtor’s insolvency was imminent, and (ii) that the transaction constituted a disadvantage for the credit. Due to several judgments of the German Federal Court of Justice (the "FCJ"), the awareness of the creditor was presumed even in cases when he merely deferred his claims against the debtor repeatedly, making the provision even more insolvency administrator/trustee friendly.
As a consequence, creditors were often confronted with significant claw-back claims. This situation was often perceived as unjust and caused widespread criticism given the legal uncertainty for debtors attached to it.
III. Aim and Purpose of the Reform
Based on this criticism, the German legislator decided to take action. The purpose of the amendments to the law was to strike a balance between the competing interests of legal certainty on one hand, and securing the insolvency assets on the other and aims at improving this situation for creditors and employees with regard to existing claw-back risks.
IV. Core Changes Due to the Reform
In the light of the foregoing, the German legislator has amended the existing system of willful disadvantage without changing the concept in its entirety.
A. Reduction of Claw-Back Period in Specific Cases
To the extent that the transaction has resulted in a satisfaction or in the provision of security, the claw-back period has been reduced from 10 to four years. For all remaining cases of claw-back due to willful disadvantage, the period of 10 years will remain.
B. Further Privileges in Cases of Congruent Coverage
In addition, the legislator has introduced the (complex) system of congruent/incongruent coverage (sections 130 and 131 of the InsO) in section 133 of the InsO.
In a nutshell, a congruent coverage is a situation in which a creditor receives a payment or a security due to an existing claim whereas no such claim exists in case of an incongruent coverage.
The legislator now explicitly distinguishes between both cases and privileges transactions of congruent coverage in two ways:
1. Illiquidity vs. Imminent Illiquidity in Section 133 Paragraph 3 Sentence 1 of the InsO
In case of a congruent coverage, the presumption of knowledge on the side of the creditor being subject to the claw-back claim only kicks in in cases of existing (and no longer imminent) illiquidity.
2. Payment Facilities
The Reform also provides that if a creditor gives the debtor payment facilities with subsequent (congruent) payments, it shall be presumed that the creditor did not know about the debtor’s illiquidity.
Both changes really increase the legal certainty of creditors. However, foreign investors in particular may have difficulties with understanding the complex regulatory mechanisms.
C. Changes to the Cash-Privilege in Section 142 of the InsO
The changes in section 133 of the InsO have been accompanied by amendments in section 142 of the InsO, the so called "cash-privilege".
Under the former law, payments on the part of the debtor in return for which his property benefited directly from an equitable consideration could (in certain cases) be contested under the conditions of a willful disadvantage pursuant to section 133 paragraph 1 of the InsO.
The German legislator has made efforts to mitigate the associated risks in this regard by introducing a new limitation according to which the receiving part in the cash transaction must have become aware that the debtor acted unfair. However, the legal term "unfair" is newly introduced in this respect in the InsO and German courts will have to breathe fresh life into it. As a consequence, the legal certainty is presumably not increased.
The same applies to the introduction of section 142 paragraph 2 sentence 1 of the InsO. The legislator solely repeats the currently existing case law of the FCJ by implementing the requirement of the term "immediateness" of the exchange of performance and consideration. No further clarification is provided by the Reform in this regard. However, the Reform provides for a considerable advantage for employees. In this respect it states that "immediate" means within a period of up to three months following the work rendered.
While the Reform clarifies certain specific points, it will not eliminate the general problems: The legal concept of the German claw-back is (still) very complex and requires profound knowledge of the law and diligent assessment of the individual case. Hence, each market participant has to act cautiously in this environment in order to avoid its pitfalls!