Update: Impending major reform of the German insolvency clawback regime

Clawback reduced? Germany limits clawback regime (somewhat)

Par:

On 29 September 2015, the German government agreed on an official legislative draft for the limitation of the German clawback regime.

This draft on the "Act for the Improvement of Contestations pursuant to the German Insolvency Code and the Creditor's Avoidance of Transfers Act" (Gesetzesentwurf zur Verbesserung der Rechtssicherheit bei Anfechtungen nach der Insolvenzordnung und nach dem Anfechtungsgesetz) will now be debated and eventually approved (with some changes to be expected in the process) by the German parliament.

Background and objective of the reform

Since the new German insolvency code came into force in 1999, the German business community has expressed its dismay about being exposed to disproportionate and unpredictable risks by the provisions for the contestation of transactions because of willful disadvantage (Vorsatzanfechtung) of creditors, according to section 133 of the German Insolvency Code (InsO). In particular, it remained unclear whether and to what extent subsequent payment accommodations (e.g. deferrals, waivers, installment payments) etc. granted to the debtor may count as a strong indication or proof that there was willful disadvantage of other creditors and thus sufficient ground for a contestation and clawback.

Furthermore, the actual application of the clawback provisions by the German court system has come under heavy criticism. There is also a perception among the German business community that the case law made the clawback regime even stricter and more business-unfriendly than the mere text of the German insolvency code. There was a widely shared belief that there was an imbalance between the various interests and intentions of the stakeholders involved in insolvency proceedings, in particular in relation to statutory interest claims in addition to clawback claims and the contestation of granted security and satisfaction received prior to the opening of the insolvency proceedings.

In response to these concerns and criticism, the draft aims to harmonize the various and often contrary interests between the stakeholders involved (e.g. insolvency administrators, employees, shareholders, vendors, customers), while attempting to leave the general structure of the German clawback regime unaffected.

As one of the major complaints is that the case law is too strict and unpredictable, the draft aims to establish legal certainty by, inter alia, making the actual application of clawback claims due to willful disadvantage of creditors more predictable, particularly for creditors that granted subsequent payment accommodations to their debtors.

Crucial changes

Willful disadvantage

  • Most importantly, it will be clarified that payments made by a debtor - after the creditor granted payment accommodations to the debtor are no longer generally contestable simply because of such accommodations. Rather, there shall now be a statutory presumption in favor of the relevant creditor that it was not aware of the debtor's illiquidity ("Zahlungsunfähigkeit", i.e. cashflow insolvency) simply because such accommodations were discussed and granted. This is one of the major parts of the reform and a crucial break with the current case law under which granting of such subsequent payment accommodations were in contrast a pretty strong indication of such knowledge and thus led to a finding of contestability almost every time.
  • The deadline for clawbacks pursuant to section 133 InsO shall be shortened from ten to four years prior to the filing for insolvency.
  • A congruent coverage (kongruente Deckung - i.e. performance by the debtor which the creditor can demand pursuant to the underlying agreement/transaction) shall only be contestable if the creditor knew that its debtor was illiquid at the time of the relevant payment/performance. According to the current law, congruent coverages are contestable at an earlier stage if a creditor knows of an impending cashflow insolvency. 
  • While these are all limitations of the clawback regime for honest creditors, it has to be pointed out that the aforementioned new limitations to the clawback regime will not apply to fraudulent transfers of assets or transactions done in the course of specific insolvency crimes. 

Cash transactions (Bargeschäfte)

Importantly, there is a statutory presumption under German insolvency law that a creditor can expect that something the creditor immediately received from a debtor in an economic transaction in exchange for a benefit given by the creditor cannot be contested and clawed-back anymore - except in the case of willful disadvantage. This kind of immediate transaction that is largely exempt from the clawback regime is called a cash transaction (Barschäft - section 142 InsO).

The new draft will broaden this exemption from clawback: In order to eliminate any uncertainties of recent case law in relation to cash transactions, the draft sets out that those may only be contested in case of willful disadvantage according to section 133 InsO if the debtor acted dishonestly and the creditor recognized this dishonesty.

To further protect employees, the future wording of section 142 InsO will clarify that if the period between the performance of work by the employee and the employee’s compensation for this work does not exceed three months, then such salary payment is regarded as a cash transaction and thus cannot be clawed back. As this is a major expansion of this protection against clawback for a certain group of persons, it can be expected that there will be future lawsuits concerning the question of who counts as an employee in this regard, i.e. whether certain managing directors or freelancers need similar protection, and whether this protection can be granted by case law, remains to be seen.

Satisfaction of claims achieved by statutory enforcement measures

Satisfaction of claims achieved through enforcement measures on the basis of an enforcement title may only be contested under the conditions of section 130 InsO, i.e. if the enforcing creditor knew about the debtor’s inability to pay its debts.

Interest rates

Section 143 InsO, which deals with the legal consequences of clawbacks, shall be amended with regard to the interest to be paid for clawback claims. In the future, clawback actions shall only bear interest according to the general rules on interest for default and section 291 of the German Civil Code. This new interest rule aims to eliminate wrong incentives for a slow enforcement of clawback claims and excessive interest charges. Until now, there was a perception in the market that insolvency administrators would be dragging their feet in prosecuting these clawback claims because the statutory interest rate under current market conditions is much higher than any market rate.

Outlook and practical consequences

As mentioned in our prior blog post on the original draft: Despite the reform containing a number of positive changes, the German clawback regime will remain an uncertain area of German insolvency law for some time.

Overall, the government draft contains some significant changes in comparison to the ministerial draft, most importantly the changes related to the re-shift of the burden of proof in section 133 InsO.

Hence, this reform will clearly lower the clawback risks in certain cases. Unfortunately, a high degree of unpredictability will remain since the new provisions contain some new terms which will need to be tested and clarified in court. However, in comparison to the original draft, there are a fewer untested new terms which demonstrates the German government's effort in clarifying the reform.

Only time will tell whether the objectives of better predictability of economic transactions and a lower risk of clawbacks have been achieved. It remains to be seen whether the new statutory wording will be applied by the courts as designed by the legislature or whether the courts will still heed to an overly broad scope of the German clawback regime.

As a result, even under this improved clawback regime those undertaking business in Germany will still need to seriously consider the clawback risks before entering into any significant transactions due to the potential financial ramifications involved. Businesses and their creditors must also continue to operate with caution because the continuing unpredictability will result in insolvency administrators continuing to exploit this uncertainty in order to maximize the assets available to insolvency companies by seeking to obtain settlements with creditors.

The German government is expected to remain in office until 2017, making it highly likely that this reform will become law in the course of 2015-2016.

Further information

The draft as well as the press release are available online.