The European Lawyer

Germany Banking/Finance

10 Mar 2010

International Acquisition Finance - Germany

Editors: Hengeler Mueller; Partnerschaft von Rechtsanwälten - Hendrik Haag

1. THE GERMAN ACQUISITION MARKET
The acquisition market in Germany was hit hard by the financial crisis that broke out in July 2007. While the volume increased from €48 billion in the first half of 2007 to €51 billion in the second half (presumably because of transactions that were already in the pipeline), the first six months of 2008 showed a dramatic recession with an acquisition volume of only €24 billion. Whereas strategic buyers had dominated the M&A market in the period July to December 2007 with a share of about 80%, during the first half of 2008 private equity and strategic investors shared the market evenly. Given the drastic change in financing conditions for leveraged investors, it was quite surprising that private equity funds continued to invest at a significant scale. In 2008 they have closed four transactions with a value in excess of €1 billion each. Two of those were acquisitions of minority stakes in listed companies (so called PIPE deals).

Generally, money has become much more expensive. Financings based on six or even seven times EBITDA belong to the past, as does a debt/equity leverage of four to one. Also, strict covenant structures have come back in the course of this year. This makes the billions of acquisition debt still in the books of the leading underwriters even harder to syndicate. Leading arrangers in the German market are the eminent domestic banks like Deutsche Bank, Dresdner Bank, Commerzbank Bank and HVB Unicredit, but increasingly also institutions from other European countries with ambitions in Germany such as RBS, HSBC, UBS and Credit Suisse.

2. FINANCING DOCUMENTATION
Like elsewhere the documentation standard in Germany is dominated by the Loan Market Association (LMA) precedents. Traditionally, the drafting style for legal documents in Germany is short and concise. This has changed over the last 10 to 15 years when Anglo-Saxon documentation became the international standard. Hence, the common language is English. On rare occasions do clients require German language loan agreements, e.g. where the borrower is a less sophisticated company with little international exposure. The dominance of English law that has developed elsewhere in Europe does not extend into Germany. In fact, the majority of financings continues to be governed by German law. In many cases, German law is chosen upon specific request by the borrower, and arrangers are generally comfortable with this choice as German law has become a perfectly acceptable governing law for the syndication market as a whole.

3. ACQUISITION/FINANCING STRUCTURES
Leveraged investors such as private equity funds use special purpose entities as acquisition vehicles. This is normally a GmbH (Gesellschaft mit beschränkter Haftung) established in Germany or purchased from a shelf company vendor. For some investments tax transparent limited partnerships are more common. This particularly applies to real estate acquisitions to allow the deduction of financing costs from German real estate income. The acquisition vehicle will be directly held by the strategic investor or fund or, as it is more common in the case of private equity, through a complex structure of intermediate companies designed to secure a favourable tax regime for the exit proceeds.

The principal elements of the financing structure are the senior facility for the acquisition vehicle to finance the purchase price, and a working capital line for the target in repayment of the existing working capital financing. Depending on the risk profile of the acquisition, these may be supplemented by second lien loans, mezzanine loans, PIK-financings (payment in kind where interest is capitalized and deferred until final maturity) or high yield bonds. As lenders to the acquisition vehicle, banks are structurally subordinated. The servicing of the acquisition debt relies on the income derived from the target, and it is thus very important to secure that funds can flow upstream freely. This may apparently conflict with the interest of banks financing the target itself, and it is for this reason why lenders providing the acquisition debt and the working capital line should be the same. There are, however, some limitations under corporate law preventing a free flow of funds to the shareholder, and those will be discussed below.

Maturities available for the senior loan vary from 2 to 5 years, often divided into two or even more tranches with different maturity profiles. Where the timeline for the acquisition does not allow for full syndication before closing, the arranger may underwrite the loan and bring it up for syndication after the acquisition has been completed. Alternatively, there may be a bridge financing with a maturity of 6 to 12 months to be taken out by the final loan or a combination of financing instruments or other sources of funds. These may include mezzanine debt, a high yield bond issue or simply proceeds from divestments to be accomplished within a certain time period. The bridge will have an escalating interest rate structure which significantly increases the cost of the loan if the takeout schedule is not met.

4. REGULATED TARGETS
The leveraged acquisition of regulated targets, such as banks and insurance companies presents particular challenges. This is less the case where the acquirer is a strategic investor pursuing a long term interest and not being focused on possible exit scenarios. Also, the fit and proper test applicable to a purchaser of a 10% or lager interest in a regulated entity is easy to satisfy if that purchaser is itself a regulated member of the industry. The German supervisor of the financial and insurance industry, BaFin (Bundesanstalt für Finanzdienstleistungsaufsicht), has traditionally been quite hesitant to approve the acquisition by a private equity fund of a bank or insurance company for these reasons. The concern was based on the expectation that the high leverage of the acquisition debt might harm the financial position of the acquired business. In addition, as mentioned above, a short investment horizon was seen as being detrimental to a long term stable development of the business in a sensitive environment like the financial and insurance markets. Nevertheless, there have recently been examples where these hurdles could have been overcome. In any event, the BaFin can be expected to explore in depth the investment structure and the long term goals of the private equity investor.

There is another specific issue for private equity investors into a German credit institution. In addition to the mandatory deposit protection scheme applicable in Europe, the German Federal Association of Banks (Bundesverband Deutscher Banken) maintains a supplemental deposit insurance system with a significantly better scope of protection. Whereas the mandatory scheme provides for a maximum amount secured of €20,000 (less a deduction of 10%), the Einlagensicherungsfond fully secures each deposit up to an amount equal to 30% of the financial institution’s liable funds per investor. Since liable fund of €5 million is the absolute minimum for obtaining a license to take deposits, €1.5 million per investor is the amount that is at least insured. The voluntary fund is based on funding obligations of its members. To become a member all entities that are in a position to directly or indirectly control the relevant deposit taking institution need to indemnify the fund for any payments it needs to make in relation to defaulted deposits. While this is not a problem for another bank as a strategic investor, the idea of indemnifying creditors of the target is quite alien to a private equity fund. A possible solution is to structure around the criteria “control” and spread the investment over a variety of funds that are not under common management. Again, the Federal Association of German Banks can be expected to quite carefully review whether this does infect avoid common control.

5. LISTED TARGETS
Acquisitions of shares in listed targets representing less than 30% of the aggregate outstanding shares do not present particular problems because this acquisition does not trigger a requirement to launch a mandatory take over bid. Of course, in the case of a traded company there are other stakeholders that will take an interest in the goals of the acquirer. This has recently become an issue in particular with respect to hedge funds which, although they hold rather minor stakes, were able to put pressure on the management to change the course of the company or even to resign. From the perspective of the financing bank, however, these issues are less relevant. The bank must be sure to have a comfortable security position with respect to the purchased shares. Often, these financings are margin loans requiring the borrower to maintain a certain safety cushion between the market value of the purchased assets and the debt incurred.

The environment is fundamentally different if the purchaser intends to purchase more than 30% or even potentially all of the outstanding stock. An acquisition of 30% or more of the shares triggers the requirement to make a mandatory take-over offer. That offer must be accompanied by proof that the bidder has access to the funds necessary to settle the offer if accepted by 100% of the shareholders. Unlike other European jurisdictions (like, e.g., Spain), certainty of funds need not take the form of a bank guarantee which in fact constitutes a drawdown under the acquisition facility and causes utilisation costs. In Germany, it is sufficient that the bidder secures the funds necessary to close the offer, which can be in the form of a financing commitment not yet refined to a full fledged loan agreement. However, the commitment of the bank will be drafted so that the ways-out for the bank are reduced to an absolute minimum. The bidder must also present a confirmation by an independent securities services firm that the certain funds requirement has been satisfied. This will also put pressure on the institutions providing the financing to give a commitment as firm as possible. A point of debate in this context is often the German law concept of termination for cause (Kündigung aus wichtigem Grund). This concept is universally applicable to German law contracts and allows a party to terminate its obligations if it can no longer be reasonably expected to perform. The termination for cause doctrine can also be used in the context of loan agreements and will allow a lender to refuse disbursement where the financial situation of the borrower has materially deteriorated. The general view is now that the application of a termination for cause can be widely reduced by proper drafting, and that any remaining scope for that concept would not prevent the certainty of funds.

6. MEZZANINE DEBT AND INTERCREDITOR ARRANGEMENTS
The cost of the senior facility can be significantly reduced if it is supported by some form of subordinated financing. The availability of such subordinated financing heavily depends on the nature and business of the target and the acquisition structure. The higher risk for investors in subordinated debt obviously needs to be compensated, and the availability, cost and size of a second rank financing as well as its effects on the costs of the senior loan need to be carefully reviewed. The subordination itself may take various forms. They range from a structural subordination in which the debt is provided to a vehicle up-stream of the acquisition vehicle (usually its shareholder), a secured loan with a second lien position or unsecured mezzanine debt. Except in the case of structural subordination, subordination is relative in that it is agreed in an intercreditor agreement between senior and subordinated lenders. This avoids that the subordination is effectively for the benefit of all other creditors. The terms of the intercreditor agreement are heavily negotiated. While it is clear that the subordinated lenders will be paid only after full satisfaction of the claims of senior lenders, it is a matter of debate when subordinated lenders will have the right to accelerate the financing. Obviously, senior lenders may stay quite relaxed for a longer time in view of the protection provided by the subordinated funds, while the second ranking lenders see the value of the acquired business deteriorate and would want to interfere sooner rather than later.

In Germany, high yield bonds have been rarely used as tools to finance acquisitions. They are considered quite unwieldy and expensive to set up. High yield bonds are traditionally governed by New York law. This is because investors for these instruments are often based in the United States and feel more comfortable with their own law. In addition, high yield bonds provide for a strict covenants structure, and waivers by the bondholders may be needed from time to time. If the bonds have been widely placed, obtaining the waiver through a bondholders meeting involves additional costs and efforts. Finally, the terms of the high yield bond will contain substantive reporting requirements, sometimes exceeding those under the loan facilities, which make the instrument less attractive.

7. EQUITY KICKERS
In Germany, equity kickers have been commonly used for seed financing or venture capital. They are less common for a typical acquisition finance, but may occur where the leverage and risk goes beyond conventional standards and the bank is looking for additional return. An equity kicker represents a right of the financier to receive part of the equity in the borrower or the target at a later time. Since the bank is only interested in receiving a fungible equity interest, the kicker is usually released when the shares of the target become listed or are being sold on to the next investor. The shares in a GmbH, which is the most popular form for a limited liability company in Germany, can only be transferred by notarial deed, are usually not certificated and thus incapable of being listed. Since an equity interest in a GmbH is a very inflexible form of investment, equity kicker arrangements usually require the transformation into a stock corporation (AG - Aktiengesellschaft). If the equity kicker is agreed at a time where the company is still private, this can be easily achieved.

There are certain hurdles, though, if the target is already a listed company. In the case of a German AG, the issue of new shares or convertible instruments is subject to a strict preemptive right in favour of existing shareholders. This preemptive right can be excluded only in limited circumstances. One scenario to exclude the preemptive right is the issuance of the instruments at market price. In this case it is assumed that existing shareholders will not suffer because the consideration for the instruments paid to the company reflects their true value. Of course, this makes it less attractive for the financing bank to accept the equity kicker because the upside potential would depend only on the future development of the stock price. If new shares or convertible instruments are issued without a valid exclusion of preemptive rights, this can be expected to result in shareholder litigation. Shareholder activism in Germany has significantly increased over the recent years.

8. SECURITY
Security instruments available are land charges (Grundschulden, Hypotheken), security transfers (Sicherungsübereignung), security assignments (Sicherungsabtretung) and pledges (Pfandrechte).

8.1 Land charges
Land charges need to be established in notarised form and need registration in the land register to be valid. Depending on the nominal amount of the charge this may involve a substantial cost. Land charges are usually in immediately enforceable form. That means, enforcement does not require a judgment against the land owner. This makes them a very efficient form of collateral.

8.2 Security transfers
Security transfers are arrangements by which title in moveable property is transferred to the banks or their agent. Security transfers just need to be in written form, with no involvement of a notary, and can be easily established. A common stumbling block, however, is that the property to be transferred must be described in an unequivocal manner for each third party to be able to identify the subject of the collateral arrangement. This may be particularly difficult with respect to inventory and similar goods that cannot be described piece by piece. In this case, the agreement will identify a certain area on the premises of the collateral provider, such as a storage room, and all items in that room will constitute the collateral. This will require floor plans and maps of the location to be attached to the agreement. There are no registration requirements to perfect a security transfer. However, there is also no public register where other parties could inform themselves about collateral previously provided.

8.3 Security assignment
The security assignment, on the other hand, relates to the rights and claims of the debtor. It can cover all claims, whether for payment or otherwise, and is also established by a written agreement. Normally, the subjects of a security assignment are a company’s receivables against third parties. Again, there is no register of security assignments, and it is possible that a fraudulent provider of security will assign the receivables twice.

8.4 Pledges
A pledge on movable property is a very unwieldy form of security in that it requires that the concerned piece of property is handed over to the pledgee. This will, of course, not work where the pledgor needs to continue to use the item for its business. Pledges on moveable property are thus rarely used in legal practice.

In respect of rights and participations in companies, a pledge is the appropriate form of security. A security assignment may not work where the debtor of claim to serve as security is the secured party. This is, for example, the case for bank accounts to be used as collateral for the banking maintaining the account. An assignment to the bank of rights under the pledge on these rights, however, is possible.

With respect to participations in companies, an assignment is generally not attractive because it would make the secured party a share or interest holder, with all that this entails (such asan obligation to pay formerly unpaid contributions). A pledge will avoid this problem.

8.5 Up-stream security
Collateral provided for the benefit of a parent or sister company (so called up-stream or cross-stream collateral) is subject to certain restrictions. The reason for this is that German corporate law has strict rules for the maintenance of the registered capital to protect creditors of a company against an attempt by the shareholders to abuse the equity for their own purposes. In relation to a GmbH, documentation on up-stream or cross-stream security will routinely contain a clause pursuant to which the security may not be enforced if and to the extent it would result in a repayment of the registered capital. This assumes that payments made to a third party for the benefit of a parent or sister company are equivalent to a repayment of capital to the parent company. A repayment of registered capital, however, requires a certain procedure for the reduction of capital involving sufficient prior notice to creditors to secure their rights.

In relation to an AG, the rules are even stricter. Here up-stream or cross-stream security is forbidden altogether. The only exception is where the AG has entered into a domination agreement with its parent company. Under a domination agreement the parent company is obliged to compensate losses which the AG suffers in following directions given by the parent company. Before entering into a domination agreement, the management of the AG must satisfy itself that the parent company will be able to provide loss compensation. This may not be the case where the parent is a highly leveraged acquisition vehicle. Also, the domination agreement may cause trouble for the acquisition vehicle where the acquired business becomes loss making for other reasons, and the acquisition entity has to make provision for these losses in its own balance sheet.

The rules described above with respect to up-stream or cross-stream collateral equally apply to guarantees and suretyships given for the benefit of parent or sister companies.

9. CORPORATE THIN CAPITALISATION RULES
It should be noted that the following only relates to corporate thin capitalisation rules, and not to those under tax law.

There are no thin capitalisation restrictions to the effect that a company may not incur debt in excess of a certain multiple of its equity. However, courts have in various circumstances denied limited liability and have pierced the corporate veil. This is the case when the capital of a company is from the very beginning not sufficient for the purpose it has been set up for. In these circumstances courts tend to assume an abuse of the corporate form and will hold the shareholders of the company directly liable for its debts. This also applies where the shareholder has not recognised the corporate existence himself by not keeping separate accounts for the company and commingling its funds with his own. These two constellations, however, are usually not relevant in the context of acquisition finance.

More relevant is a liability of the shareholder where the realisation of security results in a repayment of capital, as discussed above under the heading 8.5 (Up-stream security). Finally, a shareholder may become liable if it suddenly and radically deprives the company of liquid funds which are necessary for it to continue its business or at least undergo an ordinary liquidation procedure. Again, this is considered disrespectful to the nature of a limited liability company.

In all of these circumstances, misbehaviour by the shareholder can only be held against the bank if it can be found to have conspired with the shareholder. This is a very difficult test to satisfy. Banks must be aware, however, that as a result of shareholder liability unexpected debt may be rolled into an acquisition vehicle as borrower that may change the economics of the financing.

10. FINANCIAL ASSISTANCE
There are no rules prohibiting financial assistance with respect to a GmbH, other than the protection of its registered capital. In the case of an AG, however, rules prohibiting financial assistance are very strict. Generally speaking, an AG is not allowed to in any way support the financing incurred in connection with the acquisition of its shares. This makes it very difficult to access the funds of a target AG to help the acquisition financing. In particular, the AG is not allowed to provide an up-stream loan to the acquisition vehicle if this loan is used to pay the purchase price for the shares.

There is a question over whether an up-stream loan may be granted in connection with the refinancing of the acquisition debt. Technically, the refinance debt will not have served to acquire the shares. This technique is often used, but the residual risk that it is in violation of financial assistance rules is hard to deny.

Another possibility to access the assets of a target AG in support of acquisition debt is a debt push-down by a down-stream merger. Down-stream mergers are generally possible. They are also not prohibited if the debt to be assumed by the surviving target AG stems from the acquisition of its shares. However, this structure is used rarely because in most circumstances the debt push-down will negatively affect the financial structure of the target in an unacceptable way. Also, the down-stream merger is virtually unavailable if the target company is listed, because the proposal would raise fierce resistance from outside shareholders.

11. DIRECTORS' LIABILITY
Directors can become liable if they do not act in the best interest of the company they are managing. In the case of a GmbH, the directors are usually excused if they act upon instruction by the shareholders. This is not true, however, if they allow a repayment of registered capital to the effect that creditors of the company cannot be fully satisfied. In that case, managing directors are personally liable if the funds cannot be covered from the parent company primarily responsible for maintaining the capital. For this reason, directors are usually keen that the documentation of up-stream or cross-stream security provides for state-of-the-art limitation language, to the effect that enforcement of the security may not cause a repayment of the registered capital.

In the case of an AG, rules are much stricter. An AG is managed by a management board (Vorstand). Unlike with a GmbH, the shareholders can usually not give instructions to the management board on how to run the company. The management board has a far greater independent responsibility for the well-being of the corporation. Hence, decisions that result in an abuse or waste of corporate funds or that bring the company into a difficult financial position, or even cause its bankruptcy, may be considered by a court to constitute a defalcation, which can even be a criminal offence.

Directors will thus be keen to ensure that the financing structure is viable and not overly aggressive. Although having exercised a sound business judgement at the time usually presents a good defence, if a defaulted financing caused immediate insolvency judges are likely to find a way to question the reasonableness of the structure.

12. LENDERS' LIABILITY
The concept of lenders’ liability is not well-developed in German law. It has been applied by the courts in basically only two circumstances. One is that the lender has taken control of the borrower by getting involved in daily management decisions, or by imposing third party advisers on the management to work out a crisis. These circumstances have led courts to hold that the bank has seized control of the company and behaved like a shareholder. This turns the bank loan into shareholder financing, which becomes subject to certain restrictions if the debtor has to file for bankruptcy. Most important, all payments made during the 12-month period before bankruptcy have to be repaid. There is debate over whether a very tight covenant structure would have the same effect, especially where the list of actions requiring prior consent of the lenders is very long and not restricted to extraordinary events. There are no court precedents yet. The consensus among legal advisers is, however, that a financing structure and covenant package which is in line with international market practice is not equivalent to a bank’s managing the company and should thus not have any negative consequences.

The other scenario is linked to providing finance at a time where a company is on the verge of bankruptcy. If a lender knows that bankruptcy is unavoidable, providing further finance, for example to improve its own position, may cause other creditors to continue to deal with the company, and they may suffer a severe loss later on upon insolvency. This behaviour is considered deceptive, and the bank may become liable to the disadvantaged creditors. To avoid this, banks that are willing to continue giving credit to a defaulted company will require a third party legal opinion confirming that the restructuring has a good chance of being successful (Sanierungsgutachten). Such an expert opinion is considered a good defence against lenders’ liability in these circumstances.

13. LEGAL OPINIONS
There are a few issues to be kept in mind when looking at a legal opinion with respect to an acquisition finance involving German companies. The first are the restrictions on up-stream or cross-stream security explained above. The limitation language built into the security documentation is meant to prevent enforcement of the security resulting in a repayment of registered capital to or for the benefit of the parent. The thrust of the limitation language is to protect the directors which are threatened with personal liability if they allow a repayment of the capital. A 20 year-old court decision suggests that the security should be enforceable even if there is no limitation. But it is not certain whether this view would still prevail today. Also, the effectiveness of limitation language has not yet been confirmed by decisions of a higher court. Therefore, it is the practice to make some reservations in this area.

Further, reservations are often made with respect to equitable subordination. As explained above, financing provided by a shareholder may become subject to a clawback with respect to payments made during the last year before insolvency. There have been a few cases where courts have looked at third parties as shareholders by virtue of contractual control rights or security over the shares of the borrower. It is not fully clear what sort of control rights would bring a third party lender across the line to become a “contractual shareholder”. Hence, one should expect a qualification on the enforceability opinion.

Finally, there is an issue with respect to the recognition of deeds established by Swiss notaries. A pledge of shares in a German GmbH requires a notarial deed. German notaries are very expensive, and depending on the value of the shares they may charge up to €60,000 for a single pledge. The fees are calculated by reference to a statutory schedule, and notaries are not free to give a discount. Accordingly, it has become practice to use Swiss notaries with whom fees can be freely negotiated. However, it is not fully clear whether the deed established by a Swiss notary would be recognised for all purposes in Germany. While this is generally believed, there are certain remaining doubts which will cause the opinion to be qualified. It is for the parties to weigh the residual risk against the extra cost.

14. POST-ACQUISITION RESTRUCTURINGS
There are few techniques to optimise the finance structure by post-acquisition restructuring. One is to transform a target in the form of an AG into a GmbH. As has been explained, it is very difficult – if not impossible – to access the assets of an AG in support of the acquisition finance. This is because of the very strict financial assistance prohibition rules applying to an AG. Restrictions for a GmbH are significantly more relaxed, hence, in some cases the lenders require that the target be transformed and then up-stream security be given.

A transformation is only meaningful where the acquirer controls 100% of the shares. Otherwise, minority shareholders would become shareholders in a GmbH where they have significantly more rights and can cause disruption. A squeeze-out of minority shareholders is possible if the acquirer owns 95% or more of the outstanding capital.

If all of the outstanding interest in the target has been purchased, a down-stream merger of the acquisition vehicle into the target may be considered to improve the risk profile for the banks. As discussed above, this is only advisable where the target has a strong balance sheet that is able to absorb the acquisition debt without negative consequences for the target’s business.

Finally, it may be considered to have the target enter into a denomination agreement which will under certain circumstances release the prohibition on the repayment of capital in exchange for an obligation of the dominating company to pay for any loss incurred by the dominated company. However, the target company’s management may only enter into a domination agreement where it is comfortable that the dominating company will be able to compensate the loss. This may be doubtful where the dominating company is a highly leveraged acquisition vehicle.

15. DEBT RESTRUCTURINGS
15.1 Solvent restructurings
There are two main topics that become an area of debate when restructuring the debt of a German company. The first is that banks may become liable to third party creditors if they continue to give credit (whether fresh money or just prolongation of existing debts) at a situation where it is unlikely that the company will survive. This could be viewed as inducing third parties to extend credit to the company. This effect can be avoided by obtaining a third party export opinion confirming that the measures intended to be taken by the lenders are suitable to successfully refinance the company, and that it is likely that the company will get back on its feet. Relying on this expert opinion, banks are considered to be acting in good faith and will not incur a liability to third party creditors.

The other issue is the conversion of debt into equity. Unlike in many other jurisdictions, a capital increase of a German corporation always implies the provision of fresh money or valuable assets. Outstanding debt can thus only be converted into shares at the fair value of the debt. Since the fair market value of defaulted debt is low, this will often not allow the issue of a sufficient number of shares to give the lenders the interest in the company they want.

15.2 Insolvency proceedings
Insolvency proceedings in Germany are only to a limited extent controllable by the creditors. Once a company has filed for the opening of proceedings, the court will appoint an insolvency administrator. That administrator has to convene a committee of creditors, and certain matters need the consent of this committee. Creditors do, however, have no say in the original appointment of the administrator. Further, while German insolvency law provides for a reorganisation of the company, this reorganisation aims at reducing the debt while leaving the equity mostly unaffected. This is, of course, not acceptable to the creditors in many cases.

To avoid German insolvency law, techniques have been developed to move the company to another jurisdiction with a more creditor-friendly bankruptcy regime. This has happened in a few instances with respect to the United Kingdom. However, according to the UK courts, for them to assume jurisdiction there must be some nexus to the UK. It is sufficient if the company has substantial operations there.

16. ENFORCEMENT OF SECURITY
16.1 Solvent enforcement
If the provider of the security is still solvent, enforcement is straightforward. Receivables assigned for security may be collected by the secured party and assets transferred for security may be picked up and sold. In the case of land charges, the holder of the security may start administration proceedings (Zwangsverwaltung) or cause the real-estate to be auctioned (Zwangsversteigerung). In relation to a pledge, which is common as a security interest on shares, realisation by auction is mandatory. This is often perceived to be cumbersome and the taker of the security would rather have the right to simply appropriate the shares. However, this is not possible with respect to a German law pledge. The auction is meant to secure determination of a fair price between the provider and the taker of the collateral, and this mechanism cannot be altered by agreement.

16.2 Insolvency proceedings
In insolvency proceedings the right of the holder of collateral to realise its security interest itself is widely displaced by the authorities of the administrator. The latter’s rights have recently been expanded to prevent an insolvent business falling apart quickly as a result of the realisation of security interests. The administrator can use assets for up to one year to enable an orderly liquidation or sale of the business. While Germany as a jurisdiction is still fairly friendly to a secured creditor, in that it widely recognises the effectiveness of security interests in insolvency, the actual realisation has been made more difficult and creditors may suffer a devaluation of their security before they are paid.

16.3 Loan buy-backs
Loan buy-backs by borrowers have recently become a matter of debate in Germany, as in many other countries. Borrowers that are in financial trouble and see the value of their debt fall well below par may feel tempted to buy back the debt, thereby making a profit. This raises a number of questions, the most important being whether a bank selling its interest in the loan to the borrower needs to share the proceeds with other banks under the sharing clause in the agreement. The wording of the sharing clause will normally not address this issue, and it comes to a general construction of what the parties intended. Under German law, where construction of an agreement can extend to closing an unforeseen gap in the contract by a reference to the parties’ intentions, it is more likely than not that a court would look at the buy-back proceeds as a repayment, with the consequence that it needs to be shared.

The other matter is voting rights. Where the borrower itself repurchases its debt, under general principles of law the debt will disappear and no voting rights can be exercised with respect to it. This is different, however, if the repurchase takes place through a subsidiary of the borrower. In that case the borrower can control the voting by the subsidiary in a contentious situation and can sway the bank majority into the direction it wants. There is a general principle under German law that, when it comes to collective decisions like a vote, the party that is immediately concerned by the outcome of the vote has no voting right. This principle originally was developed with respect to companies but has been applied to other contexts. It is not certain that it would also be applied to lending syndicates, but the argument may be made for good reasons.

A revision of the LMA standard agreements is under way, and in new financings these questions will have been addressed.