Debt finance

Some of the key areas affecting the giving of guarantees and security are as follows.

Insolvency

Under German insolvency laws the fulfilment of a debt, the granting of collateral or enabling a counterparty to obtain such fulfilment or collateral may be contested by the insolvency administrator if the guarantee or security was granted by a company within certain periods of time (suspect periods) prior to the filing of insolvency proceedings against such company. This would be the case if, for example, the granting of collateral was made during the three months prior to the request to open insolvency proceedings, the company was illiquid on the date of the transaction, or the creditor was aware of his insolvency on this date (section 130 of the German Insolvency Act (Insolvenzordnung)). Awareness of circumstances indicating insolvency or to a request to open insolvency proceedings are deemed equivalent to awareness of insolvency or of the request to open insolvency proceedings. Guarantees and security may also be challenged on other grounds relating to insolvency. Outside of insolvency proceedings, transactions and payments of the company may be contested by creditors under the Avoidance of Transactions Act (Gesetz über die Anfechtung von Rechtshandlungen eines Schuldners außerhalb des Insolvenzverfahrens – AnfG) which provides rights to creditors similar to those of an insolvency administrator in insolvency proceedings.

Financial assistance/upstream security

Pursuant to German statutory law on capital maintenance requirements, a limited liability company (Gesellschaft mit beschränkter Haftung – GmbH) may, in general terms, only grant upstream security to its shareholders to the extent it has free reserves in its balance sheet. Free reserves are roughly equal to the total assets minus total liabilities and provisions, minus stated share capital. The principle also applies to the general partner in a partnership in the form of a GmbH and Co. KG. A stock corporation (Aktiengesellschaft – AG) may not grant upstream security at all. Exemptions apply under domination and profit transfer agreements and to payments which are covered by a full claim to counterperformance or restitution against the shareholder. In order to achieve compliance with the relevant statutory law, so called 'limitation language' has to be introduced in the relevant finance documentation.

Accessory security interests

Accessory security interests that depend on the existence of the underlying secured claim, such as guarantees and pledges must be granted to and held by each secured creditor and are automatically terminated and released by operation of mandatory German law upon satisfaction of the underlying secured claim. This can be an issue in certain cases, for example syndicated loans or, in case of the transfer of a lender's rights and obligations under a loan agreement, by way of novation. For such cases parallel debt structures have been established by the market.

Parallel debt structure

Non-accessory security interests (that exist irrespective of a secured claim, such as security assignment, security transfer or land charge) can be held by a security agent for the benefit of the secured parties as trustee under German law (Sicherheitentreuhänder). For more information, see Lending and borrowing. 

With respect to accessory security interests, such as guarantees and pledges, the standard technique used for sharing security between various creditors under syndicated loans is by the use of a parallel debt structure. With this structure, a second claim is created for the benefit of the security agent as an abstract acknowledgment of debt in the amount of the original payment obligations under the loan agreement (Parallel Debt). As the creditor of the Parallel Debt, the security agent can then hold and administer the accessory security. Provisions in an inter-creditor agreement or collateral agency agreement usually stipulate that the security agent acts on the instructions of the other secured parties. Please note that, although the Parallel Debt structure is commonly used in the market and generally accepted in German legal doctrine, its validity has never been tested by the German courts.

Floating charges

The concept of a floating charge is not recognized as a matter of German law.

Common forms of guarantees

Guarantees may take the form of a performance guarantee or a payment guarantee. The most common form in finance transactions is the payment guarantee.

German law further distinguishes between an accessory guarantee and an independent (non-accessory) guarantee, such as payment guarantees upon first demand. German courts held that, to be valid, a guarantee upon first demand needs to be granted by a guarantor experienced in international transactions and familiar with guarantees upon first demand. This is due to the fact that a guarantor giving a guarantee upon first demand has only limited defenses, for example the objection of abuse of law. In contrast, a guarantor who gives an accessory guarantee may rely on the defenses to which the principal debtor is entitled.

Common forms of security

The security package which is granted for financings mainly depends on the financed asset and the specific transaction. Typically, the following security interests are requested by the lenders:

Share/interest pledge

A pledge of shares in a German limited liability company (Gesellschaft mit beschränkter Haftung – GmbH) requires notarization whereas a pledge over interests in a limited partnership (Kommanditgesellschaft – KG) can be entered into in simple written form. A pledge over shares in a stock corporation (Aktiengesellschaft – AG) may also be completed without observing specific formalities; only the share certificates issued for the relevant shares need to be transferred to the pledgee. The notification of the relevant company/partnership is not required for the perfection of the security. However, the articles of association of a company may provide for the requirement of the company's approval. As an accessory security interest, the share/interest pledge must be granted to and held by each secured creditor. Therefore, a parallel debt structure is usually implemented in syndicated financings. For more information, see Lending and borrowing.

Bank account pledge

The notification of the account bank is required for the perfection of the security. The account bank usually has a first ranking pledge pursuant to its general business terms; if the lending bank wishes to obtain a first ranking security, the account bank then may be asked to waive/subordinate its rights pursuant to its general business terms. Security must be granted to and held by each secured creditor. Therefore, a parallel debt structure is usually introduced in syndicated financings. For more information, see Lending and borrowing.

Security assignment of receivables and claims

Unless disclosed to the debtors of the assigned receivables (third party debtors), the debtor may continue to pay with discharging effect to the assignor. The notification of the assignment is no perfection requirement, but common where there are only a small number of third party debtors (eg with respect to claims under insurance agreements).

Security transfer of moveable assets (such as inventory and equipment)

It is very important to describe the assets precisely, for example by using maps or serial numbers, in order to ensure their determinability when acquired (particularly in relation to future assets) or enforced. Typically, the specification of transferred assets is done by a combination of describing the area where the assets are located and by delivery of a list of the relevant assets. If the assets are fixtures (ie they relate to the relevant premises in such a way that they cannot be legally separated from the premises) then land security should be obtained.

Mortgage or land charge over land and buildings

A mortgage or land charge must be created by notarized deed. In addition, the registration of the mortgage or land charge in the relevant land register (Grundbuch) is required for its effectiveness. The notary and registration fees depend on the nominal amount and may be significant.

Giving or taking guarantees

In order to be valid, a guarantee upon first demand must be granted by a guarantor experienced in international transactions and familiar with guarantees upon first demand. This is because the guarantor of a guarantee upon first demand has only limited defenses. For more information, see Giving and taking guarantees and security – common types.

Giving or taking security

Notarization requirements

The following security interests require notarization under German law:

• a pledge over shares in a German limited liability company; and
• the creation of a mortgage or land charge.

Registration requirements

A mortgage or land charge must be registered in the relevant land register (Grundbuch) to become valid.

Initial and subsequent over-collateralization

In case of an initial disproportionate relationship between the value of the granted security and the secured claims (initial over-collateralization), the agreement creating such security may be invalid. If, after the conclusion of the agreement (subsequent over-collateralization), the value of the security exceeds 110% of the secured claims, the grantor may have a claim for release of the excess security.