Vol 4 (2007) - Issue 2

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German Law on Cash Pooling in the Insolvency Context

I. The concept of cash pooling within a group of companies

Cash pooling is a commonly used financial tool for liquidity management among members of a group of companies. It allows funds from the respective affiliates to be physically transferred and thus centralised on a regular and, generally, daily basis. Funds from the different participating accounts of the affiliates are automatically swept to a ‘master account’ typically held by the parent company.
In economic terms, cash pooling provides important benefits to groups of companies. An optimal interest result is assured, since the bank balancing the cash charges for interest only with respect to the total cash position built up on the master account at the end of every banking day. The participating accounts are left with a zero balance. The pooled liquidity swept to the master account is available to be invested as group-wide working capital, which minimises the need for external financing. Lastly, the concentration of cash in one central account permits for increased efficiency and transparency of cash management. Unlike the aforementioned concept of physical cash pooling, ‘notional pooling’ is a mechanism of calculating interest on the combined credit and debit balances of the participating accounts, without physically transferring funds. Whereas notional pooling confers a group the benefit of globally calculated interest rates, it does not save its members their own cash management.
In legal terms, it is crucial to notice that physical cash pooling among affiliated companies creates inter-company loans.1 The economic benefits of physical cash pooling are mirrored by its worldwide popularity. Accordingly, this financial tool is frequently found among international corporate structures. Nevertheless, it raises certain concerns with respect to German law. The risks associated with cash pooling will typically materialise in the course of financial distress of one or more companies participating in the cash-pooling structure.2 Thus, a parent company may incur liability for depriving a subsidiary of the funds necessary to keep on operating. This is especially true, if as a result of centralisation of liquidity, the subsidiary becomes subject to insolvency proceedings. But even if the parent’s taking hold of the subsidiary’s liquidity does not cause the latter’s insolvency, the parent, or its board of directors, is far from safe, but instead may be held liable.3 Furthermore, in case of insolvency proceedings, an insolvency administrator of a subsidiary may assert that a cash contribution was not accomplished by the parent if the contributed cash had flowed back into the master account. Similarly, an insolvency administrator may assert that liquidity transferred from a subsidiary to the parent constitutes a violation of capital maintenance rules. Again, even if the subsidiary is not subject to insolvency proceedings, the pertinent claims may be brought on its behalf. The analysis of the underlying concepts of these possible causes of action against the parent and their practical implications will follow.

II. Veil-piercing

Cash pooling may result in a parent company’s extensive liability pursuant to the theory of annihilating interference (‘existenzvernichtender Eingriff’), if the application of that financial tool is identified as the cause of financial distress of a subsidiary.4 The convenience and economic advantage of cash pooling may thus be overshadowed by the potential extent of liability, if the respective cash management system does not provide for preventive measures.