Vol 12 (2015) - Issue 4

Article preview

Draft Reform Act on German Insolvency Avoidance Rules

Introduction
On 16 March 2015, the German Federal Ministry of Justice presented its draft reform act on insolvency avoidance rules to the Federal States and to various professional bodies, requesting comments and suggestions. For several years, legal scholars and economic associations have been demanding a reform of these rules. Although the paper has already been discussed in detail within the German restructuring market, this recent proposal can only be seen as a first step in a longer legislative process – it is assumed that considerable amendments will be made to the draft before a final reform act enters into force.
The reform act aims to reduce the legal uncertainty for economic operators, which was mainly caused by the extensive interpretation of the rules by German courts. If the reform came into force, it would become more difficult to challenge antecedent transactions. This is not necessarily always a good thing: insolvency claw back is a means to increase insolvency estates and thereby to increase the distributions to creditors which can be made in the proceedings.
However, experience over the past years has shown that, under the current legal position, German insolvency administrators have no difficulties asserting claw back rights in respect of transactions which occurred long before the insolvency filing and under circumstances which are not particularly unusual. We therefore welcome the direction of the envisaged reform which may well help to re-establish a more balanced system – making the risks of trading with a German company in financial difficulties more predictable – irrespective of the harsh critique the draft reform act has received due to some undeniable technical flaws.

Status quo: high level overview on German insolvency avoidance rules
As in other jurisdictions, German law provides for a claw back right in respect of transactions negatively affecting the insolvency estate and made within certain hardening (or 'suspect') periods prior to the filing for insolvency. If the legal prerequisites for claw back are fulfilled, the insolvency administrator can challenge the antecedent transaction. The transaction will thereby be declared void and unenforceable and the assets formerly belonging to the debtor, which were beyond the reach of the insolvency creditors, are to be returned to the estate.
German law does not provide for a unique hardening period but there are various claw back provisions with different time periods. Some provisions allow for the challenge of recent transactions only and others – with higher prerequisites – allow the insolvency administrator to challenge transfers of assets which occurred further in the past. As a general rule, transactions during the last three months prior to the filing for insolvency are challengeable under relatively limited conditions. For these three months, the German Insolvency Code distinguishes between so called
– 'congruent transactions', i.e. payments or the provision of collateral that the creditor had a right to receive at that time and in that form; and
– 'incongruent transactions', i.e. payments or collateral which were either not (yet) due or due, but in another form (e.g. payment in kind instead of payment in cash).

Incongruent transactions can be challenged more easily as a successful claw back does not require the beneficiary of the transaction to be aware of the debtor’s illiquidity at the time when the transaction took place.

Other provisions have longer 'suspect' periods but their requirements are accordingly also higher. For example, the repayment of shareholders loans can be challenged if it occurred during the year prior to the insolvency filing and gratuitous performances must be repaid if they occurred during the last four years and are challenged by the administrator.