This article, authored by international secondee Pascal Urban from Gleiss Lutz, was first published in the January 2025 issue of Butterworths Journal of International Banking and Financial Law. The author thanks James Bell, Knowledge Counsel in the Finance Department at Travers Smith LLP, for his helpful assistance on this article.
In this briefing, we discuss how English lawyers must navigate a landscape of legal and practical considerations on financing transactions involving German obligors. This In Practice article outlines the critical aspects to be aware of.
The German obligors typically encountered on a financing transaction are limited liability companies (GmbH), partnerships with a GmbH as a general partner (GmbH & Co. KG), and stock corporations (AG).
CP documents consist of the (publicly searchable) commercial register excerpts (GmbH, GmbH & Co. KG, and AG), articles of association (GmbH or AG)/partnership agreements (GmbH & Co. KG), shareholders’ list (GmbH), relevant resolutions and officers’ certificates.
German obligors are generally able to grant guarantees, except for “guarantees on first demand”, which require the guarantor to pay following a formally valid demand, subject to limited permitted objections. A GmbH or AG is not allowed to directly or indirectly repay or deplete its registered share capital (ie below the thresholds stated above). However, these rules will not apply if the relevant guarantor entity has the benefit of:
As the granting of upstream and/or cross stream guarantees falls within the scope of the capital maintenance rules, German obligors and the finance parties will be bound by limitation language.
This language prohibits the registered share capital of such a company from being affected by the enforcement of the guarantee. Any violation of these provisions is subject to challenge and repayment. Guarantees granted by the AG could be deemed invalid and the managing directors or board members may face personal liability or criminal charges in the event of non-compliance.
The facilities agreement typically requires amendments to the sanctions provisions regarding anti-boycott rules. Additionally, the granting of security and guarantees must comply with various legal regimes (eg due to the Employees Part Time Act and German Social Code) and with the terms of prior ranking account pledges in favour of financial institutions.
It is not possible under German law to take a single “all assets” fixed and floating debenture; security must be taken over each type of asset separately. A typical security package comprises:
In this context, a “pledge” is akin to the English concept of a “charge” (ie an encumbrance without title transfer). German law differentiates between “accessory” security (eg pledges over receivables or shares) and “non-accessory” security (eg assignments of receivables, security transfers of title to movables). By law, security with an “accessory” nature is linked to the creditor’s claim against the debtor. As a security agent usually holds the security on behalf of finance parties, any accessory security requires a parallel debt covenant to be effective. By contrast, “non-accessory” security is legally independent from the existence of any secured claims. A security agent can hold non-accessory security directly for the benefit of secured parties.
A parallel debt covenant creates an independent claim in favour of the security agent itself, equivalent to the aggregated claims of the secured parties. The security agent must hold security in its own
name and not as a trustee, as the concept of a common law trust is not recognised under German law.
The perfection of pledges requires notification to the debtor, account bank, and pledged company; there are no formal registration requirements (except in the case of IP pledges). German security can also cover current and future assets, provided that assets are clearly defined and sufficiently identifiable.
A pledge of shares in an AG requires little formality. However, a pledge over shares in a GmbH or GmbH & Co. KG (security over both rights in the partnership and the shares in the general partner) requires notarisation. This requires forward planning as a German counsel must book a physical meeting with a notary in advance, and both German counsels must prepare powers of attorney which entitle them to represent the respective parties in the meeting.
The pledge covers shares and ancillary rights (including dividend payment claims). However voting rights must remain with the shareholder; otherwise, the share pledge could put the finance parties in a shareholder-like position, resulting in them being equitably subordinated in an insolvency event. The notarial form does not permit references to the content of other agreements. Otherwise, provisions with such cross-references (and possibly the security as a whole) may be considered void. Even though German counsels will be responsible for the drafting, English lawyers will be keen to see that:
are set out in full. Notary fees are determined by the lower of the value of the pledged shares and the value of the secured obligations, in accordance with a statutory scale with fees potentially as high as €80,000 (including a 30% surcharge for an English language agreement and 5% for the inclusion of an express choice of law clause).
The security agent receives legal title to such assets, albeit without any rights of use until an enforcement event. The transferor retains possession of the assets, which will need to be adequately identified (eg by serial number, their recorded location, or an attached labelling).
Security will be typically created over debt claims, such as intercompany receivables, insurance receivables and customer receivables. Even though the notification of third-party debtors is not critical to the creation of a security over debt claims, it ensures that such counterparties cannot discharge their obligations by making payments to the assignor.
Intellectual property rights (ie patents, trademarks, and designs or licences to use copyrights) can be either pledged or assigned as security. The security assignment is more common as it does not require registration in the relevant intellectual property register (ie German Trademark and Patent Office).
There is no requirement to agree to account control agreements or negotiate the content of the notice with the account bank.
The pledgor is usually permitted to make and receive payments on the pledged bank accounts until an enforcement event. The account bank often holds a prior ranking security over bank accounts pursuant to their general terms and conditions. Although it is market standard to request a waiver of this prior ranking pledge via acknowledgment of the notice, banks cannot be forced to comply and indeed they rarely do. The service of such notices is a post-closing obligation in practice.
The concept of debt transfer by novation should not be used in connection with German law-created security. An accessory security may cease to exist if the claims secured by it are transferred to incoming lenders in this way. The transfer of lender interests by way of assignment and assumption is therefore preferred from a German law perspective. However, a mere assignment may only be used to transfer rights and claims and would not transfer the obligation of the lender to fund undrawn commitments.
Accessory security is less flexible in the event of amendments to the terms of the finance documents (eg upsizing, higher interest rates). It is advisable to grant new (subsequent) ranking accessory security. In the context of non-accessory security, it is preferrable to expressly confirm by agreement that the existing security secures the claim despite changes in certain terms.
Accessory security expires by operation of law once the underlying claim is satisfied. Non-accessory security must be expressly re-assigned or re-transferred (as applicable). No additional formalities (eg notarisation) are required.
German courts will give effect to the choice of English law as the governing law of the finance documents subject to the Regulation (EC) 593/2008 (Rome I Regulation) and Regulation (EC) 864/2007 (Rome II Regulation).
The UK’s withdrawal from the EU has resulted in the non-application of the Brussels Regulation (EU) 1215/2012 (Recast Brussels Regulation). The 2005 Hague Convention on Choice of Court Agreements still provides grounds for enforcement if there is an exclusive jurisdiction clause in the relevant document. However, it is often only “exclusive” for obligors and entitles finance parties to obtain a judgment by any other competent court, and hence the 2005 Hague Convention does not apply. Where no such convention applies, German domestic law governs the recognition and enforcement of an English court judgment and would only in limited circumstances avoid the parties’ express submission.
German security requires by law (accessory security) or agreement (non-accessory security) that the secured debt is due and payable in order for the security to be enforceable. The parties usually waive any requirement for an “enforceable title” (ie a legal entitlement to take legal enforcement steps) to be obtained prior to commencement of enforcement. As a general rule, prior written notice of intention to enforce is required (the minimum period is one week). Security over shares may only be enforced by way of a public auction or private sale; the latter of which the pledgor may not agree in advance. Security over bank accounts and receivables may be enforced by collecting payment of the credit balance from the accounts of the account bank or from third-party debtors.
Lenders secured by way of a security transfer agreement are entitled to segregation, which means that the secured assets will be separated from the other assets and transferred to the secured lenders. Lenders secured by other assets have a preferential right to the proceeds of such assets. Following the commencement of insolvency proceedings, any new future claims will not be subject to security granted prior to the insolvency. During the hardening period, the granting of security is a reviewable transaction that the insolvency administrator is allowed to challenge on certain grounds which impair the position of the secured lenders. The hardening periods commence when the security has been perfected and ranges from one month to ten years prior to the opening of the insolvency proceedings. Thus, a lender will be keen to achieve prompt perfection to reduce the risk of challenge.
Contractual terms are invalid if they violate the rules against usury. Usury requires that one party to a transaction receives a consideration from its counterparty which is evidently disproportionate to the obligation of the first party. There are no strict rules, and all factual circumstances will be considered. Usury raises issues, for instance, when lending to startups where the lender does not only receive interest payments but also an equity component such as (virtual) warrants.
There is a key distinction to be made between initial and post over-collateralisation. An initial over-collateralisation (ie taking into account the value of the charged assets on day one) renders the security invalid if the creditors are granted security, the value of which, estimated on a fair prognosis at the time the security was initially granted, would at the time of enforcement excessively exceed the value of the secured obligations. A post over-collateralisation (ie taking into account the value of the assets subsequently added to the security package) could result in a claim for partial release of the security.
Although there are no borrowing and guaranteeing limits applicable to German companies, guarantees may be curtailed by the factors explored above.
Navigating the intricacies of cross-border financing transactions involving German obligors requires an understanding of both German and international legal frameworks. The complexities surrounding facilities agreements and security documents requires adherence to German law requirements. Given the unique aspects of German law, such as the capital maintenance rules, it is crucial for English lawyers to collaborate with German counsel.
