2011 Year-End German Law Update

January 10, 2012

While the members of the Eurozone are still struggling to find an adequate answer to the sovereign debt crisis and the stock markets are on a roller-coaster ride, the German economy is still doing remarkably well and continues to attract foreign investors from all over the world, notably China.  

At the same time, German lawmakers have not remained idle and have enacted a long-expected reform of the insolvency laws to facilitate corporate restructuring and debt-equity swaps. In the field of M&A, the legislature has finally responded to the Volkswagen/Porsche takeover battle by extending disclosure rules to cash-settled options and similar instruments. Other new laws lower the threshold required to squeeze-out minority shareholders and tighten the rules for temporary employment.

2011 also has seen a series of important court decisions (both by the European Court of Justice and the German Federal Supreme Court) that will impact many areas such as tax (anti-treaty shopping and withholding taxes on dividends), finance (clarification of regulatory framework in debt investments), real estate (transfer of land charges and use of private partnerships as acquisition vehicles) and the liability of directors who rely on legal advice. Finally, a U.S. bankruptcy court upheld the validity of cross-border license agreements in a large German insolvency and thereby resurrected the debate over the need to reform the German rules.  

Finally, some of the most prominent corruption investigations in Germany have been settled in 2011 and many lessons can be learned from these cases. We trust you will enjoy reading further details below and stay attuned to the recent developments in German law. 

Table of Contents

Insolvency Law
Corporate M&A
Corporate
Tax Law
Labor Law
Compliance
Finance
Real Estate

Insolvency Law — Getting Ready for the Next Restructuring Wave 

The German Law for the Further Facilitation of the Restructuring of Enterprises (Gesetz zur weiteren Erleichterung der Sanierung von Unternehmen, "ESUG")[1] will come into force on March 1, 2012. With a revised process to facilitate corporate restructuring in the event of an insolvency, corporate insolvency proceedings filed after March 1, 2012 will become more predictable and attractive through a number of reforms: (i) the increased influence of creditors on the proceedings, (ii) the facilitation of the use of debt-equity swaps in an insolvency plan, and (iii) the protective shield in connection with debtor in possession proceedings.  

1. Increased Influence of Creditors 

For corporate debtors exceeding certain size thresholds, the ESUG mandates the establishment of a preliminary creditors’ committee comprised of representatives of various classes of creditors (i.e., secured creditors, major creditors, minor creditors, and company employees) as soon as practicable after the debtor’s filing for insolvency. This change will enable creditors to participate at the early stages of the proceedings. In addition, the duration of the proceedings can be shortened considerably by submitting a proposal for the composition of the creditors’ committee in the debtor’s insolvency filing. Moreover, creditors and the debtor can implement pre-packaged insolvency plans more easily as the preliminary creditors’ committee may unanimously propose an interim insolvency administrator and the bankruptcy court must now follow such proposal unless the proposed candidate is not "suitable," commonly because the individual lacks the requisite independence from the debtors and creditors (e.g., an advisor who has worked on the restructuring prior to the filing would likely be excluded by the court).  

2. Facilitation of Debt-Equity Swaps 

In the past, corporate restructuring measures, including debt-equity swaps, often failed because corporate law required the consent of the debtor’s shareholders whereas now the shareholder rights are integrated in the insolvency proceeding. The ESUG allows the shareholders to participate in the insolvency proceedings as one of the (sometimes many) groups that are entitled to vote on the insolvency plan. If the shareholders reject an insolvency plan that provides for a debt-equity-swap, the plan can still be implemented so long as the shareholders fail to provide prima facie evidence that the plan is disadvantageous. Furthermore, liability risks under general corporate law in connection with the valuation of debt receivables being converted to stock are now excluded once the insolvency plan has been approved by the creditors.  

3. Protective Shield and Debtor in Possession Proceedings 

Debtors filing for insolvency at an early stage due to impending illiquidity (drohende Zahlungsunfähigkeit) or over indebtedness (Überschuldung) may now apply for protective shield proceedings (Schutzschirmverfahren) and debtor in possession proceedings (Eigenverwaltung) so long as a restructuring is not obviously futile. The debtor’s filing must be supported by an opinion of a qualified expert to this effect. The debtor then has a maximum of three months to submit an insolvency plan to the bankruptcy court. In these proceedings, the management of the debtor will not be replaced, but instead will be supervised by a trustee (Sachverwalter). As there is no payment moratorium in addition to the stay of enforcement that can be granted by the bankruptcy court, the success of protective shield proceedings is largely dependent on an advance involvement of the creditors. Otherwise, the bankruptcy court may terminate the proceedings upon application by the preliminary creditors’ committee, or, in the absence of a creditors’ committee, by a creditor if circumstances disadvantageous to the creditors become known. 

4. Outlook 

The new law is a step in the right direction. As experience in other jurisdictions shows, proper timing and cooperation among the parties involved can make the difference between a successful corporate restructuring and liquidation. Time will tell if the ESUG can change the common perception of insolvency filings as "the end" of an enterprise to a view that insolvency presents a chance for a new beginning.  

Insolvency Law — Ruling Favors U.S. Patent Licensees in Insolvency of German Licensor 

The United States Bankruptcy Court for the Eastern District of Virginia recently refused to permit a German insolvency administrator from applying German insolvency law, which would have denied U.S. patent license holders certain protections, as manifestly contrary to the public policy of the United States. 

The German Insolvency Code authorizes the insolvency administrator to unilaterally terminate contracts of the insolvent estate that have not been fully performed. In the case before the U.S. court, the bankruptcy of Qimonda AG, a German manufacturer of semiconductor memory devices, the German insolvency administrator had decided not to perform the existing license agreements but to instead re-negotiate and re-license the patents on reasonable and non-discriminatory terms. Despite this commitment, the U.S. court determined that the recognition of the German insolvency administrator’s decision is contrary to U.S. public policy. The U.S. court reasoned that applying German insolvency law would obstruct the promotion of technological innovation, and thus have detrimental effects on the U.S. economy, and would severely impinge rights generally afforded to licensees of U.S. patents given the absence of protection to the U.S. licensees.  

In Germany, there have long been attempts to create a separate legal regime for license agreements in insolvency proceedings. Such reform is overdue in particular with a view to complex cross-border licensing scenarios and sub-licensing relationships. The U.S. ruling will likely encourage this reform process. Licensees of U.S. patents held by an insolvent German licensor, at least in the interim, are able to challenge terminations by a German insolvency administrator. However, it should be closely observed if the ruling is affirmed on appeal and whether it will also apply to other industries in the future.  

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Corporate M&A — Threshold for Squeeze-Out of Minorities now Lowered to 90% 

In July 2011, the German legislature amended the German Transformation Act (Umwandlungsgesetz) to implement changes of a European Union directive. The amendment introduces a new squeeze-out procedure (i.e., a process to force out minority shareholders against cash compensation) in the context of upstream mergers (Verschmelzungen) of stock corporations into their main shareholder. While German law already allows for the squeeze-out of minority shareholders in two other types of proceedings, the novelty of the merger-related squeeze-out is that the threshold required to start the process has been lowered from 95% to 90%. 

The new proceeding is only permitted if (a) an upstream merger agreement of a stock corporation into its main shareholder has been executed and (b) the squeeze-out is approved within three months of execution of the merger agreement. 

The merger-related squeeze-out offers an interesting new mechanism to force minority shareholders out of the company against payment of cash compensation. In the past, a squeeze-out was only possible when the bidder reached the 95% threshold. This gave minority shareholders significant leverage, especially when hedge funds bought into the stock after the announcement of a takeover. The lower threshold gives takeover bidders a stronger position and increased transaction certainty.  

Nevertheless, an upstream merger has significant legal and economic consequences (e.g., the obligation to provide security to creditors of the merging company) that need to be taken into account in each individual case before deciding which squeeze-out procedure shall be used. 

Corporate M&A — German Ban of Stealth Takeover Strategies 

On February 1, 2012, a key part of the so-called Investor Protection and Capital Markets Improvement Act (Anlegerschutz- und Funktionsverbesserungsgesetz)[2] announced in April 2011 by the German legislature will formally enter into force and will have significant consequences for public M&A transactions. 

The law establishes new disclosure obligations for investors, and is a response to the stealth takeover tactics previously used in the case of Porsche/Volkswagen and the hostile takeover of Continental AG by Schaeffler. In very broad language the law states that investors must make a disclosure if "they are holding financial instruments or other instruments which due to their structure enable their owner to acquire existing voting shares of an issuer domiciled in Germany, provided that they reach, exceed or fall short of a relevant threshold" (i.e., 5%, 10%, 15%, 20%, 25%, 30%, 50% and 75% of the voting rights). In the past, the mere possibility to acquire shares did not trigger any notification obligations.   

The new rule will exclude the use of stealth takeover tactics such as were employed in the Porsche/Volkswagen and Continental/Schaeffler cases. But, due to the broad language, many other – often legitimate – structures will also require early disclosure, thus putting transactions at risk of intervention by other market players. For example, the buyer of a large stock position that is a party to a signed but not yet consummated share purchase agreement will likely have to disclose the signing. Likewise, the signing of irrevocable undertakings will likely trigger disclosures. In both cases opportunistic investors may invest and build positions even before the bidder holds any stock, thereby increasing transaction costs and risks for the strategic investor and making public takeovers more difficult. 

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Corporate — Personal Liability of Directors in Connection with Relying on Legal Advice 

On September 20, 2011, the German Federal Supreme Court (Bundesgerichtshof) held that two members of the management board and one member of the supervisory board of a German stock corporation were personally liable for the payment of a multi-million Euro cash contribution in connection with the increase of the company’s share capital because they had not obtained sufficient legal advice from competent independent legal counsel on the admissibility of the share capital increase procedure. 

In the case at hand, the member of the supervisory board, who was also a partner of the law firm advising the company, proposed that the company should borrow shares from a majority shareholder to use those shares for the acquisition of participations in other companies. Instead of returning the shares to the majority shareholder, the plan provided for new shares to be created and distributed to the majority shareholder against the majority shareholder’s waiver to demand the borrowed shares back from the company.  

The German Federal Supreme Court confirmed that such waiver was an improper contribution in kind for the purpose of the share capital increase. Further, the court held it to be insufficient for the board members to rely solely on the (wrongful) advice of the supervisory board member and the oral advice of one of the partners of the supervisory board member’s law firm, particularly in light of the fact that the legal situation was noticeably neither simple nor urgent. In order to meet the strict requirements of the director’s duty to review the legal situation and comply with applicable statutory law and case law, a director who does not possess the necessary expertise is obliged to obtain independent qualified professional advice based on comprehensive information and documentation of the company’s situation. In addition, the directors have to subject such advice to a thorough plausibility check. 

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Tax Law — Amended Anti-Treaty Shopping Rules 

With effect as of January 1, 2012, Germany has changed its anti-treaty shopping rules in reaction to an infringement proceeding initiated by the European Court of Justice (ECJ) in 2010.  

Germany levies 26.375% withholding tax on dividend distributions made by a German corporation. The rate may be reduced to 0% if a foreign corporate shareholder can rely on an applicable tax treaty or the European Union parent-subsidiary directive. In principle, the anti-treaty shopping rules also apply to royalty payments and certain interest payments (payments on profit-participating loans or convertible bonds).  

Under the old anti-treaty shopping rules, a foreign corporate shareholder was only entitled to a withholding tax relief if and to the extent the foreign company itself was owned (directly or indirectly) by shareholders that were protected by a tax treaty or the European Union parent-subsidiary directive or if the foreign company met certain tests (business purpose, gross receipts, and substance test).  

Under the new rules, a foreign company without privileged shareholders is always entitled to a withholding tax relief to the extent its gross receipts are generated from genuine own business activities.  

Unlike the prior rules, the new rules do not require that the foreign company generates more than 10% of its gross receipts from genuine own business activities in order to benefit from the withholding tax relief. Only when the foreign company fails the gross receipts test must it demonstrate that there are non-tax reasons for the interposition of the foreign company and that the foreign company has adequate business substance.  

The new rules make it easier for management holding companies to apply for a withholding tax relief. If the holding company manages at least two active German subsidiaries the dividend distributions made by those subsidiaries qualify as gross receipts generated by genuine own business activities and, therefore, they are entitled to the withholding tax relief.  

However, if the foreign company fails the simplified gross receipts test, the foreign company must now demonstrate that there are non-tax reasons for the interposition of the foreign company in relation to the concrete receipts. According to the new rules, the burden of showing the existence of non-tax reasons now rests on the foreign company.  

Tax Law — Claim for Refund of Withholding Taxes 

On October 20, 2011, the ECJ ruled that German withholding tax on dividends generated by portfolio investments and paid to corporations resident in the European Union (EU) or the European Economic Area (EEA) constrains the free movement of capital and, therefore, violates EU law.  

Dividends to EU/EEA corporations are treated less favorably than dividends to German corporations. German corporations receive a credit for withholding tax levied on the dividend or even receive a refund if no income other than dividend income is earned. EU/EEA corporations do not receive a credit and the German withholding tax becomes final. Therefore, dividends paid to EU/EEA corporations are taxed more heavily in economic terms than those paid to a German corporation.  

EU/EEA corporations that suffered withholding tax on dividends (typically when the shareholding is below 10%) should apply for a refund with the competent tax authorities. There is a four year statute of limitations for the filing of dividend withholding tax reclaims, which begins after the end of the year in which the dividend was paid. The ECJ did not decide on dividends paid to non-EU/EEA corporations (such as U.S. corporations).  

Given that the free movement of capital is restricted by German withholding tax and that the free movement of capital also applies, at least in principle, to non-EU/EEA corporations, this decision may also affect non-EU/EEA corporations. However, it is likely that German tax authorities would deny a refund and require non-EU/EEA cases to be decided in a separate court proceeding. Nevertheless, non-EU/EEA corporations that incurred German dividend withholding tax should consider filing protective reclaims in order to secure their rights to a potential refund before the statute of limitations expires. 

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Labor Law — Employee Lease Act Amended 

The leasing of temporary workers is a booming industry in Germany. An ongoing debate about the working conditions of such leased employees (temporary workers) has now triggered a reform of the German Employee Lease Act (Arbeitnehmerüberlassungsgesetz). Companies leasing temporary workers should therefore review their existing arrangements. 

While the statute does not stipulate a maximum lease period, it now expressly describes the lease of employees as "temporary," thereby indirectly ruling out permanent work of leased personnel for the employer. Also, intra-group leasing, where the employment agency and the employer belong to the same group of companies, is no longer exempted from the regulation. The act further abolished the "revolving-door effect" by requiring a company to apply the former payment conditions if it hires an employee as a temporary worker whom it previously had employed on a permanent basis. Finally, the employer is now obliged to notify the temporary worker of any available permanent positions at the company and has to grant equal access to cafeteria meals, child care facilities, commuter transport, and similar benefits offered to permanent employees. The temporary workers may seek compensation if they are denied such advantages. In addition, statutory minimum remuneration has been introduced for temporary workers effective January 1, 2012: EUR 7.89 per hour in Western Germany and EUR 7.01 in Eastern Germany, which will be increased to EUR 8.19 and EUR 7.50 as of November 1, 2012. The statute is valid through October 31, 2013. 

In this context, employers who hire temporary workers should require an indemnification clause from the agency for any violations of the equal-pay principle. According to this principle, a temporary worker must receive the same pay as comparable employees of the employer. As an exception to this principle, temporary workers may be paid less than the permanent employees if their contracts refer to a valid collective bargaining agreement. On December 14, 2010, the Federal German Labor Court denied union status to the so-called "Christian Unions" active in the leasing of temporary workers thereby invalidating their collective bargaining agreements. Consequently, the employees working under such agreements can now claim the shortfall in remuneration, which threatens the business model of some temporary employment agencies. In the worst case, if the agency does or cannot pay (e.g., due to bankruptcy) the difference in remuneration, the employer is liable for the overdue social security contributions.

Labor Law — Federal Labor Court Loosens Fixed-Term Employment 

In a recent judgment, the German Federal Labor Court considerably relaxed the prerequisites of fixed-term employment by ruling that a previous employment is irrelevant if it ended at least three years ago.  

In order to prevent circumvention of statutory dismissal protection, German law imposes strict conditions for fixed-term employment. If it is not based on one of the reasons listed in the statutory catalogue (e.g., seasonal work, probation, or substitution), fixed-term employment can only be entered into for a maximum period of two years. In addition, fixed-term employment without a reason is banned if the employee had previously been employed by the same employer. Until recently, such "previous employment" included an employment at any time in the past, even decades prior.  

This recent decision of the German Federal Labor Court relieves the employers of the burden of investigating a new hire’s employment history and thus removes a risk from fixed-term employment. 

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Compliance — Recent Cases Show Different Ways to Successfully Settle Investigations

During 2011, two major German industry groups, Ferrostaal and Linde, settled high stakes corruption-related investigations and charges by the public prosecution authorities, while a third investigation (Tognum AG) is still unfolding. In all investigations the companies cooperated with the authorities — albeit to different degrees. The three cases impart different lessons that can be important for developing a strategy to respond to similar compliance events.

Compliance violations have become career ending events for executives

If there were still doubts that compliance violations, in particular in the field of anti-corruption laws, have a career ending effect, Tognum AG proved again that this is now the standard procedure in Germany.

Tognum AG is a supplier of engines, propulsion systems, and distributed energy systems with approx. 9,000 employees and an annual turnover of approx. EUR 2.56 billion (FY 2010). As a result of an internal investigation performed by an outside auditing company, Tognum AG became aware of financial irregularities regarding an affiliated company MTU Asia Pte. Ltd. Foreign officials allegedly were paid bribes in connection with arms deals made to South Korea. Immediately after the internal investigation had been concluded in October 2011, Tognum AG informed the public prosecutor and suspended the board member who had been in charge of Tognum AG’s Asia business from 2004 until 2010. The subsequent investigations by the public prosecutors against this former board member remain ongoing. Whatever the final outcome — Tognum AG is yet another example that compliance violations have become career ending events for board members of German companies involved in corrupt activities.

Courts can have a moderating influence on settlement amounts

While there is always the desire to minimize the time span between the investigation and the settlement in high-stakes compliance matters (particularly if connected with bribery), the Ferrostaal case shows that an early settlement can be an expensive exercise. Ferrostaal AG managed to negotiate down the amount of EUR 277 million originally sought by the prosecutors by almost half (EUR 139.8 million) through an involvement of the court.

Ferrostaal AG is an industrial service provider and machinery supplier with 5,300 employees and an annual turnover of approx. EUR 1.8 billion (FY 2010). Part of their business is to act as a sales intermediary for German technology manufacturers, e.g. selling submarines for a subsidiary of German DAX 30 conglomerate Thyssen Krupp. In March 2011, the Munich public prosecutor’s office brought charges against two former managers of Ferrostaal AG accusing them, among other things, of having bribed foreign officials in connection with submarine sales to Greece and Portugal. In their indictment, the prosecutors claimed EUR 277 million from Ferrostaal AG as disgorgement of profits illicitly made through corruptive activities.

Ferrostaal AG, with support of external counsel, conducted an internal investigation and reportedly discovered that improper payments also had been made to government officials in Trinidad-Tobago, South Africa, Oman, Libya, Venezuela, and other countries. In reviewing the matter, the Munich court (Landgericht München) found that the public prosecution authorities could not sufficiently prove all the allegations made in the indictment and proposed a settlement involving a fine of EUR 177 million. The settlement ultimately agreed to by the Munich court, the Munich public prosecutor’s office, and Ferrostaal AG amounted to EUR 139.8 million. The reduction of the fine was due to the prosecutors’ lack of sufficient evidence of wrongdoing. Irrespective of the corporate settlement, the criminal proceedings against the two individuals resulted in two-year suspended prison sentences and monetary fines of EUR 36,000 and EUR 18,000, according to a separate settlement reached by the Munich court, the Munich public prosecutor’s office, and defendants.

Early cooperation and disclosure is an efficient way to accelerate the settlement process

Vigorous investigation and early involvement of the state prosecutor and full cooperation with the investigations enabled Linde AG to efficiently and quietly resolve corruption charges in the investigatory phase with minimum noise in the markets.

Linde AG is an industrial gas producer and engineering company with approx. 50,000 employees and an annual turnover of approx. EUR 12.9 billion (FY 2010). In June 2011, Linde AG agreed to forfeit EUR 35 million to the Munich public prosecutor as disgorgement of illicit profits for businesses made through improper payments. Linde AG had carried out an internal investigation, conducted with the assistance of external counsel, and had proactively informed the prosecutors about bribe payments made by consultants acting on behalf of Linde AG to potential customers.

People close to the matter reported that Linde AG had negotiated aggressively with the Munich prosecutors about the substance of the allegations and the amount of illicit profits from which Linde AG benefited and had succeeded in concluding this settlement at the earliest procedural stage, even before the prosecutors had involved the competent court by way of an indictment. In this process, Linde AG even asked the prosecutor to issue a search warrant in order to enable Linde AG to conduct internal investigations without violating German data privacy laws. This step prevented an actual search by the authorities. Thus, Linde AG was able to avoid extensive legal proceedings and media exposure. The company reportedly preferred to resolve the matter expediently rather than wait for a final court decision that could have resulted in a lower fine.

Compliance — Best Practice for Gifts & Hospitality Questions Relating to Federal Government Officials 

On UN International Anti-Corruption Day 2011 (December 9, 2011), the German Federal Ministry of the Interior published guidance on the acceptance of rewards, gifts, and other benefits (including invitations, hospitality, payments of travel cost, or discounts) by officials of the German federal administration.

Guidance was issued in the form of a Frequently Asked Questions manual (the "Manual") developed by the Initiative Committee Corruption Prevention Economy/Federal Administration, a public-private initiative among several federal government departments, industry associations, and business corporations including Deutsche Bahn AG, IBM, Siemens, and ThyssenKrupp.

The Manual explains in simple and clear terms to what extent certain benefits may be granted to and accepted by members of the German federal administration on the basis of an implicit, general, or case-by-case approval from their engaging public authority, based on current statutory laws as interpreted by German courts.

While the Manual does not have immediate legal effect, it may be considered as a best practice and serve as a guideline for upcoming administrative and court decisions. Thus, corporations that interact with officials of the German federal administration should review their policies to ensure their compliance with the Manual’s rules.

Compliance — Employee Data Protection versus Anti-Corruption Efforts

The German Federal Government is considering significant changes to the German Federal Data Protection Act (Bundesdatenschutzgesetz) through the proposed Act to Regulate the Data Protection of Employees (Gesetz zur Regelung des Beschäftigtendatenschutzes). The amendments could significantly impact a corporation’s ability to conduct internal investigations and implement effective compliance controls over employees.

The proposed changes include the possibility of data screenings (though on an anonymized or pseudonymized basis only) and the collection of data without the knowledge of the concerned employees in case of severe violations of criminal laws or other legal obligations, including the employment contract. Importantly, such a collection would be limited to employees who are individually suspected of such a breach.  The amendments, as proposed, nevertheless leave a number of highly disputed legal issues unsolved, such as the permissibility to screen the emails of larger groups of employees during e-discovery. This legal uncertainty continues to expose corporations and their officers to liability for the breach of data protection laws during internal investigations or other compliance efforts.

Due to the heavy political and legal discussion about the proposed amendments, it remains unclear whether the current Federal Government during the remainder of its term will succeed in finalizing and enacting the amendments.

Compliance — Successor Liability after Corporate Restructuring

German law provides that corporations can be subjected to fines for offenses committed by their bodies or executives in violation of duties affecting the corporation. In August 2011, the German Federal Supreme Court decided that such fines for former misconduct can be imposed on legal successors of the corporation only in certain limited cases.

In the underlying case, all shares of a corporation were transferred to a purchasing corporation, and the business then merged with other affiliates of the purchasing corporation. The German Federal Supreme Court held that the purchasing corporation could not be fined for offenses by executives of the former corporation committed prior to the corporation’s sale and merger into the purchasing corporation.

According to the German Federal Supreme Court, German law allows for liability of a successor corporation only if each of the following conditions has been met: (1) The successor corporation concerned is the universal successor and (2) the former and the new pool of assets are almost identical. The latter applies if the pool of assets concerned is used in the same or similar manner as before and comprises a significant portion of the total assets in the new corporation.

In the abovementioned decision, the German Federal Supreme Court acknowledged that this ruling and the underlying law may have certain unintended consequences. Accordingly, there are ongoing discussions whether the German legislature should close this "gap" in German law.

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Finance — Assignment of Loans and Land Charges  

In a ruling of April 19, 2011, the German Federal Supreme Court confirmed the validity of the transfer and assignment of a loan receivable and a land charge under German civil law to an investor that was not licensed as a credit institution.  

Complex regulatory questions often arise when structuring debt investments in Germany. The German Banking Act (Kreditwesengesetz) requires that entities carrying out a German credit lending business hold a banking license.  

In the past, not only were debt investments burdened by regulatory uncertainty due to the broad interpretation of what constituted "a credit lending business," but also some legal commentators argued that an infringement by an investor of the bank licensing requirements would invalidate the debt-purchase transaction.  

Previously, the German Federal Supreme Court had upheld the validity of a loan agreement even if the lender did not hold the required banking license. Now, the German Federal Supreme Court extended this ruling to the acquisition of loan receivables and land charges.

With this new ruling, the German Federal Supreme Court provides far greater contractual certainty to investors. The German banking sector retains an important refinancing option and mechanisms to reduce credit risks, which ultimately benefit borrowers as well. Despite the positive effects of the ruling, a number of unresolved issues for investors remain. Most importantly, it is not yet certain whether an investor needs a banking license when it acquires loans that have not previously been accelerated or terminated.  

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Real Estate — Requirements for the Transfer of Immediately Enforceable Land Charges Clarified 

Land charges (Grundschulden) encumbering German real estate that subject the property to immediate enforcement proceedings are regularly used as collateral for loans. The conditions under which such land charge may be enforced are stipulated in the security purpose agreement entered into between the owner and the creditor of the land charge (often the security agent). If such land charge has been transferred to a new creditor (e.g., in the context of a sale or refinancing of the loan), the new creditor needs to have the enforceable copy of the land charge transcribed to it by the competent notary before the land charge can be enforced. 

In a previous decision, the German Federal Supreme Court held that such a transcription requires the new creditor to evidence not only the transfer of the land charge but also the creditor’s entry into the (original) security purpose agreement by way of public or certified deeds. As a result, notaries had often denied the transcription of the enforceable copy to the new creditor because the entry into the (original) security purpose agreement was not evidenced in the required form. Notaries even denied such transcription in the context of the refinancing of a loan, where a new security purpose agreement had been entered into.

In June 2011, the German Federal Supreme Court ruled that the transcription of the enforceable copy of the land charge to the new creditor requires evidence for creditor’s entry into the original security purpose agreement only if such requirement is stipulated in the land charge deed (which is rarely the case). In light of this decision, the quicker and less expensive transfer of an existing land charge instead of the creation of a new one has again become an option worth considering in a refinancing scenario.

Real Estate — Existing Private Partnerships allowed to Acquire German Real Estate 

In April 2011, the German Federal Supreme Court removed a previous evidence requirement that actually made it impossible for an existing German private partnership (Gesellschaft des bürgerlichen Rechts) to acquire German real estate. 

Since the 2001 ruling of the German Federal Supreme Court on the legal capacity of German private partnerships, it has been disputed whether and under what conditions such private partnerships can acquire title to German real estate. In particular, there was substantial disagreement among German courts and legal scholars as to how the existence and the representation of private partnerships need to be evidenced for the necessary registration of the transfer of title in the land register. By ruling that such evidence cannot be provided unless the private partnership was formed immediately before the conveyance has been declared (Auflassung), several Higher Regional Courts in Germany (Oberlandesgerichte) effectively denied existing private partnerships the ability to acquire German real estate.

The April 2011 decision establishes that the existence and the representation of the private partnership are sufficiently evidenced if the partners and the private partnership are named in the notarial conveyance deed and the persons acting on behalf of the private partnership confirm that they are the sole partners. This decision thus allows also existing private partnerships to acquire German real estate. 

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