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 Upd@te Germany
16 December 2010
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Legal news from Germany
Below you find the newsletter of the International Department of Schultze & Braun with information on current issues in German insolvency law as well as an article about discussion in the US and Germany regarding illegal real estate foreclosure.

Dr H. Philipp Esser, LL.M. (Chicago)
Attorney at law (Germany)
Attorney at Law (New York State)

Dr H. Philipp Esser
Comfort Letter
In a company crisis shareholders frequently grant enforceable comfort letters (in German: „hard“ comfort letters) for the benefit of a subsidiary and its creditors. The German Federal Court of Justice (Bundesgerichtshof, BGH) ruled in a decision dated 20 September 2010 (II ZR 296/08 “Star 21”) that such “hard” comfort letters can be terminable ex nunc, if a right to terminate has been agreed in the individual case.

The BGH remanded the present case for retrial. The Court of Appeals had not considered the shareholders’ defense that (i) the comfort letter had been granted to prevent an insolvency of the company only while the possibility of a restructuring was under review and (ii) that the comfort letter was no “guarantee of survival”. The BGH held that such an agreement may constitute a right to terminate.

The effectiveness of a termination would not be affected by the principles of capital replacement law because the company did not in fact receive any new capital. Neither did the shareholders grant an avoidable security for a third party loan to the subsidiary. Furthermore, the BGH did not consider a loan commitment to be similar to a capital contribution which would be subject to the principles of the finance plan loan (Finanzplankredit) – in such cases German law does not allow the shareholder to cancel its commitment – because the shareholders had waived any recourse claims. Additionally, a finance plan loan might also be subject to a right to terminate. Neither is the termination subject to avoidance (sec. 135 Insolvenzordnung (German Insolvency Act)). No claim equivalent to a claim for the repayment of a shareholder loan exists; besides a termination cannot be regarded as a satisfaction of a loan.

“Hard” comfort letters will now probably appear more frequently in German restructuring cases. A right to terminate gives the shareholders significantly more flexibility. However, the decision is based on the particularities of the case – where there were no recourse claims, and no de facto third party security. Practitioners will have to keep an eye on these factors.
Amendments to the German Insolvency Act – Budget Complementary Act 2011
On 28 October 2010 the German Bundestag passed the Budget Complementary Act 2011, which changes the law on insolvency proceedings filed on or after 1 January 2011. The new provisions are part of budget consolidation efforts and shall primarily prevent tax shortfalls due to insolvency proceedings.

More drastic legal reforms were announced at first – e.g. priority and extended set off rights for tax and social security authorities, and no avoidance of tax claims –, the reform will in fact have far less reaching consequences. Now the debtor’s tax obligations incurred by the preliminary insolvency administrator or by the debtor with approval of the preliminary insolvency administrator will be classified as administrative claims in the insolvency proceeding. This has already been the law for tax obligations incurred after the commencement of the insolvency proceeding.

In addition a refiled insolvency petition now has more consequences. If an insolvency petition is filed again within two years, such petition will not be dismissed simply because the third party petitioner is later paid in full. In such cases the debtor has to bear the administrative expenses.
Mortgage Foreclosure Turbulences – Beware of the Robo Signers
The rather formal law of foreclosure at times contains unexpected pit falls that may lead to liabilities – in the US and in Germany.

Even German media had noticed current discussions in the US regarding illegal real estate foreclosure. The crisis concerns mass proceedings in which real estate servicers are foreclosing on behalf of banks against non performing mortgagers. US foreclosure law demands that the creditor confirms to the court by way of affidavit that he has reviewed the requirements for foreclosure. It appears that such affidavits were filed in many cases and as a consequence real estate owners have lost their property, although the workout staff had never in fact reviewed the legality of the foreclosure. Often the workout staff – so called robo signers – lacks any qualifications in law.

US courts have reacted to such allegations by suspending all foreclosures until the creditors guarantee that all requirements for forclosure are met. In extreme cases some US courts have declared the whole real estate financing as void and thus have granted full relief of debts. Throughout the country property owners now refer to such judgments, however, in most cases without success. Nevertheless class action law suits have been filed against the banks involved, e.g. for faulty organisation of the workout departments. The US Congress even fears that because of the rapid development of the securitisation market in the recent years many financial institutions may not be able to prove their rights under real estate loans in individual cases.

This development affects Germany not only with respect to dubitable investments in US residential real estate portfolios. In a globalised world it would not be surprising if debtors in Germany will also search more thoroughly for formal mistakes made by the creditors in the foreclosure process in the future. In this context the Risk Limitation Act (Risikobegrenzungsgesetz) has already been enacted in 2008. This Act was intended to allay fears that non-regulated financial investors would foreclose on mortgages recklessly and in mass proceedings without being entitled to do so.

A recent decision of the BGH regarding the fall closure of a real estate loan transferred to a third party financial investor gives real estate owners new possibilities to defend themselves against foreclosure. In its decision made on 30 March 2010 (XI ZR 200/09) the BGH declared a foreclosure illegal on the basis of a notarial deed granting a standardised mortgage and subjecting the borrower to immediate foreclosure. In the decision the acquirer of the loan and the mortgage had not joined the security agreement between the borrower and the bank. In this case the BGH significantly increased the requirements for foreclosure on the basis of notarial deeds created before 19 August 2008 (Risk Limitation Act). In most transfers of real estate loans for purposes of refinancing the acquirer has not joined the security agreement. However, this has to be done now otherwise German courts will automatically reject foreclosure actions.

If the acquirer forecloses on an immediately enforceable mortgage even though such foreclosure is in fact illegal, he is directly liable for any damages which the borrower suffers. Therefore, banks should update their internal guidelines on foreclosure of real estate regularly with regard to the current court decisions. Workout staff should receive the necessary training in order to avoid being labeled as German robo signers.

Dr H. Philipp Esser, LL.M. (Chicago), Attorney at law (Germany), Attorney at Law (New York State)

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