Selected Regulatory Issues for Inveatments in German Non Performing Loans

1. Selected Regulatory Issues for Inveatments in German Non Performing Loans Herbert Rögner European Counsel

2. I. Banking Secrecy (1) • Not codified under German law • Legal source is controversial: • Part of the individual right on self determination based on Art. 2 German Constitution • Part of the ancillary duties of the Banking contract based on sec. 242 German Civil Code • No Differentiation in the scope of application between Private and Public Banking Sector • Same scope of application: German Data Protection law, sec 28 Go To View, Header Footer to Insert Document Number

3. I. Banking Secrecy (2) Banking Secrey within Due Diligence and Auction Process • Consent of the borrower to provide its individual data to third parties is not part of the standard credit documentation • banking secrecy regulation prohibits a Seller from disclosing privileged and confidential information regarding bank clients in its performing credit portfolio without the borrower‘s consent • in order to maximize proceeds from the sale, full scale access to the maximum possible disclosure of credit documentation should be available to all bidders Go To View, Header Footer to Insert Document Number

4. I. Banking Secrecy (3) Constraints: • banking secrecy rules apply within the Due Diligence process • borrower information needs to be segregated • borrower information on aggregated ans anonymous basis only if consent of the borrower is not (yet) granted (Red Data Room) • complete credit documentationwhere consent of borrower has been granted (Green Data Room) Go To View, Header Footer to Insert Document Number

5. I. Banking Secrecy (4) Applied practice in auctions: • negotiation of very similar documentation with all bidders to enable comparability of every bid • transfer of credit portfolio to SPV by operation of law („Umwandlung“) and sale of SPV‘s shares to the winning bidder • in order to satisfy Seller with banking secrecy rules, Seller no longer relies solely on a confidentiality arrangement both for Due Diligence and the actual sale and transfer of individual data as applied in ABS transactions. Performing loans may not be disclosed to third parties. The following solutions as discussed below are applied Go To View, Header Footer to Insert Document Number

6. I. Banking Secrecy (5) Controversial court ruling • loans to private borrowers: Frankfurt Court of Appeals dated 25.05.2004, WM 2004,1386 ruled that the assignment of the loan against the borrower in NPL transactions violates banking secrecy rules if (1) the loan is not in distress (2) no prior consent of the borrower is granted; note: precise definition of NPL is missing • Frankfurt and Koblenz Lower Court of Appeals (“Landgericht”) have rejected this view the latter which seems to be now the predominant position in line with my comments, see NJW 2004, 3230 et seq. • Section 354a German Commercial Code stipulates that assignment of loans entered into between merchants cannot be prohibited, thus assignment of consumer loans is the subject only Go To View, Header Footer to Insert Document Number

7. I. Banking Secrecy (6) Solutions for the period until the consent is granted: • with respect to sub-participations („Unterbeteiligungen“) confidentiality agreements are sufficient (not yet tested in court) • silent assignment of loan, disadvantage: servicing remains with Seller similar to sub-participation • data trustee could be installed satisfying banking secrecy rules Go To View, Header Footer to Insert Document Number

8. II. Banking Act • if NPLs are re-sold by the Purchaser, no banking license is required. However, BaFin is reluctant to accept a mere transfer of credit risk to non-banks (see recently in the HVB Real Estate AG case). • no Tier I/II capital relief if Seller (Bank) and/or investor is shareholder of Purchaser‘s entity and/or if and as long buyer has a right to withdraw from the contract • no off-balance sheet effect if credit risk remains with Seller ) • if the Purchaser outsources banking related activities to third parties such outsourcing could lead to disclosure of the service provider agreements to BaFin in accordance with Sec 25a German Banking Act, BaFin may investigate the outsourcing entity Go To View, Header Footer to Insert Document Number

9. III. Insolvency law (1) • quality of collaterals is the fundamental question for an investor; differenciation between international and domestic collaterals with respect to enforcement and workout strategies • in a liquidation scenario the quality of collaterals is the key question for investors to price a non performing loan • in many cases intrinsic value of claims is not assessable; real estate appraisal is reliable for pricing; liquidation value of the property backing the mortgage often lies below loan value • value of land charges depend i.a. on region, rank in land registry and declaration of purpose Go To View, Header Footer to Insert Document Number

10. III. Insolvency law (2) • timing differs from case to case; depending on kind of collaterals • enforcement is achieved by sale or forced auction of the real estate collateral or by an insolvency reorganization of the creditor. In cases of unsellable properties, especially in Eastern Germany, forced administration is the only possible way of utilization • workout: communication with the insolvency administrator regarding lien claims against certain assets; payments to the administrator for utilization of assets; quota for unsecured claims • liquidation of the company and its assets is the aim, but restructuring and turnaround by an asset deal can be an alternative pricing model Go To View, Header Footer to Insert Document Number

11. III. Insolvency law (3) • Under sec 46a German Banking Act the BaFin may impose a moratorium in payments to be made by a bank with the effect of a potential deferral of the due date of all payment obligations of that relevant bank. But that does not prevent a secured creditor from enforcing its collateral where possession of the collateral has been transferred to the secured party (Purchasers). Go To View, Header Footer to Insert Document Number

12. III. Insolvency law (4) • in the event of an insolvency of the seller, the insolvency administrator may challenge not completely performed contractual agreements (sec 103, 108, 110 Insolvency Act; Trustee agreements may expire under sec 116 Insolvency Act) • the creditor‘s right to set-off remains unaffected by the insolvency (sec 94 Insolvency Act) • Purchasers has no right to segregate not specifically designated cash assets (sec 48 Insolvency Act) Go To View, Header Footer to Insert Document Number

13. III. Insolvency law (5) • no right to challenge in the event of so-called cash transactions based on fair value („Bargeschäft“), but threat of recharacterisation as outright transfer of a security interest („Sicherungsabtretung“) which grants insolvency administrator the right to work-out security interest with a statutory deductable 9% up-front fee for the insolvency administrator Go To View, Header Footer to Insert Document Number

14. IV. VAT (Sec 13c VAT Act) • Purchaser of non-bank receivables for which VAT is payable is liable for that VAT if the Seller of the receivables has not fulfilled its obligation to pay VAT • Ministry of Finance (BMF) - letter dated 24 May and 3 June 2004 clarified that purchasing special service vehicles (Purchaser) in true sale ABS transactions are not affected by Article 13c German VAT Act • applicability of such exemption (relief) for True Sale of NPL remains open and controversial Go To View, Header Footer to Insert Document Number

15. V. Potential income tax issues if Purchaser SPV of German NPL is located outside Germany • the non-German Purchaser may become taxable under German law due to a permanent establishment caused by its activities which may be • holding German assets • rendering services related to German debt • entering into other contractual arrangements related to German debt fictiously assuming a physical presence in Germany („Fiktion einer inländischen Betriebsstätte“) Go To View, Header Footer to Insert Document Number

16. Contacts: New York Chicago Los Angeles Washington, D.C. West Palm Beach Frankfurt London Shanghai • Kaye Scholer (Germany) LLP • Schillerstraße 19 • 60313 Frankfurt • Tel.: +49 69 25494 - 0 • Fax: +49 69 25494 - 445 • www.kayescholer.com • Matthias Götz, European Partner • Email:mgoetz@kayescholer.com • Dr. Joachim Borggräfe, Tax Partner • Email: jborggraefe@kayescholer.com • Herbert Rögner, Counsel • E-Mail: hroegner@kayescholer.com Go To View, Header Footer to Insert Document Number