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The new German law on shareholder loans and Art 13 IR

The new German law on shareholder loans and Art 13 IR. PD Dr. Alexander Schall, M.Jur. (Oxford). Ways to treat shareholder loans in insolvency. Equitable subordination under certain circumstances E.g. USA

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The new German law on shareholder loans and Art 13 IR

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  1. The new German law on shareholder loans and Art 13 IR PD Dr. Alexander Schall, M.Jur. (Oxford)

  2. Ways to treat shareholder loans in insolvency • Equitable subordination under certain circumstances • E.g. USA • Similar: old German law on “Eigenkapitalersatz” - treatment as equity if loan was given at a time where no credit would have been extended by third parties at arm‘s length • Rationale unclear: notion of fairness; falsa demonstratio; sanction for delaying proceedings/undercapitalisation. • Note: repayment governed by capital maintenance • Subordination as consequence of directors‘ liability • E.g. UK (wrongful trading), France (action en comblement) • General subordination of all shareholder loans (new German approach)

  3. The newGeman law on shareholder loans after the MoMiG • § 39 I Nr. 5 InsO: subordination of shareholder loans • § 135 I Nr. 2 InsO: • Payment on shareholder loan avoidable if made within 12 months preceding petition • Security for shareholder loan avoidable if granted within 10 years preceding petition – practically impossible to secure shareholder loans • § 135 III InsO: prolongation of leases on shareholder property for max. 1 year during preceeding (starting from petition)

  4. Someobservations • Simplification and rationalisation by „streamlining“ law on shareholder loans • No more dependence on circumstances • Subordination cannot be avoided by correct conduct any more – cannot be viewed as a sanction, but as simply as a prize for privilege of limited liability • Shift from company law (GmbHG) to insolvency law (InsO) • Target: pseudo-foreign companies with German CoMI • But does it work? We will see

  5. Application on foreign companies with CoMI in Germany • Art. 3, 4 IR: German insolvency law applies • Ergo: §§ 39 I 5, 135 InsO applicable • But see Art 13 IR: • Might allow foreign companies to invoke a home state exception against German avoidance provisions • If so, this could apply to subordination as well • Answer depends on interpretation and rationale of Art 13 IR and drafting of shareholder loan

  6. Elements of Art 13 IR • „personwhobenefited from an actdetrimental to all the creditors“ • Under German insolvency law, payment on a good claimis deemed (indirectly) detrimentalif the paymentisvoidableunder insolvency law • Other MS do not usuallydeempayments on good claims „detrimental“ at all • Doesindirectdetrimentsuffice? • The answershould be yes, or else the IR could not cover all MS insolvency laws as a whole.

  7. - the said act is subject to the law of a MS other than the State of the opening of proceedings • According to wording, the shareholder loan („the legal act“) must be governed by other MS law.: i.e. the lex causae must differ from the lex fori concursus) • The applicable lex causae is generally to be determined via Art 3 et seq. Rom I • Principle of free choice (Art 3) • Otherwise: habitual residence of shareholder („characteristic performance“, Art. 4 (2))

  8. - that law does not allow any means of challenging that act in the relevant case • Not restricted to abstract comparison of avoidance provisions under the relevant insolvency laws • Rather: complete parallel test of the transaction under the lex causae • Whether void or voidable for other reasons (bona mores etc)

  9. Example • Shareholder loan by German sole shareholder to his UK Ltd with German CoMI: • German law applicable under Art 4 lit m) • But: shareholder loan might follow different law (Art 13): • Choice of law is generally possible to determine lex causae • But: will probably not be accepted if only drafted to circumvent lex fori • See also Art 3 III Rom-I: Where all elements relevant to the situation …are located in a country other than the country whose law has been chosen, the choice shall not prejudice the application of provisions of the law of that country • The involvement of a foreign company might preclude “all elements”

  10. If Art 13 is applicable, the transaction will have to be tested under UK law as the lex causae of the shareholder agreement • See in particular ss. 214, 215 IA 1986 • If the transaction is not up to any challenge under the lex causae, Art 13 will bar the application of § 135 InsO • However, both the subordination under § 39 I N° 5 InsO and the prolongation of leases under § 135 III InsO will apply

  11. Critique: Art 13 IR does not seem apt to cope with the issue of shareholder loans for several reasons • Apparently, it aims at commercial certainty for Community trade that shall not be affected by the very different insolvency laws – but shareholder loans are not commercial transactions at arm’s length, but insider dealings • Further, the avoidance provision only flank the subordination of the loan under German law –Art 13 does not deal with the latter • Also, it seems odd that the Regulation should indirectly allow law shopping via the lex causae

  12. First way to avoid the odd split treatment • Art 13 not to be applied in case of shareholder loans since they are not the kind of transactions where the lex causae barrier makes sense („teleogical reduction“) • § 135 InsO not concerned with insolvency issues like defrauding creditors/ actio Pauliana/pari passu, but with a typical company law/limited liabiliy problem • Close connection to § 39 I n° 5 InsO and § 135 III InsO which are both applicable • Shareholders are rather insiders than the third parties whose security Art 13 aims at • However, even if §§ 39 I n° 5, 135 were fully applicable, they would still have to pass the basic freedoms test (Inspire Art, Volkswagen)

  13. Alternative solution • Interpret Art 13 IR in a way that it provides a complete and better-suited answer to the issue of shareholder loans • First step: in case of shareholder loans, Art 13 should apply if the lex societatis does not cater for avoidance • The laws on shareholder loans are rooted in company law, not in contract law • Therefore, in a shareholder loan constellation, the lex societatis must be viewed as “lex causae”, not the law governing the loan contract • This so much the more as Inspire Art practically allowed free choice of company laws within EU • Inspire Art requires that hurdles on foreign companies disappear, regardless whether disguised as insolvency law – the German legislator is not competent to fix the prize for limited liability in a UK company

  14. Second step • The scope of Art 13 should be extended beyond wording so to also exclude subordination under § 39 I N° 5 in order to provide coherent solution (teleological extension) • Not acceptable that subordination and avoidance follow different treatment • The subordination of shareholder loans interferes with commercial certainty in the same way as avoidance so that rationale of Art 13 IR requires extension • Art 4 (2) (i) is typically concerned with privileges (employees, tax), not with subordination

  15. And whatabout shareholder leases? • The application of § 135 III InsO on shareholder leases should not be barred by Art 13 IR in any way • This is primarily because the interference with commercial certainty is far less invasive: unlike the loan, the leased property is not lost. Only reclaim is barred for max 1 year. • Also, the provision aims to enhance corporate rescue by the liquidator. This is an insolvency-related public interest rationale for which the lex fori concursus is competent and by which the freedom of establishment test can be justified

  16. Finally: The German GmbH abroad • Under the IR, German law on shareholder loans seems not applicable if a GmbH has its CoMI abroad (Art 3, 4 IR) • However, from a conflicts point, the law on shareholder loans is insolvency law in form, but company law in substance due to its rationale (prize for limited liability) • This leads to a „double qualification“ as both insolvency and company law. • Thus, it is (also) a company law rule that shareholder loans are hybrid instruments that rank as low as equity in insolvency (and one year prior to it) • This company law rule may and must be observed by the foreign liquidator when ranking the claims

  17. Under the afore-said approach, there are no incentives for CoMi shifting – which is in line with the aims of the IR („effet utile“) • And what about applying ss. 214, 215 to the “English” GmbH? • Art 3, 4 IR seem to allow – but could it be company law in substance? – and would that deny application anyway? • At least, we should extend Art 13 IR to insolvency law liabilities as well. They are not explicitly catered for by IR, but raise the same issues for commecial certainty

  18. Conclusion - I • According to orthodox interpretation of Art 13 IR, the new German law on shareholder loans must be split up with respect to pseudo-foreign companies • The application of § 135 I is subject to the lex causae of the loan (choice of law or residence of shareholder) • §§ 39 I n° 5 and 135 III are applicable without any restriction (apart from freedoms-test)

  19. Conclusion - II • The split treatment should be avoided at any rate • Either by not applying Art 13 IR to § 135 I InsO („teleological reduction“) • Or (rather) by subjecting also both § 39 I n° 5 InsO and § 135 I InsO to the barrier of Art 13 IR (“teleological extension”) • § 135 III remains unaffected anyway • German GmbH abroad should be subjected to the German law on shareholder loans, too, because this is also company law (“double qualification”) • Art 13 should also cover insolvency liabilities (eg wrongful trading, action en comblement)

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