Invalidity of bridge financing – new instructions by the German Federal Civil Court

The German Federal Civil Court decided by a resolution dated 7 March 2017 (file no. XI ZR 517/15) that the question whether a bridging loan is invalid due to a violation of morality cannot be answered on the basis of a certain term of such a loan, but only on a comprehensive assessment of all relevant circumstances.

Bridging Loan

Bridging loans are an important tool in the German restructuring practice. They are loans granted by financing institutions, especially banks, to satisfy the financing needs of an enterprise during or right before a financial crisis. A bridging loan is intended to help the business survive until a restructuring concept can be prepared.

Legal Situation

So far, higher courts in Germany have not yet ruled on the question of the admissible time period for a bridging loan in the forefront of an insolvency. The German Federal Civil Court had only ruled on a three-week term for shareholder loans (see decision dated 26 April 2010, file no. II ZR 60/90). In the legal literature, a period of one to three months is usually seen as an admissible period for a bridging loan.

The German Federal Civil Court in its new ruling states that an assessment of the validity of a bridging loan cannot depend on a certain time period agreed between the parties. The question whether a loan violates morality always depends on a comprehensive assessment of all relevant circumstances and the terms of the loan. The line between allowed terms for granting and securing a loan and those terms which are intolerable and therefore immoral and invalid has to be drawn considering all aspects of the single case. Specifically, a violation of morality may be the case if a bank delays the insolvency of a business in their own interests only and the bank should have been aware that the lending will only delay the collapse of the business instead of saving it.

Practical Consequences

The German Federal Court acknowledged the admissibility of bridging loans in principle, which means they can continue to be used during an out-of-court restructuring. With this new ruling, the Court is in line with the legal developments at the European Union level. A current draft directive of the European Commission provides for a legal measure comparable to the bridging loan in German restructuring practice.

In practice, however, granting of bridging loans in the forefront of an insolvency in Germany must still be carefully considered. German courts have in the past implemented strict limitations for the validity of bridging loans. The lower instance ruling, which the German Federal Court decision is based on, confirmed the invalidity of the bridge loan on additional grounds other than the time period. This has not been objected to by the German Federal Court.