German Federal Court of Justice strengthens the rights of banks and conditional sellers in the event of an insolvency
The 9th civil senate of the German Federal Court of Justice ("Bundesgerichtshof") has handed down a judgment on 24 January 2019 that strengthens the security interests and disclosure rights of creditors and conditional sellers in the event of an insolvency
(IX ZR 110/17). The judgment strengthens the positions of (1) banks who hold collateral posted by a corporation filing for insolvency and (2) suppliers of the insolvent company that are secured by way of an (extended) retention of title.
I. Facts of the case
The respondent was a company incorporated under German Law active in the sale and distribution of beverages. It had acquired structured financing through a bank loan. In return, it transferred all titles and rights to their inventory (‘Raumsicherungsübereignung’) and assigned all potential claims resulting from a resale of their goods, save those secured through an extended retention of title vis-à-vis its suppliers, to the bank as collateral.
Shortly after the company filed for insolvency under German law, the bank terminated the financing contract with immediate effect. It prohibited the debtor from reselling any of the goods used for collateralisation, as well as any collection of debt relating to the claims that had been assigned to them for the same reason. It also revoked any prior consent it had granted the insolvent party to resell the secured goods and to collect debts with regard to the assigned claims.
The insolvent company and its preliminary insolvency administrator ignored these prohibitions and proceeded to collect all outstanding claims, transferring the proceeds to bank accounts of the company designated for general business purposes. Furthermore, they resold all their remaining assets, the titles of which had been transferred to the bank as collateral, to third parties. The proceeds from these sales were also transferred to one of the company’s general business accounts. After the insolvency proceedings for the assets of the company were opened, the insolvency administrator made a notification of insufficient assets to cover at least the costs of the insolvency proceedings (‘Masseunzulänglichkeit’).
The bank brought an action claiming the proceeds of the collection of claims and the resale of goods as these rights and assets had been transferred to them to collateralise the loan agreement prior to the insolvency. The insolvency administrator argued that the proceeds had become part of the estate, rendering it undistinguishable from other assets, thereby excluding any rights of separation or separate satisfaction.
II. The ruling
The Federal Court of Justice held that an application for insolvency and the subsequent appointment of a preliminary insolvency administrator do not strip the insolvent party of its right to recover debts and/or to resell goods within the scope of the ordinary course of its business. The insolvent party ceases to have these rights only in the event that the collateral taker, such as the bank in this case, expressly revokes its consent and prohibits the resale of goods and the collection of debt. Once the bank has made its objections clear, however, the (preliminary) insolvency administrator, trustee and/or insolvent company must respect that decision.
The Court found that the recovery of claims and resale of goods prior to the bank revoking its consent can only be deemed to have taken place ‘in the ordinary course of business’ if the proceeds from such sales and debt recoveries are transferred to an open escrow account (‘offenes Treuhandkonto’). If that requirement is not met, the liquidation of assets is deemed to have been performed ‘unjustified’ pursuant to Section 48 of the German Insolvency Statute (‘Insolvenzordnung’). That holds true even if the insolvency court orders that assets posted as collateral which are subject to rights of separation or separate satisfaction may be used to continue business operations during the opening proceedings of the insolvency. While such an order pursuant to Section 21 (2), 1st Sentence, Number 5 of the Insolvency Statute allows the insolvent party to continue using assets encumbered by third-party rights, it does not give a right to sell those assets, as this would frustrate the rights and interests of the collateral taker. It follows that if the insolvency administrator chooses to liquidate assets that are subject to third-party security rights during the opening proceedings of an insolvency, they must ensure that the third party’s security interests in the proceeds resulting from such liquidation are protected, more precisely that a subsequent distinction from the estate remains possible so that the creditor can invoke their claim of separation pursuant to Section 47 of the Insolvency Statute at a later stage. This is primarily to be achieved by transferring the proceeds to an open escrow account.
Where the proceeds are not transferred to an escrow account but to a general business account, the burden of proof lies with the insolvent party. It must prove that a separation of the proceeds from the estate remains possible. This requires disclosure of all information relating to the relevant account balances. Additionally, proof must be provided that the proceeds were transferred to a ‘credited’ account. Otherwise, the proceeds will be considered not distinguishable from the estate. The court ruled, however, that the insolvency administrator may have a ‘secondary burden of proof’ (‘sekundäre Darlegungslast’) as to the development of the proceeds on the accounts of the insolvency debtor.
Creditors who hold enforceable security rights against a debtor and who become aware of an insolvency filing by that company should immediately revoke any and all authorisations to collect debt and/or sell securitised assets.
They should also request that the proceeds from the collection of debt and liquidation of assets are transferred to an open escrow account, which shall be kept strictly separate from the estate, and that they are provided with bank statements for that account and any other business accounts of the insolvent company which reflect the respective account balances on the effective date of the insolvency filing. This is to ensure that the proceeds resulting from the liquidation of assets given for collateralisation remain distinguishable from the rest of the insolvency estate. An award of damages could be sought against the insolvency administrator, trustee and/or insolvent party if they choose – as they did in this case – not to respect the creditor’s security rights.
Noerr can advise you on enforcing your security rights.
Do you have any questions? Please contact Dr. Björn Grotebrune