The COVID-19 crisis has resulted in Europe's largest economy heading for its worst recession in its postwar history, with GDP set to shrink 6.3 per cent this year. However, Germany has been hit less hard than other major European economies, which imposed stricter lockdowns.
The German government's pandemic mitigation measures, include a stimulus package worth over EUR 750bn, involving the government taking on new debt for the first time since 2013. The package comprises of a debt-financed supplementary budget of EUR 156bn and a stabilisation fund worth EUR 600bn for loans to struggling businesses and direct stakes in companies.
COVID-19-INSOLVENCY SUSPENSION LAW
The COVID-19-Insolvency Suspension Law (COVID-19-Insolvenzaussetzungsgesetz, "COVInsAG") came into force with retroactive effect from 1 March 2020. COVInsAG suspends the obligation to file for the commencement of insolvency proceedings within three weeks of the company becoming illiquid or over-indebted until 30 September 2020. The Federal Ministry of Justice and for Consumer Protection (Bundesministerium der Justiz und für Verbraucherschutz) is authorised to extend the suspension until 31 March 2021, in certain conditions.
The legislation will not apply if the insolvency was not caused by the spread of COVID-19 or if there are no prospects of resolving the company's illiquidity. If the suspension applies, payments made in the ordinary course of business, particularly payments to uphold the company's business or implement a restructuring, are exempt from the usual prohibition on payments in the event of illiquidity or over-indebtedness of a company.
If a loan granted during the suspension period is repaid by 30 September 2023, neither the loan repayment nor any security interests granted in relation to such loan may be set aside by an insolvency administrator. The same applies to repayments of any shareholder loans granted during the suspension period, although any security interests created in relation thereto remain subject to a set-aside. In addition, shareholder loans granted during the suspension period will not be subordinated in insolvency proceedings applied for up to 30 September 2023.
COVInsAG also requires creditors who apply for the commencement of insolvency proceedings between 28 March 2020 and 28 June 2020 to demonstrate that the ground for initiating insolvency proceedings already existed on 1 March 2020.
GERMAN LEGAL SYSTEM
The Federal Republic of Germany is a state made up of a federation (Bund) of 16 states (Länder). Both the Bund and Länder have executive, legislative and judicial powers. The head of the Bund is the Bundespräsident elected every five years by the Bundesversammlung, an electoral college made up of members of the Bundestag and delegates from the state parliaments. The federal legislative power is vested in the bi-cameral parliament made up of Bundestag and Bundesrat (the voice of the Länder).
The German legal system is a traditional civil law system, deriving its laws from directives and regulations passed by the European Union ("EU"), the German codified federal constitution, known as the Basic Law (Grundgesetz), and codified laws passed by the Federal Parliament. The federal states also have their own written and codified constitutions, although these are of minor practical importance, as federal law takes precedence over state laws. The country's judiciary consists of the ordinary courts responsible for all civil and criminal matters, the constitutional courts and specialised jurisdictions such as labour courts, administrative courts, fiscal courts and social courts.
KEY POINTS FOR TRADERS
- Banking licence required for "lending business" unless exceptions apply. Fully funded term loans may be transferable by assignment (see below).
- Revolving loans or any loans with ongoing funding requirements may be settled by funded participation.
- Transfer by way of German law assignment (Abtretung) or assumption of contract (Vertragsübernahme) commonplace, as English law novation may reset hardening periods.
- Equitable subordination risk in the event of the borrower's insolvency, 10 year hardening period in relation to loan security.
- Income tax of around 15 per cent is payable where there is a direct security interest over German real estate.
BANKING LICENCE REQUIREMENTS
The German Banking Act (Kreditwesengesetz, "KWG") prohibits the conduct of “lending business” without a licence. However, in general, the acquiring and holding of loans within Germany does not require a banking licence. In addition, the supervisory body responsible for granting bank licences in Germany, the Federal Financial Supervisory Authority (Bundesanstalt für Finanzdienstleistungsaufsicht, BaFin), issued guidelines in 2009 (as amended on 2 May 2016), stating that a banking licence is not required for secondary loan transactions where:
- a fully funded loan is being purchased by assignment; or
- the German borrower initiates contact with the non-German lender within the EU, thereby benefitting from the EU passive freedom to provide services - this is also known as the "first approach principle", and is generally only applicable for new loans.
Market participants should be aware that breach of the relevant provisions under the KWG may constitute a criminal offence and is punishable on indictment by a term of up to five years of imprisonment and/or a fine.
As such, entities that do not hold a banking licence will often settle trades by way of funded participation (or similar fronting structure) if there are ongoing funding requirements to a German borrower (i.e. an unfunded term loan or a revolving credit facility).
METHOD OF TRANSFER
The default transfer method under Loan Market Association ("LMA") German loan documentation is either the German law “assignment” (Abtretung) or an “assignment and transfer by assumption of contract" (Vertragsübernahme). Under a German law “assignment” only the rights under an agreement are assigned, not the obligations of the creditor. No consents are required for this form of transfer unless the credit agreement provides otherwise. The “assignment and transfer by assumption of contract" essentially combines an assignment of rights and transfer of obligations so that the transferor is no longer a party to the underlying agreement.
Borrower's consent is required unless the borrower is in default for an assignment and transfer by assumption of contract. Under the German LMA standard, borrower consent is deemed to have been given five business days after request, if not expressly refused by the borrower within that timeframe. Transfers by way of English law novation are not commonly used as they may release “accessory security” and reset hardening periods. Novation-proof collateralisation is typically achieved by way of an abstract promise of debt granted by the borrower in favour of the security agent (i.e. a parallel debt) which exists in parallel to the loan claims.
If an entity is not licenced, a funded participation agreement should be used where there is an ongoing funding requirement (i.e., an unfunded term loan or a revolving credit facility). However, there is a risk of banking licence “look through”.
SECURITY AND TRUSTS / AGENCY
Under German law “assignment” (Abtretung), accessory securities such as mortgages, pledges and accessory guarantees (Bürgschaft) are automatically transferred to the new lender. However, securities such as land charges and transfers of title for security purposes are not automatically transferred and must be considered separately.
Although German law does not have a concept equivalent to a common law trust, it is possible to appoint a security trustee to whom any non-accessory security is granted to hold on trust for the benefit of the finance parties.
Parallel debt structures are common and have been used for many years in Germany but have not been court tested.
German law recognises the concept of an agent acting in the name and on behalf of the lenders in a syndicated loan.
Under German law, any shareholder loans to a borrower are subordinated in the event of the borrower's insolvency, ranking behind the claims of other creditors. As such, it is often the case that additional representations are sought from the seller at the time of trade as to whether the seller is also a shareholder of the company. The subordination will not apply if the lender ceased to be a shareholder more than a year before the insolvency application filing.
Exceptions to such equitable subordination include:
- (i) Restructuring privilege - shareholders loans will be exempt if shares are acquired to restructure the borrower during insolvency.
- (ii) Minor, non-managing shareholder exemption
- GmbH (German private limited company): shareholder loans will be exempt where they have been provided by a non-managing shareholder holding 10 per cent or less of the share capital of the borrower.
- AG (German public limited company): the minimum shareholding must also be more than 10 per cent for the loan to be subordinated.
An insolvency administrator may challenge transactions during a one year hardening period in relation to loan repayment and during a 10 year hardening period in relation to loan security.
In light of the above, it is the transferee will often seek to obtain confirmation that the transferor is not a ten per cent plus shareholder.
DEFINITION OF FINANCIAL INSTITUTION
When purchasing debt under a German-law governed loan agreement advice should be sought as to whether the new lender meets the eligibility criteria, and any definitions in the agreement itself should be carefully considered. In determining whether an entity qualifies as a “financial institution”, German courts are likely to interpret the term less broadly than English courts and are likely to adopt the narrow definition contained in the Capital Requirements Regulation.
TAX AND STAMP DUTY CONSIDERATIONS
Foreign lenders are generally not subject to withholding tax or other deductions on interest payable on loans to domestic or foreign lenders.
However, interest payments to foreign lenders may be considered German-source income if the loan is directly or indirectly secured by German situs real property, comparable rights or ships. The foreign lender may be subject to a corporate income tax of 15 per cent plus a solidarity surcharge of 5.5 per cent, resulting in a cumulative tax rate of 15.825 per cent. It is worth noting that corporate income tax will be payable even where the debt is only part secured against German real estate i.e. German situs security will taint non-German situs security.
Such rate may be reduced if there is an applicable double tax treaty between Germany and the lender's tax resident jurisdiction. However, the foreign lender may still be obligated to file a tax return, even where the double taxation treaty reduces the required tax to 0 per cent, in order to receive the refund. In this case, the lender may submit an application for partial exemption to the competent tax authority (Bundeszentralamt für Steuern).
In 2019 the German government passed a draft bill on the future treatment of share deals for German real estate transfer tax ("RETT") purposes, which was originally expected to take effect on 1 January 2020. Under the bill;
- if 90 per cent (previously 95 per cent) of a company's shares are transferred to a new shareholder within the cooling period, RETT will be triggered on the full tax value of the real estate held by that company;
- the cooling period is 10 years (previously 5 years) or even 15 years in some circumstances; and
- RETT will be triggered if 90 per cent of a real estate holding company's shares are transferred either directly or indirectly within a 10 year cooling period (bringing them in line with partnerships).
The draft bill makes transactions involving property-related shares more costly and complex for investors. German parliament has not yet approved the draft bill, which is now expected to come into force during the course of the year.
FORMALITIES, NOTARY REQUIREMENTS AND ENFORCEABILITY
In certain transactions, original documentation may be required (for example, in respect of certain German financial instruments including Genussscheine and Schuldscheindarlehen).
For collateral transferred by assignment, there are formal requirements in relation to registration of such collateral in the land register. For any collateral to be entered in the land register in principle, authorisation for registration must be provided as a publicly certified document which can be certified by a notary.
In October 2018, a working group, including the LMA, produced a standardised form of Schuldschein loan agreement, driven by, inter alia, the growing economic significance of Schuldschein loans, leading to the increased involvement of foreign lenders and foreign issuers. Although Schuldschein loans remain underdeveloped in the UK, they are increasingly issued by companies in France, Benelux and Scandinavia as well as the traditional jurisdictions of Austria, Switzerland and Germany, with foreign company issues comprising half of the market share in 2019, compared with a third in 2018.
A Schuldschein loan is a German debt instrument which is neither a security instrument nor a bond. It is not classified as a form of security in Germany but as a loan for the purposes of section 488 of the German Civil Code (Bürgerliches Gesetzbuch, "BGB"). Schuldschein loan agreements are much shorter than standard loan agreements, due to the document automatically incorporating provisions codified in the BGB and reflecting that it is traditionally a finance instrument for investment grade borrowers.
Further information about Schuldschein loans can be found in Issue 11 of the Trade Alert.
UK CORPORATE INSOLVENCY AND GOVERNANCE BILL ("the Bill")
The Bill, introduced to Parliament on 20 May 2020, seeks to introduce both temporary and permanent changes to UK insolvency legislation. Whilst the temporary measures are aimed at dealing with the immediate impact of COVID-19 on UK businesses, the permanent updates increase the flexibility of restructuring options available in the UK.
The keys features of the Bill include:
- Moratorium - the moratorium provides companies with protection from creditors for an initial period of 20 business days to facilitate their rescue as a going concern. This period can be extended, and can last for up to a year if creditors consent.
- Cross-Class Cram Down - a restructuring tool, similar to a scheme of arrangement, but with provisions for cram-down of dissenting classes of creditors provided the compromise is approved by 75 per cent of those present and voting in one class with a genuine economic interest in the company.
- Ipso facto clauses - contractual clauses purporting to allow a party to unilaterally terminate a contract due to the counterparty's insolvency will be ineffective. These changes will apply to all contracts of an insolvent entity, even those entered into prior to the Bill's passage into law. There are transitional provisions allowing for exceptions for 'small suppliers'.
- Prohibition on winding up companies (temporary) - until 30 June 2020 courts will only grant a winding up order where it is satisfied that the company would have become insolvent irrespective of the effects of COVID-19.
- Suspension of liability for wrongful trading (temporary) - courts will assume that a director is not responsible for any financial losses of a company incurred between 1 March 2020 and 30 June 2020 when calculating their liability for wrongful trading.
DEUTSCHE LUFTHANSA AG ("Lufthansa")
On 27 May 2020, Lufthansa's supervisory board refused to approve a EUR 9bn bailout package proposed by the German government, after the European Commission demanded the airline surrender coveted slots at Frankfurt and Munich airports. Although the board has stated that it still perceives the bailout from Berlin as “the only viable alternative for maintaining solvency”, it has said that it will need to intensively analyse the economic impact of the demand.
Lufthansa, Europe's second largest airline group, released a regulatory statement on 7 May 2020 confirming that it was negotiating the EUR 9bn stabilisation package with Germany’s Federal Economic Stabilisation Fund (Wirtschaftsstabilisierungsfonds) to ensure its "future viability". The news followed Lufthansa being forced to ground 700 of its aircraft in response to the COVID-19 pandemic, leading to a 99 per cent drop in passenger numbers and a loss of approximately USD 1.1m in liquidity reserves per hour.
The stabilisation package includes a non-voting capital component, known as a so-called silent participation, and a secured loan. As part of the package, the German state will take a 20 per cent equity stake in the German company and two seats on the supervisory board. Various alternatives of a capital increase were discussed in relation to the German government's potential stake, including an increase at the nominal value of the share, if necessary after a capital cut. This sparked a political row over whether the state should take a strategic shareholding and play an active role in the stricken airline, with Angela Merkel's Conservatives opposing direct state investment and the opposition Greens deeming silent participation unacceptable. Lufthansa's chief executive, Carsten Spohr, sought to avoid the proposed state involvement, commenting that whilst Lufthansa may need government support, it does "not need government management”.
NORDEX GROUP ("Nordex")
German-listed wind turbine manufacturer Nordex announced its first quarter results on 11 May 2020, which were in line with expectations. It recorded a sales rise to EUR 964.6m with an EBITDA rise to EUR 13.1m, giving an EBITDA margin of 1.4 per cent. The sales increase is largely attributable to the upsurge in installations; Nordex installed a total of 269 wind turbines in Q1 2020, compared with 84 in Q1 2019. The turbines were installed across 21 countries, with Europe accounting for 60 per cent of the installed capacity.
The results also revealed a net debt amounting to EUR 156.4m, representing an increase of 46.1m from 31 March 2019. In April, Nordex successfully refinanced its EUR 1.21bn guarantee facility for three additional years to April 2023, with an option to extend it twice for another year each time, subject to prior lender approval. The debt was extended by a banking syndicate comprising of 21 national and international banks and insurance groups led by Banca IMI (Intesa Sanpaolo Group), BNP Paribas, Commerzbank, HSBC and UniCredit Bank. The facility is unsecured and also includes an ancillary facility of EUR 100m that can be allocated to draw on bilateral bank loans or guarantees.
Nordex also announced that it was withdrawing its guidance for the 2020 financial year as uncertainty over the duration and severity of pandemic-related disruptions, including supply chain interruptions, continue to hit its business. Chief Executive Officer, Jose Luis Blanco, commented that "Nordex and the wind energy sector as a whole are being impacted by this crisis".
RODENSTOCK HOLDING GMBH ("Rodenstock")
On 7 May 2020, Fitch Ratings ("Fitch") affirmed German lens and frame manufacturer Rodenstock's long-term issuer default rating at 'B-', with a stable outlook. The stable outlook is driven by Fitch's expectation that the additional equity of up to EUR 75m to be provided by the company's sponsor will restore its liquidity position to see the business through the pandemic crisis in financial year 2020 and support its return to normal trading levels in financial year 2021. Consideration was also given to Rodenstock's otherwise robust product portfolio and customer base, which is expected to allow the company to restore its operating and financial profile once the pandemic has been contained.
Although the pandemic severely disrupted Rodenstock's operations, leading to the collapse in demand in March and April 2020 which necessitated a liquidity injection from its sponsor, it displayed positive pre-COVID-19 momentum. Preliminary 2019 results show a record year for Rodenstock, with sales of EUR 450m exceeding expectations. The company was also able to generate a strong EBITDA margin of 20.8 per cent, supporting a stable free cash flow generation with a margin of around 3 per cent.
THYSSENKRUPP AG ("Thyssenkrupp")
German industrial conglomerate Thyssenkrupp warned it could lose EUR 1bn in equity in the current quarter due to the COVID-19 pandemic. The warning comes after its net loss increased by 40 per cent to EUR 1.31bn, pushing net debt to EUR 7.55bn. Chief executive officer Martina Merz commented that the worsening financial situation will reduce the financial leeway expected from the company's EUR 17.2bn-euro elevator business sale, the proceeds of which were intended to shore up struggling operations and fund pensions.
Advent International and Cinven, the private equity houses to whom Thyssenkrupp's elevator division is being sold, are seeking to offload their risk by bringing extra investors into Europe’s biggest buyout deal in a decade. They are trying to sell what will be an eight-times-leveraged industrial business at a hefty pre-crisis price. The deal is due to be completed in July this year.
Thyssenkrupp also confirmed that it had, on 8 May 2020, it concluded a EUR 1bn credit line from a consortium of banks led by Germany’s state-owned public investment bank KfW. It is hoped that the credit line will secure liquidity during the pandemic until the cash inflow from the elevator transaction.
PREMIER OIL PLC ("Premier Oil")
On 29 April 2020 the Court of Session in Edinburgh sanctioned oil and gas explorer Premier Oil's creditor scheme of arrangement, first proposed on 7 January 2020. The scheme relates to Premier Oil's proposed acquisition of United Kingdom North Sea ("North Sea") assets from BP plc for USD 800m, related funding arrangements and an extension to existing credit facilities from May 2021 to November 2023.
Hong Kong-based Asia Research & Capital Management Limited ("ARCM"), which holds 15 per cent of Premier Oil’s debt and a growing short position in its shares, was the only dissenting party to the scheme. ARCM called for Premier Oil to abandon the North Sea acquisition and to instead "focus on its cash flow position and protecting its balance sheet as a matter of priority”. ARCM lodged an appeal on 6 May 2020 of the Court’s judgment and, until those proceedings have concluded, Premier Oil is unable to register the Court’s order and the scheme remains ineffective. Once registered, the order will provide the necessary lender consents for Premier Oil to carry out the proposed transactions.
Chief Executive, Tony Durrant, revealed on 13 May 2020 that Premier Oil asked BP plc to cut the acquisition price in the North Sea deal due to weak oil prices. The global impact of COVID-19 on the global energy sector has seen oil prices and demand drop dramatically, with London Stock Exchange-listed Premier Oil's share price falling by approximately 70 per cent since the end of February 2020.
Nonetheless, the company's trading and operations update, released on 13 May 2020, shows that Premier Oil expects to be free cash flow neutral for full year 2020. This is despite slumping prices due to its hedging programme, which sees 30 per cent of its 2020 production protected at USD 60 a barrel. Its net debt stood at USD 1.91bn at the end of April, dwarfing its market capitalisation of approximately USD 280m.
CELSA GROUP ("CELSA")
Spanish news outlet, El Confidencial, reported that Barcelona-based Celsa, the largest manufacturer of steel reinforcement in the UK, has secured the support of the Court of First Instance of Madrid against twenty creditors seeking acceleration of guarantees. Celsa is said to have defaulted on its EUR 900m jumbo loan amid the unprecedented impacts of the COVID-19 crisis. The court ruled that the steelmaker was absolved of the EUR 34.39m payment default, which occurred on 4 May 2020, because its inability to pay was due to reasons outside of its control, namely the COVID-19 pandemic and the consequent state of alarm decreed by the Spanish government. The court also took into consideration that Celsa previously complied with payment commitments under the loan, promptly meeting 2018 and 2019 maturities totaling EUR 212.43m.
Celsa also reportedly sought UK government funding in the low tens of millions of pounds, a much smaller sum than that sought by fellow steelmakers, Tata Steel and Liberty Steel. India-based Tata Steel, owners of the UK's largest steelworks in Port Talbot, is seeking a GBP 500m government-backed loan whilst integrated producer Liberty Steel, part of the London-based GFG Alliance, is seeking roughly GBP 250m in funding.
A slump in orders from carmakers, manufacturers and the construction industry during the pandemic has hit steel producers hard, particularly as the industry was grappling with a tough market even before the outbreak.