Trade Alert: Germany

GERMANY

The German Federal Election took place on 26 September 2021, electing a new parliament and marking the end the 16-year chancellorship of Angela Merkel, who did not stand for re-election.

The centre-left Social Democrats (SPD) won the election with a narrow lead over the conservative CDU/CSU bloc. Olaf Scholz of the SPD and Armin Laschet of the CDU have both stated that they hope to form a coalition. The Green Party and free-market liberal FDP made gains and are likely to be part of the next government whether led by Scholz or Laschet. It is expected that the FDP will claim the Finance Ministry indicating a change in future German financial policy. The FDP is pro-business, advocating for a reduction in the total burden of business tax, tax breaks for private investment, and reverting Germany to its pre-pandemic budget management.

Nonetheless, as Germany heads for long and intensive negotiations over the three-way coalition, it is likely that the Liberal Democrats will be relevant in any new German government, either being a “Jamaica” coalition among the CDU/CSU, the Green Party and the FDP or the same led by the SPD instead of the CDU/CSU. 

NEW RESTRUCTURING LAW AND REAL ESTATE TRANSFER TAX REFORMS

StaRUG

German restructuring law saw significant changes at the beginning of the year with the introduction of a new pre-insolvency restructuring framework in the Corporate Stabilisation and Restructuring Act (StaRUG). Due to the economic impact of the COVID-19 pandemic, StaRUG came into force on 1 January 2021 after a legislative process of only about three months.

The new law, which implements EU Directive 2019/1023 on preventive restructuring frameworks, affords a statutory regime to debtors for a non-consensual restructuring outside of insolvency proceedings. This is a novelty, as German law had not previously provided for any tool to impose a debt-restructuring concept agreed between the debtor and the vast majority of its creditors upon a dissenting minority. Holdout creditors therefore had the power to force debtors into formal insolvency proceedings, unless those debtors were willing and able to resort to cumbersome English law schemes of arrangements.

While StaRUG cases are still rather rare in practice, the recent restructuring of ETERNA Mode Holding GmbH attracted wide interest in the media as the first restructuring of a larger enterprise under the new regime.

RETT

Earlier this year, the German Federal Council approved a reform of Real Estate Transfer Tax (RETT), which applies to transactions of real estate company shares. The reform applies from 1 July 2021.

The key reforms to RETT are as follows:

• Level of investment reduced from 95 per cent to 90 per cent

Tax on Transfer of Assets (German RETT) applies where at least 90 per cent of the shares of a real estate company are transferred, directly or indirectly.

• Tenure periods increased from 5 years to 10–15 years.

The reforms require sellers to hold the stock for a minimum period of 10 years. In addition, periods of tenure for which certain exemptions apply will be extended from 5 years to 10 years, or 15 years with periods of prior tenure. Following the expiration of such period, RETT will not apply.

• Exemption for listed entities

Transfers of shares to new shareholders through a stock market transaction are not subject to the limitations above. Such transfers are exempt, even where more than 90 per cent of the shares are transferred. Therefore, real estate funds and companies, publicly traded in the EU, EEA or other equivalent stock exchanges authorised under German law, fall outside of the scope of RETT. However, over-the-counter operations will not be covered.

These reforms affect not only real estate companies resident in Germany, but also those which are non-residents but have real estate investments in Germany.

SPECIAL THANKS

We appreciate the assistance of Michael Neises and Christian Staps at Heuking Kühn Lüer Wojtek with the following discussion on German law, regulation and practice.

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) are commonplace, as English law novation may reset hardening periods and potentially weaken accessory security rights.
• Equitable subordination risk in the event of the borrower's insolvency, 10-year hardening period in relation to loan security.
• Income tax of 15.825 per cent is payable where there is a direct security interest over German real estate.
• RETT – Real Estate Transfer Tax may apply if acquiring shares of an entity holding German real estate (see RETT paragraph above). 

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 is typically 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 a 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 which capture accessory security rights in a security trustee structure 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.

EQUITABLE SUBORDINATION

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:

• Restructuring privilege - shareholders loans will be exempt if shares are acquired to restructure the borrower during insolvency.
• 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 1-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, 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).

While not relevant to the transfer of loans of a Borrower holding real estate in Germany, if a purchaser is acquiring the shares of the German entity or if the debt is converted into equity of the borrower which is subsequently transferred to an onward buyer, then Real Estate Transfer Tax may apply (see RETT paragraph above).  

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.  

Formalities are also required to transfer a claim which has been registered in the official insolvency table (Insolvenztabelle) in respect of a debtor and assets which the court insolvency proceedings had been opened.

NOTABLE TRANSACTIONS

THYSSENKRUPP AG (“ThyssenKrupp”) 

On 16 September 2021, ThyssenKrupp announced that it has sold its Italian stainless-steel producer, Acciai Speciali Terni (AST), to Arvedi for an undisclosed amount. The transaction is expected to complete by the end of the first half of 2022, subject to merger control and approval by the Thyssenkrupp Supervisory Board. AST has approximately 2,700 employees and in its 2019/20 revenue was EUR1.69bn, with estimations for the sale price to be between EUR500m and EUR700m. 

The sale reflects Thyssenkrupp’s intentions to restructure the group’s business in response to financial hardship exacerbated by the pandemic. Martina Merz, Thyssenkrupp’s CEO stated: “This fourth transaction clearly shows that we are working through our priorities and making decisive progress in the transformation of Thyssenkrupp”.  Thyssenkrupp announced that it has a cash gap of EUR1.8bn, due to restructuring costs and higher investments, reflecting the continued effort to condense its business model.

The group released positive 3rd-quarter and 9-month results for the financial year ending on 30 June 2021. The results showcased a continued strong performance by the group, with a recorded 3^rd-quarter intake of EUR8.8bn, a dramatic increase from last year’s EUR4.8bn, with sales between April and June increasing by 51 per cent to EUR8.7bn. The group’s Adjusted EBIT of EUR266m is a marked improvement from the previous year’s  -EUR693m and the prior quarter’s -EUR220m. Notwithstanding the group’s improvements, Thyssenkrupp still expects a net loss of up to a “mid-three-digit million euro amount” for the fiscal year 2020/2021.

DEUTSCHE LUFTHANSA AG (“Lufthansa”)

On 19 September 2021, Lufthansa announced that it would proceed with a EUR2.14bn rights issue. Lufthansa will issue 597,742,822 shares with a subscription pricing at EUR3.58 per new share, representing a 39.3 per cent discount on the theoretical ex-rights price (TERP). This rights issue has a subscription ratio of 1:1 and the subscription period ends on 5 October 2021.

The rights issue has been fully underwritten by a syndicate of 14 banks. As part of the capital increase, various funds and accounts under the management of Blackrock Inc have entered into a sub-underwriting agreement for a total of EUR300m and have committed to fully exercising their subscription rights.

In June 2020, shareholders of Lufthansa agreed to a EUR9bn government bailout with the Economic Stabilization Fund (ESF). As part of the transaction, the ESF holds 15.94 per cent of Lufthansa’s share capital and the capital raised by the forthcoming rights issue is to be used to reduce the state’s equity position in the group. Lufthansa will repay the ESF’s EUR1.5bn Silent Participation I and intends to repay its EUR1bn Silent Participation II by the end of 2021.

If the ESF subscribes to this rights issue, it has committed to selling its 15.94 per cent stake in Lufthansa six months after the completion of the rights issue at the earliest and no later than two years. Lufthansa Chief Financial Officer, Remco Steenbergen, outlined that Lufthansa will remain “committed to further explore portfolio measures when full value can be achieved to maximize the value and strategic flexibility of the Group.”

BERLIN BRANDS GROUP (“BBG”)

BBG, a global German e-commerce business, has attracted Bain Capital in a USD700m equity and debt financing deal, making the German company the latest European Unicorn. Bain Capital replaces investment house Ardian as a minority investor. BBG CEO Peter Chaljawski stated that this investment “allows us to tackle strategic goals of acquiring and developing brands globally, as well as the operational and logistical expansion. Bain Capital’s experience working with founders worldwide will help us continue our evolution as a leading e-commerce company in scaling brands.”  

BBG is a pioneer of the direct-to-consumer business (D2C) with 14 brands and over 100 channels in 28 countries, selling 3,700 products. The group has access to 1.5bn e-commerce customers in Europe, the U.K., the U.S., and parts of Asia. BBG had a net revenue of over EUR300m in 2020 and its business model incorporates product R&D, production, distribution, brand creation, and marketing sales & services. Its goal to expand into new markets and increase its portfolio through M&A.

This fund raising follows previous expansion initiatives by the group. At the beginning of 2021, BBG announced that it would commit EUR250m to acquire D2Cs to consolidate its place in the market. This commitment came from equity and has accelerated the group’s capacity to acquire and scale e-commerce brands to the largest in Europe. In April 2021, BBG raised USD240m through debt financing to acquire smaller enterprises whose sales range between USD1m to USD100m  in Europe and North America. The debt financing was provided by Unicredit, Deutsche Bank and Commerzbank.

KION GROUP AG (“KION”)

On 23 September 2021 Fitch Ratings upgraded the long-term issuer default rating of Kion, the German based industrial truck manufacturer and supply chains provider, to BBB from BBB-. Fitch also upgraded Kion’s senior unsecured rating to BBB from BBB-. The robust operating cash flows of the group, the funds from operations (FFO) rebounded strongly in first-half 2021 to 8.5 per cent compared with 6.2 per cent in the previous year. Fitch predicts that Kion will return to a FFO pre-pandemic level soon and achieve 9 per cent in 2022 at the latest. Fitch forecasts that Kion will continue to generate consistent free cash flow (FCF) in the short to medium term and beyond this year, it believes that Kion is in a strong position to reach a FCF margin of up to 4 per cent.

The group’s interim report illustrated a strong increase in order intake by 33 per cent to EUR5.882bn in the first half of 2021, up from a year previous of EUR4.4bn. Reasons for this increase in performance were due to forward purchases of Kion products and rapid growth in the market as a whole. In particular, the Industrial Trucks & Services (ITS), which predominately sells forklift trucks and the Supply Chain Solutions (SCS), the latter improving due to the demand for warehouse automation in North America and Europe.

At the end of 2020, Kion successfully generated proceeds of EUR813m by way of a rights issue against cash contributions.  The proceeds were to be used to reduce the group’s indebtedness and to terminate a syndicated revolving credit facility it had agreed with the KFW, the German Development Bank.

FAURECIA S.A (“Faurecia”)

On 14 August 2021 Faurecia and Hella GmbH agreed to merge their automotive manufacturing businesses in a deal valued at EUR6.7bn.  The deal features a public tender cash offer of EUR60 per share and the acquisition of the family 60 per cent stake in Hella, creating the 7^th largest global automotive supplier in the world, with a forecasted revenue of EUR33bn by 2025. Faurecia, advised by Lazard, has secured financing of EUR5.5bn for the acquisition. This financing will comprise of an EUR800m bridge-to-equity rights issue, a EUR4.2bn committed facility through bond issuance and bank loans, and a 3-year term loan of EUR500m.

Post-merger, the group will focus on four areas to reflect the changing trends in the automotive industry: Electric Mobility, ADAS & Autonomous Driving; Cockpit of the future; and Lifecycle Value Management.  Faurecia predicts that by 2025 sale synergies from the merger should generate between EUR300m and EUR400m due to Faurecia’s strong Asian and American footprint and Hella’s electronic position with German OEMs.

The industry trend to turn from internal combustible engines to electric vehicles has necessitated auto suppliers to change tactics. Faurecia estimates that the group’s revenue of internal combustion engine cars would decrease from 25 per cent of its operations last year to 20 per cent next year and to 10 per cent by 2025.  Faurecia’s CEO Patrick Koller stated: “Electric vehicles will increase constantly. This is the future very clearly, not only battery electric vehicles but also hydrogen fuel cells”.

ENGLAND – ONGOING COVID-19 MEASURES

LANDLORDS: COMMERCIAL RENT ARBITRATION

Landlords’ hands remain tied when dealing with rent arrears. Existing protections for commercial tenants experiencing financial difficulties due to the impact of COVID-19 have been extended to March 2022, with the current prohibition on eviction and use of the commercial rent arrears recovery process extended until 25 March 2022, and the moratorium on landlords being able to issue a winding up petition against tenants with rent arrears extended to 31 March 2022.

The UK Government has indicated that these extensions are to allow time to introduce legislation which will ‘ringfence’ commercial rent arrears accrued as a result of COVID-19 and put in place a system of binding arbitration to settle rent disputes. It has been indicated that the arbitration system should only be used as a last resort where the parties have been unable to come to a commercial agreement following negotiations. The Government will, in due course, publish a revised Code of Practice which will contain principles which landlords, tenants and arbitrators must take into consideration during the negotiations and arbitration.

With this in mind, lenders to English borrowers should be on the look-out for borrowers engaging in discussions with their landlords, and the potential impact this may have on existing financings. A consensual agreement with a landlord, as envisaged by the new guidelines, could trigger an event of default under existing finance documents, which would present an opportunity to re-negotiate terms or call in loans, if desired.

The new guidelines do not, in themselves, represent a change in a borrower’s financial position. It is likely that any lender considering how these guidelines affect their borrower is already in a position to call a default, should they wish to do so, given the accrual of significant arrears and the well-publicised cashflow difficulties of certain UK commercial borrowers during the course of the COVID-19 pandemic. The new guidelines may well, therefore, not represent any significant deviation from the status quo.

However, for lenders seeking to exit positions, the commencement of negotiations with a landlord could provide a useful and concrete default on which lenders may seek to proceed.

Lenders should also consider whether the commencement of arbitration would entitle them to additional or enhanced financial reporting from a borrower. For a lender seeking to compile evidence of insolvency in order to trigger a default or open discussions around re-negotiation, this could be a useful tool.

In summary, it is expected that, when the new guidelines come into force, borrowers with significant rent arrears may be approaching their lenders before commencing discussions with landlords. Lenders should be alert to this and the potential opportunities it may afford them.

For further information on commercial rent arbitration, please contact Colin Ashford or Helena Clarke in Brown Rudnick’s Restructuring and Insolvency team.

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CONTACT 

Please contact Louisa Watt or Iden Asl with any queries regarding this month's Trade Alert. 

DISCLAIMER:

This publication is for general purposes and does not provide comprehensive or full legal advice. It is based upon public information available at the time of publication and is subject to change. Brown Rudnick LLP does not accept any responsibility for losses that may arise from reliance upon information contained in this update. This publication is intended to give an indication of legal issues upon which you may need advice. The contents of this update may not be relied upon as accurate or sufficient and full legal advice should be taken in relation to specific trading situations.