German Insolvency Law – Overview On Insolvency Challenge Rights - Insolvency/Bankruptcy

The most important principle of the German insolvency law is the equal treatment of the creditors of the insolvency debtor. To satisfy their claims, the creditors are entitled to receive satisfaction from the debtor's insolvency estate. The insolvency estate consists of the entire assets of the debtor belonging to it at the time the insolvency proceeding is opened and the ones obtained during the proceeding.

In order to increase the insolvency estate, insolvency challenge rights enable the insolvency administrator or – in case of self-administration proceedings – the insolvency trustee (Sachwalter) to have certain transfers of assets, which have reduced the insolvency estate to the detriment of individual or all creditors, reversed. The challenge of transactions therefore in particular takes into account that it is often attempted in pre-insolvency phases to deprive the creditors of access to the debtor's assets by way of objectively unjustified transfers of assets or to put individual creditors in a better position.

BASIC PRINCIPLES

The insolvency administrator is in general entitled to challenge all legal acts taken prior to the filing for insolvency and which place the creditors at a disadvantage.

1. Legal Act

The term "legal act" has to be interpreted broadly, in order to expose as far as possible all disadvantageous measures, with the exception of mere accidental changes in assets, to challenge rights. It includes any action which has a legal effect, e.g., promissory contracts, contractual obligations, real acts (Realakte), acts of legal procedure, resolutions taken by corporate bodies, but also omissions. It is not necessary for an asset of the debtor to be permanently removed from his assets by a legal act. Rather, temporary sacrifices of assets, such as the provision of collateral, are also sufficient.

2. Placing Creditors at a Disadvantage

The placement of creditors at a disadvantage must be assumed if the challenged legal act has limited the creditors' possibilities to satisfy their claims. A disadvantage can be given in case of a decrease in assets, an increase of liabilities, an aggravation of access possibilities or an aggravation or a delay of enforceability. The challenge rights partly differentiate between direct and indirect disadvantages. A direct disadvantage is given where the disadvantages relating to a transaction occur in the debtor's assets without further circumstances, e.g., the sale of an asset below value. In contrast, an indirect disadvantage exists if, besides the transaction itself, additional circumstances arise that cause the adverse effect on the creditors. For example, this is the case where the debtor in fact receives an equivalent consideration which, however, is irrecoverable.

3. Privilege of Cash Transaction

a) General

The exchange of equivalent values in form of a so-called cash transaction (Bargeschäft) is privileged (Section 142 German Insolvency Code (InsO)). Thus, the InsO in general excludes challenge rights in the case of a cash transaction.

Such a cash transaction exists if the debtor's assets directly receive an equivalent consideration for the debtor's performance.

In case of employee salaries, such close connection in time shall, e.g., be given, if the time between work performance and payment of the remuneration does not exceed three months.

The burden of proof for the existence of a cash transaction lies with the addressee of the challenge right.

b) Exceptions to the Privilege of Cash Transaction

Exceptions to the privilege of cash transaction apply with respect to a challenge due to willful disadvantages and, according to settled case law, in case of a challenge due to incongruent coverage.

In case of a challenge due to willful disadvantages, the privilege for cash transactions is not excluded in general, but only if the debtor has acted unfairly and the addressee has realized such unfairness. Therefore, a challenge of cash transactions is only possible in case of a targeted disadvantaging of creditors.

The assumption of unfairness may only be drawn considering high requirements. Examples are the intent of the debtor to cause damage, the dissipation of assets or the unload of company assets required for continuation of the business.

The burden of proof for any placement of the creditors at a disadvantage as well as the unfairness lies with the insolvency administrator. In this regard, however, the law provides for several alleviations of the burden of proof.

4. Related Parties

In the event that the transaction was concluded between the debtor and one of its related parties (nahestehende Person), less stringent requirements for a challenge apply. These parties normally have better opportunities to be informed about the financial circumstances of the debtor and are, by experience, more likely willing to collaborate with the latter to the detriment of the creditors. If the debtor is a natural person, related parties are, inter alia, spouses or relatives. Related parties of a corporate entity are, in particular, members of the management or supervisory board and personally liable shareholders. Furthermore, persons who have the opportunity to inform themselves about the financial circumstances of the debtor due to a relation under corporate law or a service contract are related parties to the respective corporate entity, as well as to the debtor.

5. Challenge against Legal Successors

A transaction may also be challenged and enforced against legal successors (Section 145 InsO). This challenge right applies to universal succession (Gesamtrechtsnachfolge) as well as to singular legal succession (Einzelrechtsnachfolge). Hence, a transaction may be contested against the heir or another universal successor, and also against any other legal successor, if such legal successor (i) was, at the time of his acquisition, aware of the circumstances giving rise to the contestability of his predecessor's acquisition, or (ii) was, at the time of his acquisition, a related party, unless he was at that time unaware of the circumstances giving rise to the contestability of his predecessor's acquisition, or (iii) obtained the object of contestability by way of a gratuitous transfer.

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