1. Background of the claw-back reform
German insolvency law allows claw-back for actions made by the debtor during a period of up to 10 years prior to insolvency proceedings. Until the new rules entered into effect in April 2017, this long look-back period also applied to so-called coverage transactions, meaning payments to which the creditor was entitled under contract or law. The insolvency administrator only needed to prove that when making the payment the debtor willfully disadvantaged its other creditors, and the recipient of the payment was aware of this.
Over time, ample case law had developed that allowed the insolvency administrator to prove the debtor’s acceptance and the creditors’ knowledge in court by relying on certain indicators, such as direct debit returns, continuous arrears, requests for deferrals, or installment payments on amounts owed. This case law resulted in an excessive use of claw-back proceedings by insolvency administrators. Creditors were often confronted with claw-back resulting from payments made by the debtor on justified claims years prior to the insolvency filing. When claw-back cases went to court, the insolvency administrators often succeeded, especially when creditors at some point before the contested payment had agreed on deferred payment terms. This legal situation was often perceived as unfair and received fierce criticism by numerous associations as well as unions and employee representatives. The claw-back reform is the result of this criticism.
2. The reform in detail
At the core of the new law is a limitation of the rules on claw-back based on willful disadvantage (Section 133 of the German Insolvency Code (IC)) and a widening of the cash transaction defense (Section 142 IC).
Claiming willful disadvantage is now limited in two respects. Firstly, new Section 133 para. 2 IC provides that coverage transactions granting performance or security to a creditor will only be contestable if the contested legal act took place within four years prior to the insolvency filing. The second limitation applies to congruent coverage transactions, meaning transactions where the debtor pays or performs in accordance with its legal obligations or, in other words, where the creditor received on or after the due date exactly what it was owed. To contest such transactions, the insolvency administrator must now generally prove that the creditor knew that its debtor was already illiquid at the time of the contested payment/performance. Under the previous law, it had generally been sufficient to prove that the creditor was aware of the debtor facing imminent illiquidity.
The new rule comes with a statutory presumption in favor of the creditor: In the event that the creditor enters into a payment agreement with the debtor or otherwise grants the debtor a payment accommodation, it is presumed that the creditor was not aware of the debtor’s illiquidity when the debtor continues to make payments or to perform. This is quite a significant change because, under the former law, agreeing on deferred payment terms as well as equivalent payment accommodations counted as strong evidence for the creditor’s knowledge of (at least) imminent insolvency.
Before the reform, performance for which the debtor “directly” received an equivalent return were exempted from claw-back pursuant to the statutory privilege of cash transactions (Section 142 IC), except in cases of willful disadvantaging. Revised Section 142 para. 1 IC now allows the creditor to rely on the cash transaction defense also if the claw-back is based on willful disadvantaging, unless where the creditor recognizes that the debtor acts in bad faith. New Section 142 para. 2 IC contains a legal definition for the term “directly”, which basically reflects rules already established by case law. The same is true for new Section 142 para. 3 IC, which states that wage payments qualify as cash transactions if made within three months after the performance of the work. The cash transaction defense also applies to wage payments if the wages are paid (unrecognizable for the employee) by a third party, e.g. a group company.
If an insolvency administrator seeks claw-back of a payment, according to the new Section 143 para. 1 clause 3 IC, interest on the claw-back claim starts to accrue only once the insolvency administrator has put the creditor in default or upon filing suit (cf. Section 291 of the German Civil Code). According to Art. 103 lit. j) para 2 of the Introductory Act to the Insolvency Statute, after 5 April 2017 the new interest rules apply to proceedings which had been commenced before 5 April 2017. This means that for existing insolvency proceedings, interest on claw-back claims that started to accrue upon opening of the proceedings stops accruing on 5 April 2017, unless the requirements of the new rules are already met.
3. Assessment and outlook
According to the preamble of the reform law, the aim of the new rules is, inter alia, to dispose of legal uncertainties existing on grounds of current case law. Whether this goal will be achieved is unclear since the new law contains some vague legal concepts that require interpretation by the courts. However, it seems quite clear that the new rules will significantly strengthen the position of creditors.
Especially suppliers and service providers can expect benefit in the insolvency proceedings of their (former) customers. The new rules set forth in Section 133 para. 2 and 3 IC will complicate the insolvency administrator’s task to prove the supplier’s knowledge of the debtor’s intention to disadvantage his creditors. This is true at least in cases where suppliers do not have detailed knowledge of the financial situation of their customers and when the payment arrears are not so serious that an insolvency cannot reasonably be denied. The fact that an agreement on deferred payment terms does not per se increase the claw-back risk is especially helpful. However, it should be noted that payments may still be subject to claw-back if the customer reveals that it is illiquid when requesting a payment accommodation. In this case, the insolvency administrator may be able to contradict the statutory presumption in Section 133 para. 3 sentence 3 IC.
In many cases, the cash transaction defense will also protect honest suppliers from claw-back. However, in this respect, attention should must be paid to detail. The new rules do not change the scope of the cash transaction defense insofar that it requires a “direct” exchange of equivalent consideration (cash for product). This means in particular that a supplier cannot rely on the cash transaction defense if its sales terms contain the widely used extended reservation of title clause (“erweiterter Eigentumsvorbehalt”), and title to the supplied goods does not transfer to the debtor due to continuing payment arrears.
The new Section 143 para. 1 sentence 3 IC finally is to be appreciated. Insolvency administrators could previously increase the insolvency estate by asserting claw-back claims at a very late point in the insolvency proceedings. The contest claim would have been subject to interest rates (retroactive) from the opening date of the insolvency proceedings. This unfair legal situation has been remedied by the reform.