THE DELTA REPORT
A recent decision of Germany’s highest court in civil matters, the German Federal Court of Justice (Bundesgerichtshof, the "BGH"), dated 9 June 2016 is likely to have a significant impact on netting clauses in a financial contract that is subject to German law. The BGH has determined that contractual provisions on netting arrangements that deviate from the statutory provision will be replaced by section 104 of the German Insolvency Code (Insolvenzordnung, the "InsO"). In response to the decision, a joint statement by the German Federal Ministry of Finance and the German Federal Ministry of Justice and Consumer Protection was issued stating that both ministries will initiate a statutory clarification at short notice to ensure that the usual master agreements continue to be accepted. Germany’s regulatory authority, the German Federal Financial Supervisory Authority, (Bundesanstalt für Finanzaufsicht, the "BaFin") has also published an administrative decree, which provides that netting agreements pursuant to Article 295 of Regulation (EU) No. 575/2013 ("CRR") will be treated as effective from 10 June 2016 until 31 December 2016.
(a) The calculation method to determine a close-out amount and the calculation date must not deviate from the method / timeframe set out in section 104 paragraphs 2 and 3 of the InsO.
(b) Section 340 paragraph 2 of the InsO, a special conflict of law provision in the InsO, refers to the relevant applicable substantive insolvency law.
Two German companies, the plaintiffs in the BGH proceedings, had agreed under the German law master agreement (the "DRV") to grant the defendant, a trading company organised under the laws of England and Wales, stock options for shares in SAP AG. The stock options were secured by a pledge over SAP shares in favour of the defendant. The defendant became insolvent and administration proceedings were instituted in the UK, while the plaintiffs still had one option transaction open. The defendant demanded a compensation claim calculated on the basis of the close-out provision of the DRV in its favour, as the market value of the SAP shares of 15 September 2008 (the time of the close-out) was higher than the agreed option price. The plaintiffs refused to release the shares pledged to it.
The plaintiffs successfully challenged the defendant in the Regional Court of Frankfurt (18 O 374/10), but, except for a very small part, the Higher Regional Court of Frankfurt (the "OLG") as a competent court of appeal, awarded the defendant with a compensation claim calculated pursuant to the DRV (16 U 183/12). The BGH generally agrees with the OLG decision, thus accepting the defendant’s claim, but disagrees with the calculation method under the DRV. The BGH stated that the calculation of the compensation claim should not be based on the DRV but on section 104 paragraphs 2 and 3 of the InsO, referring to the option’s market price of 17 September 2008.
The decision is based on section 119 of the InsO, which states that "agreements excluding or limiting the application of sections 103 through 118 shall be invalid". As the DRV calculation method for the compensation claims in a netting agreement deviate from those laid out under section 104 paragraphs 2 and 3 of the InsO, the BGH came to the conclusion, that the derogating DRV provisions are invalid and the calculation method under section 104 paragraphs 2 and 3 of the InsO have to be applied. Furthermore the BGH explicitly ruled that, even though section 104 paragraph 2 sentence 3 of the InsO refers to master agreements, a deviation from section 104 of the InsO in contractual provisions is not applicable.
This new ruling is a consequent continuance of the previous BGH ruling of 15 November 2012 (BGHZ 195, 348 et seqq.). In this case the BGH also stated that section 119 of the InsO protects the foregoing provisions, here section 103.
In this context section 119 of the InsO has to be understood as a protection of the "cherry picking" right of the insolvency administrator, meaning that he has the right whether or not to enforce contracts which have not been fully performed yet or to terminate them.
The new BGH ruling affects all master agreements governed by German law, which include calculation methods that deviate from the provisions laid out in section 104 of the InsO. The consequence of the statutory netting is laid out in section 104 paragraph 3 of the InsO. Claims for performance are replaced by claims for non-performance covering the difference between the agreed price and the market or exchange price on a contractually agreed date (but at the latest on the fifth working day after the opening of insolvency proceedings; only without such agreement on the second working day), while the DRV replaced the relevant claims by compensation claims. Therefore there are two possible scenarios in which the contractual provision can become invalid: (1) the contractual provision uses a calculation method that deviates from the statutory provision, (2) the calculation date of the relevant values deviates from the timeframe provided for in section 104 paragraph 3 of the InsO.
However it is noticeable that a contractually agreed early termination of a transaction covered by section 104 of the InsO based on the filing for the opening of insolvency proceedings seems to be valid. The BGH has not ruled on this specific matter but as such early termination does not modify the provisions laid out in section 104 of the InsO, one might argue that such an early termination right may still be effective.
Furthermore this impact on netting agreements cannot be bypassed by choosing another governing contract law. Section 340 paragraph 2 of the InsO contains a special insolvency conflict of laws rule that specifies netting agreements shall be governed by the "laws of the country governing the agreement". But this provision is part of the conflict of insolvency laws section, meaning it only applies if the insolvency proceedings are subject to this section (sections 335 et seqq. of the InsO). This particular section of the InsO is subsidiary to the EU rules on international insolvency proceedings Council Regulation (EC) No.1346/2000 of 29 May 2000 on insolvency proceedings ("EUIR"). However insolvency proceedings concerning insurance companies, credit institutions, investment firms which provide services involving the holding of funds or securities for third parties, and collective investment undertakings (UCITS) are not within the scope of the EUIR.
While previously discussed whether "laws of the country governing the agreement" means the substantive insolvency law, the substantive contract law or the terms of the agreement, the new BGH ruling made clear, that section 340 (2) of the InsO refers to the relevant applicable substantive insolvency law.
Reaction by German Authorities and Politics
As this new BGH judgment caused some turmoil and uncertainties in the market, BaFin published an administrative decree on 9 June 2016, the day the BGH judgment was released. In it BaFin states that netting agreements as described in article 295 of the CRR are to be settled as agreed by their contractual parties, including those ex officio acting for or against them. As this decree entered into force on 10 June 2016 and will remain in effect until 12pm on 31 December 2016, this decree does not affect insolvency proceedings commenced before 9 June 2016.
This decree is intended to give the parliament enough time to amend the relevant InsO provisions and issue a new version, which, it is hoped, will reflect a more commercially acceptable interpretation.
Therefore the German Federal Ministry of Finance and the German Federal Ministry of Justice have published a joint statement, declaring that both ministries are willing to initiate immediate legislative measures to clear up the wording of the affected provisions.
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