Germany

Julia Rakob

I.Introduction

1.General background; structure of national law re security over tangibles

a)Historical development

As a civil law jurisdiction, Germany relies heavily on statutes and codifications as sources of law. Legal relations between citizens are primarily governed by the Civil Code (Bürgerliches Gesetzbuch), supplemented by the Commercial Code (Handelsgesetzbuch) for merchants and commercial transactions. A survey of the German law of secured transactions relying on these statutory sources, however, would miss the reality of granting and taking security in Germany entirely. The creation of security has come a long way since the Civil Code entered into force in 1900.

The Civil Code only contains rules on retention of title1 and on pledges.2 Retention of title is a contractual security right of the unpaid seller in the sold goods. Retention of title is very popular; almost all written contracts for the sale of goods contain retention of title clauses in one form or another. For other creditors, the Civil Code provides for the traditional pledge which may be used to encumber both tangible movable assets3 (“movable things”, “bewegliche Sachen”) and rights4 (“Rechte”), including receivables (“Forderungen”). Pledges are public security devices in the sense that they may not be created confidentially without external evidence of their creation: the creation of a pledge in a “thing” requires a transfer of direct possession from the pledgor to the pledgee; the creation of a pledge over receivables requires that notice of the pledge be sent to the third party debtor. This, of course, made pledges unpopular – loss of possession deprives the pledgor of the chance to work with the collateral,

1§ 449 BGB.

2§§ 1204 et seq. BGB.

3§§ 1204-1259 BGB.

4§§ 1273-1296 BGB.

notice to third party debtors of receivables may damage the reputation and credit of the pledgor or may confuse the debtor about who to pay to.

German legal practise found a way around these difficulties, not by stretching the statutory rules on pledges, but by using the rules on absolute transfer of assets – transfer of title in tangible movables, assignment of receivables and other rights – to create security rights by effect of party agreement.

Under the Civil Code, a transfer of title in a “movable thing” may be achieved without transfer of actual possession.5 If, in a non-security situation, e.g. a sale, the parties agree that the buyer shall become the owner of the sold goods on 1 April, whereas the goods will only be delivered a month later on 1 May and will remain with the seller until delivery, this arrangement is possible and title will actually pass on 1 April. For the title to pass, it is sufficient if the parties agree that from 1 April on, the seller holds the goods on behalf of the buyer and thus create fictitious possession. Fictitious possession (“mittelbarer Besitz”) is sufficient to transfer title, but it would not suffice if the parties wanted to create a pledge in the goods. Pledges require actual possession,6 so in the circumstances above, the parties could not have created a pledge on a contractually agreed date which suited their needs, but only upon delivery when the pledgee acquires actual possession. This difference between pledges and transfer of title in the requirements regarding possession made title, taking the form of title transfer by way of security, an attractive security device in situations where the debtor needs possession of the collateral.

The same development occurred regarding security over receivables: assignment of receivables for security was used to avoid the notice requirements7 for the creation of pledges in receivables. As with a transfer of title by way of security with respect to tangibles, it is easier to assign a receivable than to create a pledge in it, and therefore assignment for security became the dominant form of security over receivables rather than the pledge.

After a transfer of title or assignment for security purposes, the secured creditor holds clean title to the movable assets or the assigned rights, just like someone who has acquired these assets by way of a sale.

5§ 930 BGB.

6Arg. §§ 1205, 1206 BGB.

7To create a pledge over a receivable, the Civil Code requires that the third party debtor is notified of the pledge (§ 1280 BGB), whereas an absolute assignment of receivables is valid without notice to the debtor (§ 398 BGB). The debtor is protected not by a notice requirement as precondition for the validity of the transfer, but by rules stipulating that the debtor does not have to pay twice if he paid to the original creditor because he was not aware of the assignment (§ 407 sec. 1 BGB).

In rem, as far the title is concerned, his position is not restricted. Contractually, however, the secured creditor is bound to use his rights in the assets exclusively for purposes of securing the relevant loan or other form of credit. Security thus created is called fiduciary security, because the secured creditor is holding more rights or better rights – full title – than he needs for the purposes the parties want to achieve with their transaction. The secured creditor holds the excess rights on trust („Treuhand”) for the borrower granting the security.8

The questions for the courts of course was whether the use of rules on absolute transfer to create a security right was to be considered a circumvention on the mandatory rules on pledges. Surprisingly, perhaps, the German Imperial Court (“Reichsgericht”), the predecessor of the Federal Supreme Court (“Bundesgerichtshof”), ruled that this practise was permissible.9 “Secret liens”, security rights without any external signs like transfer of possession, markings or labels, registration or other devices to notify or alert the public, were thus accepted.

In spite of the “clean title subject only to contractual restrictions” doctrine, insolvency law recognised that assignment and transfer of title for security are essentially security devices and economically quite different from clean title in other circumstances. In the insolvency of the debtor, these security rights therefore do usually not entitle the secured creditor to demand delivery of the collateral, but only to preferential satisfaction out of the proceeds of the collateral.10

b)Core Characteristics

The German law on secured transactions is in large part the result of the creative imagination of lawyers using concepts under the Civil Code originally meant for other purposes and the efforts of courts to control the process. It is therefore patchy, non-uniform and inconsistent. For different types of assets, different security devices are used. Security can only be granted strictly on an asset-by-asset basis, and very often the effectiveness of an agreement creating security will depend on how specifically the encumbered assets were described and how well the draftsperson envisaged possible later changes in the identifying factual circumstances. In spite of these flaws, German law makes it possible to create security over almost any type of asset, present and future, fixed or floating, and to secure all kinds of obligations. It is also not relevant

8 Reinicke/Tiedtke, Kreditsicherung (5th edn. 2006), p. 624.

9 RG 11 March 1904, RGZ 57, 175, at 177; RG 8 November 1904, RGZ 59, 146, at

147.

10 §§ 50, 51 Nr. 1 InsO.

whether creditor or debtor are regulated financial institutions,11 corporations or individuals. There are also no limitations to grant security for pre-existing debt. Security may be created simply by agreement between the parties; and with few exceptions, no form requirements apply. Usually, security rights will be created by way of written agreement; however, there is no such legal requirement and there are cases where the secured party indeed relied on an oral contract or at least on something short of a contract in writing.12

Again with very few exceptions,13 German security interests in personal property are privy to the parties who created them, and are not registered or otherwise notified to the public. The absence of any public debate or political lobbying in this respect suggests that German creditors in general and the banking industry in particular are happy with this system of unpublicised security interests. Discussions about registries for security interests arise only in the context of international unification of the law on secured transactions, never for the domestic system. German banks rely on representations of their prospective borrowers about encumbrances over their various assets instead of registries. Of course, a potential borrower may lie – but not everybody lies. In many circumstances lying will not work without the support of forged accounts, a threshold that is not easily crossed. Apparently German banks find that it is not worth the effort to establish, operate and use a registry to prevent damages that might be inflicted by the occasional crook. A different important group of creditors, the financing sellers, are protected against any adverse effects of prior existing security arrangements anyway, so this group also has no strong incentive to push for the introduction of a security registry.

There is generally no right to trace proceeds from collateral that is sold, destroyed, commingled or lost due to processing.14 (A limited exception applies, in an insolvency, with respect to the receivable resulting from an unauthorised sale of goods held subject to a retention of title

11Under the avoidance rules in § 130 InsO, there is a privilege for certain financial security interests (margin security) granted in favour of financial institutions (“Finanzsicherheiten”), § 130 InsO, § 1 sec. 17 KWG. But this provision is a rare exception from the general rule that the status of debtor or creditor are irrelvant.

12BGH 5 January 1966, BB 1966, 140 (acceptance of bank not in writing, but implied from disbursement of loan); OLG Oldenburg 19 October 2004, DAR 2005, 90 (car dealer kept title document until complete payment, evidence for oral retention of title agreement); BGH 10 October 1956, NJW 1956, 1918 (parties did not include identification of the collateral in the written contract; identification was done orally or even implied in the circumstances).

13On registered security interests in vessels and aircraft, see para. 9 infra.

14Lwowski, Recht der Kreditsicherung (8th edn. 2000), p. 88.

arrangement.)15 Depending on the circumstances and in particular the form potential proceeds may take, the absence of a general right to proceeds can be addressed in the security agreement ab initio by creating security directly over future proceeds. Receivables from a future sale of the collateral, be it authorised or unauthorised, may be subjected to an assignment for security,16 or the parties may agree that in case that processing the collateral raw materials will result in the creation of new goods, the seller rather than the buyer shall be considered manufacturer and therefore the one who acquires title17 by processing.18 Cash proceeds, on the other hand, are much more difficult to encumber. This can usually only be achieved by creating security over the bank accounts in which cash proceeds might be paid into, an option realistically only available to banks who take security over all assets of the borrower, but hardy feasible for a financing seller who is concerned about the proceeds of a machine he delivered.

German security law allows the creation of security over future assets, as long as they can be sufficiently described to meet the applicable tests. Security rights in future assets are generally effective in insolvency, subject only to the insolvency administrator’s power of avoidance if the security was created within the applicable time frames before insolvency proceedings were started.19

15If the debtor or the insolvency administrator has sold to a bona fide purchaser an asset which does not belong to the insolvency estate (§ 47 InsO) without authorisation to do so, the party thus losing its asset has a right to the receivable owed by the buyer (§ 48 InsO). If the buyer has paid the purchase price, the original owner of the asset may claim the cash proceeds as long as they can be identified in the insolvency estate. However, collateral does usually belong to the insolvency estate and, thus, does not qualify under § 47 InsO. Only assets subject to a retention of title arrangement and leased assets fall under § 47 InsO, so their owners benefit from the tracing rules of § 48 InsO.

16So-called “prolonged retention of title” (“verlängerter Eigentumsvorbehalt”). See

Reinicke/Tiedtke, Kreditsicherung (5th edn. 2006), p. 318 et seq.

17§ 950 BGB.

18“Processing clause” (“Verarbeitungsklausel”). See Reinicke/Tiedtke, Kreditsicherung (5th edn. 2006), p. 317 et seq.

19§§ 129 et seq. InsO. For a discussion of the right of avoidance with respect to revolving security rights and a decision by the OLG Karlsruhe 8 April 2005, ZIP 2005, 1248, which seems to extend this right, see Kuder, Das Ende der Globalzession?, ZinsO 2006, 1065. If the Federal Supreme Court follows the rationale of this decision, many security interests over receivables created or goods acquired within the last three months before insolvency may become voidable.

2.Security devices denominated as such

a)Possessory devices

The traditional security device for movable tangible assets (and rights) is the pledge (“Pfandrecht”), governed by §§ 1204 et seq. BGB. The creation of a pledge over a tangible asset requires transfer of actual possession to the pledgee. Pledges are still often used to take security over certain rights (securities not evidenced by a certificate, most importantly shares in limited liability companies (“Gesellschaft mit beschränkter Haftung (GmbH)”), IP rights, bank accounts), over certificated securities and – in humbler circumstances – at pawn shops, but have otherwise been replaced in practise by the non-possessory transfer of title.

After the pledgor has defaulted on the secured claim and the pledgee has become entitled to enforce the pledge, the parties may agree on any enforcement mechanism they like; agreements concerning enforcement made prior to default are invalid.20 If the parties cannot agree after default on how the pledge is to be enforced, the asset must be liquidated by way of public auction. “Public” auction means an auction not only open to the general public, but conducted by a court clerk or a notary public.21 This cumbersome enforcement mechanism added to the unpopularity of pledges.

b)Non-possessory devices

Other than the registered security interests in vessels, aircraft and – under certain circumstances – farming equipment discussed later in the report, there are no non-possessory security rights which are not title-based.

3.Title-based security devices

The Civil Code provides for a rudimentary provision22 on retention of title as a non-possessory security interest of unpaid sellers. No form

20An exception applies for commercial pledges were both parties are entrepreneurs and the assets are listed or otherwise have an established market price: under these circumstances, an agreement between the parties on the mode of enforcement may be made prior to default, § 1259 BGB.

21Münchener Kommentar zum Bürgerlichen Gesetzbuch (MünchKommBGB)/Wenzel,

Vol. 2 (5th edn. 2007), § 383 n. 6. The German States may authorise additional categories of persons to conduct public auctions.

22§ 449 BGB.

requirements apply. Inside and outside of insolvency, the seller may reclaim the sold goods as a remedy for the buyer’s default on the payment of the purchase price.

Although not expressly mentioned in the Civil Code, the reality of secured transactions is dominated by Sicherungsübereignungen – transfer of title for security purposes. Title may be transferred without any change in actual possession and is not otherwise made public. No form requirements apply. Sicherungsübereignung allows the parties to agree on their preferred enforcement mechanism outside of insolvency proceedings and gives the secured creditor a preferential right to the liquidation proceeds in the insolvency of the debtor.

4.Existing registries

Registries exist only for security interests in vessels, aircraft, offshore cables, and (under certain circumstances and with very little practical relevance) for security interests in farming equipment.

5.Issues beyond the scope of this survey

German law on security interests seems quite liberal and generally rather lender friendly, as taking security seems easy, cheap, and confidential; almost all possible obligations may be secured and almost any asset may be used as collateral. When lending to a group of companies, supplying debt capital for a corporate acquisition or setting up security structures for a capital markets transaction, the picture becomes less favourable. Inter alia German corporate law with its strict capital maintenance provisions and financial assistance rules and the threat of subordination for lenders deemed quasi-shareholders severely limits the possibility to take security at all or security which actually has material economic benefits. Quirks like the Akzessorietät of pledges – the rule that pledges are irresolvably tied to the obligation they secure – makes structuring a secured transaction more complex, in particular where the collateral package is multi-national and German assets form only a part of the collateral. Some of these issues are sketched in an Annex to this survey.

II.Case studies

General remarks on all case studies

a)Status of parties

In none of the case studies is the status of debtor or creditor as corporation, sole proprietorship or regulated financial institution relevant to the applicable rules or the outcome of the case.

b)Registration

There are no registries for the entry of security rights or other property rights in Germany, with the exception of registries for land and land charges and for certain assets listed and described below in para. 9. (“Special Property Registries”) of the report.

c)Super-priority

There are no super-priorities or super-privileges overriding the security interests in the cases discussed below. Even statutory liens for repairs or upkeep of the collateral23 or landlords’ liens24 will not impair the rights of the lender, because these liens only attach if the respective object belongs to the person who became party to the contract for the repair or the lease. In case of a retention of title or a security transfer of title, it is the secured lender who holds title to the object, not the holder of the object who entered into the contract for its repair. As there is no bona fide acquisition of these liens,25 the repairman remains unprotected and the secured creditor enjoys unrestricted rights to the collateral.

Even though not really a super-priority, the Insolvency Code provides that unsecured creditors have a – very limited – share in the benefits of collateral that is realised and liquidated by the insolvency administrator. The code provides that the insolvency administrator will deduct 9% of the proceeds as a lump-sum compensation for his efforts to realise the collateral.26 If the secured creditor can show that actual costs of realisation were less than 9% of the proceeds, the compensation may be re-

23“Werkunternehmerpfandrecht”, § 647 BGB.

24“Vermieterpfandrecht”, § 562 BGB.

25BGH 21 December 1960, BGHZ 34, 125; BGH 21 December 1960, BGHZ 34, 153 et seq.

26§§ 170, 171 InsO.

duced.27 The deducted amount goes to the estate for distribution among all creditors.

1.Non-possessory security right in specific existing items of equipment

a)Documentation and formalities to achieve effectiveness against grantor and against third parties

Security rights in the equipment may be created by a Sicherungsübereignung, a transfer of title for security. A transfer of title for security is created by a simple agreement between Manufacturer and Lender. No requirements as to form apply; even an oral agreement is sufficient.28

The Civil Code allows a transfer of title without a transfer of actual possession.29 The parties may agree that title shall pass to Lender and Manufacturer shall hold the assets on behalf of Lender. The security right becomes effective against third parties at the time when the agreement is entered into. No specific requirements apply to fix the time of perfection or to discourage fraudulent pre-dating.

The agreement has to specifically identify the assets it refers to. The identification has to meet certain standards. The assets must be identified in a way that enables anyone aware of the agreement to determine which individual assets are affected, without reference to documents or other sources outside the agreement.30 A clause like “50 machines” would not work, because Manufacturer owns 200 machines and you could not tell which machines out of the 200 were meant by the clause. An agreement like “all machines not subject to a retention of title clause” would also not meet the test, because, in addition to the agreement, you would have to check the books of Manufacturer to find out which of the machines were delivered under a retention of title clause and which ones not. To

27§ 171 sec. 2 sentence 2 InsO.

28MünchKommBGB/Oechsler, Vol. 6 (4th edn. 2004), Anh. §§ 929-936 n. 25.

29§ 930 BGB.

30BGH 3 July 2000, NJW 2000, 2898; BGH 31 January 1979, BGHZ 73, 253, at 254; BGH 24 June 1958, BGHZ 28, 16, at 19; BGH 13 June 1956, BGHZ 21, 52, at 55;

Reinicke/Tiedtke, Kreditsicherung, (5th edn. 2006), p. 218 et seq.; MünchKommBGB/

Oechsler, Vol. 6 (4th edn. 2004), Anh. §§ 929-936 n. 5 (with further references). For cases where the description was held to be insufficient, see BGH 19 September 1994, NJW-RR 1994, 1537, at 1538; BGH 18 April 1991, NJW 1991, 2144; BGH 3 Dezember 1987, DNotZ 1988, 366 = NJW-RR 1988, 565; BGH 21 November 1983, NJW 1984, 103; OLG Frankfurt 21 June 1994, ZIP 1994, 1438, at 1439; OLG Düsseldorf 10 June 1992, OLGR Düsseldorf 1993, 125.

create a security interest in the machines of Manufacturer, the parties may add a list with descriptions and serial numbers to the agreement, or may describe the machines as “all machines currently on the premises of Manufacturer”.31 There is no gold standard for proper identification; methods of identification strongly depend on the facts in each case.

The identification has to be specific at the time the agreement is entered into.32 Later confusion, on the other hand, does not affect the validity:33 if Manufacturer should later acquire more machines also located on the premises and identification becomes difficult, this does not render the security interest in the original 200 machines invalid, even though it makes it harder for Lender to prove its security interest in the original machines.

b)Discoverability of earlier-created rights in the collateral

Except for the specialised registries for certain assets (see below para. 9) German law does not provide for any mechanism to obtain reliable information whether movable assets have already been encumbered. Lenders rely on representations of their borrowers, request statements by banks (for reasons of banking confidentiality, subject to permission by the prospective borrower) or other lenders known to be extending credit to the borrower or ask to see evidence that the purchase price for the assets has been paid and any retention of title arrangement in respect of the assets has expired. These business measures may lead to greater confidence in the value of the security, but do not create certainty in a legal sense.

An exception applies for charges on immovables (“Grundschulden” or “Hypotheken”): charges on immovables may extend to goods located on the property34 and those charges will usually take priority over later transfers of title to those goods for security. Such charges are reflected in the land register. Interested parties may obtain an excerpt.

If there is indeed a retention of title arrangement or a prior in time transfer of title for security in favour of another creditor, the security transfer by Manufacturer to the Lender will not be effective. Even if the Lender does not know about the earlier rights, it will usually not acquire any rights by way of a bona fide acquisition. The rules on bona fide acquisition require that the person trying to grant the rights delivers the

31BGH 18 April 1991, NJW 1991, 2144, at 2146 (“Raumsicherungsübereignung”).

32Reinicke/Tiedtke, Kreditsicherung (5th edn. 2006), p. 642.

33BGH 31 January 1979, BGHZ 73, 253.

34§ 1120 BGB.

goods to the bona fide purchaser.35 This will usually not happen in a security transfer of title situation. However, if the tangibles have been previously encumbered, it is possible presently to create a security interest that will automatically take effect later, once these prior interests have terminated.

c)Rights of secured creditor upon sale

aa) Rights in the sold collateral

Title to the machines has passed to Lender (if only for security purposes) and Manufacturer is no longer the owner. Manufacturer therefore does not have the power to transfer title to the machines to any buyer. However, a buyer may still acquire title by effect of law as a bona fide purchaser, usually under § 932 sec. 1 BGB. If the buyer does not know that the seller is not the owner of the respective asset, and his ignorance is not due to gross negligence, the buyer acquires title to the asset. Bona fide acquisition, however, generally requires delivery the object to the bona fide purchaser.36 If Manufacturer sells machines to a third party, the third party will only become the owner of the assets when they are delivered to him.

bb) Rights in the proceeds of the sold collateral

The transfer of title in itself does not give Lender any right to the proceeds of a sale. It is possible to create a security interest over proceeds, if Lender thinks ahead and enters into a sufficient agreement with Manufacturer. The parties may create a pledge over all bank accounts of Manufacturer, in case proceeds end up in a bank account, or could enter into an assignment for security over any receivables resulting from any – prohibited – sale of the machines. The effectiveness of these devices in capturing the proceeds will depend on whether they are the right type of agreement with the right description of the assets for the form the proceeds do in fact take.

35§§ 932, 933 BGB.

36§§ 932, 933 BGB.

d)Rights of secured creditor in replacement collateral (real subrogation)

If the agreement provides for a transfer of title in the current machines only, it does not automatically extend to any replacement machines. However, security interests under security transfer agreements are creatures of contract and can be tailored to the purposes of the parties. It is possible to extend the transfer of title to machines acquired later as replacement of the original machines, if the agreement says so. The description of the new assets has to be sufficiently specific. If Manufacturer and Lender use a clause like “all present and future machines of Manufacturer”, any replacement machines will be covered. This clause, however, will also cover additional machines in excess of the original 200 and may therefore not reflect the commercial deal between Manufacturer and Lender. A clause “200 machines listed in Annex 1 and any machine acquired as a replacement” may be ineffective, because an observer may not be able to determine which new machines are replacements and which are not. The parties may resort to an undertaking by Manufacturer to submit specific information to Lender when he acquires replacement machines. However, if the Manufactures fails to meet this obligation and does not provide the required information, no security interest attaches.

e)Remedies upon default

Lender may enforce its rights under the transfer of title for security when the secured claims fall due.37 The enforcement mechanism is usually set out in the agreement between the parties.38 It usually provides for enforcement by private sale after a deadline of several days has expired and Manufacturer has not satisfied the secured obligation. Notice requirements and notice periods are subject to party agreement. Clauses providing, however, that no notice shall be required for enforcement are not effective.39 When realising the collateral, Lender has to reasonably and

37MünchKommBGB/Oechsler, Vol. 6 (4th edn. 2004), Anh. §§ 929-936 n. 48.

38BGH 9 July 1953, BGHZ 10, 228; MünchKommBGB/Oechsler, Vol. 6 (4th edn. 2004), Anh. §§ 929-936 n. 49.

39MünchKommBGB/Oechsler, Vol. 6 (4th edn. 2004), Anh. § 929-936 n. 50; Palandt/

Bassenge (66th edn. 2007), § 930 BGB n. 30; reasonable notice required in BGH 7 July 1992, NJW 1992, 2626, at 2627 (case on security assignment of receivables); question left open in case on Sicherungsübereignung BGH 13 January 1994, NJW 1994, 864, at 866.

adequately protect the interest of Manufacturer.40 A sale at dumping price may trigger liability for damages caused to the debtor as well as to competing creditors who have an economic interest in the proceeds of the collateral.41 If the security agreement does not explicitly specify how the security interests may be realised, courts will look to whether implied agreements on realisation can be found in the contract. The rules on enforcement of pledges in the Civil Code may be deemed as impliedly agreed to by the parties if they are in line with modern business practises.42 The fundamental enforcement rule for pledges43 – sale by public auction – no longer corresponds to business practise and will therefore usually not be assumed to be the parties’ implicit choice of enforcement mechanism.44

Lender may request that the encumbered items be handed over for realisation. If Manufacturer does not do so voluntarily, Lender must go to court and sue Manufacturer for delivery. Repossession by force is illegal and would entitle Manufacturer to use force to defend against it.

If Manufacturer cooperates with the sale, enforcement is quick and costs moderate. Enforcement costs have to be borne by Manufacturer.45 If the parties included the reimbursement claim for enforcement costs in the secured obligations clause of the security agreement, Lender may deduct his enforcement costs from the proceeds of the realisation. The procedure need not take longer than several days to a few weeks. Depending on the nature of the collateral, Lender may want to obtain an accountant’s opinion on the value of the goods, in order to be protected against the charge of having made a sale under value and Lender may incur internal costs to organise the sale. Other than that, there are no enforcement costs.

If Manufacturer does not cooperate, Lender has to sue for delivery of the machines. (A judgement on the obligation is not required.) Depending on the workload of the local court, it may take several months up to over a year to obtain a first instance judgement. Court and attorneys’ fees depend on the value of the machines. If Lender wins, he may claim these costs from Manufacturer under the general rules for the distribution of court costs and lawyers fees in civil cases.46

40BGH 1 March 1962, WM 1962, 673, at 674; BGH 9 January 1997, WM 1997, 432, at 433; BGH 5 October 1999, NJW 2000, 352, at 353; MünchKommBGB/Oechsler, Vol. 6 (4th edn. 2004), Anh. §§ 929-936 n. 49.

41MünchKommBGB/Oechsler, Vol. 6 (4th edn. 2004), Anh § 929-936 n. 49.

42Reinicke/Tiedke, Kreditsicherung (5th edn. 2006), p. 716.

43§ 1235 BGB.

44Reinicke/Tiedke, Kreditsicherung (5th edn. 2006), p. 716.

45BGH 24 January 1962, WM 1962, 393; Lwowski, Recht der Kreditsicherung (8th edn. 2000), p. 259.

46§ 91 ZPO.

Proceeds of the sale will be applied to the secured claim. Depending on the definition of “secured claims” in the security agreement, enforcement costs may also be recouped from the proceeds of enforcement of the security interest. Surplus, if any, has to be paid out to Manufacturer.

f)Insolvency of the grantor

In case of insolvency proceedings, the insolvency administrator will liquidate all assets on behalf of all creditors. Proceeds from the sale of the Machines will be paid out to Lender, subject to a fee of 9 %47 which goes to the bankrupt’s estate48 for distribution among all creditors. If the proceeds exceed the secured claims, any surplus will also go to the estate; if the proceeds are insufficient to discharge the secured claim, Lender will be treated like an unsecured creditor for the remaining claim.49

g)Motor vehicles collateral

No differences apply, with one practical exception: for each motor vehicle, there is a title document (“Fahrzeugbrief”).50 This Brief is not essential for a transfer of title, but nonetheless serves as evidence of ownership. In case of a transfer of title for security over motor vehicles, lenders will request that the title documents are handed over (usually, however, lenders will not have their name entered into the Brief). Should the borrower attempt to sell the vehicle to a third party without authorisation, bona fide acquisition will almost certainly fail, because the purchase will not be considered to be acting in good faith if he has not asked to see the title document. So, with motor vehicles, protection against unauthorised sales of the encumbered assets is somewhat more effective than with assets of a different kind.

2.Non-possessory security right in present and after-acquired equipment (floating security right)

A transfer of title for security can easily be expanded to cover afteracquired property. The practical difficulty usually lies in providing a

47§§ 170, 171 InsO.

48§ 170 sec. 1 sentence 1 InsO.

49§ 52 InsO.

50 For relevance of the title document, see Bülow, Recht der Kreditsicherheiten (7th edn. 2007), n. 1357.

legally sufficient description of the future assets. In this case, however, a simple clause like “all present and future machines” is sufficient.

3.Non-possessory security right in present and after-acquired inventory (floating security right)

Whether collateral is classified as equipment or as inventory is irrelevant to the analysis under German law. Both types can be subjected to a transfer of title for security. In case the secured lender is willing to allow the borrower to sell collateral – inevitable for inventory as collateral, but also not unusual for depreciated or obsolete equipment – the agreement may authorise the borrower to freely dispose of the collateral. It is not required that the secured lender exercises any kind of control over the collateral. Usually, such an authorisation to dispose is combined with the creation of a security interest (“Sicherungsabtretung”) in the receivables resulting from the disposal. Unless the parties have agreed upon a security interest in the receivables, the secured lender does not have rights in the proceeds of the original collateral.

The parties are also free to determine the obligations secured by the transfer of title. It does not make a difference whether the loan is a term loan or a revolving credit line, as long as the agreement makes it clear which obligations – present and future – are secured.

4.Purchase-money (asset-acquisition) financing – alternative sources

a)General remarks

All three asset financing options addressed in the case studies are viable under German law. First, if the seller is willing to finance the purchase price, he will retain title to the machine until the purchase price is paid (“Eigentumsvorbehalt”). Second, under a lease arrangement, the lessor will usually acquire the machine from its manufacturer or from a different source and will thus become the owner of the machine with unrestricted title. It will then lease the machine to Manufacturer as lessee, who in turn will pay the agreed leasing rates. Manufacturers’ rights to the machines under the lease will be purely contractual; the position of the lessor as owner and holder of unrestricted title is no affected by the lease agreement. Third, if a third party lender is willing to finance the acquisition of the machines by lending the purchase price to Manufacturer, the loan may be secured by a transfer of title for security (“Sicherungsübereignung”) in the machine.

No special rules exist regarding the formalities of creation or perfection of these arrangements. Simple agreements between the parties suffice; agreements in writing are standard, but not required by law.

In the insolvency of Manufacturer, a title-retaining seller and a lessor may – unless the insolvency administrator decides to fulfil the respective contracts and meets the resulting payment obligations51 – request that the insolvency administrator deliver the machine to them.52 A third party lender who financed the acquisition of a machine and holds title for security to it usually has a right to the proceeds resulting from the insolvency administrators’ liquidation of the machine, subject only to the 9% deduction mentioned earlier as liquidated compensation for enforcement costs.53

Due to their structure, the first two arrangements, retention of title and leasing, give the secured creditor or lessor priority over all other creditors of Manufacturer, even if Manufacturer should have entered into an agreement with a different creditor transferring title of all his present and future machines to him prior to the purchase of the machine in question. Under these arrangements, prior-in-time security interests have no chance to attach, because Manufacturer does not acquire title to the machine until the credited purchase price is paid or – if at all – the term of the lease has expired. Without title, Manufacturer is not able to grant security over the machine to a different creditor whose claims to the machine or its liquidation proceeds may compete with the claims of the party financing the acquisition.54

Even though title-retaining sellers and lessors are protected against adverse effects of prior transfer of title agreements, German law does not embrace a general concept of super-priority for a creditor who finances the acquisition of an asset: under the third option, financing by a third party lender, where Manufacturer will acquire title to the purchased machine and transfers it by way of security to the third party creditor, it is possible that the acquired machine is caught by a pre-existing transfer of title arrangement with a different creditor: if Manufacturer has entered into an agreement under which he transfers title to all his present and future machines to Bank A, and later signed an agreement transferring

51§ 103 InsO.

52§ 47 InsO. For leasing, see BGH 27 February 1995, BGHZ 94, 44, at 49; MünchKomm/Habersack, Vol. 3 (4th edn. 2004), Leasing, n. 136.

53§§ 50, 51 InsO.

54As mentioned supra, bona fide acquisition of title (including title for security) is possible under German law, but requires transfer of actual possession to the bona fide purchaser (see § 930 BGB). With a transfer for security, the borrower will almost inevitably remain in possession of the collateral and thus, a bona fide acquisition will almost certainly fail.

title to Bank B as security for the financing provided for the acquisition of a new machine, title to the machine will pass to Bank A rather than Bank B the moment Manufacturer acquires the machine. Bank B will remain unsecured. In this situation, an honest borrower will ask Bank A for a release of the machine the acquisition of which Bank B is willing to finance. Should the request be denied, Manufacturer will have to inform Bank B that he is not able to grant effective security over the machine to be acquired.

Apparently, German law shows a certain preference for the financing seller or lessor compared to a third party financing the acquisition of an asset. In insolvency, a financing seller (or lessor) may ask for delivery of the goods rather than for preferential satisfaction out of the liquidation proceeds, and he is protected against the effect of a pre-existing transfer of title agreement a buyer may have in place which may take priority over a third party financing seller. At first glance, the reason for this preference lies in the dogmatic structure of the different security devices available to sellers and third-party financiers. Functionally, the difference is more difficult to justify. I believe there are good reasons to argue that a creditor who financed the acquisition of an asset should be no better or no worse off than a creditor who, for example, provided working capital to cover running expenses and thus enabling the borrower to pay for new machines out of its cash flow.55 The position under the UCC, for instance, is the direct opposite. All purchase money financing is privileged and gives the financier a security interest which takes priority over all pre-existing security rights in the purchased good.

The difficulty of a concept, it seems to me, where all purchase money financing is (equally) privileged lies in the necessity to determine if a loan extended to a borrower was indeed used for the acquisition of an asset. 56 This requirement triggers all kinds of difficult questions: loans are usually disbursed by crediting the loan amount to a bank account and typically all kinds of payments are made out of these accounts. Does it matter if the borrowers’ account went into overdraft between disbursement of the loan and the acquisition of the collateral? Plans about an intended purchase discussed with and approved by the financier might be changed and may lead to an acquisition of a machine that is not quite of the same type, brand, price or making that was originally

55Rakob, Ausländische Mobiliarsicherungsrechte im Inland (2001), p. 269-272; see also Grunsky, Sicherungsübereignung, Sicherungsabtretung und Eigentumsvorbehalt in der Zwangsvollstreckung und im Konkurs des Schuldners, JuS 1984, 497, at 503.

56Compare UCC §§ 9-107 (b) “if such value is in fact so used”. For a discussion of the concept, see White/Summers, Uniform Commercial Code, Practitioner Treatise Series, Vol. 4 (4th edn. 1995), §§ 33-5.

agreed upon. And what if the borrower buys something completely different with the funds? Original financing may be repaid and replaced by a new loan. Can this still be secured with a privileged PMSI, even though if obviously did not enable the buyer to make the purchase? The line seems hard to draw, distinctions sometimes arbitrary, and in cases that are less then clear cut, the justification for the PMSI privilege over other creditors becomes blurred and far less obvious.

Considering the practical difficulties the universal PMSI privilege model inevitably runs into, German law may be understood as embracing a concept of purchase money privilege in clear cut cases only. In retention of title and leasing cases, there is no real question whether the seller or lessor financed the acquisition of a certain machine or involuntarily ended up financing something else.

b)Asset acquisition financing from seller: retention of title

aa) Basic structure

If the acquisition of an asset is financed by the seller – usually by crediting the purchase price – the seller will retain title to the respective asset. If Manufacturer defaults, the financing seller may terminate the sale contract57 and demand that the machine subject to the retention of title arrangement be returned to him. If Manufacturer does not do so voluntarily, the seller must go to court and sue Manufacturer for delivery. Repossession by force is illegal and would entitle Manufacturer to use force to defend it.

Once insolvency proceedings have commenced, the position of a seller relying on a retention of title arrangement is somewhat stronger than that of a lender secured by a transfer of title for security.58 The insolvency administrator has the right to chose whether to fulfil the contract or terminate it. If he chooses to keep the contract alive, he has to pay the purchase price and no question of enforcement of the retention of title arises. If the administrator chooses not to fulfil the sales contract (and consequently does not pay the agreed purchase price),59 the unpaid seller may request that the sold goods are returned to him.60 Title based on a retention of title arrangement is treated as “real title” under insolvency law and the seller may reclaim the sold goods just like someone who has

57§ 323 sec. 1 or § 324 BGB.

58See Reinicke/Tiedke, Kreditsicherung (5th edn. 2006), p. 296.

59§ 103 InsO.

60§ 47 InsO; BGH 21 November 1991, BGHZ 116, 156, at 158; Münchner Kommentar zur Insolvenzordnung (MünchKommInsO)/Ganter, Vol. 1 (2001), § 47 n. 72.

accidentally parked his car on the premises of the insolvent debtor. This difference between Eigentumsvorbehalt and other security devices shows that in the intrinsic logic of German civil and insolvency law, Eigentumsvorbehalt is essentially not a right which secures the payment of the purchase price – rather, it secures the unpaid seller’s right for a return of the sold goods if the buyer does not meet its payment obligations under the sale contract.61 In addition to his right to demand return of the sold asset, the seller may also ask for damages62 as compensation for the buyer’s breach of contract – including damages for wear and tear of the sold asset, and lost profits. The buyer (or the insolvency administrator on his behalf) may demand repayment of the instalments of the purchase price,63 if any. The buyer’s and seller’s claims for repayment of damages are included in a calculation of the parties’ rights and obligations against each other.64 Only the holder of a positive balance may ask for payment from the other party. This means that the buyer may only ask for repayment of its partial payments if this claim is higher than the claim for damages the seller may assert against the buyer.65

There is very little case law on the issue of calculation of damages in title retention cases, and legal scholars have equally shown little interest.

61 Reinicke/Tiedtke, Kreditsicherung (5th edn. 2006), p. 289. Under German law, the scenario without Eigentumsvorbehalt looks like this: if the buyer does not pay the purchase price as agreed, the seller may terminate the sale contract under § 323 sec. 1 or § 324 BGB. Consequently, the claim for the purchase price lapses and the right of the buyer to the sold asset lapses as well. The seller may therefore demand that the buyer returns the asset to him. In the buyers’ insolvency, this claim for the return of the sold asset is treated like any other claim for the delivery of goods – converted into a payment claim and satisfied with the respective quota. If there is an Eigentumsvorbehalt, the insolvency code allows the seller to claim the sold asset. The downside to this treatment of the Eigentumsvorbehalt as “real title” is the effect on the sale contract: other than with a genuine security interest securing a payment claim, the unpaid seller may only ask for the return of the sold goods if he terminates the sale contract. He must therefore choose if he wants to hold on to the contract and demand payment of the purchase price or to terminate the contract and ask for return of the goods. The concept underlying the Eigentumsvorbehalt under German law is therefore quite different from other security devices; in essence it is not a security for credit extended, but for the right of the seller to have his goods returned to him.

62MünchKommInsO/Ganter, Vol. 1 (2001), § 47 n. 72.

63BGH 5 May 1977, BGHZ 68, 379, at 381.

64MünchKommInsO/Ganter, Vol. 1 (2001), § 47 n. 72.

65BGH 5 May 1977, BGHZ 68, 379, at 381.

bb)Competing secured creditors: Security transfer of purchased goods and security assignment of receivables resulting from a sale of the purchased goods

If Manufacturer buys a machine under a standard retention of title agreement, he will only become the owner of the purchased machine when the purchase price is fully paid. If Manufacturer attempts to transfer title to a third party, i.e. fiduciary title for security to a second creditor, the transfer will usually fail: Manufacturer may not transfer title if he does not hold title himself, and a bona fide acquisition would require a transfer of direct possession which in case of a security transfer will usually not take place.

German courts and legal doctrine have long accepted, however, that even before full payment, the buyer holds a right in nature, but not in effect similar to full ownership: an expectancy right (“Anwartschaftsrecht”), which allows to create limited security over the purchased asset in favour of a second creditor. The test whether the chance to acquire a property right has become concrete enough to be deemed an Anwartschaftsrecht is usually whether, in a multi-step acquisition process, so many steps have been completed that the transferor can no longer stop the acquisition of the right unilaterally.66 In case of retention of title agreement this is usually the case: the buyer will acquire title when he makes the final payment, and as long as the buyer does not default on its obligations, there is no way the seller could prevent this.

It is widely accepted that a buyer under a retention of title scheme may transfer its expectancy right just like full title. The expectancy right may be used as collateral and subjected to a transfer of title for security67 to a second creditor. In practise, standard security transfer agreements will contain such a clause as a fallback provision and provide that in case the transferor does not hold full title, the transfer under the agreement shall extend to any expectancy rights the transferor might have.

If Manufacturer pays the last instalment, the expectancy right in the hands of the second creditor will grow into full ownership. The second creditor will then hold ordinary fiduciary title (“Sicherungseigentum”), which will be treated according to the general rules. If, on the other hand, Manufacturer defaults on his payments to the seller, the seller may terminate the sale and demand return of the machine. In this case, the expectancy right terminates and the second creditor loses its security right. The second creditor has no right against the seller for a turnover of

66BGH 5 January 1955, NJW 1955, 544.

67Leading case BGH 22 February 1956, BGHZ 20, 88 (for further references, see MünchKommBGB/H.P.Westermann, Vol. 3 (4th edn. 2004), § 449 n. 55); MünchKomm BGB/Oechsler, Vol. 6 (4th edn. 2004), Anh. §§ 929-936, n. 20.

proceeds in case the value of the returned machine exceeds the value of the outstanding purchase price or any other right a creditor with a second ranking pledge, for example, may have.

In this latter situation the second creditor may protect his security interest by paying the outstanding purchase price to the seller.68 The expectancy right will then grow into full title in the hands of the second creditor, and he may proceed as any holder of fiduciary title may. Even though the Anwartschaftsrechte doctrine does not allow creating second ranking security interests in the strict sense, the economic effect of the combination of the expectancy right with a second secured creditor’s right to pay the outstanding purchase price is in some respects similar.

If, however, the second creditor would like to enforce its security over the expectancy right while the purchase price is not yet due, there is nothing he can do but wait. His position is not better than the position of the buyer who transferred the expectancy right to him. If the buyer may not cause the retention of title to terminate because he may not yet pay the outstanding purchase price, neither may the second creditor.

The recognition of expectancy rights gives the buyer under a retention of title agreement the option to use the equity value in the purchased goods which has accrued due to the partial payment of the purchase price as collateral. The value of the collateral is restricted, as shown above, and in any conflict of interest of the financing seller and the second creditor, the mechanics ensure that the seller prevails.

The second situation where the interests of financing sellers secured by retention of title arrangements and a financial creditor may clash is the following: Dealer buys goods subject to an extended retention of title arrangement which combines title reservation with an assignment for security of any receivables which may result from a sale of the goods. Earlier, however, Dealer has entered into an assignment for security over all present and future receivables resulting from the sale of goods (a socalled “global” assignment) to secure his general corporate loan from a bank. Under the general rules of priority of German law, one would think that the transfer first in time, i.e. to the bank, is effective, and the second one to Dealer void for lack of anything to transfer. The Federal Supreme Court has come to a different view69 and has stuck to that ever since:70 it found that the bank acted unconscionable when it accepted the global

68Though there is some dispute about the correct rationale, it is accepted that (contrary to the wording of § 267 BGB) the purchaser has no right to oppose such payment by a third party creditor who holds a fiduciary expectancy right. See MünchKommBGB/Krüger, Vol. 2 (5th edn. 2007), § 267 n. 17.

69BGH 30 April 1959, BGHZ 30, 149, at 153.

70For a recent case, see BGH 14 July 2004, WM 2005, 378, at 379. Further references at Reinicke/Tiedtke, Kreditsicherung (5th edn. 2006), p. 953 footnote 170.

security assignment, because it had been aware that its customer would not be able to obtain further deliveries without agreeing to retention of title clauses in their extended form, and thus induced the customer to breach its future contracts with suppliers.71

From a purely rational point of view, the argument may have worked the other way as well – suppliers know that their customers will not receive bank credit without global assignments of receivables and extended retention of title clauses will therefore oblige them to breach their contracts with financing banks – but the Federal Supreme Court did chose to argue in the opposite direction. There are of course a lot of voices who have remained unconvinced by this reasoning. The underlying rationale for the views of the Federal Supreme Court, as many suspect, is probably an implicit preference for the sellers of goods as an industry. Usually smaller in size, very often typical German Mittelstand, courts tend to be more sympathetic with the sellers’ concerns than with banks who are perceived as powerful big business, well able to protect their interests themselves.

c)Asset-acquisition financing by leasing

The second option for asset acquisition financing is leasing.72 Under a system in which security interests are registered or otherwise made public, or which restricts the admissibility of security interests altogether, the distinction between “true” leases and “financial” leases is vital, because the latter qualify as secured transactions and therefore trigger registration requirements or otherwise raise questions of validity. Under German law with its nonchalant acceptance of secret security interests, these issues do not exist. The question whether a certain arrangement qualifies as true lease or financial lease is relevant only for accounting and tax reasons73 or for the question how far the parties’ agreement may deviate from the lease provisions of the civil code or which rules to apply to answer questions the parties have not considered in their agreement. For

71BGH 30 April 1959, BGHZ 30, 149, at 153.

72A lease arrangement will qualify as financial lease if the risk for the amortisation the investment in the leased object is placed on the lessor rather than the lessee (BGH 11 January 1995, NJW 1995, 1019 at 1021; MünchKomm/Habersack, Vol. 3 (4th edn. 2004), Leasing, n. 4). This is deemed to be the case if the leasing payments of the lessor over the agreed time of the lease will amortise the investment of the lessee completely or predominantly. (Ibid.) A different approach looks to the value of the lessor’s claim for the return of the leased item. Zero or close to zero-value is a sign for a financial rather than a true lease.

73MünchKomm/Habersack, Vol. 3 (4th edn. 2004), Leasing, n. 14 et seq.

the issues discussed in this report – rights upon default and in the insolvency of the lessee – the distinction is irrelevant. The rights of a lessee under a financial lease are no different from the rights of a lessee under an arrangement qualified as true lease for accounting and tax purposes.

If Manufacturer fails to meet its obligations under the lease agreement, including a failure to pay the agreed leasing rents, the lessor may terminate the lease agreement and demand delivery of the leased machines. If Manufacturer goes into insolvency, the insolvency administrator may choose whether he wants to continue the lease or terminate it.74 If he opts for continuation, he has to meet all payment and other obligations under the lease agreement.75 Only if he fails to do so may the lessor terminate the lease unilaterally.76 If the lease is terminated, either by choice of the administrator or by termination by the lessor, the right to possession of the lessee terminates and the lessor may reclaim its assets.77 Under insolvency law, title of a lessor (regardless whether the lease is qualified as true of financial lease) is qualified as “real” title, giving the right to reclaim the leasing goods, rather as title for security, which only reserves a preferential right to the proceeds of the collateral.

d)Asset-acquisition credit furnished by a third-party lender: transfer of title for security

The rights of third party lender secured by a transfer of title for security will depend on the agreement between Manufacturer and third party lender in the agreement creating the security right.78 Usually, the agreements will provide for a right to demand delivery of the collateral and a right to conduct a private realisation sale, if Manufacturer defaults on its payments.79 In the insolvency of Manufacturer, the administrator would gather all assets of Manufacturer to liquidate them. Under a transfer of title arrangement, title to the machine has passed to the lender and therefore one might argue that the machine is no longer part of the assets of Manufacturer and should therefore not be subject to an administrator’s right to liquidate, but the insolvency code takes a different view: assets encumbered with a transfer of title or assignment for security are part of the insolvent’s estate and may usually be liquidated by the administra-

74§ 103 InsO; Obermüller, Insolvenzrecht in der Bankpraxis (6th edn. 2002), § 7.15.

75MünchKommBGB/Habersack, Vol. 3 (4th edn. 2004), Leasing, n. 136.

76MünchKommBGB/Habersack, Vol. 3 (4th edn. 2004), Leasing, n. 136.

77§ 47 InsO; BGH 27 February 1985, BGHZ 94, 44, at 49.

78Reinicke/Tiedtke Kreditsicherung (5th edn. 2006), p. 243.

79Reinicke/Tiedtke Kreditsicherung (5th edn. 2006), p. 241.

tor.80 The Lender is merely entitled to preferential satisfaction of its secured claims81 out of the liquidation proceeds of the machine. Thus, the rights and position of the third party lender are in no way enhanced by the fact that it provided acquisition finance which enabled Manufacturer the acquire the asset.

5.Bona fide acquisition

In the case of inventory, the security agreement (either a transfer of title for security or a retention of title agreement) will usually allow the borrower/buyer to sell the goods in the ordinary course of its business (usually combined with the creation of a security interest (“Sicherungsabtretung”) in the resulting receivables).82 Thus, the retailer buying inventory acquires title to the inventory from an authorised seller and the question of a bona fide acquisition does not arise. In the absence of an authorisation to sell – rare with inventory, but standard for security agreements regarding equipment – the borrower/buyer does not have the right to transfer title to a buyer of the respective goods, but the buyer may still acquire title if he meets the requirements for a bona fide acquisition,83 in which case title passes by effect of law. The buyer must have acted in good faith84 and the goods must have been delivered to him. As there are no public registries or other formal notice mechanisms, there is no easy way for the secured lender or title retaining seller to prevent a loss of his rights to a bona fide buyer. Signs or labels on machines or other collateral suitable to be marked this way are an option to make bona fide acquisition much harder (unless, of course, the borrower took them off again), however, even though many security agreements contain a right of the creditor to mark the collateral if he chooses, it is not a standard thing to do.

80§ 166 sec. 1 InsO.

81§ 51 No. 1 InsO.

82“Verlängerter Eigentumsvorbehalt”.

83§§ 932 et seq. BGB

84§ 932 sec. 2 BGB. Under this standard, a buyer or other acquirer is be acting in good faith unless a) he knows that the seller is not the owner of the transferred object, or b) he doesn’t know it, but his ignorance is due to gross negligence.

6.Possessory pledge – constructive or fictitious possession

The traditional pledge usually requires a transfer of actual possession from the pledgor to the pledgee. The Civil Code provides for an exception and allows the transfer of constructive (indirect) possession (“mittelbarer Besitz”), but only when a third party – and not the pledgor – is holding the asset.85 If a third party has actual physical possession of the asset (“unmittelbarer Besitz”, direct possession), and the owner only indirect possession (e.g. when the object is stored with a third party), the owner may create a pledge in the object by transferring such indirect possession to the pledgee.86 This is done by instructing the party in direct possession (e.g. the warehouse) to hold the item now for the pledgee. Usually, however, the parties want to create security over items the borrower wishes to retain in its direct possession. Under these circumstances, there is no accepted way to evade the requirement of a transfer of direct possession to the pledgee. On the other hand, fictitious delivery, i.e., delivery achieved by the mere agreement of the transferor to hold for the transferee, is sufficient to satisfy the delivery requirement for a transfer of title for security.

7.Over-security

German law maintains that taking security in obvious excess of what is accepted as reasonable to ensure satisfaction of the secured claims is unconscionable and thus the security right created is void.87 The concept of over-collateralisation used to be a dangerous pitfall for secured lenders in situations when the secured claims were reduced over time – e.g. in the case of amortised loans – but the value of the collateral remained unchanged. Case law provided that the agreements creating the security right had to take this future development into account and had to contain elaborate clauses giving the borrower the right to reclaim collateral (i.e., obtain the release from the security right) when certain ratios of the realisation value of the collateral and the amount of the secured obligations have been exceeded. The question when this was the case and how the value of collateral should be calculated gave rise to a lot of litigation.88 In the absence of such release clauses, the agreement was consid-

85§ 1205 sec. 2 BGB.

86§ 1205 sec. 2 BGB.

87Reinicke/Tiedtke, Kreditsicherung (5th edn. 2006), p. 732 et seq.

88The question was highly disputed even among different senates of the Federal Supreme Court. For an excellent overview see Reinicke/Tiedtke, Kreditsicherung (5th edn. 2006), p. 737.

ered a violation of public morals (“gute Sitten”) and thus rendered void.89 The courts changed their view and adopted principles which were more lender-friendly: since a leading case of the Federal Supreme Court,90 security agreements are considered to imply a right of the borrower to ask for the release of excessive security. Because this release right is now considered inherent in any security agreement, the lack of an explicit clause dealing with the release of excess security developing over time no longer renders the agreement invalid.91

However, if the realisation value of the collateral exceeds the value of the secured claim already when the security agreement is entered into (initial over-collaterisation, “anfängliche Übersicherung”), the inherent right to obtain the release of excess security does not help: a lender taking excessive security from the outset is still considered to act unconscionably92 – even if the agreement provided an explicit a right to demand release.93 The Federal Supreme Court still maintains that a security agreement violates public morals if the value of the collateral ab initio exceeds the value of the secured claim excessively and therefore exceeds the legitimate interest of the lender in securing its claims.94 There is no bright line indicator establishing when this is the case: The Federal Supreme Court holds that there cannot be a fixed threshold when collateral is to be considered excessive, but that it will consider the factual circumstances of each individual case. There are good reasons95 to look to the threshold suggested by § 237 sec. 1 BGB for guidance. The rule of that provision applies when there is a legal obligation (e.g. procedural) obligation to provide security. The rule suggests that the realisable value of the collateral may – indeed must – exceed the secured claim by 150%. Even though the Federal Supreme Court explicitly refused96 to adopt this threshold as binding, it still gives some guideline what may still be acceptable.

89§ 138 BGB; BGH 12 March 1998, NJW 1998, 2047.

90BGH 14 May 1996, NJW 1996, 2092.

91MünchKommBGB/Armbrüster, Vol. 1 (5th edn. 2006), § 138 n. 100.

92BGH 12 March 1998, NJW 1998, 2047; Reinicke/Tiedtke, Kreditsicherung (5th edn. 2006), p. 732-735.

93BGH 27 November 1997, BGHZ 137, 212, at 223.

94BGH 12 March 1998, NJW 1998, 2047.

95MünchKommBGB/Armbrüster, Vol. 1 (5th edn. 2006), § 138 n. 101.

96BGH 12 March 1998, NJW 1998, 2047.

8.Legal (non-consensual) rights of unpaid seller

Under German law, there are several legal liens protecting landlords, innkeepers, manufacturers, shippers, warehouse keepers and the like, but there is no legal lien or other privilege protecting unpaid sellers.

9.Special property registries

As set out in the general remarks at the beginning, there are no registries for security rights – other than security over real estate – in general. For some categories of assets, however, registries exist which allow the registration of security interests. Such registries exist for aircraft, vessels, offshore cables (“Hochseekabel”)97 and, under certain circumstances, farming equipment.98

a)Vessels

Ships registered in either the German inland navigation vessel registry or in the registry for seagoing vessels and ships under construction may be subjected to a Schiffshypothek,99 a mortgage under the Statute on Rights in Registered Vessels and Vessels under Construction.100

To create a mortgage in a qualifying ship, the mortgage has to be entered into the registry.101 Several pledges in the same vessel are possible; they rank according to the order of registration.102 The pledge in vessels is a strictly accessory security right.103 The secured creditor may not

97However, the relevant act (Kabelpfandgesetz, 31 March 1925, RGBl. I, 37) was revoked in 1995 (Art. 13 Postneuordnungsgesetz, BGBl. I 1994, 2325, at 2396), and thus new registered pledges in offshore cables may no longer be created.

98Pachtkreditgesetz, 9 July 1926, RGBl. I, 399, allows depositing a pledge agreement over farming equipment pledged in connection with a lease of the farm with the local court. Interested parties may request to see the pledge agreement. For an example see BGHZ, 7 October 1970, 54, at 319, but the option is rarely used.

99§ 1 SchRG (Gesetz über Rechte an eingetragenen Schiffen und Schiffsbauwerken,

15 November 1940, RGBl. I, 1499).

100See Baur/Stürner, Sachenrecht (17th edn. 1999), § 14 I.2.

101§ 8 sec. 2, § 3 SchRG. To transfer title in a seagoing vessel, registration is not required (§ 2 SchRG). The rule on the creation of pledges in all vessels points to § 3 SchRG, the provision on transfer of title in barges, which requires registration in order for the transfer to be effective.

102§ 25 sec. 1 SchRG.

103§ 51 SchRG.

enforce the security interest itself, realisation by way of formal foreclosure proceedings is mandatory.104

b)Aircraft

Registered pledges in aircraft are governed by a special statute, the Gesetz über Rechte an Luftfahrzeugen.105 The registry for pledges in aircraft is kept by the local court (“Amtsgericht”) of Braunschweig. The registry is open to the public; anyone can check its content or ask for excerpts.106 The pledge in aircraft is designed after the mortgage in vessels and follows very similar rules. To create a pledge in an aircraft, it has to be entered into the registry.107 The following information is required: identification of the aircraft by reference to the registry for aircraft (“Luftfahrzeugrolle”), nationality, type, registration number of cabin, name and domicile of owner of the aircraft, the name of secured party, identification and amount of the secured claim, interest rate and total amount of additional fees (if any).108 Several pledges in the same aircraft are permissible; they rank according to the order of registration.109 The pledge in aircraft is a strictly accessory security right. The secured creditor may not enforce the security interest himself, realisation by way of formal foreclosure proceedings is mandatory.110 The registered pledge is the only security device available with respect to aircraft listed in the German aircraft registry. The parties may not subject a registered aircraft to a transfer of title for security arrangement or any other security right other than the registered pledge under the LuftFzgG.111

10.Non-possessory security rights in raw materials –

effect of processing (commingling, attachment/accession)

As a financial lease of raw materials would be highly unusual, this paragraph focuses on financing sellers and third party secured creditors.

104§ 47 sec. 1 SchRG.

10526 February 1959, BGBl. I, 57 (LuftFzgG), see Wendt, Dingliche Rechte an Luftfahrzeugen, MDR 1963, 448.

106§ 85 LuftFzgG.

107§ 5 sec. 1 LuftFzgG.

108§ 24 sec. 1 LuftFzgG.

109§ 25 sec. 1 LuftFzgG.

110§ 47 sec. 1 LuftFzgG.

111§ 9 sec. 1 LuftFzgG.

Under German law, combining with other goods,112 commingling113 and processing114 can affect the title to the combined, commingled or processed goods. A secured creditor – either a seller secured by a retention of title arrangement, or a third party creditor secured by a transfer of title for security – may lose its security right under these circumstances.

If raw materials are combined with others so that they are no longer separate objects but part of a single new object, all rights to the raw materials terminate. The rights in the new product of the previous owners of the raw materials depend on the relative value of the materials: if one of the raw materials is considered the “main thing”, and other raw materials only additions to that main thing, the owner of the main material will become the sole owner of the resulting product.115 The other owners will be compensated in money for their loss of title.116 If the raw materials are of substantially equal value, the owners of the vanished raw materials will become co-owners of the resulting product.117 If the owners only held title for security, joint title for security is the result of the combination.

The same principles apply when goods are inseparably commingled.118 If goods are used as raw material in the manufacturing of a new prod-

uct, and the value of the conversion (i.e. the labour applied to effect the conversion) is not significantly lower than the value of the raw products, the owners of the raw products will lose title to their goods and the manufacturer will acquire exclusive title to the new product.119 Again, the previous owners will be compensated in money for their loss of title.120

In Case 10, the outcome would be the same for a financing seller or a financing third party. Depending on the relative value of the combined or commingled raw materials and the value of the work done to convert the material to a new product, a creditor may have exclusive title (for security) to the resulting product, hold title jointly with the previous owner of other raw materials or lose its rights entirely.

Secured creditors will try to prevent a loss of their rights by contractual arrangements. While the application of the processing rules cannot

112§ 947 BGB.

113§ 948 BGB.

114§ 950 BGB.

115§ 947 sec. 2 BGB.

116§ 951 sec. 1 BGB.

117§ 947 sec. 1 BGB.

118§ 948 BGB.

119§ 950 sec. 1 BGB.

120§ 951 sec. 1 BGB.

be excluded by party agreement, courts allow stipulations that the secured seller or third party creditor shall be considered manufacturer (“Herstellerklausel”) of the new product, and therefore title to the new product is vested in the secured creditor.121

11. Cross-border issues

a)General rules

If the item of equipment crosses the border and enters Germany, it comes encumbered with whatever rights have been created at the prior situs.122 So, if goods are subject to a foreign security interest which has been validly created according to the rules at the place where the goods were situated at the time the rights were created, these rights do not cease when the goods cross the border.

Germany maintains a principle called numerus clausus of rights in rem, which implies that under German law, one may only create rights in rem123 which fall within one of the types already prescribed by law. Foreign security interest (unless identical to the domestic ones) do not conform to the accepted local types and are therefore at odds with the numerus clausus principle. To be recognised, the foreign security interests must be integrated into the local system of rights in rem.124 The current view – which has been criticized but is probably still prevailing – on how to do this is a “transposition” of the foreign security right into the equivalent right according to the accepted German categories.125 A different approach looks to the domestic rules which particular rights and obligations a security interest confers upon its holder and decides in this context whether a foreign security interest meets the criteria set out by these rules and therefore gives a right to preferential satisfaction out of the proceeds or a right to repossession.126 A foreign security interest may be treated like its German equivalent, if the features of the foreign law right are basically compatible with German law. As German law permits

121BGH 19 October 1966, BGHZ 46, 118 et seq.

122Art. 43 sec. 1 EGBGB.

123Rights in rem (“Sachenrechte”) are effective against third parties (e.g. other creditors) and not only among the parties who created them contractually.

124Art. 43 sec. 2 EGBGB.

125For an overwiew over different approaches see MünchKommBGB/Wendehorst, Vol. 10 (4th edn. 2006), Art. 43 EGBGB n. 147 et seq.

126Rakob, Ausländische Mobiliarsicherungsrechte im Inland (2001), p. 76 et seq., for further reference see p. 34.

secret security rights, lack of registration or other public notice devices is no impediment.

There has been a number of cases in which the effect of foreign security interests in Germany was decisive, and all courts have come to the view, albeit based on varying rationales, that the foreign security right at hand was compatible with German law and gave it the desired effect.

The first case decided by the Federal Supreme Court127 concerned a French lorry encumbered with a French registered pledge in favour of a French bank. The lorry was owned by a Lorraine scrap metal dealer and operated both on the French and the German side of the border. While on its way in Germany, the lorry was caught up in German foreclosure proceedings. The Federal Supreme Court held that the French bank was entitled to preferential satisfaction out of the proceeds of the liquidation (§ 805 ZPO). The court stated that the asset came into Germany with the “imprinting” received under the foreign lex situs. It then asked whether the foreign security right was at odds with the German ordre public, a theory the court very decisively rejected: German law knew registered pledges in certain types of assets (vessels, aircraft) and even recognised security transfers of ownership without registration or any other signs of publicity, and therefore a French registered pledge could not be considered to violate the German ordre public.

The next decision128 concerned a knitting machine that was delivered from Italy to the German buyer subject to a retention of title agreement. Under Italian law – the lex situs at the time when the contract with the retention clause was made – the retention of title was only effective among the parties, for lack of a data certa. The Federal Supreme Court held that the retention of title was nonetheless fully effective against third parties from the time the machine crossed the border. The parties had intended a retention of title effective in Germany and the court allowed the parties to reach ahead in time and effectively agree on a security interest under the prospective future lex situs, i.e. under German law. There are a number of cases by lower courts following the ruling that in a cross border sale situation, the parties may create security rights under the laws of the envisaged future situs.129

A third decision130 deals with an Italian security right – a motor vehicle hypothec – in a Ferrari. The Italian owner drove the car to Germany and sold it to a German buyer. The Federal Supreme Court had to decide

127BGH 20 March 1963, BGHZ 39, 173.

128BGH 2 February 1966, BGHZ 45, 95; discussed in Kegel, Der Griff in die Zukunft, JuS 1968, 162.

129LG Hamburg 20 November 1980, IPRspr. 1980, p. 162; OLG Hamm 13 July 1989, NJW-RR 1990, 488; OLG Koblenz 16 January 1992, IPRax 1994, 46.

130BGH 11 March 1991, IPRax 1993, 176.

whether the German buyer had acquired clean title – by way of a bona fide acquisition or otherwise. The Federal Supreme Court held that the Italian motor vehicle hypothec was functionally equivalent to a German security transfer of title and would be treated as such in Germany. In the same year, the Federal Supreme Court131 decided that a US mortgage in a sporting airplane that was registered in the United States was effective in Germany and was to be treated like a German registered pledge in an aircraft.

The survey of Federal Supreme Court decisions shows that, even though rationales vary and decisions do not always seem consistent, the outcome of the cases is always the same (and usually detrimental to the German party): the foreign security interest is effective in Germany and its effect is similar to its closest German equivalent.

b)Perfection of security interests in a cross-border situation

German law does not distinguish between attachment and perfection of security rights, i.e., under German law there is no such thing as a right that has attached to collateral but is not effective erga omnes. The closest equivalent is probably a contractual promise to grant a security right, and the granting of the right itself. In the case of a foreign security interest which has attached but not yet been perfected under the applicable law, German courts would look to the effects a security right with this status would have in its home jurisdiction. If its lacks effect against third parties, courts would probably find that it is not equivalent to any German security interest. Its effect in Germany would probably be only contractual and would not give the secured lender any rights in insolvency or against third parties. The case of the Italian knitting machine132 mentioned above looks like a case on point – the retention of title was agreed upon while the machine was still in Italy, where it had effect only inter partes. To be effective against third parties, title retention required a data certa, which could be achieved by notarisation by a notary public. However, the way the Federal Supreme Court looked at the case avoided the problem of unperfected foreign security interests: the court asserted that the parties had intended a German retention of title and wanted that to be effective from the time on when the machine crossed the border to Germany. In the court’s view, the question was therefore not: is an unperfected Italian security right effective in Germany, but rather: can the parties reach ahead in time and agree on a security interest under German law, the law of the place of the machines destination, effective upon

131BGH 7 October 1991, IPRax 1993, 178.

132BGH 2 February 1966, BGHZ 45, 95.

its arrival in Germany, even though the machine is still in Italy at the time of contracting. The second question was answered affirmatively; the first one was never discussed.

Art. 43 sec. 3 EGBGB deals with situations where the creation of a security interest (or any change in a right in rem) is a more-than-one-step process. The rule states that for an asset that has entered Germany, steps which had already been completed abroad shall be taken into account for the creation of the respective right. This rule (introduced in 1999) seems to support the outcome of the knitting machine case with a different rationale; however, it raises the question if the same principles shall apply if the parties had, for whatever reason, intentionally refrained from perfecting the security interest. Assuming that the seller and the buyer of the knitting machine intentionally avoided the notarisation and did not want a fully effective retention of title, it seems absurd to apply Art. 43 sec. 3 EGBGB to the scenario and claim that what the parties did in Italy was enough to create a perfected right in Germany. Art. 43 sec. 3 EGBGB makes sense with respect to facts – the passing of time for a question of acquisition by adverse possession, the delivery of goods or transfer of possession, the question of notice. With respect to party agreements, it seems necessary to consider what result the parties wanted to achieve, and to consider all steps taken here or abroad necessary to achieve this aim. The rule may not be applied without consideration of the intentions of the parties. The approach the Federal Supreme Court took – that the parties created a German retention of title which took effect after the machine has crossed the border – seems more convincing than a decision based on Art. 43 sec. 3 EGBGB.

However, a security interest which had been perfected and effective against third parties in its home jurisdiction will remain “perfected” after crossing the German border. No particular steps to achieve or maintain “perfection” in Germany are required.

c)Priorities

In case of a dispute about priorities involving a later secured party or a seizing creditor, courts will treat the foreign security interest like its closest equivalent under German law – a German retention of title, a German transfer of title for security or a German lease arrangement (the latter will not even be considered a question of recognition of foreign security interest, because title of a lessor is simply considered title and recognition not an issue). In all three cases, a later secured creditor could acquire a security right only as a bona fide purchaser; otherwise the security interest of the foreign secured party would prevail. The foreign security interest would also give the secured creditor the right to either

stop any enforcement proceedings of a seizing creditor („Drittwiderspruchsklage”, § 771 ZPO) or at least to claim preferential satisfaction out of the proceeds of the seizure and realisation (“Klage auf vorzugsweise Befriedigung”, § 805 ZPO), depending on whether the foreign security interest resembles more closely a German retention of title arrangement or real title, on the one hand, or a German pledge or transfer of title for security, on the other hand.

d)Advice to foreign secured creditors

As counsel to the foreign secured creditor, I would have advised that a relocation of the equipment to Germany was unlikely to diminish the legal effectiveness of the security interest. It would, however, create a certain degree of uncertainty and a higher likelihood of disputes and litigation, because competing creditors and insolvency administrators – and to some degree courts as well – in Germany will generally be inexperienced in dealing with foreign security interests. To avoid any uncertainty, the secured creditor could enter into a German transfer of title for security agreement over the equipment, taking effect when the equipment crosses the border to Germany.

Annex –

Limitations on granting and holding security under German law

1.Corporate Law Issues:

upstream security and financial assistance

If the borrower is a member of a group of companies, or an acquisition vehicle looking to finance an acquisition with bank debt, lenders will usually ask for security not only over the assets of the borrower itself, but also over those of other members of the group or, in case of an acquisition, over the assets of the target.

German corporate law imposes serious restrictions on the ability of stock companies and limited liability companies to grant security for debt of their parent companies (upstream security) or to grant security for a loan that was used to finance its own acquisition (financial assistance).133

133See generally Maier-Reimer, Das Recht der konzernexternen Fremdfinanzierung, in

Lutter (ed.), Handbuch der Konzernfinanzierung (1998), p. 484; Bastuck, Kreditbesicherung im Konzern, WM 2000, 1091, 1097; Rakob, in Kronke/Melis/Schnyder

(eds.), Handbuch internationales Wirtschaftsrecht (2005), p. 630 et seq.

a)Upstream/cross-stream security

§ 57 AktG prohibits the repayment of equity capital to the shareholders. The rule is broadly construed and also prohibits other benefits conferred upon shareholders like the granting of security for their debts.134 Therefore, German stock corporations (“Aktiengesellschaft (AG)”) may not grant security for debt of any parent (upstream) or sister company (crossstream) at all.135 Any security granted in violation of this rule is void.136

German limited liability companies (“Gesellschaft mit beschränkter Haftung (GmbH)”) may grant upstream or cross-stream security, but only to the extent doing so does not violate its obligation to maintain its stated share capital (“Stammkapital”).

The capital maintenance rules provide that a GmbH may not make payments to its shareholders which affect its stated share capital.137 The term “payment” is construed broadly and includes providing security for debt of the shareholders such as the granting of guarantees, pledges or mortgages. The stated share capital of a GmbH is affected if its net assets (which is its total assets less its liabilities as shown on its balance sheet) are less than the amount of its stated share capital.

A violation of these principles will usually not affect the validity of the security, but will result in personal liability138 and possibly even criminal charges against the managing director of the GmbH. Due to these consequences, it is common for upstream and/or cross stream security to be limited to an amount equal to the guarantor’s free net assets (i.e. its total assets less its liabilities and less its stated share capital). If security is limited in accordance with the capital maintenance rules, a secured lender can only recover amounts which would be left once the direct creditors of the company have been paid in full and the amount of the stated share capital is set aside. Thus, a secured creditor with security rights limited according to the capital maintenance rules is in effect subordinated to the direct creditors of the GmbH.

The capital maintenance rules apply mutatis mutandis to limited partnerships where the general partner is a limited liability company (“GmbH & Co KG”).

134Hüffer, Aktiengesetz (7th edn. 2006), § 57 n. 3.

135OLG Düsseldorf 24 October 1979, AG 1980, 273, 274; OLG Hamburg 23 May 1980, AG 1980, 275, 279; OLG Koblenz 10 February 1977, AG 1977, 231, 232; Hüffer, Aktiengesetz (7th edn. 2006), § 57 n. 12.

136Hüffer, Aktiengesetz (7th edn. 2006), § 57 n. 23, however, the issue remains disputed.

137§ 30 GmbHG.

138§ 43 sec. 3 GmbHG.

Currently, the German Act on Companies with Limited Liability (GmbHG) is under review and will probably change considerably in the near future.139 Changes will probably also affect the capital maintenance rules and may make granting upor cross-stream security easier in the future.

b)Financial assistance

The German Stock Corporation Act (AktG) prohibits financial assistance (including the provision of security) in connection with an acquisition of shares in a German stock corporation.140 The target company of the acquisition may not assist (before or after) the acquisition by granting security for the loan which was used to finance the purchase price for the shares. The prohibition extends to financial assistance given by any related entity of the stock corporation, including any subsidiary. Any security granted in violation of this rule will be void or at least subject to a claim for unjust enrichment and therefore in effect unenforceable.141 There are no whitewash-procedures less costly or less time-consuming than a merger of the acquired stock corporation with the acquisition vehicle (so the emerging entity secures its own debt) or a change of corporate form from a stock corporation to a limited liability company (so the financial assistance rules for stock corporations no longer apply).

German law does not prohibit financial assistance in connection with the acquisition of shares in a GmbH. However, any such agreement entered into by a GmbH will be subject to the capital maintenance rules as set out above, and thus the secured creditor will in effect be subordinated to direct creditors of the GmbH.

2.Holding accessory security for several lenders

In the case of a secured syndicated loan agreement (or secured bonds), it is usually desirable to have all security held by a security trustee on behalf of the lenders. In particular when the identity of the creditors changes, e.g. when rights under the syndicated loan agreement are traded, it seems advisable to avoid the need to transfer security from an

139 See draft Gesetz zur Modernisierung des GmbH-Rechts und zur Bekämpfung von

Missbräuchen (MoMiG), 23 May 2007, available at http://www.bmj.bund.de (1 Au-

gust 2007).

140§ 71a AktG. See Hüffer, Aktiengesetz (7th edn. 2006), § 71a n. 1.

141Lutter, in Claussen/Zöllner (eds.), Kölner Kommentar zum Aktiengesetz, Vol. 1 (2nd edn. 1988), § 71a n. 5, 8.

old lender to a new lender. The idea is to grant all security in favour of the security trustee, securing the claims of all lenders under the loan agreement. The lenders and the security trustee enter into a security trust agreement under which the security trustee holds the security rights for the lenders and which spells out how decisions on realisation of the security etc. are taken. New lenders simply accede to the security trust agreement, thus avoiding a transfer of security rights.

This internationally accepted standard structure for securing syndicated loan agreements meets with difficulties when German accessory security rights are part of the security package. Pledges („Pfandrecht”), suretyships (“Bürgschaft”) and mortgages (“Hypothek”) are accessory security rights. An accessory security interest is irresolvably tied to the claim it secures. It cannot exist without the secured claim;142 it may be transferred only together with the secured claim, and – and this makes it difficult – it may be granted only to and may be held only by the owner of the secured claim. An accessory pledge granted to a security trustee can secure only obligations owed to the security trustee itself, and not, as required by the structure described above, secure the obligations owed to all syndicate lenders under the loan agreement. Most assets may be validly and effectively subjected to non-accessory security rights and the problem thus avoided. Instead of accessory pledges, security transfer of title or security assignment can be used, non-accessory land charges (“Grundschuld”) instead of mortgages, guarantees (“Garantie”) instead of suretyships. With these non-accessory security interests, no problem arises.143 However, if the security package for the loan calls for security over shares in subsidiaries, this can only be achieved by encumbering the shares with a pledge. A security assignment of the shares is an option only in theory, but never done in practise, because it would make the security trustee a shareholder and therefore lead to a whole armful of undesirable consequences.

If German law pledges can’t be avoided, one – and I believe the most widely used – way to address the issue is by introducing a “parallel debt structure”. Under the parallel debt structure, the borrower agrees to “owe

142However, as accessory security rights may be created for future claims, no problem is posed when the secured claims do not exist yet – e.g. because the secured loan has not yet been disbursed – or are temporarily reduced to zero, e.g. under a revolving loan or a current account.

143The confidence in the viability of the structure with non-accessory security interest has recently been affected by a decision of the Federal Supreme Court (BGH 2 June 2005, NJW-RR 2005, 1636) which challenged the notion that non-accessory security interests may be granted to a trustee on behalf of other lenders, securing the claims of the other lenders. The relevance and weight of this solitary decision is still open.

any amount owed to the lenders also to the security trustee”. This duplicates the secured obligations and gives the security trustee his own claim against the borrower, equal in amount to the aggregate amount of all obligations owed to the lenders. Of course the borrower cannot be obliged to pay twice the amount that he owed the lenders without the parallel debt. The duplication of the claims is therefore combined with the provision that payment made on the original debt reduces the parallel debt claim and vice versa. The parallel debt concept makes the security trustee and each lender joint creditors (“Gesamtgläubiger”). The pledges can now be created in favour of the security trustee, securing the parallel debt claim. I am not aware that this structure has ever been tested in a courtroom, but the German law security over substantial assets in countless domestic and international loan transactions depends on it.