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Insolvency law: Risks for Shareholders in case of Providing Loan Collateral in the Company's Insolvency

If a company takes out a third-party loan, the shareholder often provides the collateral. In case the company then repays the loan and subsequently becomes insolvent, this can result in the shareholder being liable for the repayments made on the third-party loan.

Background

The defendant is the sole shareholder of the later insolvent E. GmbH (hereinafter "Debtor"). In 2010, the Debtor was granted a loan of several million euros by its bank. For this, the bank was granted land charges on six properties of the defendant and on one property of the Debtor as security. Furthermore, the bank was granted additional rights in various agreements to ensure the repayment of the loan; including the obligation of the defendant to retain all of the Debtor's profits.

After the Debtor filed for insolvency in October 2013, insolvency proceedings were opened on January 1, 2014. In 2013, the bank's loan was repaid by approximately EUR 1.5 million. Moreover, the bank realized the land charge on the Debtor's property and received approximately EUR 700,000 in proceeds.

The plaintiff insolvency administrator now demands payment of around EUR 2.2 million from the defendant. This is because the repayment of the loan and the realization of the Debtor's property based on the land charge had released the defendant from the security it had provided.

The decision of the Federal Court of Justice of 25.06.2020, file no. IX ZR 243/18

The Federal Court of Justice ("BGH") upheld the action and thus confirmed the decision of the lower court. This is because if a shareholder provides collateral for a third-party loan and the loan is repaid in the last year before filing for insolvency, the shareholder is liable for the repayment. The reason for this is that the shareholder benefits from the repayment, as it is released from its obligation under the security. The present case was also not different because the bank had been granted special contractual rights. After all, these contractual rights only secured its rights under the loan agreement, but did not grant the bank a position similar to that of a shareholder.

Comment

The BGH's decision was based on a case of so-called "double collateralization". The term double collateralization is used when a third party (e.g. a bank) grants a loan to the company and the repayment of the loan is secured by both the company and the shareholders. In the event that the company subsequently becomes insolvent, the law stipulates that a shareholder who has directly granted a loan to the company and a shareholder who has "merely" secured a third-party loan are to be treated equally. In both cases, the shareholder only has a so-called subordinated claim, meaning that repayment on its claims shall only be made once all other company creditors have been satisfied.

This valuation also applies to the last year before insolvency. If the company (partially) repays a shareholder loan in the last year before insolvency, the insolvency administrator can challenge these payments against the shareholder, with the consequence that the shareholder has to repay the amount. If the loan was issued by a bank and the shareholder "merely" provided the collateral, nothing else shall apply. In this case, the shareholder also has to "repay" to the insolvency administrator the amount the bank received as repayment on the loan. This is because the shareholder has benefited from the repayment of the loan to the extent that it was released with its security in the amount of the repayment. This also applies if the loan was repaid because other securities provided by the company itself were realized. As according to the law, the shareholder is first liable in full for the amount that it was willing to provide either as a loan or as collateral.

As a shareholder, this risk of default should therefore be consciously taken into account. If the company becomes insolvent, the collateral provided by the company itself will only be used as subordinate collateral; the full collateral provided by the shareholder must be used first. Therefore, if the bank nevertheless requires additional collateral from the shareholder, the shareholder must at least ensure that the amount is limited.

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