Retention of title (Eigentumsvorbehalt) is a standard tool in German business for granting security in supply relationships. Usually, it is granted as an extended and/or expanded retention of title (verlängerter und/oder erweiterter Eigentumsvorbehalt). Basically, the supplier receives a revolving security to the delivered movable assets until receipt of all payments under the business relationship. According to a recent decision by the highest German civil court this kind of security may not sufficiently protect the supplier in the context of insolvency proceedings, potentially resulting in the supplier unwittingly being an unsecured creditor.

 

By Thilo von Bodungen and Silke Goschler (both IPT) as well as Peter Jark and Tom Braegelmann (both Restructuring)

 

1. Introduction

The protective effect of a major kind of German law security has been further restricted by recent German case law. Payments made by a purchaser to the supplier in the context of an extended and expanded retention of title can be contested/clawed back according to a February 2015 decision of the Federal Court of Justice (Bundesgerichtshof – “BGH”), available here, case no. IX ZR 180/12.

Under such retention of title the supplier usually reserves title to all products sold to the purchaser until receipt of all payments under the business relationship. The purchaser may still process and/or resell the products in the course of its ordinary business activities, but it assigns to the supplier in advance all claims accruing from the resale.

Importantly, the BGH initially confirmed in its decision that pursuant to general German civil law an extended and expanded retention of title is regularly valid in business transactions, even if used in standard terms (Allgemeine Geschäftsbedingungen – “AGB”).

While it is good that retention of title is recognized as in principle valid by German case law, the decision raises serious concerns pursuant to specific German insolvency law that an extended and expanded retention of title may often be economically useless as security. The reason is that the decision implies that payments made in connection with an extended and expanded retention of title are likely no longer shielded from clawback claims by a German insolvency administrator based on the provisions on the contestation of legal transactions (Insolvenzanfechtung), especially in cases of willful disadvantage (Vorsatzanfechtung).

The principles developed by German case law will become more and more important also in an international context. Arguably, the extended and expanded retention of title may be used less frequently in cross-border transactions, as its enforcement may face issues of recognition in the country of delivery. However, it is becoming more relevant and applied in practice in Germany, in particular if small and medium sized businesses are involved. In the light of the ongoing increase in international investors and suppliers seeking to do business and make investments in Germany, also international stakeholders will have to deal with this topic more and more.

 

2. Facts of the case

In the case at hand, a miller provided the debtor with ingredients (flour etc.) for bakery products. Pursuant to the terms of delivery and payment, the parties agreed to an extended and expanded retention of title, retaining the miller’s title to the delivered ingredients. The debtor, while not the owner of the ingredients, was nonetheless authorized to process the ingredients, transform them into bakery products and then sell those bakery products to the end customers. As security, the debtor pre-assigned to the miller all of its accounts receivables against the end customers from the sales of these bakery products. These assigned accounts receivables served as security for the miller’s title to the ingredients and also for all other claims that the miller had against the debtor pursuant to the miller’s overall business relation with the debtor. This assignment was not made public to the end customers, rather, the debtor was entitled to collect in its own name payments from the end customers. Once collected, the debtor would then forward these payments to the miller.

After a while the debtor suffered from financial distress, failing to make key payments to social security institutions and to its employees etc. The miller nonetheless received significant payments from the debtor during this period, even though certain payments were charged back by the debtor’s bank as the debtor’s business account was overdrawn. Once insolvency proceedings were opened over the estate of the debtor, the insolvency administrator demanded from the miller the repayment of an amount of EUR 156.108,89.

 

3. Decision and Key Legal Issues

The court held that the miller had to pay the amount back because the payments to the miller were disadvantageous to all the other creditors and no justification of the payments was applicable (pursuant to sec. 129 para 1, sec. 133 para 1 of the German Insolvency Code (“InsO“)).

a) Payments disadvantaging other creditors

 According to the court the payments disadvantaged other creditors, as the debtor did neither pay the miller in order to discharge the miller’s right of segregation (“Absonderungsrecht“) nor any substitute right of segregation (“Ersatzabsonderungsrecht“) with regard to the assigned purchase price payments by the end customers. Even if such right for the miller had followed from the retention of title, the miller would have lost it because every time the debtor had collected the payments from the end customers who were unaware of the assignment. As a consequence, any right of segregation concerning these payments was discharged and not transformed into a substitute right of segregation (“Ersatzabsonderungsrecht“).

 The court held that the miller could only have avoided the loss of its right of segregation if the miller had made the aforementioned security assignment public and had collected the claims against the end customers by itself or had advised the debtor to collect the payments from the end customers on a trust account pledged to the miller or a similar security.

 b) Intention to disadvantage other creditors

 The court further held that the debtor also had the intention to disadvantage the other creditors (Gläubigerbenachteiligungsvorsatz), since the debtor knew it was illiquid at the time of the payments. German case law has eased the insolvency administrator’s burden of proof in this regard: If the debtor has ceased making significant payments on its debt, case law assumes that the debtor had the intention to disadvantage the other creditors.

 In theory, this assumption can be refuted if in direct connection with the contested legal transaction a performance of equal value is given to the debtor in return, hence, if an immediate exchange of performances occurs that is similar to a cash transaction (Bargeschäft) under German insolvency law. This may also apply in the case of a simple retention of title.

 However, in the case at hand the extended and expanded retention of title could not be deemed to be such a direct exchange of performance and counter-performance. According to the court the exchange was not of equal value since the provisions concerning the retention of title stipulated that the debtor shall obtain title to the delivered products only after (1) having paid the purchase price and also (2) having repaid all other open claims based on the business relationship with the miller. As a consequence, the assumption that the debtor intended to disadvantage the other creditors could not be refuted by the specific retention of title.

 

4.    Consequences in practice

The consequence of the decision is that the extended and expanded retention of title is by itself no effective shield against the contestation rights of the insolvency administrator, in particular if the supplier, knowing that the debtor is in financial distress, explicitly or tacitly allows the debtor to continue collecting the payments from the end customers. Unfortunately, the court did not finally decide whether or not the outcome of the case would have been different if the miller had not implicitly allowed the debtor to continue payment collection.

The decision appears, however, to insinuate that depending on the specific wording of the clause the extended and expanded retention of title may still be valid as a protection against clawback claims in insolvency proceedings. In the light of the court decision, there seems to be a need to differentiate between retentions of title concerning

(i) products that are simply resold by the purchaser; and

(ii) products that are processed and transformed into other products by the purchaser.

For a resale of products under (i) it appears that it may be possible to find a viable wording that would somewhat strengthen the position of the supplier in relation to the court decision: Corresponding clauses should provide a right for the supplier to request that the assignment of the claims is disclosed to the respective end customers and that the debtor’s right to collect the claims may be revoked under certain circumstances.

In relation to (ii) products that will be further processed and transformed into new products, it is not yet clear how broad the impact of the court decision is. Usually, retention of title clauses provide that the assignment of claims against end customers shall be effected only in the proportion of the co-title shares in the products reprocessed. Thus, if only parts of the claims are assigned, it may be difficult to validly provide that the supplier itself collects the entire claims. The legal literature and discussion in this regard is still scarce and just beginning. However, at least in the B2B context, where payments are not made in cash, we consider that the following solutions might be viable:

• Multiple suppliers may join in a pool of security holders that is centrally administered and which holds the security (i.e. the whole property title to the produced goods) for the pool members;
• In addition or alternatively, the debtor may be instructed ‑ either by each supplier separately, or by the supplier pool ‑ to collect all of the accounts receivables on an account not held by the debtor but rather by a trustee, or at least on an account of the debtor that is separated from its other accounts of the debtor and pledged to the supplier or multiple suppliers.

Such solution, while addressing complex situations, does not need to be complicated more than necessary. It may not be necessary in all cases for all multiple suppliers to negotiate and to come to a common understanding and solution. We still see room for a viable solution in an individual supply relationship.

Therefore, suppliers should urgently review their retention of title clauses governed by German law. Further, suppliers should review their practical handling of such retention of title clauses. In order to be able to salvage the benefits from the retention of title as much as permitted under this decision, the supplier must take care that it exercises its corresponding right under the retention of title clause as soon as there is an indication that the debtor is in financial distress.

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