I. Background of the problem and previous practice

When it comes to group-financing activities, but also in cases of financing activities in the private equity sector, lenders often demand that subsidiaries of the actual borrowers provide securities (so-called “upstream securities”).
Subsidiary GmbHs or AGs have to comply with creditor-protecting provisions in order to preserve their equity (§ 30 GmbHG [GmbH-Gesetz – German law on limited liability companies], § 57 AktG [Aktiengesetz – German Stock Corporation Act]. The security shall not result in an outflow of assets, which leads to a reduction in the protected share capital of a GmbH or in the equity of an AG (in case of an AG, the protection goes beyond the capital stock).
In practice, the focus has been based so far on the time of liquidating the securities for precautionary reasons concerning this issue. In addition, it had established on the market as standard to adopt particular reservations to limit a liquidation by contract in order to protect the management of a company against personal liability if such a liquidation would entail a violation of § 30 GmbHG, § 57 AktG (so-called Limitation Language). This Limitation Language resulted in an unsatisfactory result for borrowers, as securities were economically devaluated which, as a rule, simultaneously increased the amount of a loan in the form of higher interest rates. If the lender exploits the furnished security, it is replaced by a recourse claim against the parent company. These kinds of recourse claims, however, were often not accepted as fully adequate (anymore), because in these cases the exploitation of the security resulted from the parent company’s (limited) inability to pay its debt.
It was partly argued that furnishing of securities was unproblematic, as long as the parent company is able to repay the loan granted to it, because the furnishing of a security was offset against a valuable recourse claim against the parent company. However, if the parent company becomes insolvent, furnishing of a security may constitute a redemption of share capital and thus a violation of the capital maintenance provisions. According to § 42 para. 2, para. 3 page 1 GmbHG, a managing director is fictitiously liable for the amount paid out (because already warranted by furnishing of the security).
The decisive date for assessing the recoverability of the recourse claim has controversially been discussed up until now. In practice, this led to the conclusion of contracts on furnishing securities subject to the solvency of the shareholder. If the parent company was unable to pay the debt at maturity, the liquidation of the security was accordingly excluded.

II. BGH ruling dated 21 March 2017

In its judgment of 21 March 2017 (file reference: II ZR 93/16), the BGH ruled on a case where the managing director of a GmbH & Co. KG [limited partnership with a limited liability company as general partner] created a mortgage for private debts of a shareholder. In its judgment of 10 January 2017 (file reference: II ZR 94/15), the BGH had already ruled similarly for the AG involved.
The main concern is to determine which time is decisive for the question of whether a payment within the meaning of § 30 para. 1 GmbHG (§ 57 AktG) prevails. The Second Senate ruled that the decisive time for applying § 30 GmbH is the time of the furnishing of a security and not the time of the liquidation of such security. Accordingly, the examination on the adequacy of the counterclaim has to be carried out at the same time. However, the BGH did not specify what this examination should look like.
In its ruling the BGH refers to furnishing a security in rem. It is indeed argued in the literature that the principles could be transferred to the obligation of furnishing a security at a later date and to any obligation arising under the law of obligations, e.g. a declaration of surety.

III. Changes to be expected for managing directors of subsidiaries

As good as the BGH ruling may sound, it probably involves only few positive changes for managing directors. Lenders will make use of the judgments in order to justify the dispensability of the Limitation Language and thus to improve their position. As a result however, managing directors may be exposed to the risk of personal liability in the future if the intrinsic value of a recourse claim towards the parent company is not given.

1. Examination of financial solvency of a shareholder when furnishing a security

The key message of the BGH is that the managing director has to determine at the time of furnishing a security that a loss of the claim against the shareholder is unlikely. It remains unclear, how much effort a managing director has to put into providing enough evidence to show that he justifiably assumed the intrinsic value of the claim when furnishing the security.
Each indication which could constitute an imminent insolvency should consequently entail that a security is not furnished.
In return, indications which suggest a positive development of the parent company should make it possible for a managing director to furnish securities. A managing director should not be content with, amongst others, generalized statements on the future development of the parent company. In fact, a positive development has to be highly probable based on the current figures and a comprehensible forecast.
Should any unforeseeable circumstances arise later on which may lead to the insolvency of the parent company the initially targeted furnishing of securities remains legitimate, according to the BGH. However, it is in particular hardly conceivable when it comes to group-related matters that the managing director of a (small) subsidiary GmbH can actually gain a comprehensive and reliable picture of the creditworthiness of the parent company. Without this picture, however, he is continuously exposed to a substantial liability risk. Furthermore, the BGH does not provide an answer to the question as to the (legal) basis on which the managing director of the subsidiary should be able to obtain such information.

2. Continuous monitoring of the solvency of the shareholder

This must clearly be separated from the continuously existing obligation of the managing director to constantly monitor the solvency of the parent company and to take an occurring indication for any kind of deterioration of its financial situation as opportunity to abolish the furnishment of securities or to otherwise prevent the security from being exploited.
A managing director may therefore not easily exculpate himself from a liability after completing the examination at the time of furnishing the security, whereby the capital maintenance provisions do not apply, but the liability for infringement of the general duty of care does apply. In the event that an insolvency of a parent company is looming and the managing directors would have been able to determine this by a proper control (and thus reduce the damage), the managing director’s liability shall remain as provided in accordance with § 43 para. 2 GmbHG.
Therefore, a type of “notification system” has to be introduced which enables the parent company to pass on current information on the financial situation of the company to the subsidiary to an appropriate extent.

3. Limitation Language

Even though it was expected that the Limitation Language would no longer be necessary after issuing the judgment, it seems to be still required in the future. Especially because the question already arose as to whether the managing director had examined (or was able to examine) the creditworthiness of the parent company in a sufficiently reliable manner at the time of furnishing the security. In addition, the “continuous monitoring of the parent company’s financial status” which is subsequently necessary, requires regulations as well, as the manager does generally not have sufficient access to information without appropriate intra-group measures.

IV. Outlook

The rulings of the BGH passed in the previous year indicate at least a tendency with the intention to partially release managing directors from their strict liability. However, this has so far not taken place with the necessary clarity.
When it comes to intra-group assumptions of liability (upstream), it is necessary to provide access to information on the group’s situation at the time of furnishing a security to the managing directors. In addition, the parent company should provide ongoing information in order to grant managing directors of a subsidiary the possibility to comply with their monitoring obligations. A Limitation Language will also continue to be necessary – but with a wording differing from the current formulation – in order to protect managing directors.