The typical security package in a German real estate financing includes the following:
Last modified 3 Apr 2023
In terms of security creation, real estate generally includes:
Occasionally, the land will be encumbered with a hereditary building right (Erbbaurecht) which entails that ownership of the land itself is split from the ownership of the buildings, fixtures and fittings which then belong to the holder of the hereditary building right. In such cases, the hereditary building right itself can be encumbered with a land charge (Grundschuld) or mortgage (Hypothek).
Last modified 3 Apr 2023
No, the common law trust concept is unknown in German law. However, certain security interests can be held by a security agent for other lenders under an arrangement known in German law as Treuhand (a contractual fiduciary relationship).
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Secured debt is commonly traded between lenders. Syndicated lending documentation is becoming standardized on the terms of the standard documents governed by German Law issued by the Loan Market Association and this allows free transferability of debt between lenders with the security being held on their behalf by a security agent.
In addition, there are several ways of transferring secured debt directly to a new creditor being:
Assignment and transfer and assignment by way of assumption of the contract (Vertragsübernahme) of debt secured over real estate requires registration in the land register thus in those cases formal requirements must be complied with.
For German mortgage-backed securities transactions the time-consuming process of registering the assignments can be avoided by using what is known as the refinancing register which is provided for under the German Banking Act (Kreditwesengesetz).
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There are no restrictions on granting security over real estate to foreign lenders.
Last modified 3 Apr 2023
The grant of security over real estate and shares in a German limited liability company or 'GmbH' requires notarisation which will involve the payment of notary’s fees. In addition, security over real estate requires registration in the land register which will involve registration fees. The notarisation and registration fees are determined by statute and can be quite substantial.
Security over real estate is enforced by way of court proceedings and in such cases court fees will become payable.
A successful public auction of real estate would trigger real estate transfer tax. The tax rate is between 3.5 percent and 6.5 percent of the purchase price, depending on the German federal state.
The grant of security generally does not result in any VAT liability. If the security over real estate were to be enforced, the sale by public auction would be exempt from German VAT unless the borrower opts out of the exemption from VAT. This option may only be exercised if the person granting the security as well as the purchaser both qualify as entrepreneurs within the meaning of German VAT law and the purchaser uses the real estate for the purpose of its enterprise.
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Yes, there are financial assistance rules and corporate benefit rules which must be complied with.
The prohibition on financial assistance only applies to German stock corporations (Aktiengesellschaft). The definition of ‘assistance’ is wide; there is no distinction between assistance by the company itself and assistance by its subsidiaries. There is no ‘whitewash’ procedure which can be applied.
Since November 2008, the prohibition has not applied if there is a control agreement or a profit transfer agreement (Beherrschungs- oder Gewinnabführungsvertrag) in place between the stock corporation and the ‘financially assisted’ company. The consequence of a violation would be that the transaction would be void.
Managing directors have a statutory duty to their company to act as prudent business people. This is a broad concept and various factors such as the group interest can be taken into account when assessing whether it has been met. In case of up-stream or cross-stream loans within a group, there is an obligation to the lending entity to take security if there is credit risk in relation to the borrowing entity.
The German Code of Corporate Governance (GCCG) applies to German listed stock corporations. Members of the managing board and of the supervisory board must declare that they have followed the recommendations of the GCCG.
If there is a violation the transaction is not invalid but the directors, managing board, or supervisory board are potentially liable.
There are other corporate and insolvency law issues which apply and include rules relating to capital maintenance, restrictions on transactions between a company and its affiliates other than its own subsidiaries and provisions relating to transactions which disadvantage creditors and which have been entered into within certain periods before the commencement of insolvency proceedings.
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There are generally no restrictions on repayments being made to foreign lenders under a security document or loan agreement.
Under German national tax law, banks and other financial services providers must withhold taxes on interest payments made to foreign lenders which do not themselves qualify as a bank or financial services provider.
In addition, lenders enjoying security over German real estate must pay a certain limited amount of income tax on interest arising in Germany. This only becomes relevant for lenders resident in countries which do not have a double taxation treaty which excludes Germany’s right to levy taxes on interest paid to foreign lenders.
If, however the foreign lender has a permanent establishment in Germany and the loan is attributable to this permanent establishment, the foreign lender is subject to German taxation on the profit resulting from the loan. Depending on the applicable double taxation treaty the interest will generally be either tax exempt in the foreign jurisdiction or the German tax will be credited against the tax liability which arises in that foreign jurisdiction.
Last modified 3 Apr 2023
A debt is subordinated either pursuant to a contractual agreement or because it constitutes a shareholder loan.
A creditor can agree to subordinate its debt/security to that of another creditor by means of a priority agreement; either an agreement on priority or an intercreditor agreement. The agreement will regulate the subordination of the debt as well as the security and will cover matters such as rights of enforcement. The subordination of one real estate security holder to another must be registered in the land registry.
Loans made by shareholders to the company and other arrangements equivalent to shareholder loans are subordinated to the claims of all other creditors by law. There are two exceptions to this rule:
When a public auction of a property takes place in the course of insolvency proceedings, outstanding debts due to public authorities such as real estate tax and compensation payments for the removal of contamination enjoy priority over secured loans. Any auction proceeds will be used first to satisfy these obligations to the state.
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In general, if a choice of law is a sensible choice (ie not chosen to deliberately avoid a national law or policy) it will be recognised and upheld by the German courts and accordingly the foreign law will govern the validity, binding effect and enforceability of the documents against the parties to the contract.
However, the choice of a foreign law for creating security over assets located in Germany will not be recognised by the German courts. The lex rei sitae (law where the asset is situated) applies so that German law governs the creation of security over a German asset.
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If the security has not been validly perfected before the opening of insolvency proceedings it can not be perfected at a later stage. With the opening of the proceedings, the right to manage and dispose of the debtor’s assets passes from the management of the debtor to the appointed insolvency administrator.
In preliminary insolvency proceedings (the time between the petition for the opening of the insolvency proceedings and the actual opening) the court can prohibit or stay execution measures being taken against the debtor and can order that certain movable assets (including receivables) which are subject to creditors’' security rights may not be removed from the insolvent estate if those assets are required for the continuation of the debtor’s business. In addition, the court may (and almost always does) appoint a preliminary insolvency administrator.
The preliminary insolvency administrator’s power to control the debtor's assets will depend upon the level of restrictions imposed on the debtor by the court. The court may appoint either a ‘strong’ preliminary insolvency administrator with authority to take over the management of the debtor completely or a ‘weak’ preliminary insolvency administrator with authority only to supervise continued management by the directors. In practice the appointment of a ‘weak’ administrator is the most common route adopted, since in general the management will not act without the administrator's approval. This means that, so long as preliminary insolvency proceedings last security interests cannot be perfected, that is to say not without the consent of the preliminary insolvency administrator. Even if the ‘weak’ preliminary insolvency administrator consents to a perfection of the security, the transaction would be subject to claw-back by the insolvency administrator in any subsequent full insolvency proceedings.
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A holder of security over real estate is not liable for environmental damage provided it does not take possession of the land and does not itself cause damage to the environment.
Great care must be taken if the security is enforced. This will be done by way of contractual arrangements involving the owner of the real estate or the insolvency administrator who has been appointed in relation to the property-owning company. This is because the owner of real estate or the insolvency administrator can be liable for environmental damage on that land or arising from it, even if it did not cause the damage.
A contractual instruction to the owner/insolvency administrator to act in a certain way may then lead to liability on the part of the instructing security holder itself. A mortgagee/land chargee should not take up possession of real estate without careful consideration of the implications of potential environmental liability.
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Normally, the documents involved in security provide for pre-conditions before the security can be enforced. Typically, the borrower must be in default or a declared default must have occurred. Generally, the lender must give notice of enforcement to the grantor of the security before starting enforcement procedures. In addition, a land charge (Grundschuld) must be terminated before enforcement; the mandatory termination notice period is six months.
Once the contractual requirements for enforcement are met, the land chargee/mortgagee may apply to the court to commence a public auction process and forced administration proceedings. Before proceedings can be commenced the land charge/mortgage deed must have been formally delivered to the property owner.
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No.
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The insolvency administrator may in certain circumstances challenge transactions, which would discriminate against other creditors and were effected prior to the filing for the opening of insolvency proceedings (or afterwards). There are various heads of challenge which the insolvency administrator can rely on, generally based on the following grounds:
The relevant periods which must have elapsed before transactions become unchallengeable vary between one month and ten years; if all parties are acting in good faith, the relevant period is normally three months. Transactions for which immediate and adequate consideration was received by the borrower are only voidable if the creditor knew that the transaction was undertaken wilfully to discriminate against other creditors' rights, ie if the security taken reflects a proper consideration for the credit risk in relation to the loan facilitated, there is no claw-back.
The opening of preliminary and/or final insolvency proceedings may in some circumstances prevent the secured creditor from enforcing its security interests. However, the lender’s security interests will be acknowledged by the (preliminary) insolvency administrator by compensating the lender for any use of the secured assets by the administrator. In addition, in the event that the security is realized, the secured creditor will receive the enforcement proceeds from the insolvency administrator.
In insolvency proceedings real estate collateral can be realized through a forced auction (Zwangsversteigerung) or a forced sequestration (Zwangsverwaltung); in practice, there is often an agreement between the creditor and the administrator to sell the property out of court, since enforcement proceedings might be costly and inefficient.
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Once formal insolvency proceedings are opened by the court, the insolvency administrator takes full control of the business of the insolvent company. Creditors are asked to lodge their claims against the company and to inform the administrator of their security interests over the company’s assets.
German insolvency law differentiates between preferential creditors, secured creditors, unsecured creditors and subordinated creditors.
As a general rule, the claims of preferential creditors are paid undiscounted and directly from the insolvency estate – unless the estate has insufficient funds to cover even these claims. Any payments or distributions of proceeds to the other creditors are made:
Within the group of secured creditors, each creditor receives the net realization proceeds of the sale of the assets over which the creditor held a security interest. In the unlikely event that several creditors hold equal-ranking security over the same asset the proceeds are split in equal shares.
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What sort of security is typically created or entered into by an investor who is borrowing to acquire or develop real estate?
The typical security package in a German real estate financing includes the following:
Last modified 3 Apr 2023