Germany has notoriously broad voidability laws. As a rule of thumb, any payment by a third party has high voidability risks if the third party has no obligation to make the payment under the contract. Such payments qualify as incongruent (3 months hardening period, very few further requirements) and often qualify as gratuitous (4 years hardening period, without any further requirements). A recent decision of the German High Court has stirred hope that the Court may give some leeway to cash pool payments by group companies. However, on a closer look at the decision, it becomes clear that the boundaries for an exemption from voidability were set very narrowly.
Comment on the German High Court decision dated 12. September 2019 (file no.: IX ZR 16/18) by Christine Borries, LL.M. (Sydney) and Dr. Markus Huber, lawyers of the German Hogan Lovells insolvency and restructuring practice.
General rule: Voidability of third party payments due to incongruence or lack of consideration
If a creditor receives payment not from his contractual counterpart but from one of its affiliated group companies, such payment is incongruent unless the creditor had a contractual payment claim against the entity making the payment. Incongruence means that someone has received something in a way he had no legal claim to (section 131 InsO). Hence, if and to the extent such payment was not owed by the third-party payer, such third-party payment is incongruent. The hardening period is three months (meaning that the payment can be challenged if made in the three months preceding the payer’s insolvency).
Further, if at the time of the payment the actual debtor was already in a state of (impending) illiquidity, the German High Court considers such third party payments as gratuitous. The Court argues that the creditor wouldn’t have been able to economically enforce its claim against its original debtor anymore. Hence, by receiving payment from a third party the creditor does not lose a valuable claim against the original debtor, but receives something without consideration. In this case, the hardening period is four years.
The worst part for creditors in this is that under German statutory law, they have no right to refuse a third party payment.
A glimmer of hope: third-party payment neither incongruent nor gratuitous in case of a number of years of punctual payments by the same pool leader
In the case now decided by the German High Court, the third-party payment was made on the basis of the cash pool existing between the group companies. The cash pool was structured in such a way that all funds received by the group companies were collected in a target account of the pool leader. The pool leader in turn paid the invoices addressed to the individual group companies, making payment directly to the respective creditors on corresponding instructions. This practice was carried on for more than ten years.
The German High Court found that the third-party payments in this case were not incongruent, as they only represented a minor deviation from the contractual agreement. At the same time, the High Court upheld the general principle that third-party payments in cash pool systems without corresponding (tripartite) contractual obligations remain incongruent payments.
No incongruence if…
The German High Court justified the (exceptional) assumption of congruence with the fact that the third-party payment would not objectively give rise to the suspicion that the group companies were in crisis due to the debtors’ practice over many years. Specifically, he stated that
- the payment system had been in place for more than 10 years, long before the crisis;
- the pool manager had acted as paying agent for more than 10 years and thus effectively acted as a group bank;
- there were no delays in payment;
- the payments were made by the pool leader irrespective of whether the internal clearing accounts were debited or had a credit balance;
- the pool leader had to ensure the solvency of the participating companies on the basis of the capital maintenance regulations and the possible subordination of shareholder loan claims for each payment at least in part;
- the cash pool did not accelerate the insolvency of the group.
In summary the pool leader acted as an internal bank in a system which had functioned for years without any abnormalities. The Court’s reasoning for allowing the exemption and thereby rejecting the claim of voidability is not completely clear. It seems that the decisive factor for the assumption of congruence was probably that it was always the same company that paid instead of the company that just happened to have enough liquidity (as had been the case in previously decided cases).
But: how can a creditor know?
Ultimately, creditors can only assess to a limited extent whether third-party payments qualify as congruent or incongruent. The reason is that most of the circumstances the High Court took into account cannot or only insufficiently be determined from the outside.
Thus, creditors who have a permanent business relationship with the debtor may recognise that it is being paid through a payment system that has been established and operated for years, in which payments are always made by the same company and there are no delays in payment. However, creditors will generally not be able to tell whether the pool leader is actually just managing an insufficient amount of cash, thereby covering up any lack of liquidity and masking the creditworthiness of pool companies.
Creditors would only be able to recognise this if the High Court either waived all internal circumstances and/or recognised third-party payments by a pool leader as a commercial practice or custom. In the present decision, however, the High Court (again) expressly rejected the latter.
It doesn’t matter whether the creditor knew…
The statements of the High Court strongly indicate that it is still not relevant for the voidability of a payment whether the creditor was able to detect the incongruence. This is in line with standing case-law of the High Court. It also makes it very likely that the present decision will remain an exception rather than becoming a new rule.
In this respect, creditors should continue to sound the alarm bell if they receive payments from different group companies (and/or payments are made late or only partially or in instalments). If you have any questions, please do not hesitate to contact us!