Acquisition finance is typically arranged and provided/underwritten by banks in the first place. In the case of LBOs, it is also common to have different financing layers (senior, mezzanine/second lien). Replacing parts of the bank financing after closing by high-yield bonds has become a common feature in the case of bigger LBOs. In these structures, various layers of bonds are often issued that are structurally subordinated to facilitate a restructuring under the control of the senior lenders in the event that the business does not develop as expected. In the case of smaller LBOs, unitranche financings provided by debt funds and not banks have become more common. Direct lending funds are active in the market but due to the fact that lending requires a banking licence in Germany, activities of debt funds are still limited. Even though bigger corporates refinance their acquisitions through the issuance of bonds or loan notes (Schuldscheine), it is very common that such financing instruments are only put in place after closing of an acquisition and the acquisition is closed on the basis of a bridge loan.
In the case of bigger transactions, international banks (in particular from France, the UK and the USA) play an important role and syndicates that only include German banks are very rare. As most of the major private equity investors still have their financing teams in London, it is also very common that financings for bigger LBOs are arranged out of London, while corporate borrowers arrange their financings via Frankfurt.
M&A volume with German involvement has decreased in 2019 with volume down by 25 per cent compared to 2018. This will likely have been the consequence of international political tensions, instabilities in international trade relations caused by the US government and the general perception that asset prices are inflated and the next financial crisis is looming as a consequence of the monetary policy of the European Central Bank, with negative interest rates. However, the volume was, with USD171 billion, still close to the ten-year average. Given that most German corporates are active internationally, approximately 40% of the deal volume is accounted for by outbound transactions. Inbound transactions account for 32% of the market and the remaining 28% are domestic transactions. Financial sponsors account for approximately 25% of the market volume (Market data from Dealogic/J.P. Morgan).
Generally, loan agreements are governed by German law (except in the case of LBOs; see below). English law is only relevant in the case of larger LBOs as the debt teams of most private equity investors are still placed in London and they arrange all their LBO financings for acquisitions all over Europe out of the London market, which gives the sponsors the ability to push through their respective standards and use their existing banking relationships in a very efficient manner. The question of the governing law is not a matter of the acceptance of German law as the governing law in the market and most of the biggest loans raised by corporate borrowers are governed by German law, even though they have been syndicated to more than 60 banks worldwide in some cases. Thus, the dominance of English law that has developed in many other countries in Europe does not extend into Germany. Consequently, the Loan Market Association (LMA) published a German law-governed precedent a couple of years ago.
However, it has to be noted that due to certain judgments from the German Federal Court (Bundesgerichtshof) – according to which, upfront fees may not be validly agreed under agreements that constitute general business conditions – fee letters are these days often governed by English law or Luxembourg law if there is a link to these jurisdictions, which is normally the case for syndicated loans.
Like elsewhere, the documentation standard in Germany is dominated by the LMA precedents. Traditionally, the drafting style for legal documents in Germany was concise. This has changed since the mid-1990s, when Anglo-Saxon documentation style became the international standard. There are only minor differences between the English law and the German law investment grade loan agreements recommended by the LMA and subject to the credit quality/post-acquisition leverage, the documentation will include various elements from the LMA leveraged loan documentation.
The common language for the predominant part of syndicated loans is English. Only on rare occasions do clients require German language loan agreements; eg, where the borrower is a less internationally oriented company with little international exposure or where the market is deep enough to raise the relevant funds from German banks or international banks acting out of Germany. In certain instances, German language has also been chosen by borrowers to create an additional barrier with respect to the trading of their loans.
The market is currently a borrower market and it is therefore quite common that borrowers' counsel prepare the first draft of the loan documentation, as in the case of LBOs that involve US/UK sponsors. It is also common that the validity/enforceability opinion is issued by lenders’ counsel, and borrowers’ counsel only issue a capacity opinion. In the case of very big corporates, the opinions of borrowers’ counsel are often replaced by an opinion from the general counsel or at least certain aspects of the capacity opinions (ie, due authorisation) are only covered by a statement from the general counsel. If guarantees are obtained from foreign subsidiaries, very often the entire opinion with respect to those subsidiaries is provided by the local counsel engaged by the borrower.
The principal elements of the financing structure are senior facilities (with various tranches with different maturities) to finance the purchase price and a working capital line (with an ancillary option) for the target’s working capital financing, and, as the case may be, letter of credit needs.
Maturities available for senior loans vary from two to five years, often divided into two or even more tranches with different maturity profiles (bridge v permanent financing) in the case of loans for strategic/corporate investors, whilst in the case of LBOs, financing packages will comprise five, seven and even nine-year tranches, where the seven and nine-year tranches are mostly funded by institutional investors and less so by banks.
With respect to covenant-lite and Term Loan B structures, please see 3.1 Senior Loans of the UK chapter. The same structures/developments can be seen in the German market in the case of more substantive LBO financings.
Depending on the risk profile of the acquisition, the senior loan financing is supplemented by second-lien loans, mezzanine loans, PIK financings (payment in kind, where interest is capitalised and deferred until final maturity) and/or high-yield bonds. Lenders are often structurally subordinated.
In the case of crossover corporate borrowers, hybrid bonds/hybrid loans have been more often used in the last couple of years to support an acquisition finance structure as they do not count as debt when it comes to the calculation of financial covenants, provided these are properly drafted. On the other hand, this kind of capital can be easily returned after a couple of years following a substantive acquisition when financial ratios are back to normal.
Where the timeline for the acquisition does not allow for full syndication before closing, the arrangers may underwrite the loan and bring it up for syndication after the acquisition has been completed. Alternatively, there may be a bridge financing with a maturity of 6 to 12 or even 24 months to be taken out by the final loan or a combination of loans, loan notes, bonds and additional equity. A bridge will have an exploding interest rate structure that significantly increases the cost of the loan if the take-out schedule is not met and participation fees are often staggered over time and calculated on the basis of the outstanding commitments at the relevant time to create an additional incentive for a timely take-out. Often, maturity of a bridge is only 12 months, with the borrower having the right to demand an extension two times for six months against payment of an additional fee (12 + 6 + 6).
Bonds are usually not used for the initial funding of acquisitions but only to (long-term) refinance, in particular, bridge loans. There are signs that bonds may become cheaper than loans, which should give bond financing some advantage in an environment that has predominantly relied on bank financing (except for very large corporates and large LBOs). The vast majority of the so-called German Mittelstand entities have also relied on bank financing in the case of large M&A transactions. Whether this will change in the future will depend on the lending policy of the banks. The market has said in the past that banks would shrink their books but so far there are no clear signs that this will happen.
Among corporate borrowers, so-called Schuldscheine (loan notes) have become very popular during the last couple of years to cover financing needs, including the refinancing of bridge loans incurred in connection with acquisitions. Legally, Schuldscheine are loans and not securities, and they cannot be traded on an exchange and no prospectus is required in connection with their placement. This used to be a very German-specific product with a very short documentation that was in particular placed with savings banks and insurance companies by first-class borrowers but these days international banks and other investors also invest in Schuldscheine and requirements as to credit quality have become less strict. As a result of the international investors' and non-German borrowers' increased interest in the Schuldschein market, the LMA has developed a Schuldschein master documentation along the line of the standards that had been established in the market. However, given the history of the product, it is unlikely that Schuldscheine will be used in the context of LBOs.
US private placements (USPPs) are seen in the German market but not in the context of acquisition finance and more in the case of long-term asset finance such as rolling stock and similar infrastructure assets.
If there are multi-layered financing instruments (senior loans, second lien, mezzanine, high-yield bonds), it is common to have intercreditor agreements that follow in their core architecture the LMA precedents and the UK precedents outlined in detail in 4.1 Typical Elements of the UK chapter. In essence, the German market has adopted UK practice for larger financings and security pooling agreements developed by the German banking market, which are mainly focused on the joint administration of collateral for a variety of creditors, are used only in the case of German club deals (which are not very common in the context of acquisition finance).
Irrespective of the use of an LMA-style intercreditor agreement or a German-style intercreditor agreement, it will, in most cases, be necessary that the intercreditor agreement contains a so-called parallel debt provision. This is also the case where the intercreditor agreement is not governed by German law but the collateral package involved a pledge governed by German law. For details, see 5 Security.
In the backwash of the financial crisis, some German corporates fell into financial difficulties and had to rearrange their debt financing through secured loans and secured bonds. In these cases it has become common that loans and bonds are secured on a pari passu basis (as opposed to the bank/bond financings in the case of LBOs where the loan element is in most cases senior to the bonds) and, as a consequence, voting arrangements between bank lenders and bondholders have been discussed in depth and "one dollar, one vote" has become the commonly chosen structure in these cases. UK-style intercreditor agreements are adopted accordingly to reflect this and the pari passu ranking between the claims of lenders and bondholders. As far as LBOs financed by a combination of bank debt and high-yield bonds (HYBs) are concerned, the market follows the UK precedents as these deals are mostly arranged out of London.
One additional feature of intercreditor agreements that has developed in the market and which is worthwhile to note is that not only the security in rem is governed by the rules of the intercreditor agreements but also all guarantees (i) to ensure equal satisfaction of all secured creditors and (ii) to prevent the enforcement of guarantees, in particular by single bondholders, from interfering with an orderly workout and giving them a holdout potential. This is not standard but should be carefully considered.
Besides the lenders, it is also common that hedging counterparties are party to the intercreditor agreements to share in the collateral with the other lenders. However, in cases where only lenders can become hedge counterparties, there have been cases where the hedge counterparties had no voting rights under the intercreditor agreement to avoid, inter alia, difficulties when it comes to the question with respect to which amount a hedge counterparty may vote. However, given that a tendency has developed that some banks only lend but do not provide hedging products, this may no longer be an appropriate structure in the future.
In an LBO, lenders would commonly expect to obtain collateral over the shares in the main group entities (including over the shares of the companies forming the holding structure typically set up by the investor) and asset collateral from all the main entities (with the aim that between 75% and 90% of the asset value in accessible countries (ie, taking collateral over assets of subsidiaries or shares in subsidiaries in countries such as China, India or Russia is not common and is normally avoided) is subject to collateral) over their core assets, such as accounts, receivables, machinery, inventory, real estate and intellectual property rights. However, there is no "one size fits all" approach and collateral packages are carefully agreed on a case-by-case basis, taking into account the practical value (eg, one may have to agree a limitation language that in many cases may severely reduce the value of the relevant collateral in the hand of the lenders) of the collateral and the cost to create and administer it. As a general rule, one may say that in LBOs, asset collateral is very common, whilst in the case of acquisition financings for corporates (if secured at all), only the major subsidiaries and bank accounts may be pledged (and guarantees provided by major subsidiaries).
Moreover, it should be noted that borrowers will have a tendency to avoid to grant mortgages (this can also trigger tax implications; see 9.2 Withholding Tax/Qualifying Lender Concepts) given the cost involved and security over intellectual property rights, which may often trigger the requirement to register the security agent with the relevant registers.
Accessory/Non-accessory Collateral – Need for Parallel Debt
The security rights available are land charges (Grundschulden, Hypotheken), security transfers (Sicherungsübereignung), security assignments (Sicherungsabtretung) and pledges (Pfandrechte). Whilst pledges and Hypotheken (which are not common in acquisition finance) are accessory in their nature (ie, the secured party has to be the holder of the secured claim), all other collateral can be held by a security agent acting as trustee for all secured parties. To achieve commercially the same effect and to use, in particular, the pledge over shares and bank accounts as collateral for bonds and loans with a fluctuating group of lenders, it is common (but not yet court-tested practice) to create an independent claim of the security agent (so-called parallel debt), which is then secured by the pledge and through the security agent the lenders/bondholders take benefit from the pledge.
In respect of rights and participations in companies, a pledge is the appropriate form of security. ¬
Shares in limited liability companies (Gesellschaft mit beschränkter Haftung, or GmbH) and partnerships are treated like rights and their pledge follows the rules on the pledge of claims with specific modifications with respect to form requirements (notarisation required; see below) in the case of a GmbH. Shares in stock corporations are normally certificated and in such case, the shares are pledged following the rules regarding the pledge over movable assets; ie, in addition to the pledge agreement, possession in the shares has to be transferred, which is done by a notification of the custodian bank.
Legally the shares in a company that shall serve as security could also be assigned to a security agent. However, an assignment is generally not advisable as the lenders will then be treated as shareholders with the consequences that the rules on equitable subordination would apply (see 7.1 Equitable Subordination Rules). A pledge will avoid this problem. Moreover, such transfer could trigger real estate transfer taxes if the relevant entity holds real estate.
Pledges over shares in a limited liability company need to be notarised (arguably in front of a German notary; sometimes notarisation is made by Swiss notaries but whether this is valid is unclear) and in such case the share pledge agreement has to be drafted without cross-references to any other finance documents to avoid the need for these to be notarised. The notarial fees are set by statute, cannot be negotiated and are calculated on the basis of the value of the transaction. They can be significant (up to approximately EUR65,000).
Inventory can be pledged or transferred by way of security to a security agent. A pledge on movable property is, however, not common as it requires that the relevant property is handed over to the pledgee. This does not work, of course, where the pledgor needs to continue to use the asset for its business. To be valid, the transferred assets have to be specified to a detail that would enable a third party that has only the relevant transfer agreement to identify the assets that are subject to the transfer. If the relevant assets cannot be identified by asset lists (eg, in the case of machinery or vehicles, each machine or vehicle may be identified by a machine or vehicle number) or in the case of a fluctuating pool of assets, it is common to identify the area in which the assets are located (eg, all assets in the warehouse "xy").
Rights under a bank account can be assigned to a security agent or pledged. A pledge only becomes effective if it is notified to the account bank. As it has certain advantages in the event of insolvency of the borrower (lower haircut for the benefit of the insolvency estate), it is common that accounts are pledged. As the general business conditions used by German banks provide for a pledge in favour of the bank, it is necessary that the account operating bank waives its pledge to ensure that any pledge in favour of the lenders is first ranking. Parties cannot agree on the rank of a pledge with respect to a right such as claims under a bank account but the ranking is a question of priority in time. Therefore, previously agreed pledges have to be waived to achieve the required rank.
Given that a pledge of claims under German law only becomes effective if it has been notified to the third-party debtor (see above under "Bank Accounts"), which is not practicable in most cases, collateral over receivables is taken by way of assignment. If the receivables comprise claims against natural persons (eg, assignment of receivables from deliveries by a retail company), certain measures (use of a data trustee) have to be taken to comply with the very strict (directly applicable) European data protection rules.
Intellectual Property Rights
All sorts of intellectual property rights (patents, trade marks, internet domains, etc) can be subject to collateral. Such rights are either pledged or assigned. This requires a careful analysis with respect to the kind of rights and whether they are registered. Details would go beyond the scope of this chapter.
Germany has a land register system and transfer of title to real estate and any form of land charges or other right in rem with respect to real estate requires (except for very specific exceptions) registration. Therefore, due diligence with respect to real estate is very efficient and makes real estate an easily accessible collateral. However, in the context of acquisition finance, mortgages are not commonly used given the cost involved (except in the case of real estate companies). Land charges need to be established in notarised form and need registration in the land register to be valid. Land charges are usually in immediately enforceable form. That means enforcement does not require a judgment against the landowner, which makes them a very efficient form of collateral. Making them immediately enforceable may, however, involve substantial notarial fees.
Movable Assets (other than Inventory)
Whilst ships and aircraft are registered and can, under German law, be mortgaged like real estate, other movable assets (such as trucks or trains) can only be pledged (which requires transfer of possession and is therefore not practicable) or transferred by way of security to a security agent, or, in the case of a single lender, the lender. The same rules apply as with respect to inventory.
As set out in 5.1 Types of Security Commonly Used, the pledge over shares in a GmbH requires notarisation. In the case of the creation of land charges, notaries also have to be involved. The same is true in the case of ships and aircraft. Otherwise, no specific form requirements have to be complied with, provided that written form should be complied with.
Collateral provided by a German corporation for the benefit of a parent or sister company (so-called upstream or cross-stream collateral) is subject to certain restrictions. The same applies to upstream or sidestream guarantees and suretyships. The reason for this is that German corporate law provides for strict rules for the maintenance of the capital of a corporation to protect creditors of that corporation against any attempt by the shareholders to abuse the capital for their own creditors.
German law does not set forth any sort of corporate benefit test or whitewash procedure. In relation to a GmbH, documentation on upstream or cross-stream security will therefore routinely contain so-called limitation language, which, in essence, provides that the secured party may only benefit from/enforce such security in an amount equal to the net assets of the relevant corporation. Net assets are (in simplified form) calculated as the amount of the assets of the company (as shown in its balance sheet drawn up for such calculation) after deducting the amount of its liabilities and its registered capital. Without such limitation language, courts may hold such collateral void and at least the managing directors of the relevant entity and the parent company run the risk of personal liability. It is also widely seen that, in addition, it is agreed that the enforcement of upstream/sidestream security may not deprive the grantor of the upstream/sidestream security of any liquidity it requires to stay out of insolvency. The same rules apply in the case of limited liability partnerships where the general partner is a GmbH, which is a very common structure in Germany. There have been recent court decisions that have been interpreted in a manner whereby the net asset test has to be calculated as of the time of granting the security and not as of the time of enforcement. However, better reasons support the view that the time of enforcement is decisive. Legal uncertainty may lead to situations where parties spend substantial time on the negotiation of the appropriate limitation language. Given the risk of personal liability of the managing directors of the pledger, parties should carefully look into these matters on a case-by-case basis.
In relation to a stock corporation (Aktiengesellschaft, or AG) – the same rules apply to a limited liability company by shares (Kommanditgesellschaft auf Aktien, or KGaA) and a SE (Societas Europaea) – the capital maintenance rules are even stricter. Here, upstream or cross-stream security is entirely forbidden as an AG may only distribute dividends to its shareholders. The only exception is where the AG has entered into a domination agreement with its parent company. Under a domination agreement, the parent company is obliged to compensate losses that the AG suffers for whatever reason. Before entering into a domination agreement, the management of an AG must satisfy itself that the parent will be able to provide loss compensation. This may not be the case where the parent is a highly leveraged acquisition vehicle. Also, the domination agreement entails a certain risk for the parent/acquisition vehicle to become insolvent. If the acquired business becomes loss-making for whatever reason, the acquisition entity has to compensate such losses by payments to the dominated (target) entity in cash and such payment obligation may not be waived or deferred. With respect to the restrictions on financial assistance, see 5.4 Financial Assistance.
Finally, from a tax perspective, it will very often be necessary that the borrowing entity pays a kind of guarantee fee to those group entities that provide upstream/sidestream collateral/guarantees. The relevant tax issues need a careful analysis on a case-by-case basis to avoid any hidden distribution from a tax perspective.
There are (except with respect to the acquisition of shares by a managing director) no rules prohibiting financial assistance with respect to the acquisition of shares in a GmbH, other than the capital maintenance rules as set out under 5.3 Restrictions on Upstream Security.
In the case of the acquisition of shares in an AG, KGaA or a SE, however, the rules prohibiting financial assistance are very strict. Generally speaking, an AG (or KGaA or SE) is not allowed to support in any way the financing of the acquisition of its shares. This makes it very difficult, if not (in most cases) impossible, to access the assets of a target AG to support the acquisition financing. In particular, an AG is not allowed to provide an upstream guarantee or an upstream loan to the acquisition vehicle if this guarantee or loan is used to secure or repay the purchase price for the shares respectively.
There is some dispute over whether an upstream loan may be granted in connection with the refinancing of the acquisition debt. Technically, the refinance debt will not have served to acquire the shares. This technique is often used, but the residual risk that it is in violation of financial assistance rules (which may render the relevant agreements void) is hard to deny.
Another possibility to access the assets of a target AG in support of acquisition debt is a debt push-down by a downstream merger (or upstream merger of the target into the acquisition vehicle) or payment of a (debt-financed) dividend by the target AG. Such special dividends are not subject to any restrictions and downstream mergers are also generally possible. They are also not prohibited if the debt to be assumed by the surviving target AG stems from the acquisition of its shares. However, this structure is rarely used because in most circumstances the debt push-down will negatively affect the financial structure of the target in an unacceptable way and may also have adverse tax consequences. Also, the downstream merger is virtually unavailable if the target company is listed, as this will normally trigger fierce resistance from the remaining shareholders.
There are no other restrictions.
Enforcement of collateral generally requires that the secured claims have become due and payable; ie, it is not possible to agree that collateral may be enforced just because a default has occurred under the secured loan agreement without the secured loan having been accelerated.
Moreover, at least with respect to pledges, German law does not allow for provisions of the forfeiture of the collateral for the benefit of the secured party or the right of the secured party to freely sell the collateral unless by way of a public auction unless the asset that serves as collateral is traded on an exchange so that there is a form of objective determination of its value.
Pledges have to be realised by way of public auction, whilst in the case of other collateral, there is more flexibility as to how the realisation process can be agreed in the relevant collateral agreements.
As most collateral is only realised in an insolvency, it should be noted that in the event of insolvency of the party providing the collateral, the realisation is handled by the receiver and approximately 9% of the proceeds realised are for the benefit of the bankruptcy estate.
Moreover, the realisation of collateral will in many cases trigger value added tax that has to be deducted from the realisation proceeds.
German law provides for two forms of a promise to pay a third-party obligation, the surety (Bürgschaft) and the guarantee (Garantie). Whilst there are very detailed provisions with respect to surety in the German Civil Code, there are no specific rules with respect to guarantees. The main difference between the instruments is that a surety has an accessory nature; ie, it automatically ceases to exist with the repayment of the secured claim. Moreover, the transfer of the secured claim automatically leads to a transfer of the rights under the surety to the assignee. This is all different in the case of a guarantee, which exists independently from the guaranteed obligation. The grantor of a surety may therefore raise all objections the debtor of the secured claim may have against the creditor, whilst the guarantor has no such right.
However, in practice, guarantees are the most common form of credit enhancement in connection with the financing of group entities and sureties are only used in domestic transactions or if the party that is supposed to give the guarantee/surety is a natural person.
There have been court rulings that have called into question whether a non-bank may grant a first demand guarantee and therefore it is very common that guarantees are not structured as guarantees payable on first demand.
With respect to guarantees and sureties, the same restrictions apply with respect to upstream or sidestream guarantees and financial assistance as in the case of any security (see 5.3 Restrictions on Upstream Security and 5.4 Financial Assistance).
To avoid adverse tax consequences, it can become necessary that the guarantor receives a guarantee fee. This has to be carefully analysed on a case-by-case basis. In any case, a guarantee is valid even if – from a tax perspective – a guarantee fee should have been paid but was not paid. Moreover, there has been a discussion as to whether non-payment of a guarantee fee would constitute an infringement of capital maintenance rules but the prevailing market view seems to be that this is not the case.
In principle, all claims for repayment of shareholder loans or any comparable transaction (eg, deferral of payment of purchase price with respect to the supply of goods by a shareholder beyond customary payment terms) are subordinated in a company’s insolvency.
Exceptions apply, inter alia, for loans granted by shareholders who (i) do not participate in the management of the company and who hold an interest of only 10% or less in the company’s capital, or (ii) acquired the shares in order to rescue the company from a financial crisis.
However, as the rules on equitable subordination only become relevant in the event of insolvency of the borrower and before insolvency the borrower is, under such rules, not hindered from making any payments on a shareholder loan, it is common in the case of complex financing structures that the shareholders agree with the other lenders that any shareholder loan shall be subordinated and generally no payments shall be made on the shareholder loan, except for interest, as long as any other financing instruments are still outstanding.
In a few cases, the rules on equitable subordination have also been applied by the courts with respect to lenders that were not (directly or indirectly) shareholders but interfered with the management of the borrower as if they were shareholders. There is more discussion about this question among legal scholars than practical cases. Lenders should be aware of this risk in case a loan has to be restructured and lenders consider forcing the borrower to appoint a new management. There may also be cases where the agreement of certain undertakings in a loan agreement may be seen as critical.
In the case of shareholder loans and comparable transactions, all repayments made by a company within one year prior to the filing for insolvency proceedings can be challenged by the company’s insolvency administrator.
Lenders generally have a claw-back risk with respect to any payments or security received at a time when they knew that the borrower was in a financial crisis/close to bankruptcy. The claw-back period is four years in most cases.
If lenders finance in a crisis, they may also face the risk that they are held liable by other creditors in the event that the borrower becomes insolvent, with the argument that lenders knew that the borrower was not financed properly; ie, lenders only extended the time to insolvency. So, in the case of financing in a crisis, lenders should make sure that following the financing, the borrower has a positive continuation prognosis to avoid/minimise any claw-back and lender liability risk in case the borrower should become insolvent. In the relevant cases, lenders customarily receive a form of independent business review (commonly referred to as S6, which is the relevant standard for such IBRs applied by German accountants) prepared by an accountancy firm or certain other specialised advisers to document that they could assume that the borrower would be able to overcome the crisis.
Provided the loan agreement does not restrict the buy-back of own loans (which has normally been the case since the global financial crisis, at least in the case of LBO financings), there are no specific restrictions under German law dealing with debt buy-backs. It should be noted that if debt is bought by a shareholder or an affiliate of a shareholder of the borrower, there are good arguments under German law that such shareholder may not vote in the syndicate with respect to loan portions held by it even if there are no relevant disenfranchisement/non-voting provisions in the loan agreement. In the case of a buy-back through a shareholder, the relevant claims will also become subject to the equitable subordination rules set out under 7.1 Equitable Subordination Rules.
In the case of a debt buy-back of bonds, certain procedures have to be complied with if the buy-back is not made over the exchange but through a public offer.
Germany does not provide for any stamp taxes or the like with respect to loan agreements or collateral agreements.
Germany does not impose a withholding tax with respect to the payment of interest on loans as long as the loan has no equity component, which has to be considered in the case of hybrid loans that participate in the profits. However, there is an exception with respect to loans secured by German situs real estate. Here also, a foreign lender that is otherwise not a tax resident in Germany has to file a tax return in Germany with respect to the relevant interest income and tax authorities can order that the borrower is withholding relevant tax payments. To avoid the administrative and, as the case may be, financial burden (tax gross-up) consequences, parties very often agree that if there is also other collateral, the security over real estate shall not serve as collateral for the claims of those lenders that are not tax resident in Germany.
Under German thin cap tax rules, interest may not be tax deductible under certain circumstances. The rules are very complex and it would go beyond the scope of this publication to set out the provisions in detail. In any case, careful tax planning is required, in particular with respect to the funding of a German entity by way of shareholder loans from a foreign shareholder.
Apart from the control of foreign investments under the Foreign Trade Regulation (Aussenwirtschaftsverordnung), under which the Federal Ministry of Economy (Bundeswirtschaftsministerium) may prohibit or restrict the acquisition by a foreign investor if and to the extent this is required to safeguard the public order or national security, the acquisition of a business in Germany is generally not subject to any specific legislation. However, there are specific restrictions with respect to the acquisition of banks and insurance companies, and with respect to the telecommunications and media industry.
The leveraged acquisition of banks and insurance companies presents particular challenges. This is less the case where the acquirer is a strategic investor pursuing a long-term interest and not focused on possible exit scenarios. Also, the fit and proper test applicable to a purchaser of a 10% or larger interest in a regulated entity is easy to satisfy if that purchaser is itself a regulated member of the industry. The German supervisor of the financial and insurance industry, BaFin (Bundesanstalt für Finanzdienstleistungsaufsicht), which now supports the European Central Bank in decisions about the acquisition of a significant interest in a bank in Germany, has traditionally been quite hesitant to approve the acquisition of a bank or insurance company by a private equity fund. The concern was based on the expectation that the high leverage of the acquisition debt might harm the financial stability of the acquired business. In addition, as mentioned above, a short investment horizon was seen as being detrimental to a long-term stable development of the business in a sensitive environment like the financial and insurance markets.
Acquisitions of shares in listed targets representing less than 30% of the aggregate outstanding shares do not present particular problems because such acquisition does not trigger any requirement to launch a mandatory takeover bid. However, if the ownership percentage in the voting held by a party crosses 3, 5, 10, 15, 20, 25, 30, 50 or 75%, it has to notify the relevant company and BaFin accordingly.
Shares can be acquired in bilateral transactions or via the stock exchange. The environment is fundamentally different if the purchaser intends to purchase more than 30% or even potentially all of the outstanding shares. An acquisition of 30% or more of the shares triggers the requirement to make a mandatory takeover offer.
Any public offer (including a takeover offer) must be accompanied by proof that the bidder has the funds available necessary to settle the offer if accepted by 100% of the shareholders. Unlike other European jurisdictions (eg, France, Italy or Spain), a certainty of funds needs not take the form of a bank guarantee or similar confirmation. In Germany, it is sufficient that an independent financial institution firm confirms to BaFin (such confirmation is made public in the offer document to be published by the bidder) that the necessary funds are available to the bidder. The bidder may secure the funds necessary in the form of available cash, a firm financing commitment letter or a fully documented loan from a creditworthy financial institution or bank syndicate. The latter is the usual way and such loan agreement will contain certain funds language to prevent lenders from denying funding for any reasons that are not under the full control of the bidder as otherwise the relevant financial institution firm will not be in a position to issue the relevant confirmation that funds are available. As the relevant financial institution firm issuing the letter to BaFin can be held liable if its confirmation proves to be wrong and the bidder does not fund such financial institution, the relevant financial institution firm issuing the letter to BaFin will demand that lenders give a commitment as firm as possible.
In order to enable a majority shareholder to acquire all of the shares in the target company, German law provides for a squeeze-out of minority shareholders against adequate cash compensation, if the majority shareholder has acquired at least 95% of the share capital of the stock corporation (in certain structures, the threshold is only 90%per cent). The squeeze-out rule applies to all stock corporations, whether listed or not. According to court rulings, the cash compensation may not be below the market value of the shares. Independent auditors appointed by the court must review the adequacy of the cash compensation and the majority shareholder must provide a guarantee of a financial institution guaranteeing the payment of the cash compensation. At the motion of a minority shareholder, the adequacy of the cash compensation will be determined in special court proceedings (Spruchverfahren), which do not delay or prevent the execution of the squeeze-out.