Germany: Corporate Finance: Leasing

Financial & Economical Aspects Of Inbound Cross-Border Leasing In Germany
Last Updated: 19 October 2001
Article by Ulrich Eder

New German tax reform acts result in a drastically decrease of municipal tax income during the next years. This results in the urgent need for new municipal income sources. The business of cross-border leasing in Germany concentrates on municipal companies and municipalities. Private sector industries are reluctant due to the lack of suitable assets.

German municipal companies face tough competition and are in a process of privatization and globalization. There is a strong need to optimize financing structures and to gain windfall profits by utilizing innovative leasing transactions. Over the last five years cross-border leasing transactions have become part of municipal business and permanent discussions.

Tram deals which closed in 1995 through 1998 (lease-in-lease-out) have been based mainly on standardized transaction descriptions and were treated as "copy transactions". The design as well as the negotiation of present lease-to-service-contracts for waste-to-energy or waste water treatment-facilities and pipelines have to be tailor-made according to the needs and requirements of municipality, investor and banks.

  • Requirements For Formal Tender In Germany
  • German municipal companies and municipalities are bound to the principle of economic behavior. With regard to the identification and selection of participants for the leasing transaction, the formal tender requirements have to be met.

    A formal tender is required under German law, if:

    The municipal body qualifies as a public client ("öffentlicher �Auftraggeber, § 98 GWB")

    Certain minimum amounts have been exceeded -("Schwellenwerte, § 100 Abs. 1 GWB")

    The agreement covers a public order &("öffentlichen Auftrag, § 99 GWB")

    No special exception is fulfilled ("Bereichsausnahmen, § 100 Abs. 2 GWB")

     

  • Economic Risks Of The Tender Procedure
  • On February 1, 2001 the new "Vergabeverordnung" came into force. Sect. 13 of this regulation establishes an obligation on part of the municipal body to inform the defeated bidder in writing at least 14 days before the agreement is valid and binding. If this requirement is not met, the contract will be invalid and void.

    It is general practice for German cross-border leasing transactions to formally select the banks in such bidding process as well as to have such procedure for the selection of the trust / investor. Needless to say, this does not mean that the arranger can lean back, relax and wait for the bidding offers. Instead, the formal tender process is integrated in the whole process to avoid delays.

    It is questionable, whether there exists a tender obligation with respect to the identification and selection of an arranger. If the arranger contract would be null and void under the new regulation, the arranger's fee would not become due. On the other hand the obligations agreed upon on part of the arranger may not be effective either. This may become relevant with respect to the obligation to release the lessee from breakage costs. For this particular case it might be necessary to agree on such release obligations in a separate and independent agreement.

    However, according to the dominating legal discussions a contract entered into by the municipality without a required tender procedure is valid.

  • Economics Of The Transaction
  • Cross-border leasing transactions do not have the objective to finance the acquisition or production of assets and consequently, do not compete with domestic leasing transactions or municipal credits. Therefore, from the point of view of some governmental bodies leasing transactions are beneficial and economical, even if only a small net profit value benefit can be achieved.

    However, it should be realized that an actual minimum amount should be met to make it reasonable to enter into such long-term relationship with an U.S. investor. Even though the U.S. tax framework appears to be stabile and solid under the Bush administration, the sharp decrease of the interest rate may seriously harm the cross-border leasing industry.

    In times of low interest rates it should be the most urgent matter for the arranger to find ways and means to maximize the profitability of the transaction to perpetuate the interest of German municipalities and municipal companies in cross-border leasing. Above all, the expectations of the investor regarding his yield should be recalculated and reassessed taking into consideration the lower market interest rates.

  • Risk Allocation Between Lessee And Lessor
  • It is accepted by U.S. parties that the investor bears the risk that the structure of the transaction will provide the expected U.S. tax benefits. It is accepted by the German lessee that he bears the indemnification risk for any loss of those benefits in case of a breach of specified representations or failure to comply with covenants. From the perspective of a German tax counsel representations and covenants should not address an economic compulsion due to

    German taxes arising as a result of executing or not executing the purchase option (income tax, solidarity tax, trade income tax, VAT, real estate transfer tax) an unreasonable determination of the purchase option price or the provisions of the service contract.

    Permitted acts have to cover:

    German tax issues disclosed to the investor (tax ruling papers, VAT reclaim procedure, tax handling during the lease period)

    Structural circumstances (e.g. previous German leasing financing, co-ownership in the asset between city and municipal company)

    Trigger events agreed in the operational documents (springing servitude, springing L/C, springing pledge of the equity PUA)

    Although the lessee will have to accept the indemnification of all parties for increased costs as a result of withholding taxes during the lease term, there should be no obligation for the lessee to cover any withholding tax for closing date payments.

    If an obligation to indemnify other parties falls due, the contracts have to cover provisions regarding principles to give evidence for any tax losses, obligations to cooperate and restructure the transaction, contest-clauses and the right for a burdensome buyout by the lessee.

  • Risk Allocation Between Lessee And Banks
  • Dealing with banks in cross-border leasing has become much more complicated during the last two years. On one hand this is a result of increased structural requirements of lease-to-service-contract transactions. On the other hand the banks noticed the aggravated financial situation of the municipalities and the dramatic desire to privatize even essential parts of the municipal companies. In addition, we have to focus on two substantial changes of the banking world which will become effective in the near future or are already in effect.

    A. The Basel II Proposal

    During the last years the Basel Committee on Banking Supervision has managed to amend the 1988 international capital adequacy framework for banks. Due to some delays in the decision making process the final version will come into effect not before 2005. Under the new capital adequacy framework it can be expected that municipal companies and even municipalities will be subject to rating classifications, the costs for credits for some municipal entities will increase, a restructuring respectively privatization of municipal companies which had entered into leasing transactions in the last years will be more complicated and more expensive.

    As a result it has to be stated that the zero-weighting for municipal credits cannot be remained during the full lease term. It can be expected that some banks will sustain increased costs for their credit portfolio.

    B. The Big Landesbanken Rating Meltdown

    In contrast to private banks, the public sector banks were subject to an unlimited liability guarantee, to the Guarantor’s liability and the liability assumed by a public sector body for the debts of a corporation incorporated under public law ("Anstaltslast" and "Gewährträgerhaftung").

    By the resolution of July 18, 2001, the European Commission and the Federal Republic agreed in a historic compromise, that unlimited guarantees for public sector banks would be abolished by a transitional agreement of four years. The Brussels compromise will be transformed into German law by the end of 2002.

    "Grandfathering I"

    "Grandfathering II"

    Full privatization

    Nothing will change during the aggregate life of lending operations, which have been concluded up to July 18, 2001

    Loans, which are issued up to July 18, 2005, will be subject to the guarantees matured until the end of 2015

    All guarantees will be abolished for business, which has been concluded from July 18, 2005

    Due to this development, Landesbanken are focussed with certain problems to refinance any time period after 2015. In addition, it has to be considered, that they might have the burden of increased costs after 2005.

  • Risk Allocation Between Lessee And Lawyers
  • The German lessee needs a sufficient opinion of the lawyers involved in the transaction above all regarding these issues:

    • Sect. 544 German Civil Code (BGB), Sect. 34 Introductory Act to the German Civil Code (EGBGB): Is it possible to avoid the legal ban on a lease contract exceeding 30 years by agreeing on New York law or is there an ordre public which cannot be excluded?
    • § 29a Code of Civil Procedure (ZPO): Is it possible to agree on New York jurisdiction or does compelling German law request the jurisdiction of local courts at the location of the immovable property because of special provisions for lease contracts?
    • §103 Insolvency Act (InsO): Does the insolvency administrator of the lessee have the right to a refund of the payments rendered by the lessee under the payment undertaking agreement to the bank or is there a claw-back risk?
    • § 741 German Civil Code (BGB): Is the U.S. concept of undivided interest, i.e. a fractional interest in an asset owned by two or more holders, comparable to the joint ownership of rights ("Gemeinschaft nach Bruchteilen") under German law?
    • Ultra-vires: Is it possible for a public law entity to enter into a cross-border leasing transaction even if this is not provided for in the statutes respectively special law. What are the consequences for the lessee and its members if the leasing contracts are void due to the ultra-vires-doctrine?
    • EC Notification: Is there a requirement under German respectively EC law to file a formal notification to the European governmental bodies before entering into a cross-border leasing transaction? Is it a relevant fact whether the lessee is part of the municipality ("Eigenbetrieb") or a separate entity ("Eigengesellschaft") of the municipality?
    • EC Tender Procedure: Is the tender procedure for the banks and trust properly executed? Is there a tender obligation for the bank loans, because these loans are part of a financing package?

    The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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