In December 2016, the German legislature amended the German Insolvency Code (the "Insolvency Code") to clarify the status of netting arrangements in financial transactions. Doubts about that status were raised by a June 9, 2016, ruling by the German Federal Court of Justice (Docket No. IX ZR 314/14) invalidating netting provisions used throughout the financial industry (patterned, for example, on the German Master Agreement for Financial Derivatives Transactions and the International Swaps and Derivatives Association Master Agreement) if they deviate from the requirements set forth in section 104 of the Insolvency Code, which are mandatory pursuant to section 119 of the Insolvency Code. Specifically, the court invalidated the contractual calculation method for claims of nonperformance in the case of insolvency by either party. The decision left open whether a contractually agreed-upon early termination right violates section 104.

The amendments were published in the Federal Gazette on December 28, 2016. Among other things, the amendments:

  • Clarify and clearly differentiate between the statutory resolution rules for financial contracts and the scope of permissible contractual departures from the statutory rules;
  • Leave largely intact the existing statutory model for resolving and settling financial contracts in case of insolvency; and
  • Update the list of covered financial transactions to reflect the current status of financial services supervision.

The core of the reform is revised paragraph 4 of section 104. This provides that counterparties may contractually agree on netting provisions which deviate from the statutory provisions governing termination and settlement of regulated contracts as long as the deviations are compatible with the essential principles of section 104, thereby in principle upholding existing standard industry netting arrangements. On the day the June 9 court ruling was rendered, the German Federal Financial Supervisory Authority (Bundesanstalt für Finanzdienstleistungsaufsicht, or the "BaFin") issued a general decree to the effect that closeout netting arrangements of the type which were dealt with in the court ruling would be consummated as agreed upon among the parties concerned. This administrative decree was effective only until December 31, 2016. The statutory amendments to section 104 of the Insolvency Code apply from December 29, 2016, onwards. Thus, due to the rapid response by the BaFin and the German legislature, the impact of the Federal Court of Justice's decision is limited.

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.