GERMANY Law and Practice Contributed by: Michael Josenhans, Lucas Lengersdorf and Beatrice Zobel, Freshfields
Reorganisation Procedures Other Than Insolvency for further discussion of StaRUG. Sanctions Sanctions imposed in connection with the Ukraine war are still drawing close attention to the sanctions claus - es in financing agreements. While in most cases the previous market standard of flexible sanctions provi - sions is sufficient to cater for this increased aware - ness and does not require (extensive) changes, the continuous development of sanctions laws and funds’ internal policies requires a stronger focus on these provisions. Henceforth, loan documents are expected to include more detailed representations or covenants in this regard. 3.7 Junior and Hybrid Capital Junior debt is usually provided through subordinat - ed, mezzanine or profit-participating loans ( Genusss- cheine ); convertible instruments; and holding company (HoldCo) PIK instruments. These structures, combin - ing debt and equity features, are tailored for growth funding, recapitalisations, acquisitions or restructuring scenarios. Mezzanine financing blends subordinated or unsecured debt with equity-related features such as warrants. Subordinated loans rank below senior debt in repayment priority, offering higher yields, while profit-participating loans tie returns to the borrower’s performance. Convertible instruments allow debt to convert into equity under specific conditions, align - ing lender returns with the company’s growth poten - tial. HoldCo (PIK) financings are also seen in certain transactions, enabling borrowers to defer interest pay - ments and conserve cash flow. Notable documentary features include so-called anti-layering-covenants which preclude the borrow - ers from incurring new subordinated debt, layered between the senior and subordinated tranches, hence ensuring that the subordinated debt will only be junior to the current senior tranches. Another prominent pro - vision is the prohibition on making short-circuit pay - ments. This provision has two purposes: ensuring on the one hand, that no shareholder contribution will be structurally senior to the HoldCo financing and, on the other, that distributions made upstream are funnelled through the HoldCo entity.
Other features in subordinated financing agreements are subject to negotiation, such as a potential cove - nant-look-through to the operating company (OpCo) group as well as events of default and their scope with a view to the OpCo group or material subsidiar - ies thereof. Further, the granting of certain information and/or participation rights (eg, by way of designated board-members or observers) is frequently discussed. Such information and/or participation rights would, however, need to be assessed critically, especially with a view to corporate governance, confidential - ity and equitable subordination aspects. Additionally, junior lenders may want to have the option to cure payment/financial covenant defaults at OpCo level (so-called step-in rights). See 5.1 Assets and Forms of Security for discussion In Germany, PIK arrangements in private debt are not particularly common in traditional markets but have become more frequent in high-yield, distressed or leveraged finance transactions, especially in private equity-backed deals. PIK loans allow borrowers to defer interest payments, which are instead capitalised into the principal. This structure can be attractive for borrowers looking to preserve cash flow during growth or restructuring phases. But, pursuant to Section 248 paragraph 1 of the German Civil Code ( Bürgerliches Gesetzbuch – BGB), the parties to a loan governed by German law may not agree upfront to compound interest (ie, interest may not be charged on interest) but can do so once the interest has accrued (ie, PIK toggle arrangements are possible, but may require certain procedural steps to ensure compliance with mandatory law). 3.9 Call Protection Call protections conflict with the circumstance that, by law, the borrower can terminate loans with variable interest rates at any time with a notice period of three months in accordance with Section 489 paragraph 2 of the BGB. Loan agreements with a fixed interest rate can be cancelled at the end of the fixed interest period and after ten years at the latest, according to Section 489 paragraph 1 of the BGB. Any prepayments which are made prior to the last day of the current interest of the customary scope of collateral. 3.8 Payment in Kind/Amortisation
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