Subordination (Rangrücktritt)

What it is for

The situation is almost always the same: a company's assets no longer cover its liabilities, so it is balance-sheet insolvent, and a material part of those liabilities are shareholder loans. If the shareholder declares a qualified subordination for their loan, the claim is no longer recognised in the over-indebtedness test – and the balance-sheet over-indebtedness can fall away, and with it the looming duty to file for insolvency.

The reach matters: a subordination works on the balance sheet, not on liquidity. It does not help against impending illiquidity – that needs a 13-week cash forecast and measures that actually move money.

Simple or qualified

A simple subordination only governs the ranking in a later insolvency and is not sufficient for the over-indebtedness test. What counts is the qualified subordination: the creditor ranks behind the claims of all other creditors within the meaning of section 39(1) nos. 1 to 5 of the German Insolvency Code, and declares at the same time that payment will be sought only from free assets, from a surplus, or from liquidation proceeds.

What the declaration has to contain

• the express subordination behind the creditor groups named
• the restriction of the payment obligation to assets free of debt
• a binding that cannot be revoked unilaterally
• unambiguous identification of the claims covered, interest included

Drafting errors have consequences here. A declaration that misses these requirements has no effect in the over-indebtedness test – the over-indebtedness then persists without anyone noticing.

Distinction from a letter of comfort

Both instruments are used in the same situation and work differently. A subordination concerns an existing claim and affects the over-indebtedness test. A hard letter of comfort, by contrast, is a binding undertaking by a third party – usually the parent – to fund the company so that it can meet its liabilities; it therefore supports the going-concern forecast. A soft letter of comfort is a mere statement of intent and helps with neither.

Tax side effect

A subordination can give rise to taxable income where it is drafted such that the liability may no longer be recognised for tax purposes – typically where repayment is promised solely out of future profits. The wording therefore belongs in front of accounting and tax advisers together, before it is signed.

When it is not enough

A subordination buys time; it does not restructure. Where the restructuring is to be financed, banks as a rule require a restructuring opinion under IDW S 6; where agreement with creditors is not reachable, the route leads into proceedings under the StaRUG.

Who produces the underlying numbers alongside the running business is set out under Interim CFO.

This is general information, not legal or tax advice. The specific wording belongs with a specialist law firm – in good time, not afterwards.