The development of an insolvency privilegle for derivatives in German law

Abstract

The article outlines the development of insolvency privilege with respect to derivatives under German law in its historical perspective. It traces the evolution of special privilege from the moment when it was first announced in the German insolvency statute (Insolvenzordnung) and came into force on August 1, 1994, up to the moment when legislative provisions securing the functioning of derivatives in insolvency context were amended in response to the 2016 Federal Court of Justice Verdict. This court ruling ended the long-standing consensus on “friendliness” of the German insolvency law to derivatives and other financial transactions. German highest court concluded that contractual clauses on the termination of obligations under derivative contracts in the event of bankruptcy are invalid unless their legal result is identical to the one prescribed by law. This court decision created significant legal uncertainty for recognition of claims under derivative transactions and directly influenced the use of standard master agreement for over-the-counter derivatives. Drafted under the auspices of the German Banking Union (GBU), an organization representing the interests of German financial institutions, German Master Agreement for Financial Derivatives Transactions ( Deutscher Rahmenvertrag fur Finanztermingeschäfte ) provided a contractual framework for the relevant market, and it came under significant pressure. Overall, German insolvency rules were significantly enforced to achieve the enforceability of close-out netting thus expanding the insolvency privilege for derivative transactions.

Keywords

• close-out netting
• financial collateral
• insolvency
• cherry picking
• cherry picking