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Collateral Security Law: No General Right to Exchange Collaterals in Germany

The German Federal Court of Justice (Bundesgerichtshof; “BGH”) recently ruled that a collateral provider, which has agreed on a specific collateral with a secured party, may not demand that said collateral be exchanged for a different one the provider finds more convenient. Consequently, a person, who has agreed on the provision of specific collaterals, may not demand that these be subsequently exchanged for different ones. In this respect, the provider is bound by the contractual agreement with the other party.

Solution by concurrent mortgage

In the case decided here, the later plaintiff had caused a land-register entry of a security mortgage of up to a maximum of EUR 250,000 in favor of the defendant to secure claims arising from a continuing obligation. When the plaintiff later wanted to sell the property concerned said entry turned out to be an obstacle. Therefore, the plaintiff demanded that the mortgage be cancelled concurrently against the provision of a directly enforceable bank guarantee in the same amount and/or deposit of the amount with the local court (Amtsgericht).

No exchange of collateral in Germany

According to the BGH, the contractual agreement between the parties is decisive. The agreement did not provide for the cancellation. The court found no reason allowing for a supplementary interpretation of the agreement. The court also refused to acknowledge that the contract had been frustrated because the risk that had materialized only lay within the sphere of the plaintiff. However, the latter could have been aware, from the moment the contract was concluded, that the mortgage on the property might be an obstacle in case of a sale.

The senate accepted no general grounds of equity, either. As the agreement did not provide for the possibility of exchanging collaterals, no such exchange could be derived from the principle of good faith, either.

Possibility to exchange collaterals must be provided by contract

In this context, the BGH made it clear that its ruling was not inconsistent with an earlier decision of 2004. In the case decided at the time, a property owner had prematurely redeemed a loan and offered a different than the previous collateral to the financing bank in order to be able to sell the property more easily.

In that case, however, the possible exchange of collaterals was laid down in the agreement between the German borrower and the bank and the new collateral was equally well suited to protect the bank against risks so that the bank did not suffer a disadvantage.

Be careful when selecting collaterals in Germany

The BGH’s recent decision recalls that an agreement on loan collaterals is a contractual agreement that neither party can unilaterally modify. Borrowers in Germany should therefore be careful when choosing collaterals offered by a bank and not rely on the bank to accept an exchange of collaterals prior to repayment of the loan.

Our experienced attorneys advise banks and borrowers on all issues of collateral security law in Germany. We are looking forward to hearing from you.

BGH Judgement of 06/30/2017, file reference: V ZR 248/16

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Your German Banking Law Attorney

Dr. Annette Wagemann

Dr. Annette Wagemann

Dr. Annette Wagemann comprehensively advises companies and their managers on questions regarding business law and banking regulations. She is specialized in the legal structuring of business models, corporate governance and compliance, and especially in business models that require a BaFin license.

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