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21 June 2010
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Legal News from Germany
Below you find the newsletter of the International Department of Schultze & Braun with information on current issues in German and international bankruptcy and restructuring law.

Dr H. Philipp Esser, LL.M. (Chicago)
Attorney at law (Germany)
Attorney at Law (New York State)

Dr H. Philipp Esser
MoMiG I: German Federal Court of Justice Finds GmbH Reform Act Constitutional
Since the intensely debated GmbH (Gesellschaft mit beschränkter Haftung – limited liability company) reform act (MoMiG) was passed in 2008, the constitutionality of the new sec. 19 para. 4 GmbH Act (GmbHG) was subject to discussion as the provision regarding undisclosed contributions in kind (verdeckte Sacheinlage) also applies retroactively to pre-MoMiG contributions. Various legal commentators considered this provision – which often applies in intra-group cash management systems – unconstitutionally retroactive with respect to events terminated in the past. By decision dated 22 March 2010 the German Federal Court of Justice (Bundesgerichtshof, BGH) now expressly rejected this opinion.

Under the old law the BGH held that any performance of an undisclosed contribution in kind – i.e. a cash contribution and a receipt of property or another benefit, which are economically equivalent to an undisclosed contribution in kind – is invalid and void. In case of a bankruptcy, the trustee of the GmbH could again demand payment of the cash contribution by the shareholder. The shareholder then only had a worthless insolvency claim for repayment of the earlier cash contribution and for rescission of the connected acquisition of property or similar benefit.

The MoMiG has replaced this case law by a deduction mechanism which also applies to past contributions. Agreements on undisclosed contributions in kind and the performances under such agreements – in the case decided by the BGH: the purchase of licenses – are now no longer invalid (sec. 19 para. 4 sent. 2 GmbHG). The value of the contributed property or other benefit at the time of the contribution is simply deducted from the continuing obligation of the shareholder to pay the cash contribution. Thus, with respect to the deductable value of an undisclosed contribution in kind the insolvency trustee can no longer request (again) payment of the cash contribution.

The BGH does not consider this loss of a claim a breach of the constitution. The legislature does not exceed its powers if it only partially sanctions the breach of the formal law regarding contributions in kind, i.e. to the extent the company does not receive other value. The indirect retroactivity of the MoMiG is generally permitted by the constitution as it affects events that have begun in the past but have not yet terminated. Furthermore, the parties do not deserve to be protected in their expectation that the previous case law does not change. The legislature has the discretion to provide more legal certainty and to prevent litigation by denying the company the benefit of a de facto double cash contribution as long as the company receives the value of the promised contribution at least once.

Although the German Constitutional Court (Bundesverfassungsgericht) is the guardian of the German constitution, after this decision of the BGH it seems unlikely that constitutional law will bar any of the above provisions of the MoMiG.
MoMiG II – Directors’ Duties to Disclose: Back and Forth Payment
Only after the enactment of the MoMiG an important discussion for legal practice evolved concerning the meaning of the directors’ duties to disclose pursuant to secs. 19 para. 5 sent. 2, 8 para. 2 GmbHG. The discussion relates to the reform of the so called “back and forth payment”, i.e. payments on cash contributions which are immediately returned from the company to the shareholder (often as loans, but without being an undisclosed contribution in kind).

Before the MoMiG back and forth payments (e.g. payments on a bank account with a positive balance in an intra group cash management system) were treated as nonexistent under German capital maintenance law. Since the MoMiG such cash contributions are deemed to be paid pursuant to sec. 19 para. 5 sent. 1 GmbHG, if the company has a claim against the shareholder for repayment which is fully valuable and due and payable at any time or which can be accelerated at any time. However, the director has to disclose the back and forth payment (or any such agreement) to the registry court upon the filing of the incorporation of the company or of the capital increase (secs. 19 para. 5 sent. 2, 56a GmbHG). According to the BGH a failure to disclose causes the payment on the contribution to be irrevocably invalid (decision dated 20 July 2009 – “Cash Pool II”). This also applies to pre-MoMiG contributions, although at that time directors could impossibly have complied with disclosure requirements which were only enacted by the MoMiG.

Many commentators have criticized this case law. In its broad scope it runs contrary to the goal of the new sec. 19 para. 5 GmbHG, which – even retroactively – tolerates an economically justifiable back and forth payment. If the director fails to disclose the back and forth payment, the payment on the contribution is invalid. If the director discloses the back and forth payment, he will have to proof to the registry court that the requirements of sec. 19 para. 5 sent. 1 GmbHG are met, which will lead to further legal uncertainties in the registration process. Therefore, many legal commentators argue that the obligation to disclose is a procedural rule without consequences for the validity of a payment on contributions.
MoMiG III – Directors’ Duties to Disclose: Undisclosed Contribution in Kind
Similar liability risks exist regarding the payment of an undisclosed contribution in kind (e.g. payment on a bank account with negative balance in a cash pool) due to the new deduction mechanism in sec. 19 para. 4 sent. 4 GmbHG. The deduction is only effective as of the registration of the company in the commercial register. However, the director already has to represent at the filing for registration with the registry court that the company has received all payments and other performances on contributions at its final and free disposal. At the incorporation of a company the deduction mechanism therefore leads over the stony path of a wrong representation to the registry court. In case of an accurate filing which states the undisclosed contribution in kind, a registration of the incorporation would have to be denied by the registry court as well (sec. 9c para. 1 sent. 1 GmbHG).

If the director wrongly represents or fails to disclose relevant facts at the filing with the commercial register, the director risks personal civil and criminal liability, secs. 9a, 82 GmbHG. This alternative is not acceptable to the directors.

Therefore, with respect to the issues outlined above the MoMiG has not created the legal certainty intended by legislature. In particular in case of restructurings with intra group cash management systems the incorporation of a GmbH or a capital increase cannot be recommended because of the underlying risks. Alternative restructuring strategies, e.g. the transfer of assets into the free capital reserve (freie Kapitalrücklage), continue to be attractive alternatives.
EU Plans for Harmonization of Insolvency Law
A current study of the European Parliament shows the tendencies of a future harmonization of the insolvency laws of the EU member states. The investigation conducted by INSOL EUROPE identifies the need for harmonization in particular regarding the commencement and various aspects of the operation of insolvency proceedings, the filing of a reorganization plan and avoidance actions. Furthermore, the report demands a harmonization of the directors’ and shareholders’ liability as well as a law for group insolvencies.

The report recommends a harmonization of the criteria for commencing insolvency proceedings. In the member states covered by the study these criteria mostly depend on the liquidity of the potential debtor, but vary significantly in each of their content. For a company involved in cross-border business it is therefore difficult to predict when and in which member state the commencement of a main, secondary or territorial insolvency proceeding is imminent.

Further issues to be harmonized are the filing and verification of claims and the treatment of unperformed contracts. The right to propose a reorganization plan and the possible content of such a plan (e.g. shareholder rights) and the voting on, confirmation of and appeal against a reorganization plan in Europe shall also be adjusted. Following the recent case law on the sole jurisdiction of the insolvency court for avoidance actions, the report recommends not to continue applying the avoidance law of two member states in cross-border cases, as is provided by the EU Insolvency Regulation at the moment. In addition a harmonization of the time periods subject to avoidance appears sensible.

The report is of the opinion that insolvency rules for group companies are necessary. Related to this issue is the request for harmonization of the liability of directors and shareholders. Nevertheless the report acknowledges that such a reform would require significant changes in the corporate laws of the member states.

If and when these issues will actually be transformed into an EC legislative proceeding remains currently open. In particular with respect to criteria for commencing insolvency proceedings and a group insolvency, legal reforms can also be expected in Germany in the near future. Therefore, insolvency law reforms in the member states may pass European efforts for harmonization.

The report is available under http://www.insol-europe.org/download/file/2492.
German Federal Government Considers Re-enactment of Tax Authority Privilege
In the context of its plans for cutting the federal deficit, the German federal government has decided to re-enact the tax authority privilege in insolvency proceedings beginning from 2011. According to a strategy paper the government expects annual additional revenues from the privilege of approximately € 500 mio. for the budget years 2011-2014. The tax authority privilege gives the fiscal administration preferential rights vis-à-vis the other insolvency creditors. This privilege existed under the Konkursordnung but was abolished in 1999 with the introduction of the Insolvenzordnung (German Insolvency Act) in order to prevent the depletion of the insolvency estate. How exactly this privilege shall be re-enacted has not been announced. If the legislature approves of the plans of the government, the additional revenues for the public sector due to the re-enactment of the privilege will be received at the expense of the insolvency estate and thus of the non-privileged and unsecured insolvency creditors. The government estimates these amounts at more than € 40 mio. per month. On the other hand such additional revenues could cause significant decreases in tax revenues with respect to the insolvency creditors affected.

The approach of the Insolvenzordnung not to give priority to certain insolvency creditors had also been recognized abroad. In the bankruptcy proceeding In re Fairchild Dornier Bankruptcy Judge Leif Clark (San Antonio, USA) commented: "Indeed, the Insolvenzordnung admirably affords no priorities at all."

Dr H. Philipp Esser, LL.M. (Chicago), Attorney at law (Germany), Attorney at Law (New York State)


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