German law

‘A new face for the German limited liability company (GmbH)’ – changes in the German company law influence German insolvency law

In recent years the European Court of Justice (ECJ) established the possibility for companies to enjoy freedom of movement within the territory of the European Union. In its famous decisions of ‘Centros’, ‘Überseering’ and ‘Inspire Art’ the ECJ held that it is possible for a company which is established effectively under the rules of its country of origin to move to any other country of the European Union and to establish a place of business or a branch in these other European countries.

In particular in Germany this new opportunity has caused a situation that an impressive number of private limited companies established under English law (Ltd) started its business operation in Germany. Instead of founding a German limited liability company under German law – a GmbH - a lot of founders chose to register an English private limited company with the Companies House and to start with this company the business operation exclusively within the territory of Germany. This practice has led to new situations and new problems which have to be solved, e.g. how to handle an English company registered under English company law in German insolvency proceedings.

The main advantage of an English private limited company is that there is no minimum amount of a share capital required for its establishment. In comparison, for the German limited liability company a minimum amount of the nominal capital (Mindeststammkapital) - currently 25,000 Euro - is required. The German legislator wanted to reform the legal form of a German GmbH to make such companies more attractive on the international market of legal forms by making it more competitive with forms such as the English private limited company.

With this in mind, the federal cabinet of Germany concluded the governmental Draft Act on ‘modernisation of the limited liability company law and for preventing any fraudulent use’ (Regierungsentwurf des Gesetzes zur Modernisierung des GmbH- Rechts und zur Bekämpfung von Mißbräuchen; Abbreviation: ‘MoMIG’) on 23 May 2007. The Draft Act is expected to come into force in the first half of 2008. According to the Draft Act on ‘MoMiG’ it will be easier to establish a GmbH and the protection of creditors will be improved in the events of the company having a financial crisis or even becoming involved in insolvency proceedings.

This article presents a general overview of the Draft Act on ‘MoMiG’ and focuses on modifications which might be interesting for foreign lawyers and creditors.

Easing and speeding up the establishment of a GmbH

The share capital of a GmbH is the deposit - the initial contribution - which needs to be procured jointly from all shareholders for the establishment of the company. The current required minimum amount of the nominal capital of 25,000 Euro will be reduced to 10,000 Euro according to the Draft Act.

Taking into consideration the situation of founders of a new business who, in general, do not have a huge amount of money, and who will not need a huge amount to start their business running - especially in the service sector - the Draft Act establishes a new version of a ‘GmbH’: a so called ‘German limited liability entrepreneur - company’ (haftungsbeschränkte Unternehmergesellschaft) in accordance with Section 5 a of the limited liability company law in the version of the Draft Act (German Abbreviation ‘GmbHG – RegE’).

This is not a new legal form of a GmbH but only a new way to establish a GmbH as there is no requirement of minimum nominal capital. However, after its establishment the GmbH is not allowed to completely distribute its profits but must keep a prescribed part of it. The structure of this ‘German limited liability entrepreneur - company’ is that the company generates the minimum nominal capital of a normal GmbH (10,000 Euro ) during its course of business.

Furthermore, the Draft Act enables the shareholders to be more flexible with the amount of their initial contribution (Stammeinlage). Currently, the initial contribution must be at least 100 Euro and can only be made up of sums divisible by 50. According to the Draft Act it is possible to have a share in the company in the amount of only 1 Euro.

Also, in the future it will be possible to take over more than one share in the company according to Section 5 paragraph 2 sentence 2 of the GmbHG – RegE.

For a standard establishment – where the share capital is paid in cash, minimum of three shareholders - the Draft Act offers a standard form to fill in as an attachment. This form is a sample of articles of incorporation. If this form is used, a notarisation of the content of the articles of incorporation is no longer necessary. The rules and sections of this sample are easily structured and self-explanatory. Therefore, the legal advice of a notary is no longer needed. Only the signatures of the shareholders on the articles of incorporation must be attested. This certificate of the signatures shall secure that the correct person signs the articles of incorporation. Hence, such a certificate’s only purpose is correctly identifying the shareholder.

Since the begin of this year it has been easier and faster to register a company with the company register as this register was established in an electronic version. In general, the necessary documents for the establishment of a GmbH should be presented in electronic form. Therefore, it can be decided on the registration without delay and the data can be adopted into the electronic register.

The MoMiG will further shorten the time for the registration still:

In particular the time for the registration will be shortened for companies whose operating business is subject to authorisation, e.g. a handcraft business or a restaurant. According to Section 8 paragraph 1 No. 6 of the current limited liability company law (GmbH – Gesetz), for a company whose operating business is subject to authorisation, the registration in the companies register requires the presentation of the administrative license certificate (Genehmigungsurkunde). For these companies the registration process will be separated from the administrative licensing procedure. It will then be possible to register the company without presenting the administrative license certificate.

Furthermore, the establishment of a ‘single member GmbH’ (Ein- Personen- GmbH) shall no longer require any special security deposits. The competent court for the registration shall only be entitled to ask for any deposit slips or any other evidence if there are substantial doubts that the share capital was not duly raised.

Possibility to go abroad with a GmbH

As already mentioned, it is possible under European law, for a company which is duly established under the laws of its origin country to move to another country of the European Union and to have its administrative centre abroad. Such foreign companies like the English private limited company are recognised in Germany.

However, under the current limited liability company law this system does not work the other way around: so far it has not been possible for a German GmbH to move its administrative centre aboard pursuant to Section 4 a paragraph 2 of the current limited liability company law.

To change this unsatisfying situation the Draft Act will delete the aforementioned section. Thereafter it will be also possible for a German GmbH to have its administrative centre abroad as it will no longer required to have the administrative centre at the same location as its registered office. This modification is interesting in particular for German corporate groups which could, in the future, run their affiliates, even abroad, in the familiar legal form of a GmbH.

Further changes to improve the legal form of the GmbH

It is the intention of the legislator to promote greater transparency in relation to the company’s shares. Hence, the Draft Act establishes the rule that only such shareholders as are recorded on the shareholders’ list (Gesellschafterliste) will be considered shareholders under Section 16 paragraph 1 of the GmbHG – RegE. With this system it shall become easier for business partners of the GmbH to check the shareholder structure and who has an interest in the company. A shareholder entering and investing in the company is entitled to be recorded on the shareholders’ list. As the structure of the company is traceable for anyone it should be easier to prevent such crimes as money-laundering in future.

Such a shareholders’ list is further relevant for the acquisition of shares in good faith (gutgläubiger Erwerb von Gesellschaftsanteilen). In future, the buyer of a share will be able to verify the ownership of any shares they are considering purchasing simply by searching the register.

If an incorrect record has not been objected to within three years of its registration the list will be considered as correct in favour of the buyer of a share, i.e. the buyer is entitled to rely on the person who is reported on the list as owner. The same applies if the incorrect registration has existed less than 3 years if the error is due to any action / behaviour of the correct owner of the share.

This modification should lead to more security and should decrease the costs for a transaction of shares. Currently, it is the risk of the buyer that he buys the shares from the correct owner and that the shares are not owned by someone else. In particular, this modification should facilitate the purchase of shares of older / longer established GmbHs.

Furthermore, this reform has the intention of obtaining a reliable base for ‘Cash- Pooling’ which is popular in international business. With that instrument an equalisation of liquidity can be achieved among the parts of a company group. For this purpose the affiliates transmit funds to the holding company / parent company where the funds are combined to a jointly cash- management. In consideration for this transfer of funds the affiliates are entitled to repayment claims against the holding company/ parent company.

In its decision on 24 November 2003 the German Federal Court of Justice (Bundesgerichtshof, Abbreviation: BGH) decided that granted loans from the GmbH to its shareholders are defined as a prohibited out-payment of share capital in accordance with Section 30 paragraph 1 of the current limited liability company law. The precondition of such a prohibition is that the out-payment of the loan is not covered by any reserves or retained earnings but is made at the expense of the assets of the company. If the director of a GmbH fails to prevent such loans he will be liable to the GmbH.

This decision has created some legal uncertainty as to for the legitimacy of ‘Cash- Pooling’ despite its common practice within company groups.

The new rule of Section 30 paragraph 1 sentence 2 of the GmbHG – RegE will resolve this uncertainty. According to the new rule a payment from the company to one of his shareholders is not a prohibited out-payment of company’s own assets as long as there is a pure accounting exchange of the asset side (reiner Aktivtausch): i.e. if the repayment claim of the company against its shareholder is valuable and covers the amount of the former out-payment.

Extension of the duty to apply for insolvency

a) Currently, according to Section 64 paragraph 1 of the limited liability company law only the directors (Geschäftsführer) of the GmbH have the duty of filing for insolvency not later than three weeks from the occurrence of over-indebtedness or illiquidity. A breach of this strict duty to file for insolvency is punishable under civil law (Section 64 paragraph 2 of the limited liability company law) and could even give rise to criminal liability (Section 84 of the limited liability company law). In practice, the restriction of the duty to the director has led to attempts to evade punishment by dismissal or resignation of the director.

In future, according to Section 15 a paragraph 1 of the insolvency code in the version of the Draft Act (German Abbreviation ‘InsO-RegE’), the duty to file for insolvency will apply to ‘all members of the company organ which is representing the legal entity’. Therefore, the duty to file for insolvency is neutral in relation to the legal form of the company and applies still to the directors of a GmbH. But in connexion with Section 15 a paragraph 3 of the InsO-RegE such duty will also exist for the shareholders of a GmbH, the members of a board of directors of a German stock corporation (Aktiengesellschaft) and German societies (Genossenschaften) under the precondition that they are ‘without a leader’. The term and the required conditions for being ‘anchorless’ are legally defined for the GmbH. Thereafter, a GmbH is ‘without a leader’ according to Section 35 paragraph 1 sentence 2 of the GmbHG – RegE if it does not have a director.

In addition to the fact that the certain legal company is ‘without a leader’ the shareholder or the member of the board of directors must have knowledge about the over-indebtedness or illiquidity of the company. If both preconditions are met the duty to file for insolvency applies also to the shareholders and to the members of the board of directors.

b) While presently this duty only applies to directors of companies incorporated under German law, under the Draft Act any kind of corporations and partnerships will be affected, as long as they do not have an individual as a general partner. In principle, the Draft Act now constitutes also for non-German companies and their directors the duty to file for insolvency not later than three weeks form the occurrence of over-indebtedness or illiquidity. But contrary to several publications, the Draft Act does not provide such duty for non-German companies which even do not possess assets in the territory of Germany.

In fact, one has to distinguish between non-German companies whose centre of main interests (COMI) is located beyond Germany but within the territory of the European Union, respectively the territory of the Council Regulation (EC) No 1346/2000 on insolvency proceedings (covering the territory of the European Union except Denmark; abbreviation: EIR), and companies established outside the European Union.

Following this EIR and its mechanism built for domestic, hence, secondary proceedings, EU- companies are only affected by the Draft Act, if they possess an establishment within the territory of Germany.

By the wording of the Draft Act on non-EU companies the duty to file for insolvency is already imposed if the have assets in Germany, since the German international insolvency law (which applies for non EU-companies) provides for commencement of secondary proceedings in Germany only the requirement of assets – as opposed to an establishment- in Germany.

But in this respect, however, the wording conflicts with the legislative history and reasoning. According to this, non-German companies shall only be subject to such duty, if the COMI is located in Germany and German insolvency law is applicable. Hence, during the legislative procedure a clarification in the wording is due. Definitely and in any event, non-German companies neither with establishment nor with assets within Germany are not affected by the Draft Act. Obverse notions apparently conflict both with the wording and the legislative history.

Pursuant to the German international insolvency law and the EIR, the Draft Act’s relevant regulation will only be applicable to non-German companies if the (hypothetical) main insolvency proceedings can be opened in Germany. Basically, this is only the case if the company’s COMI is located in the territory of Germany. If the COMI is situated outside Germany German courts do only have jurisdiction to open secondary insolvency proceedings if the company possesses assets (in the case of non- European companies) or an establishment (in the case of European companies) in the territory of Germany. In that case the effects of secondary proceedings are restricted to the assets of the company situated in Germany.

Modifications for preventing fraudulent use of the legal form of a GmbH

In practice it is known that there are several attempts to use the legal form of a GmbH in a fraudulent way. The following modifications are made to prevent such fraudulent use:

It should become easier for creditors to enforce a claim against a legal entity. For this reason the creditors need to know the address of the legal entity. In future it will be necessary to register the company in the company register with an address within the territory of Germany. This duty does not only apply to a GmbH but also to German stock corporations (Aktiengesellschaft), to sole traders (Einzelkaufleute) and to business partnerships (Personengesellschaften) and to branches of foreign companies located in Germany. In case that it is not possible to deliver a writ of summons to this registered address it will be possible to satisfy the precondition of an effective service by public service, i.e. by a notice on the blackboard of the competent court. This change is made in favour of the creditors who face the problem to enable an effective service under the present law. With this modification the creditors are unburdened to bear the whole risk and problem to achieve an effective service.

The reasons for banning someone from the profession as a director of a GmbH are extended. According to the Draft Act it will also be possible to get banned from the profession of a director by committing the following crimes: procrastination of insolvency (Insolvenzverschleppung), giving misstatements or by being convicted for a common criminal offence in relation to business affairs. In bottom line, being appointed as a director will not be possible anymore for somebody who breached central rules of the law relating to economic offences (Wirtschaftsstrafrecht. It is interesting to know that the same applies if the person is convicted for a similar crime offence by a foreign court.

Deregulation of the institute of subordinated equity (Eigenkapitalersatz)

The very complex matter of equitable subordination (ruled in Section 30 et seqq. of the current limited liability company law) will be significantly simplified.

The matter of equitable subordination deals with the question if loans which were granted by shareholders to the company are defined as ‘normal’ loans or as equitable subordination (Eigenkaptialersatz). The creditors who are entitled only to a claim defined as subordinated equity against the insolvent debtor will only get any settlement of this claim after all other insolvency creditors, i.e. this claim is ‘subordinated’.

The main idea of the new ruling is that shareholders and representatives of a company which is not in a financial crisis should be secure about the legal frame within they can operate. For this purpose the current prevailing case law for Section 30 of the current limited liability company law will be overruled. The main reform is that there will not be any distinguish between subordinated and ‘normal’ loans granted to the company. In addition to this the ‘equitable subordination law’ (Eigenkapitalersatzrecht) will not distinguish between the legal forms of the companies but will be neutral in this relation and will be established in the German insolvency code (Insolvenzordnung). Therefore, the modified equitable subordination law covers more companies not only the GmbH but as well the German stock corporations, association limited by shares (Kommanditgesellschaft auf Aktien) and societies (Genossenschaften). In comparison an association (Verein) will not be covered by these rules of this modified equitable subordination law. But such rules applies in general also to foreign companies.

According to the Draft Act all claims of a shareholder against the company resulting from granting a loan or any other actions with the similar economical results are defined as subordinated in the future. Such claims will be satisfied in insolvency proceedings after all other insolvency creditors (Section 39 paragraph 1 No. 5 of theInsO-RegE).

In future it is irrelevant if such loan would have been granted in a financial crisis of the company or in a situation in which the company generated profits. All payments are avoidable in accordance with Section 135 paragraph 1 No. 2 of the InsO-RegE which were made from the company to the shareholder for the purpose of satisfying a claim based on a granted loan within the period of one year prior to the application for opening the insolvency proceedings. The current existing ‘restructuring privilege and privilege for small investments’ (Sanierungs- und Kleinbeteiligungsprivileg) will remain. There will be made only some little modifications and such privileges will be established in the German insolvency code in the new rule of Section 39 paragraph 4 sentence 2 and paragraph 5 of the InsO-RegE. One privilege applies to shareholders which do not operate the business of the company and who are holding only ten of hundred or even less of the share capital (privilege for small investments / Kleinbeteiligungsprivileg). The other extension of the subordination applies to lenders who acquire shares of the company which is already in a financial crisis for the purpose of getting the company over the crisis. If this condition is met the rule of subordination does not cover the granted loans to the company.

Unfortunately, it has not been given a particular time specification for the MoMiG to come into force. But as aforementioned it is still the manifested ambition of the legislator by the time of putting together this article (autumn 2007) to enact the MoMiG in the first half of 2008.

In this connexion it might be interesting to know that according to Article 103d of the introduction to the insolvency code in the version of the Draft Act (German Abbreviation: ‘EGInsO- RegE’) the current law remains applicable to all insolvency proceedings which have been opened prior to the date on which the MoMiG will be into force. This rule creates the necessary legal certainty that you will know which law will be applying to your particular case.

Now, we are waiting for the enacting of the MoMiG and hope that the intended improvements can flower out and will strengthen the legal form of the GmbH.