A new law bringing significant changes for limited liability companies incorporated in Germany takes effect on November 1, 2008. This article examines the business trends which inspired the new law as well as how, going forward, the new law will affect the formation and operation of a German limited liability company (GmbH).

Background. In recent years, European corporate structures other than the GmbH have arrived in the German market. Companies formed under the law of other EU member states have become more and more popular. Many German enterprises have opted to organize as English limited liability companies (even though they have permanent management in Germany) in order to circumvent the relatively burdensome requirements for forming a GmbH—that is, higher levels of required capital and a longer time-horizon to complete incorporation.

As a result of this competition among business forms, the German government decided to modernize the law governing German limited liability companies. After considerable debate, the so called "Law for the Modernization of the German Limited Liability Company Law and the Prevention of Misuse" ("Gesetz zur Modernisierung des GmbH-Rechts und zur Bekämpfung von Missbräuchen" - abbr. "MoMiG") was adopted. The law takes effect on November 1, 2008.

What will change under the new GmbH law?

The new law is intended to amend Germany's GmbH law in three significant respects. First, the GmbH formation process will be accelerated. Under the new law, it will be easier to provide share capital, and it will be simpler to divide, merge and transfer shares. Furthermore, there will be measures which will lead to faster registration, as the registration process at the commercial registers is streamlined.

Second, the GmbH is expected to become a more attractive way of incorporating a business. The new law allows a GmbH to locate its headquarters outside of Germany (which previously was not permitted) and creates more transparency with regard to share ownership (which will simplify acquisition processes). It also provides a long-awaited legal basis for group financing, which will finally allow the GmbH to participate fully in cash pooling systems such as are common in other countries.

Finally, the new law stipulates several measures for combating deceptive and fraudulent business practices, including streamlining procedures for servicing legal claims, preventing artificial delays in insolvency filings, and strengthening the qualification standards for managing directors.

Which parts of the new law will be of interest to non-German shareholders?

Formation with €1. The German government's initial approach of lowering the GmbH's minimum share capital from €25,000 to €10,000 was rejected as a dilution of the GmbH's robust and highly regarded capital structure. Instead, the new law provides for an entirely new legal type of GmbH in Germany. The so-called "UG" (Unternehmergesellschaft, which can be roughly translated as "business company") may be formed with share capital of just €1. The new law requires that the abbreviation "UG" or the word "Unternehmergesellschaft" be part of the company name until the general minimum share capital of €25,000 is reached. Until then, the company must place 25% of its annual profit into a new capital reserve. The reserve may only be used for increasing nominal capital or for balancing losses or loss-carry-forwards of the UG. As distinct from the "regular GmbH," with its minimum nominal capital of € 25,000, contributions in kind during formation or as part of later capital increases are not permitted for a UG.

Cash pooling will be permitted. Due to the strict German capital contribution and maintenance rules mandated by the case law of Germany's Federal Court of Justice (BGH), it was difficult for a GmbH to participate in otherwise internationally accepted cash pooling structures for group financing. Until the law was revised, payments to the GmbH for capital contributions by a shareholder, which were paid immediately to a group account under a cash pooling structure, were regarded as void because case law held that such payments were never under the direct control of the GmbH. As a result, under the old law, the shareholder was required to make the payment again.

The new law codifies that payments made by shareholders or by affiliated companies are now valid insofar as an adequate repayment claim is guaranteed. Such long-awaited statutory clarification replaces the current BGH case law and allows upstream loans in cash pooling structures even in cases where companies are experiencing negative equity. However, loans or payments to shareholders or group entities remain delicate, as the adequacy of the repayment claim needs to be determined by the managing director, who may be personally liable for any damages suffered by the company or creditors. For now, it remains unclear in what cases a repayment claim is deemed legally adequate (book or market value?).

Transfer of shares and their acquisition in good faith. Under the old GmbH law, a purchaser of shares could not simply rely on the statements made by the seller regarding his ownership of the shares. Assuring ownership required time-consuming due diligence—including documentation and verification of each corporate action, beginning with the formation of the company. Even then, the buyer did not become legal owner of the shares if it turned out later that the seller's warranties or the due diligence assumptions were wrong. The new law neither dispenses with the need for due diligence investigations nor for the obtaining of seller's warranties, but it does strengthen the legal position of the purchaser to a great extent. The list of existing shareholders—which is a document filed with the commercial register—increases in importance under the new law. The acquisition of shares from an individual or entity listed on this shareholders' list will be deemed effective even if the seller had no right to dispose of the relevant shares. However, such statutory assumption of ownership does not apply if the share or shares do not exist, the purchaser knew about the defect in title or the seller was listed for less than three years on the official shareholder list.

Extended personal liability for managing directors. Several new provisions shift liability from shareholders to the managing director of a GmbH. For example, the managing director will be liable personally for payments of the GmbH made to a shareholder if those payments lead to the company's insolvency, even if he was instructed by the shareholder to effect such payments. The managing director will also have additional liability in connection with the shareholders' list. While under current law he is only liable for the correctness of the shareholders' list as it is presented to creditors of the company, under the new law he is also liable for the accuracy of the list presented to sellers and purchasers of company shares.

In addition, the managing director remains personally liable with regard to capital maintenance issues. He is required to negotiate cash pooling agreements with the necessary termination option in order to prevent over-indebtedness or insolvency. He is also personally responsible for making the assumptions necessary to determine whether the repayment claim of the company for loans to the cash pool remains at full value. (Should its value be threatened, an immediate repayment request becomes necessary in order to avoid personal liability).

Conclusion. In addition to the issues discussed in this article, there are numerous other changes which force shareholders as well as managing directors to adjust past company practices in order to avoid personal liability. The new law contains the most significant changes in GmbH law in at least 20 years. While the reform in part achieves its intention of simplifying the formation process and making the GmbH an attractive alternative to other European structures for limited liability companies, it also creates a need for additional legal counsel to avoid liability issues that arise under the new rules. Furthermore, due to the many structural changes, courts will have to establish through case law specific answers to which the statute only provides broad guidance or generalized obligations. Nevertheless, the GmbH will remain a popular and effective corporate form to use as a European investment vehicle when a limited liability company structure is desired. The new law, however, makes the GmbH even more attractive given the increased level of legal flexibility it provides.

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