Recognition of Foreign Companies in Germany

The German Supreme Court ruled that U.S. companies with its management centre in Germany have legal capacity. The new ruling has a fundamental impact on corporate and tax law and may achieve avoidance of German co-determination.

Through its judgments in the "Überseering" and "Inspire Art" cases in 2002 and 2003, the European Court of Justice initiated a change of paradigm in German Corporate Law. In these decisions the Court held that a foreign EU company with a domicile in Germany has legal capacity in Germany and is also capable of being a party to legal proceedings in Germany.

German lawyers have already spoken about a "Delaware effect" regarding the lowest requirements under Corporate Law for the formation of companies as well as for the protection of creditors in Europe.

U.S. Corporation with its Management Centre in Germany

However, on 5 July 2004 the German Supreme Court reached the decision that a U.S. company with its management centre in Germany is basically equivalent to a EU company; an U.S. corporation has the capacity to acquire rights and incur obligations as well as to be party in a lawsuit. Furthermore the German Supreme Court ruled for the first time that U.S. Corporate Law may be applicable with regard to the company’s legal structure, in particular the liability of shareholders.

This new ruling over the application of foreign Corporate Law to companies with its management centre in Germany may also apply to companies domiciled in one of the 25 member states of the EU. The Supreme Court reasoned that the Treaty of Friendship, Commerce and Navigation between the U.S. and the Federal Republic of Germany conforms to the freedom of establishment in the EU-Treaty.

Genuine Link

In order to avoid misuse by forming US letterbox companies (Briefkastengesellschaft), a "genuine link" between a corporation and its country of origin is required. However, the requirements of the German Supreme Court can easily be met since holding a bank a account in a US state (not necessarily in the State of formation of the company) is sufficient.

Application of U.S. Corporate Law

The decision opens a wide range of possibilities. A US group may implement in its group structure a corporation with its executive board in Germany that retains the US "single-tier-boards". With regard to the due diligence benchmark of the executive board of the U.S. corporation, the "business judgment rule" applies. This will shortly also apply to German public companies limited by shares. Consequently, the position of the deputies of German companies will in essence be worse because of the shifting of the burden of proof under German Stock Corporation Law at the expense of executive boards. This is not provided for in U.S. Corporate Law. Furthermore, the personal liability for measure resulting in the insolvency of the company (existenzvernichtende Eingriffe) which evolved from the decision in "Bremer Vulkan" will not be applicable to U.S. corporations because piercing the corporate veil complies with U.S. Common Law.

Tax Consolidation

The consequences under Tax Law of the decision relate to the taxation of groups. To date it was unclear whether a foreign corporation with its executive management domiciled in Germany is able under Civil Law to conclude a profit and loss pooling agreement, which is required for a corporate tax consolidation under Corporate Income Tax Law and Trade Tax Law. Because of the recognition of the capacity to act of an U.S. corporation this must be approved.

Furthermore, changes are expected over the treatment of U.S. corporations as dominated companies under Tax Law. Under the present legal position the dominated company must be a corporation (Kapitalgesellschaft) having a domestic domicile and a domestic executive management ("double domestic nexus/ doppelter Inlandsbezug"). The decision as to whether an U.S. corporation may be considered as a corporation will be reached in the future on the basis of a comparison by type (Typenvergleich).

In this respect a statement of the Federal Finance Court from 2003 is shown in a new light. Thereafter, the "double domestic nexus" breaches the non-discrimination rule of the Double Tax Convention between the U.S. and Germany. As a consequence, the same must apply to dominated companies. It is only a question of time whether U.S. corporations with a domestic domicile can form a German tax consolidation as a dominated company as well as a dominant enterprise.

Restructuring/Co-Determination

The decision opens a wide range of domestic or cross-border restructuring measures and might be an alternative to the recently established legal form of the European Company (SE).

Furthermore, German co-determination rules can be avoided under certain conditions as co-determination is generally not applicable for foreign corporations with its management centre in Germany.

Copyright © 2007, Mayer, Brown, Rowe & Maw LLP. and/or Mayer Brown International LLP. This Mayer Brown article provides information and comments on legal issues and developments of interest. The foregoing is not a comprehensive treatment of the subject matter covered and is not intended to provide legal advice. Readers should seek specific legal advice before taking any action with respect to the matters discussed herein.

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