Germany: Limited Liability Company Reform: New Rules Governing The Incorporation , Sale Of Shares, And Change Of Administrative Seat

Last Updated: 28 May 2008
Article by Martin Kock

Simplification of Rules Regarding Incorporation

Under current law, a limited liability company ("GmbH") must be established by notarial deed. The reform law permits exceptions to this formal requirement if (i) the founders use model articles of association, (ii) the GmbH is incorporated by no more than three shareholders via a cash contribution, and (iii) only one managing director is appointed. Eligible business purposes pursuant to the model articles of association are production, trade, and provision of services. If the model articles of association are used with the permissible variations (firm, seat, share capital), the mere certification of the signatures of the incorporators by a notary is sufficient. The same applies to subsequent amendments within the same scope.

The above-mentioned simplifications will reduce incorporation costs, particularly if subsidiaries are being established, since provisions regarding shareholder rights and obligations are often not detailed in such group companies. Further reforms such as the abolishment of the notarial-deed requirement for share transfers and pledges have—unlike in Switzerland—not been effected.

Reduction of Share Capital; Divisibility

The minimum share capital of a limited liability company is reduced to €10,000. Further, the minimum nominal amount per share is reduced to €1.00. These reductions will enable smaller companies to allocate shareholder equity in a more flexible manner. Also, contrary to the laws currently in effect, an upfront division of shares (e.g., for the subsequent sale or pledge of the divided shares) will be permitted, and more than one share can be sold to the same acquirer. Current restrictions on share divisions will be abolished.

The creation of €1.00 shares will in particular facilitate the establishment of employee participation plans. The reduction of the minimum share capital will further remove capital restrictions, which will particularly benefit group companies.

Removal of Restrictions Pertaining to Capital Contributions

According to laws currently in effect, granting a loan to a shareholder and acquiring assets from a shareholder are problematic if such measures coincide with the incorporation or capital increase of a GmbH. Granting such a loan or purchasing assets was considered a hidden contribution in kind, or the underlying capital contribution was deemed not to have been made to be freely disposed of by the company's managing directors. The legal consequences of this characterization are harsh: the obligation to contribute capital is deemed not to have been fulfilled, and the shareholder transaction (purchase or loan) is invalid. In an insolvency scenario, this results, on one hand, in the obligation of the shareholder to once again contribute the capital in cash and, on the other hand, in the worthlessness of the shareholder's claim for repayment of the loan or retransfer of the sold asset.

According to the reform legislation, in the context of the acquisition of assets, the obligation to contribute capital is deemed to be fulfilled to the extent that the relevant asset is bought at fair market value. The shareholder remains liable for the difference between the purchase price and the fair market value of the asset (balance-sheet assessment). This conforms to laws triggering liability for overvalued contributions in kind.

With respect to granting loans to the subscriber of a new share, the contribution obligation is deemed to be fulfilled only if the loan repayment claim is valued at its nominal value. If the value of the repayment claim is below its nominal value, the contribution obligation is deemed to be fulfilled only when the loan is actually repaid. In the current legislative process, it is still disputed whether this "all or nothing" concept should be replaced by liability for the difference between nominal and fair market value (as in the context of the purchase of assets).

These more permissive capital contribution requirements will further reduce existing restrictions relating to share capital maintenance and will allow newly incorporated companies in particular to participate in groupwide cash pools.

Entrepreneurial Company

The entrepreneurial company with limited liability (Unternehmergesellschaft) can be incorporated as a limited liability company without observing the minimum capital requirements of a GmbH, but it must have a share capital of at least €1.00. In order to address further creditor protection concerns, the legal form of the entrepreneurial company may be chosen only in connection with the incorporation of a company and only if the share capital has been fully paidin in cash. Concerns regarding the lower share capital and the related risks for creditors are highlighted by the mandatory addition of "limited liability" after the company's name. The entrepreneurial company has an obligation to retain earnings: 25 percent of annual profits must be booked into the company's surplus reserve. The only permitted uses of the amounts recorded in such reserve are to increase capital out of retained earnings and to compensate annual losses. If the capital is increased to an amount equal to or higher than the minimum capital required for an entrepreneurial company (€1.00), the company can be renamed as a "regular" GmbH.

While the entrepreneurial company is a useful vehicle for small enterprises, its practical use in group company structures is doubtful. It is questionable whether, due to the obligations to retain earnings, it may serve as a general partner of a limited partnership. Further, the execution of a domination agreement with the entrepreneurial company by the dominated entity is likely to be illegal, since such profit-sharing agreement requires the transfer of all of the company's profits.

Change of Registered Office

Through the deletion of restrictive provisions currently in effect, the cross-border transfer of the administrative seat of a company has become possible. As a consequence, group companies outside Germany may in the future be registered in the form of a GmbH or stock corporation. Also, the only branch office of a GmbH may in the future be located outside Germany. However, whether such country will recognize the transfer and which company law will apply will be determined by the conflict rules of the respective foreign country.

The tax-neutral transfer of the statutory seat of a company (without changing its identity) is still not permissible under German corporate law. Currently, an EU Directive relating to the cross-border transfer of the statutory seat to other EU countries is under discussion; however, this would be limited to EU countries and would have to be implemented by statute.

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