Germany: 053. Repair of Covert Non-Cash Contributions to Capital

Last Updated: 17 July 1996
KPMG Germany Webpage
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For years, scholars and courts in Germany have grappled with the issue of how to repair so-called "covert" or "disguised" non-cash contributions to capital (verdeckte Sacheinlage). The complicated doctrine of covert contributions in kind, which applies to both GmbHs and AGs, was developed by the courts to prevent circumvention of the requirements for non-cash contributions. The doctrine operates, for instance, on purchase of property by a corporation from a shareholder in connection with a cash contribution by the shareholder in like amount. It can apply, however, to contributions honestly intended to be cash contributions. A recent decision by Germany's highest civil court, the Federal Court of Justice (DB 1996, 872 - 4 March 1996) illustrates the dilemma involved and indicates a solution to the problem.


By fixing a lower corporation tax rate for distributed earnings, the German legislature wished to create an incentive for corporations to distribute their earnings to shareholders. In situations in which the shareholder's personal tax liability with respect to the earnings would be less than the corporation's tax rate on retained earnings, a distribution results in a net refund of taxes. Corporations often seek to take advantage of this effect by distributing a dividend and then arranging with their shareholders for its immediate reinvestment. Such procedures are common and not in themselves problematic.

Whenever new shares are issued in return for the recontributed capital, such distribution-recontribution procedures contain a possible pitfall to which many shareholders fell victim before it was generally recognised some five years ago. Much energy has since been expended trying to find a way out. The new court decision shows such a way.

To simplify the distribution-recontribution procedure, some shareholders did not bother to have their corporations actually pay out the dividend declared. Instead, the corporation offset the dividend it had to pay against the capital contribution it was to receive. While offset by the corporation, as opposed to the shareholder, is not prohibited outright, it is now clear that even offsets by the corporation involving shareholder claims can be treated as covert contributions in kind (sec. 19 par. 2, 5 GmbHG, sec. 66 par. 1 AktG and case law).

The distinction is one of great significance, because German corporate law (sec. 5 par. 4, 19 par. 5 GmbHG, sec. 27, 183 par. 3 AktG) establishes special procedures for non-cash contributions to capital. In particular, non-cash contributions must be identified as such in the articles of incorporation; the non-cash consideration must be described; and the value assigned to this consideration must as a rule be confirmed by a valuation opinion from a neutral expert. Otherwise, the obligation vis-…-vis the company to make the non-cash contribution is not discharged. The reason for these requirements and for the court-developed doctrine of covert non-cash contributions is to protect creditors by ensuring that assets used to increase corporate stated capital have the value which is attributed to them.

When the original obligation is to make a cash contribution, but the actual contribution is in kind, the non-cash contribution formalities are obviously not fulfilled. The resulting undeclared non-cash contribution never discharges the original obligation to make a cash contribution. Furthermore, there is no obvious way under German law to nullify a contribution obligation, once it has been created. Such obligations are, for instance, readily enforceable by creditors and by a trustee in bankruptcy.

Federal Court of Justice Decision

The recent decision by the Federal Court of Justice indicates a way out of such dilemmas, at least for the shareholders of a GmbH. The case involved a GmbH whose shareholders agreed in 1988 on an increase in capital for cash. The required minimum amounts (25 %) were paid in cash, but the balance was offset three years later against dividend claims the shareholders had in the meantime acquired against the GmbH. In 1992 the shareholders became uncertain whether the set-off had discharged their contribution obligation and passed a new shareholder resolution calling for a contribution in kind of their claims against the company for unjust enrichment. The contribution in kind was valued as equivalent to the amount of the offset. The theory behind this was that the offset had discharged the company's dividend payment obligations to them, but not their contribution obligations to the company. Hence the company had been unjustly enriched.

Registration of the transaction was refused by the two lower courts. On appeal to the Federal Court of Justice, the case was remanded.

The Court's decision is lengthy and complicated. The most important statement made by the Court was that, even if the offset involved constituted a covert non-cash contribution and was ineffective to discharge the original cash contribution obligation, the original cash contribution obligation could nevertheless be converted by shareholder resolution into an obligation to contribute non-cash consideration, i.e. the shareholders' dividend payment claims against the GmbH. Various requirements and formalities have to be observed. These are set forth in detail in the Court's decision. The "repair" method chosen by the parties to the litigation, i.e. contribution of claims for unjust enrichment, was rejected by the Court.

The decision is of great importance to the considerable number of shareholders who unintentionally made covert non-cash contributions in connection with the distribution-recontribution procedure described above. By converting the original cash contribution obligation into a non-cash contribution obligation, which has in essence already been performed, the shareholders can escape the liability which would otherwise continue to hang over them.

The details of the decision involve factual circumstances not typical of distribution-redistribution procedures gone awry. They are therefore not reported here, but are also of major significance for the doctrine of covert contributions in kind in general.

Disclaimer and Copyright
This article treats the subjects covered in condensed form. It is intended to provide a general guide to the subject matter and should not be relied on as a basis for business decisions. Specialist advice must be sought with respect to your individual circumstances. We in particular insist that the tax law and other sources on which the article is based be consulted in the original, whether or not such sources are named in the article. Please note as well that later versions of this article or other articles on related topics may have since appeared on this database or elsewhere and should also be searched for and consulted. While our articles are carefully reviewed, we can accept no responsibility in the event of any inaccuracy or omission. Please note the date of each article and that subsequent related developments are not necessarily reported on in later articles. Any claims nevertheless raised on the basis of this article are subject to German substantive law and, to the extent permissible thereunder, to the exclusive jurisdiction of the courts in Frankfurt am Main, Germany. This article is the intellectual property of KPMG Deutsche Treuhand-Gesellschaft AG (KPMG Germany). Distribution to third persons is prohibited without our express written consent in advance.

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