Germany: Problems In Integrating German Companies In Group Structures

Last Updated: 18 June 2008
Article by Marc O. Peisert

Subsequent to the strategic acquisition of a German company by a German or foreign company group, the target is usually integrated into the group organization of the acquirer. Group companies are usually organized in a vertical (meaning top-down) and functional manner. In many cases, the classic functional division is applied (purchasing, sales, finances, HR); however, particularly diversified company groups may prefer a division based on industry practice or product lines.

In order to reflect the organizational structure of the acquirer group in the newly acquired subsidiary, the parent company's management usually intends to suppress local organization structures at the level of the German company, to the extent possible. For a German company, this often means that the self-sufficiency it previously enjoyed has to give way for the benefit of vertical integration. This may lead to conflicts with mandatory German corporate and labor laws.

Corporate Governance—Conflicts With the Duties of the Managing Directors

Conflicts with German governance rules can arise, particularly in cases where the acquirer's group structure provides that the German company's employees will report not to the local management but instead to a superior in the relevant functional or divisional hierarchy who is not an employee of the German company. This can lead to a situation where the German company's management is no longer able to comply with its statutory organization and monitoring duties, particularly the general duty of care and its obligation to file for insolvency if the situation arises. As a consequence, the managing directors may be personally and, in cases of failure to make insolvency filings, even criminally liable.

While in cases based on duty-of-care violations the liability exists only vis-à-vis the company, so that in the context of wholly owned subsidiaries there will be no person practically asserting any damage claims, in an insolvency scenario, such claims may nevertheless be asserted by the insolvency trustee independent of the intentions of the company group.

Instructions by the sole shareholder to the German company's management generally exclude management liability; however, such exclusion does not apply in cases of violations of the rules regarding the maintenance of capital and instructions that threaten the existence of the company (discussed below), as well as in connection with the duty to file for insolvency.

Therefore, in connection with an integration, it is important to ensure that the managing directors become part of the respective business divisions (e.g., through integration in their respective divisions) or obtain the information required for performing their respective corporate duties.

Capital Maintenance

In connection with integrating a company into a group finance and liquidity structure, the main issue to be taken into account is the German limitations regarding capital maintenance. While GmbH law permits payments to upstream and sidestream group companies to the extent such payments are made out of the capital reserves of the company (disregarding any repayment claim), such payments are generally prohibited in the case of stock corporations. These limitations become practically relevant in cases of groupwide cash-pooling systems or similar institutions or measures resulting in a movement of funds to upstream or sidestream affiliates. Such systems must contain protective provisions taking into account the capital maintenance limitations; however, the impending reform of the GmbH law will loosen restrictions in this respect.

Capital maintenance limitations can be avoided in case of the execution of a control and/or profit-sharing agreement. However, the execution of such agreements triggers obligations on the part of the dominating group company to compensate the subsidiary's losses, which are not always desired.

Liability of the Shareholder

The German Supreme Civil Court's rulings relating to cases of so-called qualified factual control pursuant to which an intensive integration of a subsidiary into a company group in the absence of a formal control agreement automatically triggered an obligation of the dominating company to compensate the losses of the subsidiary were abandoned a couple of years ago. However, in cases of measures that affect the illiquidity of the company, the shareholder is nevertheless subject to the so-called liability for measures that destroy an entity's existence (Existenzvernichtungshaftung). In integration scenarios, this liability would attach if, due to the group organization, the German company is systematically disadvantaged vis-à-vis other group companies and as a consequence is no longer able to meet its liabilities (the so-called Snow-White cases).

Labor Law Issues

Similar problems may arise in connection with the employment of new employees or the restructuring of employees assumed in the acquisition. Again, the problem is the submission of the German employees to the sole instructions of an external superior within the divisional organization. In grave cases of such foreign determination, an employee could assert that he or she maintains an employment relationship not only with the German company but also with the foreign parent company, or with the parent alone. This would have adverse consequences for the group, particularly in cases of conflict or termination. In order to avoid such problems, it is important to ensure that according to employment documentation, despite the permitted influence of superior executives, a sufficient connection to the German companies is maintained.

If the company has a works council, the integration may also trigger codetermination rights on the facility level, which should also be clarified prior to engaging in an integration measure.

Summary

Generally, the integration of a German company into a corporate group can be implemented without major problems. However, during the integration planning, German company and employment law limitations should be taken into account in order to avoid liability risks for management and shareholders. Through cautious implementation of the group structure at the German level, the potential for conflict can be minimized. In addition, the execution of control and/or profit-sharing agreements in particular can provide further flexibility, at least with respect to corporate law. Finally, experience shows that effective communication between group management and the subsidiary during the integration process helps to avoid conflicts.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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