Germany: 017. Equity Substitute Loans

Last Updated: 13 June 1995
KPMG Germany Webpage
Click on the above link to visit the KPMG Germany webpage on the Mondaq website
For disclaimer and copyright see end of this article.

A recent decision by Germany's highest court of general jurisdiction, the Federal Court of Justice, has added to the long line of cases defining when loans made by shareholders in a limited liability company (GmbH) will be regarded as so-called "equity substitute loans" and what consequences this has. In the recent decision, the Court held that the failure of a shareholder to insist on prompt payment by his GmbH for goods sold by him to it could cause the unpaid amount to be treated as an equity substitute loan.

The decision is best understood after a brief review of the general rules. In a bankruptcy context, detailed statutory provisions exist. In addition, inside and outside of bankruptcy, a court-created doctrine applies.

1. Definition of equity substitute loans

Section 32a of the law on limited liability companies provides that a shareholder who makes a loan to his GmbH at a time when a reasonable businessman would have instead injected additional equity may not claim the amount of the loan in a bankruptcy or arrangement proceeding. The same applies to loans made by third parties to the extent secured or guaranteed by shareholders and to other actions by shareholders or third parties which are the economic equivalent of a loan. If the GmbH repays equity substitute loans within one year of commencement of a bankruptcy proceeding, the bankruptcy trustee can compel the shareholder to return the entire amount to the GmbH. Security granted by the GmbH with respect to equity substitute loans is also voidable in bankruptcy without temporal limit.

Inside and outside of insolvency proceedings, a shareholder who has received repayment of an equity substitute loan can be required to reimburse the GmbH, meaning its creditors, to the extent of the difference between the GmbH's net worth and the nominal amount of its stated capital. A shareholder receiving repayment of an equity substitute loan of DM 1 million can, for instance, be required to reimburse half of this amount if the GmbH had negative net worth of DM 400,000 and stated capital of DM 100,000 at the time of repayment. (If bankruptcy proceedings were commenced within one year of the repayment, the shareholder would have to reimburse the entire DM 1 million.)

Reasonable businessmen are expected to inject equity instead of making a loan when the GmbH is insolvent either in the sense of having negative net worth (using fair market values for company property) or in the sense of being unable to pay its debts as they fall due. Such a GmbH is said to be in a "crisis situation". Inability to obtain credit on the open market is another indication of a GmbH in crisis. While a shareholder may argue that he neither was nor should have been aware of the crisis, such pleas are seldom successful absent special circumstances and almost never for shareholders involved in managing the company.

Loans made before the inception of a crisis can later become equity substitute loans if not called for repayment at first opportunity after the crisis ensues. The terms on which the loan may be terminated are important in this connection, at least where these are at arm's length.

The doctrine of equity substitute loans has been held to apply to lease and rental relationships as well. Lease or rental of real or personal property by a shareholder to his GmbH at a time when the GmbH is insolvent or failure to terminate existing lease or rental relationships when a GmbH enters a financial crisis are in as much analogised to a loan. However, the consequence is not loss of ownership of the property involved by the shareholder, but rather an obligation to continue to make this property available to the GmbH or the bankruptcy estate free of rent. Much still remains to be clarified concerning such situations.

2. Equity substitute loans and stock corporations (AG)

The law of stock corporations (AG) does not contain statutory provisions analogous to those discussed above. However, the case law doctrine applicable in and out of bankruptcy to a GmbH and its shareholders is also valid in principle for stock corporations and certain of its stockholders. The doctrine does not apply to stockholders with tiny shares of stock, but probably applies to any shareholder holding a block of stock sufficient to prevent certain important shareholder decisions requiring a qualified majority under German law. Generally, such a blocking minority requires a 25 % share. In certain circumstances, the threshold might be even lower.

3. Consequences of equity substitute loans

The above doctrines do not by any means compel shareholders to inject new equity into a foundering GmbH. They are free to liquidate the company or place it in bankruptcy. (It will be recalled that German law requires the management of an insolvent company to file for bankruptcy.) Should, however, the decision be taken to provide the company with additional funds, the law seeks to give creditors priority rights thereto even if the funds are formally injected as debt.

It should also be stressed that "equity substitute loans", contrary to what the term implies, never become true equity. Firstly, such loans lose their equity substitute character if the GmbH weathers its crisis and again becomes solvent and creditworthy. While interest may not be paid on the loans until the GmbH's net worth again equals its stated capital, such interest (according to the prevailing view) continues to accrue on the books of the company and may also be paid out when the GmbH has returned to financial stability. Secondly, equity substitute loans are always shown as debt for accounting purposes, although certain authorities believe it should be identified as equity substitute debt either on the balance sheet or in a note. Thirdly, and perhaps most importantly, the Federal Tax Court has rejected the argument that equity substitute loans constitute equity for tax purposes and accepts the tax deductibility of interest accruing on such loans.

It should, however, be noted that the tax consequences of forgiveness (cancellation) of shareholder loans including equity substitute loans and their conversion into true equity is the subject of a case pending before the en banc panel of the Federal Tax Court. Among the questions to be decided is whether this procedure can cause the debtor company to realise income to the extent of the excess of the loan's face value over its fair market value.

4. Late collection of trade receivables as equity substitute loan

The case here reported upon involved a shareholder who sold goods to his GmbH but permitted the GmbH pay for these up to 8 1/2 months subsequent to delivery even after the GmbH had entered a crisis stage. Shortly before bankruptcy, payments were made which substantially reduced the level of overdue trade receivables. Since a reasonable businessman would probably have insisted on punctual payment or ceased deliveries, the Court held that such overdue receivables could constitute an equity substitute loan if the shareholder was aware of the GmbH's financial situation. An explicit contractual arrangement to defer payment was not required. However, the Court suggested that sound commercial reasons might exist for continuing to deliver goods since the GmbH apparently sold the purchased goods back to its shareholder after processing, which permitted netting of the resale price with the purchase price. Furthermore, the Court held that the amount of the equity substitute loan was to be determined with reference to the average amount of overdue receivables, not their total amount. The case was remanded for further findings on these issues.

5. Conclusion

The decision reported on shows that a shareholder should exercise caution when loaning money, renting property, or even selling goods or services to his GmbH. Existing loan, lease/rental, or trade relationships should be reviewed and possibly terminated if the economic fortunes of the company decline.

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. 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.

To print this article, all you need is to be registered on

Click to Login as an existing user or Register so you can print this article.

Some comments from our readers…
“The articles are extremely timely and highly applicable”
“I often find critical information not available elsewhere”
“As in-house counsel, Mondaq’s service is of great value”

Related Topics
Related Articles
Up-coming Events Search
Font Size:
Mondaq on Twitter
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
Email Address
Company Name
Confirm Password
Mondaq Topics -- Select your Interests
 Law Performance
 Law Practice
 Media & IT
 Real Estate
 Wealth Mgt
Asia Pacific
European Union
Latin America
Middle East
United States
Worldwide Updates
Registration (you must scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of

To Use you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these Terms or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.


The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use of the Content or performance of Mondaq’s Services.


Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions