• Editorial
  • News From the Locked Box
  • Distressed M&A: Swap of Debt for Equity in an Insolvent Company to Be Simplified by a New Law on the Facilitation of the Reorganization of Enterprises
  • Kept Out: Appointment of Foreign Managing Directors That Do Not Have the Ability to Enter the Country at Will
  • Purchasing a Shelf Company After the GmbH Reform: Problems and Practice
  • New Developments in Management Board Compensation
  • Jones Day's German M&A Practice Shortlisted for 2010 JUVE Award


This issue of German M&A and Private Equity News provides a selection of current topics in the areas of M&A practice and corporate law, as well as relevant legislative projects.

"News From the Locked Box" is the title of our practice-oriented article dealing with new developments in the area of purchase-price clauses in M&A acquisition agreements. We commence by examining the two common adjustment models in the context of share deals, namely, the working-capital adjustment based on a closing balance sheet and the simpler but more generalized locked-box model. We then discuss a merged approach that has been used in recent practice. This solution combines the advantages of both models and is therefore expected to be widely used in the future.

The contemplated reform of the restructuring of insolvent companies in Germany is still in a fairly early stage. However, the draft for discussion prepared by the German Ministry of Justice is highly relevant to the area of distressed M&A, so we have decided to offer our comments at this time. The planned legal reform enables investors to obtain a majority or sole participation in an insolvent company by way of a debt-for-equity swap effected through a capital increase. The crucial novelty here is that if certain conditions are met, such measures may be effected without the consent of the incumbent equity owners, which is currently generally required. Such a share acquisition may in certain cases result in substantial advantages vis-à-vis restructuring by way of an asset deal, which constitutes the current standard practice.

The appointment of a foreign national as the managing director of a GmbH, e.g., as a means of maintaining control following the acquisition of a German company by a foreign buyer, is common and in general not problematic. However, due to the unclear legal situation, problems related to registration with the commercial register could arise under certain circumstances, particularly if the foreign managing director is not permitted to enter the country. We discuss the ramifications of the recent internationalization of German corporate law on this issue and the development of case law resulting therefrom.

The acquisition of "shelf companies" and "shell companies" as acquisition vehicles remains, at least in the case of tight acquisition time frames, a crucial part of the German M&A and Private Equity practices, irrespective of the easing of requirements regarding the establishment of GmbHs provided by the GmbH reform. We examine whether and to what extent the legal problems associated with the use of such companies have disappeared or whether they have merely been replaced by new issues.

Finally, in the area of stock corporation law, we discuss the new rules regarding the adequacy of management board compensation. Although these rules attempt to clarify legal terms that had previously been unclear, the determination of adequate compensation as required by law continues to be rather complex. Since granting excessive compensation exposes the supervisory board to the risk of personal liability, an understanding of this topic is essential, and the establishment of formal compensation systems is recommended. Our summary provides an initial overview of the relevant aspects of the new rules.

We hope that you find the topics selected for this newsletter interesting and informative.

News From the Locked Box

By Martin Schulz

In German share deals, two types of purchase-price clauses predominate: on the one hand, the adjustment of a base purchase price by the net debt of the target company and variations in its working capital as of the closing; on the other hand, the calculation of the purchase price on the basis of the latest audited balance sheet of the target company and interest payments on such purchase price for the period between the balance-sheet date and the closing ("locked box"). In recent times, a combination of both mechanisms has been used as an alternative: the calculation of the purchase price as of an effective date between the date of the last audited financial statements and the closing and interest payments for the period between such effective date and the closing. This article briefly discusses the established mechanisms and then explains the new alternative.

Determination of the Purchase Price as of Closing

In recent years, the most common purchase-price mechanism used in share deals—on a simplified basis—is as follows: base purchase price plus cash less financial debt plus excess or less shortfall in working capital equals final purchase price.

The reason for this mechanism lies in the valuation of the target company. Buyers typically value target companies using the discounted-cash-flow method and/or an enterprise- value multiple, such as a multiple of the target company's EBIT or EBITDA. Both types of valuations have in common the fact that the value of the target company—and thereby the purchase price—is determined in two steps. First, the so-called enterprise value is determined, which is the present value of the target company's expected payments to its equity and debt holders. In order to determine the target company's equity value and thereby the purchase price, the market value of the target company's debt, which normally equals its book value, then has to be deducted from the enterprise value. Furthermore, nonoperating assets, particularly excess cash and cash equivalents, are compensated separately and therefore have to be added to the purchase price. Second, the target company's working capital is compared to a certain target working capital figure. To the extent the target company's working capital exceeds or falls short of such target, the purchase price is increased or decreased, respectively.

The advantage of this purchase-price mechanism is that the balance-sheet items required to calculate the equity value and thereby the purchase price are determined as of the closing. Therefore, this mechanism is more accurate than the locked-box approach discussed below, which through the interest component contains a certain lumpsum element.

However, in practice this mechanism has several disadvantages. First, it is often difficult for the parties to agree on the individual items constituting the financial debt, cash and cash equivalents, and working capital, as well as on the target working capital. Since the items have to be determined on the basis of an interim balance sheet as of the closing, the parties are usually forced to close at the end of a calendar month, which might delay the closing. Second, as the balance sheet can be prepared only after the closing, there often is a significant time period between the closing and determination of the final purchase price, particularly if a dispute between the parties develops concerning the accuracy of the closing balance sheet. Finally, from the perspective of the seller, the mechanism has the disadvantage that the purchaser controls the target company post closing and therefore often only the purchaser will be able to prepare the closing balance sheet. The seller then only has the opportunity to review the balance sheet prepared by the purchaser.

Locked Box

In order to avoid the problems described above, private equity sellers in particular have increasingly been using a different purchase-price mechanism in recent years, the so-called locked-box mechanism. In that mechanism, prospective purchasers are requested to submit a purchase- price bid on the basis of the target company's latest available financial statements. Such purchase price then bears interest between the effective date of the financial statements and the closing.

The economic rationale behind this mechanism is as follows: the balance-sheet items required to derive the equity value from the enterprise value as of the latest balancesheet date are available in the latest financial statements. Therefore, prospective purchasers are able to determine the purchase price as of the latest balance-sheet date on the basis of the available data. Since the purchase price was calculated as of an effective date in the past, it bears interest until the closing date.

The practical advantages are obvious. Since the bidders are requested to calculate the purchase price from an economic perspective retroactively on the basis of available data, they can (and have to) offer the equity value of the target company they consider appropriate as the purchase price. Therefore, there is no need to determine the equity value as of the closing based on an interim balance sheet. Furthermore, there will be no discussions as to the balance-sheet items by which the enterprise value has to be adjusted in order to obtain the equity value.

Despite these advantages, the parties nevertheless are often unable to agree on this mechanism, particularly if there is a substantial period between the last balancesheet date and the closing and if the target company is (very) profitable. The main reason for this is that the parties are often unable to agree on an appropriate interest rate for the period between the balance-sheet date and the closing. The seller, which will argue that the reason for the interest is to get a lump-sum compensation for the profits generated by the target company between the balancesheet date and the closing, will therefore demand a corresponding interest rate. The purchaser, on the other hand, will argue that it has borne the economic risk of the target company since the last balance-sheet date because the purchase price was calculated as of that date. Therefore, it should be entitled to the profits. The interest rate thus should be that of a secure alternative investment, e.g., for fixed-term deposits.

The Combination of Both Mechanisms

In order to avoid at least some of the problems discussed above, parties in recent times have started to combine both mechanisms. For that purpose, the parties agree to determine the purchase price in the form of the target company's equity value as of a balance-sheet date between the date of the latest audited financial statements and the closing and on the interest on such purchase price until the closing. The appropriate effective date for the determination of the purchase price depends on the circumstances of the transaction, e.g., whether the target company requires some lead time for the preparation of the interim balance sheet (e.g., in order to prepare a physical inventory), the expected time period between signing and closing, and whether there is a profit-and-loss pooling agreement to be terminated. Typically, the effective date will be either shortly before or after signing.

The share purchase agreement then provides that the equity value (purchase price) of the target company shall be determined as of such effective date. To that end, the mechanics described above in the section "Determination of the Purchase Price as of Closing" are used; i.e., starting with a base purchase price (enterprise value), the target company's cash and cash equivalents, financial debt, and working-capital excess or shortfall are determined on the basis of an interim balance sheet, and then the final purchase price (equity value) is derived from the base purchase price. The interim balance sheet is prepared by the seller because the seller still controls the target company. In addition, an appropriate procedure for the review of the balance sheet needs to be agreed upon. The purchase price bears interest for the period between the interim balance- sheet date and the closing.

Even though this mechanism, in contrast to the pure locked-box approach, requires the parties to agree on the individual positions of the cash, cash equivalents, financial debt, and working capital and to prepare an interim balance sheet, the mechanism has several advantages. From the perspective of the seller, a major advantage is that it can prepare the interim balance sheet. Furthermore, there is no longer any need to close at the end of a month in order to be able to prepare a closing balance sheet. Since the effective date for the interim balance sheet is prior to the closing so that there will be time to start preparing and reviewing the balance sheet prior to the closing, the procedure is considerably faster than if the balance sheet had to be prepared post closing. Compared to the pure locked box approach, the mechanism has the advantage that the equity value (purchase price) is determined as of an effective date later than the date of the last audited financial statements. Therefore, the profits generated by the target company until the interim balance-sheet date are directly taken into account in the calculation of the purchase price rather than being compensated on a lump-sum basis through interest payments. At the same time, the period during which the purchase price bears interest is much shorter, so the relevance of the interest to the total purchase price decreases and the parties are more likely to determine an interest rate acceptable to both of them.


This new approach is a combination of established mechanisms. Applied correctly, it leads to an expedited determination of the final purchase price and to greater flexibility regarding the timing of the closing. Furthermore, from the perspective of the seller, it has the advantage that the seller, rather than the purchaser, can prepare the balance sheet required for the determination of the final purchase price. Due to the relatively short period between the interim balance- sheet date and the closing, the parties will be more likely to agree on an interest rate for the purchase price.

Distressed M&A: Swap of Debt for Equity in an Insolvent Company to Be Simplified by a New Law on the Facilitation of the Reorganization of Enterprises

By Dr. Volker Kammel

As part of an intended comprehensive amendment of German insolvency law, the German Federal Ministry of Justice has prepared a draft of a new law to facilitate the reorganization of enterprises ("Reorganization Facilitation Act"). The new law will curtail the rights of shareholders of insolvent companies and allow capital measures and other corporate measures to be taken in the insolvency of a company without the participation of the shareholders. The new regulation is of interest to investors because it will significantly simplify the purchase of the shares of an insolvent company.

Investors usually buy insolvent enterprises by means of an asset deal. The advantage of this approach is that the buyer, in principle, assumes only those liabilities that he actually wants to assume. (Exceptions may apply, as in the case of liabilities stemming from employment agreements.) In addition, unprofitable parts of the enterprise can be left with the insolvency administrator. There are, however, serious shortcomings inherent in an asset deal. Agreements with third parties that may be of fundamental importance to the business cannot be transferred to the buyer without the consent of the other party to the agreement, which may not be obtained at all or only if the buyer is prepared to make substantial concessions to the other party. Furthermore, public permits required for the operation of the business may not be transferable, so they cannot be assigned to the buyer in the course of an asset deal. The buyer will need to apply for a new permit, which may create difficulties. The purchase of the insolvent enterprise by means of a share deal is frequently preferable in these cases, but only after the debt of the insolvent entity has been restructured by means of a plan of restructuring, which will need to cure a (calculatory) overindebtedness and ensure that the company has an appropriate equity ratio going forward.

Cooperation of Existing Shareholders Required Under the Current Law

Creditors are generally not prepared to waive a company's debt or support the reorganization in any other way if the shareholders themselves do not make an appropriate contribution to the continuation of the business. If the shareholders are unwilling or unable to do so, then the creditors may consider taking shares in the company by swapping their debt for equity. The first step of a debt-forequity swap is usually to reduce the registered share capital of the company (to zero, if required) in order to extinguish any losses in the balance sheet. After the capital decrease, the registered share capital is increased, the company's debt is contributed as consideration for the new shares and any subscription rights of existing shareholders are excluded. The new shares created by the capital increase are allocated to the participating creditors. Opportunities for investors arise if the existing creditors do not want to take equity in the insolvent company but are prepared to sell their claims (below par) and thus enable the investor to participate in the debt-for-equity swap. An investor can, of course, also agree to subscribe to new shares issued by the company and contribute cash funds as consideration for these shares.

Under current law, the issuance of shares to creditors or investors without the cooperation of existing shareholders is only possible, if it is possible at all, if the existing shareholders are required to cooperate because they have fiduciary duties to the company. Whether such fiduciary duties exist in a specific case is frequently unclear. At any rate, it is usually not possible to enforce fiduciary duties with the help of the courts in time for the reorganization. It goes without saying that there is no incentive for the existing shareholders to agree on the necessary capital measures if the outcome is that they will no longer hold a (meaningful) stake in the company. Creditors that intend to reorganize the insolvent company frequently have no choice but to buy the shares of the existing shareholders at a purchase price that exceeds the actual residual value of the shares in the insolvent company.

No Cooperation Required by Existing Shareholders Under the New Law

The draft Reorganization Facilitation Act provides for the rights of shareholders to be curtailed by means of a plan of restructuring without their consent. Under the new law, capital measures in connection with a debt-for-equity swap, the exclusion of existing shareholders' subscription rights, compensation payments to shareholders exiting the company, the continuation of a company that was dissolved as a result of the opening of insolvency proceedings, the transfer of shares in the company, and other corporate measures may be provided for in a plan of restructuring. Appropriate compensation needs to be provided for in the plan if the existing shareholders lose their shares as a result of such measures. If the shares in the insolvent company are no longer worth anything, then no compensation is required.

The plan of restructuring and the regulations contained therein become effective once the plan has been confirmed by the insolvency court and such confirmation is no longer subject to an appeal. A court will not confirm the plan if mandatory provisions on the content of the plan, on the process, or on the adoption of the plan by the creditors and the existing shareholders were not complied with in all essential points. Voting on the plan of restructuring occurs in groups. The plan itself allocates creditors and shareholders to different groups according to the specific legal position of the respective participant. There will usually be more than one creditor group. In general, an insolvency plan is adopted only if all of the groups consent to the plan. In order for a creditor group to consent to the plan, the majority of the creditors in that group (head count and sum of claims) need to have voted in favor of the plan. In the case of a shareholder group, the new law will provide that a majority of the shareholdings is necessary for the group to consent. A group, especially a group of shareholders, that votes against the plan may nevertheless be crammed down if: (i) the members of the dissenting group are not worse off under the provisions of the plan of restructuring than they would be if there was no plan, (ii) they participate in an appropriate manner in the economic value made available to the participants under the plan, and (iii) the majority of the group vote in favor of the plan.

The plan of restructuring may withdraw shares from the existing shareholders without any compensation if the shares are no longer worth anything, which is usually the case if the company is insolvent. If the group of existing shareholders votes against such a plan, then it can be crammed down. Since the members of the group would not receive anything if there was no plan and the company was liquidated, they will not be worse off with the plan than they would be without it. Members of such dissenting group will participate in an appropriate manner in the economic value that is made available under the plan if no creditor obtains funds or other assets in excess of its claim and no other shareholder is better off under the plan than the members of the dissenting shareholder group. In exceptional cases where the shares in the insolvent company still have some (residual) value, the plan of restructuring needs to provide either for the continuing participation of the existing shareholders in the company following the reorganization in a scope determined by the residual value of their shares or for their shares to be withdrawn and appropriate compensation to be paid.

The value of the shares of the current shareholders needs to be determined as soon as the plan of restructuring is drawn up. The potential residual value of the shares determines the provisions that can be made in the plan with respect to such shares. If the majority of a shareholder group are of the view that the provisions in the plan of restructuring are based on a valuation of the shares which is too low and that they would be better off without the plan than they are with it, then they will vote against the plan. If the insolvency court crams down the dissenting shareholder group and confirms the plan nevertheless, the members of such group may appeal the court decision. In order for such appeal to be admissible, the shareholders need to provide prima facie evidence that they would be materially disadvantaged by the plan and that such disadvantage could not be cured by any payments provided for under the plan. This requirement intends to prevent abuse of the right of appeal.


The new law will prevent existing shareholders from blocking debt-for-equity swaps and other corporate measures with respect to companies in insolvency. It can be expected that the reorganization of insolvent companies and the participation of investors in such companies by means of either loan-to-own strategies or some other acquisition of shares will be facilitated.

Kept Out: Appointment of Foreign Managing Directors That Do Not Have the Ability to Enter the Country at Will

By Marc O. Peisert

Appointing a foreign national as the managing director of a German limited liability company ("GmbH") is a wellestablished practice in Germany. Particularly when a foreign company acquires a German company, a representative of the parent company is often appointed as an additional managing director on the German management team. It is undisputed that foreign citizenship as such is not by any means an obstacle to such an appointment. What is disputed is whether and to what extent a managing director who is not resident in Germany must be authorized to enter Germany, an issue not expressly addressed by statute. More specifically, the question is whether a managing director must be present in Germany in order to meet his obligations and to what extent his ability to enter and exit the country plays a role in this context.

On a practical level, this question becomes relevant when the appointment of the managing director is registered in the commercial register. The commercial register may refuse to make such registration if there is an obstacle to the appointment. The practical application of these rules by the commercial registers has been inconsistent. Frequently, the appointment of a foreign national as a managing director is simply waved through. No problems arise in the case of nationals of EU member states, who are entitled to enter the country at any time under EU law, as well as nationals of countries exempted from visa requirements, who typically receive a residency permit of up to three months without any particular authorization. Since a high-court decision has not been forthcoming, the courts at the commercial registers may question the residence-permit status of a managing director in individual cases, which in the worst case may lead to the refusal to register the managing director. However, a recent decision of the court of appeal of Munich (31 Wx 142/09, December 17, 2009) emphasizes that the law, particularly due to the internationalization of corporate law in recent years, is leading towards liberalization of the treatment of nonresident managing directors.

Decision of the Court of Appeal of Munich

In the case before the court, the presence of the managing director in Germany was merely tolerated by the authorities, and he had no valid residency or work permit. The trial court was of the opinion that a foreigner from a state outside the EU had to prove he had the ability to enter Germany at any time. This was not the case with respect to the petitioner, since he was threatened with deportation and prohibition on re-entering the country. The court of first instance, concluding that there was no guarantee the managing director could satisfy the legal obligations of his office, confirmed the commercial register's rejection of his registration.

Until 2008, proponents of this hard line were supported by the so-called domicile theory (Sitztheorie), which generally applied to German companies until that time. According to this theory, the domicile of a company's administration had to be within Germany. The move of a company's administration to a location outside Germany would consequently lead to the liquidation of the company in Germany. Therefore, the business and administrative activities of the company could not be conducted from outside the country on a permanent basis without being subject to the charge of (impermissibly) having a foreign-domiciled administrative center. The only option a foreign nonresident managing director had was to reach material administrative decisions during regular visits to Germany. The question of whether he was entitled to enter the country therefore played a significant role.

Acknowledging that the question had previously been in dispute, the court was of the view that the requirement for a managing director living outside Germany to be able to enter the country at any time was invalid after the introduction of the so-called incorporation theory (Gründungstheorie) due to the recent reform of GmbH law. According to this theory, the administrative center of a GmbH may be located outside the country. Since a GmbH now has the option to transfer its entire administration outside the country without fear of sanction, there is no longer any foundation to the argument that it is extremely difficult for a managing director who is not entitled to enter the country at any time to access the company's books and records or contact its employees and business partners. The same principle must apply to a managing director who is currently residing in Germany but may not enter the country in the future. The court declined to give the commercial- register court the authority to review the residency status and the associated interconnection of laws concerning legal aliens and corporate law, since simpledeportation or a prohibition on entering the country—particularly in light of the revised wording of the Limited Liability Companies Act—does not qualify as a ban from a profession that would render an appointment as managing director illegal under the Act.

Meeting the Obligations of a Managing Director From Outside the Country

This result is based on the assessment that lack of ability to enter the country at any time does not essentially pose an obstacle to the managing director's duty to properly manage the company, a duty that is also in the public interest. The court of appeal only marginally addresses this, presumably supported by the assumption that this assessment has already been made by the legislature and that express permission for a GmbH to have a foreign domicile is incompatible with the requirement for a managing director to have a place of residence in Germany.

This assessment, however, is also justified on the merits. Thanks to modern forms of communication, it is possible for a managing director residing outside the country to obtain the information relevant to the performance of his duties, as well as to implement his decisions in Germany by delegation. Even important actions that are reserved for the managing director—such as filing for bankruptcy—can be taken care of from outside the country.


The court of appeal of Munich follows previous decisions by the courts of appeal of Düsseldorf and Dresden. It is to be expected that additional courts will follow this view.

Although formal barriers regarding the registration in Germany of nonresident managing directors are increasingly likely to disappear, none of the substantive obligations to which managing directors are subject have been eased in any way. In order to avoid personal liability, a managing director residing outside Germany must ensure that he meets such obligations, and to this extent, he may find himself in a more difficult situation than a local managing director. As mentioned above, however, these practical difficulties can be largely dispelled through the establishment of adequate information, compliance, and delegation mechanisms by the managing director.

Purchasing a Shelf Company After the GmbH Reform: Problems and Practice

By Dr. Rastko Vrbaski

So-called shelf companies are frequently used in connection with various corporate transactions. These shelf companies are typically incorporated by commercial service providers but are not initially involved in any entrepreneurial activities. Participants in a transaction, instead of newly establishing a company, may purchase all of the shares in a dormant shelf company from the service provider. Further, the sale and use of a company that had formerly been operative but has ceased to do business (a so-called shell company) in lieu of liquidation are of practical relevance. Acquiring a shelf or shell company is often faster than incorporating a company but also involves certain risks. In case a shell company is used, there is a particular risk that the purchaser of the shares will be responsible for any outstanding capital contributions that should have been paid in by its predecessor in title. In addition, there is also a risk to the purchaser that the seller is not in fact authorized to sell the shares in the company.

On November 1, 2008, the German Act to Modernize the Law Governing Private Limited Companies and to Combat Abuses (commonly referred to as the "MoMiG") came into effect. The changes relating to the laws governing limited liability companies ("GmbHs") introduced by the MoMiG also affect the purchase of shelf or shell companies in several respects.

Notification of the Company With Respect to the Acquirer

Previously, only those persons notified to the company as such were recognized by the company as shareholdersIn connection with the purchase of a shelf company, the purchaser had to be registered as a shareholder with the company prior to being able to appoint its managing directors and make changes to its articles of association.

The new law no longer provides for such a notification requirement. The required registration of the new shareholder in the list of shareholders partly takes the place of the notification. Accordingly, vis-à-vis the company, only those persons who are included in the list of shareholders accepted by the commercial register are deemed to be shareholders. Such acceptance is deemed to have occurred when the list becomes available from such register online. If after the sale but prior to inclusion in the list of shareholders, the purchaser concludes any resolutions concerning the managing directors of the company or its articles of association, these resolutions are effective only if the purchaser is "promptly" included in the shareholder list after the date of the resolution. Accordingly, the purchaser bears the risk that its inclusion in the list of shareholders is not deemed to have been prompt or that delays due to other participants in the transaction (seller, notary, commercial register) are attributed to the purchaser. In connection with the purchase of a shelf company, it is therefore advisable that immediately prior to the sale of the shares, the measures that the purchaser wishes to implement be carried out by resolutions enacted by the seller.

Share Splits

Previously, shares could be split only in the context of a sale or an inheritance. A mere preparatory split or a split for financing purposes was not permissible. In order to be valid, a split had to receive the approval of the company. Under the new law, a preparatory split or a split for financing purposes is now permitted and no longer requires the consent of the company, although a resolution of the shareholders is required. The new rules simplify the deal structuring in connection with the purchase of a shelf company when various parties are involved on the purchaser's side. Size and number of shares can now easily be tailored to the desired acquisition structure.

Good-Faith Purchase of the Shelf or Shell Company

Under previous law, a share could be validly transferred only by its legal owner, and there was no protection available to a good-faith purchaser against transfer of ownership from a person who was not the rightful owner of the shares. In the case of shelf companies sold by professional providers, this was routinely not an issue. The risk in case of the purchase of a shell company was higher, however, since the shares were potentially subject to a number of previous share transfers, and therefore the purchaser could not be certain that the seller was actually able to transfer ownership of the company to the purchaser. The MoMiG now provides for a share transfer by a person who is not a shareholder to a good-faith purchaser if: (i) the seller is identified as a shareholder in the list of shareholders, and (ii) such list has been incorrect for not less than three years from the date of the purchase or the incorrectness is attributable to the true shareholder. As discussed in a previous edition of this newsletter, this new provision has also raised a number of issues. For instance, the purchaser bears the risk that the shares are encumbered by third-party rights, particularly pledges, since a good-faith purchase free from encumbrances is not possible according to the new law. In addition, the purchaser may not simply rely on the contents of the shareholder list; the list does not have official bona fide status as would an extract from the land registry. The determining fact is the period during which the list has been incorrect, which often cannot be definitively ascertained. Therefore, even a 10-year-old shareholder list could have become incorrect in the last three years. In light of the fact that the good-faith protection provided by the MoMiG is incomplete, a shell purchase remains risky and should be considered only under special circumstances, e.g., in the case of purchases of companies within a company group where the shareholding history can be sufficiently determined.

Determination of the New Corporate Purpose

An important step in the sale of a shell or shelf company is the change of the corporate purpose of such company. Under previous law, the new corporate purpose, if it required governmental authorization (e.g., a banking or real-estate agent's license), could be registered in the commercial register only if such official authorization had already been obtained. Under the new law, this requirement has been abolished. If the purchaser wants to conduct business that requires a license, the purchaser can obtain registration of the new corporate purpose prior to receiving official approval. In many cases, however, applicable regulatory laws regard the registration as commencing business operations. Therefore, in order to avoid the risk of illegally commencing business operations prior to obtaining a license, purchasers should generally continue to register the new corporate purpose only after receiving the relevant license.

New Developments in Management Board Compensation

By Dr. Ralf E

On August 5, 2009, the German Act on the Appropriateness of Management Board Compensation (Gesetz zur Angemessenheit der Vorstandsvergütung; "VorstAG") became effective. This legislative amendment has had such a major impact that most stock corporations are currently reviewing their compensation systems. A mandatory adjustment obligation exists in case new employment contracts for management board members are concluded. Moreover, listed stock corporations must consider the recommendations of the German Corporate Governance Code, particularly with a view to caps on severance pay. In addition, in the future, a deductible in the D&O insurance will generally become mandatory for management board members. The following is an overview of the consequences that the VorstAG has had on management board compensation.

Amendment of Section 87 of the German Stock Corporation Act (Aktiengesetz; "AktG")

By virtue of the VorstAG, the notion of "appropriateness" of management board compensation has been specifically defined. Section 87, para. 1, AktG now reads as follows:

When fixing the total remuneration of an individual management board member (salary, profit participation, expense allowances, insurance premiums, commissions, incentive-based remuneration commitments like, e.g., stock options and fringe benefits of any kind), the supervisory board shall make sure that the remuneration is in adequate proportion to the duties and responsibilities and the performance of the management board member as well as to the situation of the company and does not exceed the customary remuneration without particular reasons. The remuneration structure for listed stock corporations shall be geared towards a sustainable development of the company. Variable components of the remuneration shall therefore be based on a perennial assessment; the supervisory board shall agree on means of limitation in case of extraordinary developments. Sentence 1 applies mutatis mutandis for retirement pay, survivors' pensions, and related benefits.

Furthermore, a reduction of the remuneration is possible pursuant to Section 87, para. 2, AktG if the company's situation deteriorates and a continued granting of the remuneration would be unreasonable. However, in the case of retirement pay, widows' pensions, and related benefits, this is possible only within the first three years after withdrawal from the company.

The Major Criteria

The appropriateness of the total remuneration of the individual management board members is therefore based on the member's duties, responsibilities, and performance, as well as on the situation of the company. Furthermore, the remuneration of the individual members must not exceed the remuneration customary in the industry or country without particular reasons.

With respect to the term "situation of the company," there is consensus that this term must be construed in a very broad sense so that, for instance, the supervisory board, despite a difficult economic situation, would have the option of paying a high remuneration for a management board member specifically appointed for the purpose of restructuring the company, particularly with a view to the difficulty of the task and the risk of failure. When fixing the management board compensation, the supervisory board must ensure that such compensation is on a level with that of companies of the same trade with comparable size and complexity, but it should also take into account the particular salary and wage structure within the company. In addition, the supervisory board must consider what salary is deemed " customary" within the statute's area of application. Remuneration in excess of such customary levels requires an explanation by the supervisory board. But since "customary" remuneration is not always deemed to be adequate, it is advisable to always provide the reasons for exceeding those customary levels.

In the case of listed stock corporations, the remuneration structure shall be geared towards the sustainable development of the company through variable components in the remuneration with long-term assessment indicators. Bonuses and special payments shall not depend on certain due dates, such as the end of a calendar quarter or the end of the year. Rather, sustainable development of a company shall be achieved by rewarding its continuous improvement and development. The long-term assessment indicators are intended to result in payment at a later point in time; according to the legislators, the relevant time period should be up to four years. Through this time lag, a company's potential negative developments can also be incorporated into the assessment.

Legal practice has not yet clarified when management board remuneration is inappropriate in the individual case within the meaning of Section 87, para 1, AktG. Empirical figures for management board remuneration actually paid in Germany can be found in the surveys on remuneration issued on a regular basis by human-resources consulting companies.

Liability Risks for the Management Board

A violation of the supervisory board's obligation to determine appropriate management board compensation does not lead to the invalidity of the employment or remuneration agreement. Rather, the management board member is entitled to compensation in the full amount agreed. Invalidity comes into question only if the amount of the remuneration is contrary to public policy pursuant to Section 138 of the German Civil Code (Bürgerliches Gesetzbuch). However, the fixing of an inappropriately high remuneration constitutes a breach of duty of the supervisory board, with the consequence that the members of the supervisory board become personally liable for reimbursement of the damage the company has incurred as a result of the fixing of the excessive management board compensation. Accordingly, if the management board member does not (voluntarily repay the excessive portion of the compensation, this portion has to be compensated for by the members of the supervisory board.

Management Board Compensation and the Shareholders' Meeting

The VorstAG further provides for a legally nonbinding vote at the shareholders' meeting regarding the "acceptance of the system for the compensation of management board members" (Section 120, para. 4, AktG) for listed stock corporations. This measure was intended to give the shareholders a tool to control the existing compensation system. The legislature is of the hope that a disapproving vote at the shareholders' meeting regarding the compensation system will lead to public pressure on the management, which shall be urged to fix the management board compensation. However, resolutions regarding the specific amount of the management board compensation, particularly the fixing of an upper limit, are inadmissible. The management has the right, but not the obligation, to include on the agenda a "vote regarding the management board compensation system." If it fails to do so, the item may be placed on the agenda only by virtue of a minority request pursuant to Section 122, para. 2, AktG. Otherwise, no vote regarding the management board compensation can be cast at the shareholders' meeting.

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.