In the context of the transfer of interests in a German limited liability company, a bona fide purchase of the shares from a seller owning such interests was not possible. In contrast to the purchase of real property or movable goods, the purchaser's good-faith belief in the ownership of the would-be seller was not protected. The purchaser therefore could not obtain ownership rights over the shares. Although the purchaser in an M&A transaction typically receives broad warranties that at least cover financial damages, these seldom compensate for the full commercial damages of a failed transaction.

The MoMiG now provides for a bona fide purchase of shares in a GmbH; this means that the effective acquisition of shares from a nonowner will be possible in the future. The good faith required to make such a bona fide purchase will now be based on the shareholder information contained in the shareholder list that has to be submitted to the commercial register. This shareholder list had previously served as an information source for the shareholdings in the GmbH, but due to the lax provisions on submitting such a document, it was inadequate as a basis for a finding of good faith. In order to increase the reliability of the shareholder list, the MoMiG has now tightened the provisions requiring its submission. Notaries that are involved in transactions made by notarial deed in which the shareholders change (such as the transfer of shares via notarial deed) now have the obligation to submit the shareholder list to the commercial register. In addition, the liability of the managing directors, who must submit the shareholder list in all other cases, is exposed in the case of nonsubmittal

Despite these safeguarding measures, the reliability of the shareholder list is limited. The accuracy of the shareholdings according to the shareholder list is not examined by the commercial register. Also, if the transfer is subject to a condition precedent (such as approval by the competition authorities), the notary recording the conditional transfer is not obligated to keep informed about whether the condition has been satisfied, nor to submit the shareholder list at that time; this continues to be the obligation of the managing director of the company. Further, the legislature decided against requiring notarial certification of the signature of the managing director submitting the application; therefore, it is possible that falsified shareholder lists will be submitted. Due to these loopholes, the legislature decided that the list should not have a full and immediate impact on the finding of good faith and instead introduced a step-by-step system.

Time Limitations

The intensity of the protections provided by the MoMiG is determined by how long the shareholder list was inaccurate at the time of the transfer. The shareholder list can be inaccurate for two reasons: it can be inaccurate at the outset, such as when the submitted list is inconsistent with the actual shareholdings of the company, or it can become inaccurate later, if the shareholdings change without submission of a new list.

If the list was inaccurate for a period of more than three years at the time of transfer, the purchaser is required only to demonstrate good faith. "Good faith" means that the purchaser may not have had knowledge of the inaccuracy of the shareholder list or was not grossly negligent in lacking such knowledge. If the shareholder list was inaccurate for a period of less than three years, in addition to the good faith of the purchaser, the inaccuracy of the list must be able to be imputed to the true owner of the shares. This is the case, for instance, when the true owner affirms the inaccuracy of the shareholder list or, despite knowledge to the contrary, does not object to the inaccuracy of the shareholder list.

Independent of the length of time that the shareholder list is inaccurate, the purchaser cannot obtain the shares from the person not authorized to sell them if an objection as to the inaccuracy of the list is entered with the commercial register. Such entry is possible either with the consent of the person authorized to sell the shares according to the shareholder list or on the basis of an interim judicial order. If an objection is incorrectly entered, it remains possible to purchase the shares from the actual owner set forth in the shareholder list. However, in such a case, due to the fact that no bona fide transfer will be possible, the purported ownership should be verified with the utmost diligence.

Limits on Bona Fide Transfers

The scope of the good-faith protection is limited. First, good faith applies only in the case of shares that actually exist; there is no good-faith creation of a nonexistent share. Further, good-faith protection does not extend to existing encumbrances such as pledges or easements; a bona fide purchase extinguishing prior liens as under the law of real property based on the land register is therefore not possible. Good faith is also not sufficient to override provisions restricting transferability that may be found in the company's articles of association—in this context, the consent of the shareholder remains necessary.

A further disadvantage for the purchaser in the future is in the case of transfers subject to a condition precedent. Here, subsequent disposals of the shares vis-à-vis the first purchaser had been invalid (Section 161, paragraph 1, of the German Civil Code). According to Section 161, paragraph 3, of the German Civil Code, the provisions relating to good faith will now apply so that in the case of a subsequent transfer during the time that the condition precedent has not yet been satisfied, the second good-faith purchaser can obtain ownership of the shares. A corresponding protective mechanism, as under real property law, in the form of priority notice in the commercial register to safeguard the first purchaser's claim has not been created by the legislature. Alone, the registration of an objection by mutual consent could be of assistance here; however, the shareholder list is not inaccurate until the condition is satisfied so that the objection would, in fact, be unfounded in substance. It remains to be seen how this gap is closed in practice; it is possible that the legislature will propose further amendments.

Effects on Due Diligence and Contractual Documentation

For the M&A practitioner, the question arises as to the practical effects of the new rules in carrying out M&A transactions. In the context of M&A due diligence, one is faced with a dilemma: on the one hand, the length of time that the list is inaccurate determines the level of protection afforded to the purchaser, so that in theory, a positive determination of the point in time at which the shareholder list became inaccurate is necessary. At the same time, however, the positive determination of the inaccuracy would destroy good faith. Too much knowledge can therefore be harmful. This means, in practice, that if a shareholder list is more than three years old, transfers of shares prior to that time can be disregarded, although it will still be necessary to ascertain whether there have been any subsequent transfers of shares.

A related practical question is whether failing to conduct any due diligence whatsoever is to be considered grossly negligent per se, with the consequence that no bona fide transfer is possible. The question has to be answered in the negative, since the purpose of the good-faith transfer would otherwise be defeated—an innocent purchaser is exactly the one who should be protected here. However, due to the loopholes discussed previously, there is a danger that the transfer would fail on the grounds identified above, in which the protections of good faith do not apply (nonexisting shares, restrictions on transferability). To this extent, the liability of the management of the purchaser is still possible, due to the lack or insufficiency of due diligence.

While the new rules apply to companies that are incorporated after the effective date of the new law, the law provides for a transitional period for existing companies so that the full protections of good faith apply, at the earliest, three years after the reform takes effect. In order to avoid complications, companies with interests in GmbHs should utilize this transitional period to ensure that they are registered as shareholders in the respective shareholder list; in addition, in the subsequent period, regular checks of the shareholder list should be made for compliance reasons.

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.