GmbHs and UGs with limited liability

This document can be accessed at www.ihk-berlin.de under Doc. No. 120552 GmbHs and UGs with limited liability Contents: 1. General... 3 Corporations with their own legal personality... 3 Limitation of liability... 3 2. Establishing a company... 3 Procedure for setting up a company... 4 Alternative ways of setting up a company... 4 3. Content of the shareholdership agreement... 5 Name of the company... 5 Company headquarters... 6 Object of the company... 6 Share capital and shares held by shareholders... 6 Rules of representation... 6 4. Appointment of managing directors... 7 5. List of shareholders disclosing share ownership... 7 6. Domestic business address and serving documents on the company... 7 7. Procedures prior to entry in the Commercial Register... 7 8. Costs of setting up a company... 9 9. Share capital and contributions... 9 Contributions and raising capital... 9 Single-shareholder GmbHs... 11 Maintenance of capital... 11 Increased capitalisation... 11 Special regulations relating to the share capital of a UG with limited liability... 12 10. Corporate bodies... 12 The managing director... 12 The general meeting... 12 The supervisory board... 13 11. The status of the managing director... 13 Appointment and removal of the managing director... 13 Engagement of the managing director... 14 12. Rights and obligations of a managing director... 15 Management... 15 Representation... 15 Fiduciary duty... 16 Obligation to submit accounts and keep records, Reporting commitment... 16 Duties if half of the share capital is lost, and in the case of excessive debts / illiquidity... 16 Commercial Register obligations... 16 Disclosure... 16 13. Managing director s liability... 16 Your contact: Sabine Kirschgens Email: sabine.kirschgens@berlin.ihk.de www.ihk-berlin.de Rev: 01 May 2016 1

14. Rights and obligations of the shareholders... 18 Asset rights and obligations... 18 Administrative rights and obligations... 18 15. Liability of the shareholders... 18 Commingling of assets... 18 Liability for destroying the economic basis of the company... 19 16. Dissolution, liquidation and completion... 19 Dissolution... 19 Liquidation... 20 Completion... 20 2

1. General Limited liability companies (referred to in this document as GmbHs ) and entrepreneurial companies ( UGs with limited liability ) are corporations with their own legal personality (i.e. legal entities), whose liability is restricted to the level of company assets. Entrepreneurial companies (UGs with limited liability) Unternehmergesellschaften (haftungsbeschränkt) in German came about as a result of legislative reform to the GmbH Act. They are another type of GmbH, but not a legal form in their own right. Consequently the law which applies to GmbHs (the GmbHG) also applies to UGs with limited liability. This document explains the law as it applies to both corporate forms. Unless different rules are specified for UGs with limited liability, it can be assumed that those described in relation to GmbHs apply equally to both. Special rules relating to these latter companies are to be found in Art. 5a of the Limited Liability Companies Act (GmbHG), and mostly relate to the founding of the company and to its capital. UGs with limited liability are primarily intended to offer new startups which have a low level of capital resources with the speediest, most cost-effective way of adopting a legal form with limited liability. Corporations with their own legal personality If it has its own legal personality, this means that the company is itself a holder of rights and obligations. It can as represented by its management act autonomously in legal matters, bring its own lawsuits and be sued, acquire property and own its own assets. It is independently responsible for paying its taxes. All business-related activities are the responsibility of the company. The company s own rights and obligations exist in isolation from those of the shareholders and managing directors. Limitation of liability Liability is limited from the time the company is listed in the Commercial Register. Limited liability means that if the company has debts, liability shall extend only to the company assets and not to the personal assets of the shareholders. This rigid distinction between private and corporate assets means that if the worst comes to the worst, the shareholders only risk losing the contribution they agreed to pay in the articles of incorporation. If this contribution has not yet been made in full, the shareholders must, if need be, pay in the outstanding amount. As a matter of principle, the company is liable up to the level of its total assets, i.e. not just the level of its share capital. For instance, if a GmbH was established with share capital of Euro 25,000 and this was lost as a result of unwise investments, there would no longer be any corporate assets from which to pay any liabilities. If the same GmbH had corporate assets of Euro 100,000, however, the entire amount would be recoverable by creditors. Exemptions from this limitation of liability include, for instance, cases of malpractice or the delayed filing of insolvency, or failure to forward social security contributions which have been deducted to the relevant insurer. In such cases, claims may also be made against the personal assets of shareholders and managing directors. 2. Establishing a company The company can be set up by one or more shareholders. Any natural or legal entity (e.g. an AG or GmbH) is entitled to do so, as are other companies with legal capacity (such as ohgs, KGs and GbRs). Foreign individuals or companies may also become shareholders in a GmbH or UG with limited liability without having to obtain special authorisation. 3

Procedure for setting up a company The first step is for the shareholders to draw up articles of incorporation. These must be signed by all the shareholders and notarised. If one of the shareholders is unable to attend the signing in person, he may appoint a representative. This agent must present a power of attorney which has been certified by a notary. The notary also makes the necessary preparations for the company s registration in the Commercial Register. The founders then make their share capital available to the company. The minimum amount of capital required by a GmbH is Euro 25,000, but the figure is only Euro 1 for a UG with limited liability. The share capital is paid after the document has been notarised but before the company has been entered in the Commercial Register into a bank account opened by the new GmbH in Gründung ( GmbH i.g. ) or UG (haftungsbeschränkt) i.g. The notary must be presented with proof that the payment has been made (e.g. by submitting a bank statement). Only then will he transfer the documents to the Commercial Registration Court; in this way, there is no doubting the accuracy of the declarations prepared by the managing directors with respect to the availability of share capital when they met with the notary. The company only actually exists as such once its details have been entered in the Commercial Register. Alternative ways of setting up a company The shareholders can opt for one of two alternatives when setting up a GmbH or a UG with limited liability. They can set up the company using either a simple notarised standard document (sample protocol) in which the memorandum of association is pared down to a minimum, or else individually designed notarised articles of incorporation. One should only opt for the cheaper standard document if the minimum terms of articles of incorporation required by law are deemed sufficient for setting up the company. The shareholders can agree more far-reaching provisions in the individual articles of incorporation. Setting up a company with a notarised sample protocol The shareholders may set up the company in accordance with the default terms of the sample protocol, which must be notarised. An application is then made for entry in the Commercial Register, signed by the managing directors and witnessed by the notary. The notary is then responsible for forwarding the application electronically to the Local Court (Commercial Register) together with the protocol. The legislative authority provides both a sample protocol for the formation of a singleshareholder company and a sample protocol for the formation of a company with up to three shareholders. The option of setting up a company with a sample protocol is available only if the company is founded by no more than three shareholders. If there are four or more, individual articles of incorporation are required. the shareholders are able to agree to appoint no more than one managing director. This managing director will then be authorised to act as the company s sole representative. the managing director is exempt from the prohibition on self-contracting (i.e. the managing director is entitled to enter into business transactions between the company and himself as a private individual or as the agent of a third party). 4

Setting up a company with a sample protocol is possible only if cash contributions are used to found it. Moreover, if a standard document is used, shares in the company may easily be sold to third parties. Under the former GmbH legislation, the consent of the management representing the GmbH was required before shares could be sold. This condition no longer applies. Every share can now be sold to unknown or even undesirable persons. The only way of preventing this is by opting for individual articles of incorporation. Setting up a company on the basis of individually designed notarised articles of incorporation The articles of incorporation can be tailored to the individual needs of the company and notarised. An application is then made for entry in the Commercial Register, signed by the managing directors and witnessed by the notary. The notary is then responsible for forwarding the application electronically to the Local Court (Commercial Register) together with the articles of incorporation. An individual, notarised approach to setting up a company is advisable if more than three founders are involved (individual articles of incorporation are then mandatory) more than one managing director is to be appointed individual rules of representation are to be agreed self-contracting is not to be permitted the notary is required to provide more than the usual level of consultation additional contractual regulation is required, e.g. o an individual ruling can be made as regards the conditions regulating the sale of shares o a list of legal transactions which require consent, i.e. which are only to be conducted by the managing director with the consent of the shareholders, can be included in the agreement o provisions can be specified with regard to termination, the final winding up the company, or its continued operation. 3. Content of the articles of incorporation Articles of incorporation must cover at least the following areas: Name of the company The company name may be formed from a personal name (that of the shareholder[s]), a descriptive name (identifying its business purpose), a purely imaginative name, or a combination of these. It is essential that the name is distinctive and cannot be confused with others. For example, a purely descriptive name such as Textil GmbH would not be allowed, as it would not be sufficiently distinctive. In addition, the company name must not contain any information which might tend to mislead potential customers about important aspects of its business relations. Examples would be where the name of the company was inconsistent with its area of activity, for instance if XYZ Textilhandels GmbH had actually been set up to deal in foodstuffs or real estate. It is also important for the company name to include the appropriate suffix indicating its legal form, such as Gesellschaft mit beschränkter Haftung or the abbreviation GmbH, or the suffix Unternehmergesellschaft (haftungsbeschränkt) or the abbreviation UG (haftungsbeschränkt). 5

In order to obviate the need for expensive retrospective amendments to the articles of incorporation, we would advise you to check on www.unternehmensregister.de whether a company with a similar name is already operating at the same location or in the same municipality. Furthermore, we offer you to discuss your choice of name with IHK Berlin under the telephone numbers 030/ 315 10-258, 494, 511 or via our online-form Anfrage zur Firmierung in Berlin (www.ihk-berlin.de, Dok.-Nr. 82356). Registered office of the company Any political municipality in Germany can be chosen for the registered office of your company. Irrespective of where your company is located according to the Commercial Register, it can even have its administrative headquarters the place where the main administrative work is carried out outside Germany. However, it is not possible to transfer the registered office of a German GmbH or UG with limited liability to a foreign location. Object of the company The object of the company is available for scrutiny in the Commercial Register, and must clarify the business activities of the GmbH. The object of the company also ring-fences management activities internally. The intended business activity of the company can be defined with precision. In addition, all areas of activity can be enumerated and areas of special priority highlighted. If the object of the company includes activities for which a permit or licence is required (this applies, for instance, to estate agents and craftsmen), evidence that the permit has been issued does not have to be produced at the time the company is entered in the Commercial Register. This speeds up the registration process. It will suffice if the necessary permit can be produced once the relevant activity commences. It must be shown when registering with the trade office. Share capital and shares held by shareholders The minimum amount of capital which must be invested in a GmbH by law (its share capital) is Euro 25,000. This is made up of the individual shareholdings. The nominal value of each share must be in whole Euro. A shareholder may take over several shares. The nominal value of shares owned by individual shareholders may differ. The total of all nominal values must correspond to the level of share capital. The first name and surname, date of birth and place of residence of each shareholder must be listed individually, together with the value of their investment. For a clearer overview of how many shares have been issued, they must be numbered consecutively. The share capital of a UG with limited liability must be at least Euro 1. N.B.: If the level of share capital is extremely low, the risk of the company rapidly falling into debt will be correspondingly high. In addition, the late filing of insolvency is a criminal offence. Consequently, the level of share capital should be determined in the light of the company s actual capital requirement. Rules of representation The articles of incorporation contain provisions establishing who represents the company externally and how the managing directors are normally allowed to represent the company. A decision is made on whether one or more managing directors will be appointed with sole or joint management authority. 6

4. Appointment of managing directors At the time the company is established, the shareholders must appoint one or more managing directors. This is achieved by a simple majority resolution, and can be recorded in a private document. The application for the managing director to be listed in the Commercial Register requires the managing director s signature to be certified by the notary. The managing directors must provide a written assurance that there are no circumstances preventing their appointment (e.g. a final judgment relating to an insolvency offence or a court ruling prohibiting the pursuit of business activities) and that they have been advised of their duty of full disclosure vis-à-vis the court. They must also declare whether the original contributions agreed in the memorandum of association have been made, and state whether the managing director can now freely dispose of the share capital. 5. List of shareholders disclosing share ownership The list of shareholders must contain the surname, first names, date of birth and place of residence of each shareholder, as well as the nominal values and sequential numbers of their shares (Art. 40 Para. 1 GmbHG). The managing director is under an obligation to ensure that the information is kept up to date and that the Commercial Register is advised of any changes. The GmbH reform means that only those persons included on the list submitted to the Commercial Register are now deemed to be shareholders (Art. 16 para. 1 GmbHG). This is designed to make it easier to identify all the individuals behind a particular company. The list is also helpful for those looking to buy shares in good faith. Potential shareholders can be assured that the individuals included in the list are bona fide shareholders. If an error is made when registering the list of shareholders and no objection is raised within at least three years, the list shall be deemed to be accurate as far as purchasers of shares are concerned (Art. 16 para. 3 GmbHG). Thus under certain circumstances, it may be possible to attempt to acquire shares from an individual who is included in the list of shareholders but does not actually own the shares. 6. Domestic business address and serving documents on the company At the time of registration in the Commercial Register, the company must provide a domestic business address which is recorded in the Register and to which everyone has online access. This should make it easier to serve documents on the company. The Register must be notified of any change of address, so that the details can be updated. The company is at liberty to choose a preferred location. In addition to the registered office, possible alternatives are the domestic residential address of the managing director or of a shareholder. In addition, the company may nominate an authorised recipient who can be served documents and receive declarations. The details of this individual will also be included in the Commercial Register. 7. Procedures prior to entry in the Commercial Register GmbHs and UGs with limited liability only become established companies once they are listed in the Commercial Register. Prior to this, a distinction is to be drawn between two different phases, 7

namely the pre-formation phase and that of the pre-gmbh (known as a Vor-GmbH, GmbH in Gründung or GmbH i. G. ). A pre-formation company exists if legally binding agreements have been made by the founders with the aim of concluding a GmbH agreement with one another. In legal terms, this qualifies as a company constituted under civil law (GbR). 8

There is a risk of personal liability during this phase in respect of commitments entered into for the company which has yet to be established. Exemption from liability would have to be agreed expressly with the contractual partners. A pre-gmbh exists once the GmbH agreement has been notarised. The pre-gmbh is not regulated by law, but is recognised by the judicial authorities as a sui generis company. The pre-gmbh may be a holder of rights and obligations. It is entitled, for instance, to adopt a company name. Indeed, the pre-gmbh should appear under its company name prior to its entry in the Commercial Register. It must, however, add the suffix in Gründung or i. G. to remain within the law. The individuals acting on behalf of the GmbH before it is registered assume personal and joint liability, which ends upon registration in the Commercial Register. In addition to this, the shareholders are liable for the debts of the pre-gmbh. 8. Costs of setting up a company A court fee of Euro 150 is charged for registering a GmbH or UG with limited liability in the Commercial Register if it is founded with cash contributions. Publication of the entry in the electronic Federal Gazette costs Euro 1 per entry. The notary s fee for setting up the company will depend on the number of shareholders, the share capital, and goodwill, as well as on whether the cheaper sample protocol or individual articles of incorporation are used. Illustrations of the court and notary fees generally incurred when setting up a business and entering the company in the Commercial Register can be found in the summary of Fees incurred during the Commercial Register process (Doc. No. 78725). 9. Share capital and contributions The minimum share capital required for a GmbH is Euro 25,000. Although there was talk of reducing the level of share capital to Euro 10,000 as part of the GmbH reform, this never came to fruition. The minimum share capital required by a UG with limited liability is Euro 1. The share capital is made up of the contributions of the shareholders (nominal share values). The shareholdings of the individual shareholders can vary in value, but must never be less than Euro 1. Contributions and raising capital The contributions may be made in a number of ways: in cash; through contributions in kind: materials or rights are contributed, e.g. items of property, machinery, receivables, etc. Contributions in kind are not acceptable when setting up a UG with limited liability; through a mixture of the above: for instance, the shareholder may make part of his contribution in cash as well as contributing machinery or other goods to the company. 9

The level of contributions to be made at the time the GmbH is registered in the Commercial Register is as follows: Only a quarter of the cash contributions not the full amount has to be deposited. In the case of a UG with limited liability, the full amount of the contribution must be paid. If contributions in kind are to be made, the full amount is always required. In addition, evidence of the value of contributions in kind must be provided in a Sachgründungsbericht. If there are grounds for considerable doubt about the accuracy of this, based on indications that the contribution has been overvalued to a significant degree (e.g. in the case of secondhand goods), the Local Court may instruct an expert to reassess the contribution, which will result in additional costs being incurred. That is why it may be simpler and more costeffective to make cash contributions. If the contribution comprises a mixture of cash and benefits in kind, the latter must be produced up front in full; in the case of the cash element, only one quarter is required. The GmbH may only apply for entry in the Commercial Register once a quarter of each primary deposit has been made, unless contributions in kind have been agreed. In the case of a GmbH, however, at least Euro 12,500 (in cash and any contributions in kind) must be produced. This has the following consequences as far as cash and mixed contributions are concerned: Cash contributions: The share capital of the GmbH amounts to Euro 25,000. Since only a quarter of cash contributions have to be produced up front, Euro 6,250 would have to be produced in this case. But since at least Euro 12,500 is required before the company can be listed in the Commercial Register, the shareholders would have to top up this amount to Euro 12,500. In practice, what happens when the company is founded with cash contributions is that a bank account is opened for the company which is placed at the business s free disposal. When making the entry in the Commercial Register, the managing director must give his assurance that he has access to the contribution. If there are substantial doubts about the veracity of this assurance, the Local Court may demand proof, e.g. a deposit receipt or bank statement. It is the practice for the notary to submit the documents required to register the company to the Commercial Registration Court only once he has received evidence that the share capital has been deposited. Mixed contributions: The GmbH has share capital of Euro 25,000. If the mixed contributions are to comprise 50 % each in cash and assets in kind (Euro 12,500 in contributions in kind and Euro 12,500 in cash), the full amount of the contributions in kind must be produced (to the value of Euro 12,500); one quarter of the cash contributions (i.e. Euro 3,125) must also be produced. The total of the contributions therefore amounts to Euro 15,125, which is in excess of Euro 12,500. As a result, the shareholders do not need to top up the cash amount. The GmbH has share capital of Euro 25,000. If the mixed contributions comprise 80 % assets in kind and 20 % cash (Euro 20,000 in contributions in kind and Euro 5,000 in cash), the full amount of the contributions in kind must be produced (Euro 20,000); one quarter of the cash contributions (i.e. Euro 1,250) must also be produced. The total of the contributions therefore amounts to Euro 21,250, which is also in excess of Euro 12,500. As a result, the shareholders do not need to top up the cash amount. The GmbH has share capital of Euro 25,000. If the mixed contributions comprise 20 % assets in kind and 80 % cash (Euro 5,000 in contributions in kind and Euro 20,000 in cash), the full amount of the contributions in kind must be produced (Euro 5,000); one quarter of the cash contributions 10

(i.e. Euro 5,000) must also be produced. The total of the contributions therefore amounts to Euro 10,000, but since entry in the Commercial Register requires at least Euro 12,500 to be produced, the shareholders will have to top up the total to Euro 12,500. There is no statutory deadline by which the remainder of the contributions must be paid. Instead, the payment must be forthcoming by a deadline specified in the articles of incorporation or at the request of the managing director. The shareholders shall be liable to the GmbH in the amount of the outstanding contributions. Thus limited liability for the shareholders with respect to the company assets shall apply to its full extent only once all of the contributions have been deposited. Single-shareholder GmbHs The GmbH reform waived the previous requirement for special security to be provided in respect of share capital which had not yet been deposited. Previously, when a single-shareholder GmbH was established or recognised retrospectively, the sole shareholder had to provide collateral in favour of the future GmbH to cover any shortfall in his cash contribution to the share capital. Maintenance of capital As a basic principle, assets required to maintain the level of the share capital may not be paid out to the shareholders (Art. 30 para. 1 sent. 1 GmbHG). Consequently, it is important to ensure that the level of company assets is no less than the level of share capital. The GmbH reform extended this principle. Thus a payment to a shareholder which is prohibited according to this principle shall be deemed not to have been made if the company receives in return a claim for counter-performance or repayment to the full extent of the payment (Art. 30 para. 1 sent. 2 GmbHG). This is intended to affect in particular loans and other credit-type company benefits provided to shareholders. This was designed to protect cash pooling, which is now a common international practice in the world of group finance, and to place it on a sound legal footing. Repayments of loans granted to the company by the shareholders (shareholder loans), are exempt from the above prohibition (Art. 30 para. 1 sent. 3 GmbHG). In fact, shareholder loans and benefits of an equivalent type are no longer to be treated as liable equity capital. With their reform of GmbH legislation, the lawmakers have removed the earlier distinction between capital-replacing loans and normal loans. However, should the GmbH suffer serious financial problems or become insolvent, the repayment of shareholder loans shall have a lower priority than the claims of other creditors. Increased capitalisation There are two possible ways of increasing capital: either through capital contributions, or from corporate funds. Whilst in the first case new capital is injected into the business, in the second scenario, reserve funds are converted into share capital. Increased capitalisation is possible only if a corresponding resolution is adopted by the shareholders. Since the level of share capital is specified in the memorandum of association, the resolution must be passed by a majority vote, as is required for a change in the memorandum, and notarised. Since the GmbH reform, the shareholders have also been able to stipulate in the memorandum of association that the managing director is entitled to increase the share capital of the GmbH (Art. 55a GmbHG, so-called authorised capital). This has brought the situation into line with Company Law. Other measures required for an increase in capitalisation are as follows: a transfer agreement must be concluded between the company and the transferee of the increased capital, at least part of the contribution must be made, the increase in capital must be registered in the Commercial Register, and an official announcement must be made of the entry. 11

Special regulations relating to the share capital of a UG with limited liability The UG with limited liability should aim gradually to build up the share capital of a GmbH. Consequently, it may not distribute all of its profits, but is instead obliged by law to create statutory provisions every year (Art. 5a para. 3 GmbHG). Any losses brought forward from the previous year are first deducted from the year s surplus. One quarter of the remaining surplus is then allocated to the provisions. The provisions may only be used to increase the company s share capital. Once the share capital of the UG with limited liability together with the statutory provisions reaches Euro 25,000, the UG with limited liability can convert into a GmbH by increasing its share capital from these corporate resources. The company is entitled to keep the same name, apart from the component which indicates its legal form. However, a UG with limited liability is not obliged to convert into a GmbH. If it does not do so, however, the UG with limited liability shall remain obliged by law to allocate profits to provisions as its capital resources grow. 10. Corporate bodies GmbHs and UGs with limited liability may only act as legal entities through their corporate bodies. These comprise the managing director, the general meeting and, if applicable, the supervisory board. The managing directors represent the company externally, whilst internal decision-making is the responsibility of the general meeting. The managing director The managing director is the company s vital executive body, as he represents it vis-à-vis third parties. No statutory limit is placed on the number of managing directors, but at least one must be appointed. The managing director may also be a shareholder of the company (a managing shareholder), but this is not essential. As well as representing the company, the managing director s duties are as follows: steering the company, record-keeping, and drawing up the annual financial statements and an annual report convening the general meeting providing shareholders with information making entries in the Commercial Register submitting an (amended) list of shareholders to the Commercial Register filing a petition for the opening of insolvency proceedings in the case of illiquidity or excessive debts The general meeting The general meeting is the supreme decision-making body, and comprises all the shareholders. It must fulfil the duties assigned to it in the articles of incorporation. If the agreement contains no relevant provisions, Art. 46 GmbHG shall apply. 12

According to this, the general meeting must make decisions with respect to the following: approving the annual financial statements and making appropriate use of the results calling in contributions dividing, combining and withdrawing shares appointing authorised signatories and agents If a suitable resolution is passed, the general meeting can instruct the supervisory board if one has been appointed to fulfil these duties. The general meeting must also pass resolutions as appropriate on changes to the articles of incorporation, the winding up of the company and the calling in of supplementary payments. These tasks cannot be transferred to a supervisory board, should one exist. The shareholders make decisions by adopting a resolution. A resolution shall be deemed to have been adopted if more than half of the votes cast are in favour. Exceptionally, a 75 % majority is required if amendments are to be made to the memorandum of association. The articles of incorporation can also regulate which resolutions require what kind of majority (e.g. unanimity or a 75 % majority). The supervisory board Not every GmbH need have a supervisory board; however, the shareholders may decide in the articles of incorporation to appoint one. A supervisory board is mandatory if the company employs a suitably large number of employees (five hundred pursuant to the One Third Participation Act). The precise circumstances in which a supervisory board is required are specified in Federal employment legislation. Only natural persons of full legal capacity may normally be appointed members of the supervisory board. The members are appointed by the general meeting, and its tasks include monitoring the activities of the management. It also has a comprehensive entitlement to receive information, particularly as concerns the annual financial statements. 11. The status of the managing director Appointment and removal of the managing director Any natural person of full legal capacity aged 18 or over may be appointed as managing director. The person selected may be a third party from outside the company, but it is equally possible for him to be one of its shareholders. In a single-shareholder company, the sole shareholder appoints himself as the sole managing director. No final judgment must have been passed against the candidate for an insolvency offence (bankruptcy, a violation of the duty to keep records, fraudulent preference of creditors or debtors, etc.) or another criminal offence such as fraud or breach of trust (Art. 6 para. 2 GmbHG). Other reasons for rejecting a potential managing director include cases where a final judgment has been issued for late filing of insolvency making false statements pursuant to Art. 82 GmbHG or Art. 399 AktG (Company Law) false representation pursuant to Art. 400 AktG, Art. 331 HGB, Art. 313 UmwG (Transformation Act), Art. 17 PublG (Disclosure Act) the offence of fraud pursuant to Arts. 263-264a or Arts. 265b - 266a StGB (German Criminal Code) 13

A conviction abroad for similar offences would also constitute suitable grounds for rejecting the candidate. The managing director does not, per se, have to possess any special qualifications. If the activities of the managing director require him to be issued with a licence or permit for which a personal aptitude is required for the activity in question, however (e.g. a qualification as a master craftsmen), only a suitably qualified managing director may be appointed. Neither must the managing director have been prohibited from practising a trade or profession in which the GmbH is involved. Neither is there anything to prevent a foreigner from being appointed as managing director. He does not have to live in Germany or in the EU, or to have a permanent right to reside there. If he is to manage the company from Germany, he must ensure that the necessary residence permit or work permit does not prevent him from practising the trade in question. If he is to manage the company from abroad, he should ensure that he complies with the statutory regulations of the Aliens Act and that he has no problems entering the country. Under certain circumstances, it may make sense to appoint an additional managing director in Germany. The managing director is usually appointed by resolution of the general meeting. However, the memorandum of association may transfer the right to appoint him to another body. The managing director may be removed from his post by the body specified in the memorandum of association at any time and without notice. His appointment and removal as well as any changes in the managing director s authority to represent the company must be entered in the Commercial Register. According to the GmbHG reform, the shareholders are liable to the company for any loss or damage caused by a managing director who did not meet the requirements for the post (Art. 6 para. 5 GmbHG). Engagement of the managing director A distinction is to be drawn between the managing director s status as a corporate body and the contract under the law of obligations which relates to his employment. The managing director s rights and duties as a corporate body derive from the terms of his engagement, and can be altered only by the articles of incorporation or a resolution pursuant to the memorandum of association, and not by the terms of a contract. The contract relating to his employment, on the other hand, generally governs such matters as his salary, and possibly also his pension and similar conditions. It can be terminated with or without notice pursuant to the general rules. The managing director generally signs a self-employed service contract with the GmbH, rather than an employment contract. This will be the case if a managing shareholder plays an important role in managing the finances of the company (especially if he owns a majority shareholding). But even managing shareholders who own less than fifty percent of the share capital should be regarded as self-employed if they are not bound by the instructions of a superior. In Germany, the self-employed are not generally subject to mandatory social security contributions (pension, health and unemployment insurance). Voluntary continued insurance under the statutory health insurance scheme is possible for former employees. There is also the option of applying for compulsory or voluntary insurance under the statutory pension scheme. In some sectors, entrepreneurs are also subject to compulsory insurance under the statutory accident insurance scheme (Employers Liability Insurance Associations) even if they do not employ any staff. Voluntary insurance is possible for those who are not obliged to make contributions. For tax purposes, managing shareholders are treated as self-employed. 14

If a managing director is not also a shareholder (i.e. hired externally), and consequently cannot manage the company s financial affairs independently, an employment contract may be concluded. In such cases, he will be obliged to pay social security contributions towards pension, health and unemployment insurance. Outside managing directors must also pay income tax. 12. Rights and obligations of a managing director Management The most important duty of the managing director is to manage the company. This means safeguarding the financial interests of a third party in a fiduciary capacity and ensuring that business operations run smoothly, efficiently and on a profit-making basis. His duties include the following: the obligation to cooperate with other managing directors the obligation to monitor the activities of other managing directors a duty of organisation, i.e. organising the company s operations in such a way that there is an adequate overview of its business and financial situation at all times The scope of management duties may be restricted by the articles of incorporation or by resolution of the shareholders. If the authority of the managing director is restricted in this way, he must undertake to abide by these limitations. If he exceeds his authority, he may find himself liable to pay the company compensation. Representation The managing director represents the company both judicially and extra-judicially. The principle of joint representation generally applies. Thus if more than one managing director is appointed, they must generally represent the company together. However, alternative provisions may be stipulated in the articles of incorporation. For instance, it may be decided that a managing director is allowed to represent the company alone, or that two managing directors or a managing director and an authorised signatory may do so together. N.B.: As far as the company s external dealings are concerned, the scope of the managing director s power of representation may be restricted neither by the articles of incorporation nor by resolution of the shareholders. Thus the authority of the managing director, which may be restricted, and his power of representation, which may not, are not necessarily congruent with one another. If, despite having no authority to do so because of the restrictions imposed upon him, the managing director concludes a contract with a third party, the following consequences shall ensue: A valid contract shall be effected between the company and the third party, because the company was properly represented by the managing director, whose power of representation is unrestricted as far as the company s external dealings are concerned. The managing director, who should not have concluded the contract with the third party because of his restricted authority, has exceeded that authority and will therefore be liable to compensate the company. 15

The GmbHG reform introduced a ruling for situations where the company has no managing director (Absence of management, Art. 35 para. 1 sent. 2 GmbHG). If declarations of intent are to be submitted to the company or documents served on it, the company shall be represented by the shareholders. The business address entered in the Commercial Register may also be used. Fiduciary duty The managing director must exercise rigorous fiduciary duties vis-à-vis the company; he owes the company his loyalty. This fiduciary duty includes: the duty of confidentiality, i.e. he must not disclose confidential matters or company secrets to third parties. the duty of non-competition, i.e. the managing director must not transact any business in his own or any other name in the same business sector as that in which the company operates during his period of service, unless the memorandum of association provides otherwise. Obligation to submit accounts and keep records, Reporting commitment The managing director must undertake to keep proper records and prepare annual financial statements. He does not have to meet this obligation in person, and therefore requires no special expertise in accounting or record keeping. He must, however, employ qualified specialist personnel and oversee their activities. Duties if half of the share capital is lost, and in the case of excessive debts / illiquidity If the company uses up half of its share capital, the managing director must notify the shareholders accordingly. The notice of loss is intended to protect the company, the shareholders and the company s creditors. The shareholders must consult with one another on the consequences of the loss, so that they can, for instance, resolve to increase the company s capital. In the case of illiquidity and/or excessive debts, the managing director must undertake to file for insolvency without delay, but no more than three weeks after the illiquidity and/or excessive indebtedness occur. Commercial Register obligations The managing director must make the necessary entries in the Commercial Register. He must, for instance, register amendments to the memorandum of association, increases in share capital or changes of managing director or shareholder. Disclosure The managing director must ensure that the documents relating to the annual financial statements are submitted to the operator of the electronic Federal Gazette in electronic form. 13. Managing director s liability If the managing director violates his duty to exercise the diligence of a prudent businessman in matters relating to the company, he may be liable for any loss or damage which results to the extent of his entire personal assets. Examples of such violations of duty: Payments made to the shareholders in contravention of the prohibition of disbursements, according to which no payments may be made from corporate assets covering the share capital (Art. 43 para. 3 GmbHG). 16

Failure to inform the general meeting about the loss of 50 % of the share capital (Art. 49 para. 3 GmbHG). Moreover, violation of this duty is also a criminal offence (Art. 84 para. 1 GmbHG). Special case for UGs with limited liability: the general meeting must be convened in the event of imminent illiquidity (Art. 5a para. 4 GmbHG). In the event of imminent insolvency, the managing director must undertake to file for the initiation of insolvency proceedings within three weeks (Art. 15a InsO [Insolvency Code]). If the managing director continues to effect payments once the company is on the verge of insolvency, he shall be held personally liable to the company for these payments (Art. 64 sent. 1 GmbHG). He may also have to answer to the courts if any offences relating to fraud, breach of trust or insolvency-related matters have been committed (Arts. 263, 266, 283 ff. StGB). The GmbH reform has also introduced a clause whereby the managing director will be held liable for payments he makes to the shareholders which will necessarily lead to the illiquidity of the company, unless such a situation could not have been foreseen by a prudent managing director (Art. 64 Sent. 2 GmbHG). Apart from his liability to the company, the managing director can also be held liable towards third parties (e.g. contractual partners of the company); this liability towards third parties also extends to the managing director s entire personal assets. The managing director might be held liable towards third parties in circumstances such as the following: When concluding a contract, he does not make it clear that he is acting for the company, but rather creates the impression that he is operating as a sole trader ( apparent authority ). The managing director shall be liable to the company s creditors if he violates his duty to make due notification of changes to the list of shareholders (Art. 40 para. 3 GmbHG). Insolvency-related liability: o The managing director fails to mention, when concluding a contract, that the company is on the verge of insolvency (Art. 823 para. 2 BGB [German Civil Code] in conjunction with Art. 263 StGB). o The managing director shall be liable to the company s contractual partners if there is a delay in filing for insolvency (Art. 823 para. 2 BGB in conjunction with Art. 15a InsO). o In these cases, the managing director may also face criminal charges. Liability in relation to the obligation to make social security contributions: The managing director must also fulfil certain obligations under social security legislation. The company s employees must be registered with the relevant health insurance organisation and the contributions deducted for health, pension and unemployment insurance paid to the health insurance fund concerned. The managing director shall be held personally liable if social security contributions are deducted from employees pay but not forwarded to the relevant institution, and shall also be held criminally liable (Art. 266a StGB). 17

Liability in relation to tax: If the GmbH employs staff, the managing director assumes the responsibilities of an employer and must make income tax and turnover tax notifications every month, deduct income tax for the account of the employee and forward it to the tax authorities. The same applies to turnover tax. If there is a breach of these duties, the managing director may have proprietary liability pursuant to Arts. 69 ff. of the Tax Code (AO) as well as suffering criminal consequences pursuant to Art. 370 or Art. 378 AO. 14. Rights and obligations of the shareholders Asset rights and obligations The most important asset right is the entitlement to any net profits that are earned; these are distributed to the shareholders according to the size of their shareholding. Another such right is the entitlement to a share in the proceeds of liquidation, should the company be dissolved and liquidated. The main asset obligation is the duty to make an initial contribution and place it at the company s disposal (basic principle of raising and maintaining capital). The shareholders are also obliged to make up for a percentage of losses based on their shareholding in the company (so-called loss cover); the losses referred to here occur if the liabilities of the pre-gmbh at the time it is entered in the Commercial Register are such that there is a discrepancy between the share capital and the value of the corporate assets. The GmbH reform also introduced a clause obliging shareholders to file for insolvency within three weeks if an illiquid or excessively indebted GmbH was without a managing director (Art. 15a para. 3 InsO). Violation of this duty is a criminal offence (Art. 15 para. 4 InsO). If declarations of intent are to be submitted to the company or documents served on it, a company without a managing director shall be represented by the shareholders. Administrative rights and obligations The administrative rights of shareholders include the right to attend general meetings, to vote, and to receive information and view the company records. There are no statutory administrative obligations. However, the general fiduciary duty owed to the company by every shareholder may result in a shareholder being obliged to cast his vote in a particular way at the general meeting. 15. Liability of the shareholders As a matter of principle, the shareholders are not liable for the company s debts. It is only in exceptional cases that the shareholders are liable to the extent of their entire personal assets for the liabilities of the company (known as piercing the corporate veil). This situation may come about in circumstances such as the following: Commingling of assets Commingling of assets occurs when records have been kept deficiently or not at all, and it is unclear which assets belong to the shareholders and which to the GmbH. In situations such as this, a lone shareholder or the shareholder with the controlling interest is usually the only one to be af- 18