The German Federal Court of Justice (Bundesgerichtshof) recently had the opportunity to clarify a number of important practical questions of corporate law in connection with asset disposals, the allocation of responsibilities among directors and transactions concluded with board members. We summarize the three relevant decisions from 2018/2019 below.
I) Requirement to obtain shareholder approval for sale of entire assets of a limited liability company (GmbH)
A German stock corporation (AG) must obtain shareholder approval in order to divest its entire or quasi-entire assets. Absent such approval, the sale agreement will be preliminarily void and permanently ineffective in case of a final refusal to approve. To date, this requirement has been applied mutatis mutandis to a limited liability company (GmbH). This practice was based on an analogous application of Section 179a para 1 of the German Stock Corporation Act (AktG).
On January 8, 2019, the German Federal Court of Justice (FCJ) dismissed this view in its decision (II ZR 362/18) and held that Section 179a AktG is not applicable to a GmbH.
In the case at hand, the two sole shareholders of a GmbH in liquidation intended to sell the company’s business assets, while the GmbH did not dispose of any other substantial assets. One of the shareholders was interested in the acquisition of the respective assets. The co-shareholder however entered into a purchase agreement for the assets and granted a land title reservation in favor of a third party (the defendant). The GmbH then sued the third party for deletion of such reservation, arguing that the purchase contract was void absent a shareholders’ resolution.
The decision of the FCJ not to apply Section 179a AktG stresses that in a GmbH the shareholders, other than in an AG, do not need the special protection afforded by Section 179a AktG as they benefit from much more pronounced control and decision rights. The legislator failed to introduce a similar provision for the GmbH. Furthermore, one of the fundamental principles of German corporate law is the unlimited ability of the managing director to represent the GmbH, which would be set aside if Section 179a AktG was applied in analogy.
However, the decision holds that the internal authority (rather than power of representation) of the managing directors of a GmbH to divest its entire or quasi-entire assets still depends on a shareholder approval. The FCJ’s decision clarifies, that in the absence of such a shareholder resolution, the sale agreement is not automatically void. Rather, the sale will only be void if the managing directors can be considered to have acted ultra vires and the counterparty knew or should have known that the managing directors abused their power of representation and breached their internal duty. The FCJ ruled that the transfer of (almost) all assets of a GmbH generally exceeds the internal authority granted to a managing director and therefore a shareholder resolution must be obtained.
For this reason, buyers should in practice still require a shareholder resolution, if it is questionable whether sold assets may comprise the entire or quasi-entire business, to avoid the risk of application of the ultra vires doctrine.
II) Limits for allocation of divisional responsibilities on management level
In another recent decision, the German Federal Court of Justice (FCJ) clarified the limits of an internal allocation of responsibilities among managing directors. In the case decided on November 6, 2018 (II ZR 11/17), the FCJ ruled that an effective allocation of divisional responsibilities requires a clear and unambiguous rulebook, which ensures the full performance of the management functions by persons who are technically and personally qualified. The FCJ stresses however, that central fiduciary duties and the overall joint responsibility of the management board members remains unaffected, so that an internal allocation cannot fully exempt a management board member from responsibility if e.g. monitoring obligations are breached. Managing directors of a German GmbH should be aware of these important limitations of an internal allocation of responsibilities, as they are exposed to personal liability in this context.
In the case at hand, the plaintiff, an insolvency administrator of a GmbH, sued a managing director of such GmbH in connection with insolvency proceedings for compensation of certain payments made after the occurrence of over-indebtedness. The defendant argued that he was not responsible for financial matters, as based on an internal agreement these were allocated to his co-managing director. He claimed that the co-managing director withheld information regarding the company’s financial situation, so that he should not face liability.
According to the FCJ, while the personal responsibility and obligation of all managing directors to file for insolvency in due time does not exclude a division of responsibilities at the level of the management in principle, the requirement of an effective allocation between the defendant and the co-managing director which would have led to a release from liability of the defendant, was not established, as the defendant breached core fiduciary duties which cannot be set aside by an internal allocation, namely the duty to monitor the financial status of the GmbH and the lawfulness of actions taken by the company. To that end, strict supervising and monitoring obligations apply. In particular, the FCJ ruled that a managing director cannot simply rely on an informal information exchange (and the correctness of the information exchanged) during regular internal meetings, but must establish sufficient controls to put himself in a position to independently assess the financial status of the company, and follow-up on any doubts he might have. In the case at hand, the defendant in principle relied on a brief review of bank account statements, which by themselves do not allow a reliable conclusion as to the financial status of a company, and did not question the statements made by the co-managing director as to the financial soundness of operations, although indications of a potential insolvency existed. Thus, applying these substantive criteria, the defendant failed to adequately fulfill his duty to continuously monitor and control the company’s economic situation.
From a formal point of view, the FCJ confirmed that an allocation of responsibilities is only effective if all managing directors reach a corresponding agreement; however such agreement can in theory be verbal. In practice, managing directors should ensure in their own interest that they carefully document their division of responsibilities – especially for evidentiary purposes.
III) The stock corporation’s representation by the supervisory board
On January 15, 2019, the German Federal Court of Justice (FCJ) (II ZR 394/17) ruled that the supervisory board represents the stock corporation not only in legal transactions concluded with management board members, but also in legal transactions with a company whose sole shareholder is a management board member. The FCJ clarified that Section 112 para 1 AktG is also applicable in such a case, thereby extending the literal scope of the provision. The decision is in line with prevailing case law.
In the case at hand, the FCJ was called upon to decide whether the claimant, a stock corporation, could seek repayment of the purchase price from its contractual partner based on unjust enrichment. The claimant, represented by one of its management board members, concluded a share purchase and transfer agreement with the defendant and another company, both GmbHs, for their shares held in another GmbH. The agreement provided, as a condition precedent to the transfer, that the managing directors and sole shareholders of the two vendor companies should join the claimant’s management board. The respective appointment as a member of the management board and the payment of parts of the purchase price were made immediately after the conclusion of the contract. The claimant argued that the purchase agreement was invalid due to a breach of Section 112 para 1 AktG, as the claimant’s supervisory board was not involved in the conclusion of the contract.
Section 112 para 1 AktG stipulates that the supervisory board represents the company in and out of court vis-à-vis the management board members. According to its wording, Section 112 para 1 AktG however only applies to the representation of the company vis-à-vis the members of the management board itself. For the FCJ, it was therefore crucial to decide whether the supervisory board, in addition to the wording of Section 112 para 1 AktG, was also competent to represent the company in the case of contractual agreements between the company and a company wholly owned by a future management board member.
According to the ruling of the FCJ, the purpose of Section 112 para 1 AktG is to prevent a collision of interests and to ensure an impartial representation of the corporation towards the management board members. In the present case, this protective purpose was jeopardized because the contractual partner of the corporation was a company whose sole shareholder was the company’s future member of the management board and thus a decision of the management board automatically affected the personal economic interests of one of the management board members.