When a company incurs debts or becomes insolvent, there is often a question of who is responsible for paying them.
In a German Limited Liability Company (GmbH), shareholders are generally protected from personal liability under the law. However, there are certain situations where shareholders may be at risk of unlimited liability towards the company's creditors, known as "piercing the corporate veil" in the U.S. In a recent ruling, the German Federal Supreme Court has extended this concept to another scenario. In light of this, we will explore the key cases in which shareholders of a GmbH may be held liable for their personal assets.
In a German Limited Liability Company (GmbH), the personal liability of the shareholders is in principle excluded by operation of law. However, in certain scenarios, the shareholders run the risk of unlimited liability towards the company’s creditors, a legal concept referred to in the U.S. as “piercing the corporate veil”. In a recent decision, the German Federal Supreme Court has expanded this legal concept to yet another constellation. Therefore, we explain the most important cases in which the shareholders of a GmbH are subject to liability with their private assets.
The German legal form of a „Gesellschaft mit beschränkter Haftung“ or, in short, „GmbH“ is the equivalent to foreign legal forms such as the U.S. Limited Liability Company (LLC), the UK Limited Company (Ltd.), the French Société à responsabilité limitée (SARL), the Spanish Sociedad de responsabilidad limitada (SRL), or the Polish Spółka z ograniczoną odpowiedzialnością (Sp.z.o.o.), to name but a few.
In principle, the liability of the shareholders of a GmbH (or of its sole shareholder) is limited to the payment of the agreed capital contribution. If the capital contributions are fully paid up (and no repayments to the shareholders have occurred in violation of applicable laws), the company’s creditors can only hold the legal entity itself liable.
However, this principle is subject to certain important exceptions in which the shareholders can be personally held responsible by the creditors. This legal concept, which is not unique to Germany, is quite neatly described in the U.S. as “piercing the corporate veil”. Moreover, the shareholders’ limited liability does not apply with respect to internal claims of the company against its shareholders (whose claims can be seized by the company’s creditors, who may then proceed against the shareholder personally). Frequently, such claims are brought forward by the insolvency receivers over the estate of a GmbH in bankruptcy.
The German Federal Supreme Court (Bundesgerichtshof or BGH) recently decided that the shareholders of a GmbH who resolve on the redemption (Einziehung) of a fellow shareholder’s shares in the company are personally liable for the payment of the compensation to the exiting shareholder if (and to the extent that) the compensation cannot be paid from the company’s distributable or “free” capital. The Federal Supreme Court thereby created a new constellation in which a personal liability of the shareholders of a GmbH is possible.
The aforementioned decision causes us to explain the most important cases in which a personal liability of the shareholders may occur.
We will first explain the – less frequent – constellations where the shareholders are directly liable to the company’s creditors. Thereafter, we will describe the scenarios in which the shareholders’ internal liability towards the company can lead to a seizure of such internal claims by the creditors, and thereby to an indirect personal liability towards third parties.
2. External liability towards third parties
The most important cases of potential direct liability towards the creditors are:
a) Mingling of assets of the company and of its shareholder(s)
In a scenario where it is impossible to assess whether assets belong to a shareholder or to the legal entity in which he/she holds participation, the shareholder is prevented from referring the creditors to only proceed against the company.
b) Substantive undercapitalization and “Cinderella” scenarios
In the past, situations where a company's capitalization did not adequately match its business activities were often used as an example of when the corporate veil could be pierced. However, due to changes in case law, this type of direct liability is now less common. Instead, these cases are typically resolved through internal liability towards the GmbH (see below for more information on these cases). However, there is still ongoing discussion about direct liability towards third parties in situations where the relationship between the company and its shareholders is structured in such a way that the negative consequences of business activities necessarily fall on the company. It's important to note that this type of liability is limited to extreme cases.
c) Abuse of legal form and bad faith
This catch-all element is also reserved for extreme cases, for example where the shareholders collect receivables of the company so it becomes insolvent. It is rarely relevant in practice.
d) Liability in connection with the redemption of shares
This constellation has already been mentioned above. The direct and personal liability applies when the shareholders of a GmbH who resolve on the redemption of a fellow shareholder’s shares in the company do not procure that the payment of the compensation to the exiting shareholder can be paid from the company’s distributable or “free” capital. The open question in this constellation is whether those shareholders who have not voted in favor of the redemption are also subject to this personal liability. A legal publication by GLNS attorneys (see Gubitz/Nikoleyczik, NZG 2013, 727) has recently dealt with the issue. We opined against the prevailing view in the legal literature that such a personal liability of dissenting shareholders would not be appropriate
3. Internal liability towards the GmbH
An internal liability of shareholders vis-à-vis the company (with the resulting possibility for the company’s creditors to seize the respective claim held by the company and proceed against the shareholders on that basis) can occur in the following scenarios:
a) Liability for adverse balance/liability to cover losses
The formation of a GmbH does not happen during the notarization of the incorporation, but rather upon registration with the commercial register. Prior to registration, it existed as a pre-formation company. The shareholders who founded the company are responsible for any decrease in the value of the stated capital from the date of registration. There are two scenarios to consider: when the company is successfully registered and becomes a GmbH, and when the registration fails. In the first case, the shareholders are proportionally liable for any difference between the stated capital and the value of the net assets at the time of registration (known as liability for adverse balance). In the latter case, each founder is personally liable for the entire amount of liabilities incurred by the pre-registration company (known as liability to cover losses).
b) Secondary liability for payment of the stated capital
If the amount of a shareholder’s capital contribution in the framework of the incorporation or of a capital increase cannot be obtained from a shareholder (and can neither be compensated through a disposal of the respective shares to a third party), then the remaining shareholders are subject to a pro-rata liability towards the company for the outstanding amount. Therefore, all shareholders should take appropriate measures to ensure that the other shareholders are capable of paying their contribution and that they will in fact do so.
c) Secondary liability in the event of a violation of capital maintenance rules
According to statutory law, it is not allowed for the stated capital of a GmbH to be repaid to the shareholders. If this rule is violated and the repayment cannot be obtained from the shareholder who received it, the remaining shareholders are responsible for a proportionate liability towards the company to cover the outstanding amount. Therefore, it is important for shareholders to consistently monitor the company's adherence to capital maintenance rules.
d) Tortious interference resulting in the ruin of the company
This legal principle, known as "Existenzvernichtungshaftung" in German, is based on case law and applies to situations where a shareholder intentionally damages the company's assets, leading to insolvency or worsening financial difficulties. There are three legal requirements for this principle to apply: (i) the interference with the company's assets must cause insolvency, (ii) the shareholder must intentionally violate their duties, such as making damaging withdrawals for personal use, and (iii) there must be a violation of public policy, involving serious misconduct aimed at systematically harming the company and its creditors. It is important to note that this principle is limited to extreme cases, and there is no legal requirement for a company to be adequately capitalized in all circumstances. It should also be noted that simply being unable to pay debts when due does not automatically create personal liability. However, these extreme cases, which this principle seeks to address, do occasionally occur in practice.
The cases mentioned above demonstrate that shareholders of a GmbH are not always protected from personal and unlimited liability. It is important for shareholders to be aware of these exceptions. Piercing the corporate veil can be a crucial method to safeguard the rights of creditors.
This article is for information purposes. Please consult a lawyer for legal advice. You may contact www.counselhouse.eu