As reported in one of our earlier issues, the recent reform of the German Limited Liability Company Act (“GmbHG”) has eased the restrictions on cash pooling within group companies. However, a current decision of the German Federal Supreme Court demonstrates that caution is still warranted in the area of overlap between cash-pooling systems and the requirement of making effective capital contributions in connection with the incorporation of a limited liability company (GmbH) or the increase of its capital.
- Facts
The decision was based on the following fact pattern: H-GmbH was founded in March 1998 by S GmbH & Co. KG (“S”). According to a cash-pooling agreement between H-GmbH and S, S managed a cash-pooling system that included H-GmbH. All payments by H-GmbH were processed through a company account that was included in the cash pool. All credit balances of H-GmbH were transferred to a central cash-pooling account of S at the end of each business day (“zero balancing”). At the same time, S had granted H-GmbH a credit line via this central account. The dispute in question related to several cash contributions paid by S to the company account of H-GmbH that were transferred by way of zero balancing the same day to the central account of S. The insolvency administrator of the (by now insolvent) H-GmbH required S to pay once more the contribution amount in cash.
This case constitutes a practical example of the existing problems connected with the contribution of share capital by a shareholder managing the company’s cash pool system. The court analyzed two alternatives:
To the extent that, at the time of the cash contribution, the company had fully or partly drawn down the credit line from the cash pool, the contribution economically effected a repayment of the related loan-repayment claim. Germany’s Federal Supreme Court correctly qualifies this as a “hidden contribution in kind” (verdeckte Sacheinlage), as this leads to the same result that would have arisen if the contributing shareholder had contributed the repayment claim as a contribution in kind in the first place.
If, on the other hand, the credit line had not been drawn down or the contribution had exceeded the drawn-down credit, the capital contribution would have qualified as having been repaid through the cash pool as a loan by the company to the shareholder. According to case law established by the court, such a “back-and-forth payment” (Hin- und Herzahlen) does not qualify as a valid contribution, since the company’s management is at no point able to freely dispose of the contributed cash.
In the case at hand, both alternatives were present. Although the payments in question were effected in 1998, their legal qualification is subject to the new GmbH law. This is because the reformed capital contribution rules apply retroactively to contributions made prior to the entering into force of the GmbH reform.
- Treatment of Hidden Contributions in Kind
To the extent a hidden contribution in kind is present, prereform law provided for the invalidity of the original contribution (for reasons of circumvention of valuation requirements for contributions in kind), and the shareholder had to make a new contribution in cash. The recent GmbH law reform has relaxed the issue, as it has removed the consequence of invalidity. Instead, the actual fair market value of the contribution is deducted from the remaining contribution obligation of the shareholder. Therefore, if the contribution’s value equals the value of the stated amount, no further obligation to make cash contributions exists. It was not clear in the case at hand whether it was the contributions of S that paid off the loan-repayment claim and, if so, whether the loan-repayment claim was valued at full value. The court remanded the dispute to the lower court for purposes of assessing such requirement.
- Consequences of Back-and-Forth Payments
The situation is different in cases of back-and-forth payments. Pursuant to the old as well as the new law, the original contribution is invalid and must generally be repeated. Accordingly, S would continue to be obligated to make the contribution in cash. Although the original contribution did not flow back to S without consideration but instead is granted by way of the loan, thus creating a loanrepayment claim of H-GmbH, the contribution is not considered to be at the free disposition of H-GmbH’s management due to its immediate transfer, and therefore the obligation to make the contribution persists. However, the postreform GmbH law provides for an exemption from this continuing obligation under certain conditions that ensure that management always has the option to dispose of the contributed funds. This is the case if the repayment is backed by a repayment claim of full value and if such a repayment claim is payable at any time or can be made payable by immediate termination by the company (Section 19, Para. 5, Sentence 1 GmbHG). In the case decided by the court, no such free terminability of the cash pool arrangement existed, so already for that reason, no exemption from the contribution obligation could be granted.
Section 19, Para. 5, Sentence 2 GmbHG further requires that notification of the repayment or the agreement to repay the contribution to the shareholder (in this case, the zero balancing) must be made to the commercial register upon the constitutive filing of the company (or in connection with a capital increase). In accordance with a previous decision, the court interpreted this provision to the effect that the aforementioned exemption will not apply in the absence of a notification, so that in spite of the full value and payability of the repayment claim, the exemption from the contribution obligation would not apply.
This decision has been criticized by legal authorities. In particular, the argument has been made that the introduction of the notification obligation (a concession to the judiciary committee of the German Bundestag) should merely enable the commercial register to assess whether the contribution obligation has been fulfilled. However, it was never intended by the legislature that the omission of the notification should lead to the exclusion of the exemption in Section 19, Para. 5, Sentence 1 GmbHG. Nevertheless, the wording of the statute permits the interpretation applied by the court, so only a legislative clarification is likely to lead to a reversal of the court’s position in this regard.
- Practical Consequences
The main implication of the decision for legal practice is that in the future, constitutive filings of companies or filings in connection with capital increases with the commercial register must include a notification of potentially existing cash-pooling arrangements. Only in this case, and if the repayment claim against the cash pool is of full value and payable at any time, repayments of contribution to a cash-pooling account of the contributing shareholder are permitted.
In addition, due to the retroactive effect of the GmbHG’s new Section 19, any past capital contributions that were made to a company account included in the cash pool will not be deemed to have been validly made, even if the other requirements (i.e., the full value of the repayment claim and the terminability of the cash-pooling arrangement) are present. Since the requirement of such notification was not known in the past, it will practically never have been fulfilled. Therefore, the relaxation of existing restrictions intended by Section 19, Para. 5 GmbHG will practically never apply to past cases.
If in fact the view of the court is contrary to the intentions of the legislature, a clarifying correction to the effect that Section 19, Para. 5, Sentence 2 GmbHG merely constitutes a procedural provision would be desirable. In general, however, the decision confirms the relaxation of the capital contribution rules provided by the GmbH reform in the context of cash-pooling systems and, provided the requirements set forth by the court are met, does not generally call into question the practice of cash pooling involving GmbHs. Also, it always remains possible for shareholders to effect contributions via an account not included in the cash pool, provided, of course, that such amounts in this case would not be for the company group’s liquidity management.
