The German Federal Ministry of Justice (BMJ) published a preliminary proposal for several far-reaching amendments to the German Limited Liability Company Act (GmbHG) in May 2006. By far the most popular German corporate form, particularly for small and medium sized-businesses, an estimated one million limited liability companies (GmbH) currently exist in Germany. The proposed amendments intend to both enhance the attractiveness of the GmbH as a business vehicle in light of increasing competition with other European corporate forms and to prevent abuses of the GmbH structure.

Although the draft proposal may still be subject to further changes during the parliamentary process, the amendments propose to lighten existing financial requirements, eliminate restrictive capital share preservation rules and improve investor protections in share acquisitions.

The cost of incorporating has always been considered a significant obstacle for those intending to launch small or medium-sized businesses in Germany. German laws currently require a GmbH to have a statutory minimum capital of €25,000 (of which at least half actually has to be paid up upon incorporation). Several recent European Court of Justice rulings have stated that businesses operating solely within Germany may also be incorporated under the laws of other Member States (with less restrictive incorporation requirements), which establishes what is often referred to as a “competition” of corporate forms. Considering the significant financial burden, businesses have no incentive to incorporate in Germany if they can do so elsewhere for a lower fee and still operate within German territory. To encourage businesses to incorporate in Germany, the amendments propose a reduction of the statutory minimum capital amount from €25,000 to €10,000 (of which €5,000 must be paid up upon incorporation).

Currently every acquirer of shares in German limited liability companies faces uncertainty to some extent. Because German laws currently do not provide for a bona fide acquisition of shares

in a GmbH from someone who is not the true holder of such shares, investors cannot be sure their share acquisitions are valid. In every transaction where the intended target company is incorporated as a GmbH, the acquirer’s advisors have to try to retrace an uninterrupted chain of share transfers from the incorporation of the company until the present in order to assess whether the potential seller actually owns the shares in question. However, advisors can only examine the documents they are given, which may not include every sale and transfer of shares.

Despite not providing for the aforesaid bona fide acquisition of shares, German law nevertheless obliges the managing directors of a GmbH to submit updated shareholder lists to the commercial register, a public register maintained by the local courts (Amtsgerichte), after every change in a GmbH’s shareholder structure. If Parliament passes the amendments, however, potential acquirers of shares will be able to rely on a shareholder list that displays incorrect shareholdings, provided the respective false entry has remained unchallenged for a period of three years. While the proposed amendment does not provide for an unrestricted possibility of a bona fide acquisition of GmbH shares, it will significantly ease the process if incorporation occurred many years before the intended acquisition. Under the amended law, a potential acquirer would only have to retrace the uninterrupted chain of share transfers for a period of three years prior to the intended transaction.

It is important to note the shareholder lists do not state whether shares are pledged or otherwise encumbered. Therefore, investors should still cover their risk and secure the seller’s guarantee.

Other proposed amendments concern the deregulation of capital preservation rules. Under German law, assets required to maintain the nominal capital of a GmbH must not be repaid to the shareholders. According to the Federal Supreme Court (BGH), upstream loans (those granted by the GmbH to its shareholders) might be considered impermissible repayment. As a result, not only the shareholder who receives the funds but also the managing director of the company is liable for the repayment of the loan. The draft proposal includes an exemption to this rule and deems transactions between the GmbH and a shareholder permissible if they are in the interest of the company.

The amendments will also affect loans granted by the shareholders to the GmbH (shareholder loans)—currently, the rules are highly complicated. According to the German rules on so-called “equity replacing loans” (eigenkapitalersetzende Gesellschafterdarlehen), shareholder loans are considered equity (rather than debt) if granted or not immediately terminated when a GmbH experiences a financial crisis. In case of an insolvency, the loan is qualified as subordinated debt (nachrangige Verbindlichkeiten). These complicated laws are to a large extent founded in the sophisticated case-law of German courts. The draft proposal intends to delete the respective provisions in the GmbHG and to introduce new rules in the German Insolvency Code (InsO). Shareholder loans will then always be considered subordinated debt in case of insolvency, regardless of when they were granted.

Will the amendments truly result in a boost to the popularity of the GmbH in the “competition” of corporate forms? If and when—and in what form—the proposed changes will finally be adopted remains to be seen.