The Legal Framework of Investing in Germany

(Dr. Ulrich Lohmann, LL.M. Berkeley)

American investors seeking preliminary information about investing in Germany will often hear discouraging news, such as: "Transactions involving German assets are difficult and costly"; "Assets owned by German corporations cannot be used to secure the debt incurred to finance the investment"; "Industrial relations are difficult to manage"; and finally, "German taxes are too high".

Reality is different. Potential investors obtaining qualified legal advice will find that the German legal framework for foreign investment is generally designed to enhance the value of the investment rather than making investments difficult.

This report will focus on two asset classes, German business entities and real estate located in Germany. It provides only a very general picture; it should not be relied on as legal advice.

German corporations come into existence upon registration by the local court. The registers serve to verify the existence and capitalization of any German corporation.

Corporate transactions can take several forms, depending on the legal form of the corporate entity:
Stock corporations (Aktiengesellschaften) may list their shares on a stock exchange. Buying such shares is not much different from buying stock in a U.S. listed corporation. However, setting up a stock corporation requires proof that its registered capital has been paid in; the statutory minimum is Euro 50,000. The structure of a German stock corporation is different from that of a U.S. corporation: It has two boards, a management board and a supervisory board. The supervisory board is elected by the shareholders, but cannot manage the corporation itself. The management board, which is appointed and supervised by the supervisory board, manages the corporation with certain discretionary powers. As a result, the shareholders have no direct influence on the management of the corporation. They are not, however, relegated to passivity. To the contrary, there are a number of cases where well-advised investors have been able to steer corporations into certain directions. One legal tool for such moves is the shareholders' right, unknown in American corporate law, to have the courts review any shareholder resolution, even if all other shareholders have voted the other way. In addition, minority shareholders have certain information and audit rights and may even cause the company to claim damages from the management personally. These rights, if properly exercised, may cause the management of a German corporation to listen to shareholders.

Most German corporations are limited liability companies (GmbH). Limited liability companies must have a minimum capital of Euro 25,000. Most limited liability companies have a simple structure consisting of just one or more shareholders and one or more managing directors. The transfer of shares in limited liability companies, however, is more cumbersome than the purchase of shares in a stock corporation, because the underlying contract as well as the transfer itself are valid only if they are recorded by a German notary. As a result, shares in limited liability companies cannot be traded publicly. German notaries are government-appointed lawyers who act in the interest of both parties, ensuring that the transaction works. Their fees, which are fixed by statute, add to the transaction cost, so transactions should be designed to minimize this exposure. The notarization requirement also applies to other contracts on which the decision to invest in a limited liability company rests, such as shareholder agreements. On the other hand, notaries may add value, particularly to complex transactions.

Interests in German commercial partnerships can be acquired without notarization. Investors may structure partnerships in accordance with their particular requirements.

Corporations organized in other Member States of the European Economic Area may also be used as vehicles for an investment in Germany.

Since November of 2008, the entire assets of German limited liability companies may be used to make loans to the shareholders and as collateral for debt incurred by the shareholders, if such transactions are made on arm's-length terms. "Arm's-length terms" means that the company receives fair compensation and that the value of the claim of the company against the shareholder is not in any way impaired, except if the company and the shareholder have entered into a profit-and-loss-pooling agreement. Before, it was unclear whether such transactions were possible at all if they affected the registered capital. This uncertainty exposed the management to personal liability and made leveraged transactions as well as cash pools difficult. These issues may now perhaps be regarded as overcome, although legal battles about the meaning of "arm's-length terms" may be expected.

Stock Corporations may provide financial assistance to a shareholder for the purchase of their own shares only if a profit-and-loss-pooling agreement between the Stock Corporation and the shareholder concerned is in place.

Transactions in which the investor acquires the individual assets making up a particular business (asset deals) are not as common in Germany as share deals. One reason is that, as in other European countries, the purchaser cannot avoid taking over the contracts with the employees working in the business, making it impossible to shake off human resources by choosing an asset deal over a share deal. Another reason is that the total tax burden levied on the proceeds of the asset sale is, as a rule, higher than in a share deal, so that the investor generally will be asked to pay a higher price if it insists on an asset deal. Only purchases from an insolvency receiver are habitually structured as asset deals. Asset deals may also require notarization.

Employees - as opposed to members of the management of a corporation - do have more rights in Germany than in many other countries, but they can neither block the investment nor dictate the management of a German corporation. Except in small businesses, employment contracts may be terminated or modified only if the notice is justified by business or personal reasons and certain social parameters have been taken into account. Therefore, a corporation cannot unilaterally change the terms of employment at the request of an investor. Employees may form representative bodies (works councils) with which the management needs to consult. Plant closures may even require the consent of the works council. On the other hand, works councils often facilitate the management of human resources. In larger corporations, employees are also represented on the supervisory board. Stock options and other incentive schemes may be used to align the interests of employees and shareholders.

The ownership of and charges on real estate located in Germany can be verified in land registers maintained by local courts. The acquisition of real estate and, in most cases, the taking of security over real estate requires notarization. Real estate transactions often come in the form of the acquisition of shares in a real estate holding company. If so, the rules for corporate transactions described above apply.

German tax rates may appear high at first sight, but investors should assess the tax consequences of a proposed investment in detail, taking into account all possible deductions and the relevant double-taxation treaties. This may yield a much more positive outlook. It may also pay off to use an acquisition vehicle located outside Germany. German real estate, for instance, is often held via a Luxembourg holding company.

The investor should also take into account the possibility of a dispute. Litigation in Germany is usually more expedient than in the United States: There are no contingency fees, no juries and no punitive damages. The average time to trial is less than one year, because there is no pre-trial discovery. Whether or not this is a good system, the differences between the German and the U.S. system make it worthwhile to consider the choice of law and the choice of forum carefully before making the investment. In many cases, international commercial arbitration under the auspices of one of the recognized arbitration bodies, including the American Arbitration Association (AAA) and the German Arbitration Institution (DIS), may be the best choice.

Dr. Ulrich Lohmann, LL.M. (Berkeley)