Corporate disputes

Disputes and differences of opinion occur every day and everywhere. They are essential for human and entrepreneurial progress and are, therefore, not negative per se. However, the manner and content of disputes that are not resolved in good time can also have a destructive effect in individual cases.

In the early phase of a corporate dispute, shareholders communicate outside of the company law stage. This stage involves the exchange of points of view and, at best, the determination of the respective individual position. Based on our experience, we can provide advice during this phase to professionally prepare and mediate the possibilities of reaching an agreement or protecting interests.

The matter becomes more formal when they introduce to shareholders’ meeting. The shareholders’ meeting is the formal will-forming body of the GmbH in which the shareholder express formally their decisive will. The means of this decision is the shareholders’ resolution. The management must observe and implement the shareholders’ resolution.

In this phase, the respective shareholders need to know what influence they can exert and in what way. It is essential to assert information rights vis-à-vis the company, request the convening of a shareholders’ meeting, define agenda items and put them to the vote on the agenda and, ideally, control the course of a shareholders’ meeting. The right to prohibit voting must be known to exclude (controlling) shareholders from voting and, in this way, to ensure that one’s own proposed resolution is valid.

Although the majority shareholder usually prevails, this does not apply to every case. Minority shareholders are not powerless. The GmbH Act (GmbHG) only contains rudimentary provisions on order or conflict resolution at this stage, so the company’s articles of association are of considerable importance. In these, the shareholders can include their individual and company-related conflict resolution provisions that deviate from the predominantly dispositive law of the GmbH. The provisions should be formulated differently depending on the company’s phase. In case of doubt, a start-up needs provisions specific to the founding situation, which may seem inappropriate for a third-generation family business operating successfully on the market for many years. It has several shareholder tribes without an investor. As experienced advisors in out-of-court and in-court disputes, we recommend having the contents of the articles of association professionally reviewed every 4-5 years after the company is founded.

Knowledge and evaluation of one’s rights and claims are necessary to ensure that one’s interests are asserted in this phase. If required, however, fighting through the conflict is a prerequisite for breaking through a lethargic decision-making situation.

The management or managing director is often at the center of the dispute. They are obliged to remain neutral towards the shareholders and act solely in the company’s best interests. They must comply with the provisions of the articles of association and the resolutions of the shareholders’ meeting, so much for the theory.

The disputing shareholder usually accuses him of a breach of the duty of neutrality so that the managing director, whether as a shareholder managing director or as an external managing director, is drawn into the conflict. Depending on the situation of the conflict, he is threatened with dismissal and termination and, more rarely, claims under the principles of managing director liability.

Section 38 (1) GmbHG states that dismissing a managing director is generally possible at any time. All that is required is a shareholder resolution passed by a majority. If a shareholder managing director is to be dismissed, he or she is not entitled to vote on the resolution. The termination of the managing director’s employment contract must be separated from this, as the appointment as managing director (executive body function) must be separated from the employment of the managing director (paid employment contract).

Dismissal as managing director can occur in corporate law disputes for strategic reasons. However, in the strategic preparation of a dismissal, the question must also be answered as to whether the dismissal will also help the company and who should manage the company as an alternative. A minority shareholder can hardly stand up to the majority shareholder as managing director.

Sometimes, it makes sense for a shareholder-managing director to resign from office in a shareholder dispute to escape the line of fire and a potential liability scenario as managing director. From the “only” shareholder position, the company can also be driven without a target.

The company’s managing director(s) are obliged to remain neutral in disputes between shareholders. The attention and responsibility of the management are focused exclusively on the company. As the management can be held liable on the basis of various standards (see principles of management liability), managing directors are often drawn into disputes between shareholders. Therefore, managing directors should seek separate legal advice in disputed cases at the shareholder level to avoid suffering damage to themselves in this minefield. On the lawyer’s side, the professional principles of the prohibition of representation of conflicting interests (sections 43a BRAO, section 3 BORA) and party treason (section 356 StGB) must be observed. According to these standards, the lawyer only has to check whether he is allowed to represent both a shareholder and the managing director of the company at the same time.

While terminating the company leads to the dissolution and destruction of the entire association, the legal system recognizes the possibility of removing individual shareholders from the company or forcing them out for practical reasons and to protect the company.

Exclusion by legal action

Even if the articles of association of a company or the GmbH Act do not provide a separation option, the legal system recognizes an extraordinary right to exclude a shareholder from the GmbH for good cause. This option is usually the last arrow in the quiver for a company, as the courts only allow exclusion as a last resort after weighing up all interests. The prerequisite for this compulsory exclusion is that there are such serious circumstances in the person or behavior of the shareholder concerned that the other shareholders cannot reasonably be expected to remain in the company with the shareholder concerned. Extensive casuistry has developed in this regard. If the articles of association do not permit exclusion by shareholder resolution, the exclusion must be challenged in court through an exclusion action. This consequence is only possible for those affected to achieve with expert legal assistance. Furthermore, the proceedings can drag on for a very long time and have the disadvantage that the exclusion is only legally secure once a court decision has been reached.

Exclusion by shareholder resolution – redemption of the GmbH share

If the decision to separate from a shareholder can be made by shareholder resolution, faster results can be achieved.

To this end, the company’s articles of association must contain corresponding redemption or compulsory assignment provisions, as the GmbH Act does not provide such provisions (Section 34 GmbHG). If the articles of association requirements are met, the redemption or compulsory assignment resolution takes effect immediately. Due to the complexity of bringing about such a shareholder resolution in practice and the requirements for its legal validity, it can subsequently be reviewed in court by means of an action for defects in the resolution.

The redemption leads to the loss (amortization) of the company share. It requires a resolution by the shareholders’ meeting, for which the shareholder concerned is not entitled to vote (voting prohibitions in the meeting). The shareholders’ resolution may only be passed if the articles of association state the reasons that permit the redemption. These reasons can be formulated in concrete terms (e.g., loss of a required professional qualification of a shareholder, death of a shareholder, permanent illness of a shareholder, etc.) or described in more general terms as long as it constitutes a recognized objective reason. The articles of association often contain the catch-all provision of redemption for good cause, the characteristics of which must be derived from the relevant case law. Examples of such good reasons can be the misappropriation of company assets, competitive activity towards the company, or the defamation of the company’s reputation to the outside world.

A further prerequisite for the effectiveness of the redemption is that the pro rata share capital for the share has been paid in full, and the company can compensate for the lost share from its assets. This circumstance often leads to legal disputes in the aftermath and to the invalidity of the redemption resolution determined by the court. Therefore, this circumstance must be carefully examined during the preparation phase.

It would be better and more efficient if the articles of association also provided provisions to enable the compulsory assignment of the company share and the redemption provision. Compulsory assignment, which essentially has the exact requirements as redemption, does not lead to the loss of the share but to a mandatory transfer to a third party. This third party is liable to pay the share to the withdrawing shareholder, so it does not matter whether the company has sufficient free assets.

It is not uncommon for the end of a shareholder dispute to be crowned by a dispute over a settlement payment if one of the shareholders has to give way.

Exclusion of the claim?

A claim to severance pay is not regulated in the GmbHG but is derived as a general legal principle from partnership law (Section 728 (1) sentence 1 BGB). According to Supreme Court rulings and prevailing doctrine, such a claim is one of the so-called basic membership rights of a GmbH shareholder, which can only be withdrawn within very narrow limits (e.g., in the event of death or employee/manager shareholdings).

How is the severance payment calculated?

As the GmbHG is silent on the type, assessment, and method of payment of a severance payment, the vast majority of GmbH articles of association contain specific provisions on this in order to fill the legal silence.

The provisions of the articles of association regarding the assessment, the amount of the settlement, and the method of payment are subject to dispute and risk.

Without further provisions in the articles of association, the company always owes an “appropriate” settlement, Section 728 (1) BGB. According to case law, this means compensation at market value. In conceptual terms, this is the value that could be achieved on the open market if the shares were sold to a third party outside the company. The method of calculating the settlement and the individual valuation factors are naturally the subject of heated debate. The burden of proof lies with the departing shareholder. If he lacks information, he can obtain it from the company using a request for information. If the parties do not agree on the amount of the settlement, an (arbitration) court must decide. In case of doubt, the court will appoint an expert to determine an appropriate settlement. The valuer will generally use a standard capitalized earnings value method to determine the value. It is therefore advisable to seek expert help from lawyers familiar with company law promptly to lay down suitable and straightforward rules for determining the settlement in the articles of association. This can prevent any disputes.

Who owes the severance payment?

In the event of redemption, the company itself is the debtor of the settlement. If the compensation claim has arisen due to a share redemption, the shareholders of the GmbH who voted in favor of the redemption at the shareholders’ meeting are liable to the withdrawing shareholder in the amount of the compensation debt, according to Supreme Court rulings. This liability claim helps, for example, if the shareholders have abusively run down the company’s operations or become insolvent.

Only in the event that the articles of association provide for a regulation according to which the share to be collected is to be assigned to another person (compulsory assignment) does the recipient owe the settlement.

Is the severance payment due?

The settlement, which in the standard statutory model is due in full when the departure from the company takes effect, is paid in installments over several years in accordance with the provisions of the articles of association of the vast majority of companies to preserve the company’s liquidity. As a rule, the departing shareholder is at a disadvantage here.

Taxation of the severance payment?

Irrespective of whether the departing shareholder loses his shares due to a termination, redemption, compulsory assignment, or exclusion and receives a settlement payment in return, income tax law treats him as if he had sold his shares. In terms of tax law, this is an application of Section 17 EStG (sale of shares). Under the provisions of the partial income procedure (Section 3 no. 40 lit. c EStG), 40% of the capital gain (compensation less acquisition costs of the shares) remains tax-free. The remaining profit is subject to the personal income tax rate. As an exception, the flat tax rate is applied if the departing shareholder’s interest does not reach the materiality threshold of 1% of the share capital.

Regarding the settlement valuation, the softening shareholder relies on experienced lawyers and tax advisors to support him in valuing the company and navigating the procedural challenges.

More-tier companies characterize a need for more effective majorities. In case of doubt, the shareholders neutralize each other. Escalating disputes lead to the shareholders trying to force each other out of the management and excluding each other as shareholders (mutual resignation). In principle, the principles of voting prohibitions in the shareholders’ meeting also apply here. Due to the distribution of votes, none of the shareholders can appoint a chairperson at the meeting, meaning the resolutions cannot be legally binding. The shareholders must, therefore, instruct a court to clarify this. In case of doubt, these proceedings take a long time. This protracted delay can also cause damage to the company. It is advisable to consider the solution to such a situation when drafting the articles of association. To this end, provisions can be made for binding purchase offers which, in the event of rejection, oblige the party making the offer to sell to the other shareholder at the purchase price offered. This only requires a little creativity when drafting the articles of association.

Action for annulment

If the company’s articles of association do not assign corporate law disputes to the jurisdiction of an arbitration tribunal, they must be brought before the state courts. As a rule, these are legal proceedings concerning the contestation or annulment of shareholder resolutions. These so-called actions for defective resolutions are not expressly regulated in GmbH law. Nevertheless, they have been recognized for a long time. In terms of content, the type of action draws on both the general procedural provisions of the German Code of Civil Procedure (ZPO) and the provisions on actions for defective resolutions (sections 246 et seq. AktG), specifically standardized in stock corporation law. From 01.01.2024, the provisions on challenging resolutions in partnership law introduced by the Act on the Modernization of Partnership Law (MoPeG) in Sections 108 et seq. of the German Commercial Code (HGB) will also influence the challenge of resolutions in chapter company law.

Battle for the list of shareholders – interim legal protection

Legal proceedings only provide material legal certainty once a judgment has been reached. It can take years for this to be obtained through the courts. Temporary legal protection is, therefore, the means of choice to prevent the implementation of contested shareholder resolutions or management measures until a judgment is issued. This requires an application for an interim injunction to the court of first instance in accordance with Section 935 ZPO. The defendant is the company itself.

The list of shareholders is of particular importance in this context. Pursuant to Section 16 GmbHG, the person who is included in the list of shareholders submitted to the commercial register is deemed to be a shareholder in relation to the company. Anyone entered on the list may vote, participate in decisions, request information, and exercise other rights as a shareholder vis-à-vis the company. From the company’s perspective, those included in the list must be invited to the shareholders’ meeting. The submission of amended lists of shareholders, for example, after an alleged redemption of a share or an alleged exclusion of a shareholder, must generally be prevented in interim legal protection proceedings. In this regard, filing a protective letter with the commercial register should also be considered in preparation.

This is an area in which specialized lawyers’ swift and experienced action is essential.

While terminating the company leads to the dissolution and destruction of the entire association, the legal system recognizes the possibility of removing individual shareholders from the company or forcing them out for practical reasons and to protect the company.

Exclusion by legal action

Even if the articles of association of a company or the GmbH Act do not provide a separation option, the legal system recognizes an extraordinary right to exclude a shareholder from the GmbH for good cause. This option is usually the last arrow in the quiver for a company, as the courts only allow exclusion as a last resort after weighing up all interests. The prerequisite for this compulsory exclusion is that there are such serious circumstances in the person or behavior of the shareholder concerned that the other shareholders cannot reasonably be expected to remain in the company with the shareholder concerned. Extensive casuistry has developed in this regard. If the articles of association do not permit exclusion by shareholder resolution, the exclusion must be challenged in court through an exclusion action. This consequence is only possible for those affected to achieve with expert legal assistance. Furthermore, the proceedings can drag on for a very long time and have the disadvantage that the exclusion is only legally secure once a court decision has been reached.

Exclusion by shareholder resolution – redemption of the GmbH share

If the decision to separate from a shareholder can be made by shareholder resolution, faster results can be achieved.

To this end, the company’s articles of association must contain corresponding redemption or compulsory assignment provisions, as the GmbH Act does not provide such provisions (Section 34 GmbHG). If the articles of association requirements are met, the redemption or compulsory assignment resolution takes effect immediately. Due to the complexity of bringing about such a shareholder resolution in practice and the requirements for its legal validity, it can subsequently be reviewed in court by means of an action for defects in the resolution.

The redemption leads to the loss (amortization) of the company share. It requires a resolution by the shareholders’ meeting, for which the shareholder concerned is not entitled to vote (voting prohibitions in the meeting). The shareholders’ resolution may only be passed if the articles of association state the reasons that permit the redemption. These reasons can be formulated in concrete terms (e.g., loss of a required professional qualification of a shareholder, death of a shareholder, permanent illness of a shareholder, etc.) or described in more general terms as long as it constitutes a recognized objective reason. The articles of association often contain the catch-all provision of redemption for good cause, the characteristics of which must be derived from the relevant case law. Examples of such good reasons can be the misappropriation of company assets, competitive activity towards the company, or the defamation of the company’s reputation to the outside world.

A further prerequisite for the effectiveness of the redemption is that the pro rata share capital for the share has been paid in full, and the company can compensate for the lost share from its assets. This circumstance often leads to legal disputes in the aftermath and to the invalidity of the redemption resolution determined by the court. Therefore, this circumstance must be carefully examined during the preparation phase.

It would be better and more efficient if the articles of association also provided provisions to enable the compulsory assignment of the company share and the redemption provision. Compulsory assignment, which essentially has the exact requirements as redemption, does not lead to the loss of the share but to a mandatory transfer to a third party. This third party is liable to pay the share to the withdrawing shareholder, so it does not matter whether the company has sufficient free assets.