Personal Liability of Shareholders of a GmbH
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.
1. Introduction
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 (which 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 firstly explain the – less frequent – constellations where the shareholders are directly liable towards 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 a participation, the shareholder is prevented from referring the creditors to only proceed against the company.
b) Substantive undercapitalization and “Cinderella” scenarios
In previous years, constellations where the capitalization of the company was not adequate when weighed against its business activities were an important example where the corporate veil could be pierced. Due to changes in the relevant case law, this direct liability does not apply frequently any more. This is because the respective cases are now resolved through an internal liability towards the GmbH (see below for a description of these cases). A direct liability towards third parties is still discussed, however, in the event that the relationship between the company and its shareholders is set up in such a way that the detriments from the pursued business activities do necessarily lie with the company – a liability which, however, 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 appropriat
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 GmbH comes into existence not upon notarization of the incorporation, but only upon registration with the commercial register. Prior to that, it exists as so called pre-formation company (Vorgesellschaft). The founding shareholders are accountable towards the company for any loss in value of the company’s stated capital as of the date of registration of the GmbH with the commercial register. In this regard, it is distinguished between the situation where the company has been registered and, thereby, has become a GmbH, and the situation where the registration fails. In the first case, the shareholders are subject to a pro rata liability according to their shareholdings for any difference in value between the stated capital and the value of the net assets (which can also be negative) as of registration with the commercial register (liability for adverse balance). In the latter case, each founder is personally liable for the entire amount of the liabilities incurred by the pre-registration company (liability to cover losses – Verlustdeckungshaftung).
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
Pursuant to statutory law, the stated capital of a GmbH may not be paid back to the shareholders. If this principle is violated, and the amount paid back cannot be obtained from the shareholder who has received the payment in violation of laws, then the remaining shareholders are subject to a pro rata liability towards the company for the outstanding amount. Therefore, the shareholders should always closely monitor the company’s compliance with capital maintenance rules.
d) Tortious interference resulting in ruin of the company
This tort law principle, referred to in German as “Existenzvernichtungshaftung” and based on case law, refers to constellations in which a shareholder tortiously damages the assets of the company in a way resulting in insolvency (or deteriorating an existing insolvency). The legal requirements are (i) an interference with the company’s assets causing insolvency, (ii) the intentional violation of a shareholder’s duties, in particular where the shareholder makes damaging withdrawals for external, private purposes, and (iii) a violation of public policy, which requires a particularly serious misconduct, for example where the intent is to systematically harm the company and, thereby, its creditors. It bears emphasis, though, that the principle of tortious interference resulting in a ruin of the company is limited to extreme cases, and that there is no legal requirement to adequately capitalize a company under all circumstances. It should be noted that no personal liability exists merely on the basis that the company cannot pay its debts when due. However, the extreme cases that this principle seeks to capture every so often occur in practice.
4. Conclusion
The cases described above show that the use of a GmbH does not under all circumstances shield its shareholders from personal and unlimited liability, which is why the shareholders should keep the following exceptions in mind. To pierce the corporate veil can be a practically important method to protect the creditors’ rights.