A Quick Aid for U.S. Practitioners
By Anna-Katharina Hoffmann, LL.M.
In the United States, attorneys, business owners, and trusts and estates practitioners who deal in transnational contracts, disputes, business deals and tax or estate planning often come across foreign entities and assume that a particular corporate structure is similar to that of a U.S. entity.
While that general assumption may be correct, important differences can create traps for the unwary. With the German economy a leading force in Europe, it is a good time to quickly compare how German law handles the corporate structure.
Limited liability entities commonly used in the United States include trusts, foundations, S-corporations, C-corporations and limited liability companies (the “LLC”). Each state regulates these entities on the state level, with federal regulations affecting all 50 states. This creates a dynamic patchwork where corporate practitioners seek to exploit jurisdictions favorable to client goals.
A key consideration in choosing an entity type in the U.S. is limiting personal liability of owners while managing tax burdens. A small corporation may elect under Subchapter S of the Internal Revenue Code to be taxed as a pass-through entity and avoid double taxation. The LLC is flexible in facilitating different types of ownership structures. Trusts, foundations and not-for-profits may be used in lieu of or in combination with the above to effect generational wealth transfer, protect legacies, and shield charitable activities from taxation. For a discussion of tax implications of various U.S. corporate entities, please see Choosing A Business Entity: Tax Considerations by Dunnington tax partner Joseph Michaels IV (available here).
As in the U.S., limiting liability is a concern when forming German entity. However, German entity types do not share all of the same characteristics of the U.S. counterparts. This article focuses primarily on two of the most common German entity types that limit shareholder liability, the GmbH (Gesellschaft mit beschränkter Haftung) (“limited liability company”) and AG (Aktiengesellschaft) (“stock company”), as well as an entity type less frequently used for business purposes, the Stiftung (“foundation”). We also discuss the “entrepreneurial” limited liability company, known as the UG. Developed in 2008, this special type of GmbH may grow in popularity for small businesses and startups.
Germany requires that every German company, partnership and association be officially registered in the Commercial Register (Handelsregister). There are a total of eight hundred and ten Commercial Registers in Germany. Each local court (Amtsgericht) runs its own Commercial Register. On establishment of a new company, or if an existing GmbH or AG makes certain changes to its articles of association (for instance, capital increase, reductions of share capital, new purpose of business, change of directors, profit transfer agreements), the documents relating thereto must be notarized and the respective changes recorded with the Commercial Register where the company is registered. This is done to ensure that the general public has reliable information about the company, including its shares, its directors and its business address.
Practitioners looking for corporate documentation in English can find it at https://www.unternehmensregister.de, the official central database of all 810 German commercial registers.
I. The Limited Liability Company – GmbH
The most popular and most widely used form of entity in Germany is the GmbH (Gesellschaft mit beschränkter Haftung), which is a private limited liability company.
The GmbH provides a high degree of flexibility with relatively few corporate compliance requirements while protecting its shareholders from personal liability. Founders are personally liable as joint debtors only for liabilities that arose prior to registration of the company in the Commercial Register.
Only one shareholder, either a natural person or a legal entity, is needed to form a GmbH. Shareholders and managing directors may be foreign nationals or residents. However, the company’s registered office must be located in Germany as stipulated in the articles association. The location of the registered office may differ from the location of the operational facilities, management and administration of the GmbH, all of which can be outside Germany.
The required minimum share capital to set up a GmbH is 25,000 EUR (payable in cash or in kind). At least 12,500 EUR must be deposited at incorporation. The share capital must remain in the company.
The GmbH must have at least one managing director, who in turn must be a natural person who is geschäftsfähig (legally competent, e.g. of certain age, sound mind, etc.). The managing director represents the GmbH judicially and extrajudicially. The managing director also manages the business of the GmbH in accordance with decisions made in shareholders’ meetings. The company may be represented only by the managing director and not by the shareholders themselves.
The steps to set up a GmbH are as follows:
1. Articles of Association
The shareholders must agree on the articles of association. Articles of association must list the share capital, initial contribution of the shareholders, business name, purpose of the company, and place of organization. Both the articles of association and any transfer of shares must be notarized.
2. Registration in the Local Commercial Register
The most important step prior to engaging in commercial activities is registration with the local Commercial Register and the local trade office. This is not only required by law, it also affects the liability of the company because the GmbH arises only upon registration. Before registration, the company is a so-called pre-GmbH and the shareholders are liable without restriction for all activities. The Commercial Register requires documentation verifying that the minimum share capital has been paid in. The registration process generally takes from four weeks up to several months depending on the workload of the courts. The associated fees start at 700 EUR (depending on the capital contribution and notary expenses).
The Entrepreneurial Limited Liability Company (UG)
On November 1, 2008, a statute was enacted to modernize the GmbH (known as “MoMiG”) by creating an alternative entity structure to encourage the establishment of new companies: the entrepreneurial company (UG). The minimum share capital for a UG is only 1 EUR. However, the UG must keep 25% of its net income (profit) in a reserve fund until the share capital reaches 25,000 EUR. De facto, the UG is not a separate type of company but rather a special type of GmbH, which automatically transforms into a regular GmbH when 25,000 EUR in reserves is attained. Contributions in kind are not permitted—the initial share capital must be paid in full immediately as a cash contribution.
II. The Stock Corporation – AG
An entity type suitable for larger enterprises with more shareholders is the Aktiengesellschaft (AG), or stock corporation. Its eligibility for a stock exchange listing and the easy assignability of its shares make the AG ideal for attracting capital. Liability is limited to the corporation’s business assets, including share capital.
The AG has three mandatory governing bodies: the shareholders’ meeting, the management board and the supervisory board. The supervisory board’s main tasks are to supervise the management board and determine the compensation of its members and to report to the general shareholders’ meeting. The management board runs the company; however, fundamental corporate decisions are made at the shareholders’ meeting.
The procedure for forming an AG is similar to that for a GmbH but more complex in terms of certain founding and organizational formalities. As with the GmbH, the AG can be established by one or more shareholders (private individuals or legal entities), and nationality and residence of the shareholder(s) and management and supervisory board members do not matter. However, the company must have a German business address and a local representative and maintain a higher minimum share capital, which can be contributed in cash or in kind.
The steps to set up an AG are as follows:
1. Establish articles of association and subscription of shares through a notarial deed of formation
2. Appoint the boards – The incorporators appoint the first supervisory board and the first auditors (notarization required); the supervisory board then appoints the first management board
3. Draw up a formation report addressing the procedure of the formation of the company, followed by a (formal) formation audit usually done by Aufrsichtsrat (advisory board) and Vorstand (board)
4. Payment of share capital – The minimum share capital is EUR 50,000. At least 25 percent of the par value of each share and if shares are issued above the par value (referred to as “Agio”), the full Agio has to be paid into the share capital before formation.
5. Registration with the Commercial Register (similar procedure to GmbH)
The Foundation – Stiftung
The vast majority of Stiftungen in Germany are charitable. While the legal structure of a Stiftung can secure assets held for generations, a Stiftung also offers tremendous legal and fiscal flexibility.
The Stiftung is akin to the trust or foundation in the United States. A Stiftung pursues a purpose determined by the founder and specified in the bylaws. The purpose defines the responsibilities and goals of the Stiftung. The income of the Stiftung‘s assets are used exclusively for this purpose. However, the assets themselves generally remain in the Stiftung indefinitely. Stiftungen can be established in various legal forms according to private or public statutes and for any lawful purpose—not necessarily charitable.
Stiftungen, both charitable and non-charitable, may be linked to corporations. They are often used as an instrument for regulating corporate succession. Germany’s largest are worth billions, facilitating the commitment of many entrepreneurs to social causes and projects.
The relationship between a Stiftung and a German corporation may take one of many forms. For example, a corporation with a business purpose may be purely a source of income for a Stiftung with a charitable purpose, in which case there is no link between the Stiftung’s central purpose and the commercial activities of the corporation. Alternatively, the purpose of the Stiftung may lie in the entrepreneurial leadership/business purpose itself. Such corporate Stiftungen can hold shares in companies (for example, Bertelsmann-Stiftung and the Lidl-Stiftung) or actually operate a company (for example, the Carl-Zeiss-Stiftung). Of these two options, the shareholder Stiftung (where a Stiftung acts through a corporate form to which it delegates certain responsibilities) is the more popular. For instance, a combination of Stiftung and AG may provide the right combination of management control and ability to act quickly.
- Sect. 25, Subsection 1 of the German Commercial Code (HGB) specifies that if the existing business name of the acquired company is used by the purchaser, the purchaser may be liable for debts incurred by the previous owner. Such liability may to some extent be avoided by a disclaimer and by an entry in the Commercial Register.
- Section 613a of the German Civil Code (BGB) states that if a business or a business unit passes to another owner by legal transaction, existing employment agreements and the liabilities resulting from the employment are transferred to the purchaser if the transferred assets qualify as a business or business unit. Since employment protection is a paramount principle under German law, German courts generally are very generous in defining a “transfer of business”.
Commerce and cooperation with Germany will inevitably lead to new understandings between the German and U.S. business, legal and charitable communities. We hope that this article is of assistance in helping you navigate the terrain.