Germany

BREAKING: Coronavirus (COVID-19) considerations for directors

1. What are the key issues for directors during the COVID-19 crisis?

Solvency

Maintaining solvency will be the main challenge for many companies. Both for practical and legal reasons, directors have to analyse the sustainability of the company’s business with particular care. Under normal circumstances, both short-term illiquidity and a lack of mid- to long-term sustainability might trigger the obligation to file for insolvency. 

Strategy

For many companies, the business perspective will heavily depend on present and future lockdown regulations. Public expectations as to future restrictions tend to change rather quickly. Directors need to establish alternative plans for a variety of different scenarios.

Risk

Although risk management systems will have been in place already before the crisis, the new health risks and their potential consequences for employees, for business relationships and for maintaining the overall operation of the company’s business will often require unprecedented decisions. Existing risk management systems need to adapt to the new challenges.

Communication

Established communication channels will be disrupted as a consequence of lockdown rules. Meetings need to be replaced by different forms of interaction. IT systems have to cope with particular challenges. Employees are working from home, and management needs to establish new forms of communication within the organisation. Shareholder meetings cannot take place, so that necessary shareholder resolutions need to be passed in alternative forms. The crisis may mean that shareholders, having practically unlimited information rights under German law, require more and more detailed information than previously.

2. What government relief measures have been made available to directors?

Financing

Various state aid programmes have been set up in order to support companies in maintaining solvency. This includes a variety of loan programmes of the state-owned Kreditanstalt für Wiederaufbau (KfW). In addition, state guarantee programmes have been extended and improved. There is also an economy stabilisation fund for Germany which may participate in recapitalisations.

Tax Payments

If companies are unable to make tax payments due in 2020 as a result of the COVID-19 pandemic, these payments may be deferred on request for a limited period of time and generally without interest. This extends to, inter alia, corporation tax and VAT. Companies can apply to their tax office until 31 December 2020. Advance payments for taxes may be adjusted upon request. Companies that will report a loss in 2020 due to the consequences of the COVID-19 pandemic may receive liquidity support which will be granted by offsetting foreseeable 2020 losses against 2019 profits.

Short-Time Work

If operational processes are disrupted by the pandemic the introduction of short-time work can be a solution. This would mean a temporary reduction of regular working hours due to a considerable loss of work. The employees receive short-time allowance from the Federal Employment Agency as compensation for remuneration, and the employer is released from the obligation to pay salaries and compensated for social security contributions. The criteria and consequences for short-time work and short-time allowance have been improved.

No Termination of Leases

If a tenant of land or premises does not pay the rent in the period from 1 April 2020 to 30 June 2020, such delay does not entitle the landlord to terminate the lease if the tenant can substantiate that non-payment is due to the effects of the COVID-19 pandemic.

3. What changes have been made to directors’ duties as a consequence of the COVID-19 crisis?

Obligation to File for Insolvency Suspended

Generally, managing directors of a German limited liability company are under a strict duty to file for insolvency if the company becomes insolvent or over-indebted (see question 12 below). This statutory filing obligation is suspended until 30 September 2020, and the suspension may be extended until the end of March 2021. Only where the insolvency is not a consequence of the COVID-19 pandemic, or where there are no prospects of remedying the insolvency, the filing obligations remain intact.
As a consequence of the suspension, payments made by the company in the ordinary course of business during insolvency or over-indebtedness – which generally are forbidden and give rise to personal liability of the director (see question 13 below) – may be permissible.

Filing of Annual Accounts

While the statutory deadlines for submitting and publishing annual financial statements have not been changed, the authority in charge of enforcing these obligations has decided on several measures to relieve the burden on companies that have not yet been able to submit their annual financial statements on time. Where capital market-oriented companies have not filed their 2019 annual financial statements until the deadline regularly expiring on 30 April 2020, no administrative fine proceedings will be initiated before 1 July 2020.

Shareholders’ Resolutions

Directors are generally obliged to call for an ordinary shareholders’ meeting in order to, inter alia, resolve on the annual financial statements and the distribution of the company’s results. However, holding shareholders’ meetings as physical meetings may be difficult or even illegal. During 2020, resolutions of the shareholders may also be passed in text form or by written vote even if such alternative is not provided for in the company’s articles of association.

Directors duties and responsibilities

1. What form does the board of directors take?

German companies do not need to form a board of directors. Generally, appointing just one managing director (“Geschäftsführer”) is sufficient. The company’s articles of association (“Satzung”) may specify a higher number of directors. If there is more than one managing director, the managing directors together might be regarded as “the board”.

Establishing a separate supervisory board may be mandatory under employee co-determination rules if the company has more than 500 employees. In such a case, a part of the supervisory board members is elected by the employees. A voluntary advisory board or supervisory board may also be provided for in the articles.

2. What is the role of non-executive directors or supervisory board members?

There is no distinction between executive directors and non-executive directors. In particular, all directors share a joint responsibility for the affairs of the company. The role of a supervisory board and its members is limited to oversight. In case of a mandatory supervisory board, the tasks are defined by the applicable co-determination rules, and more extensive co-determination rights apply if the company has more than 2,000 employees.

3. Who can be appointed as a director?

There are generally very few restrictions on who can become a managing director. Only individuals (as opposed to companies or other corporate entities) may be appointed as managing directors. Managing directors are not required to be German citizens and do not need to be resident in Germany. The practice of some commercial registers (“Handelsregister”) is, however, to require foreign managing directors to be capable of entering Germany at any time.

4. How is a director appointed?

The method of appointing managing directors is determined by law and the articles of association of the company. A managing director is normally appointed by a resolution of the shareholders or, if permitted under the articles of association, by a committee of shareholders or the advisory board. If there is a mandatory supervisory board and the company has more than 2,000 employees, managing directors are appointed by the supervisory board. In this instance, one of the company’s managing directors must be an employment director (“Arbeitsdirektor”), with special responsibility for employment matters. Where an employment director is required, the minimum number of directors is increased to two.

Notification of the appointment and an affidavit signed by the managing director and notarised by a notary public must be submitted to the commercial register.

Appointments are frequently open-ended, but can also be made for a fixed term. In addition to formal appointments, companies regularly enter into service agreements with their managing directors.

5. How is a director removed from office?

A managing director may resign from his/her office at any time by giving notice to the company, although such resignation may constitute a breach of contract.

A managing director is subject to removal by shareholders’ resolution at any time. However, he/she may still be entitled to his/her salary and other benefits under a service agreement.

Notice of the resignation or removal of a director must be provided to the relevant commercial register in notarised form.

6. What authority does a director have to represent the company?

The power of managing directors to represent the company in dealings with third parties (“Vertretungsbefugnis”) is generally unlimited. German law distinguishes between the unlimited external power to represent and the internal authority to conduct the business of the company (“Geschäftsführung”). Only the latter may be limited, while third parties are protected by the unlimited power of representation.

Generally, the company is represented by all its managing directors acting jointly. This rule, however, is often altered by the company’s articles. For example, one of the managing directors may be granted sole power of representation, or alternatively any two managing directors together, or one of the managing directors together with a holder of procuration (“Prokurist”), may represent the company.

The managing director’s authority to conduct the business of the company is restricted by the articles of association, internal management rules, the service agreement and possibly by shareholders’ resolutions, supervisory board resolutions and decisions taken by the managing director(s) themselves. It is common practice to include a list of matters which fall outside the managing director’s authority in either the articles of association, the internal management rules or the service agreement. The managing director may not act in respect of such matters without prior approval from the competent body (usually the shareholders’ meeting).

7. How does the management board operate in practice?

If there is more than one managing director, their cooperation should be regulated by the company’s articles or by internal management rules. Under the statutory model of a German limited liability company, all “board members” have the same rights and duties. The managing directors are, as a general rule, required to jointly manage the company. The shareholders or the directors may allocate certain tasks to one or more managing director(s). However, such allocation of responsibilities does not affect the overall responsibility of each managing director for the company’s business as a whole.

8. What contractual relationship does the director have with the company?

Appointment as a managing director does not in itself create a contractual relationship between the director and the company or entitle the director to remuneration.

The company therefore usually enters into a service agreement with the managing director, specifying the managing director’s duties and remuneration and containing provisions on matters such as confidentiality, non-solicitation, non-competition and fringe benefits. The service agreement is entered into by all shareholders on behalf of the company (unless there is a mandatory supervisory board) and the managing director.

Alternatively, such service agreement may also be concluded between the managing director and a different group company, e.g. the shareholder of the company.

Removal of a director does not automatically terminate a service agreement and vice versa. Subject to certain restrictions, the service agreement may, however, expressly stipulate that if an individual ceases to be the managing director of the company, then his/her service agreement shall terminate as if notice of termination had been given.

9. What rules apply in respect of conflicts of interest?

A managing director is subject to a statutory covenant not to compete with the company’s business while holding his/her office. The shareholders may release the managing director from this covenant at any time. Any non-competition and non-solicitation covenants which go beyond the statutory covenant must be set out in the service agreement.

A managing director cannot represent the company in dealings with himself/herself or with a third party represented by him/her (such as another “affiliated” company for which he/she also acts as managing director), unless authorised by a shareholders’ resolution. Such a resolution has to be permitted by the company’s articles and filed with the commercial register.

10. What other general duties does a director have?

The duties of the managing director are complex and this section merely provides a basic introduction to the subject. A managing director must comply with mandatory provisions of the law, the articles of association, the provisions of any service agreement, and shareholders’ resolutions.

In all matters concerning the company, a managing director must exercise the diligence of an “orderly businessperson”. The test is objective and requires the director to exercise reasonable care, without regard to his/her own individual level of skill and experience.

A managing director is subject to a wide range of specific statutory duties, for example requiring him/her to:

  • ensure all statutory filings with the commercial register are made
  • comply with the statutory requirement to maintain accounts
  • uphold the principles of capital maintenance (i.e. not to pay back to shareholders the stated share capital of the company) – a doctrine that has led to very complex case law and which particularly affects intra-group transactions such as cash pooling or upstream loans/upstream securities
  • prepare for and convene the annual shareholders’ meeting,
  • report to shareholders and answer their requests for information.

The managing director must also ensure that the company meets its obligations under public law – in particular tax and social security laws.

11. To whom does the director owe duties?

The managing director must, in all circumstances, act in the best interests of the company, which are not necessarily identical to the shareholders’ interests. However, the shareholders’ meeting or the sole shareholder of a limited liability company may influence every single management issue by giving instructions to the managing directors. A breach of the duty to act in the best interests of the company can also be ratified by the company’s shareholders.

There are also many duties of a managing director aimed at protecting the interests of third parties such as the company’s creditors and even the general public (for example, the tax and social security authorities).

12. How do the director’s duties change if the company is in financial difficulties?

If the company is in financial difficulties, there is a greater onus on the managing director to act in the interests of creditors, and a greater risk of the managing director incurring personal liability. Professional advice should therefore be obtained as a matter of course.

If the company becomes insolvent or over-indebted, the managing director must file a petition for insolvency proceedings without undue delay, but in any case within 3 weeks of the company becoming insolvent or over-indebted. As soon as the company gets into financial difficulties and well before filing for insolvency may be required, managing directors are under a continuous monitoring obligation so that they are in a position to act without undue delay once insolvency or over-indebtedness are established.

If the company’s financing through to the end of the following financial year is in question, managing directors need to assess carefully the future viability of the company’s business. Should they fail to conclude that there is a high likelihood that the enterprise will continue to exist, a stricter over-indebtedness test applies even at that point in time.

Failure to file for insolvency proceedings in time is a criminal offence. One of the consequences of a conviction would be a prohibition on being a managing director of a company for a period of 5 years.

13. What potential liabilities can a director incur?

A managing director who negligently or intentionally breaches his/her duties to the company is liable for damages vis à vis the company. However insofar as a managing director’s action has been (validly) approved or ratified by the shareholders, the company is, as a general rule, precluded from claiming damages in relation to such breach.

If misconduct can be attributed to several managing directors, they are liable on a joint and several basis. Particular liabilities may arise in connection with the managing director’s duty to monitor the contribution to, and maintenance of, the company’s share capital.

If the obligation to file for insolvency in time is not complied with, the managing director is liable for damages not only to the company but also to third parties – in particular to creditors of the company. In such a case, the managing director may also be held liable by the company or, in particular, by its insolvency administrator for payments made by the company after insolvency or over-indebtedness are established.

A breach of the managing director’s obligations under tax and social security laws may also have implications extending beyond liability to the company. In the event of misconduct or gross negligence, the relevant governmental authorities may have a cause of action against the managing director, and in extreme cases, criminal sanctions may ensue.

14. How can a director limit his/her liability?

It is somewhat doubtful under German law whether the managing director’s liability to the company can be validly limited in advance by any kind of general agreement.

The company, however, may waive specific claims against a managing director. The shareholders of a company regularly resolve to approve the managing director’s management (“Entlastung”) after the close of each business year. Such formal approval operates as a waiver of any claims which were identifiable at the time of the resolution.

The managing director’s potential liability towards third parties is not subject to limitation or waiver by the company. Equally, there can be no limitation or waiver where the managing director’s liability to the company is related to the interests of the company’s creditors (most particularly, in an insolvency situation). A managing director’s liability may be covered by an indemnity from the parent company – if so agreed and to the extent permitted by law. Furthermore, the company may take out directors’ and officers’ liability insurance cover (“D&O”) in favour of its managing directors.

Jan Schepke
Dr. Jan Schepke
Partner
Hamburg