CMS Expert Guide to cash pooling in Germany

a ) Intro

There is no specific legal framework that governs cash pooling in Germany. A multitude of different legal requirements must be taken into account in order to minimise the risk of civil or criminal liability.

b) Social interest and due diligence

The directors of a company have a duty to manage the company's affairs with the diligence of a prudent businessman. This applies to the directors of a German limited liability company (“GmbH”) (§ 43 sec. 1 German Limited Liability Companies Act (“GmbHG”)) and to the board of directors of a joint stock corporation (“AG”) (§ 93 sec. 1 sentence 1 German Stock Corporation Act (“AktG”)). Therefore, the directors must weigh up the chances and risks of cash pooling with the care and diligence of a prudent businessman.

c) Insolvency proceedings – contestation of transactions and shareholder loan provisions

Subsidiaries which are in an ongoing liquidity crisis should generally not be financed through a cash pool as this involves several liability risks for shareholders and the management. One of these risks is based on the contestation rights of a later insolvency administrator. The insolvency administrator can reverse transactions of an insolvent company, such as payments granted to other group companies. The recipients must then reimburse the respective amount.

The risk of contestation lies primarily with the cash pool leader if insolvency proceedings are opened on the assets of a subsidiary participating in the cash pool. The insolvency administrator can contest loan repayments made by the insolvent company to the master account for a period of one year prior to application for opening of insolvency proceedings and demand repayment in this amount from the cash pool leader. Payments from the cash pool leader's master account to the pool participants are shareholder loans. The insolvency administrator can contest repayments on shareholder loans which took place during the year preceding the insolvency application without any other criteria having to be met.

The loan repayments received must be repaid to the insolvency administrator. In addition, outstanding claims of the cash pool leader against the subsidiary for loan repayment are subordinated to the other claims of the insolvency creditors in the event of insolvency of the subsidiary.

d) Liquidity protection

The directors of each cash pool participant are required to observe the liquidity protection regulations (§ 15b sec. 1, 4 and 5 German Insolvency Code (“InsO”)). Directors may not make payments to third parties (e.g. the ordinary account) if the payments result in the illiquidity of the company or are made while the company is illiquid or over-indebted.

e) Capital maintenance

A cash pooling arrangement must comply with the principle of capital maintenance and the resulting legal requirements. This principle forbids the distribution of assets which are necessary to preserve the company's share capital. This would especially include payments which would lead to an adverse balance (Unterbilanz) or which would aggravate an existing adverse balance or over-indebtedness (Überschuldung). An adverse balance is deemed to exist when the company’s assets have fallen to a level below the registered amount of share capital (in the case of a GmbH, the registered share capital must not be below EUR 25,000. In the case of an AG the capital maintenance is even stricter: the registered share capital is at least EUR 50,000 and § 57 AktG does not allow any payments to be made to shareholders in general, not only if they would lead to an adverse balance.

f) Hidden distribution of profits

In principle, profits may only be distributed to shareholders subject to a formal shareholders' resolution and compliance with statutory provisions (in particular, evidence of freely distributable reserves in the gross amount (i.e. including withholding tax, if any) of at least the distribution stated in the most recent audited financial statements). Hidden distributions of profits are not allowed. As a hidden distribution of profit is deemed to exist if the company makes payments to shareholders without appropriate consideration, interest must be payable on such loans at arm's length conditions.

g) Raising capital

The regulations on raising capital also need to be taken into account. The initial capital must be paid in in such a way that it is freely and finally at the disposal of the company (“real capital raising”).

This is questionable in cases where a new entity is incorporated or where the capital of a subsidiary is increased by the parent/treasury company if the initial contribution is paid into a bank account which takes part in a cash-pooling system. Depending on the type of account balance these cases are treated as follows:

1. Hidden contribution-in-kind
   If there is a credit balance in favour of the pool leader at the time of the capital increase and the contribution is immediately moved back to the master account, this constitutes a "hidden contribution-in-kind" (verdeckte Sacheinlage). From an economic point of view, the cash pool leader merely contributes the existing loan claim to the company. This procedure is, in principle, permitted. However, the pool leader is required to make a subsequent payment if the loan claim that was deposited was no longer fully recoverable at the time of the capital increase. This is the case if the pool participant was already no longer able to meet all its liabilities at that time, the result being that the claim could not be fully recovered.
2. Repayment
   If the pool participant has a credit balance on its pool account at the time of the capital increase, the shareholders (in this case the cash pool leader) must ensure that the contributions are made in such a way that the company can dispose of them freely and finally. It would be inconsistent with the principle of "real capital raising" if the cash pool leader were to make its contribution to the account of its subsidiary and the contribution were then to immediately be moved to the master account of the cash pool leader in the cash sweep. This would constitute what are referred to as "back and forth payments" (Hin- und Herzahlen). In such cases the contribution is only deemed to have been made validly if the repayment claim against the master account is valid and enforceable and can be asserted at any time by terminating the participation in the cash pool without notice.

a) Intro

Cash pooling entails a range of liability risks both for the management and the shareholders of the participating entities as well as for the management and the shareholders of the cash pool leader.

A breach of the capital maintenance or liquidity protection requirements results in personal liability of the directors, and possibly also the direct, indirect and ultimate shareholders of the companies involved. In contrast to liability for other failures to act in the interests of the company, it is not possible for shareholders to vitiate this liability through a shareholder resolution.

The risk of liability becomes particularly significant if one of the participating companies becomes insolvent, or is sold, since it is at this point that an insolvency administrator or the incoming directors of the sold company may pursue such claims.

b) Liability of directors of subsidiaries

The directors of a company are liable for any loss or damage to the company which occurs as a result of their failure to manage the affairs of the company with the care and diligence of a prudent businessman. This requires adequate steps to ensure the repayment of the funds the company has contributed to the cash pool. If there is a risk of insolvency of the parent company or the group as a whole, the company’s participation in the cash pooling arrangement must be terminated. Even a profit and loss transfer agreement which leads to relaxation of restrictions becomes worthless and cannot avert the director’s liability in such a case of insolvency.

The directors of each pool participant are also required to observe the liquidity protection regulations. Directors are personally liable for payments to third parties (e.g. the master account) if these payments caused the company to become illiquid or were made while the company was illiquid or overindebted.

Furthermore, the directors are personally liable if, in contravention of the capital maintenance provisions, payments are made out of company assets in favour of a shareholder without the company receiving equivalent remuneration. The directors who authorised the payment which leads to an adverse balance (Unterbilanz) or which would aggravate an existing adverse balance or over-indebtedness are liable jointly and severally for any resulting losses. This also applies if a profit and loss transfer agreement exists. It is not possible for the shareholders to vitiate this liability in the name of the company, neither through a shareholder resolution nor otherwise. However, shareholders could grant the directors discharge. Discharging the director under certain premises means that the company loses or forfeits its claims against the director under GmbH law. This cannot be achieved under the law governing AGs.

c) Liability of shareholders

The cash pool leader must continuously monitor whether the loan claims of its subsidiaries arising in connection with the cash pool can be repaid. In the event of a breach of the capital maintenance rules, the cash pool leader must repay all the payments made by the subsidiary to the master account. The only exception to the repayment obligation is if the payment was offset at the time by a valid and enforceable claim for restitution. The repayment claim amounts to the total payments, irrespective of the amount of the repayments received by the lender. This also applies if the agreements have been terminated in the meantime.

The cash pool leader may not withdraw any assets from the participating subsidiary without sufficient compensation. If the subsidiary participating in the cash pool is deprived of so much liquidity that it can no longer settle its own liabilities when they fall due and thus becomes insolvent, this constitutes an action threatening the corporate existence of the company, based on the case law of the German courts. If the cash pool leader commits such an act, it is liable to pay compensation. Such liability is conceivable, for example, if, as a result of the cash pooling arrangement, the company no longer has sufficient liquidity to satisfy its obligations to its creditors, for example because the pool leader is also illiquid or just does not allow more drawdowns from the cash pool. The management of the cash pool leader and the participating subsidiary can also be held liable under civil law and criminal law for having assisted with an action threatening the corporate existence of the company.

a) Articles of association

In general, the decision to participate in the cash pool falls to the management of the cash pool leader or the cash pool participant. Under German law, a company can generally take part in a cash pooling system as long as the articles of association do not prohibit participation in a cash pool. However, it is unclear whether a cash pooling arrangement is considered an exceptional measure and therefore requires a consenting shareholders' resolution. A shareholders' resolution is recommended in any event.

b) Internal cash pooling agreement

To minimise these risks, cash pooling requires a thorough contractual basis. Careful consideration must be given to the rights of the participating companies as regards provision of information and termination (see below).

1. Right to information
   Monitoring the economic situation of the other companies involved in the cash pool is essential so that the management of both the cash pool leader and the participating subsidiary can react flexibly to an economic crisis being faced by their contractual partners.
   We recommend frequently exchanging at least financial statements, interim statements, quarterly reports, budget calculations and plan calculations (including ongoing liquidity planning). Furthermore, it makes sense for the cash pool leader to frequently provide information about the liquid funds available on the master accounts and a liquidity plan for the cash pool leader, taking account of the liquidity requirements of all subsidiaries in the cash pool for the following 24 months.
   The agreement should include the obligation to immediately notify ("ad hoc") the relevant circumstances or events that imply a deterioration in the financial situation or even indicate such a deterioration.
2. Right to terminate and to be repaid
   Each participant must be able to react flexibly to an economic change in the contracting partner by being able to terminate the contract at any time with immediate effect and without having to prove a valid reason for the termination. Therefore, the right of a company to terminate the cash pooling arrangement at any time in respect of itself and to be repaid any funds it has provided to the cash pool within 24 hours is of vital importance.
   Option to set off payments against reimbursement claims owing to a violation of applicable national capital maintenance provisions
   In order to minimise the liability of the cash pool leader and its governing bodies for prohibited disbursements, the cash pooling agreement should contain a repayment provision. This sets out that the respective next payments of the cash pool leader to the pool participant constitute satisfaction of the respective reimbursement claim resulting from the breach of the capital maintenance rules.
3. Target balancing
   To avoid risks of liability, companies should consider conditional or target-balancing instead of zero-balancing cash pooling. In this respect, a basic amount, in the amount of the share capital, should be kept on a separate account. However, the economic advantages of the cash pooling system are weakened in this type of cash pooling.
4. Credit limits
   In the context of contestation risks, it is advisable to agree on specific credit limits. Courts of the highest instance have not established the extent of the right of contestation with respect to cash pooling. Agreeing on credit limits increases the likelihood that the principles developed by the German Federal Court of Justice on current accounts will be applied and that liability will be limited to the credit limit. Accordingly, if the credit line was not exhausted, the cash pool leader would only be liable for the highest balance during the contestation period.
5. Participating subsidiaries' claims with respect to raising capital and loss compensation
   It should be ensured that the principle of "real" capital raising is not violated. The principle of "real" capital raising means that the assets must actually accrue to the company and be at its free disposal. Payments made by the cash pool leader to subsidiaries to satisfy claims based on a capital increase or loss compensation claims should not be paid into the account related to the cash pool of the participating company.

c) Bank agreement

1. Termination rights of individual participating companies
   External cash pooling agreements with banks will often envisage that only the parent company may submit valid legal notices to the bank in respect of the cash pooling arrangement. It is important that this general rule does not prevent an individual participating company from terminating the individual cash pooling agreement to which it is party. Moreover, it is important that this termination right is synchronised with a corresponding right of the individual company in the internal agreement to terminate the internal agreement in relation to itself.
2. Joint and several liability and security
   External cash pooling agreements frequently provide that the participating group companies are jointly and severally liable for any negative balance on the master account and require them to provide security. In addition, the standard terms and conditions used by banks in Germany sometimes contain provisions creating liens on all accounts of each of the group’s companies with the bank. If possible, the participating companies should avoid such joint and several liability and security and should seek an exception from the lien-creating provisions of the standard terms and conditions. If this is not possible, the company’s liability should be restricted at the very least to the lesser of (i) the actual amount of funds drawn from the cash pool by the company at any one time and (ii) the amount by which its net assets exceed its minimum required level of share capital as prescribed by law at any one time. The liability of a company should also be fully excluded to the extent that a claim jeopardises the existence of such company.

d) Liability on a sale of a group company

If a company which has participated in a cash pooling arrangement is sold, the seller will usually ask for an indemnity regarding potential liabilities arising from the cash pooling arrangement which the seller and the remaining members of the group may have in respect of the target company.

The buyer will usually request an indemnity in relation to capital maintenance matters since it will be liable as an incoming shareholder for any payments previously made in contravention of capital maintenance provisions. A seller will usually try to resist such indemnity.

In the case of physical cash pooling, interest may be payable on sums lent and borrowed by the participating companies. Such interest payments will be subject to the usual tax rules regarding interest – in particular, taxation of interest earned on sums lent, deductibility of interest incurred on sums borrowed and thin capitalisation issues. Under German law neither the pool leader nor the pool participant require the approval of the banking supervisory authority or an operating licence for a cash pool as long as only affiliates participate in the cash pool.