Shareholder dispute in the German limited liability company (GmbH) – what do I need to know?

The shareholders of a German limited liability company (GmbH) hold their shares in the company and have control over the central decisions of the company. It is their innovative and economic ideas that shape the company’s business activities in the long term. In a sense, they form the heart of the company. The effects can be even more devastating if disputes arise among the shareholders.

What does the shareholder dispute mean for the GmbH and its shareholders?

The purpose of the limited liability company is already to facilitate the competitive entry of a small group of business owners with a common idea. This is reflected in the combination of limited liability of the company on the one hand and control of the company’s management by the shareholders as its owners on the other hand. While the second aspect in particular represents a significant advantage over other legal forms in the initial stages of the company, because a common vision is euphorically pursued, numerous problems can arise from this over time. In the end, crises, changes in the business world or even a personal change of individual shareholders can lead to disputes developing in the original group of businesspersons with a common plan, so that people are no longer pulling in the same direction.

The subject of such disputes will often be central basic elements of the company. Inparticular, the composition of the management board or the decision-making process within the shareholders‘ meeting on asset investments, profit distributions, or similar issues should be considered. As a result, shareholder disputes quickly affect the entire company and, depending on their duration and intensity, can have serious economic and reputational effects.

For this reason, there is a great need to prevent such disputes or – where this is not possible – to settle them as soon as possible. In order to achieve these aims, competent advice from specialists experienced in the field of corporate law is required.

Cost savings by settling disputes before a court of arbitration?

If a shareholder dispute arises, there is a great interest in settling it as fast and cost-effectively as possible. Here, dispute resolution before an arbitration court has a central role to play. Because the arbitration proceedings are not open to the public and the arbitrators regularly reach their decisions quickly, arbitration can be an attractive way of settling the shareholder dispute quickly. However, arbitration proceedings first require an effective arbitration clause between the parties to the dispute in the articles of association. This must (1.) be formally concluded in accordance with Sections 1029 et seq. German Code of Civil Procedure (ZPO) and (2.) be sufficiently specific with regard to the assignment to an out-of-court legal process, (3.) have an arbitral dispute as its subject matter and (4.) still exist validly at the time of the dispute.

The arbitration proceedings begin with an application by the plaintiff and essentially correspond in their further course to those of state court proceedings. At the end there is an arbitral award, the effect of which corresponds to the operative part of a final court judgment.Arbitration can also be an effective tool at an early stage of the dispute to prevent it from getting out of hand.

Under certain circumstances, however, even a discussion with an experienced mediator can uncover and eliminate misunderstandings without the need for proceedings before a court of arbitration or an ordinary court.

Dispute over the dismissal and termination of a GmbH Managing Director?

The Management of the GmbH is responsible for the economic success of the company and is thus of decisive importance for the direction in which the operational business of the company develops and thus inevitably often the subject of disputes among the shareholders. The dismissal of a GmbH Managing Director with the appointment of a new candidate who is more in line with the shareholder’s own objectives enables shareholders to expand their influence within the company or to consolidate it for the future.

In principle, the dismissal of an external Managing Director ispossible without further ado by means of a shareholders‘ resolution with a simple majority of votes in accordance with Section 38 (2) Sentence 1 of the German Limited Liability Companies Act (GmbHG) („appointment relationship„) – i.e. without any special legal grounds. However, this is not the case if the articles of association contain a clause to the contrary. This is conceivable, for example, to the effect that a dismissal can only take place if there is an objective or important reason.

In this context, it should be noted that the employment relationship is an independent legal relationship separate from the fiscal unity of the Managing Director. Accordingly, the employment contract continues to exist even after the dismissal of the GmbH Managing Director. An independent effective termination of the employment contract is required. This must be in writing and generally requires a separate resolution by the shareholders‘ meeting. In addition, the relevant special features of the service/employment contract must be observed – such as the two-week period for extraordinary termination in accordance with Section 626 (2) of the German Civil Code (BGB).

However, good cause for dismissal is always required if the articles of association provide for the position of Managing Director as a special right of the shareholder. This constellation of Shareholder Managing Director is widespread in practice, but has various pitfalls, in particular with regard to the concept of „good cause“. In this respect, the law does not exhaustively list in Section 38 (2) Sentence 2 of the German Limited Liability Companies Act (GmbHG) in particular the gross breach of duty and the inability to manage the company properly. Good cause may also be based on a characteristic of the shareholder in persona,such as advanced age or lack of specialist knowledge, if this was untruthfully feigned when the shareholder joined the company. In most cases, however, the important reason will be rooted in the conduct of the shareholder. However, not every breach of duty is sufficient. Examples from case law include criminal acts to the detriment of the company, significant breaches of the articles of association or the withdrawal of liquid funds from the company for selfish purposes.

Possibility of exclusion of a querulous shareholder?

Due to the central importance of the shareholders in the structure of the GmbH (see above), it follows that the exclusion of a shareholder represents a profound cut in the personnel structure of the company. Consequently, a large number of legal challenges have to be mastered in the course of squeeze-out proceedings. Corresponding squeeze-out proceedings should therefore always be accompanied by expert advisors.

Confiscation and compulsory assignment as out-of-court solutions?

It is possible to exclude the shareholder concerned without a provision to this effect in the articles of association by way of an action for exclusion (see below). However, it is advisable to include such a provision in the GmbH articles of association in orderto be able to have the effect of the exclusion come into effect immediately upon adoption of the resolution by the shareholders‘ meeting and not only after the expiry of an often protracted court process by way of a judgment. A compulsory exclusion of the shareholder should be regulated with the simultaneous liquidation of his shares, because this procedure makes it possible to release the shareholder from all rights and obligations arising from his share with one resolution.

There are two conceivable ways of doing this: On the one hand, a redemption (cf. Section 34 of the German Limited Liability Companies Act (GmbHG)) is possible, with the consequence that the shares of the shareholder concerned cease to exist. In addition, there is also the possibility of a compulsory assignment under the articles of association, in the course of which the shares of the shareholder concerned are transferred to a co-shareholder, the GmbH itself („acquisition of own shares„) or a third party; the share is therefore not extinguished. In both cases, the membership of the shareholder concerned lapses with the loss of his shares.

For the GmbH, such regulations on the exclusion of shareholders offer, among other things, the advantage that they can reduce the requirements for the exclusion procedure in many respects compared to an action for exclusion in court. It should be noted, however, that a provision under which exclusion would be at the discretion of the company or an individual shareholder would be inadmissible. In this respect, therefore, at least an objective reason must always be provided for as a requirement in the GmbH agreement. In addition, some important questions must be clarified in advance with regard to the course of the proceedings and the economic consequences, so that competent legal advice is essential even when drafting the clauses in the articles of association.

However, the shareholder concerned is not defenseless in such exclusion proceedings. As a rule, they can defend themselves against the resolution within a period of one month (cf. Section 246 (1) of the German Stock Corporation Act (AktG) by analogy) by way of an action for rescission (or, if applicable, an action for annulment),for example by asserting formal errors in the adoption of the resolution or the absence of sufficient objective grounds. Thelack of an objective reason in particular is often the subject of actions for defects in resolutions to this effect.

In principle, the excluded (former) shareholder is entitled to compensation in theamount of the market value of his share. However, a lower settlement can also be provided for in the articles of association, whereby the limit of immorality (Section 138 of the German Civil Code (BGB)) prevents an excessively low sum. In practice, case law applies a strict assessment standard here, so that caution is generally advisable in the case of a lower severance payment amount. With a few exceptions (e.g. in the case of a purely non-profit GmbH), a complete exclusion ofthe severance payment is generally not permissible.

Possibility of exclusion action as judicial solution?

If the partnership agreement does not contain any provision under which the withdrawal or compulsory assignment of a shareholder’s shares is possible by resolution – even against the will of the shareholder concerned – the only remaining option is an action for exclusion. This also requires a resolution of the shareholders‘ meeting to bring an action for exclusion, which must in principle be adopted by a majority of three quarters of the votes cast. The shareholder concerned can challenge this resolution with the aforementioned actions for defects in the resolution, whereby the scope of the court’s review is limited to formal errors in the resolution.

If the aforementioned resolution was validly adopted, after the company has filed an action it will be clarified in the subsequent exclusion proceedings whether there was sufficient cause for exclusion. In principle, reference can be made here to the above remarks on good cause in the case of dismissal of a shareholder-director. However, a stricter standard must be applied because the loss of the shareholder position has more far-reaching economic consequences for the GmbH shareholder concerned than the mere loss of management.

If a judgment is finally issued in favor of the company, the exclusion effect – according to the disputed case law of the Federal Supreme Court – does not take effect vis-à-vis the shareholder concerned until payment of the settlement sum determined by the court. In the period between the judgment becoming final and the payment of the compensation, the judgment is initially intended to have the effect of establishing the justification for the exclusion and preventing the shareholder from frustrating measures taken to implement his exclusion (such as the takeover, withdrawal or assignment of his shares).

Shareholder disputes – what can be done prophylactically?

Disputes between shareholders do not always have to assume such proportions that they result in a change of management or even personnel changes in the shareholder structure. Possible points of contention can be individual management measures in the form of certain investments, decisions on the annual financial statements – especially with regard to the distribution of profits – or the exercise of certain control rights. In this respect, too, individual solutions in advance are possible, such as the implementation of an advisory board or other (special) provisions in the GmbH articles of association to counteract disputes.

In this case, it is advisable to seek legal advice as early as possible and to settle the dispute out of court if possible.

Conclusion

Disputes between shareholders can lead to complicated, time-consuming and costly legal proceedings. In particular, a carefully drafted partnership agreement can prevent troublesome disputes from the outset. However, even in the event of a dispute, there are numerous ways of settling the dispute amicably and, above all, for the benefit of the entire company. If this is not possible either, the only option is to resolve the dispute using the appropriate instruments of corporate law (action for exclusion, etc.). In this respect, legal advice should always be sought promptly in the event of shareholder disputes in the GmbH.

The author of this article will be pleased to advise you in cases of shareholder disputes!

Author: Dr. Karl Brock