January 20, 2010
As the German economy continues to suffer heavily from the consequences of the global financial crisis, 2009 saw the introduction of many changes in the fields of corporate, securities and banking law. To prevent similar turmoil in the future, the legislature responded by tightening the German corporate governance and compliance rules and this trend is continuing.
Furthermore, to stimulate businesses facing the economic crisis, certain tax benefits, additional state grants for short-term work and a temporary relief from the insolvency test were introduced. A total overhaul of the German Bond Act, which had remained unchanged for a stunning 110 years, was enacted to deal with the wave of restructurings expected to continue as bond financings mature in the coming years.
Compared with the massive wave of legislation triggered by the financial crisis, other changes in German law may have been less prominent, but they are equally important for investors: The increased sensitivity for data protection led to a tightening of the respective law, the German merger control law was further streamlined, and German GAAP was significantly changed to become more aligned with international accounting standards.
The following update summarizes some of the most noteworthy legal developments that occurred in Germany in 2009.
Tax Law – Significant Benefits Introduced through the Growth Acceleration Act
On December 18, 2009, the German Parliament passed the Growth Acceleration Act (Wachstumsbeschleunigungsgesetz). Most of its provisions took effect on January 1, 2010. The Growth Acceleration Act provides, in particular, for an amendment to the change-of-control clause and the interest barrier rules as well as an implementation of an intra-group restructuring clause for real estate transfer tax purposes.
1. Amendment to Change-Of-Control Clause
Under the so-called change-of-control clause, a transfer of more than 25%, but less than 50% of the shares in a loss-making corporation to new shareholders within a period of five years, starting with the first transfer to that shareholder, results in a forfeiture of current losses and loss carry-forwards on a pro rata basis of the shares transferred. If more than 50% of the shares in the loss-making corporation are transferred, all current losses and loss carry-forwards are forfeited. The Growth Acceleration Act provides for three significant events upon occurrence of which a loss utilization is permissible even in the event of a change-of-control:
First, share transfers related to a qualifying financial restructuring of distressed companies are exempted from the change-of-control clause. This exemption, originally set to expire by the end of 2009, has now been extended for an indefinite period of time.
Second, current losses and loss carry-forwards can now be preserved if 100% of the shares in the transferee and the transferor are held directly or indirectly by the same person. This intra-group restructuring exemption does not apply if, in the course of the restructuring, new shareholders join or acquire shares in the loss-making corporation.
Third, current losses and loss carry-forwards shall not be forfeited upon a share transfer up to the amount of hidden reserves of the loss-making corporation. Hidden reserves that are not subject to German taxation (in particular shares in corporations for which a capital gain exemption applies) will not be counted.
2. Amendment to Interest Barrier Rules
Generally, according to the interest barrier rules, net interest expenses are deductible for tax purposes in an amount equal to 30% of the taxable EBITDA of the relevant German business. Above that amount, interest expenses are not deductible for tax purposes. The Growth Acceleration Act mitigates the negative effects of the interest barrier rules through the following modifications:
Up to EUR 3m net interest expenses will remain fully deductible beyond 2009 for an indefinite period of time. This unlimited extension of the originally only temporary relief has the most practical relevance, especially for medium-sized companies and real estate holding SPVs: All net interest expenses up to EUR 3m are deductible regardless of the amount of taxable EBITDA. Given an interest rate of 5%, the threshold of EUR 3m allows a debt-financing of approximately EUR 60m.
Furthermore, retroactively for 2007, unused taxable EBITDA can be carried forward over a period of five years. Unused EBITDA constitutes any excess EBITDA, which has not been used for the 30% net interest deduction rule (because actual net interest expenses were lower than 30% of taxable EBITDA). Unused EBITDA in years for which the EUR 3m threshold or an escape clause applies would not be available for the EBITDA carry-forward.
Finally, the equity ratio comparison test – a complicated escape clause from the interest barrier rules for a German business that is part of a worldwide group – is slightly revised by changing the annual volatility margin for the equity comparison from 1% to 2%. All net interest expenses are deductible (subject to harmful shareholder financing) if the equity ratio of the German group is not lower than 2% of the equity ratio for the worldwide group.
3. Intra-group Restructuring Exemption for Real Estate Transfer Tax Purposes
According to the German Real Estate Transfer Tax Act, each direct or indirect transfer or consolidation of 95% or more of the shares in a German real estate holding company triggers German real estate transfer tax ("RETT"), even if the change of ownership occurs within a group.
The Growth Acceleration Act provides for a limited group restructuring exemption for RETT purposes. Under the new rules, any taxable event triggered by a transfer of shares in a German real estate holding company is exempted if the transfer occurs in the course of a merger, spin-off or asset transfer within the meaning of the German Reorganization Act (Umwandlungsgesetz). The tax exemption only applies if the transaction occurs between a controlling entity and one or more controlled entities. An entity qualifies as controlled if the controlling entity directly or indirectly has held at least 95% in the company for five years prior to and after the restructuring. In order to enable the German tax authorities to monitor compliance with the five year holding period, changes in ownership must be notified to the tax authorities.
Stock Corporation Law – Shareholder Meetings Brought into the Internet Age
On September 1, 2009, significant amendments to the German Stock Corporation Act (Aktiengesetz) took effect. The amendments, which also implement the European Directive on Shareholders’ Rights, are expected to enhance the use of modern media in German stock corporations when preparing and holding general meetings and give foreign shareholders easier access to shareholder meetings of a German stock corporation.
The articles of association of a German stock corporation may now allow (or authorize the management board to allow) shareholders to participate in the general meeting via TV, internet or telephone conference. A prior change of the articles of association is required to benefit from these amendments.
Furthermore, the articles of association may now also afford (or authorize the management board to do so) the shareholders the right to cast their votes in absentia by letter, fax or email. This new procedure, however, may lead to certain restrictions of the shareholder’s right to challenge certain resolutions later in court, either as a result of interruptions of the online connection, or as a result of the shareholder voting in absentia being not considered "present" at the shareholders meeting. Therefore, a careful analysis is required in order to avoid a loss of otherwise available rights.
The changes also require listed companies to publish any documents relevant for the general meetings on their website shortly after the meeting is called and to provide electronic access to items added to the agenda upon the shareholders’ request as well as to shareholders’ counterproposals to the management board’s or the supervisory board’s voting proposals. This allows institutional investors to more effectively communicate any dissenting positions and will likely increase the pressure on the management to justify its position.
The recent law changes also aim to improve attendance at the general meetings by further encouraging the shareholders to use banks as proxies. In the past, shareholdings of only 15% to 30% were often sufficient for securing the majority of the votes due to low attendance at general meetings. The legislature aims at improving attendance by no longer requiring banks who act as proxies to prepare their own proposals.
Finally, the law introduces a number of significant changes to mitigate potential abuses of shareholder claims to block corporate reorganizations or public-to-private transactions.
Management Compensation, Liability and Corporate Governance – Stricter Rules and an Emphasis on Diversity
On August 5, 2009, the German Act on the Appropriateness of Management Board Compensation (VorstAG) came into force. The VorstAG introduces changes to the compensation structure for management board members of German stock corporations and aims at having management focus on sustainable long-term development of the company.
The VorstAG introduces clarifications to the criteria that are relevant for determining the appropriateness of board compensation, in particular:
(i) The compensation must not only be appropriate in view of the respective board member’s tasks (as was required before the changes), but also with respect to the individual board member’s performance;
(ii) The compensation shall not exceed "customary" (übliche) levels, unless there is a good reason;
(iii) Variable components need to be assessed on the basis of performance over a period of several years and shall include provisions to limit such variable components in the event of extraordinary developments in the business of the company. For listed stock corporations, the compensation structure shall be based on sustainable development of the company.
Additionally, the VorstAG extends the waiting period for exercising stock options under new stock option plans: New stock option plans launched by a German stock corporation based on a contingent capital increase passed by the general shareholders’ assembly convened after August 5, 2009 must provide for a non-execution period of at least four years (formerly two years).
Please see our special client alert that has been circulated in this respect.
Also on August 5, 2009, the revised wording of the German Corporate Governance Codex (Deutscher Corporate Governance Kodex, DCGK) was published, which already incorporates – inter alia – the changes that are required under the VorstAG (see above).
The DCGK recommendations are not mandatory, but often (largely) followed by listed corporations as they must disclose and explain any deviations from the DCGK recommendations. While incorporating the changes introduced by the VorstAG, the amended DCGK further emphasizes that "diversity" shall also be considered in composing both the managing board and the supervisory board.
Additionally, the changes to the DCGK further clarify amendments introduced by the Act to Modernize Accounting, Reporting and Auditing (BilMoG) for the establishment of an audit committee, namely requiring that the chairman of the audit committee have considerable knowledge and experience in the application of accounting practices and internal control processes and that the audit committee, in addition to its statutory minimum competencies, also engage in the company’s compliance efforts, etc.
Securities Law – New Disclosure Duties Relating to Significant Shareholdings
On May 31, 2009, the new Sec. 27a Securities Trading Act (Wertpapierhandelsgesetz – WpHG) came into force. Sec. 27a WpHG requires investors holding at least 10% of the voting rights in a German listed company (directly or by way of attribution) to disclose to the company their intentions, and any changes thereto, with respect to their shareholding as well as the origin of the funds used to purchase them, unless the articles of association of the company waive such duty. These new disclosure duties also apply to investors who already hold 10% or more of the voting rights in a German listed company once they reach or exceed another threshold.
With regard to its intentions, each investor will be required to disclose to the issuer, within 20 trading days after passing a relevant threshold, (i) whether the investment aims to attain strategic goals or to achieve trading profits, (ii) whether it plans to obtain further voting rights within the next 12 months by way of purchase or otherwise, (iii) whether it strives for representation in corporate bodies of the company, and (iv) whether it strives for substantial changes of the capital structure of the company, in particular with regard to the ratio of equity financing and debt financing as well as to the dividend policy. When disclosing the origin of the funds, the investor will also be obliged to indicate whether and to what extent it has used equity or debt.
The company will be required to publish the information received from the investor and, if applicable, non-compliance of the investor with the disclosure duties. The amendment does not (yet) provide for any specific sanctions in case of non-compliance. Please note, however, that non-compliance with these duties may, under certain circumstances, violate the prohibitions on market manipulation and insider trading.
Securities Regulator BaFin Revised Issuer Guidelines
On May 20, 2009, the German Federal Financial Supervisory Authority (BaFin) published its revised Issuer Guidelines ("Issuer Guidelines", Emittentenleitfaden) containing – among many other more detailed points – guidance on notification obligations for persons holding derivatives providing for cash settlements such as total return equity swaps or cash-settled call options. The Issuer Guidelines do not have the force of law but they are a very important guideline for securities law practitioners as they reflect the practice of the BaFin.
There are detailed disclosure obligations that apply to shareholdings in listed corporations which are particularly relevant in public company acquisitions. In addition, pursuant to Sec. 25 WpHG, holders of financial instruments conferring the right to acquire voting shares (e.g. call options) have notification duties if their financial instruments refer to a shareholding which reaches, exceeds or falls short of the thresholds of 5%, 10%, 15%, 20%, 25%, 30%, 50% or 75%.
Following the highly publicized hostile situations in Schaeffler/Continental and Porsche/VW in late 2008, the revised Issuer Guidelines confirm the prevalent view that the holding of derivatives that provide for a cash settlement does not lead to notification duties under Sec. 25 WpHG. Moreover, the BaFin confirmed its current practice that return or delivery claims under repurchase agreements (i.e., agreements for the sale of a security with a simultaneously agreed upon re-purchase date) or securities loans also do not lead to notification duties.
Insolvency Law – Temporary Relief Extended
On September 30, 2009, the German legislature extended the expiry date for temporary changes to the German Insolvency Statute (Insolvenzordnung) from December 31, 2010, to December 31, 2013, in order to give companies more time to overcome the balance sheet effects stemming from the economic and financial crisis.
If a German legal entity is either unable to pay its obligations when due, or if its liabilities exceed its assets ("overindebtedness"), then the management must promptly file for insolvency, at least within the maximum time frame of 3 weeks.
The term "overindebtedness", as used in the German Insolvency Statute, has been subject to change in the aftermath of the financial crisis. Since the fall of 2008, the test of "overindebtedness" was relaxed by adding an exception in the case of an overall positive prognosis for business continuation. Under the revised overindebtedness-test, a company is only considered overindebted when "the assets owned by the company no longer cover its existing obligations to pay, unless a continuation of the business under the prevailing circumstances is deemed to be more likely than not". Investors should be aware of the change when evaluating distressed businesses in Germany.
If no further extensions occur, the old law will once again apply starting on January 1, 2014, which will remove the positive outlook exception from the overindebtedness test and again narrow the test to simple balance sheet ratios with no further prognosis allowed to establish overindebtedness.
Employment – Duration of Short-Term Work Adjusted Downwards to 18 Months
On December 12, 2009, adjustments to the term during which certain payments (Kurzarbeitergeld) are granted by the German Labor Agency (Bundesagentur für Arbeit) were announced. Payments for short-term work are made by the German Labor Agency in order to temporarily compensate for certain decreases in net salaries incurred by employees who are subject to a reduction of working hours due to economic reasons.
In order to avoid dismissals in the economic downturn, the German government introduced so called "short-term work" (Kurzarbeit). The introduction of short-term work allows companies to temporarily and considerably reduce the working hours and salaries of their employees in order to manage decreasing demand for their products and services. During this period, employees under certain conditions are eligible for additional state grants to cover the decreases in their net salaries for the duration of the short-term work.
While the maximum period for such grants was prolonged from six to 24 months in 2009, this period has now been adjusted downwards to a maximum of 18 months starting in 2010.
Employee Data Protection – German Federal Data Protection Act Amended
On September 1, 2009, the German Federal Data Protection Act (Bundesdatenschutzgesetz – FDPA) was amended. The amendments cover a range of data protection-related issues, including restrictions on the use of customer data for marketing purposes, the introduction of a security breach notification obligation, the introduction of additional mandatory safeguards in service provider contracts, as well as the increase of fines for violations of data protection law provisions. Two amendments are particularly noteworthy:
1. Protection of Employee Data
For the first time, German data protection law introduces specific regulations for the protection of employee data, including data of potential employees ("Employee"). Under the revised FDPA, it is possible to collect, process and use Employee data for decisions regarding the establishment, implementation and termination of an employment relationship. For any other purposes, the Employee’s consent is required. For purposes of crime prevention and detection of criminal offences, Employee data may only be collected, processed and used if (i) a concrete (documented) and founded suspicion exists that the Employee has committed a crime during employment; (ii) the collection, processing and use of the data is necessary for the criminal investigation; (iii) the employee’s legitimate interests do not take precedence; and (iv) the measures taken are not out of proportion with respect to the issue in question.
2. Introduction of Security Breach Notification Obligation
The revised FDPA establishes the first statutory data security breach notice requirement in Europe. Under the new law, notification to the supervisory authority is required in the event of an unlawful data transfer or unauthorized access by third parties if the data loss/abuse is likely to have a serious impact on the rights or protected interests of the customers concerned. This notification duty applies to (i) bank and credit card data, (ii) telecommunications data and data collected online, (iii) data related to criminal offences, and (iv) other particularly sensitive data (e.g. health, political opinion, etc.). The security breach notification duty also applies where a security breach occurs outside of Germany if the breached data were collected in Germany by the data controller, regardless of whether the data controller is located inside or outside of Germany.
Merger Control Streamlined – Second Filing Threshold Introduced
On March 25, 2009, an important amendment to the German merger control regime has taken effect. Under the revised merger control regime, two categories of transactions will no longer require a merger filing: (i) large international mergers where one of the parties does not have a strong market position in Germany (i.e., German turnover of less than EUR 5 million) and (ii) mergers with or between small and medium-size enterprises in Germany. Under both scenarios, the economic effects on competition in Germany are deemed to be insignificant.
This amendment is designed to significantly decrease the number of de minimis and extra-territorial mergers that are expected to be notified to the German Federal Cartel Office ("FCO", Bundeskartellamt). Previously, an obligation to notify mergers to the FCO was triggered if the combined worldwide turnover of the parties to the transaction exceeded an amount of EUR 500 million and at least one of the parties achieved a domestic turnover in Germany exceeding EUR 25 million (only very limited de minimis exceptions existed to this rule). Under the previous regime, mergers where only one party met the notification thresholds were reportable, regardless of the domestic turnover generated by the other party in Germany and whether the transaction had any material impact on competition in the relevant German market. The amendment to Sec. 35 (1) no. 2 of the German Act on Restraints of Competition (Gesetz gegen Wettbewerbsbeschränkungen, GWB) now requires that, in addition to the domestic turnover of at least EUR 25 million generated by one party, another party to the transaction will need to have revenues in Germany in excess of EUR 5 million.
The amendment has been discussed for some time and has been long overdue in its enactment. It corresponds with the international "recommended practices" of the International Competition Network (ICN) for merger control and also with the recommendations of the OECD. It is therefore highly welcome insofar as it reduces the comparatively high number of merger filings that were previously reportable in Germany.
Foreign Investment – Germany Established National Security Review
On April 24, 2009, an amendment to the German Foreign Trade and Payments Act (Außenwirtschaftsgesetz, AWG) entered into force, materially impacting a significant number of transactions involving German companies or enterprises. The new legislation allows the German Federal Ministry of Economics and Technology (Bundesministerium für Wirtschaft und Technologie, BMWi) to prohibit non-European investors and non-EFTA investors from buying German enterprises or voting shares of 25% or more in German companies if such acquisitions constitute a danger to the national security or public policy of the Federal Republic of Germany.
The scope of the new review is broad; it also includes asset deals and even situations where a foreign investor buys a foreign company that owns a business or company in Germany. A foreign investment will rarely represent a "danger to national security or public policy" because the term is to be interpreted narrowly and does not allow for a restriction of an acquisition due to considerations of industrial policy. However, it may not be ruled out that certain investments in the field of sensitive infrastructure or security-related industries will require a filing to obtain clearance up-front. Usually, the fastest way to obtain certainty is to file for a certificate of non-objection which must be granted within a month of filing all necessary information.
Consent prior to any transaction is not required. However, if no certificate of non-objection has been acquired, the BMWi is entitled to instigate a review of the acquisition within three months after the acquisition agreement takes effect. In this case the acquirer is obliged to submit the relevant documentation, upon which the BMWi may restrict or prohibit the transaction within an additional time frame of two months.
Our recent experience shows that the case team at BMWi is proactive, but they have limited resources which may have an impact on timing. Please see also our Client Alert for more information.
Private Company Law – End of Swiss Notarizations in Sight
The transfer or pledge of shares in German limited liability companies requires notarization in order to be valid. In the past, it was recognized practice to notarize such agreements before the cheaper Swiss notaries in Basel, Switzerland in cases where the non-negotiable German notarial fees were considered to be excessive.
Following the reforms of both the German law on limited liability companies (MoMiG) and Swiss law, the continued legality of notarization in Switzerland has become subject to controversy. While the legal arguments for such a "re-nationalization" of notarization are far from conclusive, the District Court of Frankfurt (LG Frankfurt) stated in an obiter dictum on October 7, 2009, that it is leaning towards rejecting the validity of post-reform Swiss notarizations.
The judgment highlights that Swiss notarizations of German limited liability share transfers or pledges will henceforth be subject to the risk of illegality. In particular, financing banks will no longer accept them as a feasible alternative despite sizeable cost advantages. Going forward, it will be the most prudent approach to only notarize share transfers or pledges in Germany until there is further guidance on the direction the case law is taking. Please see also our Client Alert for more information.
Debt Restructuring – New German Bond Act Replaces Bond Act of 1899
On August 5, 2009, the new German Bond Act came into force (the "New Bond Act", Schuldverschreibungsgesetz)). The New Bond Act replaces the Bond Act of 1899 (the "Pre Reform Act") which had been in force for more than a century. The Pre Reform Act has long been considered outdated and an obstacle to the restructuring of German law bonds outside formal insolvency proceedings. The New Bond Act seeks to bring German law in line with international market practice and to make German law more attractive for bond issues. Key provisions of the New Bond Act include:
The New Bond Act applies to all bonds issued after August 5, 2009, and governed by German law irrespective of the registered seat/jurisdiction of incorporation of the issuer. The New Bond Act does not apply to covered bonds (Pfandbriefe) or bonds issued or secured by the public sector. Holders of bonds issued prior to August 5, 2009, may opt for the application of the New Bond Act by supermajority vote (i.e., 75% of votes cast).
The powers of a supermajority of bondholders to amend material terms and conditions of bonds are significantly increased. In particular, a waiver of the principal amount or interest and a debt-for-equity swap can now be agreed upon with the issuer.
The New Bond Act modernizes voting procedures by allowing the passing of resolutions without the need for the physical presence of a bondholders’ meeting. In such cases, the notice soliciting the bondholders’ vote sets out a period (of at least 72 hours) within which votes may be cast in writing (or electronically).
The New Bond Act further expands the role of the bondholder representative. The representative may already be appointed and authorized by the issuer in the bonds’ terms and conditions or later by way of bondholder resolution. The issuer or the bondholders may exclusively grant the representative certain rights to act on behalf of the bondholders vis-à-vis the issuer. If so appointed by bondholder resolution, the representative may even be vested with the right to waive payments on behalf of the bondholders.
It remains to be seen whether the New Bond Act will be accepted by the markets as an attractive alternative to other established jurisdictions and will lead to an increased activity of issuers in bonds issued under German law.
Accounting Rules – Shift Towards International Standards
On May 29, 2009, the Act to Modernize Accounting, Reporting and Auditing (Bilanzrechtsmodernisierungsgesetz, BilMoG) took effect. The BilMoG modernizes the German GAAP through adjustments of individual regulations that bring it closer to International Accounting Standards.
Among many other changes, the BilMoG eliminates the mandatory application of certain German tax accounting rules for statutory accounting purposes (umgekehrte Maßgeblichkeit). Moreover, the BilMoG now allows the recognition of certain development costs for internally generated, non-current intangible assets. Dividend distributions to owners, however, are prohibited to the extent that those development costs are recognized as an asset in the balance sheet. Accordingly, profits generated through such recognition may also not be transferred to the controlling entity under a profit and loss pooling agreement. Please note that this may require a careful review of existing profit and loss pooling agreements in order to align them with the new law. According to guidelines of the German Ministry of Finance dated January 14, 2010 the new law does not have impact on the effectiveness of existing profit and loss pooling agreements.
Also, since the introduction of BilMoG, auditors of US or other Non-EU issuers that have securities listed on an organized market in Germany may be required to register in Germany. There is a temporary exception under pertinent EU rules for auditors from certain jurisdictions, but it requires a successful short form filing.
Gibson Dunn & Crutcher’s lawyers are available to assist in addressing any questions you may have regarding the issues discussed in this article. The Munich office of Gibson Dunn & Crutcher brings together lawyers with extensive knowledge of corporate, tax, labor, real estate, antitrust and intellectual property law. The group is comprised of seasoned lawyers with a breadth of experience who have assisted clients in various industries and in jurisdictions around the world. The group’s lawyers work closely with the firm’s practice groups in other jurisdictions to provide cutting-edge legal advice and guidance in the most complex transactions and questions law. For further information, please contact the Gibson Dunn lawyer with whom you work or any of the following members of the Munich office:
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