2012 Year-End German Law Update

January 10, 2013

In retrospect, 2012 likely will be remembered as another year of manifold challenges in the Eurozone and of slow consolidation rather than one of fundamental reform or renaissance. However, the policy of Mr. Draghi, the chairman of the European Central Bank, appears to have stabilized the markets and the Euro since last summer, Germany’s economy is prospering and the stock markets are almost back to pre-2008 levels. Nonetheless, there are fundamental doubts that the measures taken have a lasting effect and will fundamentally reform the economies in the Eurozone. Consequently, the financial sector has not recovered yet and M&A activity is still relatively slow.

As so often is the case in economically challenging times, it has again been left to the courts to provide key guidance on some of the most pressing issues in the areas of Corporate & M&A, Real Estate, Labor and Data Protection law. The European Court of Justice has delivered two important decisions on the disclosure of sensitive inside information and the cross-border movement of companies. But the German Federal Supreme Court and other regional courts also have come up with a number of interesting and highly relevant rulings discussed herein.

The year 2012 furthermore marked the entry into force of a significant reform of the German Insolvency Code, which aims to reorganize struggling entities rather than to merely liquidate them. Additionally, 2012 also has planted the seeds for a number of other key legal reform projects that are likely to see the light of day in 2013. New laws in the areas of antitrust (pending reform of the Act against Restraints of Competition), an all-encompassing codification of investment law in Germany based on European directives, and a tightening of the legal regime for administrative sanctions and fines in the area of corporate misconduct and liability are firmly in the pipeline and well-positioned for adoption some time in 2013.

Continuing the trend over the last years, 2012 also saw a significant number of investigations as well as settlements of allegations of high-stakes corruption and other compliance violations, sometimes involving leading German blue chip companies. The numerous cases of corruption and other compliance violations that came to public attention in 2012 evidence an increasing focus on compliance as well as continued enforcement activities by German and foreign authorities.

We trust you will enjoy reading further details below and stay tuned to the recent developments in German law and case law.

Table of Contents

Corporate, M&A
Tax
Insolvency
Labor
Antitrust
Data Protection
Compliance
Real Estate

Corporate, M&A – European Court Tightens Disclosure Rules

On June 28, 2012, the European Court of Justice ("ECJ") issued an important judgment that will have a significant impact on the disclosure of non-public, price-sensitive information (so-called "inside information") by public companies listed on stock exchanges in the European Union. The decision clarifies the definition of inside information in cases where the circumstances relevant to the disclosure develop over time, potentially involving several intermediate steps.

The issue before the ECJ was whether the company in question had met its obligation to timely disclose inside information. The ECJ made two findings. First, in situations where the relevant facts (here: the departure of the CEO and his replacement by a successor) develop over time (here: over several months) the final decision in the matter may not be the only information that could trigger disclosure. Rather, intermediate steps leading to such an event may be sufficiently concrete to themselves represent inside information. Second, future circumstances also may qualify as inside information, provided that they can be reasonably expected to occur, taking into account all circumstances. If, however, a future event is not likely to occur, this cannot be outweighed by a potentially strong impact on the market price.

This decision is relevant beyond the facts of the case because price-sensitive events that develop over time frequently can occur, for example, when an important contract is negotiated or a public takeover is planned. Although the German securities regulator BaFin in the past has already required disclosure of intermediate steps, companies now will be required to monitor such processes even more carefully. As a result, issuers are expected to disclose earlier (or ensure that the legal prerequisites for delaying disclosure are all met).

The respective Gibson Dunn Client Alert is available on our website at the following URL: http://www.gibsondunn.com/publications/pages/EuropeanCourtTightensDisclosureRules.aspx.

Corporate, M&A – New Rules on Delisting

On July 11, 2012, the German Constitutional Court (Bundesverfassungsgericht — BVerfG) reset the rules for the delisting of public companies in Germany by questioning the constitutional arguments underlying the principles developed by the German Federal Supreme Court (Bundesgerichtshof — BGH) in 2002 in the Macrotron case.

In Macrotron, the Federal Supreme Court established a number of limitations for companies wishing to delist their stock in order to protect the (minority) shareholders. Among these limitations are the requirement of shareholder approval, the obligation to submit a purchase offer to the minority shareholders, and the right of such shareholders to claim a review of such compensation by the court. In 2002, the Federal Supreme Court based the establishment of such rights mainly on the argument that the delisting had an impact on the right of property in the shares, which is protected by article 14 of the German Constitution (Grundgesetz – GG).

Now the German Constitutional Court held that the listing does not enjoy the constitutional protection of a property right according to article 14 GG and thus the delisting also would not affect the right of property. However, it also found that by setting such rules, the Federal Supreme Court had not exceeded its authority in an unconstitutional manner. As a result, although the German Constitutional Court rejected the Federal Supreme Court’s main argument, the consequences of the German Constitutional Court’s ruling on future delistings currently are disputed. It remains to be seen whether the Federal Supreme Court will change the requirements for a delisting or uphold some or all of them by using another argumentation.

In the meantime, any companies considering delisting should continue to apply the Macrotron principles. For details please see the Gibson Dunn Client Alert of July 24, 2012: http://www.gibsondunn.com/publications/Pages/GermanConstitutionalCourt-RewritesDelistingRules.aspx.

Corporate, M&A – Growing Trend of Holding Managers Liable in Connection with Controversial M&A Transactions

M&A transactions always have carried liability risks for the managers who execute them. However, two current prominent examples reveal a recent trend in Germany pursuant to which civil or criminal proceedings are more readily initiated against managers in connection with controversial M&A transactions.

In July 2012, the public prosecutor’s office of Stuttgart initiated a criminal investigation against the former Prime Minister of the State of Baden-Wuerttemberg and the former German head of the mandated investment bank, among other things, into potential embezzlement and aiding and abetting of embezzlement, respectively, in connection with the acquisition of stock in the energy supplier EnBW by the State of Baden-Wuerttemberg. In December 2010, the state government under the leadership of its then Prime Minister acquired 45.01% of shares in EnBW for a purchase price of EUR 4.67 billion. In the public prosecutor’s opinion, this amount (which contained a premium of 18% over the then current stock price for ENBW shares) was too high. Furthermore, the transaction documentation was reportedly shorter than is customary for a transaction of this size and the Prime Minister executed the transaction without obtaining the approval by the state parliament. The former German head of the investment bank involved is accused, inter alia, of having conflicts of interest due to his close relationship with both the Prime Minister and senior representatives of the seller. The outcome of the proceeding is currently unclear.

2012 also witnessed the opening of the civil trial against eight former members of the management board of the Bavarian State Bank (Bayerische Landesbank – BayernLB) as well as the filing of a civil lawsuit by BayernLB against two former members of its supervisory board (Verwaltungsrat) in connection with BayernLB’s acquisition of another bank for an allegedly inflated purchase price. These civil proceedings follow criminal proceedings brought against the former CEO of BayernLB arising from the same incident. In May 2007, BayernLB, which is majority-owned by the State of Bavaria, acquired 50% plus one share in the Austrian bank Hypo Group Alpe Adria (HGAA) for a purchase price of EUR 1.625 billion. The purchase reportedly caused damages to BayernLB in excess of EUR 3.7 billion. The due diligence process allegedly lasted only a few days and had been based principally on information provided by an asset consultant, who apparently profited from the transaction. The advisory board reportedly approved the transaction by way of a circular resolution over the weekend without any further deliberation. The outcome of these proceedings is also still open. Thus, it remains to be seen if and to what extent the German courts will enhance, or at a minimum more clearly specify, the requirements of a manager’s duty of care and duty of loyalty in M&A transactions.

Corporate, M&A – Compensation for Disadvantages Already to be Determined in the Resolution of the Annual General Meeting

On June 26, 2012, the Federal Supreme Court (Bundesgerichtshof — BGH) issued an important decision in connection with an intra-group transaction of a major European bank that disposed of its Eastern European business against allegedly inadequate consideration for the disadvantage suffered by the controlled entity.

The decision will impact the requirements for the compensation of detrimental measures imposed by controlling shareholders of a German stock corporation on controlled entities.

The Federal Supreme Court ruled that if the annual general meeting of a controlled German stock corporation resolves to undertake a detrimental measure by using the majority vote of the controlling shareholder, such resolution already will have to set forth how the disadvantage resulting from the detrimental measure will be compensated. If the disadvantage is quantifiable, a compensation agreement must determine precisely the disadvantage and provide for an unconditional payment claim setting forth exactly and without limitation the corresponding advantages (type, amount and date of performance). Thus, in the future it will no longer be feasible for controlling shareholders to agree to compensation for the disadvantage caused only subject to the prerequisite that a respective claim is established by a court or otherwise. As a consequence, the management of a controlling shareholder already at the planning stage of the proposed measure will have to (i) assess whether such measure imposed is or would be detrimental and (ii) quantify such disadvantage.

If mandatory statutory or case law does not require involvement of the annual general meeting, the management boards of the companies involved must determine the specific disadvantage caused and enter into a compensation agreement neutralizing such disadvantage by the end of the fiscal year in which the detrimental measure was taken.

As a result of this decision, in the future the management board will have to plan much more carefully before voluntarily presenting a detrimental intra-group measure to the annual general meeting for its approval if not legally required to do so.

If a measure must be brought before the annual general meeting, the timing of such measure can create new challenges for the management board, in particular in cases that require a more complex analysis of the resulting disadvantages because the board now must have completed all relevant determinations by the time the annual general meeting is conducted.

Corporate, M&A – Early Reappointment of Members of the Management Board

Section 84 (1) of the German Stock Corporation Act (Aktiengesetz — AktG) provides that the members of the management board of a German stock corporation are appointed by the supervisory board for a maximum five-year term. Although the term can be renewed or extended, such renewal is permissible no earlier than one year before the member’s current term ends.

In its decision of July 17, 2012, the Federal Supreme Court (Bundesgerichtshof — BGH) ruled that the supervisory board may reappoint members of the management board even if it had — with the consent of the relevant member of the management board and in the same supervisory board meeting in which the reappointment was resolved — only just revoked the previous five-year appointment two years into the original five year term. Although the measures taken complied with the letter of the law, the Federal Supreme Court effectively developed a course of action to enable earlier reappointments.

Prior to the ruling, the question of a consensual termination of the office of a member of the management board coupled with a renewed appointment for a full five-year term had been highly controversial. In particular, it had been argued that such measure qualifies as an illegal circumvention of Section 84 (1) of the AktG. In its judgment, the Federal Supreme Court now has expressly held that the absence of specific reasons for the steps taken does not, in itself, constitute a circumvention of the law. As a result, this procedure may be a viable tool for German stock corporations seeking early reappointments. However, the Federal Supreme Court clarified that this procedure still can be deemed illegal if there are indications of misuse, e.g. if the supervisory board and the members of the management board collude with malicious intent and act contrary to their fiduciary duties in order to limit the powers of a newly composed supervisory board whose election is imminent. Also, the German Corporate Governance Codex, which is applicable to listed stock corporations, presently allows this procedure only in case of extraordinary circumstances (such as the management board member’s intent to leave the corporation unless an extension is resolved). Thus, unless the Corporate Governance Codex is amended, a listed stock corporation will have to notify and explain its non-compliance with the Corporate Governance Codex in the absence of qualifying circumstances.

Corporate, M&A – New Rules on Consulting Fees of Supervisory Board Members

On July 10, 2012, the German Federal Supreme Court (Bundesgerichtshof — BGH) published an important decision on consulting agreements with members of the supervisory board, i.e. non-executive directors who are supposed to control the management. The court held that the management of a German stock corporation acts illegally if it approves and makes payments to individual members of the supervisory board before the underlying consulting agreements have been approved by the supervisory board. According to Section 114 of the German Stock Corporations Act (Aktiengesetz — AktG), any service contract between a corporation and a member of its supervisory board requires the consent of the supervisory board to avoid any hidden conflicts of interest. Prior to this decision, there had been a debate in Germany whether such consent had to be given in advance or if such a contract could also be approved after the fact.

In its decision, the Federal Supreme Court separated two aspects: The validity of the contract and the duties of the corporation’s management. For the validity of the contract, it is sufficient if the supervisory board gives its consent afterwards. However, the corporation’s management violates its duties if it pays any fees owed under a consultancy contract before the supervisory board has given its consent. The Federal Supreme Court reasoned that although an approval after the payment was made remains possible in order to save the contract, such a scenario could put undue pressure on the supervisory board to grant the consent.

In its ruling, the Federal Supreme Court did not have to decide the question whether a general consent allowing consultancy agreements combined with a post facto approval of the individual contract meets the legal requirements. As a result, the management of a stock corporation should refrain from paying any consultancy fees to members of the supervisory board before the individual consultancy contract has been approved by the supervisory board (or a committee thereof).

Corporate, M&A – High Potential Quota-Women

Boardrooms of large German corporations are still largely male dominated. Despite several initiatives for negotiated commitments (Selbstverpflichtungen) and the incorporation of female diversity into the German Corporate Governance Codex several years ago, only slow progress has been made in recent years towards a more balanced gender ratio in German management boards (Vorstand) and supervisory boards (Aufsichtsrat). In order to better leverage the resources of high-potential female candidates, 2012 saw legislative initiatives both domestically as well as at EU level.

Legislation proposed in Germany in 2012 addresses the composition of supervisory boards and shall apply to listed stock corporations and limited liability companies that are subject to employee codetermination (500 employees or more). The proposal envisages the implementation of certain minimum numbers of male and female members in relation to the aggregate number of members of the corporate body. Beginning on January 1, 2018, the quota for the underrepresented gender shall be 20%, provided that there is at least one female (or male) member in a supervisory board consisting of three to six members altogether. As of 2023, the quota shall be increased to 40% in general and to at least one female/male member in a supervisory board comprising up to four members. In all cases, exceptions apply where 90% of employees are of the same gender and for important cause, for example, in case a company has undertaken its very best efforts (erhebliche Anstrengung) but ultimately could not meet the quota.

On November 14, 2012, the EU Commission issued a draft directive on improving the gender balance among non-executive directors of companies listed on a stock exchange. The directive imposes an obligation regarding future appointments for listed companies that do not yet have a presence of the underrepresented gender of at least 40% of non-executive directors. In such cases, future appointments must be made on the basis of a comparative analysis of the candidate’s qualification by applying pre-established, neutrally formulated, and unambiguous criteria to achieve the aforementioned percentage by January 1, 2020 at the latest. Similar to the German proposal, an exception applies when members of the underrepresented gender represent less than 10% of the workforce. In case of public undertakings where the Member State exercises a controlling influence the target date is January 1, 2018.

Large parts of the German business community as well as a number of politicians oppose fixed quotas and instead argue in favor of a so called "flexi-quota," whereby companies would set their own target percentage figure that then will become binding on the company. The purpose of this proposal is to achieve a quota of 30% of women on supervisory boards by 2020.

At present, it is still unclear if and when any of the proposals will become binding law. However, as the term of service of a number of supervisory board members ends in 2013, companies that have put the quota discussion on the agenda of governance issues before any binding legal enactment is introduced will be in the lead with regard to one of the key elements of board diversity.

Corporate, M&A – Freedom of Movement across EU Borders

On July 12, 2012, the European Court of Justice ("ECJ") decided in the Vale case (Case C-378/10, VALE Építési kft) that overriding principles of European law on the freedom of movement permit companies from one Member State to convert into a company form in another Member State by way of reincorporation as a company governed by the respective laws of the receiving state and claiming to be the universal successor to the company formerly incorporated in the original state. The main caveat the ECJ made in its decision was that the desired change of company form from one entity to another must also be permitted in a comparable purely national context in the receiving state. Legally, such a cross-border conversion maintains the legal and economic substance of an entity that begins its corporate life in one jurisdiction before continuing its corporate life upon reincorporation in another jurisdiction.

In Germany, where the national law is fairly flexible in allowing the various types of German companies to convert into other German company forms, but until now did not allow for cross-border company conversions from or into foreign jurisdictions, the judgment has broadened the restructuring tools that are theoretically available. This ECJ judgment — but most certainly any subsequent transformation into predictable and reliable statutory law — may open up interesting structuring options for internationally active groups of undertakings with several subsidiaries in Europe. Currently, the German tax regime would hinder a tax-neutral cross-border conversion out of Germany in most cases. If Germany forfeits its right to tax due to the cross-border conversion of an entity out of Germany, in particular, if the assets of the newly converted foreign company do not remain in a German permanent establishment, the cross-border conversion leads to an exit taxation in Germany.

For more information see the Gibson Dunn Client Alert of September 7, 2012: http://www.gibsondunn.com/publications/Pages/ECJPermitsCross-BorderMovement-NationalCompanies-IntoEUMemberStates.aspx 

Corporate, M&A – Liability for Underfunding of Shelf or Dormant Companies

German courts over the past years have developed extensive case law on the liability of managing directors as well as shareholders and purchasers of shares of German limited liability companies (GmbH) in connection with the "activation" of empty shelf companies (i.e. the commencement of actual business activities) or the reactivation of dormant companies. Such companies are frequently used in M&A transactions as an acquisition vehicle.

Generally, German corporate law requires that each newly founded or (re)activated limited liability company has sufficient funds to cover the registered share capital at the moment such incorporation or (re)activation is filed for registration with the registry court. In case of non-compliance with these statutory laws on sufficient funding and disclosure requirements, some courts had held the managing directors as well as the shareholders liable for the company’s debt, even in cases when such debt was incurred only after the (re)activation, thus piercing the corporate veil.

On March 6, 2012, a ruling by the German Federal Supreme Court (Bundesgerichtshof — BGH) limited the liability of a company’s shareholders. In cases of underfunding at the time of (re)activation, the shareholders are liable only for the difference between the registered share capital and the net asset value of the company as of such time. The liability does not increase with additional debt subsequently incurred by the company, thereby overruling the contrary position of certain courts.

In the same judgment, the court also clarified that liability for such underfunding applies both to the current shareholder (even if he was not involved in the activation which occurred prior to his acquisition of the company) as well as the shareholder who activated the company (even if he in the meantime has sold the company), such liability claims against the former shareholders becoming time-barred five years after the sale.

Even though the Federal Supreme Court has limited the scope of potential exposure in case dormant or shelf companies are (re)activated, investors should continue to ensure that the use of such entities is carefully managed and monitored to ensure that no underfunding occurs and that the formalities of the filing procedure are duly complied with. In case of regular share deals, the prior use of a (re)activated company by the seller in the past needs to be assessed in a thorough corporate due diligence and, if doubts remain, protection by means of indemnification should be sought.

Corporate, M&A – Investment Law– Getting Ready for the Proposed German Investment Act (KAGB) and Investment Tax Act (Investmentsteuergesetz)

I.          Regulatory Regime

The deadline for the implementation of the European Union Directive 2011/61/EU on Alternative Investment Fund Managers ("AIFMD") into German law will expire on July 22, 2013. On October 30, 2012, the German government issued an updated government draft of the law to implement the AIFMD into German law, which proposal has been accepted with minor changes by the German government cabinet on December 12, 2012.

If this government draft of the German Investment Act (Kapitalanlagegesetzbuch — KAGB) is adopted by the German legislator, as currently proposed, the German implementation of the AIFMD would exceed the minimum requirements set by AIFMD. In particular, the KAGB as currently proposed is not just a piece-meal transformation of the AIFMD requirements, but has a much broader, more ambitious reach. It aims to provide an overreaching, unified codification of the investment law in Germany for open-end funds and, for the first time, closed-end funds. The KAGB draft replaces the existing German Investment Code ("InvG"), which, inter alia, effected the harmonization of national rules based on the Directive 2009/65/EC on the coordination of laws, regulations and administrative provisions relating to undertakings for collective investment in transferable securities (UCITS), and seeks to regulate previously unregulated "alternative investment funds" and their managers. In essence, the proposed KAGB would contain rules on all types of investment funds and their managers.

1.         Selected Key Points

Once the draft law is adopted, the operation of a fund vehicle (Kapitalverwaltungsgesellschaft) dealing in alternative investment funds ("AIF") also will require a concession granted by the German regulatory authority for financial services (BaFin) unless certain exceptional cases apply. While there will be grandfathering rules for existing fund vehicles and their managers, managers of AIFs should be aware of this future concession requirement to plan accordingly.

The existing rules on the placement of investment funds (Vertrieb) are also modified which is a further area where the affected interested industry circles are well-advised to familiarize themselves with the proposed draft law.

As the KAGB replaces the current InvG in its entirety and introduces a new nomenclature and terminology, even provisions in the existing regulatory regime that are introduced into the KAGB in materially unchanged form will require legal advisors and other industry participants to re-familiarize themselves with the new terminology and changed systematic structure of the law.

2.         Outlook

The KAGB draft is still at the early stages of the legislative procedure. The current government draft already reflects some of the criticism that the initial discussion draft of the KAGB (published in July 2012) was met with. As such, it is to be expected that the draft text likely will be further refined and amended in the further process of legislation.

However, the overall approach of adopting an all-inclusive codification of German investment law applicable to all types of funds and their managers, as well as the fact that the KABG in some instances will go beyond the minimum requirements contained in the AIFMD, is unlikely to change. Experts currently expect the KAGB to be adopted in time to meet the implementation deadline provided for in the AIFMD. As a consequence, potentially affected sectors and market players need to be aware of and familiar with this draft law and monitor the further developments closely.

Bearing in mind that on December 19, 2012, the European Commission released its delegated Regulation (Durchführungsverordnung) under the AIFMD on technical matters such as, inter alia, the capital requirements for managers of AIFs, the conditions and procedures in relation to the authorization of such managers, reporting requirements and leverage calculation methodology and rules on depositaries, including details on their obligations and liability, it remains to be seen how these so-called Level 2 implementation measures, which are a precondition for the application of the AIFMD in EU countries, will impact on the draft KAGB. The delegated Commission Regulation now will be assessed by the European Parliament and the European Council during a three-month review period and, provided there are no objections, would enter into force the day after it is published in the Official Journal of the EU. As a Regulation, this Level 2 Regulation would be directly applicable law in the EU Member States and, unlike the AIFMD itself, would not require any further transformation into national law.

II.        New Investment Tax Regime

In the course of the regulatory implementation of the AIFMD by the KAGB, the German Ministry of Finance plans a fundamental reform of the German investment tax regime, which may also have a significant impact on existing fund structures. According to the ministerial draft of a German Act on the Adoption of Investment Fund Taxation in Connection with the AIFM Directive ("Draft") as of December 4, 2012, the scope of the tax regime of the German Investment Tax Act (Investmentsteuergesetz) will be expanded to all alternative investment funds, including private equity funds and other closed-end funds, which are currently unregulated. The tax regime of German and non-German private equity funds and other closed-end funds (such as mezzanine or real estate funds), which will be treated in the future for tax purposes as "non-qualifying investment funds" (Investitionsgesellschaften), will depend on their legal form.

If the closed-end funds are structured as partnerships, there will be no changes to the taxation rules currently in force. The fund will be treated as transparent and the criteria used to differentiate between business activities and pure asset management remains applicable. However, if the closed-end fund qualifies as a corporation for German tax purposes (e.g. a GmbH, Luxembourg SICAV, Irish PLC), the fund faces significant changes to its tax regime, whereby taxable income of the investor will be calculated in the future on a mandatory, lump-sum basis covering all distributions plus 70% of the increase of the fund unit’s value in the relevant business year, but at least 6% of its last redemption or market price. Even though the taxable income will be taxed at the level of the investor as a dividend distribution, a corporate investor may only benefit from the privileged dividend taxation regime (tax exemption of 95%) if the fund itself has been subject to an effective tax burden of 15%. With respect to non-qualifying investment funds the Draft does not provide for any grandfathering rules; therefore, SICAV or PLC structures will be subject to the mandatory lump-sum taxation once the Draft becomes effective.

With respect to open-end funds that fall within the scope of the current German Investment Tax Act, there will be no changes to the tax regime of limited tax transparency. However, the requirements for an open-end fund to benefit from this tax regime will be tightened: In a change from the current rules, the open-end fund must be subject to supervision in the state of its statutory seat, and the investor must have a redemption right at least once a year. Furthermore, the Draft provides for mandatory limitations for investments in listed companies and investments in one and the same corporation as well as for short-term loans. Contrary to the current rules, the open-end fund may also lose its privileged tax status if the fund no longer complies with the mandatory investment limitations. According to the Draft, the new rules will only apply to open-end funds established on or after July 22, 2013.

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Tax – Annual Tax Act 2013

The two chambers of the German Parliament (Bundesrat and Bundestag) failed to reach an agreement in 2012 on the Annual Tax Act 2013 (Jahressteuergesetz 2013). The legislative process is rescheduled for January 2013. Because the governing parties in the Bundestag do not hold the majority in the Bundesrat, further conciliation proceedings are expected and may continue until the first quarter of 2013. Nevertheless, most of the expected amendments will become effective as of January 1, 2013.

From an international tax perspective the draft Annual Tax Act 2013 provides for some significant changes:

a) Authorized OECD Approach

The proposed amendments in the draft Annual Tax Act 2013 would standardize the German tax consequences regardless of the legal form through which the business is conducted (i.e. whether through a corporation, partnership or branch). This would require, in particular, the closer alignment of the tax treatment of a permanent establishment ("PE") with that of subsidiaries. Thus, the draft Annual Tax Act 2013 proposes changes to bring German law in line with the authorized OECD approach regarding the treatment of a PE. Under this approach, a PE would be treated as a separate and independent enterprise from a tax perspective, whereby transactions between the headquarters and its PE have to be at arm’s length. If the draft Annual Tax Act 2013 becomes effective as proposed, the functionally separate legal entity approach would be nearly fully adopted, with only minor differences remaining.

b) Hybrid Instruments

Hybrid instruments are financial instruments that are qualified as debt in the jurisdiction of the issuer (interest expense) and as equity in Germany (dividend income). Typical examples are profit participation rights (Genussrechte) and Luxemburg CPECs. The draft Annual Tax Act 2013 provides for a system of corresponding taxation between the tax treatment in Germany and the jurisdiction of the issuer. The German exemption of dividend income shall only be applicable as far as the dividend was not deductible in the jurisdiction of the issuer.

c) Partnership Taxation

Germany does not allow a deduction for payments by a German partnership to its German partners for services or use of capital. To apply this concept in a cross-border context, the draft Annual Tax Act 2013 provides for a restriction of tax treaty protection for payments by a German partnership to its non-German partners in order to fully tax those payments in Germany. Taxes in the jurisdiction where the non-German partner is resident will be credited.

d) Portfolio Dividends

Under current law, 95% of the dividends from shares in corporations are exempt from corporate income tax for German corporate shareholders irrespective of the amount of shareholding. Until 2011, withholding tax on dividends was refunded to German but not to non-German corporate shareholders. The European Court of Justice ("ECJ") held in October 2011 that the German withholding tax levied on portfolio dividends paid to non-German shareholders infringed European law, unless the requirements of the parent subsidiary directive were met (i.e., a minimum participation of 10%).

A reaction by the German legislator to the decision of the ECJ is still pending. The German legislator has two alternatives: Either there will be a switch to a full taxation of portfolio dividends for German corporate shareholders or a refund procedure will be implemented where EU corporate shareholders are entitled to a refund of taxes withheld on portfolio dividends distributed by German corporations.

The taxation of portfolio dividends is subject to a separate legislative proceeding, which is expected to be finalized at the earliest in March 2013.

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Insolvency – Insolvency Trigger-Event Over-Indebtedness

On November 9, 2012, the German Parliament resolved to permanently retain the so-called two-tier concept of over-indebtedness (zweistufiger Überschuldungsbegriff). According to this two-tier concept of over-indebtedness, a company is not obliged to file for insolvency in Germany if it has a positive continuation prognosis (positive Fortbestehensprognose) even though it is technically over-indebted. In essence, a positive continuation prognosis exists if it is likely, based on a realistic and thorough finance plan, that the entity in question will generate sufficient income in the short to medium term to cover its current and projected future liabilities in a sustainable manner. The term covered by such prognosis is most commonly the current and next business year of the company. The drawing up of such a continuation prognosis is usually entrusted to independent, external financial advisors.

This simplified concept of over-indebtedness, pursuant to which a positive future prognosis overrides an insufficiency of assets, was originally introduced in the context of the financial crisis in autumn 2008 for an interim period until December 31, 2010 to help businesses deal with the effects of the sudden weakening of the financial markets. Although the concept thereafter was extended until December 31, 2013, it was anticipated that Germany would return to the prior, stricter concept of over-indebtedness at the end of the interim period. However, based on various expert opinions that the new two-tier concept had been successful in practice, the German Parliament has now lifted this temporal restriction, thus permanently abandoning the older, stricter concept.

Insolvency — Draft Amendment to EU Regulation on Cross-Border Insolvency

The existing EU Regulation on cross-border insolvencies (Council Regulation (EC) No 1346/2000 of May 29, 2000) has been in force since May 31, 2002. It provides a procedural framework for insolvencies involving debtors with assets in more than one Member State. In an effort to further increase a "rescue and recovery culture" in Europe, the European Commission on December 12, 2012, issued a draft proposal for amending the existing EU Regulation ("Draft Amendment"). In addition to EU-wide publication obligations regarding insolvency proceedings, the key features of the Draft Amendment are the following:

First, the Draft Amendment extends the scope of the EU Regulation considerably. In the future, the EU regime also applies in case of hybrid proceedings where the debtor remains in control, provided that the assets and affairs of the debtor are subject to court supervision. Consequently, it would cover debtor in possession proceedings and certain types of (voluntary) pre-insolvency arrangements with creditors.

Second, the place of jurisdiction will be further specified by complementing the existing definition of the center of main interest ("COMI"). In addition, courts in the future will be forced to review the COMI ex officio and creditors may challenge the jurisdiction of the court where the filing is made. Consequently, the Draft Amendment likely would limit existing tendencies for forum shopping.

Third, the possibilities for the commencement of secondary insolvency proceedings alongside main insolvency proceedings will be limited. At present, secondary proceedings over assets situated in one Member State are often an obstacle to restructuring activities in the main proceedings in the other Member State. Pursuant to the Draft Amendment, the court and/or liquidator of the main proceedings may request that secondary proceedings in another Member State are not opened or are put on hold, provided the liquidator of the main proceedings commits to treat the creditors of the secondary proceedings in the main proceedings as if secondary proceedings had been opened. However, the liquidator of the main proceedings may request the opening of secondary proceedings where useful, for example to implement an employee lay-off, which in turn helps the restructuring process. Further improvements concern (i) far ranging cooperation duties between the liquidators and courts involved in the main and secondary proceedings respectively, including a right to be heard, and (ii) the secondary proceedings would no longer have to be winding-up proceedings.

Finally, the Draft Amendment provides for a framework regime for the insolvency of group companies that goes beyond the existing tool of a joint COMI in case of highly integrated groups. While the entity by entity approach and local filing competencies will be maintained in the future, the liquidators shall have far reaching cooperation duties, in particular regarding rescue and cooperation measures. Also, the liquidator of one group company shall have a standing in insolvency proceedings of other group companies. This modification likely leads to considerable cross-border influence as restructuring activities in one Member State can be discussed directly with the creditors of another group company in the other Member State.

Although it is not yet clear if and when the proposed regulation will enter into force, it certainly supports recent trends in national legislation by several EU Member States, including Germany, to promote restructuring as an equitable alternative to liquidation of insolvent entities. If the Draft Amendment becomes law, it would further broaden the range of tools available in cross-border insolvency proceedings while addressing some of the more pertinent criticisms of the current EU Regulation that have been regularly voiced in the past.

Insolvency – Preliminary Experience with the ESUG

The German Law on the Further Facilitation of the Restructuring of Enterprises (Gesetz zur weiteren Erleichterung der Sanierung von Unternehmen — ESUG) which has been in force since March 1, 2012, was generally well received. Since then, the number of German debtor in possession proceedings (Eigenverwaltung) has increased considerably and there have been a number of cases where creditors, debtors, and courts cooperated to achieve the purpose of the ESUG. In addition to the rising number of actual proceedings, there have been several occasions in our practice where board members and managing directors of companies, who are not even in financial distress, have enquired about managerial duties in an insolvency scenario and the procedural options available in such a scenario. Thus, it appears that the perception of insolvency as "a new beginning" is gradually taking hold.

Still, the first months since the enactment of the ESUG also have shown that certain insolvency judges have raised concerns about the composition of the creditors’ committee proposed by the debtor even in well-prepared cases. Some insolvency courts have been reported to challenge the committee members proposed by a debtor, and the insolvency administrator who was unanimously proposed by such creditors’ committee. This tends to endanger at least the timing of the contemplated restructuring if not the overall restructuring. Thus, the question for many debtors and creditors is how such issues can be overcome in the future.

First and foremost, debtors and their advisors, although not required to do so by law, would be well-advised to contact the competent insolvency courts, including judges and court clerks, well in advance of the filing to familiarize them with the intended insolvency filing, the suggested creditors’ committee and the proposed insolvency administrator rather than simply presenting the completed documentation once it is final. This is particularly relevant in case the competent insolvency court does not handle ESUG proceedings on a regular basis. Typically, judges and court clerks appreciate such advance interaction and are willing to cooperate when they have had a chance to learn that their possible concerns have already been considered and taken into account by the debtor, the main creditors and their respective advisors.

In other cases, debtors may risk finding themselves before an insolvency court that has gained a reputation of generally not supporting the spirit of the ESUG during the short term the law has been in force. In such a case, a debtor may be well advised to consider changing its registered office before the filing to come within the jurisdiction of a more welcoming court district. Of course, such a measure requires even more advance planning. In addition to applicable filing deadlines, the time period required for the shareholder meeting on the resolution on the change of the registered office and the registration period with the registry court, which is often difficult to predict, have to be factored in.

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Labor Law — Managing Directors Can Claim Age-Discrimination

On April 23, 2012, the Federal Supreme Court ruled that the Anti-Discrimination Act (Allgemeines Gleichbehandlungsgesetz — AGG) also applies to managing directors of corporations. This widely-recognized decision will have a considerable impact on how companies choose their managing directors, and how they justify and communicate their decisions.

In the case at hand, the term of a 62-year-old managing director of a large public hospital in Cologne expired after the five years he had been appointed for. Although the incumbent offered to serve for another term, the supervisory board decided not to renew the incumbent candidate and chose a younger candidate (41) instead. In a press conference, the board’s spokesman mentioned that the candidate must be able to position the hospital "like a strong fortress in the wind" for the long run. Also, in its considerations, the board predominantly discussed the current managing directors age as the relevant factor for their decision. The court held that the non-renewal discriminates against the incumbent hospital director and awarded damages.

This court ruling significantly changes corporate relations with managing directors. Until now, their terms could be fixed without considerable legal risk. Going forward, companies will have to decide more carefully and document such decision adequately if they elect not to renew a contract with an incumbent candidate.

Labor Law – Carmakers Relieve E-mail Stress

In 2012, although there have not been any particularly noteworthy new labor laws in Germany, there are some developments on the labor relations front. German carmakers are spearheading an attempt to reduce work-related stress induced by the 24/7 availability due to mobile devices. As the pioneer in this regard, Volkswagen agreed on an agreement with its works council last year that provides for an email pause on the employee’s handheld from 30 minutes after the end of the workday until 30 minutes before the start of the next workday.

According to reports in the press, Daimler will introduce a slightly different model starting in 2013: Employees on vacation can opt out of emails on their blackberries. If they make use of this option, incoming emails are deleted during their vacation. In consideration of urgent queries, the sender is directed to contact a colleague of the respective employee, who will take care of the query in the meantime.

It is still too early to fully summarize and evaluate the experiences with these new email rules. In any case, both models have one thing in common: They do not apply to managers from a certain level upwards. Thus, the carmakers’ heads of production, sales, legal, M&A, etc. will remain available for customers and other business partners for the foreseeable future.

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Anti-Trust – 8th Amendment to German Antitrust Law — Currently on Hold but on Its Way

The primary goal of the 8th amendment of the German Act against Restraints of Competition (GWB) is to align German domestic antitrust law with its European counterpart in order to reduce discrepancies between the two regimes. The core elements of the proposed reform affect the area of merger control, the definition of a dominant market position, as well as the antitrust procedure. While the current substantive test under German merger control asks whether the envisaged transaction would result in the creation or strengthening of a dominant market position, the new substantive test will assess whether a concentration would result in a significant impediment of effective competition. This so-called "SIEC-test" also is utilized in EU merger control and is generally believed to provide more flexibility for the assessment of oligopolistic market structures and vertical or conglomerate merger cases. This measure is supplemented by a provision that introduces the possibility to close a transaction prior to merger clearance when the transaction concerns a public bid for securities and attached voting rights are not exercised prior to the merger clearance.

In a further attempt to align German antitrust law with its European counterpart, the draft legislation raises the threshold for a presumption of a dominant market position from the current 33% to 40%, thereby slightly lifting the regulatory burden on companies with high market shares. In terms of antitrust procedure, the draft legislation above all foresees a right to bring proceedings for omission and remediation of antitrust law infringements for associations of undertakings and consumer associations as well as extended obligations for companies to co-operate with the authorities during antitrust proceedings.

Currently the draft is being reviewed in a Conciliation Committee (Vermittlungsausschuss) between the two German chambers of Parliament but legislative negotiations have been postponed until January 2013. The current disagreement mainly focuses on the extension of antitrust laws to certain industries, such as health insurers, but does not concern substantive areas of the reform. Therefore, businesses should expect a new set of German antitrust rules to come into force during the first half of 2013.

Antitrust – Access to Files in Private Claims for Damages — A Peek through the Keyhole

Like in other European jurisdictions, Germany also has witnessed an increase in private claims for damages in the context of antitrust infringements. The Local Court Bonn (Amtsgericht Bonn) on January 18, 2012 and the Court of Appeals in Düsseldorf (Oberlandesgericht Düsseldorf) on August 22, 2012 delivered two ground-breaking judgments whether claimants can successfully apply for access to files in order to review leniency applications submitted by antitrust infringers. This question is of particular importance because the vast majority of antitrust infringements have been discovered by leniency applications in which whistleblowers disclose the existence of a cartel to the authorities in exchange for immunity from fines or a fine reduction.

Claimants for damages who hope to obtain access to the authority’s file in order to base their claim on evidence contained in leniency statements have been disappointed by both courts. Access to the leniency application itself, and the documents that were handed over voluntarily by the whistleblower, were denied. Both judgments were largely based on the reasoning that permitting broader access to files would discourage whistleblowers from coming forward and disclose cartels, thereby weakening effective enforcement of antitrust laws and, furthermore, would disappoint the legitimate expectations in terms of document protection against disclosure. Additionally, the Court of Appeals in Düsseldorf held that complete disclosure of other documents had to be denied as the necessary procedure of disguising business secrets would have taken several weeks, thereby unduly delaying court proceedings. The claimant was only provided with an index of relevant documents.

In consequence, damage claimants are rather left with a peek through the keyhole instead of full access to files. Germany remains a jurisdiction where documents in antitrust proceedings are protected particularly well against disclosure.

Antitrust – Case Law on Essential Patents — A Strong Position for Patent Holders and A Long Way to Go for Defendants in Germany

According to established case law in Germany (Orange Book-Case of 2009), defendants in a patent infringement claim who are sued by the owner of a so-called standard essential patent may successfully raise a defense that the patent holder abuses a dominant market position if he is not willing to license the patent on fair, reasonable and non-discriminatory (FRAND) terms. One central precondition that must be fulfilled in order to invoke this defense requires that the defendant comes forward with a proposal for a license agreement. This is where most defendants struggle.

In several decisions during the past year, German courts such as the Regional Court in Düsseldorf (Landgericht Düsseldorf) or the Court of Appeals in Karlsruhe (Oberlandesgericht Karlsruhe) have set the bar for such a contract proposal very high. These decisions follow a line of cases according to which a relevant contract proposal must be sufficiently precise and complete in order to act as a basis for a license agreement. Courts have expressly held that the relevant proposal must be unconditional and, in particular, no reservations can be made as to the legitimacy of the patent holder’s claim. Hence, it is not possible for the defendant to make an offer but to reserve its right to withdraw from the license agreement should a court decide that there was no patent infringement in the first place.

In their attempt to define the preconditions for a successful defense against patent infringement claims, German courts at the moment are following a very strict approach vis-à-vis alleged patent infringers. Defendants are required to have detailed market knowledge in order to make a sufficiently precise and complete license proposal and they also must be prepared to put all their eggs in one basket because relevant reservations cannot be made in order not to jeopardize the defense.

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Data Protection — Cloud Computing

2012, in some respect, was the "Year of the Cloud" — not only concerning the interface between economic potential and environmental threats, but also due to major privacy concerns that were raised by German regulators. At its April 2012 meeting, the International Working Group on Data Protection in Telecommunications (aka the "Berlin Group"), which is chaired by the Berlin Commissioner for Data Protection, released a "Working Paper on Cloud Computing – Privacy and data protection issues" that identified certain main areas of risk linked to cloud computing including (i) breaches of information security such as breaches of confidentiality, integrity or availability of (personal) data; (ii) data being transferred to jurisdictions that do not provide adequate data protection; (iii) acts in violation of laws and principles for privacy and data protection; (iv) the controller accepting standard terms and conditions that give the cloud service provider too much leeway; and (v) cloud service providers or their subcontractors using the controllers’ data for their own purposes without the controllers’ knowledge or permission. The Berlin Commissioner concluded that privacy and data protection may not be reduced due to the outsourcing of data services "into the cloud" or, in other words, "privacy may not evaporate in the cloud."

Similarly, the Federal Commissioner for Data Protection recently complained about "the often unmindful and uninhibited" treatment by cloud service providers of user data and stressed that "users very often do not even know which data is collected and for what purpose". As an express, informed and voluntary consent is required by German and EU law for the collection, use, and particularly for the transfer of personal data, it can be reasonably expected that in light of the Federal Commissioner’s statement cloud computing will be under increased scrutiny by German regulators in 2013.

Data Protection — Social Networks

Social networks were another main area of concern in 2012 for German privacy regulators; the related privacy law aspects are similar to those seen in the context of cloud computing. The Federal Commissioner for Data Protection e.g. recently criticized the new terms of use of Couchsurfing, which in his view compel users to entirely abandon any control of their personal data, which "is not permitted under German and EU privacy laws". Also Facebook became a target of privacy regulators and consumer associations which did apparently not conceive the requirements and habits of an online community under rapid development. In April 2012, the Federation of German Consumer Organizations (Verbraucherzentrale) sued Facebook in the Berlin Regional Court (Landgericht) concerning the find-friends feature. The Berlin court held that the feature violated privacy laws as it was not clearly communicated to the users that data from their local address books were uploaded to use this service. Facebook has appealed the decision. The Federation again sued Facebook in September 2012 regarding the app center service, arguing that the service allegedly transfers personal data of users to third party providers of apps without first obtaining the express consent from the users. Further, in mid-2012, the Hamburg and Kiel Commissioners for Data Protection targeted Facebook’s face recognition service arguing that Facebook had not obtained sufficient prior consent from its users. Finally, on December 14, 2012, the Kiel Commissioner issued a decree requesting that Facebook permits pseudonymous accounts which — in his view — was required by the German Telemedia Act (Telemediengesetz). Facebook argues that it is subject to Irish law only as its European operations are based in Ireland, that it fully complies with Irish data protection laws, which fully implement the applicable European law, and that the German Telemedia Act violates European law.

Although neither the decision of the Berlin court nor the decree are final, both show that regulators and courts in Germany are willing to enforce privacy laws, also against foreign companies, much more strictly than in the past and that topics such as valid consent and the legal transfer of data can be expected to play a major role in future enforcement practice.

Data Protection — Expiry of Transition Period

Due to the aforementioned importance of valid consent and legal transfer of data, it is worth mentioning that the transition period for the processing and use of data collected prior to September 2009 for marketing purposes expired on August 31, 2012. Therefore, as of September 1, 2012, personal data may only be processed or used for marketing purposes if the data subject has given his or her consent. The consent declaration must be highlighted and clearly specify the purpose and scope of the processing and use. Certain exceptions apply; for instance, no consent is required if a company uses a limited set of personal data (name, title, degree, address, year of birth and profession) that it has itself collected from its customers for its own marketing purposes. However, even if a valid exception applies, the data subjects may object to the further processing and use of their personal data; therefore, they must be informed about their right to object in any marketing letter. Stricter rules apply to email marketing.

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Compliance — Increased Corporate Liability for Law Violations in the Pipeline

In recent years, German prosecutors and courts have become very active enforcers of sanctions against corporations for compliance offenses, including bribery, tax evasion, or antitrust violations. German authorities and courts have imposed significant administrative fines and sought the disgorgement of profits generated by illegal conduct against corporations.

In 2012, the German legislator initiated steps to amend the current German Administrative Offences Act (OWiG) in response to (i) criticism by the OECD that sanctions imposed on corporations under German law for corruption are not sufficiently effective, proportionate, and dissuasive, and (ii) rulings by the Federal Supreme Court (Bundesgerichtshof – BGH) which held that fines for historical misconduct only can be imposed on the legal successors of a corporation in certain limited cases.

The Federal Chamber of Parliament (Bundestag) resolved to amend the Administrative Offences Act as of January 1, 2013 as follows:

(i)         The current statutory maximum fines for certain corporate compliance offenses shall be increased from EUR 1 million to EUR 10 million for intentional conduct and from EUR 500k to EUR 5 million for negligent conduct.

(ii)        In cases of (partial) universal succession under the German Transformation Act (Umwandlungsgesetz) administrative fines can be imposed on the legal successors of a corporation up to the value of the assets assumed.

(iii)       When corporations are subject to administrative fine proceedings, relevant assets subject to confiscation (Arrest) may already be confiscated as soon as a regulatory authority has issued the administrative order for such fines (even if these are found to be illegal or excessive by the courts later). Currently, confiscation of such assets is only permissible once a court has confirmed such fine.

Despite well-argued suggestions to the contrary, the Administrative Offences Act will not acknowledge compliance management systems as a defense or mitigating factor to decrease fines. Rather, the individual court and/or regulatory authority shall retain discretion in each case whether (or not) to consider this in mitigation.

Since its introduction into Parliament, the proposal to amend the Administrative Offences Act has stalled due to objections by the Regional Chamber of Parliament (Bundesrat) to other provisions contained in the same legislation (see above "Anti-Trust – 8th Amendment to German Antitrust Law — Currently on Hold but on Its Way"). In mid-December, the Conciliation Committee (Vermittlungsausschuss) adjourned the matter to a yet to be determined session in 2013. Nevertheless, given the strong political will in Germany to strengthen sanctions for corporate misconduct, it is highly likely that Germany will adopt the amendments to the Administrative Offences Act in the near future.

The amendments further increase the need for corporations to conduct thorough risk assessments to avoid significant corporate responsibility for white collar crimes and other illegal conduct. It is advisable for companies to review whether their existing compliance procedures are sufficiently robust and effective to control such risks, and further refine these systems if needed.

Compliance – New Governmental Efforts to Fight Corporate Corruption

In the wake of the financial crisis and widespread corporate wrongdoing, German politicians renewed the longstanding debate whether Germany should impose criminal sanctions against corporations. At present, the concept of criminal liability for corporations does not exist under German law. In case of criminal misconduct by a member of a company’s management, corporations can be sanctioned only by the imposition of an administrative fine. In addition to introducing criminal liability for corporations, German politicians also discussed whether to adopt a number of potential new sanctions for corporate misconduct ranging from the exclusion of corporate violators from public tenders, to disqualification from subsidies and tax advantages, to company liquidation.

To strengthen Germany’s ability to effectively combat corporate corruption, the governments of the German Federal States proposed on November 15, 2012 that the German Federal Ministry of Justice (Bundesjustizministerium) consider

(i)         Implementing a legal means to sanction corporations for "intentional irresponsibility" based on an "abstract need for sanctions".

(ii)        Protecting whistleblowers by revising Section 17 of the German Act Against Unfair Competition (UWG) ("disclosure of trade and industrial secrets") to abolish liability for reporting potential corporate misconduct.

(iii)       Implementing a federal register of companies suspected of corruption to be considered by public authorities in awarding public tenders.

(iv)       Strengthening the anti-corruption provisions of the German Criminal Code (StGB) by criminalizing the offence of "bribe of parliamentarians".

(v)        Implementing a new criminal offence for untruthful profit promises.

(vi)       Implementing a new criminal offence for the violation of audit and informational duties by managers (in addition to the existing criminal offence of embezzlement).

It is likely that the initiative of the German Federal States will generate new legislation in the near future. Gibson Dunn will continue to closely monitor this development.

Compliance – Internal Investigations in Germany — New Development on Scope of Legal Privilege

On July 3, 2012, the Regional Court of Mannheim (Landgericht Mannheim) issued an important ruling on the scope of privilege for documents identified during an internal investigation. Departing from prior legal decisions, the court held that the investigation report, client documents reviewed for the report, and the interview protocols in the possession of an outside law firm engaged by a corporation to conduct an internal investigation were protected from seizure by German investigators under Section 160a (1) of the German Code of Criminal Procedure ("StPO").

The court reasoned that said provision, in connection with others, provides that information cannot be seized by public prosecutors if the information was entrusted to an attorney or became known to a person in his capacity as an attorney. However, the court clarified that this protection would no longer apply where a client provided documents to its outside counsel in bad faith in an effort to shield the incriminating documents from seizure.

Prior to the 2011 amendment of the StPO, the StPO only protected information that was held by criminal attorneys (representing individuals, not corporations) from prosecutorial measures. Consequently, the Regional Court of Hamburg (Landgericht Hamburg) in 2010 interpreted Section 160a StPO to hold that memoranda from the internal investigation conducted by outside counsel could be seized by German law enforcement officers even when the documents were in the possession of attorneys who conducted the investigation.

We view this decision of the Mannheim Regional Court as a welcome development for companies that rely on external counsel to help conduct internal investigations. While the decision is not binding on other German courts and the scope of the protections of Section 160a StPO remains uncertain, this decision strengthens outside counsel’s assertion that reports and working documents prepared by counsel and obtained in the course of an internal investigation are protected by legal privilege against government seizure.

Compliance — Recent Self-Disclosures from Internal Investigations

A number of self-disclosures stemming from internal investigations indicate the continuing challenges faced by German export-oriented companies in their international activities. In August 2012, Fresenius Medical Care, the world’s largest integrated provider of products and services for dialysis treatment, which is listed both on the Frankfurt Stock Exchange as well as the New York Stock Exchange, without providing details announced that the company is conducting an internal investigation on certain conduct that may violate the U.S. Foreign Corrupt Practices Act ("FCPA") and other anti-bribery laws, and that the company has voluntarily advised the U.S. Securities and Exchange Commission and the U.S. Department of Justice about the allegations.

During 2012, an internal audit at the German steelmaker and engineering company ThyssenKrupp AG discovered suspicious payments of several million euros at its marine and civil engineering subsidiary GfT Bautechnik GmbH in connection with a construction project in Kazakhstan. The findings led to the removal of several employees from the unit. In December 2012, ThyssenKrupp AG requested the Essen public prosecutor to investigate whether employees may have engaged in foreign bribery in connection with these payments.

Compliance – Increased Accountability of Management

In today’s German corporate world, compliance violations have frequently become career ending events for the executives involved. In an effort to address a series of commercial and compliance issues, including past antitrust violations and pending corruption cases, ThyssenKrupp AG on December 10, 2012 announced the termination of three members of its six member management board by the end of 2012. Among those executives asked to leave ThyssenKrupp AG is the Head of Legal & Compliance.

In addition to being suspended from office, executives today face personal prosecution and significant criminal liability for compliance violations. On September 19, 2012, the Munich Regional Court (Landgericht München) sentenced the former head of MAN SE‘s Truck & Bus division and a member of MAN SE‘s management board to a 10-month suspended jail sentence and the payment of a EUR 100,000 fine for aiding and abetting bribery in connection with the sale of commercial vehicles in Slovenia. The former MAN SE Chief Executive Officer and the former Chief Financial Officer remain under investigation by German prosecutors on similar charges. German prosecutors opened their investigation into MAN’s former management after the former head of MAN‘s audit department testified in a related trial that both knew about "possible corrupt practices" in Slovenia.

On December 21, 2012, the Augsburg Regional Court (Landgericht Augsburg) sentenced the former CEO of Media Markt, a multinational retailer of consumer electronics, to 5 years and 3 months imprisonment for accepting commercial bribery payments from 2006 and 2011 to allow marketing activities by DSL providers.

Compliance – Public Investigations on the Rise

In October 2012, authorities from the Landshut prosecutor’s office raided the offices of the construction engineering company Bilfinger SE in connection with allegations that the company had paid bribes in several Eastern European countries in 2006 and 2007. The prosecution focuses on bribe payments to public officials of approximately EUR 5 to 6 million in connection with infrastructure projects in Hungary and Slovakia. Simultaneously, Frankfurt prosecutors continue to conduct a probe at Bilfinger SE over alleged bribery payments in Nigeria.

Beginning of November 2012, the Munich public prosecutor’s office and police also raided several German offices of European Aeronautic Defense & Space ("EADS") as part of an investigation into alleged bribes in connection with the 2008 EUR 1.6 billion sale of fighter jets to Austria. The Munich prosecutor’s office reported that the probe focused on whether EADS had used advisory contracts to disguise bribes in the three-digit million Euro range.

Frequently, in cases of public investigations German companies publicly assert that they are fully cooperating with the authorities. Despite public announcements to be cooperating fully, Deutsche Bank on December 12, 2012 experienced the largest dawn raid in Germany’s recent history, with more than 500 prosecutors and police officers searching the offices and apartments of employees in Frankfurt, Berlin and Düsseldorf, and arresting 25 employees on suspicion of tax fraud in connection with the trade with carbon dioxide pollution permits. Prosecutors assert that Deutsche Bank did not adequately respond to prior information requests by the authorities, leaving the authorities no alternative but to conduct to the dawn raid, which caused significant negative publicity for Deutsche Bank.

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Real Estate – Share Deals may Trigger Pre-Emption Rights in Rem

A pre-emption right in rem (dingliches Vorkaufsrecht) is an encumbrance of real property that is registered in the land register. It allows its holder under statutory law to enter into an asset purchase agreement concerning the encumbered real property by exercising the pre-emption right if such real property is sold to a third party by way of an asset deal.

In January 2012, the Federal Supreme Court (BundesgerichtshofBGH) held that a pre-emption right in rem may also be triggered if the real property is indirectly sold to a third party by way of a share deal. In such a case, the holder of this pre-emption right is still entitled to enter into an asset purchase agreement concerning the encumbered real property.

In the case at issue, the seller had transferred real property encumbered by a pre-emption right in rem to a newly formed affiliated entity by way of a contribution in kind and, shortly thereafter, sold the shares in such entity to a third party. The Federal Supreme Court argued that the pre-emption right in rem was triggered because such a transaction structure was materially identical to an asset deal and the contribution in kind did not have any economic reason other than prepare for the later sale of the encumbered real property. In light of this decision, existing pre-emption rights in rem need to be taken into account when structuring a share deal transaction.

Real Estate – The Breach of the Non-Competition Clause of a Lease Agreement leads to a Defect of the Leased Object and a Rent Reduction

In general, commercial lease agreements protect the tenant against competition from competing tenants in the same rental object. According to the Federal Supreme Court, such protection either can be provided for by way of an expressly agreed non-competition clause or, under certain circumstances, it can be held to be inherent in the commercial lease agreement without being expressively agreed upon.

On October 10, 2012, the Federal Supreme Court decided that a landlord’s violation of a non-competition clause, be it expressively agreed upon or inherent in the commercial lease agreement, constitutes a defect of the leased object and, as one of the consequences, the rent is reduced automatically by law. The question whether such a violation leads to a defect of the leased object long had been a subject of discussion and had previously not been decided by the Federal Supreme Court. Prior to the ruling, in case of a breach of a competition restriction, a tenant was entitled to claim removal of the competitive situation or, if such removal was not possible, to claim damages (subject to the willful or negligent behavior of the landlord). The tenant further had an extraordinary right to terminate the lease agreement. Now, additionally, the rent is reduced by law, thereby further strengthening the tenant’s rights.

Real Estate – No Transfer of the Employment Contract of a Property Manager to the New Owner of the Administrated Property

On November 15, 2012, the German Federal Labor Court (Bundesarbeitsgericht) held that in case of a sale of a property an existing employment contract with a caretaker will not be transferred to the new owner of the property.

A property company ("PropCo") owned property that had been rented to a local authority ("Tenant") on a long-term basis. PropCo employed a caretaker to maintain the property. The Tenant acquired the property from PropCo by way of an asset deal. Upon the closing of the deal, PropCo was liquidated. The caretaker argued that his employment contract had been transferred by operation of law to the new owner, the Tenant.

Until the aforementioned decision of the Federal Labor Court, it was the general opinion that employment contracts would be transferred by operation of law to the new owner if a property company transfers its entire business. Such transfer had been assumed in case of a sale of a rented property that was the only property of the seller. The Federal Labor Court now clarified that the property management relates to the property company’s administration business, which business is not transferred to the Tenant by way of a sale of the property. The Federal Labor Court argued that in relation to the administration business, the property does not qualify as an operating resource but is an object of administrative activities. Therefore the employment contracts of the employees of a property owning company who manage the property before its disposal shall not be transferred by law to the new owner.

The ruling of the Federal Labor Court dealt with a special case as the Tenant of the property acquired a property it had previously leased. Thus, we recommend as a precaution to continue to incorporate a standard guarantee into the sale and purchase agreement to the effect that the seller has not entered into any employment agreement.

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Gibson, Dunn & Crutcher LLP 

Gibson, Dunn & Crutcher’s lawyers are available to assist in addressing any questions you may have regarding the issues discussed in this update.  The Munich office of Gibson Dunn brings together lawyers with extensive knowledge of corporate, tax, labor, real estate, antitrust, intellectual property law and extensive compliance / white collar crime experience.  The Munich office is comprised of seasoned lawyers with a breadth of experience who have assisted clients in various industries and in jurisdictions around the world.  Our German 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 legal matters.  For further information, please contact the Gibson Dunn lawyer with whom you work or any of the following members of the Munich office:

General Corporate, Corporate Transactions and Capital Markets
Benno Schwarz (+49 89 189 33 110, bschwarz@gibsondunn.com)
Philip Martinius (+49 89 189 33 121, pmartinius@gibsondunn.com)
Markus Nauheim (+49 89 189 33 122, mnauheim@gibsondunn.com)
Birgit Friedl (+49 89 189 33 151, bfriedl@gibsondunn.com)
Marcus Geiss (+49 89 189 33 154, mgeiss@gibsondunn.com)
Eike Grunert (+49 89 189 33 121, egrunert@gibsondunn.com)

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Birgit Friedl (+49 89 189 33 151, bfriedl@gibsondunn.com)
Marcus Geiss (+49 89 189 33 154, mgeiss@gibsondunn.com)

Tax
Hans Martin Schmid (+49 89 189 33 110, mschmid@gibsondunn.com)
Christian Schmidt (+49 89 189 33 110, cschmidt@gibsondunn.com)

Labor Law
Mark Zimmer (+49 89 189 33 130, mzimmer@gibsondunn.com)

Real Estate
Peter Decker (+49 89 189 33 115, pdecker@gibsondunn.com)
Daniel Gebauer (+ 49 89 189 33 115, dgebauer@gibsondunn.com)

Antitrust and Intellectual Property
Michael Walther (+49 89 189 33 180, mwalther@gibsondunn.com)
Kai Gesing (+49 89 189 33 180, kgesing@gibsondunn.com)

Corporate Compliance / White Collar Matters
Benno Schwarz (+49 89 189 33 110, bschwarz@gibsondunn.com)
Michael Walther (+49 89 189 33 180, mwalther@gibsondunn.com)
Mark Zimmer (+49 89 189 33 130, mzimmer@gibsondunn.com)
Eike Grunert (+49 89 189 33 121, egrunert@gibsondunn.com)

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