German-Law GmbH Share Transfers or Pledges — The End of the Road for the Notarization in Switzerland?

January 12, 2010

A recent court judgment passed by the District Court (Landgericht) Frankfurt in October 2009 may signal the end of a long-since established German corporate and financing practice, the notarization of limited liability company share transfers or share pledges in Switzerland. In the past, this was common practice to avoid the significant cost of a notarial recording in Germany.

I.  Formalities for German Share Transfers and Pledges

The sale and transfer of shares in German limited liability companies (GmbH) requires mandatory notarization under German law. The same is true if shares in a German GmbH are pledged as part of the security package in customary acquisition financing or other syndicated financing transactions. This formal notarization requirement applies regardless of whether the pledgor or transferror is German-based or located abroad. A share transfer or pledge that is not duly notarized is invalid for formal reasons.

The notary fees payable in Germany are based on a non-negotiable statutory fee regime. The fees are calculated in relation to the value of the pledged or transferred shares. They can be significant cost factors in a transaction. German notarial fees of up to USD 50,000 are not uncommon. Note that German notaries are highly educated legal professionals that exercise a public office and are not comparable to notaries fulfilling merely secretarial functions that are common in other jurisdictions.

In the past, and based upon a decision of the German Federal Supreme Court (Bundesgerichtshof) of 1981, the notarization of German GmbH share transfers or share pledges in certain regions of Switzerland (in particular in Basel) were a viable alternative as fees could be freely negotiated with Swiss notaries. Significant five-figure cost savings were thus possible for clients. It was generally accepted in Germany that a Swiss notarization was structurally equivalent to the notarization in Germany and met the formal requirements under German law.

A general reform of both the German Act on Limited Liability Companies (the so-called MoMiG which came into effect on November 1, 2008) and the Swiss laws on the formal requirements for Swiss GmbH share transfers have since cast doubt on the continued equivalence of notarizations in Switzerland.

II.  The District Court Frankfurt Judgment

The above mentioned recent judgment of the District Court Frankfurt/Main has reinforced these doubts. In essence, the judgment, although not an authoritative precedent with binding force, will most likely mean that, for example, a Swiss notarization of a German GmbH share pledge will henceforth no longer be acceptable to lending banks.

The District Court Frankfurt claimed in an obiter dictum not relevant for the case at hand that, if it were to decide the question whether Swiss notarizations continue to meet German formal requirements, the chamber would likely no longer consider such notarizations recorded by non-German notaries to be valid. This is also the view that has been promoted by a number of legal commentators as well as the lobby for the German notaries.

The reasons cited for this position are, on the one hand, the fact that the German MoMiG reform introduced a certification requirement for German notaries which involves the exercise of public powers which are only incumbent in German notaries but not in extra-territorial Swiss notaries who do not represent a German public office. Secondly, the above Swiss law reform has introduced provisions pursuant to which the transfer of Swiss limited liability company shares now deviates from earlier formal Swiss-law requirements and no longer requires notarization in Switzerland. As a consequence, the Swiss notarization as such is argued to no longer be equivalent to a German notarization as Swiss notaries are not used to performing similar recordings under their own law.

While these arguments, legally, are very much open to debate and there are strong proponents that argue that the MoMiG did not intend to re-nationalize notarization but rather intended to make the German GmbH more internationally competitive, the consequences of this judgment are significant, at least as long as there is no clear change in case law, e.g. through a contrasting or overruling decision of one the regional Courts of Appeal or the Federal Supreme Court.

III.  Consequences for the Legal Practice

In particular in the context of international finance transactions, the lending banks regularly ask for legal opinions that confirm the enforceability of the securities granted in accordance with their terms. This also includes an implied or express statement by the opining law firm on due observance of the formal requirements for German GmbH pledges and thus the validity of the pledge. Even before the judgment, a number of notable German high street and commercial banks had become increasingly averse to Swiss notarizations. This is understandable from their perspective as the high costs for notarization are usually borne by the borrower. Thus, the lower fees achievable in Switzerland do not benefit the lending banks directly.

Following the judgment, it can be expected that lenders will only accept a Swiss notarization of pledges if the legal opinion is “clean” and unreserved. The opining counsel, on the other hand, will need to cover the above-described risk of invalidity inherent in a Swiss notarization by adding a respective qualification to its legal opinion. The result can be a conflict between the borrower’s wishes to save notarial costs in Switzerland and legal counsel’s inability to vouch for the unqualified legal validity of a Swiss-notarized German GmbH-pledge. As the validity of share transfers is also concerned, the same issues may arise, in particular if a legal opinion on share title is required.

If at all, the notarization in Switzerland may remain a viable option in the context of inter-company German GmbH share transfers that do not involve third parties. But even in such an intra-group scenario, the cost savings may be outbalanced by the potential risk that the judgment of the District Court Frankfurt may only be a first step towards a more solid case law supporting the future invalidity of Swiss-notarized share transfers.

Finally, it is clear from the judgment itself and the applicable literature that past notarizations in Switzerland recorded while the old law was in effect prior to November 1, 2008 will not be affected. Such share transfers or pledges are not at risk of formal invalidity.