Newsletter No. 252 (DE) - Februar 2024

Minority shareholder protection with respect to dividend payments in Germany

Reading Time: 12 minutes

Status quo

 

Both the German stock corporation (AG) and the German limited liability company (GmbH) are by their nature characterized by majority rule. This can lead to minority shareholders being outvoted and therefore having their interests bypassed, particularly concerning the allocation of profits.

German Public Stock Cooperation (AG)

 

The AktG (German Stock Corporation Act) does not stipulate a mandatory distribution of a dividend in the form of a compulsory or minimum dividend. However, the articles of association may specifically stipulate that different classes of shares have different rights. For example, non-voting shares often have a higher dividend entitlement.

Indirectly, however, an obligatory distribution may result from Section 254 AktG.  Following a successful challenge to the majority resolution (the period of ONE MONTH under Section 246 I AktG must be observed), this resolution may be declared to be invalid with the consequence that a new resolution (which will most likely have a different result) must be passed.

Right of avoidance under section 254 AktG

 

The wording of Section 254 AktG (highlights added):

Section 254: Action for the avoidance of the resolution as to the appropriation of the net income

(1) An action for avoidance may be brought against a resolution adopted as to the appropriation of the net income also on the grounds, besides those set out in section 243, of the general meeting allocating amounts from the net income to retained earnings or carrying amounts forward as profits that are not, according to the law or the by-laws, precluded from being distributed among the stockholders, and this having been done in spite of the fact that so allocating the amounts or carrying them forward is not necessary, when the matter is assessed while applying prudent business judgment, to secure the viability and resilience of the company for a foreseeable period of time in terms of economic and financial requirements, meaning that no profits can be distributed among the stockholders in the amount of at least four percent of the share capital reduced by the contributions not yet called in.

 

(2) Sections 244 to 246 and sections 247 to 248a apply to the action for avoidance. The period for avoidance (of one month pursuant to Section 246 I AktG) commences running on the date on which the resolution is adopted also in those cases in which the annual financial statements are to be audited anew pursuant to section 316 (3) of the Commercial Code. Stockholders have the authority to bring an action for avoidance pursuant to subsection (1) only if their shares, taken together, are at least equivalent to one-twentieth of the share capital or to a stake of 500,000 euros.

 

The wording of Section 254 I AktG therefore gives rise to a right of avoidance in respect of the resolution on the allocation of the net profit. More precisely, the resolution pursuant to Section 58 III AktG. This right of avoidance does not apply in cases where a profit of at least 4% of the share capital (less any uncalled contributions) can be distributed to the shareholders.

The objective of Section 254 AktG

 

The objective of the provision is to protect minority shareholders from a starvation policy of the majority shareholders. This can occur, for instance, if the majority shareholders decide on an unjustified retention of profits. However, it should be noted that this provision is only a provision for the protection of the minority and NOT for the protection of individual rights – as can be seen in particular from the quorum in Section 254 II AktG. This lack of individual protection also means that the right of avoidance under Section 254 I AktG does not apply, even if some shareholders or classes of ordinary shares are not to receive a dividend of 4% of the share capital, as long as the overall amount does not fall below the 4% lower limit. This right is therefore not a particularly effective tool in a conflict with the majority shareholders.

 

Formal requirements for the action for avoidance

 

The wording of Section 254 II 1 refers to Sections 244-246 and Sections 247-248a AktG. Consequently, the general requirements for avoidance apply. According to Section 246 I AktG, the action for avoidance must therefore be brought within one month of the resolution being passed. According to Section 254 II, this period also applies if the annual financial statements are to be audited again in accordance with Section 316 III HGB (German Commercial Code).

Like the right to contest the annual financial statements itself, the requirement that the quorum set out in Section 254 II 1 AktG must be fulfilled is not a prerequisite for a judgment on the merits. However, the absence of this requirement means that the action for avoidance is no longer deemed to be meritorious.

Requirements for the establishment of a ground for avoidance

 

First of all, a net retained profit is required for avoidance under Section 254 AktG.

Furthermore, there must have been a failure to distribute a minimum dividend because the net retained profits are used to form revenue reserves or are carried forward as profit. If the balance sheet profit is used for other purposes (e.g. in accordance with Section 272 III 2 HGB), this may lead to a possible contestability under Section 58 III 2 AktG, but not to a contestability under Section 254 AktG. An exclusion of profit distribution which excludes avoidance pursuant to Section 254 AktG may also exist on the basis of the articles of association or the law. This again limits the applicability of the right of avoidance under Section 254 AktG.

In applying the law, the most complex problems with regard to failing to meet the minimum distribution are caused by the business necessity requirement.

The wording of Section 254 I stipulates three requirements.

  1. The retention must ensure the viability and resilience of the company.
  2. This assessment must relate to a period that is foreseeable in terms of economic and financial requirements.
  3. The retention must be necessary for the purpose of ensuring security during this period.

 

The “prudent business judgment” is to be used as a standard for this purpose. Therefore, a certain amount of room for judgment must be allowed. However, the exact scope of this room for judgment is disputed. It is still unclear whether there is even a “right to error” for majority shareholders at the minority shareholders’ expense. According to the prevailing opinion, there will likely not be any far-reaching room for judgment under little or no review of the courts, as is the case with Section 93 I 2 AktG, as the allocation of profits, is not an entrepreneurial decision by the Board of Directors.

Rather, in addition to the entrepreneurial aspects, the legislator’s objective – namely the protection of minorities from exploitation tactics by the majority – must also be observed.

Burden of proof

 

According to the general principle of favourability, the company is obliged to set out and prove the existence of the actual retention requirements. Generally speaking, for exceptions such as the retention of profits, strict standards apply.

Court rulings on section 254 AktG

 

The undefined legal terms of Section 254 I AktG lead to difficulties in practical handling. Viability and resilience will probably be understood as the (continued) existence and long-term profitability of the company.

However, the courts are very reluctant to declare such shareholders’ resolutions to be void. In particular, the standard of “prudent business judgment” is interpreted rather in a wide sense in practical application. The courts often only briefly state that the intended non-distribution would not be objectionable and therefore the requirements of Section 254 AktG are not met (see OLG Frankfurt judgment of 28 November 2017 Ref.: 5 U 6/17 (establishment of an equity ratio of 12.5%)).

The decision of the Regional Court of Stuttgart is somewhat more instructive (Regional Court of Stuttgart, judgment of 28.07.2020 Ref.: 31 O 4/20 KfH). The Regional Court of Stuttgart found that the necessity of retaining profits to maintain the “viability and resilience of the company” is not limited to a static and past-related consideration and to the absolute preservation of substance. Rather, the non-distribution of the minimum dividend is also justified if this is necessary at the time of the decision – i.e. at the time of the resolution of the shareholders’ meeting on the allocation of profits – “to maintain the status achieved vis-à-vis competitors“, i.e. to maintain the company’s competitiveness.

According to the Regional Court of Stuttgart, a schematic determination of a minimum period is also not permissible. However, if it is already clear when looking at a short period of time in the future that the company would become illiquid if the minimum dividend were to be paid out, there is no need to explain the company’s further planning up to the end of the planning horizon.

If a resolution on the allocation of profits of a stock corporation is challenged on the grounds that the statutory minimum dividend pursuant to Section 254 I AktG was wrongfully not distributed, although this would have been possible, then according to the Regional Court of Stuttgart, the court’s review of the resolution must take into account the fact that the majority decision (and the management proposal usually submitted on this) has an inherent forecasting element. From a debt or liquidity perspective, the basis for judgment can only be an entrepreneurial planning calculation, which is subject to limited judicial review.

The assumption will correctly have to be made that the higher the profits already retained, and the net retained profits now reported are, the stricter the requirements for the assessment. By contrast, one must also come to the conclusion that the lower the retained profits are, the easier it will be to justify a retention.

Nevertheless, one should be aware that the shareholders’ meeting is also at liberty to pass a new, possibly only slightly different resolution on the allocation of profits, which again may not satisfy the minority shareholders. Although they can again bring an action for avoidance, this also bears considerable (cost) risks and does not necessarily lead directly to the desired profit distribution.

German limited liability company (GmbH)

 

The limited liability company also has a principle of majority rule. This is set out in Section 47 I GmbHG (German Limited Liability Companies Act). In the case of profit distribution, it is affected by the corporate duty of loyalty based on Section 242 BGB (German Civil Code) – which applies in particular to the internal relationship between the shareholders. Although the profit distribution interests of the minority company must be taken into account, this does not typically result in an enforceable claim for dividend payments.

Shareholders’ balancing decision

 

At the heart of this consideration is the balancing of the distribution interests of minority shareholders with the company’s need to secure its further existence and self-financing.

The Higher Regional Court of Nuremberg (judgment dated July 9, 2008 – 12 U 690/07) does not exhaustively list numerous interests on the company’s side: Among others:

  • the objective of the company and the resources required to pursue it,
  • adequate (investment) planning,
  • the economic situation of the company, its equity base, the amount and availability of existing reserves,
  • its creditworthiness and the amount and term of liabilities,
  • the general economic and market situation,
  • the outlook for the industry in question,
  • the necessity of any precautionary measures for damage and warranty claims,
  • any special equity requirements with regard to shareholder withdrawals and
  • the necessity of research and development efforts.

According to the Higher Regional Court of Nuremberg, on the side of the minority shareholders, their economic situation and their interest in an appropriate return on the capital investment, especially taking into account the extent and amount of past profit distributions, must be taken into account.

Burden of Proof

 

In terms of the burden of proof, the respective reasons for the (full) retention must be provided by the company in order to allow for a legal review. However, it is then up to the minority shareholder to demonstrate that this decision was completely unjustifiable. According to the Higher Regional Court of Nuremberg, judicial intervention in these decisions is only permissible if the overall consideration of these circumstances would only allow one decision and all other possible decisions would be flawed, as otherwise the court would be making entrepreneurial decisions.

This interpretation probably also corresponds to the legislator’s intention. The legislator deliberately decided against a comparable standard to Section 254 AktG for the limited liability company.

Therefore, the regulation from Section 29 GmbHG remains applicable. According to Subsection I, each shareholder has a “claim” to their respective profit share, but according to Subsection II, this can be allocated to revenue reserves or carried forward as profit on the basis of a simple majority vote.

This intentional decision by the legislator shows that there is no unintended regulatory gap for an analogous application of the provisions of the AktG. The even weaker protection of minorities in the case of the limited liability company, particularly with regard to the retention of profits, is criticized with good reason, but the result is nevertheless not in dispute.

Conclusion

 

Minority protection is relatively weak for both the limited liability company and the stock corporation. The law does not provide for an enforceable claim to profit distribution, and the existing legal instruments generally only give rise to such a claim in the most exceptional cases. While this might seem surprising at first glance, it is arguably what the legislator intended.

Ultimately, acquiring a shareholding in a corporation is also a substantial decision that not only offers opportunities but also harbors considerable risks. A minority shareholding in a company should therefore be considered carefully and, above all, only be made with an awareness of the existing risks and the potential lack of influence. If stronger minority protection is desired, this can and must be laid down in the shareholders’ agreement or in the company’s articles of association.

We hope that we have been able to assist you with this information.
If you have any further questions, please contact us:

Lorenz & Partners Co., Ltd.

27th Floor, Bangkok City Tower, 179, S Sathorn Rd,

Thung Maha Mek, Sathon, Bangkok 10120

Email: [email protected]
www.lorenz-partners.com
+66 (0) 2 287 1882

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