Position of a Director - CEO

Overview of the topics

• Liability Traps of CEO during the Formation of the Company,
• Liability Traps when Conducting the day-to-day Business of the Company
• Liability During Crisis and Bankruptcy of the Company
• Quitting as a CEO

Who is eligible for being a director? Are there any restrictions – especially for foreigners?

Generally, anybody having full legal capacity to sign contracts may become a CEO. The following exclusions do exist:

• partially or in full restricted to close contracts on his own,
• prohibited by a final court verdict or other authoritative decision banning from a certain profession, or kind of trade if the line of business of the company is the same as the ban,
• punished for committing “commercial crimes”:
  • bankruptcy crimes,
  • providing tampered details on your company's setup,
  • any such crime committed and sentenced abroad.
• Shareholder who intentionally or negligently appoints a director who is not eligible for such situation.

Do I have to live in Germany to be a director of my company?

No. Residence and the position of a CEO are two absolutely different issues! If you want to live and work in Germany then you will have to apply for a residence permit either on employment, Blue Card EU, or Entrepreneurship (when owning a significant amount of shares).
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Appointing a Director

How do I get a director into my company?

This is a two step process:

1. express appointment – orally or in writing
   and
2. entry into Commercial Registry by the company's director.

The shareholders have to resolve on this topic best in writing and the new director can have himself registered in front of a notary.

When is the candidate legally appointed as director?

Once the principal employs the candidate as a Geschäftsführer. The entry in the Commercial Registry is actually only declaratory. However this may be, the director will still have to visit a notary to apply to have him registered with the Registry. This is important to prove your appointment in everyday business!

Can my business partners rely on the Commercial Registry? Really?

All participating in business may rely on the contents of Commercial Registry. If you do not update any changes, this can be held against you! In contrast to the German approach: e.g. the Companies House in UK does not guarantee the correctness of its database. This phenomenon is why there is such circumstance in bringing anything into the Commercial Registry.

Liability Traps of CEO during the Formation of the Company

What is the most typical risk for a director when founding the corporation?

The main risk arises if the director engages in business prior to the corporation's entry in the Commercial Registry (§11 II GmbHG). Business prior to registration, establishes personal liability of the director or acting shareholders until the entry has been published in the Federal Gazette. If there is more than one shareholder, for your own freedom from liability make sure to get written instructions signed by all shareholders on what you are allowed to do during the phase of founding the corporation. What the heck is the notary refering to when he talks of a "Unterbilanzhaftung"? He could not even translate it into English! It sounds like I am liable when the draft of my balance sheet is subpar.

Haha. It has nothing to do with the formating of any balance sheet! Law expects you to supply your company with sufficient funds for the initial capital when you are registering it. Though you are allowed to operate, you remain liable for any damages until the company has been entered into the Commercial Registry. N.B. you are fully liable with all your private assets in this phase. In practice, this rule is mostly relevant for GmbHs when the shareholders do not timely fund the company and yet start business interaction.

Liability Traps when Conducting the day-to-day Business of the Company

What are my duties as director to observe during normal ongoing business. These are the most common duties:

• catch-all clause: duly managing the company,
• distribute resolved profits to shareholders,
• activities towards creditors of the company,
• tax and social security duties,
• forwarding social security premiums,
• ban on competition,
• register changes amongst shareholders,

What about the company's funds? May I not spend the capital paid to fund the company?

One of your major and core duties towards the company is to maintain its liquidity. Therefore, §30 I 1 GmbHG determines that payments against the capital stock may not be passed on to the shareholder. If this rule is violated, you will be liable to the company.

My shareholder is asking for a loan from the company and I prefer not to do that. I am reluctant, since the shareholder is financially pretty weak.

It is generally a good inclination to be careful – especially with shareholders. Some shareholders erroneously believe company funds are their own… The question of whether to grant a loan is beyond your competence. However, it is one of your important duties to check if the debt can be repaid at any time or if there any means for securing the loan. A violation constitutes liability for damages towards the company.

With one shareholder warded off, another one comes in and also needs a loan – as if I don't have anything else to do. But this one is really crazy! He wants a loan of three times the annual turnover. If that happens it will kill the company. Argh. What am I to do?

Simple! Deny the loan. Why? Any payment that leads to bankruptcy of the company has to be denied. This liability will not be towards the public but to the company. It is important to collect as many documents as possible in regards to such approach. These documents are to show the financial status of the company and at best the requiring shareholder's personal financial status. Save any information that can exempt you!

I arranged a contract with a supplier for the company. Unfortunately everything went wrong and the contract was voided. When I say everything, I really mean everything! This idiot supplier is telling me that I have to bail them out for their damages just because my company's letterhead was insufficient.

Though this might sound strange, never forget that Germans love formalities! This is another example of the Germans' desire to have everything correctly and meticulously detailed. This problem is actually based in the “law of agency.” You must clearly communicate exactly who you are representing. In German, it is a significant difference to say „Peter Pan Airlines” and “Peter Pan Airlines GmbH”. It is the difference between a physical person and a legal person. This rule applies to emails, faxes, and just any kind of “manifested” correspondence.

The tax office has assessed me for the company's taxes! WTF... Isn't the company supposed to be liable for taxes? I don't see why I have to have any worries.

Don't ever forget, the company, as a juristic person, is only a fiction. The company acts via a physical person, the director (= legal representative). It is always the person who acts that is responsible. You, as the CEO, are to make sure that the tax returns are submitted on time, as well as wage tax payments and social security premiums are punctually forwarded. The greatest trap for a CEO is in times of illiquidity to just withhold wage tax and pay the full salary to the employer.

Well, what am I supposed to do to if my company is in a liquidity crunch and it cannot pay all costs right now? Though I would love to refrain from paying the taxes but from what you say that is not a good idea.

If this liquidity crunch is a “one-off” then just pay wage tax, social security and remains after that to the employee. Be sure to discuss this in advance with your employee to maintain his solidarity. If this is something still far away from bankruptcy, you can negotiate to reduce the wages, and thus reduce the tax burden.

Okay, I have the liability to forward social security. So what? If I can't pay, I go bankrupt or leave the country. What are the consequences?

To start with the worst first, you will be subject to imprisonment not exceeding five years or a fine. If you want to defend yourself with any excuses, forget it! You actually have no chance to defend yourself against prosecution!! German authorities show no mercy or pity when the social system is touched. Next to that there is also a civil law liability for damages

After an audit of the company, the shareholders wanted me to reimburse the company for VAT and default interest because of incorrect invoices I allowed to be issued. That can't be true, can't it?

Such is imaginable because one of your main duties is to correctly issue invoices not only by what is sold but also with the correct VAT percentage. Admitted, you cannot know everything, but then you have to get the correct information.

I heard through the grapevine that a colleague was held liable from contractual partners of his company for not having reported a change in the persons of the shareholders and their shares. What does that relate to?

This relates to your duty pursuant to §40 I GmbHG to report any changes in the corporate structure to the commercial court, the Amtsgericht, of registration. In the event that the shareholders act independently from you to organize a notary, you will not be held liable for any damages if you were not correctly informed §40 III GmbHG.

Liability During Crisis and Bankruptcy of the Company

What am I to do when the company starts tilting?

The period when a company is in a liquidity crunch that may lead to the company's insolvency is the most problematic time for a director! The CEO has the highest duties and obligations. His or her civil law and criminal law risks go hand in hand. The following Q&A will give you a basic idea and guidelines for what to consider.

Gee, it seems as if the company is about to sink. The turnover seems to be in constant decline. I have no clue if we are heading towards bankruptcy or not. What am I to do?

What an awful situation! The first thing to do is to get the financial statements from your tax consultant, then call an urgent shareholders meeting to discuss and analyze this liquidity crunch. Explicitly label the invitation “Discussion of Liquidity Crunch”. The clear labeling is to prevent any liability or criminal prosecution on your end. This is your statutory duty, see §49 III GmbHG. Maybe even invite your accountant and a specialized business consultant.

What should be discussed during this meeting on the liquidity crisis?

The shareholders are to determine whether or not more funds are to be provided or to file for bankruptcy. The latter is in general a requirement when a severe illiquidity crisis exists and it is not just a large drop in turnover (which was expected and intentionally spent); if the annual report shows the loss of half of the capital stock, you must call a shareholders meeting! Failure to do so leads to civil liability pursuant to §43 II GmbHG as well as criminal liability following §84 GmbHG.
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Gee, our company has really been hit badly! We are waiting for this one project to come through and we will be saved for another half year. We are virtually broke. But what am I to do if the project fails?

Be careful with whatever you do! You must make the correct decision quickly! If you are going to apply for bankruptcy, you only have three weeks' time after illiquidity of the company to request the opening of insolvency proceedings. If you fail to do so, you can be held personally liable with all your personal assets – even if you have to go bankrupt. The only way to prevent your liability is to apply for bankruptcy. If you err, well, you can always withdraw an application.

Phew! Although our company is insolvent, we have several CEOs. I am glad that I don't have to lose face among the shareholders. Maybe one of my colleagues will apply for insolvency.

Wait a minute! This duty applies to all directors – regardless of how many there are. It also doesn't matter if you only have certain responsibilities or specific directions from the shareholders. You can't avoid responsibility. The three weeks’ time is maximum! However, this time limitation does not count for concrete efforts for recapitalization with realistic expectations.

When is a company bankrupt?

Excess indebtedness or insolvency exists if the company is not able to meet due payments. Suspending payment constitutes the legal assumption of inability to pay! A debt overload is legally assumed if the currently existing assets cannot match the outstanding debts, unless, based on current facts, continued operation will predominantly show the opposite.

Wow! That sure sounds strict! How often and when do I have to test the financial situation of the company?

You have to continuously monitor the situation. This monitoring is best done by diligently studying the financial assets from your tax consultant.

Okay, what I am to do now? I applied for insolvency but our creditors still demand payment and the tax office is sending its reminders. Now whom do I pay what and when?

You do not pay anyone anything anymore! Nothing – unless you want to be held liable pursuant to §64 cl. 1 GmbHG. Payment, if at all, is actually only something for the bankruptcy manager. However, the law provides that a prudent businessman may still make necessary payments. Nevertheless, resist that temptation! Just declare bankruptcy and that's that. The legal situation is much too complicated to dare do something like that on your own!

I've got an idea how to work around this liability issue. I just resign shortly before the company is officially bankrupt. Will that not work?

Nice try, but that won't work!

Quitting as CEO

After having left my previous company, I opened my own business in exactly the same line as my previous employment. My prior bosses were “not at all amused”. They demanded that I stop competing with them. My employment contract did not contain any stipulations for any kind of no-compete clause after my employment ended. What am I to do? Give in?

There are two sources for such demand of your previous employers to be found. This can be either the employment contract, and if not there, then the law will have to be consulted. As you say, your contract does not provide any such stipulation. Therefore the prior company has no rights to demand you to close down the company. The law does not regulate this situation. So if the contract does not specifically prevent it, then your previous employer has no right to demand that you stop competing with them. This again shows how important contracts are!

I just left my corporation and all of a sudden somebody wants to make me liable for not paying social security premiums. Huh? That cannot be, can it? There must be something going wrong, I left the company!

Well, maybe not. Leaving a corporation as a director is not that easy! There are labor as well as corporate legal rules to be considered. When you left, you only terminated your employment with the company. The corporate obligations remain until you have been struck from the commercial registry as director. So, when leaving a corporation, don't just end your employment, but also get yourself out of the registry. Take care of this ASAP! You personally can only do this as long as you are still director – before giving notice to the shareholders.

That sounds as if I need a lawyer to keep me out of trouble when I quit. What would be the scope of consultation that I need?

First of all, relax. You will really only need legal consultation if you do not amicably leave the company! In that case the questions for consultation will be:

• strategic consultation when preparing to leave,
• strategies to prevent any kind of liability after you have left,
• preparation of required resolutions and shareholder meetings to terminate your position as director,
• representation of director's interests inside and outside of court in disputes regarding dismissals or revocations,
• measures in regards to temporary injunctions.

What is actually needed to withdraw as director, so that all relationships/ties to the company end?

The shareholders have to meet and formulate a board resolution to terminate and exonerate the director. Typically a withdrawal is given with important reasons and secondarily given normal notice (“ aus wichtigem Grund und hilfsweise ordentlich gekündigt”).

I’m contemplating with the idea of finding a new working environment. What is the time limitation for giving notice?

The law provides that a director can be dismissed at any time. However, the contract or Articles of Association may stipulate that a CEO can only be dismissed under certain conditions. Withdrawing from the status of a Geschäftsführer is always possible for extraordinary reasons! Such reasons include the inability to carry out the duties of the position or the infringement of important rules, thus making it impossible for the shareholders to keep the director – weighing the interests of both sides.

Hah! These idiot partners want to throw me out of the company. Hah! I have shares in the company and I will vote against that. Even if I only create a stand-off, I will have won because everything will be stalled. Hah!

Wake up from dreaming! Sorry, I had turn on the alarm clock for you to wake up! Nice idea, but it won't work because your vote as a shareholder will exceptionally not count – in this particular situation. Even if you come to a standoff, that is not the end of the dispute. A new level will be reached because then this dispute will go to court. However, if you wish to stall this process, the court has its own rules and will soon decide with full legal effect. Two sets of lawyers and a regional court will be involved.

Geee, we are going nowhere. The company lost its director, the shareholders can't decide on a new one. How is the company to operate now?

That is not a big problem. Upon application, the court might install an emergency director on a temporary basis (so-called “Notgeschäftsführer ”). However, courts are extremely reluctant to install by their order because the shareholders are to expected to decide by themselves.

I just got fired and am wondering about the normal period for terminating such labor contract. How much notice do they have to give?

The normal rules and regulations for firing employees are not applicable to CEOs as they are not considered as such. However, the rule for terminating on extraordinary grounds remain. Shareholders have to give notice within two weeks after having received knowledge of facts that lead to immediate termination. Otherwise, there is no time limitation to give notice – when the articles of association say nothing else.

Working for my company sucks! I want to quit. How soon can I leave?

Generally, you can leave whenever you want and without any special reason. However, take a good look in the articles of association. If the articles stipulate anything else, then that will be binding! Your revocation is usually announced at any shareholders' meeting. Do it in writing! Cancel both your position and employment and make sure you are deregistered without undue delay!