Liability Traps While Founding the Company

As the legal representative of a corporation, a lot is expected of you. Dangers sometimes come from inside the company and sometime from the outside. We will be describing liability risks while the company is being founded.

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

The main risk arises if the managing 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 managing 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.

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

The CEO has extensive duties to observe during normal ongoing business. LG2G has listed the most common duties.

They all will be introduced on individual pages if not listed below.

What about the company’s funds? May I not spend the capital stock to finance assets for 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 (§43 III GmbHG).

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 pursuant to §43 II GmbHG.

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 (§64 cl 3 GmbHG) 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 best of 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.

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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 fictitious. The company acts via a physical person, the managing 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.
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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?

CEO behind bars

To start with the worst first, you will be subject to criminal prosecution pursuant to §266a I StGB – 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 based on §823 BGB i.c.w §266a StGB.

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. Admittingly, you cannot know everything, but then you have to get the correct information.

I heard it 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.