The GmbH is considered a popular legal form in Germany, primarily because of the liability protection for the shareholders. However, under certain circumstances, this security can be breached, which can also make the shareholders unexpectedly liable for their private assets.
Cases of encroachment liability
Below we take a brief look at these exceptions and their conditions, which can trigger personal liability for shareholders:
Undercapitalization :
A GmbH must be adequately capitalized in order to start and run its business operations . If this is not the case, liability of the shareholders can be discussed in extreme cases. Case law has not yet established any clear criteria as to when exactly thin capitalization is considered, which makes this group of cases particularly controversial.
Example:
Let's imagine a fictitious company in the legal form of a GmbH, which was founded by its only shareholder, Max. Max decides to found a start-up in the field of high technology that specializes in the development of innovative energy efficiency solutions. To found the GmbH, Max brings in the legally required minimum share capital of 25,000 euros. However, Max estimates the capital required for the development of technology, marketing, sales and operations of the company to be far below the actual needs.
In fact, at least 500,000 euros would be needed to successfully take the company from concept to market launch. In the first few months after it was founded, it quickly becomes clear that the GmbH is significantly underfinanced. Max has not found any other investors and the GmbH can no longer pay its bills because the paid-in share capital is nowhere near enough to cover the running costs. In addition, the development costs for the new technology are significantly higher than originally calculated. Max tries to close the financial gap with private loans, but these aren't enough either.
The GmbH gets into financial difficulties and suppliers begin to sue for their claims. In this situation, a creditor could attempt to assert liability against Max personally by arguing that the LLC was undercapitalized to begin with. The creditor could claim that Max, as a shareholder, breached his duty of care by not providing the company with sufficient capital for planned business operations and technology development.
This would create a risky financial situation in which the GmbH's creditors were exposed to an increased risk of default from the start. In reality, however, the legal situation regarding pass-through liability due to undercapitalization is complex and the hurdles to successful enforcement of liability are high.
Nevertheless, this example illustrates how significant undercapitalization can lead to serious legal and financial consequences for the shareholder, particularly if it jeopardizes creditor interests.
Commingling of assets :
This occurs when the assets of the GmbH and the private assets of the shareholders can no longer be clearly separated. Such a situation can lead to personal liability for the partner as the boundaries of assets are blurred.
Example:
Max is the sole shareholder and managing director of a GmbH, a small company that specializes in the import and sale of exotic foods. The GmbH operates a warehouse and a small office, both on property that Max personally owns.
Over the years , Max has begun to separate the GmbH's finances and his personal finances less and less strictly. He uses the GmbH business account for personal expenses, such as buying a new car and renovating his private home. At the same time, money from his private assets flows into the company in order to bridge short-term liquidity bottlenecks, without these transactions being properly documented as loans. In addition, some of the GmbH's premises are used privately by him and his family, without any market rent being paid to the GmbH. Business and personal records are stored together and there is no clear separation between business and personal inventory.
This mixing of assets means that if the GmbH is in financial difficulties, it can no longer be clearly distinguished between the company's assets and Max's private assets. Creditors of the GmbH could argue that due to the mixing of assets, a clear demarcation between the assets of the GmbH and those of Max is not possible. Under certain circumstances, this could result in Max being held personally liable for the GmbH's liabilities, as the mixing of assets could justify pass-through liability.
Mixing of spheres :
If a shareholder does not clearly communicate to third parties which legal entity he is acting for, and this creates the impression that he is personally responsible for liabilities, this can give rise to pass-through liability.
Example:
Max is the owner of a GmbH that offers high-quality interior furnishings and, at the same time, runs a home accessories business as a sole proprietor. Both businesses are located in the same building that Max owns, and Max uses the same phone number and website for both businesses, without clearly differentiating between the two.
Customers who visit the website or call the store do not always receive clear information about which of the two companies they are dealing with. Invoices for GmbH services are sometimes issued on the sole proprietorship's letterhead and vice versa. When negotiating with suppliers and customers, Max often does not clearly represent either of the two separate business units, leading to confusion over authority and accountability.
Employees from both companies share space and resources, such as office supplies and IT infrastructure, without a clear allocation of costs to the respective companies. In addition, Max also uses the GmbH business account for sole proprietorship transactions and personal expenses.
In the event of legal disputes or financial problems of one of the companies, this mixing of business spheres can lead to creditors citing a lack of clarity between the two business areas and between business and private matters. You could argue that because of the mixing of spheres and the resulting ambiguities, Max should be personally liable for liabilities that should actually be attributable to the GmbH. The risk is that due to the lack of differentiation, the courts will assume pass-through liability and hold Max directly liable, which could jeopardize his personal assets.
Abuse of legal form and institution :
This concerns cases in which the GmbH structure is used to harm creditors. Here, too, the question arises to what extent the general liability rules of the German Civil Code (BGB) are sufficient or whether specific comprehensive liability rules should be applied.
Example:
Max is the managing director and sole shareholder of a GmbH that specializes in management consulting. However, in addition to consulting, Max has a plan for how to use the GmbH structure to avoid personal debt while putting his creditors at a disadvantage.
Max founds the GmbH with the minimum required share capital and begins to offer his consulting services. At the same time, however, he has significant personal debts that he cannot or does not want to pay off. In order to protect himself from his private creditors, he begins to transfer his personal assets to the GmbH by "selling" these assets without actually receiving adequate compensation from the GmbH. This is concealed through manipulated contracts and accounting.
Shortly afterwards, the GmbH takes on high business debts, for which Max signs as managing director. However, he consciously and systematically withdraws the funds collected for personal purposes instead of using them for the growth or security of the company. He also uses the GmbH to make personal purchases and investments, which increasingly blurs the boundaries between his private assets and the assets of the GmbH.
When the creditors of the GmbH want to assert their claims, it turns out that the GmbH has hardly any usable assets because Max has systematically taken them for personal purposes. At the same time, her personal assets have been formally reduced through the fake sales to the GmbH, which makes it more difficult to enforce her private claims.
In this case, a court could come to the conclusion that Max misused the GmbH as a legal form in order to enrich himself personally and at the same time disadvantage his creditors. This would represent a clear case of abuse of legal form and institution, which could lead to personal liability for Max to compensate the injured creditors.
Existence- destroying intervention :
Actions that deprive the GmbH of its assets to such an extent that it can no longer meet its obligations lead to personal liability. However, these interventions must be of a certain severity in order to be considered immoral harm.
Example:
Max and Pia are the partners of Maschinenbau GmbH, which specializes in the production of special machine parts for the automotive industry. The company has built long-standing relationships with its key customers and enjoys a good reputation for quality and reliability. At the same time, Max and Pia are also involved in a start-up that is developing a new technology that could revolutionize production processes in the automotive industry.
In order to move the start-up forward quickly, Max and Pia decide to withdraw financial resources from Maschinenbau GmbH and invest in the start-up. They believe that the potential profit from the start-up will far exceed the GmbH's current business. Without informing the other shareholders or the creditors of the GmbH, they divert a significant part of the working capital and reserves into the start-up. This means that Maschinenbau GmbH is no longer able to pay its current liabilities, as a large part of its liquid assets is now tied up in an unsecured and speculative investment.
When the suppliers and lenders of Maschinenbau GmbH insist on the payment of outstanding invoices and the repayment of loans, the GmbH has to file for bankruptcy because it has become insolvent. The sudden bankruptcy leads to job losses, financially damages suppliers and lenders and destroys the company's good reputation.
In this case, it could be argued that Max and Pia have committed an act that destroys the existence of the start-up by misusing the assets of the GmbH for the start-up. This intervention led directly to the insolvency of the GmbH as it was no longer able to meet its obligations. A court could classify this as abusive behavior that harms the GmbH's creditors and hold Max and Pia personally liable to compensate for the damages caused.
Final consideration
Pass-through liability is a complex and controversial area of law. The cases in which shareholders have to be personally liable are narrowly limited and require serious misconduct. This underlines the importance of dealing responsibly with the legal form of the GmbH. A legal clarification of this matter could help clarify matters, but practice shows that case law already finds a balanced path between protecting creditors and promoting economic freedom. Nevertheless, it is essential for entrepreneurs to be aware of the potential liability risks and to minimize them through careful business management.
The lawyers in our office will be happy to help you clarify your questions.
