Brexit – impact for British companies operating in Germany

Posted by Sascha Stiegler

February 2017

Pros and cons of setting up a private limited company in Germany

Last year the British people decided to leave the European Union. Since then ‘Brexit’ has been on the business world’s mind. The upcoming exit of the UK from the EU could also have a significant impact for British private companies limited by shares based in Germany. At the beginning of this century, the liberal judgments handed down by the European Court of Justice on the freedom of establishment (Arts. 49, 54 TFEU) allowed many German founders to set up foreign companies as ‘letter box companies’ or ‘pseudo-foreign companies’. Such a company could legally establish its head office or ‘real seat’ in a Member State (e.g. Germany) different from their place of incorporation (e.g. the place of their registered office). The benefit of setting up a British private limited company was seen in the fast (possibly even on the same day) and cheap (less than EUR 100) incorporation. But the number and importance of such British letter box companies registered as domestic branches (Sec. 13d et seq. of the German Commercial Code [Handelsgesetzbuch – HGB]) in Germany has decreased signifi-cantly over the past few years. While more than 50,000 private limited companies had head offices in Germany at the peak of their popularity, less than 10,000 exist today. The reasons for this decline include the introduction of the German ‘entrepreneurial company’ or UG (haftungsbeschränkt), the UK’s stricter accounting provisions, the perceived lower creditworthiness of private limited companies and the application of certain liability regimes under German law also to foreign companies based in Germany.

Potential impact of the UK leaving the European Union

In the upcoming ‘Brexit’, the questions arise what will happen to existing private limited companies with their head offices in Germany and how such companies can avoid the potential risks attached to the UK leaving the EU. Private limited companies registered as domestic branches in Germany could – at worst – not invoke the European freedom of establishment anymore. As a result, the (European) legal basis would disappear for the recognition of such pseudo-foreign companies incorporated in another Member State. The private limited company may even be forced to convert into a German partnership. The worst consequence of this would be the unlimited personal liability of all former shareholders, who would then be viewed as partners in a general partnership.

What should private limited companies based in Germany do?

To prevent this, two options are worth considering. First, it is possible to carry out a cross-border conversion (grenzüberschreitender Rechtsformwechsel) of a British private limited company into a German ‘limited liability company’ (Gesellschaft mit beschränkter Haftung – GmbH). Such a conversion into a foreign company is permitted in principle according to the European Court of Justice. You won’t find explicit provisions on this, though, either in the British Companies Act 2006 or in the German Reorganization Act (Umwandlungsgesetz – UmwG). Yet two German courts have already recognized such a cross-border conversion into a GmbH by way of (analogous) application of the German Reorganization Act.

The second option – which may provide a higher degree of legal certainty – is a cross-border merger (grenzüberschreitende Verschmelzung). National rules on the basis of European Union legislation apply, allowing such a cross-border merger both under German law (Sec. 122a et seq. of the Reorganization Act) and under British Law (Companies Cross-Border Mergers Regulations – CBMR 2007). But the drawback of this option is that at least two companies have to be involved for a merger. Smaller startups in particular usually don’t have (foreign) subsidiaries, and neither do they plan to incorporate one only for the above reasons as the incorporation of a German GmbH is not as cheap as a British private limited company. Nevertheless, carrying out a cross-border merger instead of a cross-border conversion is an attractive option due to legal certainty it provides.

Of course, the question remains as to how likely it is that existing British private limited com-panies with domestic branches in Germany will lose all their current privileges as foreign companies. Even in the event of a ‘hard Brexit’, either the UK might gain the status of a European Economic Area (EEA) member or Germany and the UK may enter into a bilateral trade agreement. The former scenario would mean that the European freedom of establishment would continue to apply and British companies in Germany could still be recognized as foreign corporations. In the latter scenario, a bilateral agreement could state that the legal personality of companies from the respective other country has to be recognized unconditionally. This is the case in the treaty between Germany and the US. Then, basically nothing would change compared to the existing legal framework.

Given the high degree of legal uncertainty prevailing at the moment, it may not be advisable at this stage to incorporate new private limited companies with the sole or primary purpose of operating from Germany. However, if any existing private limited company with domestic branch office in Germany is no longer recognized here one day, tools exist to convert it into a German entity. The same also applies to existing private limited companies or public limited companies without any domestic branch offices in Germany that are to be relocated to Germany.