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Brexit and the UK limited – Is an end to the limitation of liability avoidable?

The UK’s exit from the EU on 31.1.2020 further raised the pressure on UK Limiteds (Ltds.) registered in German commercial registers. Admittedly, in the Withdrawal Agreement, the EU and UK agreed that the current law would continue to apply during a transition period lasting until 31.12.2020. However, at the end of this period, Ltds. may no longer claim freedom of establishment, which is based on EU law. In Germany, Ltds. would then be exposed to the risk of not being recognised there any longer and their shareholders would be personally liable in accordance with Sec.128 of the Commercial Code [Handelsgesetzbuch, HGB].

Legal situation prior to Brexit and ...

Prior to Brexit, ’incorporation’ theory based on the EU freedom of establishment provided the legal foundation for the recognition of a Ltd. with its head office in Germany as a corporation with a legal personality and limited liability. According to the ’incorporation’ theory, German company law does not apply to such companies; in particular, this concerns the requirements with respect to the formation of a corporation and entering it into the German commercial register.

Please note: The number of Ltds. in German commercial registers had admittedly already been continually going down prior to the looming Brexit, nevertheless, as at 1.1.2019 there were still approx. 6,500 of them.

… after the transition phase

The consequences for Ltds. with head offices in Germany as of 1.1.2021 will largely depend on whether or not a comprehensive agreement between the UK and EU can be concluded and what it contains.

The German perspective – no grandfathering …

In the legal literature it has only occasionally been assumed that, even after Brexit, Ltds. will still be able to invoke freedom of establishment, possibly with the argument that these are based on companies incorporated in accordance with the statutory provisions of a member state. A more prevalent consideration in legal writings is the enactment of a grandfathering provision for Ltds. for a certain period of time. However, it is questionable as to whether or not this could also apply after the transition period as, after all, it would give the Ltds. concerned the option of being operative. Moreover, with the creation of Section 122m of the Reorganisation Act [Umwandlungsgesetz, UmwG], the German government clearly positioned itself against any further grace periods.

… but instead the ’real seat’ theory will apply …

The predominant view is that the ’real seat’ theory – which evolved from German case law pertaining to foreign enterprises from third countries – should apply directly to Ltds. once they are no longer able to invoke the freedom of establishment. According to the ’real seat’ theory, the place where an enterprise has its administrative headquarters will be decisive when determining which law system is applicable. According to the settled case law of the Federal Court of Justice [Bundesgerichtshof, BGH], this would result in a Ltd. no longer being regarded as a corporation. Instead, a Ltd. would either be treated like a general partnership [offene Handelsgesellschaft, OHG] if it conducts commercial business, or else as a company under civil law [Gesellschaft bürgerlichen Rechts, GbR]. If the Ltd. has only one shareholder then it would be viewed as a sole proprietorship by way of universal succession.

… with the consequence that the limitation of liability will cease under English law and …

The shareholders of a Ltd. would no longer be able to invoke the limitation of liability provided under English law and, analogously to Section 128 HGB, would be personally liable for the obligations of the company, or as a consequence of universal succession would become the party that is directly liable. Up to now, there has not been any clarification with respect to the issue of whether this would also apply to old liabilities or only to those that arise subsequent to the change of legal form.

… there is a need for further clarification

Furthermore, following an automatic change of legal form, former directors of the Ltd. who are not shareholders themselves will no longer be entitled to represent the emerging partnership if they have not been authorised accordingly. Moreover, there has so far not be any definitive clarification as to whether or not changing the legal form into a partnership and transferring of assets to the sole shareholder would result in fair value adjustments from the realisation of “hidden reserves“ of the former Ltd company.

UK perspective

From a UK perspective, the application of the German ’real seat’ theory and the legal changes in Germany associated with this would have no consequences for the existence of the Ltd. According to the ’incorporation’ theory that applies under English law, the Ltd would continue to exist as a limited liability corporation.

Please note: Accordingly, the legal consequences under German and English law could potentially differ from each other.

Problems can be avoided by carrying out a cross-border merger still during the transition period

There is one option for avoiding the negative consequences of Brexit for a Ltd. that can still be used during the transition period, thus at least until 31.12.2020. This would be a cross-border merger with a German company, as was already possible previously for a Ltd. The legal basis for this exists both in Germany, under Sections 122a ff. UmwG, as well as in the United Kingdom, under the UK Companies (Cross-Border Mergers) Regulations 2007; such an arrangement would also be recognised under EU law (cf. ECJ, judgement from 13.12.2005, case: C-411/03, SEVIC Systems AG).

Please note: Based on experience, the above-mentioned merger arrangements would take around three months to realise, therefore, there is now an urgent need to take action in order to still be able to use the transition period to adopt the appropriate measures.

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