Resolution deficiencies in a German Stock Corporation – what can I do?

Action for avoidance and cancellation as effective participation rights of Shareholders of a German Stock Corporation!

Although Shareholders are the legal owners of the Stock Corporation, they possess little sway over the Managing Board. One of the few and likely the most pivotal means of affecting the future trajectory of the public limited company is by commencing legal action over inadequacies in decisions. Shareholders may launch a legal review of decisions made during the Annual General Meeting, as these often bear significant consequences for the future of the company. The Executive Board, on the other hand, has a vested interest in ensuring that the AGM’s resolutions are passed without errors to ensure smooth implementation. The section below outlines the available options for Shareholders to contest the legitimacy of resolutions approved during the Annual General Meeting, as well as the actions the Management Board can take in response to these challenges.

Void or just contestable?

Right from the outset, it is crucial to differentiate between defects that only render the resolutions in question contestable and those that result in the direct nullity of the Annual General Meeting resolutions. Based on practical frequency, it is possible to distinguish that contestability in the case of defects in resolutions is the norm, while nullity of a resolution of the Annual General Meeting tends to be an exception in practice. The severity of the defect determines the legal consequences which ensue. The severity of the defect determines the legal consequences which ensue. Where direct nullity arises, the resolution is deemed illegitimate, resulting in its complete lack of intended legal effect. In contrast, contestable resolutions can still be effective, unless a court judgment deems them null and void. It is only at this point, and not before, that a contested resolution becomes null and void, with retroactive effect.

Who can bring an action against resolutions of the Annual General Meeting?

First and foremost, Shareholders have a right of avoidance as an administrative right arising from their membership. However, Section 245 No. 1 of the German Stock Corporation Act (AktG) contains three restrictive conditions for the right to rescind, which the Shareholder must fulfil in order to be able to bring an action for rescission. First, the plaintiff must have attended the General Meeting, which is to be determined on the basis of the attendance list to be drawn up by the Chairman of the Meeting. It is not necessary for the plaintiff Shareholder to have been present in person; it is sufficient to have participated by means of electronic communication, if provided for by law or the articles of association, or to have been represented by a proxy. Exceptionally, a non-attending Shareholder is also entitled to bring an action for annulment if his non-attendance is due to a cause within the sphere of the company, such as an unjustified refusal of admission, a lack of proper notice or an improper announcement of the subject matter of the resolution. In addition, the plaintiff must have acquired the share(s) before the announcement of the agenda and held them until the action for rescission became pending, i.e. until the action for rescission was filed. According to the prevailing opinion, the loss of the share after the lis pendens has arisen – e.g. through sale – does not affect the right to challenge, but the plaintiff may then have to demonstrate a legitimate interest in continuing the proceedings. Finally, the Shareholder must also file an objection for the minutes. For this purpose, it is sufficient for the Shareholder to state in his statement at the General Meeting that he does not wish to recognise the resolution as valid, so that a careful minute-taker can recognise the existence of an objection. In addition to the Shareholders, the Board of Directors as a body and the individual members of the Board of Directors and the Supervisory Board are also entitled to bring an action for rescission if they would commit a criminal or administrative offence or become liable for damages by implementing the resolution.

A Shareholder, the Board of Directors or Members of the Board of Directors and the Supervisory Board may also bring an action for annulment under Section 249 of the German Stock Corporation Act (AktG). In this case, however, Shareholder status is not an element of the right to bring an action, but a factual requirement to distinguish it from an action for nullity under Section 256 of the German Code of Civil Procedure (ZPO), which can be brought by anyone. In contrast to the nullity action, the existence of Shareholder status is determined by the time of the last oral hearing. If the plaintiff loses his or her status as a Shareholder during the course of the proceedings, the courts will continue the action as an ordinary action for declaratory judgment under Section 256 of the German Code of Civil Procedure (ZPO) and no longer as an action for nullity under Section 249 of the German Stock Corporation Act (AktG). However, this only occurs if the claimant still maintains a satisfactory interest in a declaratory action.

What is a serious defect? When is a General Meeting resolution null and void?

Defects that lead directly to the invalidity of the resolution without a court decision are listed conclusively in Sections 241, 250, 253 and 256 German Stock Corporation Act (AktG). These include:

• Serious errors in convening the meeting pursuant to Section 121 (2), (3) Sentence 1, (4) of the German Stock Corporation Act (AktG);
• Deficiencies in notarisation pursuant to Section 130 (1), (2) Sentence 1, (4) of the German Stock Corporation Act (AktG);
• Resolutions that are incompatible with the nature of a stock corporation;
• Resolutions the content of which violates provisions which exclusively or predominantly serve to protect the Company’s creditors or other persons in the public interest;
• Resolutions the content of which is contrary to common decency;
• Serious deficiencies in the election of Supervisory Board members pursuant to Section 250 of the German Stock Corporation Act (AktG);
• Resolutions regarding claims for the appropriation of profits, to the extent that these in turn are based on an invalid approval of the annual financial statements pursuant to Sections 253, 256 of the German Stock Corporation Act (AktG).

These statutory grounds for nullity are conclusive; in all other cases, the effectiveness of a resolution can only be removed by a successful action for annulment.

When can a resolution be challenged?

It follows from the above that, in principle, all defects that do not directly lead to the nullity of the resolution by operation of law justify its contestability. Restrictions in this respect only arise from Section 243 (3) Nos. 1 to 3 of the German Stock Corporation Act (AktG) – e.g. for participation rights exercised electronically. The defects that give rise to a challenge can be divided into procedural and substantive defects.

A procedural irregularity is any irregularity resulting from a breach of the law or the Articles of Association with regard to the passing of a resolution by the General Meeting. They may occur at any stage of the General Meeting. Failure to comply with the provisions of Sections 123 to 127 of the German Stock Corporation Act (AktG) – for example, failure to comply with the notice period, failure to publish or failure to comply with notification requirements – may already result in a procedural defect at the time the Annual General Meeting is convened. In the course of the Annual General Meeting, such deficiencies may arise, for example, in the form of unlawful exclusion of Shareholders, incorrect admission control or a violation of the Shareholders‘ right to information due to an unjustified refusal to provide information.

There are also a number of sources of error in determining the result of a resolution, in particular due to incorrect assessment of the required quorum by the Chairman of the Meeting, incorrect treatment of invalid votes or simple counting errors. However, case law has limited all these infringements to the extent that they only justify a challenge if they are relevant to the Shareholder’s right to participate, i.e. in the sense of a lack of information inherent in the resolution, which justifies the legal consequence of contestability pursuant to § 243 (1) of the German Stock Corporation Act (AktG).

In addition, defects in the content of the resolution of the General Meeting of Shareholders may also justify its contestability. In addition to violations of individual statutory provisions that do not already result in direct nullity, the focus here is on violations of the principles of the duty of loyalty under Stock Corporation Law and the principle of equal treatment codified in Section 53a of the German Stock Corporation Act. A breach of the latter presupposes unequal treatment of Shareholders that is not justified by the actual or legal circumstances of those affected. A breach of the social duty of loyalty results, for example, from the duty of the Shareholder to protect the interests of the company and not to act contrary to them. An other example of a breach is the act of voting in opposition to a voting obligation.

What is the mandatory deadline for the action for annulment?

There is also a time limit of one month for bringing an action for rescission under Section 246 (1) of the German Stock Corporation Act (AktG). This is mandatory and cannot be waived or extended by the parties to the proceedings or the court. There is also no possibility of full restoration. The deadline must therefore be observed in all cases from the perspective of the Shareholder bringing the action.

It begins at the end of the day on which the resolution was adopted (at the end of the last day in the case of a General Meeting that lasts several days) and ends at the end of the day in the following calendar month that corresponds in number to the day on which the period began. The law does not provide for a time limit for an action to set aside a resolution, although in certain cases it may be forfeited.

Curing the contestable resolution by means of a confirmation resolution

The consequences of an invalid resolution can be avoided by means of a so-called confirmatory resolution within the framework of Section 244 of the German Stock Corporation Act (AktG). In this case, the challenged resolution is replaced by a new, fully effective resolution. The content of this resolution must reflect the will of the General Meeting to recognise the first resolution as an effective corporate regulation for the relevant matters in the future, despite possible defects.

This procedure can only be considered in the case of formal procedural defects, as any deficiencies in the content of the contested resolution would also affect the confirmatory resolution, so that a cure would not be possible. If such a confirmatory resolution is issued while an action for annulment is pending, the grounds for annulment are no longer applicable, which means that the plaintiff must declare that the case has been settled on the merits in order to avoid having to bear the legal costs that would otherwise be incurred due to the foreseeable defeat of the action.

Register blocking and the option of the release procedure as the ideal solution?

Certain resolutions of the general meeting only take effect upon registration in the Commercial Register. However, if an action is pending against them, the registration court will generally suspend the registration procedure until a final decision has been made in the matter. The resolution will therefore not take effect until the end of the potentially lengthy process. Since such a blockade of the register can have serious economic consequences for the company concerned and has often been exploited in the past by so-called „predatory shareholders„, the legislator has introduced a release procedure which allows the resolution to be entered in the commercial register despite a pending lawsuit.

In accordance with Section 246a (1) of the German Stock Corporation Act (AktG), this applies to resolutions on capital increases and capital reductions and on inter-company agreements (such as a domination agreement), as well as to resolutions on integration in accordance with Section 319 (6) of the German Stock Corporation Act (AktG) and the exclusion of minority Shareholders („squeeze-out“) in accordance with Section 327e (2) of the German Stock Corporation Act (AktG).

The release procedure is successful if the action against the resolution of the Annual General Meeting is inadmissible or manifestly unfounded or the plaintiff cannot prove within one week of service of the request for release that he has held shares with a pro rata amount of at least EUR 1,000 since the Annual General Meeting, or the immediate entry into force of the resolution of the Annual General Meeting – in the free opinion of the deciding court – appears to have priority after weighing up the conflicting interests.

Conclusion

Actions for defective resolutions in public limited companies are proving to be an effective way for Shareholders to participate. At the same time, there is a risk for the Board of Directors and the company as a whole that an important resolution of the General Meeting may become legally invalid after lengthy proceedings. It follows that careful preparation by the company and its Board and careful follow-up by the Shareholders are of considerable importance. In any event, the company should make use of the possibility of an approval procedure for resolutions of the General Meeting to be entered in the commercial register in order to counteract the economic consequences of an initially invalid resolution.

Competent legal advice is always essential, whether it is to prevent defects in resolutions or to detect defects in the resolutions of a public limited company.

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If you have any queries regarding the subject or any other matters related to corporate law, please do not hesitate to contact the author of this article.

Authors: Lawyer Dr. Karl Brock, Research Assistant Constantin Dorschu