German Corporate Governance in International and European Context

German Corporate Governance in International and European Context Jean J. du Plessis · Bernhard Großfeld Claus Lutter...

Author: Jean J. du Plessis | Bernhard Großfeld | Claus Luttermann | Ingo Saenger | Otto Sandrock

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German Corporate Governance in International and European Context

Jean J. du Plessis · Bernhard Großfeld Claus Luttermann · Ingo Saenger Otto Sandrock

German Corporate Governance in International and European Context

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Prof. Dr. Jean J. du Plessis Deakin University Waurn Ponds Geelong Victoria 3217 Australia [email protected]

Prof. Dr. Ingo Saenger University of Muenster Universitätsstraße 14-16 48143 Muenster Germany [email protected]

Prof. Dr. Bernhard Großfeld Von Manager-Straße 16 48145 Muenster Germany [email protected]

Prof. Dr. Otto Sandrock Birkhahnweg 1 48155 Muenster Germany [email protected]

Prof. Dr. Claus Luttermann Catholic University of Eichstaett-Ingolstadt Chair of International Bussiness Law Auf der Schanz 49 85049 Ingolstadt Germany [email protected]

Library of Congress Control Number: 2007928573

ISBN 978-3-540-71186-5 Springer Berlin Heidelberg New York This work is subject to copyright. All rights are reserved, whether the whole or part of the material is concerned, specifically the rights of translation, reprinting, reuse of illustrations, recitation, broadcasting, reproduction on microfilm or in any other way, and storage in data banks. Duplication of this publication or parts thereof is permitted only under the provisions of the German Copyright Law of September 9, 1965, in its current version, and permission for use must always be obtained from Springer. Violations are liable to prosecution under the German Copyright Law. Springer is a part of Springer Science+Business Media springer.com © Springer-Verlag Berlin Heidelberg 2007 The use of general descriptive names, registered names, trademarks, etc. in this publication does not imply, even in the absence of a specific statement, that such names are exempt from the relevant protective laws and regulations and therefore free for general use. Production: LE-TEX Jelonek, Schmidt & V¨ ockler GbR, Leipzig Cover-design: WMX Design GmbH, Heidelberg SPIN 12027620

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Preface

The global economy brings us into a new world of legal players and legal transactions.1 Corporations from many countries and divergent cultural backgrounds become our partners for business and investment. Therefore, it is indispensable to know the main principles of other countries’ corporate governance structures. Some remarkable developments have taken place in the European Union (EU) in recent times: the EU now comprises 27 Member States after Cyprus and several other Eastern and Southeastern European States became members in 2004 and with Romania and Bulgaria joining the EU in January 2007. Company law harmonisation is once again high on the agenda of the EU; the first European Companies (SE) started to do business at the end of 2004; and every day more and more cross-border trade takes place within the EU. This book aims to provide the reader with a basic understanding of the German corporate governance system. It offers an overview of German corporations law and explains the interrelationship among the various organs required for German public corporations. It also gives an overview of recent corporate governance developments in Germany. The German system of employee codetermination and its future is dealt with in detail, while we also focus on accounting as the documentary proof of good corporate governance. The dominant role played by the German banks in controlling some of the company organs of large corporations is touched upon as it has always been seen as one of the characteristics of German corporate law and corporate governance. We are of the opinion that this book probably provides one of the most comprehensive and in-depth discusisons in English of the German corporate law and corporate governance system. We trust this would assist non-German readers in obtaining a better understanding of German corporate law and corporate governance. In the final chapter we add some further dimensions by discussing corporate governance developments in the EU, the OECD Principles of Corporate Governance, and corporate governance in selected jurisdictions (the United States, the United Kingdom and Australia).

1

Bernhard Groȕfeld, ‘Loss of Distance: Global Corporate Actors and Global CorporateGovernance— ‘Internet v Geography’ (2000) 34 The International Lawyer 963; Bernhard Groȕfeld ‘CyberCorporation Law: Comparative LegalSemiotics/Comparative Legal Logistics’ (2001) 35 The International Lawyer 1405.

VI

Preface

The book is aimed at all managers and directors who want to understand corporate governance in Germany. It will also provide a useful source of reference for commercial law practitioners with German companies as clients. Students studying European business will find the book an easy reference to German corporate law and corporate governance, discussed within a broader European and international context. March 2007

Jean du Plessis Bernard Großfeld Claus Luttermann Ingo Saenger Otto Sandrock

Table of Contents

Chapter 1 An Overview of German Business or Enterprise Law Jean du Plessis and Bernhard Großfeld 1.1 Introduction.....................................................................................................1 1.2 General Characteristics ...................................................................................2 1.3 Various Types of Business Organisations.......................................................4 1.4 Delineation......................................................................................................6 Chapter 2 An Overview of the Corporate Governance Debate in Germany Jean du Plessis and Ingo Saenger 2.1 Introduction.....................................................................................................9 2.2 History and Significance of the German ‘Corporate Governance’ Debate .............................................................................................................9 2.3 Focus on the Supervisory Board ...................................................................12 2.4 Important Role and Recommendations for Improvement .............................14 2.5 Initial Reaction..............................................................................................18 2.6 The German Corporate Governance Code ....................................................23 2.6.1 Overview ...........................................................................................23 2.6.2 Parts and Layout ................................................................................27 2.6.3 Some Noteworthy Provisions of the Code.........................................28 2.6.4 The Legal Nature of the Code............................................................31 2.7 Need for a European Corporate Governance Code .......................................33 2.8 Concluding Remarks.....................................................................................35

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Chapter 3 The General Meeting and the Management Board as Company Organs Jean du Plessis and Ingo Saenger 3.1 Introduction................................................................................................... 37 3.2 The General Meeting .................................................................................... 38 3.2.1 Function as a Corporate Organ .......................................................... 38 3.2.2 Some Functions ................................................................................. 39 3.3 The Management Board................................................................................ 40 3.3.1 Function as a Corporate Organ .......................................................... 40 3.3.2 Appointment, Qualifications, Removal and Remuneration of Members........................................................................................ 41 3.3.3 Rights, Powers and Responsibilities.................................................. 50 3.3.4 Duties and Forms of Liability............................................................ 58 3.4 Concluding Remarks..................................................................................... 63 Chapter 4 The Supervisory Board as Company Organ Jean du Plessis and Ingo Saenger 4.1 Introduction................................................................................................... 65 4.2 Qualifications and Appointment of Supervisory Board Members ................ 66 4.2.1 Conditions for Qualifications ............................................................ 67 4.2.2 Appointment Prerequisites................................................................. 73 4.3 Removal of Supervisory Board Members..................................................... 76 4.4 Remuneration of Supervisory Board Members............................................. 77 4.5 Rights and Responsibilities of Supervisory Board Members........................ 81 4.5.1 Appointment and Termination of Management Board Members ............................................................................................ 81 4.5.2 Determination of the Remuneration of Management Board Members ................................................................................. 82 4.5.3 Supervision ........................................................................................ 85 4.5.4 Reporting to the General Meeting ..................................................... 98 4.5.5 Instituting Action Against Members of the Management Board for a Breach of Their Duties .............................................................. 99 4.6 General Duties and Forms of Liability ....................................................... 101

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4.7 The Supervisory Board as Integral Part of the German Two-Tier Board System ..............................................................................................104 4.8 Contrasting the One-Tier and Two-Tier Board Systems.............................105 4.9 Concluding Remarks...................................................................................109 Chapter 5 The German System of Supervisory Codetermination by Employees Jean du Plessis and Otto Sandrock 5.1 Introduction.................................................................................................111 5.2 Historical Development of Codetermination (Mitbestimmung) ..................111 5.2.1 Overview .........................................................................................111 5.2.2 Social Codetermination ...................................................................112 5.2.3 Supervisory Codetermination ..........................................................113 5.2.4 The Two-Tier Board System and Supervisory Codetermination Contrasted........................................................................................119 5.2.5 Perceptions Regarding Codetermination in Germany from a Historic Perspective .........................................................................122 5.3 Current Practical Perspectives on Codetermination....................................125 5.3.1 General Concerns.............................................................................125 5.3.2 The Dependancy of the Management Board on the Employee Delegates on the Supervisory Board................................................129 5.3.3 Some Recent Scandals Associated with Employee Representatives Serving on Supervisory Boards .............................131 5.3.4 Remuneration of the Employee Representatives Serving on Supervisory Boards.....................................................................137 5.3.5 Recent Attempts to Modify the System of Codetermination ...........138 5.4 Issues Related to Supervisory Codetermination..........................................140 5.4.1 Codetermination in the Management Board—the Personnel Director............................................................................................140 5.4.2 Classification of Employees ............................................................141 5.4.3 The Role of Trade Unions ...............................................................142 5.5 Concluding Remarks...................................................................................143

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Chapter 6 The Impact of European Developments on German Codetermination Otto Sandrock and Jean du Plessis 6.1 Introduction................................................................................................. 145 6.2 Recent Decisions by the European Court of Justice (ECJ) and Their Impact on German Codetermination........................................................... 146 6.2.1 The Enforcement Under the Common Market Treaty of the Freedom of Settlement..................................................................... 146 6.2.2 The Impact of These Decisions on the National Laws of the European Community Member States............................................. 155 6.3 The Creation of the European Company (SE) and the Regulation of Its Codetermination..................................................................................... 159 6.3.1 Stormy History ................................................................................ 159 6.3.2 European Companies and Codetermination— Specific Arrangements .................................................................... 159 6.4 Cross-Border Mergers of Limited Companies............................................ 164 6.4.1 The Sevic Decision by the European Court of Justice..................... 164 6.4.2 The Directive on Coross-Border Mergers of Limited Companies ..................................................................... 165 6.5 The European Commission—Action Plan of May 2003 ............................ 167 6.5.1 The Action Plan: Consequences ...................................................... 168 6.5.2 Harmonisation versus Practical Realities ........................................ 169 6.6 Concluding Remarks................................................................................... 169 Chapter 7 Accounting as the Documentary Proof of Good Corporate Governance Claus Luttermann 7.1 Handling the ‘Invisible’ .............................................................................. 177 7.2 Accounting Law.......................................................................................... 178 7.2.1 Accountability ................................................................................. 178 7.2.2 European Law and IAS/IFRS .......................................................... 180 7.2.3 German and European Law (IAS/IFRS).......................................... 181 7.2.4 Regulatory Interactions.................................................................... 182 7.2.5 Corporate Governance Statement (Directive 2006/46/EC) ............. 183

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7.3 Financial Statements: ‘A True and Fair View’ ...........................................184 7.3.1 International Focus and Comparative Law ........................................184 7.3.2 European Court of Justice................................................................185 7.3.3 IAS/IFRS, Company Law and Tax Law..........................................187 7.3.4 Rules of Accounting ........................................................................188 7.3.5 Expectation Gaps and Procedural Law ............................................189 7.4 Valuation.....................................................................................................190 7.4.1 Financing and the 'Numbers Game' .................................................190 7.4.2 The Legal Focus of Accounting Practice.........................................191 7.4.3 Consolidated Financial Statements ..................................................194 7.4.4 Liability, International Taxation and Cash Pooling .........................195 7.5 Auditing, Control and Sanctions .................................................................197 7.5.1 About Watchdogs and Materiality ...................................................197 7.5.2 Disclosure and Enforcement............................................................198 7.5.3 Liability and Sanctions ....................................................................199 7.5.4 Judicial Relief and International Court of Accounting ....................201 7.6 Strategic Governance and Audit Committee...............................................202 7.7 Concluding Remarks...................................................................................204 Chapter 8 The Dominant Role of the German Banks and New Players in the German Financial Sector Jean du Plessis and Claus Luttermann 8.1 Introduction.................................................................................................205 8.2 The Traditional Position..............................................................................206 8.2.1 Control Through the General Meeting.............................................206 8.2.2 Control Through the Supervisory Board..........................................208 8.2.3 Control over the Management Board...............................................208 8.3 International Influences...............................................................................210 8.3.1 The Wind of Change........................................................................210 8.3.2 Controlling German Banks ..............................................................211 8.4 Concluding Remarks...................................................................................212

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Table of Contents

Chapter 9 Corporate Governance in the EU, the OECD Principles of Corporate Governance and Corporate Governance in Selected Other Jurisdictions Jean du Plessis and Claus Luttermann 9.1 Introduction................................................................................................. 215 9.2 European Union (EU) ................................................................................. 216 9.2.1 Enhancing Corporate Governance ................................................... 216 9.2.2 Projects (IAS/IFRS Etc.) ................................................................. 216 9.2.3 Future Priorities ............................................................................... 218 9.2.4 Regulatory Basics and Outlook ....................................................... 219 9.3 OECD Principles of Corporate Governance ............................................... 220 9.3.1 Background to the OECD Principles of Corporate Governance........ 220 9.3.2 Broad Aims and Application ........................................................... 221 9.3.3 Parts and Layout .............................................................................. 221 9.3.4 Ensuring the Basis for an Effective Corporate Governance Framework....................................................................................... 222 9.3.5 Disclosure and Transparency........................................................... 223 9.4 United States ............................................................................................... 225 9.4.1 Background to the Corporate Governance Debate in the United States ............................................................................................... 225 9.4.2 The American Law Institute’s Involvement in the Corporate Governance Debate.......................................................................... 227 9.5 United Kingdom ......................................................................................... 234 9.5.1 Background to the Corporate Governance Debate in the United Kingdom .......................................................................................... 234 9.5.2 The Cadbury Report and the Unfolding of the Concept of ‘Corporate Governance’ in the United Kingdom............................. 234 9.5.3 The Greenbury Report (1995), the Hampel Report (1998), the Smith Report (2003) and the Higgs Report (2003).......................... 238 9.5.4 The UK Combined Code ................................................................. 240 9.6 Australia...................................................................................................... 241 9.6.1 Background to the Corporate Governance Debate in Australia....... 241 9.6.2 The Bosch Reports........................................................................... 244 9.6.3 The Hilmer Report........................................................................... 248

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9.6.4 The Virtues of Good Corporate Governance in Australia Between 1991 and 1998...................................................................250 9.6.5 The IFSA Blue Book .......................................................................251 9.6.6 The Australian Stock Exchange Ltd (ASX).....................................252 9.7 Concluding Remarks...................................................................................256 Appendix English Translations of Some European Provisions for Purposes of Chapter 7...........................................................................257 About the Authors .................................................................................275

Chapter 1

An Overview of German Business or Enterprise Law Jean du Plessis and Bernhard Großfeld

1.1 Introduction It is hardly possible to judge the merits of the German corporate governance system without also having a basic knowledge of German business or enterprise law1 and without analysing it within its wider cultural context2 and linguistic background.3 Whereas business law or enterprise law refer to all legal aspects pertaining to businesses or enterprises, the focus of this book is on corporate governance in context of primarily large companies or corporations. A distinctive feature of German companies or corporations is the particular relationship amongst the various corporate organs and the unique synthesis between corporations law and labour law. Understanding this synthesis is fundamental when the merits of the English and American one-tier system and the German two-tier system (the management board and the supervisory board) with employee participation are analysed and compared.4 These aspects have often been neglected in the academic 1

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In Germany, phrases like company law, corporate law and corporations law have different meanings and are often associated with specific political or academic theories. See and compare, for example, Thomas Raiser, ‘The Theory of Enterprise Law in the Federal Republic of Germany’ [1988] AJCL 111, 122 ff; Gunter Teubner, ‘Enterprise Corporation: New Industrial Policy and the “Essence” of the Legal Person’ [1988] AJCL 130 ff. For the purposes of this book these terms will be used interchangeably. See Bernhard Großfeld, ‘Comparative Law as a Comprehensive Approach’ (2000) 1 Richmond J of Global L and Bus 1; Bernhard Großfeld, Core Questions of Comparative Law (Carolina Academic Press, Durham NC 2004). Bernhard Großfeld, ‘Corporatists and Languages’ in Legrand and Munday (eds) Comparative Legal Studies: Traditions and Transitions (OUP, Oxford 2003) 154. For a general overview see Bernhard Großfeld, ‘Management and Control of Marketable Share Companies’ in International Encyclopaedia of Comparative Law (Mohr and Siebeck Verlag, Tuebingen 1973); AR Oquendo, ‘Breaking on Through to the Other Side: Understanding Continental European Corporate Governance’ (2001) 22 U Pennsylvania J of Intl Eco L 975.

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Jean du Plessis and Bernhard Großfeld

literature attempting to analyse the German corporate governance system from a traditional Anglo-American perspective.

1.2 General Characteristics When German corporate law is studied, it should always be kept in mind that unique historic events played a major role in shaping German business organisations generally,5 but these historic events also led to a unique feature of German corporate law, namely the concept of codetermination (Mitbestimmung).6 At one stage labour law was conceived to be a branch of the law ‘[a]lmost entirely outside the horizon of commercial and company law’.7 This is, however, not the case any more. Corporations law and labour law are now linked by various statutory provisions dealing with the rights and duties of employee representatives on supervisory boards and by rules pertaining to collective bargaining.8 It is, however, the concept of codetermination, more than any other concept, which forms the most fundamental link between corporations and labour law in Germany.9 Shortly after World War II the application of this concept made employees a part of the corporate governance structure of many large corporations and companies in Germany. Notwithstanding this long-lasting interrelationship between corporations law and labour law, not all theoretical and practical difficulties associated with it have been solved.10 Two further aspects of German corporations law should be appreciated. Firstly, it has not escaped the influence of international debates on major corporate law 5

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7 8 9

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See in particular Rudolf Wiethölter, Interessen und Organisation der Aktiengesellschaft im Amerikanischen und Deutschen Recht (CF Müller Verlag, Karlsruhe 1961) 272 ff; Bernhard Großfeld, Aktiengesellschaft, Unternehmenskonzentration und Kleinaktionär (Mohr and Siebeck Verlag, Tuebingen 1968) 113 ff; Friedrich Kübler, Gesellschaftsrecht (5th edn CF Müller Verlag, Heidelberg 1998) 5 ff; Bernhard Großfeld and Ulrich Irriger, ‘Intertemporales Unternehmensrecht’ (1988) 43 JZ 531. For purposes of this book, the term codetermination (Mitbestimmung) will be used in its legal context, indicating the codetermination of employees in terms of various statutory provisions— see Chapter 5 for a closer description of the different ways in which the term codetermination is used. The term Mitbestimmung is also sometimes used in more general terms—see Christene Windbichler, ‘Grenzen der Mitbestimmung in einer markwirtschaftlichen Ordnung’ [1991] ZfA 35. See generally Raiser (n 1) 116 ff; Detlev F Vagts, ‘Reforming the “Modern” Corporation: Perspectives from the German’ [1966] Harvard L Rev 23, 26 ff. Raiser (n 1) 111, 113. Ibid 114. See especially the comprehensive exposition by Dieter Reuter, ‘Der Einfluß der Mitbestimmung auf das Gesellschafts—und Arbeitsrecht’ [1979] AcP 509–566. Ibid 409–517.

An Overview of German Business or Enterprise Law

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issues, for example, the debate on the social responsibilities of large public corporations;11 the debate on the most effective ways of regulating these powerful institutions in society;12 and the debate on how the rights and duties of all stakeholders in the modern corporation (i.e. the shareholders, employees, creditors, consumers, the community etc.) should be recognised and balanced.13 Today, International (European) Financial Reporting Standards;14 the rise of rating agencies;15 and new evaluation techniques16 bring new dimensions to the corporate governance discussion in Germany. Secondly, although the German law of corporations is indeed classified as ‘private law’,17 it should be kept in mind that, particularly in the case of large public corporations, this ‘private law’ is based on very specific and detailed statutory provisions,18 which do not allow for much deviation from the prescribed model.19 These statutory provisions are not only contained in the basic act regulating public

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Raiser (n 1) 118, 122 ff. See especially Großfeld (n 5) 5 ff; Bernhard Großfeld and Werner Ebke, ‘Probleme der Unternehmensverfassung in rechtshistorisher und rechtsvergleichender Sicht (I)’ (1977) 22 AG 59, 62 ff. See also Klaus-Peter Martens, ‘Das Bundesverfassungsgericht und das Gesellschaftsrecht’ (1979) 8 ZGR 493, 508–9. Eckard Rehbinder, ‘Das Mitbestimmungsurteil des Bundesverfassungsgerights aus unternehmensrechlicher Sicht’ (1979) 8 ZGR 471, 478, 480–81; Kübler (n 5) 163 ff. Bernhard Großfeld, ‘Global Accounting: Where Internet Meets Geography’ (2000) 48 Am J Comp L 261; Bernhard Großfeld, ‘Comparative Corporate Governance: Generally Accepted Accounting Principles v International Accounting Standards?’ (2003) 28 North Carolina J of Intl L and Com Reg 847; Bernhard Großfeld, ‘Lawyers and Accountants: A Semiotic Competition’ (2001) 36 Wake Forest L Rev 167. Bernhard Großfeld, ‘Changing Concepts of Rules: Global Corporate Assessment’ (2002) 8 L and Bus Rev of the Americas 341. Bernhard Großfeld, ‘Global Valuation: Geography and Semiotics’ (2002) 55 SMU L Rev 197; Bernhard Großfeld, ‘Global Financial Statements/Local Enterprise Valuation’ (2004) 29 J of Corp L 338. B Großfeld and U Lehmann, ‘Management Structures and Worker’s Codetermination in Germany with European Perspectives’ [1994] Corporate Law Development Series 41, 43. See also Kübler (n 5) 1; Ulrich Eisenhardt, Gesellschaftsrecht (6th edn CH Beck Verlag, Munich 1994) 2. This was in accordance with the general principle of the German law of corporations that large public corporations should be regulated in detail in a separate act—see Großfeld and Lehmann (n 17) 42; Großfeld and Ebke (n 12) 59 ff; Kübler (n 5) 4. For recent developments pertaining to smaller AGs, see Marcus Lutter, ‘Das neue Gesetz für kleine Aktiengesellschaften und zur Deregulierung des Aktienrecht’ (1994) 39 AG 429 ff. See s 23(5)1 AktG which provides that the articles of incorporation can only contain deviations from the prescribed provisions of the Act when it is specifically provided for.

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companies in Germany, namely the Aktiengesetz, 1965 (AktG), but also in various other statutory instruments.20 A vital part of these other statutory instruments deals with codetermination.21 They are of great importance, since they extend the operation of codetermination beyond public corporations to other types of business organisations like private or proprietary companies (Gesellschaften mit beschränkter Haftung (GmbHs), companies with one or more general partners but limited by shares (Kommanditgesellschaften auf Aktien (KGaAs) and cooperatives (Genossenschaften).22 Furthermore, most of these provisions have, to a greater or lesser degree, been influenced by court cases, provisions in companies’ articles of incorporation (Satzung) and conventions.23 All these considerations make German business or enterprise law a very interesting area for purposes of comparative research, especially since German business or enterprise law not only provides a unique blend of typically German features, but also shows the signs of several modern international influences.24

1.3 Various Types of Business Organisations German business or enterprise law employs a unique system of classifying enterprises.25 Basically, one finds the sole proprietor, partnerships (unlimited “offene Handelsgesellschaft” or limited “Kommanditgesellschaft”) and companies or corporations.26 As far as companies or corporations are concerned, the Aktiengesellschaft (AG) is the most important type of company or corporation from a corporate governance point of view and also forms the primary focus of this book. As far as English terminology is concerned, the word Aktiengesellschaft (AG) is often

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24 25 26

Eisenhardt (n 17) 3. See in particular Peter Hanau, ‘Einführung’ in Mitbestimmungsgesetze in den Unternehmen mit alle Wahlordnungen (4th edn Deutscher Taschenbuch Verlag, Munich 1991) VII–XX. See further Chapter 5. Kübler (n 5) 13. With regard to the articles of incorporation (Satzung), see HansJoachim Mertens ‘Zuständigkeiten des mitbestimmenten Aufsichtsrats’ (1977) 6 ZGR 271, 283–88 and Hans-Joachim Mertens ‘Satzungs—und Organisationsautonomie im Aktien– und Konzernrecht’ (1994) 23 ZGR 426, 438–40; Barbara Grunewald, ‘Die Auslegung von Gesellschaftsverträgen und Satzungen’ (1995) 24 ZGR 68, 84–5. See in particular Chapters 2 and 4. Vagts (n 6) 33. On the basic forms of German enterprises, see Theodor Baums, ‘Corporate Governance in Germany: The Role of the Banks’ [1992] AJCL 503. For an interesting exposition of the legal rules applicable to undertakings not regulated by statutory provisions in Germany, see Großfeld and Irriger (n 5) 531 ff.


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translated as ‘joint stock corporation’.27 The use of the term ‘joint stock company/corporation’ or ‘joint-stock company/corporation’ was common when the various Joint Stock Companies Acts were passed in the 1800s in England,28 but the term was used long before that.29 This is also reflected in the titles of some of the leading textbook of the 1800s.30 However, nowadays in the United States, the United Kingdom and other Anglo-American jurisdictions, the trend is to refer to companies or corporations comparable to the Aktiengesellschaft (AG) simply as ‘public companies or corporations’; ‘publicly-traded companies or corporations’; ‘public companies or corporations limited by shares’; or ‘public limited companies or corporations’. The identifiable abbreviations for these companies or corporations are ‘Ltd’ (Limited) or ‘plc’ (public limited company). We will use these terms interchangeably when we refer to AGs. Public companies or corporations are distinguished from so-called private or proprietary companies. The identifiable abbreviation used for these companies in the United Kingdom and several other Anglo-American jurisdictions is ‘(Pty) Ltd’ ((Proprietary) Limited). In Germany it is the Gesellschaft mit beschränkter Haftung (GmbH) that is comparable to the private or proprietary company. 31 However,

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See Hannes Schneider and Martin Heidenhain, The German Stock Corporations Act (2nd edn CH Beck Verlag, Munich 2000); Martin Peltzer and Anthony G Hickinbotham, German Stock Corporation Act and the Co-Determination Act: German-English Text with an Introduction in English (OVS Otto Schmidt Verlag, Cologne 1999). In particular the Joint Stock Companies Act 1837 (1 Vict c 73); Joint Stock Companies Act 1844 (7 & 8 Vict c 110) (5 September 1844); Joint Stock Companies Act 1856 (19 & 20 Vict c 47) (14 Julie 1856) and several Amendments Acts like the Joint Stock Companies Act 1862 (25 & 26 Vict c 89 6); Joint Stock Companies Amendment Act 1867 (30 & 31 Vict c 131; Joint Stock Companies Amendment Act 1877 (40 & 41 Vict c 26); Joint Stock Companies Amendment Act 1879 (42 & 43 Vict c 76); Joint Stock Companies Amendment Act 1880 (43 Vict c 19); Joint Stock Companies Amendment Act 1883 (46 & 47 Vict c 28); and Joint Stock Companies Amendment Act 1886 (49 Vict c 23). See WR Scott, The General Development of the Joint-stock System to 1720 (The University Press, Cambridge 1912). Charles Wordsworth, The Law of Mining, Banking, Insurance and General Joint Stock Companies Not Requiring Express Authority of Parliament (6th edn WG Benning and Co, London 1854); Nathaniel Lindley, A Treatise on the Law of Partnership, Including its Application to Joint-stock and other Companies (William Maxwell, London 1860); Francis William Clark, A Treatise on the Law of Partnership and Joint Stock Companies according to the Law of Scotland (T & T Clark, Edinburgh 1866); Henry Thring, The Law and Practice of Joint-stock Public Companies (2nd edn Stevens & Sons, London 1868); Charles Fiish Beach, Company Law: Commentaries on the Law of Private Corporations whether with or without Capital Stock, also of Joint-stock Companies (TH Flood & Co, Chicago 1891); CEH Chadwyck Healy, Percy F Wheeler and Charles Burney, A Treatise on the Law and Practice relating to Joint Stock Companies under the Acts of 1862–1890 (3rd edn Sweet and Maxwell, London 1894). See Oliver Niedostadek, The Proprietary Company—das Recht der Australischen Private Company (LIT Verlag, Muenster 2004).

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there are also some similarities between the GmbH and what is called ‘close corporations’ in some other jurisdictions.32 There are not nearly as many AGs as GmbHs in Germany.33 The number of AGs steadily declined between 1973 and 1985, with a gradual growth from 1988 to 1993. In 1973 there were 2260 AGs while there were still only 2934 AGs in 1993.34 However, since 1999 there were a steady growth of the number of listed AGs, from 7375 in 1999 to 16 114 in 2005.35 The number of GmbHs also showed a steady growth in number from 122 063 in 1973 to 543 440 in 1993 and to almost 1 million since 1999.36 It is difficult to predict in which direction this trend will go. Due to the dramatic change from the ‘seat theory’ towards a more liberal ‘incorporation theory’ that started in 2002, foreign corporate forms will probably increase in Germany, reducing the relative positions of AGs and GmbHs.37 We discuss these theories and the consequences of them for the German corporations law in some detail in Chapters 5 and 6.

1.4 Delineation In the next chapter we will give an overview of corporate governance in Germany. The following two chapters (Chapters 3–5) deal with the interrelationship among the various company organs (general meeting, management board and the supervisory board), mainly in large public corporations and larger private companies, and the important concept of codetermination (Chapter 5). In Chapter 6 we discuss the impact of European developments on German codetermination. Chapter 7 is devoted to the pivotal role played by accounting in modern corporate governance, 32

33 34 35 36

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See, for instance as far as South Africa is concerned, Nico Olbrisch, Die südafrikanische close corporation und ihre strukturellen Unterschiede zur deutschen GmbH, Münsteraner Studien zur Rechtsvergleichung (Band 23) (LIT Verlag, Muenster 1997); Nico Olbrisch and Jean J du Plessis, ‘Some Structural Differences Between the South African Close Corporation and the German GmbH’ [1997] TSAR 315 ff. Kübler (n 5) 161. Ibid. Deutsches Aktieninstitut (DAI), DAI-Factbook 2006. Klaus J Hopt, ‘Gemeinsame Grundsätze der Corporate Governance in Europa?’ (2000) 29 ZGR 779; Udo Kornblum, ‘Bundesweite Rechtstatsachen zum Unternehmens- und Gesellschaftsrecht’ [2007] GmbHR 28–39. It is interesting to note that only about 453 000 GmbHs were considered to be actively trading (gathered from the fact that they are paying turnover tax) – Statistisches Bundesamt, Umsatzsteuerstatistik 2004. Werner Ebke, ‘The European Conflict-of-Corporate-Laws Revolution: Überseering, Inspire Art and Beyond’ [2005] The International Lawyer 39; Christian Kersting and Clemens Philipp Schindler, ‘Inspire Art Decision of Sept 2003 and its Effects on Practice’ (2003) 4 German L J (Electronic Journal) No 12.


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while Chapter 8 deals with the dominant role of the German banks an the new players in the German financial sector. We conclude our study in Chapter 9 by focusing on corporate governance in a few selected jurisdictions (the US, UK and Australia, the OECD principles of corporate governance and developments regarding corporate governance in the EU).

Chapter 2

An Overview of the Corporate Governance Debate in Germany Jean du Plessis and Ingo Saenger

2.1 Introduction The term corporate governance was adopted directly from English into German. Although there is no exact definition of corporate governance, it seems to be a sensible approach rather to use the English term even in German. Any translation could have created considerable confusion. In this chapter we give an overview of the corporate governance debate in Germany. It will be noted that the debate is not an old one, but it should be kept in mind that there are several German phrases that were used for a long period of time that encompass core aspects of what is now phrased corporate governance. It will be noted that there were several recent developments that indicate, at least to a certain extent, some convergence with corporate governance practices in the United States and the United Kingdom.

2.2 History and Significance of the German ‘Corporate Governance’ Debate The debate on corporate governance in Germany started in all seriousness during the late 1990s. It was closely linked with the relatively difficult economic conditions experienced in Germany during the middle and late 1990s1 and in particular 1

This has been mentioned by quite a few chairmen of management boards in their yearly reports—see Klein-Gunnewyk (Chairman’s Statement: PWA AG) 24 June 1994; Fulconis (Oberland Glas AG) 23 June 1994; Holler (Chairman’s Statement: Mauser Einrichtungen AG) 30 May 1994; Winkhaus (Chairman’s Statement: Henkel AG) 6 June 1994. The financial years 1993 and 1994 were described by some as the most difficult years after World War II—see Deuss (Chairman’s Statement: Karstadt AG) 13 June 1995 and Reuter (Chairman’s Statement: Daimler Benz AG) 18 May 1994. See further Carsten P Claussen, ‘Aktienrechstreform 1997’ (1996) 41 AG 481; Carsten Berrar,

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Jean du Plessis and Ingo Saenger

with the difficulties experienced in the German iron and steel industry.2 Problems in some of the large German industries were blamed on failure and neglect of management and those overseeing the business of large corporations, particularly the supervisory boards.3 Besides these difficulties, globalisation of the economy and liberalisation of capital markets are also drivers of the debate on corporate governance, since worldwide operating institutional investors have, for the past ten years, played an increasingly decisive role in financing German enterprises.4 If a company wants to acquire capital, it turns to the national and international capital market. However, it was mainly economic difficulties that attracted public attention in the 1980s when shareholders were rediscovered as investors, resulting in companies satisfying their financial needs by capital increases or the sale of a corporation’s common shares to public investors. The tension between economic difficulties and an increased involvement of shareholders in the economic landscape required effective and legitimate institutional safeguards to secure investor confidence and successful management of companies. As pointed out above, the English term ‘corporate governance’ is common in German, since there is no German translation for the term and the term itself is not used in a uniform way.5 Ultimately, the use of English terminology must be deemed as an expression of a broader development, in which Anglo-American standards on capital market law and corporate law are dominant and concepts like ‘shareholder value’ or ‘stock options’ have infiltrated the German vocabulary.6

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‘Die zustimmungspflichtigen Geschäfte nach § 111 Abs. 4 AktG im Lichte der Corporate Governance-Diskussion’ (2001) 54 DB 2181. Marcus Lutter, ‘Der Aufsichtsrat: Konstruktionsfehler, Inkompetenz seiner Mitglieder oder normales Risiko?’ (1994) 39 AG 176. See also Marcus Lutter, ‘Deutscher Corporate Governance Kodex’ in Dietrich Dörner, Dieter Menold, Norbert Pfitzer and Peter Oser, Reform des Aktienrechts, der Rechnungslegung und der Prüfung (2nd edn Schäffer-Poeschel Verlag, Stuttgart 2003) 69. The public often connects companies like ‘Bremer Vulkan’, ‘Balsam Procedo’ and ‘Holzmann’ with the debate on corporate governance, since these were the most spectacular cases which have been intensively treated in the media. Claussen (n 1) 481. Axel von Werder, ‘Ökonomische Grundfragen der Corporate Governance’ in Peter Hommelhoff, Klaus J Hopt and Axel von Werder (eds), Handbuch Corporate Governance (Otto Schmidt Verlag, Cologne 2003) 3, 5; Eberhard Vetter, ‘Deutscher Corporate Governance Kodex’ (2003) 54 DNotZ 749. Vetter (n 4) 748. The implementation of share options is governed by ss 192(2) 3, 193(2) 4 AktG which were enacted in the course of the KonTraG in 1998. The adaptation of share options, which stand for a shareholder value-oriented type of remuneration scheme, and eased conditions for repurchasing a company’s own shares according to s 71(1) 8 AktG— which was also enacted in the course of the KonTraG—can be deemed an expression of the shareholder concept.

An Overview of the Corporate Governance Debate in Germany

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Therefore, the term ‘corporate governance’ can be deemed a German legal term,7 although a generally acceptable definition is still evasive. Du Plessis, McConvill and Bagaric define corporate governance as: [T]he process of controlling management and of balancing the interests of all internal stakeholders and other parties (external stakeholders, governments and local communities ...) who can be affected by the corporation’s conduct in order to ensure responsible behaviour by corporations and to achieve the maximum level of efficiency and profitability for a corporation. 8 From a German point of view, corporate governance describes legal mechanisms and external capital market-oriented mechanisms governing the relationship of an active management, its supervision and the function of the shareholders’ meeting within (mainly listed) corporations.9 Theories of corporate governance not only describe the relationship between these functions, but also provide guidance on how the organs work together in the best and most effective way. While an AngloAmerican understanding of corporate governance has its natural starting point in analyses of dysfunctional impacts of the separation of ownership and control (the famous Berle and Means hypothesis), the German and European understanding not only considers the relationship of management and shareholders, but also includes the relationship between management and other stakeholders, and the relationships amongst stakeholders themselves.10 Apart from these ‘peculiarities’ of the German corporate governance debate, it is—exactly like the prevailing worldwide theories on this topic—focused on creating internationally acknowledged standards for an independent, sound and responsible management of corporations in order to increase their efficiency and to augment the shareholders’ benefits. It is, therefore, understandable that the German Corporate Governance Code (GCGC) is aimed at national and international investors.11 From the perspective of 7

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Cf Klaus J Hopt, ‘Die rechtlichen Rahmenbedingungen der Corporate Governance’ in Hommelhoff, Hopt and von Werder (n 4) 29, 30. Jean J du Plessis, James McConvill and Mirko Bagaric, Principles of Contemporary Corporate Governance (CUP, Sydney 2005) 6–7. Cf Johannes Semler and Gerald Spindler, in Bruno Kropff and Johannes Semler (eds), Münchener Kommentar zum Aktienrecht (2nd edn CH Beck Verlag Munich 2004) Introduction of S 76 para 219; Martin Peltzer, Deutsche Corporate Governance (2nd edn CH Beck Verlag, Munich 2004) para 9; Vetter (n 4) 748. Von Werder (n 4) 8. See Foreword of the GCGC, Sentences 2 and 3 – The German Corporate Governance Code (GCGC) 12 June 2006 : “The Code aims at making the German Corproate Governance System transparent and understandable. Its purpose is to promote the trust of international and national investors, customers, employees and the general public in the management and supervision of listed German stock corporations.”

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German companies confronted with the Code, this kind of regulation is terra incognita, since management boards in Germany have been accustomed to acting on the basis of government statutes rather than codes. While listed corporations—for the above-mentioned reasons—take centre stage in the debate on corporate governance, other types of enterprises have not escaped the impact of the corporate governance debate. The controversy over conflicts of interest, which was exclusive to public listed corporations and which is one of the major topics of corporate governance,12 started to affect other types of German business associations. Therefore, it is currently debated which policies have to be fulfilled in dealing with conflicts of interest in cooperatives13 and foundations14. For instance, cooperatives, which are often used as legal structures for banks, are concerned with the problem that members of the executive board decide about the salary of the association’s president who is responsible for sending auditors into the executive board members’ banks in order to audit the annual accounts.

2.3 Focus on the Supervisory Board15 In Germany the effectiveness of supervisory boards received considerable attention in academic literature during the late 1990s.16 These appraisals vary considerably in scope. The gist of criticism is aimed at the ineffectiveness of supervisory

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See Ingo Saenger, ‘Conflicts of Interest of Supervisory Board Members in a German Stock Corporation and the Demand for their Independence—An Investigation in the Context of the current Corporate Governance Discussion’ [2005] Corporate Governance L Rev 147–189. See FAZ 5 Jan 2005, ‘Genossen hadern mit “Regeln für die Big-Mac-Ökonomie”’‚ 18. The law for the introduction of the European Cooperative Society (Gesetz zur Einführung der Europäischen Genossenschaft und zur Änderung des Genossenschaftsrechts vom 14 Aug 2006, Bundesgesetzblatt Teil I (BGBl I 2006, 1911)) also brought an improvement of corporate governance in this area. See Ingo Saenger and Till v Heltmann, ‘Corporate Governance in Stiftungen’ (2005) 3 ZSt, 67. In 2006 the Bundesverband Deutscher Stiftungen published Principles of Best Practice for Foundations (Grundsätze Guter Stiftungspraxis, cf ). Parts of the following discussion are based on the following two articles: Jean J du Plessis, ‘The German Two-Tier Board and the German Corporate Governance Code’ (2004) 15 Eur Bus L Rev 1139–64; and Jean J du Plessis, ‘Reflections on some Recent Corporate Governance Reforms in Germany: A Transformation of the German Aktienrecht?’ (2003) 8 Deakin L Rev 389–404. Marcus Lutter, ‘Defizite für eine effiziente Aufsichtsratstätigkeit und gesetzliche Möglichkeiten der Verbesserung’ (1995) 159 ZHR 287 ff; Wolfgang Bernhardt, ‘Aufsichtsrat—Die Schönste Nebensache der Welt?’ (1995) 159 ZHR 310 ff; J Shearman, ‘Controlling Directors the German Way’ (1997) 18 Company Lawyer 123 ff.


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boards generally.17 This particular aspect is articulated in different ways. Some point out that supervisory board members do not take their tasks seriously and that they do not pay enough attention to their responsibilities.18 Others suggest that the supervisory board cannot fulfil its functions of supervising and overseeing the management of the corporation if it only meets a few times a year for relatively short periods.19 The reality as far as supervisory boards are concerned has been compared with the standard question and answer in the British admiralty: ‘All under control?’—‘Aye, aye Sir, all under control!’20 Some commentators direct their criticism towards the relationship between the supervisory and management boards. They question whether the supervisory board can really be a proper advisor21 for the modern, professional management board in large corporations.22 They argue that the supervisory board is not only prohibited, by statutory provisions, from managing and directing the business of the corporation, but it also relies completely on the management board for receiving adequate, relevant and correct information.23 The argument proceeds that these facts, combined with the fact that the supervisory board members are confronted with entrepreneurial management processes which are becoming progressively more complex, make the supervisory boards anything but an ideal advisory forum for large public corporations.24 It has been questioned whether a supervisory board with up to 20 members (half of them employee representatives) could properly fulfil its supervisory and overseeing function over the management board.25 17

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See in particular Lutter (n 16); Bernhardt (n 16); Bettina Husemann, ‘Diskussionbericht: Lutter und Bernhardt’ (1995) 159 ZHR 322; Eberhard Scheffler, ‘Der Aufsichtsrat— Nüztlich oder überflüssig’ (1993) 22 ZGR 63 ff. H H (pseud), ‘Das Eigentor des Jahres’ 1994 (4) AG-Report R 114 refers to the observations of Martini (der Präsident des Bundesverbandes deutscher Banken) in 1994 that he never prepared for supervisory board meetings for longer than one evening per meeting. Bernhardt (n 16) 311–13. See also Theodor Baums, ‘Der Aufsichtsrat—Aufgaben und Reformfragen’(1995) 16 ZIP 17. H H (n 18). See discussion above. Horst Steinmann and Hans Klaus, ‘Zur Rolle des Aufsichtsrats als Kontrollorgan’ (1987) 32 AG 29 ff. Also Scheffler (n 17) 70–73. See in particular Scheffler (n 17) 71; Kersten von Schenck, ‘Die laufende Information des Aufsichtsrats einer Aktiengesellschaft durch den Vorstand’ (2002) 5 NZG 64 ff. See further Marcus Lutter, ‘Vergleichende Corporate Governance—Die Deutsche Sicht’ (2001) 30 ZGR 232; Shearman (n 16) 124. Friedrich Kübler, Gesellschaftsrecht (5th edn CF Müller Verlag, Heidelberg 1998) 409. See generally also Shearman (n 16) 123–24. Peter Ulmer, ‘Der Deutsche Corporate Governance Kodex-ein neues Regulierungsinstrument für börsennotierte Aktiengesellschaften’ (2002) 166 ZHR 180. See also HansChristoph Hirt ‘The Review of the Role and Effectiveness of Non-executive Directors: A Critical Assessment with Particular Reference to the German Two-tier Board System: Part 1’ (2003) 14 ICCLR 245 at 269.

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A third group of criticisms, originally spearheaded by Lutter, was directed towards defects in the composition of the supervisory board (eine Fehlkonstruktion).26 Lutter27 pointed out that the supervisory board is still basically unaffected by the process of modernisation which was of such vital importance in Europe during the past 30 years.28 He indicates that as a result of this, there exists a lacuna as far as the task of supervising and overseeing the management of the corporation (Überwachungslücke) is concerned.29 Therefore, he urged in the middle of the 1990s that this deficiency should be addressed urgently and persuasively30 and he recommended very specific ways to make the supervisory board a more effective institution.31 Finally, there are some other aspects raised as part of the broader debate on the role and effectiveness of supervisory boards generally, including the board’s role in groups of companies;32 the desirability of supervisory board members sitting on the boards of directly competing companies;33 the admissibility of former management board members taking seat on the supervisory board;34 and the fact that a relatively small number of individuals occupy the majority of supervisory board positions available to shareholders.35

2.4 Important Role and Recommendations for Improvement Solutions proposed to rectify existing deficiencies of the supervisory board vary just as widely as the criticism of the supervisory board itself. In 1994 the German 26

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Lutter 1994 (n 2) 177. See also Martin Peltzer, ‘Handlungsbedarf in Sachen Corporate Governance’ (2002) 5 NZG 594; Lebrecht Rürup, ‘Möglichkeiten verbesserter Kontrolle und Beratung der Geschäftsfürung durch den Aufsichtsrat mit Hilfe des Wirtschaftsprüfers’ (1995) 40 AG 219 fn4. Lutter (n 16) 309. Ibid. Ibid. Ibid. Ibid 297–309. See further Lutter (n 23) 227–28. Klaus-Peter Martens, ‘Der Aufsichtsrat im Konzern’ (1995) 159 ZHR 567; Michael Hoffmann-Becking, ‘Der Aufsichtsrat im Konzern’ (1995) 159 ZHR 325 ff. Jochem Reichert and Michael Schlitt, ‘Konkurrenzverbot für Aufsichtsratsmitglieder’ (1995) 40 AG 241 ff; Uwe H Schneider, ‘Wettbewerbsverbot für Aufsichtsratmitglieder einer Aktiengesellschaft’ (1995) 50 BB 365 ff; Saenger (n 12); OLG Schleswig, resolution of 26 April 2004 reported in (2004) 25 ZIP 1143 ff. See Art 5.3.2 GCGC. Thomas J Andre (Jr), ‘Some Reflections on German Corporate Governance: A Glimpse at German Supervisory Boards’ (1996) 70 Tulane L Rev 1819, paras 1844–46.


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government adamantly stated that neither the statutory duties of supervisory board members, nor statutory duties complementing these duties, were inadequate.36 This sentiment is strongly supported by some commentators.37 However, there are serious efforts in progress to bridge the gap between an excellent theoretical model and practical realities, showing that there are deficiencies in the way in which supervisory boards fulfil their duties in practice.38 The recommendations for improving the effectiveness of supervisory boards in Germany are very practically orientated. They focus on aspects like the size of the supervisory boards; improving the supervisory skills of supervisory board members; increasing the possibilities of holding members liable for a breach of duties; supervisory boards meeting more regularly and working more efficiently; supervisory board members devoting more time to their responsibilities; the relationship between the supervisory board and the auditors; the kind of information that the management board sends through to the supervisory board; the way in which the supervisory board reports to the general meeting; specialisation in the supervisory board by way of staff, financing and audit committees; and increasing remuneration for members to ensure a more professional approach to fulfilling the functions of members of the supervisory boards.39 Since 1997, many of these aspects were considered and incorporated into the German law by way of specific statutory amendments or by way of provisions in the GCGC.40 That is why commentators are now prepared to state that the legislature’s dedication to improve the way in which German corporations are directed and supervised had, at least for a short period of time, come to an end.41 Notwithstanding the critical stance by some, commentators also emphasise the very important advisory role of the supervisory boards in many medium-sized and

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Anonymous, ‘Pflichten und Kontrollmöglichkeiten der Aufsichtsratmitglieder’ 1994 (4) AG-Report R 114. Bernhard Servatius, ‘Ordnungsgemäße Vorstandskontrolle und vorbereitende Personalauswahl durch den Aufsichtsratsvorsitzenden’ (1995) 40 AG 223. Manual R Theisen, ‘Grundsätze ordnungsgemäßer Kontrolle und Beratung der Geschäftsführung durch den Aufsichtsrat’ (1995) 40 AG 202–03. Cf also Peter Frerk, ‘Praktische Gedanken zur Optimierung der Kontrollfunktion des Aufsichtsrates’ (1995) 40 AG 212 ff. Lutter 1994 (n 2) 177; Lutter (n 16) 297 ff; Claussen (n 1) 485–88; Michael Adams, ‘Stellungnahme zur Aktienrechtsreform 1997 von Prof Dr Michael Adams’ (Special Edition) (1997) 42 AG 10; Konrad Berger, Die Kosten der Aufsichtsratstätigkeit in der Aktiengesellschaft (Peter Lang Verlag, Frankfurt 2000) 9–17; Baums (n 19) 17–18. Lutter (n 23) 228. Johannes Semler and Elizabeth Wagner, ‘Deutscher Corporate Governance Kodex— Die Entsprechenserklärung und Fragen der gesellschaftsinternen Umsetzung’ (2003) 6 NZG 553.

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small corporations.42 Röller points out that although supervisory boards were criticised heavily in the early 1990s for not fulfilling their duties of supervising, overseeing and giving advice, the majority of supervisory boards in Germany fulfilled their duties diligently.43 Supervisory boards play a useful role when competent people are elected to serve on them44 and when they are dealing with their task in an efficient way.45 Claussen maintains that the office of supervisory board is highly dependent on the type of person occupying these positions (persönlichkeitsabhängig).46 He also observes that control and supervisory mechanisms employed by other systems, for instance the board of directors in Anglo-American corporations and the governing body (Verwaltungsrat) in Swiss corporations, are not without their problems.47 Several commentators observe that the United Kingdom and United States unitary board systems are not without their own structural flaws. Röller points out that in the United Kingdom non-executive directors are often appointed for political reasons ‘to open some doors’ rather than for their real competence as board members.48 Baums queries the efficiency of boards in cases where the board is no more than a rubber stamp for management.49 Christopher Martin points out that if one takes the Enron and WorldCom collapses as examples then it is hardly possible to conclude that the American corporate governance system is better and that it will ensure transparant corporate management.50 Paul Davies sums up the underlying problem of adopting quick-fix corporate governance solutions from other jurisdictions. After reflecting on three papers published in the Fall 2000 Comparative Labor Law & Policy Journal he observes: [A]ll three papers are suggestive and one general point emerges, which is of importance to policy makers. This is the unwisdom of becoming interested in other countries’ corporate governance systems simply because one’s own economy is doing badly in the current phase of economic cycle … As Professor O’Connor points out, U.S. 42

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Marcus Lutter and Gerd Krieger, Rechte und Pflichten des Aufsichtsats (4th edn, Otto Schmidt Verlag, Cologne 2002) 46 para 30. These authors point out that although there are roughly 400 German undertakings with more than 2000 employees, there are also 15 000 GmbHs with between 500 and 2000 employees. See also Baums (n 19) 18; Wolfgang Röller, ‘Quo vadis Aufsichtsrat?’ (1994) 39 AG 333 at 333 and 334. Röller (n 42) 333. Lutter (n 16) 301. Scheffler (n 17) 76. Claussen (n 1) 484. See also Maximillian Schiessl, ‘Deutsche Corporate Governance post Enron’ (2002) 47 AG 598; Lutter (n 23) 231–32. Claussen (n 1) 484. See also Bernhardt (n 16) 315; Shearman (n 16) 124. Röller (n 42) 334. Baums (n 19) 15. Christopher Martin, ‘Das U.S. Corporate Governance System—Verlust der Vorbildfunktion’ (2003) 6 NZG 952.


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commentators and institutions began to be interested in German and Japanese systems of corporate governance in the 1980s when the U.S. economy seemed to be out-performed by the other two. Over the past decade, by contrast, the shoe has been on the other foot, in the case of Japan, decidedly so, and the proposition currently debated in scholarly articles is, accordingly, that everyone’s corporate law is converging on the U.S./U.K. model. In fact, however, whilst these three countries have moved up and down the relative performance leagues, none has made significant changes in their governance systems.51 Commentators also point out that the United Kingdom and United States corporations law has over recent years moved much closer to a de facto two-tier system, not very different from the traditional German two-tier system.52 This is so because of the more important role played by non-executive, extermal/outside and independent directors in United Kingdom and United States unitary boards. There is also a de facto distinction between the management tier and the supervisory tier in the United Kingdom and the United States: the function of managing the business of corporations is primarily fulfilled by senior executives, managing directors and managers, while the functions of overseeing or supervising the business of the corporation are functions of the board of directors, normally consisting of a majority of non-executive, external/outside and independent directors. These arguments are used to defend the German two-tier board system and to argue strongly against the adoption of a unitary board system in Germany.53 It is, however, important to keep perspective when comparing different board structures. The so-called ‘fit-all board structure’ does not exist and will probably never exist because there are simply too many local conditions, perceptions and practical realities applying to boards, their functions and their effectiveness.54 The views of Berrar are quite interesting. He observes that if one looks at unitary board systems with several sub-committees such as audit committees, nomination committees and remuneration committees consisting of non-executive directors, then the unitary board system does not seem so one-dimensional as some would believe. On the other hand, the German two-tier board system is not always in practice as two-dimensional as some would make it out to be. Berrar is, however, real51

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Paul Davies, ‘Employee Representation and Corporate Law Reform: A Comment from the United Kingdom’ (2000) 22 Comparative Labor L & Policy J 135 para 135. Klaus J Hopt, ‘Gemeinsame Grundsätze der Corporate Governance in Europa?’ (2000) 29 ZGR 784–85; Claussen (n 1) 484; Baums (n 19) 15; Günter Langenbucher and Ulf Blaum, ‘Audit Committees—Ein Weg zur Überwindung der Überwachungskrise?’ (1994) 47 DB 2197–98; Stefan Grundmann and Peter Mülbert, ‘Corporate Governance—Europäische Perspektiven’ (2001) 30 ZGR 221–22. Also Paul Davies ‘Struktur der Unternehmensführung in Großbritannien und Deutschland: Konvergenz oder fortbestehende Divergenz?’ (2001) 30 ZGR 292; Shearman (n 16) 124. Röller (n 42) 334. Also Claussen (n 1) 484. See generally Andre (n 35) 1822. As Davies (n 51) 135 para 137 points out ‘there is no “one best” system of corporate governance’.

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istic in his final analysis: if the differences between the unitary and two-tier board systems are analysed carefully, it becomes apparent that they are not really that far removed from each other.55 This view is supported by other writers.56 Lutter57 points out that many of the problems relating to the effectiveness of the supervisory board are not caused by deficiencies in the two-tier system as such, but occur because supervisory boards do not make use of the powers they actually have in terms of the Aktiengesetz 1965 (AktG).58 As reasons for this he lists aspects like contentment, underpayment, an overload of work, a lack of professionalism, the ritualisation (Ritualisierung) of supervisory board meetings and general human weaknesses.59 One of the most difficult issues facing any proposal for reforming German supervisory boards is that a uniform or homogeneous appraisal of them is hardly possible. This is so because supervisory boards not only differ considerably amongst the various industries, but they are also made compulsory in enterprises that are almost impossible to compare, such as private companies, public corporations, city banks and cooperatives.60

2.5 Initial Reaction The corporate governance debate, and in particular the debate on the functions of the supervisory board, has for many years been considered of academic interest only.61 In the late 1990s this perception changed dramatically: corporate governance evoked the interest of the German Government;62 it formed the central theme of discussion of several seminars and symposiums;63 German industry became 55 56

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Berrar (n 1) 2185–86. Jean J du Plessis, ‘Corporate Governance: Reflections on the German Two-tier System’ [1996] TSAR 20 at 44–46. Lutter (n 16) 295. See also Lutter 1994 (n 2) 176; Lutter (n 23) 228–29; Anonymous (n 36) 114; Berger (n 39) 8. Lutter (n 16) 295. Claussen (n 1) 484. It is with frustration that Lutter (n 16) 288–89 observes that he has been writing on the rights and duties of the supervisory board members for almost 15 years, but to no avail. One does, however, also detect a hint of satisfaction in Lutter’s observations—almost as if he would like to say: ‘I have told you so!’. Dietrich Dörner and Peter Oser, ‘Erfüllen Aufsichtsrat und Wirtschaftsprüfer ihre Aufgabe’ (1995) 48 DB 1085 (fn 4); Anonymous (n 36) 114; Erich Potthoff, ‘Ein Kodex für den Aufichtsrat!’ (1995) 48 DB 163. See Shearman (n 16) 123 (fn 2); Editor, ‘Hinweis der Schriftleitung’ (1995) 159 ZHR 287: ZHR-Symposion über Gesellschafts- und Bankrecht in Königstein/Ts (Jan 1995); Heinz-Dieter Assmann, ‘Corporate Governance’ (1995) 40 AG 290; Rürup (n 26) 219.


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committed to finding solutions;64 trade unions made recommendations;65 and eminent German academics participated keenly in this debate.66 The official reaction to the corporate governance debate was a Ministerial Draft Bill (Referentenentwurf eines Gesetzes fur Kontrolle und Transparanz im Unternehmensbereich (KonTraG)) of November 1996, which was generally known as the Aktienrechtsreform 1997.67 The Draft Bill dealt with several fundamental aspects pertaining to the duties, responsibilities and liability of members of supervisory boards, proxies, financial statements and disclosure, votes by the banks on behalf of shareholders, and financial instruments and capital markets.68 This Draft Bill was widely discussed in 1997.69 Several amendments were made to the original Draft Bill before it became law in May 1998.70 The proposed changes were described by some as comprehensive and akin to the reform of the German corporations law in the 1960s.71 Others were more sceptical and described the changes as no more than cosmetic,72 or done piecemeal instead of by way of a comprehensive review of the German corporations law.73 64

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Schmalenbach-Gesellschaft/Deutsche Gesellschaft für Betriebswirtschaft e.V (Arbeitskreis—Externe und interne Überwachung der Unternehmung) ‘Grundsätze ordnungsmäßiger Aufsichtsratstätigkeit—ein Diskussionspapier’ (1995) 48 DB 1. Dieter Schulte, ‘Aufsichtsräte stärken’ (1995) 6 Das Mitbestimmungsgespräch 6. See in particular the complete 1997 (Special Edition) AG. See further Lutter 1994 (n 2) 177; Lutter (n 16) 297–309; Baums (n 19) 11, Lutter (n 23) 235–37. The recent literature has been described as ‘a true flood of opinion’—Heinrich Götz, ‘Die Überwachung der Aktiengesellschaft im Lichte jüngerer Unternehmenskrisen’ (1995) 40 AG 337. Klaus J Hopt, ‘The German Two-Tier Board (Aufsichtsrat): A German View on Corporate Governance’ in Klaus J Hopt and Eddy Wymeersch (eds), Comparative Corporate Governance (de Gruyter Verlag, Berlin 1997) 15 (fn 28) simply observes that ‘[t]he literature is extensive’. Heinz-Dieter Assmann, ‘AG-Sonderheft: Die Aktienrechtsreform 1997’ (Special Edition) (1997) 42 AG 3. See Adams (n 39) 9 for a most comprehensive discussion of most of the issues dealt with in the Draft Bill. Also see Editorial ‘Referentenentwurf zur Änderung des Aktiengesetzes (KonTraG)’ (1996) 17 ZIP 2129 ff and Editorial ‘Referentenentwurf zur Änderung des Aktiengesetzes (KonTraG)—Teil II’ (1996) 17 ZIP 2193 ff. See (Special Edition) (1997) 42 AG 9 ff by some of the most eminent corporate law academics in Germany. Gesetz zur Kontrolle und Transparenz im Unternehmensbereich (KonTraG)— Bundesgesetzblatt Teil I (BGBl I 1998, 786 ff). See Claussen (n 1) 494. Ekkehard Wenger, ‘Stellungnahme zur Aktienrechtsreform 1997 von Prof Dr Ekkehard Wenger’ (Special Edition) (1997) 42 AG 57. Ulrich Seibert, ‘Aktienrechtsreform in Permanenz?’ (2002) 47 AG 417. However, at 419–20 the author explains that such piecemeal reform was necessary as comprehensive corporate law reforms take a long time and there was simply not enough time to wait for a comprehensive corporate law reform in Germany.

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One of the more fundamental questions asked during the reform process was how German corporations law could be modified to ensure the improvement of the state of businesses and to create more jobs.74 Several items, like the role and functions of the management board and general meeting, and unnecessary bureaucratic provisions, are now mentioned as items on the long-term reform agenda of the German corporations law.75 German commentators also started to focus on the relevance and applicability of general good corporate governance principles in the context of German public corporations. Broader themes like the role and function of corporations as good corporate citizens were also debated.76 The most fundamental question was to what extent new corporate governance principles would improve the way in which German public corporations were regulated. The particular corporate governance principles that should form part of a code of best practice, and what should be the basic relationship between any voluntary code and mandatory statutory provisions,77 were also debated extensively.78 One commentator justly pointed out that whether one refers to self-regulation or formal regulation, it remains regulation and the question is whether it is necessary for Germany.79 It was also observed that there was very little scope for further meaningful Codes in the Continental European systems.80 The German corporations law was already highly regulated and there were serious calls by some German commentators for deregulation and simplification.81 It was already realised at an early stage of the German corporate governance debate that most of the changes in the Draft Bill could be effected without the necessity for statutory changes.82 In other words, voluntary or self-imposed good 74 75 76

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79 80 81

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Claussen (n 1) 481. Seibert (n 73) 419. Press Release 18 July 2001 ‘Rede von STM Bury anlässlich der Veranstaltung Corporate Citizenship—Bürgerschafliches Engagement von Unternehmen’ . In this context, the Sarbanes-Oxley Act 2002 also caught the attention of several German commentators—see Martin (n 50) 948; Mark Strauch, ‘Der Sarbanes-Oxley Act und die Entwicklung im US-Aufsichtsrecht’ (2003) 6 NZG 952; Michael Gruson and Matthias Kubicek, ‘Der Sarbanes-Oxley Act, Corporate Governance und das deutsche Aktienrecht (Teil I)’ (2003) 48 AG 337 and ‘Der Sarbanes-Oxley Act, Corporate Governance und das deutsche Aktienrecht (Teil II)’ (2003) 48 AG 394; Bernhard Großfeld, ‘Rechnungslegung als Unternehmensverfassung’ (2003) 6 NZG 843; Hanno Merkt, ‘Zum Verhältnis von Kapitalmarktrecht und Gesellschaftsrecht in der Diskussion um die Corporate Governance’ (2003) 48 AG 130–31; Schiessl (n 46) 593. Uwe Hüffer, Aktiengesetz: Beck’liche Kurzkommentare (vol 53, 5th edn CH Beck Verlag, Munich 2002) 368–69. See also Lutter (n 23) 235. Hüffer (n 78) 369. Ibid. Friedrich Kübler, ‘Stellungnahme zur Aktienrechtsreform 1997 von Prof Dr Friedrich Kübler’ (Special Edition) (1997) 42 AG 48. Berger (n 39) 10.


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corporate governance practices would be sufficient. Some commentators warned specifically against the dangers of over-regulation by the legislature and that such regulation often causes more damage than advantages.83 Following the changes in 1998 a Government Commission (Regierungskommission ‘Corporate Governance—Unternehmensführung—Unternehmenskontrolle— Modernisierung des Aktienrechts’), chaired by Professor Theodor Baums, was appointed by the Government of the day on 29 May 2000.84 The Baums Commission made 150 recommendations in its report released on 10 July 2001.85 The Commission made recommendations regarding a Corporate Governance Code for listed German corporations; intensifying the control over directing the business of the corporation and increasing the powers of supervisory boards; improving the rights of shareholders and the protection of investors; improved provisions for the disclosure of information; improved financial accounting standards and financial reporting; and the application of modern information and communication technology.86 The basic aim of the Commission was described as follows by the State Minister to the Chancellery, Hans Martin Bury, when the report was completed: The work of the Government Panel on Corporate Governance has laid the foundation for a comprehensive reform of German company law. The Panel’s recommendations aim to improve corporate management and supervision, transparency and competition. They improve the protection of stockholders and strengthen Germany’s financial market. The Government Panel not only has accomplished its mission of formulating recommendations to correct undesirable past trends, but has also developed proposals with well-reasoned future orientation to strengthen the German system of Corporate Governance and eliminate potential shortcomings.87 83 84

85

86

87

Claussen (n 1) 487; Röller (n 42) 333. See also Baums (n 19) 16. Press Release 3 Aug 2001 ‘Corporate Governance—Unternehmensführung—Unternehmenskontrolle—Modernisierung des Aktienrechts’ 3. Also Press Release 21 June 2000 No 321 ‘Konstituierende Sitzung der Expertenkommission ‘Corporate Governance: Unternehmensführung—Unternehmenskontrolle—Modernisierung des Aktienrechts’ 1. Press Release 3 Aug 2001 (n 84); Carsten Berrar, ‘Zur Reform des AR nach den Vorschlägen der Regierungskommission “Corporate Governance”‘ (2001) 4 NZG 1113 at 1113 ff for a comprehensive but to the point analysis of the recommendations of the Baums Commission. Press Release 3 Aug 2001 (n 84) 3–8. Also Press Release 10 July 2001 No 304 ‘Corporate Governance: Bundesregierung modernisiert Unternehmensrecht und stärkt Finanzplatz Deutschland’ 1. Translation by Shearman & Sterling ‘German Government Panel on Corporate Governance’ Summary of Recommendations (Translation) at 1.

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It was made known that a group of experts would be appointed to draft a Code of Corporate Governance for Germany applying to all listed German companies88 and that the Code should follow the ‘comply or explain’ principle adopted in the United Kingdom.89 This task was given to the Corporate Government Commission under the chairmanship of Gerhard Cromme (the Cromme Commission) in 2001.90 The Baums Commission recommended that the Standing Commission on Corporate Governance should consist of a maximum of twelve members and that the members should be selected based on their practical experience and knowledge of managing and overseeing corporations, some experience in local and international listed companies and also knowledge of corporations law, accounting and financial statements.91 This recommendation was implemented and is currently reflected in the composition of the Cromme Commission’s twelve appointed members (with the chairperson, there are 13 members). They come from various backgrounds. The majority of the members hold positions on supervisory and management boards, while there are also two academics (Professor Marcus Lutter and Professor Axel von Werder) serving on the Commission.92 As a continuation of the Baums Recommendations of 2001, the Cromme Commission made several recommendations to change the AktG. These changes included the strengthening of the rights of supervisory boards. The supervisory board can insist that the management board must report to it the extent to which there were deviations from the business plan of the corporation during the course of the financial year.93 The right of a single member of the supervisory board to require further information was specifically recognised by deleting the requirement that at least two members of the supervisory board were required to obtain

88

89 90

91

92

93

As the Code contains generally applicable good corporate governance practices it is also desirable for non-listed companies to follow the Code. See Axel von Werder, ‘Der Deutsche Corporate Governance Kodex—Grunglagen und Einzelbestimmungen’ (2002) 55 DB 802. Translation by Shearman & Sterling (n 87). See further Lutter 2003 (n 2) 71–72. ‘Deutscher Corporate Governance Kodex’ . See further Press Release 6 Feb 2002 ‘Mehr Transparenz und Publizität im Aktienund Bilanzrecht’ 1. Baums Report 2001: Bericht der Regierungskommission Corporate Governance: Unternehmensführung—Unternehmenskontrolle—Modernisierung des Aktienrechts reproduced by Theodor Baums (Otto Schmidt Verlag, Cologne 2001) 61 para 17. Christoph H Seibt, ‘Deutscher Corporate Governance Kodex und EntsprechensErklärung (§161 AktG-E)’ (2002) 47 AG 249 (fn 2). See also Martin Peltzer, ‘Corporate Governance Codices als zusätzliche Pflichtenbestimmung für den Aufsichtsrat’ (2002) 5 NZG 12. S 5(a)(aa) of the Gesetz zur weiteren Reform des Aktien- und Bilanzrecht, zu Transparenz und Publizität (Transparenz- und Publizitätsgesetz)—Bundesgesetzblatt Teil I (BGBl I 2002, 2681 ff). See further Press Release 6 Feb 2002 (n 90) 1.


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further information.94 The 2002 amendments also inserted a specific duty of confidentiality applying to all members of the supervisory board regarding confidential reports or confidential discussions.95

2.6 The German Corporate Governance Code 2.6.1 Overview As mentioned above,96 in Germany the introduction of a Code of Good Corporate Governance Practices was always seen in context of the broader definition of corporate governance. The approach to such a definition was a realistic one, with two aspects being of particular importance. Firstly, corporate governance cannot ignore the stakeholder debate and, secondly, the concept of corporate governance encompasses more than just the creation of legal structures for decision making and supervising the corporation.97 It was furthermore realised that because of the peculiarities of the German corporations law,98 in particular the prescriptive nature of the AktG regarding a two-tier board, no international Code would fit the German situation.99 Although there were some private initiatives to introduce a Code of Best Practice for Germany,100 the official German Corporate Governance Code (GCGC) was 94

95

96 97

98

99 100

S 5(b) of the Gesetz zur weiteren Reform des Aktien- und Bilanzrecht, zu Transparenz und Publizität (Transparenz- und Publizitätsgesetz)—Bundesgesetzblatt Teil I (BGBl I 2002, 2681 ff). See further Heinrich Götz, ‘Rechte und Pflichten des Aufsichtsrat nach dem Transparenz- und Publizitätsgesetz’ (2002) 5 NZG 601. S 10 of the Gesetz zur weiteren Reform des Aktien- und Bilanzrecht, zu Transparenz und Publizität (Transparenz- und Publizitätsgesetz)—Bundesgesetzblatt Teil I (BGBl I 2002, 2681 ff). See further Götz (n 94) 603; Schiessl (n 46) 593–94. See 2.2. Uwe H Schneider and Christian Strenger, ‘Die “Corporate Governance-Grundsätze” (German Panel on Corporate Governance)’ (2000) 45 AG 106–07. See further Martin Peltzer and Axel von Werder, ‘Der “German Code of Corporate Governance (GCCG)” des Berliner Initiativkreises’ (2001) 46 AG 1–2; Grundmann and Mülbert (n 52) 215; Carsten P Claussen and Norbert Bröcker, ‘Corporate-Governance-Grundsätze in Deutschland—nützliche Orientierungshilfe oder regulatorisches Übermaß?’ (2000) 45 AG 481. Hopt (n 52) 798–809 focuses on the three most fundamental differences between the UK and German corporate law systems and summarises them as follows: 1. Codetermination of employees versus shareholder value; 2. Full-service banking (Universalbanken) versus capital markets; and 3. The law relating to company groups versus resignation, fiduciary duties (Treuepflichten) and piercing the corporate veil. Schneider and Strenger (n 97) 107. The so-called Berlin Code and the Frankfurt Code are the ones private initiatives referred to most often—see Berliner Initiativkreis German Corporate Governance ‘German Code of Corporate Governance (GCCG)’ (2000) 53 DB 1573 ff; Schneider and

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only adopted on 26 February 2002.101 One of the main aims of the Code was to improve corporate governance practices relating to managing, directing and overseeing listed corporations.102 Two basic principles were adopted, namely that it would only apply to listed corporations103 and that it would not be mandatory, but that listed companies must explain if they do not follow certain specific recommendations104 of the Code (the ‘comply or explain’ principle).105 What is, however, different from most other systems where voluntary corporate governance models have been adopted, is that the AktG was amended on 19 July 2002 by inserting a new Section 161 in order to give this arrangement statutory backing.106 Section 161 basically imposes a statutory duty on the supervisory boards and management boards of all listed German companies to state that they ‘comply’ with the GCGC as published electronically107 from time to time by a Standing Commission, the Regierungskommission Corporate Governance, or to ‘explain’ if they do not comply with the Code.108 The ‘comply or explain’ statement must be done on an annual basis109 and must also be made available to the shareholders at all times.110

101

102 103

104 105

106

107

108

109

Strenger (n 97) 109 ff. See further Georg Borges, ‘Selbstregulierung im Gesellschaftsrecht—zur Bindung an Corporate Governance-Kodizes’ (2003) 32 ZGR 511; Peltzer (n 92) 11; Lutter (n 23) 225; Peltzer and von Werder (n 97) 1 ff. Press Release 26 Feb 2002 ‘Corporate Governance Kodex verbessert Attraktivität der deutschen Finanzmärkte’ 1. Baums Report (n 91) 54 para 10, 57 para 13; Ulmer (n 25) 154. See Seibt (n 92) 258–59. See further Knut W Lange, ‘Corporate Governance in Familienunternehmen’ (2005) 60 BB 2585 ff; Knut W Lange, ‘Der Beirat als Element der Corporate Governance in Familienunternehmen’ 2006 GmbHR 897 ff on corporate governance in family businesses. See discussion below. Baums Report (n 91) 54 para 10; Press Release 3 Aug 2001 (n 84) 2. See further Borges (n 100) 524–25; Olaf Ehrhardt and Eric Nowak, ‘Die Durchsetzung von CorporateGovernance-Regeln’ (2002) 47 AG 336, 341–44. Gesetz zur weiteren Reform des Aktien- und Bilanzrecht, zu Transparenz und Publizität (Transparenz- und Publizitätsgesetz)—Bundesgesetzblatt Teil I (BGBl I 2002, 2681 ff). Elektronischen Bundesanzeiger (<www.ebundesanzeiger.de>). This does not, however, make the Code a Statute—see Christoph H Seibt, ‘Deutscher Corporate Governance Codex: Antworten auf Zweifelsfragen der Praxis’ (2003) 48 AG 470. See Baums Report (n 91) 59–60 paras 16–17 for the background to this approach. See also Lutter 2003 (n 2) 75–76; Marcus Lutter, ‘Die Erklärung zum Corporate Governance Kodex gemäß § 161 AktG’ (2002) 166 ZHR 525–26; Peltzer (n 26) 594–95; HansChristoph Hirt, ‘Germany: The GCGC: Co-determination and Corporate Governce Reforms’ (2002) 23 Company Lawyer 350; Thomas Strieder and Andreas Kuhn, ‘Die Offenlegung der jährlichen Entsprechenserklärung zum Deutschen Corporate Kodex sowie die zukünftigen Änderungen durch das EHUG’ (2006) 59 DB 2247 ff. For details see Semler and Wagner (n 41) 554.


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According to the definitive majority opinion in literature, Section 161 of the AktG obliges companies to issue a corporate governance code declaration which is, on the one hand, oriented to the past (i.e. whether or not the company complied with the Code for the past period of accountability), and, on the other hand, the declaration must be future-oriented by declaring whether the company will comply with the Code’s provisions in the future.111 Since investors’ decisions on investments and disinvestments are based on future facts, it is clear that the futureoriented part of the corporate governance code declaration is of major importance. If the issued declaration differs from the truth, after it was once properly declared, the management board and the supervisory board are obliged to rectify the former declaration. Otherwise, the underlying aim with Section 161 of the AktG will not be fulfilled, since capital market participants will not be properly informed when they make investment decisions.112 The declaration requires strict liability of the management board and supervisory board members whenever the actual corporate governance practices do not correspond with the stated principles.113 It was realised from the beginning that such a voluntary corporate governance system would provide the advantage of responding quickly and effectively to constantly changing needs of business, something that could not be achieved if the Code was formalised through legislation and the tediousness involved in amending legislation.114 The Cromme Commission amended the original Code. This took effect from 21 May 2003.115 These changes dealt primarily with the remuneration of the members of the management board, in particular to ensure regular review of the remunera-

110

111

112 113

114

115

For the background to the insertion of s 161, see Press Release 6 Feb 2002 (n 90) 1; Press Release 3 Aug 2001 (n 84) 2. Semler and Wagner (n 41) 554 ff explain what aspects the annual statement should contain. See, different from most other commentators, Peter Hommelhoff and Martin Schwab, ‘Regelungsquellen und Regelungsebenen der Corporate Governance: Gesetz, Satzung, Codices, unternehmensinterne Grundsätze’ in Hommelhoff, Hopt and von Werder (n 4) 51, 61; Vetter (n 4) 748, 755 with further bibliography. For details see Semler and Wagner (n 41) 553, 556. The particular legal nature and factual particularities of the Code demand a differentiated regime of potential liability claims. See therefore Hommelhoff and Schwab (n 111) in Hommelhoff, Hopt and von Werder (n 4) 51, 69; Nils Abram, ‘Ansprüche von Anlegern wegen Verstoßes gegen Publizitätspflichten oder den Deutschen Corporate Governance Kodex?’ (2003) 6 NZG 307 ff; Carsten P Claussen and Norbert Bröcker, ‘Der Corporate Governance-Kdoex aus der Perspektive der kleinen und mitteleren Börsen-AG’ (2002) 55 DB 1199, 1205; all with further bibliography. Press Release 3 Aug 2001 (n 84) 2. See generally Friedrich Gelhausen and Henning Hönsch, ‘Folgen der Änderung des Deutschen Corporate Governance Kodex für die Entsprechenserklärung’ (2003) 48 AG 367; Seibt (n 92) 259. Press Release 22 May 2003 No 39/03 ‘Zypries begrüßt Beschlüsse der Cromme-Kommission’ 1.

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tion of management board members by the supervisory board;116 ensuring that their remuneration must be performance-based and contain risk elements;117 providing for the possibility that the supervisory board could put a cap on the remuneration for extraordinary unforeseen developments;118 that the salient features of management board remuneration must be explained in detail in plainly understandable language in the financial statements of the corporation;119 and the chairperson of the supervisory board must also outline the salient points of the management board remuneration and any changes thereto to the general meeting.120 These changes were introduced primarily due to international developments and in particular developments following the Sarbanes-Oxley Act of 2002.121 There were some practical difficulties for companies to comply with these provisions as no transition provisions were published and the exact wording of the new provisions was not made known until they were published on 21 May 2003.122 Some additional amendments, pertaining to the remuneration and compensation of members of the management board and the disclosure thereof, were made by way of amendments that came into effect on 12 June 2006.123 Although there are still several practical difficulties experienced in complying fully with the Code, it seems that there is a real desire to comply with the Code by most German corporations required to do so.124 As part of this process the majority of listed corporations seem keen to appoint corporate governance compliance officers to ensure proper compliance with the Code.125 But focusing on those 30 companies listed on the DAX obstructs the view on other listed companies. The majority of the approximately one thousand listed companies do not completely fulfil the demands of the GCGC.126 Particular need for action is generated by the

116 117 118 119 120 121 122 123

124

125

126

Art 4.2.2 GCGC. Art 4.2.3 (1st para) GCGC. Art 4.2.3 (2nd para) GCGC. Art 4.2.3 (3rd para) GCGC. Art 4.2.3 (4th para) GCGC. See generally Seibt (n 107) 465–66. Press release (n 115). Seibt (n 107) 477. See also Gelhausen and Hönsch (n 114) 367 at 268 ff. For the amendments see . The complete GCGC including the latest amendments is also published at (2006) 9 NZG 614 ff. Seibt (n 107) 465 ff and 470. See further Axel von Werder and Till Talaulicar, ‘Kodex Report 2006: Die Akzeptanz der Empfehlungen und Anregungen des Deutschen Corporate Governance Kodex’ (2006) 59 DB 849 ff. Seibt (n 107) 469. The duty to comply with the GCGC could also be formalised through appropriate clauses in the contracts of appointment of supervisory board and management board members, by adding this duty to the articles of incorporation, or by adding it to the directives of the managing board—see Semler and Wagner (n 41) 557–58. See ‘Corporate Governance Kodex wird nur unzureichend erfüllt’ FAZ 22 Jan 2005, 17.


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individualised reports on management board members’ remuneration.127 But even if the Code is only partially satisfied, it serves a useful role in evaluating and monitoring institutions.

2.6.2 Parts and Layout The Code consists of seven different parts.128 The first part, namely the Foreword, explains the purpose of the Code and how the provisions of the Code should be interpreted. Part two deals with shareholders and the general meeting; part three with the cooperation between the management board and the supervisory board; part four with the management board; part five with the supervisory board; part six with information that should be disclosed to ensure transparency, while part seven deals with accounting aspects like financial reporting, audit and financial statements. In the Foreword it is explained that there are basically three types of provisions in the Code.129 The first group of provisions are identifiable by the use of the word shall (soll). These provisions contain the core recommendations of the Code and are the provisions to which the principle of ‘comply or explain’ will apply. In other words, listed companies may deviate from these provisions, but any such deviations should be explained in the annual ‘comply or explain’ statement. The second set of provisions are identifiable by the words ‘should’ (sollte) or ‘can’ (kann). These provisions are considered to be good corporate governance principles, although not really the core ones. Corporations are encouraged to follow them, but no explanation is required if they do not. All remaining provisions in the Code, not identifiable by any one of the words used above, are considered to be provisions just confirming the existing legal requirements under the current German corporations law. In other words, they simply serve as a general and user-friendly way of explaining the most basic existing corporate governance rules under German corporations law, a so-called ‘communication function’ of the Code.130 These provisions are quite useful as they provide 127

128 129

130

Bernd J Wieczorek in an interview with FAZ (n 126) 17. These provisions are currently contained in Art 4.2.4 2006 GCGC. See generally von Werder (n 88) 803; Vetter (n 4) 748, 752. See generally Lutter 2003 (n 2) 73–74; Klaus Ruhnke, ‘Prüfung der Einhaltung des Deutschen Corporate Governance Kodex durch den Abschlussprüfer’ (2003) 48 AG 371–72; Borges (n 100) 513; Seibt (n 107) 470; Lutter (n 108) 524–25; von Werder (n 88) 802–03; Ulmer (n 25) 151–52, Seibt (n 92) 250. Von Werder (n 88) 801–02. Whether, as von Werder seems to suggest (see 802, fn 16), the Code will ensure that misunderstandings will stop occurring, is highly unlikely. Misunderstandings, misconstructions and misconceptions about the German corporations law will almost definitely re-occur in future because of the complexities of the German corporations law; the inaccessibility of the German corporations law (see von Werder’s sentence immediately before n16 on page 802; and Hirt (n 108) 354); and the impossibility of enunciating all the subtle aspects of the German language in research on the German corporations law published in English, often by non-German speakers. For

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one of the most basic and simple explanations of the principles of the German two-tier board system and the relationship among the various corporate organs that exist in the German literature.131 Almost half of the provisions of the Code are indeed of an explanatory nature.132 The duty to comply with the Code or to explain non-compliance extends to basically three groups, namely the two main organs of the corporation (the supervisory board and the management board); some individual members of these boards, and the corporation’s auditors.133

2.6.3 Some Noteworthy Provisions of the Code At the heart of the Code is the improvement of the supervisory and overseeing functions of the supervisory board.134 Thus, the Code explains in some detail the relationship between the supervisory board and the management board as well as the respective roles and functions of the supervisory and management boards.135 It is interesting to note that the first two parts of the Code primarily serve the purpose of explaining the current law. These parts consist of three pages, but there are only six ‘comply or explain’ provisions in them.136 There is also a fair bit of explanation of the existing law in Part four dealing with the management board. In contrast with this, there are only a few articles in Parts five to seven that do not contain ‘comply or explain’ provisions.137 The following ‘comply or explain’ provisions are particularly interesting: • The supervisory board shall specify the duties of the management board regarding reporting and the provision of detailed information to the supervisory board.138

131 132 133 134 135 136 137

138

a good example of a contribution containing several generalisations, see Mahmut Yavasi, ‘Shareholding and Board Structures of German and UK Companies’ (2001) 22 Company Lawyer 47. On page 48 the author, without quoting any sources, states as follows: ‘Accordingly, the German system of corporate governance is peculiar in two respects. First, almost all interested parties in a company are represented on the supervisory boards. Therefore, the shareholders and other parties can make use of control rights over the managers. Secondly, there is no evident social and political opposition to this structure.’ See also Ulmer (n 25) 153. Lutter 2003 (n 2) 73. Ulmer (n 25) 154–55. Pts 3–4 GCGC. See also Ulmer (n 25) 155. Pts 3–4 GCGC. Art 2.3.1, 2.3.2, 2.3.3 and 3.4 GCGC. The only exceptions are Art 5.1.1, 5.3.3, 5.3.4, 5.4.4, 5.5.1, 6.1, 7.2.2 and 7.2.4. The remaining twenty-seven Articles all contain at least one ‘comply or explain’ provision, but in most instances more than one such provision. Art 3.4 (3rd para) GCGC.


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• The management board and the supervisory board shall report each year on the enterprise’s corporate governance practices in the Annual Report.139 • The management board shall comprise several persons and have a Chairperson or Spokesman.140 • Terms of reference shall regulate the allocation of areas of responsibility and the cooperation of the management board.141 • There is a general provision that the supervisory board should form specialised sub-committees to increase the efficiency of the supervisory board and to advise the supervisory board on complex issues.142 There is then specific reference to two such sub-committees of the supervisory board, namely an appointment and remuneration committee143 and an audit committee.144 Although it is only considered to be a good corporate governance practice for the supervisory board to have an appointment and remuneration committee to assist it with the task of appointing management board members,145 Article 4.2.2 of the Code provides that the full supervisory board shall discuss and regularly review the structure of management board remuneration, on advice from the committee dealing with management board contracts.146 This provision will probably ensure that most listed companies will appoint such appointment and remuneration committees as it will be impossible to have such discussion based on the advice of such a committee if it does not exist. Another indication that there will probably be such an appointment and remuneration committee in most listed corporations, is the fact that Article 5.2 provides that the company must explain if the chairperson of the supervisory board is not also the chair of the appointment and remuneration committee.147 It is suggested that it would have been better if the Code simply made such an appointment and remuneration committee a ‘comply or explain’ provision in Article 5.1.2 in the same way it did with the Audit Committee.148 139 140 141 142

143 144 145 146 147 148

Art 3.10 GCGC. Art 4.2.1 GCGC. Art 4.2.1 GCGC. Art 5.3.1 GCGC. The term ‘compensation’ is often used in the German GCC. It is, however, suggested that ‘remuneration’ would have been a better translation in most instances where the word ‘compensation’ is used. Art 5.1.2 GCGC. See also Schiessl (n 46) 599. Art 5.3.2 GCGC. Art 5.1.2 GCGC. Art 4.2.3 (last para) GCGC. Art 5.2 (2nd para) GCGC. See Art 5.3.2 GCGC. As far as the introduction of the Audit Committee is concerned— see in particular Baums Report (n 91) 319 para 312 ff.

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• The chairperson of the supervisory board shall outline the salient features of the remuneration system and any changes thereto to the general meeting.149 • The specific remuneration of each member of the management board shall be reported in the Notes to the Consolidated Financial Statements and subdivided into fixed, performance-related and long-term incentive components.150 • Members of the management board shall take on sideline activities, especially Supervisory Board mandates outside the enterprise, only with the approval of the supervisory board.151 • The supervisory board, in consultation with the management board, shall ensure that there is long-term succession planning for management board members.152 It is also interesting to note that the Code does not overemphasise the distinction between the shareholder representatives and the employee representatives on the supervisory board. Apart from the Foreword, there is in fact only one direct reference to the respective representatives in the Code.153 Article 3.6 provides that in corporations where there are employee representatives on the supervisory board, preparation for supervisory board meetings should be undertaken by having separate meetings for the shareholder representatives and for the employee representatives and that these meetings should possibly be held with the members of the management board present. The aim of this suggestion (it is not a ‘comply or explain’ provision) is apparently to allow the respective groups to consider the interests of their constituents as part of their preparation for the actual supervisory board meetings, but that the supervisory board will operate as an organ and collectively when the actual meetings of the supervisory board take place. It also gives the respective representatives the opportunity to raise concerns with the management board before supervisory board meetings. Another advantage of such meetings is that it would make it unnecessary to invite the management board members to the supervisory board meetings as the respective groups would have had previous opportunity to inform the management board of their views and concerns about specific issues.

149 150 151 152 153

Art 4.2.3 GCGC. Art 4.2.4 GCGC. Art 4.3.5 GCGC. Art 5.1.2 GCGC. Seibt (n 107) 476 (fn 95) argues that Art 5.4.1 also contains a reference to the distinction between shareholder and employee representatives, but as this distinction only becomes apparent by inference, it will not be considered to be a direct reference to this distinction for purposes of this research.


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2.6.4 The Legal Nature of the Code As mentioned above,154 the realisation of the GCGC’s aims encounters more than just practical difficulties. Also the legal nature of the Code is controversial.155 The majority of commentators consider the Code as a form of self-regulation based on a body of ‘private law’, but there are debates among the commentators as to the exact legal nature of the Code.156 Commentators point out that it is not an Act of Parliament and that it is also not an agreement that can formally bind the various parties.157 It is obvious that the Code itself is not immediately binding while Section 161 of the AktG is directly binding by establishing a legal obligation for the declaration of compliance. It is possible that over time and through wide practical use the provisions of the Code could become recognised as wellaccepted trade practices.158 However, there are serious concerns with regard to the constitutionality of the Code. It has been suggested that self-regulation leads to an ‘erosion of parliamentarianism’159 and constitutional doubts due to deficiencies of legitimacy. Almost all authors acknowledge the Code’s practical impact, which for example arises because a company’s listing can be suspended by the Stock Exchange for noncompliance with the Code’s recommendations.160 Those commentators who deny the practical impact, although they deem listed corporations as being exposed to market forces to justify their non-compliance towards capital markets and the public,161 contradict themselves. The practical impact of the GCGC is indeed so compelling that it constitutes material intervention with basic rights, since the Code directly or indirectly encroaches on freedom of profession of the companies162 and freedom of profession

154 155

156

157 158

159 160 161

162

See 2.3. See Borges (n 100) 514; Seibt (n 107) 470; Seibt (n 92) 250 ff; Ulmer (n 25) 159, 164; Hirt (n 108) 351; Claussen and Bröcker (n 97) 482–85; Wolfgang Seidel, ‘Der Deutsche Corporate Governance Kodex—eine private oder doch eine staatliche Regelung’ (2004) 25 ZIP 285–89; Wolf Martin, ‘Corporate Governance—Der Import angesächsischer “Self-Regulation” im Widerstreit zum deutschen Parlamentsvorbehalt’ (2002) 7 ZRP 59 ff. For a detailed elaboration on the debate about the Code’s legal nature see Seidel (n 155) 285 ff with further bibliography. Seibt (n 107) 470, 471. See also Lutter 2003 (n 2) 71, 78. Seibt (n 107) 470. See, however, Borges (n 100) 516–17 and Claussen and Bröcker (n 97) 483 for some reservations. Cf Martin (n 156) 59–60. See Martin (n 156) 59, 60 for further examples of factual coercion. Cf Stefan Berg and Mathias Stöcker, ‘Anwendungs- und Haftungsfragen zum Deutschen Corporate Governance Kodex’ (2002) 56 WM 1569, 1572. S 12(1) 2 Basic Law in conjunction with S 19(3) Basic Law.

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of the management and supervisory board members.163 Hence, a state which is based on parliamentary democracy and founded on the rule of law advises and even demands an act of Parliament in order to ensure sufficient legitimacy. This statement must apply a fortiori for those parts of the Code which not only summarise legal standards set up by business and corporate law in order to brief foreign investors, but which establish rules of conduct exceeding those standards set up by statutory law. Thus, it is not surprising that some commentators contend that all recommendations of the Code are unconstitutional and void.164 One of the most controversial points of the debate is the one on individualised reports of management board members’ remuneration, which is discussed below.165 Closely linked with the debate on the Code’s legal nature and constitutionality is the issue of which role the Code can play as far as rules of interpretation are concerned. The legal elaboration of this issue is at most rudimentary. However, it is possible to derive some handy principles. Those Articles of the Code which only refer to primary statutes are descriptive. Thus, in principle they have to be interpreted like the statute referred to. Where the wording of the relevant Articles of the Code vary from the statute referred to, opinions differ. According to Seibt, such rules of the Code can be deemed as suggestions for construction of those statutes the Code refers to, since the Code intends to provide concise wording easy to understand for the general public.166 The counter argument is that such variations are only trivial interpretations of the law, which are not subject to the Corporate Governance Code declaration according to Section 161 of the AktG.167 Ultimately, a view which states that the Code can be used as an auxiliary instrument to construe statutes is compatible with both opinions. And also the Federal Court of Justice (Bundesgerichtshof, BGH) makes use of this instrument: a fact which will be relevant later.168 Thus, the position will probably be that in future it could also be used by German Courts as a useful instrument in determining the standards of good corporate governance expected of

163

164 165 166 167

168

S 12(1) 2 Basic Law. As far as board members are concerned, the recommendations of the Code create higher liability risks. This statement can be made, although the majority of the literature argues that management and supervisory board members have wide discretion when judging whether or not a company complies with the code. For instance see Seidel (n 155) 285, 291 with further bibliography. See below. See Seibt (n 107) 465, 472. Heribert Hirte, Das Transparenz- und Publizitätsgesetz (CH Beck Verlag, Munich 2003) 10; Norbert Pfitzer, Peter Oser and Dominic Wader, ‘Die EntsprechensErklärung nach § 161 AktG—Checkliste für Vorstände und Aufsichtsräte zur Einhaltung der Empfehlungen des Deutschen Corporate Governance Kodex’ (2002) 53 DB 1120, 1121. See below.


33

corporations and their officers.169 But the legal nature of the Code cannot be understood in the way the Higher Regional Court of Schleswig (OLG Schleswig) did when it stated that the statutory acknowledgment of the Code by Section 161 of the AktG has a retrospective effect on the interpretation of other regulations of the AktG.170 Therefore it will not be possible to consult the code when there are doubts about the interpretation of the AktG.

2.7 Need for a European Corporate Governance Code The increasing Europeanisation of law and in particular the latest recommendations at EU-level on the independence of non-executive and supervisory board members evoke the question whether there is a need for a European corporate governance code. The GCGC’s basic aim, to promote the trust of national and international investors, customers, employees and the general public in the management and supervision of listed German stock corporations, may also be applied in a modified way at EU-level. Multinational firms in particular might benefit from a European Corporate Governance Code instead of referring to several apparently diverging national codes. In terms of this thought, the EU-Commission seemed to be striving to find and define pan-European values in corporate governance, which might be echoed in a European Corporate Governance Code.171 This code would necessitate modifications in German law and finally lead to a more critical approach to the usefulness and practical application of the German Code. However, judged by the latest statements by the Commission, it appears unlikely that such a European Code will become a reality,172 at least not in the near future.173 The main argument is that a 169

170 171

172

See Austin J in ASIC v Rich [2003] NSWSC 85 (24 Feb 2003) para 70: ‘The Commission’s evidence does not purport to establish, directly, that Mr Greaves had specific duties on particular occasions. It seeks to establish his ‘responsibilities’ by reference to usual practice. Much of the literature of corporate governance is in the form of exhortations and voluntary codes of conduct, not suitable to constitute legal duties. It is sometimes vague and less than compelling, and must always be used with caution. Nevertheless, in my opinion this literature is relevant to the ascertainment of the responsibilities to which Mr Greaves was subject during the period from January to March 2001.’ Cf Ulmer (n 25) 166–67. OLG Schleswig, 19.09.2002, 5 U 164/01, (2003) 5 NZG 176, 179. Cf Peter M Wiesner, ‘Corporate Governance und kein Ende—Kommt der europäische Superkodex?’ (2002) 2 BKR 145 ff. Cf the ‘Modernisation of Company Law and Enhancement of Corporate Governance in the European Union—A Plan to Move Forward’ p 7 and the statement of the European Commissioner for Internal Market and Services Charlie McCreevy ‘Kommissar gegen EUKodex’, reported in FAZ 21 Jan 2005, 13.

34


European Corporate Governance Code would not add significant value but would simply add an additional layer between international principles and national codes.174 Indeed, it is questionable whether there is a need to add another Code to the approximately 44 Codes already existing in Europe.175 Besides that, the coexistence of these different national codes must not be perceived as a difficulty. And it cannot be overlooked that all endeavours to harmonise corporate control structures during the past 30 years were not successful, because of the diverging corporate concepts and cultural differences which can be found in Europe. As a result of these discrepancies, the European Corporate Governance Code, if it is realised at all, would be, in the words of the European Commissioner for Internal Market and Services, Charlie McCreevy, ‘an inevitable and possibly messy political compromise, which would be unlikely to achieve full information for investors about the key corporate governance rules’.176 This view is definitively persuasive as long as the current differences exist. But since the European Union is trying to stimulate convergence between its member states, there might be a point in future when the step necessary to move from the national level towards a single code at EU-level may not be so far-fetched. The existing differences among European Corporate Governance Codes and corporate laws are based on different historical developments in different countries and also brought about by cultural and socio-economic differences. In order to overcome these differences and tap the benefits of a European Corporate Governance Code, the EU-Commission is supposed to enact a directive which obliges national legislature to develop national codes on corporate governance complying with certain 173

174

175

176

Nevertheless since the Action Plan was adopted in 2003 most short-term measures have been realised. The Commission has published a recommendation (of 14 Dec 2004) fostering an appropriate regime for the remuneration of directors of listed companies ([2004] OJ L385/55) and another recommendation (of 15 Feb 2005) on the role of nonexecutive or supervisory directors of listed companies and on the committees of the (supervisory) board ([2005] OJ L52/51). Furthermore a proposal for a Directive of the European Parliament and of the Council amending Council Directives (EEC) 78/660 and (EEC) 83/349 concerning the annual accounts of certain types of companies and consolidated accounts, COM(2004) 725 final, and another proposal for a Directive on the exercise of voting rights by shareholders of companies having their registered office in a Member State and whose shares are admitted to trading on a regulated market and amending Directive (EC) 2004/109, COM(2005) 685 final have been published. Finally there are regular high level meetings of the European Corporate Governance Forum that comprise representatives from Member States, European regulators, issuers and investors, other market participants and academics, cf . Cf the Action Plan on Corporate Governance of the EU Commission, p. 7 (accessible online at ). Wiesner (n 171) 145 ff. See also Christian Förster, ‘Europäische Corporate Governance— Tatsächliche Konvergenz der neuen Kodizes?’ (2006) 27 ZIP 162 ff. FAZ 21 Jan 2005, ‘Kommissar gegen EU-Kodex’ 13.


35

specifications of the EU-legislature.177 An approach at EU-level which relies only on self-regulating market forces and which is restricted to non-binding recommendations does not suffice to ensure sound management of companies within one economic area in which all European capital markets are increasingly integrated.

2.8 Concluding Remarks The changes to the German corporations law since 1998 achieved at least the following things. Firstly, it broadened the rights and duties of the supervisory board.178 Secondly, it strengthened the role of the supervisory board as central supervisory and overseeing organ to fulfil its functions on behalf of shareholders, creditors and employees.179 Thirdly, it has the potential to ensure that good corporate governance practices are followed in Germany.180 Fourthly, it introduced into German corporations law several modern international best corporate governance practices.181 Finally, the Code provides an ideal instrument for German law to 177

178

179

180 181

This advocates the demand of the Group of German Experts on Corporate Law, ‘Zur Entwicklung des Europäischen Gesellschaftsrechts: Stellungnahme der Arbeitsgruppe Europäisches Gesellschaftsrecht zum Report of the High Level Group of Company Law Experts on a modern Regulatory Framework for Company Law in Europe’ (2003) 24 ZIP 863, 871. The High Expert Group on Corporate Governance of the Deutsches Aktieninstitut lists some examples which can be covered in a European Corporate Governance Code, comprising a waiver of multiple voting rights and ‘golden shares’; shareholders’ access to the general meeting by modern forms of communication (eg internet); equal treatment of shareholders as far as information transfer is concerned; disclosure of material shareholdings in third companies; disclosure of purchases or sales of shares of the company or of its affiliated companies, of options or other derivatives by members of the management board or supervisory board. Götz (n 94) 599 ff; Peltzer (n 26) 594, 595–96; Ehrhardt and Nowak (n 105) 341; Walther Von Wietzlow, Jena Gemmecke and Jones Day, ‘Corporate Governance und die Praxis der gerichlichen Bestellung von Aufsichtsräten—ein Problem?’ (2003) AG Report R 302. Manual R Theisen, ‘Zur Reforms des Aufsichtsrat—Eine betriebswirtschaftliche Bestandanalyse und Perspektive’ in Dietrich Dörner, Dieter Menold, Norbert Pfitzer and Peter Oser Reform des Aktienrechts, der Rechnungslegung und der Prüfung (2nd edn Schäffer-Poeschel Verlag, Stuttgart 2003) 437 ff; Gelhausen and Hönsch (n 114) 369; Von Wietzlow, Gemmecke and Day (n 179) 302; Hirt (n 108) 352; Peter Hommelhoff and Daniela Mattheus, ‘Corporate Governance nach dem KonTraG’ (1998) 43 AG 252–53, 256–57; Daniel Zimmer, ‘Das Gesetz zur Kontrolle und Transpareny im Unternehmensbereich’ (1998) 51 NJW 3523–24. Schiessl (n 46) 594; Lutter (n 23) 228. Gelhausen and Hönsch (n 114) 367, 371; von Werder (n 88) 801–02, Ehrhardt and Nowak (n 105) 345. An author like Seibert (n 73) 418 correctly points out that most of the corporate law reforms in Germany over the past 10 years were driven by ‘globalisation’ and ‘digitalisation’.

36


respond quickly and effectively to constantly changing needs of business, in particular regarding best corporate governance practices.182 It could safely be stated that there were such remarkable developments regarding the German two-tier board system, the respective roles of the various company organs and the interrelationship amongst these organs that some criticism aimed at the German two-tier board system as recently as 1997 could be disccounted.183 There is also little doubt that German corporations law was transformed irreversibly184 and on a scale not experienced since the last major corporate law reform in Germany in 1965.

182 183 184

Von Werder (n 88) 802. See for instance criticism by Shearman (n 16) 123. See generally Peltzer (n 26) 593 and Seibert (n 73) 420.

Chapter 3

The General Meeting and the Management Board as Company Organs Jean du Plessis and Ingo Saenger

3.1 Introduction Three organs are required for German public companies (AGs). These are the general meeting (Hauptversammlung), the supervisory board (Aufsichtsrat) and the management board (Vorstand). For a private company (GmbH), only two organs are required: the management organ (comparable to the management board in the AG) and the organ for the corporators (comparable to the general meeting in the AG)1 but codetermination legislation also makes a supervisory board compulsory for some larger GmbHs.2 There is a unique interrelationship between the general meeting, the supervisory board and the management board,3 which makes it indispensable to study them briefly for a proper understanding of German corporations law.4 In this and the following section the focus will be primarily on AGs, since it is in these corporations where the interrelationship between the various organs can best be illustrated through the extensive statutory provisions contained in the Aktiengesetz (AktG).5 In order to expose the characteristics of a dual board system and to be able to por1 2 3

4

5

Friedrich Kübler, Gesellschaftsrecht (5th edn CF Müller Verlag, Heidelberg 1998) 221. See discussion about codetermination in Chapter 5. Theodor Baums, ‘Corporate Governance in Germany: The Role of the Banks’ [1992] AJCL 504; Editorial ‘Referentenentwurf zur Änderung des Aktiengesetzes (‘KonTraG’)’ (1996) 17 ZIP 2129. From an Anglo-American perspective, curiosity is immediately raised by a statement that in the German corporations law, there is no prioritisation amongst the various company organs—see Ulrich Immenga, ‘Zuständigkeiten des mitbestimmten Aufsichtsrats’ (1977) 16 ZGR 249, 262–63. B Großfeld and U Lehmann, ‘Management Structures and Worker’s Codetermination in Germany with European Perspectives’ in [1994[ Corporate Law Development Series 43. For recent developments pertaining to smaller German public companies, see Marcus Lutter, ‘Das neue Gesetz für kleine Aktiengesellschaften und zur Deregulierung des Aktienrecht’ (1994) 39 AG 429 ff.

38


tray most of the particularities of the German supervisory board, this chapter only deals with the general meeting and the management board, while the next chapter is solely dedicated to the supervisory board’s features.

3.2 The General Meeting 3.2.1 Function as a Corporate Organ In so far as the AktG does not provide otherwise, the general meeting is the organ where the members or shareholders can enforce their rights.6 As the German legislature has defined the functions of all the various company organs in some detail,7 and since the general meeting is practically excluded from managing and directing the business of the corporation,8 some commentators have suggested that there is hardly any room for calling the general meeting the ‘primary company organ’ (oberstes Willensorgan) in the German law of public corporations anymore.9 This statement should, however, be qualified.10 The general meeting’s potential influence is, in the first instance, clearly illustrated by the important role that banks play in Germany through their dominant position in the general meetings of many German public corporations. This aspect is of such importance that it is discussed separately later in this book.11 Secondly, the general meeting may also play a meaningful role in instances where the management board may refer specific matters to the general meeting.12 The significance of the first form of influence is, however, far less than the second one.13 But in spite of the general meeting’s piv6 7

8

9

10 11 12 13

S 118(1) AktG. The AktG of 1937 (which was operational until 1965) did not define these functions in detail. This meant that the supervisory board was completely dependent on the general meeting for the nature and scope of its functions (Immenga (n 3) 263) and also meant that the functions of the supervisory board could be restricted considerably by the general meeting. The general meeting only has jurisdiction to decide on matters relating to management and direction of the business of the corporation when so requested by the management board—Ss 111(4)3 and 119(2) AktG. See in particular Immenga (n 3) 261, 262–63; Hans-Joachim Mertens, ‘Zuständigkeiten des mitbestimmenten Aufsichtsrats’ (1977) 16 ZGR 280–82; Dieter Reuter, ‘Der Einfluß der Mitbestimmung auf das Gesellschaftsund Arbeitsrecht’ [1979] AcP 525. Wolfgang Zöllner, in Kölner Kommentar zum AktG (Carl Heymanns Verlag, Cologne 1973) S 118 para 2. Some commentators allude to a dethroned King (‘entthronter König’)—see Zöllner S 118 para 3. Also Immenga (n 3) 260 n36, 261; Kübler (n 1) 194. See Chapter 8. Ss 111(4)3 and 119(2) AktG. Cf 4.5.3 and 3.3.3.

The General Meeting and the Management Board as Company Organs

39

otal role as one of the company’s organs, the number of shareholders attending general meetings has decreased steadily over the years.14

3.2.2 Some Functions The general meeting is responsible for appointing the members of the supervisory board in so far as other statutory provisions do not prescribe the appointment of these members by the employees.15 The practical consequence of this provision is that the number of members of the supervisory board to be appointed by the general meeting will vary according to the size of the corporation, according to the specific sphere of business the corporation is involved in, and also, to a certain extent,16 according to the provisions in the articles of incorporation (Satzung).17 In corporations where employee participation is not made compulsory, the general meeting may appoint all the members of the supervisory board. In other cases, the general meeting may appoint between one third and one half of the members of the supervisory board.18 The members of the supervisory board appointed by the general meeting are usually referred to as the shareholders’ representatives or representatives of capital.19 It should be kept in mind that there are several practical difficulties with filling vacancies on the supervisory board, which makes the actual influence of the general meeting over the filling of these vacancies illusory.20 As a general rule the members of the supervisory board appointed by the general meeting can be removed by a three-quarter majority of the general meeting,

14

15 16

17

18 19 20

Hannes Klühs, ‘Präsenzbonus für die Teilnahme an der Hauptversammlung’ (2006) 27 ZIP 107 ff; Susanne Lenz, ‘Steigerung der Hauptversammlungsteilnahme durch monetäre Anreize’ (2006) 9 NZG 534 ff; and Eberhard Vetter, ‘Handgeld für in der Hauptversammlung präsente Aktionäre?’ (2006) 51 AG 32 ff discuss whether financial incentives might contribute to solving this problem. See further Jessica Schmidt, ‘Stimmrechtsvertretung und Stimmrechtsausübung “in absentia” in Deutschland und Großbritannien—Speziell vor dem aktuellen Hintergrund der aktuellen Gesellschaftsrechtsreform in Großbritannien sowie der geplanten EU-Aktionärsrechte-Richtlinie’ (2006) 9 NZG 487 ff. S 101(1) AktG. In terms of s 101(2) AktG, the articles of incorporation (Satzung) can provide for special arrangements as far as the appointment of the members by the general meeting (the so-called shareholder representatives) are concerned. The articles of incorporation may also prescribe specific requirements or qualifications for the members of the supervisory board appointed by the general meeting—s 100(4) AktG. See in particular 4.2.2 and 5.2.3.2 – 5.2.3.4. Kübler (n 1) 222. See concluding discussion under 4.2 (Appointment and qualifications of supervisory board members).

40


even without cause or without compelling reasons.21 It is, however, possible that a corporation may, in its articles of incorporation, provide for a different majority or for other requirements pertaining to the removal of these members.22 The general meeting is, within certain limits, responsible for deciding on the distribution of the corporation’s profits.23 The general meeting is also responsible for instituting action against members of the supervisory board for breaches of their duties24 and for instituting action against the members of the management board25 in so far as this is not regulated by other statutory provisions.26 Special functions can also be allocated to the general meeting by provisions in the articles of incorporation.27 There is, however, a very interesting legal relationship between the general meeting and the management board as well as between the management board and the supervisory board. These relationships form the basis of the discussions in the remaining parts of this chapter. Some further perspectives regarding the relationship between the supervisory board and the management board will be dealt with in Chapter 4.

3.3 The Management Board28 3.3.1 Function as a Corporate Organ Every German public company must have a management board.29 In accordance with the basic principle that the supervisory and management functions must be 21

22 23 24

25 26

27 28

29

S 103(1)1 and 2 AktG. See 3.3.2.4 regarding removal of management board for ‘compelling reasons’ only. S 103(1)3 AktG. Ss 58, 173 and 174 AktG. S 147(1) AktG. In particular Karl Trescher, ‘Aufsichtsrathaftung zwischen Norm und Wirklichkeit’ (1995) 48 DB 661 ff. S 147(1) AktG. See s 112 AktG and Johannes Hager, ‘Die Vertretung der Aktiengesellschaft im Prozeß mit ihren früheren Vorstandsmitgliedern’ (1992) 45 NJW 352. S 119(1) AktG. In fact, the ‘Vorstand’ cannot be named anything else than the ‘Vorstand’ in Germany—eg ‘Verwaltungsrat’ (management board’) or ‘Direktorium (‘board of directors’)—see Uwe Hüffer, Aktiengesetz: Beck’liche Kurzkommentare (vol 53, 5th edn CH Beck Verlag, Munich 2002) 365. To distinguish between the management and supervisory functions of the ‘Vorstand’ and the ‘Aufsichtsrat’, the ‘Vorstand’ will be translated as the ‘management board’ for purposes of this book. For an interesting historical analysis of the different names considered for the ‘Vorstand’ see Rudolf Wiethölter, Interessen und Organisation der Aktiengesellschaft im amerikanischen und deutschen Recht (CF Müller Verlag, Karlsruhe 1961) 279. Ss 33, 36(1) and 36(4) AktG. See further Johannes Semler, Leitung und Überwachung der Aktiengesellschaft (2nd edn Carl Heymanns Verlag, Cologne 1996) 5; Hüffer (n 28) 365.


41

separated, the management board is primarily responsible for managing and directing the business of the corporation. Before rights and responsibilities of management board members concerning their managing tasks are dealt with in detail, those legal principles which have been set up to govern the basics of the management board member’s role are outlined.

3.3.2 Appointment, Qualifications, Removal and Remuneration of Members The appointment, removal and remuneration of the members of the management board are in the hands of the supervisory board. It is, therefore, inevitable that we will discuss aspects related to the remuneration of members of the management board further in Chapter 4, when we discuss the rights and responsibilities of the supervisory board in detail.30 3.3.2.1 Qualifications As general rule, there can be one or more members of the management board. However, it is also required that if the corporation was founded with more than three million Euro that the management board must consists of at least two members, unless the articles of incorporation provide differently. The corporation cannot prevent the appointment of a person designated as responsible for matters relating to labour relations (the ‘Arbeitsdirektor’—hereafter ‘personnel director’) if so required by other legislation.31 There will, therefore, be at least two members of the management board in instances where the corporation is compelled to appoint a personnel director.32 Two general conditions apply to the appointment of these members: only natural persons can be members of the management board; and no person can be a member of the management board and the supervisory board at the same time.33 Under Section 76(3) of the AktG only fully competent natural persons can serve as members of the management board. A person under guardianship under Section 1903 of the German Civil Code and a person convicted of a criminal offence pursuant to Sections 283–283d of the Penal Code are automatically disqualified from serving as management board members. Furthermore, persons who are prohibited by a judicial decision or an enforceable administrative order from engaging in any profession or trade are also disqualified from being a member of a management board during the period of such prohibition.34 30 31 32

33 34

See 4.5. S 76(2) AktG. See discussion in 5.4.1. Hüffer (n 28) 375; Marcus Lutter and Gerd Krieger, Rechte und Pflichten des Aufsichtsats (4th edn Otto Schmidt Verlag, Cologne 2002) 134–35 para 338. Ss 76(3) and 105(1) AktG. See further Hüffer (n 28) 375. S 76(3)III AktG.

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3.3.2.2 Appointment of Management Board Members The members of the management board are appointed by the supervisory board for a maximum period of five years,35 with the possibility of reappointment explicitly built into the system.36 The German Corporate Governance Code (GCGC) suggests that a listed corporation must explain in its annual financial statements if a member of the management board is re-appointed earlier than one year before the expiration of his or her current period of appointment.37 This is clearly aimed at ensuring that members of the management board are not effectively appointed for longer periods by terminating their current appointments prematurely (say after three years) and reappointing them for another five-year period. It is conceivable that a corporation may want to renew a management board member’s appointment earlier than one year before the expiration of his or her current period of appointment if that member had been head-hunted by another corporation and would insist on such a renewal to make it worth his or her while to stay on in his or her current corporation. Listed companies will now have to explain in their financial statements if they extend a management board member’s appointment earlier than one year before the expiration of his or her current period of appointment.38 Explaining this position in the financial statements may not cause too much difficulty for such a listed corporation if it ensures the retention of a top-performing member of the management board. The members of the supervisory board must, however, be sure that there are special circumstances for such early renewals, as it could be seen as a breach of their duties if they simply extend the appointment of management board members earlier than one year before the expiration of their current appointments.39 Article 5.1.2 of the GCGC also suggests that when members of the management board of listed companies are appointed for the first time, their period of appointment should as a general rule not be for the maximum period of five years, 35

36

37

38 39

S 84(1) AktG. See Holger Fleischer, ‘Bestellungsdauer und Widerruf der Bestellung von Vorstandsmitgliedern im in- und ausländischen Aktienrecht’ (2006) 51 AG 429 ff for further details on the appointment period and revocation of management board members. It is interesting to note that in the Draft Fifth Directive a period of six years is suggested. The relevance of this period is to ensure adequate time for a manager to establish himself, but not enough time so that he may become disinterested in proper management because of the fact that he is appointed for a long period of time. Reappointment is apparently taken for granted—see Wolfgang Bernhardt, ‘Aufsichtsrat—die schönste Nebensache der Welt?’ (1995) 159 ZHR 310 at 312–313. See further Jobst-Hubertus Bauer and Christian Arnold, ‘Vorstandsverträge im Kreuzfeuer der Kritik’ (2006) 59 DB 260–63. Art 5.1.2 of The German Corporate Governance Code (GCGC) 12 June 2006 . Ibid. Lutter and Krieger (n 32) 144 para 358.


43

but rather for a shorter period. The aim of this arrangement is to ensure that the corporation is not stuck with a member of the management board for a five-year period without first having the opportunity to determine whether he or she performs properly – a type of probation period. It is interesting to note that in the past it was rather the exception to appoint management board members for periods of less than five years.40 Although the appointment for a period shorter than five years is possible, it is specifically required that the net result of such shorter appointments may not be that the total period of appointment exceeds five years.41 3.3.2.3 Management Board Under Codetermination In the case of corporations where employee participation at supervisory board level is required, the process of electing the members of the management board is quite complex.42 In the first round of elections, the members of the management board can only be elected by a majority of two-thirds of the members of the supervisory board.43 If this majority is not achieved, a committee must be formed, consisting of the chairperson of the supervisory board, the deputy chairperson, a representative of the shareholders and an employee representative.44 This committee is allowed a month to propose names to the supervisory board for electing the remaining members of the management board. Proposals may, however, also be made by others.45 For the second round of elections, only an ordinary majority is required.46 In the case of a tied vote, the chairperson is allowed a second vote for purposes of the third round of elections.47 In practice, the supervisory board will fill vacancies on the management board in close collaboration with the serving members of the management board, including the opportunity for the management board to indicate what type of qualifications the new management board member 40 41 42

43 44 45

46 47

Ibid 142 para 356. S 84(1) AktG. See in general Kübler (n 1) 183–84. Immenga (n 3) 254. See also Lutter and Krieger (n 32) 138–42. The One-Third Participation Act (Drittelbeteiligungsgesetz of 18 May 2004) superseded the Works Constitution Act of 1952 (Betriebsverfassungsgesetz 1952) and eased the election of employees’ representatives for the supervisory board. The One-Third Participation Act did not change any conditions related to the election of management board members. S 31(2) MitbestG. S 27(3) MitbestG. See further Immenga (n 3) 256. These proposals may presumably come from the other members (not serving on the committee responsible for proposing the names for the second election round) of the supervisory board. S 31(3) MitbestG. S 31(4) MitbestG. The wording of the statute is unambiguous as far as the third election round is concerned (‘so hat bei einer erneuten Abstimmung der Aufsichtsratvorsitzende zwei Stimmen’). In other words, the chairperson does not get a second vote for the second election round, but only for the third round. See also Immenga (n 3) 254.

44


should have. The management board is not allowed, without close consultation with the supervisory board, to identify an appropriate candidate, to fill vacancies or to negotiate with such candidates. That function is and remains the function of the supervisory board.48 3.3.2.4 Removal of Management Board Members Apart from the grounds for summary dismissal,49 the appointment of a member of the management board may be terminated before the expiration of his or her period of office by the supervisory board, but then only for compelling reasons (wichtiger Grund)50 and by following the same procedures51 prescribed for the appointment of members.52 The following instances are cited as examples of compelling reasons for a person to be removed before the expiration of his or her term of office: (a) a gross breach of duties;53 (b) incompetence to execute management functions in an orderly fashion;54 or (c) a vote of non-confidence from the general meeting, unless the vote of nonconfidence is obviously unfounded.55 48 49

50

51 52

53

54

55

Lutter and Krieger (n 32) 133 para 336. S 626 BGB—Lutter and Krieger (n 32) 161 para 400 ff; Hüffer (n 28) 421–22; Kübler (n 1) 184; Dietmar Janzen, ‘Vorzeitige Beendigung von Vorstandsamt und –vertrag’ (2003) 6 NZG 473–74. S 84(3) AktG—Hüffer (n 28) 377, Klaus J Hopt, ‘The German Two-Tier Board (Aufsichtsrat): A German View on Corporate Governance’ in Klaus J Hopt and Eddy Wymeersch (eds), Comparative Corporate Governance (de Gruyter Verlag, Berlin 1997) 4–5. See 3.3.2.2. S 31(1) and (5) MitbestG. Some commentators have expressed serious doubts whether these complicated procedures are really necessary in the case of removal for good cause. See Thomas Raiser, ‘Der neue Koalitionskompromiß zur Mitbestimmung’ (1976) 31 BB 148; Immenga (n 3) 257. Raiser’s sound argument is that there is little use in requiring a two-thirds majority for the first vote on the removal, if everybody knows that eventually an ordinary majority will suffice. Hüffer (n 28) 410. OLG Stuttgart, 13 Feb 2002—20 U 59/01, (2003) 48 AG 211 is an example where the court held that writing out unauthorised cheques would indeed be a good reason for terminating the appointment of a management board member as this constituted a gross breach of the management board member’s duties. This ground is, inter alia, employed to remove members of the management board where the corporation experiences a crisis which cannot be resolved by the management board—see Lutter and Krieger (n 32) 43. S 84(3) AktG. See further Lutter and Krieger (n 32) 146–48, Hüffer (n 28) 411; Janzen (n 49) 471.


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However, the list of what constitutes compelling reasons is not a closed one, making it possible for the supervisory board to remove the management board if there are irreconcilable differences regarding fundamental questions of company policy and direction between the supervisory board and the management board.56 The rationale for making removal of management board members possible only when there are compelling reasons is to ensure that the management board stays independent and cannot be removed by the supervisory board simply because it does not agree with the managerial decisions of the management board.57 It is interesting to note that the rationale for the removal provisions could be circumvented indirectly by including a term in management board members’ contracts of appointment to enable removal without compelling reasons.58 Termination of the appointment of a management board member is invalid if the procedures required for termination were not followed, for instance if there was no valid resolution taken by the supervisory board; if some members of the supervisory board were not invited to attend the meeting where the resolution for termination was taken; or where, in corporations where supervisory codetermination is required, the employee representatives were not informed adequately.59 It is, however, possible that a later, properly convened meeting of the supervisory board could confirm the proceedings of the original meeting, under which circumstances the termination of the management board member will be considered to be valid.60 When there are compelling reasons for termination, the termination is effective immediately, but such a termination can be declared invalid by a court.61 In practical terms, it means that the member of the management board immediately vacates his or her office,62 but he or she can institute proceedings in order to get a court to declare the termination of appointment invalid because no compelling reason for such termination existed.63 Until such a court has ordered that such a 56

57 58 59 60 61 62 63

Lutter and Krieger (n 32) 146–47 para 365; Janzen (n 49) 470 and 471. Martin Peltzer, ‘Corporate Governance Codices als zusätzliche Pflichtenbestimmung für den Aufsichtsrat’ (2002) 5 NZG 13 points out that there are different views as to whether underperformance of the management board would constitute a compelling reason to remove a management board member. Holger Fleischer, ‘Zur Abberufung von Vorstandsmitgliedern auf Druck Dritter’ (2006) 9 NZG 1507 ff examines the influence of third parties on the decision to remove a management board member. Lutter and Krieger (n 32) 146 para 364, Hopt (n 50) 4. Janzen (n 49) 479. Lutter and Krieger (n 32) 149 para 371; Janzen (n 49) 469. OLG Stuttgart (n 53) 212. S 84(3)IV AktG. See generally Peltzer (n 56) 13. Janzen (n 49) 469. Lutter and Krieger (n 32) 149–50 paras 372–73. See OLG Stuttgart (n 53) 211 where there was an unsuccessful attempt from the complainant to challege the validity of the termination of his appointment as management board member by the supervisory board. In this case it was held that the fact that similar grounds may exist for the removal of

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termination was invalid, the affected member is released from all duties towards the corporation and also will not be able to insist on his or her usual rights, such as attending board meetings and acting as representative of the corporation visà-vis third parties.64 Notwithstanding the fact that the member’s appointment was terminated, he or she will still have the ordinary contractual claims with regard to the breach of contract of employment.65 The general protections against the termination of the appointment of the personnel director are specifically retained.66 In other words, the employee representatives on the supervisory board may veto the termination of the appointment of the management board’s personnel director. It seems as if the statutory provisions for terminating a management board member’s appointment before the expiration of the period of appointment are seldom used, because they not only provide an obstacle with regard to the voting procedure, but also with regard to the risk of removal without compelling reasons.67 The question as to which interests should be taken into consideration in judging that there is a compelling reason for removal has also not been settled.68 It seems as if the prevailing view is that it should be the interest of the corporation that should be uppermost when the removal of management board for compelling reasons is considered. This ensures that Section 84(3) of the AktG does not become a carte blanche to remove management board members.69 In practice, the supervisory board will normally simply not extend the appointment of a management board member when it is not satisfied with the member’s performance or when he or she has neglected the required duties.70 There is, of course, also the possibility that a management board member who knows that the supervisory board is keen to terminate his or her appointment prematurely for compelling reasons, may decide to resign and it seems as if this creates an important practical way for such management board members to escape the possible consequences of removal from office based on compelling reasons.71 An alternative to terminating the appointment of a management board member is suspension. Suspension must be linked to a specific period and cannot, for instance, include a suspension until the end of the management board member’s

64 65

66 67 68 69 70 71

other management board members could not serve as an defence why the removal of that particular director should be declared invalid by the court, OLG Stuttgart (n 53) 212. Janzen (n 49) 469. S 84(3)V AktG. See further Großfeld and Lehmann (n 4) 45–46; Immenga (n 3) 254; Janzen (n 49) 472–73. S 84(4) AktG. Raiser (n 52) 148. Also Janzen (n 49) 470–71; Bernhardt (n 36) 314. Janzen (n 49) 470. Ibid 470, 474–75. Raiser (n 52) 148. See generally Lutter and Krieger (n 32) 145 para 361 and 151 para 376.


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period of appointment.72 The prevailing view is that during such suspension the supervisory board member would still occupy his or her office and presumably receive all remuneration received as supervisory board member, but that he or she is prohibited from fulfilling the duties associated with the office and also from the responsibilities regarding the office.73 It should, however, be noted that the grounds that would justify suspension from office are contentious.74 3.3.2.5 Remuneration of Management Board Members With regard to monitoring and restricting the management board’s remuneration, some remarks on the controversy over disclosure of remuneration have to be added. Besides Section 87 of the AktG, a corporation’s duty to disclose the management board’s remuneration is deemed as an instrument to limit excessive remuneration since the public will become aware of any exceptionally high payments.75 To limit remuneration by further substantive provisions like statutorily fixed caps76 or statutorily fixed proportion of management board members’ remuneration in relation to the wages of employees77 appear to be competing approaches to cope with excessive payments.78 In course of the discussion on managerial reimbursements, the duty to disclose individual payments has been one of the most controversially discussed issues.79 Previously only the total sum of payments for the entire management board had to be disclosed in an amendment of the annual account80—in the explanatory notes of the consolidated financial statement.81 Hence, shareholders neither obtained any information about whether and to what extent payments were linked with success or failures of the undertaking, nor did they learn about the corporation’s remunera72 73 74 75

76

77

78

79

80 81

Lutter and Krieger (n 32) 152 para 378. Cf Janzen (n 49) 470. Lutter and Krieger (n 32) 151 para 377. Ibid 152–53. Supporters of such obligations to report remuneration in individualised figures want to solve the above-mentioned problems in defining appropriateness and reasonableness of remuneration according to s 87 AktG by these reports, which can be deemed an attempt that aims at a rather psychological impact. Suggested by Michael Adams, ‘Aktienoptionspläne und Vorstandsvergütungen’ (2002) 23 ZIP 1325 ff. Compare Rakesh Khurana, ‘Vorstände sollten ihre Gehälter nicht offenlegen’, FAZ 14 Oct 2004, 14. See Marita Körner, ‘Die Angemessenheit von Vorstandsbezügen in § 87 AktG’ (2004) 57 NJW 2697, 2700. See for an overview Henrik-Michael Ringleb in Henrik-Michael Ringleb, Thomas Kremer, Marcus Lutter and Axel von Werder (eds), Kommentar zum Deutschen Corporate Governance Kodex (CH Beck Verlag, Munich 2003) paras 548–68. S 286 sentence 1 No 9a HGB (Commercial Code). S 314(1) sentence 1 No 6a HGB.

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tion policy and which manager incentives were linked with remuneration.82 But even payments of the total sum for the entire management board were not allowed to be published, since protection of data privacy, which management board members might have claimed, could otherwise not be guaranteed.83 Despite these provisions of civil law, according to the GCGC, remuneration of the members of the management board shall be reported in individualised figures and subdivided according to fixed, performance-related and long-term incentive components.84 As explained in Chapter 2, the GCGC is based on the principle of ‘comply or explain’. Thus, numerous companies did not and still do not follow these recommendations, although they are flanked by correlative recommendations at EUlevel.85 The consequences were foreseeable—the legislature intervened! In August 2005 the directors’ fee disclosure law (VorstOG)86 came into force. From the financial year of 2006 onwards the management board members’ remuneration has to be disclosed individually. Although there is a back door—no public information if a three-quarter majority of the general meeting agrees—none of the 30 DAX companies has chosen the opting-out alternative; the pressure of the capital market 82

83

84 85

86

Compare Theodor Baums, ‘Vorschlag eines Gesetzes zur Verbesserung der Transparenz von Vorstandsvergütungen’ (2004) 25 ZIP 1877, 1879. In contrast to that, according to Peter M Wiesner, ‘Neue Brüsseler Impulse für Corporate Governance und Gesellschaftsrecht—Zum Endbericht der Hochrangigen Expertengruppe (WinterGruppe)’ (2003) 58 BB 213, 214, a report about managerial remuneration on an individualised basis is without any informational value. S 286(4) HGB. For instance, if a management board consists of only one person, the total sum of payments for the entire body is identical to the sum that management board member has received. S 286(4) HGB is also applicable if the benefits of each management board member can be adequately estimated; see Rainard Menke and Winfried Prosch, ‘Verfassungs- und europarechtliche Grenzen eines Gesetzes zur indivudalisierten Zwangsoffenlegung der Vergütung der Vorstandsmitglieder’ (2004) 59 BB 2533. Art 4.2.4 GCGC. See the draft ‘Commission Recommendation on fostering an appropriate regime for the remuneration of directors of listed companies (Text with EEA relevance)’, Section III. The document is online at ; see also ‘Report aus Brüssel: Vergütung von Direktoren—Kommission legt Leitlinien für Offenlegung und Kontrolle durch die Aktionäre fest’ (2004) 14 EuZW 642; Silja Maul and Georg Lanfermann, ‘Europäische Corporate Governance—Stand der Entwicklungen’ (2004) 59 BB 1861, 1866 ff; Silja Maul and Georg Lanfermann, ‘EU-Kommission nimmt Empfehlungen zu Corporate Governance an’ (2004) 57 DB 2407 ff. Gesetz über die Offenlegung der Vorstandsvergütungen (VorstandsvergütungsOffenlegungsgesetz—VorstOG) 3 Oct 2005, Bundesgesetzblatt Teil I (BGBl I 2005, 2267). See Gerald Spindler, ‘Das Gesetz über die Offenlegung von Vorstandsvergütungen—VorstOG’ (2005) 8 NZG 689 ff and Andre P H Wandt ‘Die Auswirkungen des Vorstandsvergütungs- und Offenlegungsgesetzes auf das Auskunftsrecht gemäß § 131 Abs. 1 Satz 1 AktG’ [2006] DStR 1460 ff.


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is simply too big and illustrates the practical force of this form of self-regulation. However, in the stock exchange segment MDax the opting-out possibility was put on the agendas of ten companies. Furthermore, about 200 of the smaller stock corporations, which are not in the focus of the international capital market, voted against transparency, as well as some well-known listed corporations, such as the car rental service Sixt and the car manufacturer Porsche. Regardless of that, it is also questionable whether EU-law allows an individualised disclosure of remuneration.87 Since shareholders are principally free to decide which issues will be dealt with at the annual general meeting, it seems inconsistent to restrict this power by forcing shareholders to deal with managerial remuneration at this meeting.88 Any publication of individual remuneration is likely to infringe confidentiality agreements on remuneration which most of the employment contracts of management board members contain.89 In respect of the often evoked ‘international market for top-managers’ which is supposed to justify an alignment of German managerial remuneration with American standards, it seems to be doubtful if this market exists at all.90 Above all, as far as practical experiences with individualised reports are available, they demonstrate that these reports have created a kind of competition amongst managers racing for the highest salary nationwide instead of limiting remuneration.91 Moreover, the obligation to set up individualised reports seems to be contrary to principles of corporate law, because the supervisory board is required to decide on the remuneration of management board members. There are also some difficulties with alternative solutions to overcome constitutional92 and practical93 problems related to improper remuneration policies, making this a fascinating area that should be followed with keen interest in future. The answer to this issue probably lies in focusing on the monitoring powers of the company organs, rather than on individual cases.

87

88 89 90 91 92

93

Moreover, Menke and Prosch (n 83) 2533 ff state that the duty of disclosure would infringe the EU-privacy policy linked with Art 8 European Convention of Human Rights (Europäische Konvention zum Schutz der Menschenrecht, EMRK). Cf Wiesner (n 82) 213, 214. Ringleb (n 79) para 563. Körner (n 78) 2697, 2700; Khurana (n 77) 14. Khurana (n 77) 14. For instance, the freedom of employment according to Art 12(1) sentence 2 Basic Law (Grundgesetz, GG) and the general freedom of action according to Art 2(1) Basic Law seems to be infringed by fixing caps for remuneration; see Kurt Kiethe, ‘Höchstgrenzen für Vorstandsbezüge im Maßnahmenkatalog der Bundesregierung zur Aktienrechtsreform 2003—verfassungswidrig und standortgefährdend’ (2003) 58 BB 1573 ff; Körner (n 78) 2697, 2700. A standardised limitation on remuneration stands for a one-dimensional solution which does not meet the requirements of a problem which asks for flexibility and answers based on each individual case.

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3.3.3 Rights, Powers and Responsibilities 3.3.3.1 Generally The management board’s primary responsibility is to direct the corporation (die Gesellschaft zu leiten).94 It is quite interesting to note that in sharp contrast with Section 76(1) of the AktG which makes directing the corporation a specific responsibility of the management board, Section 77(1) of the AktG only mentions indirectly that if there is more than one member of the management board, all members of that board are jointly responsible for managing the business of the corporation (Geschäftsführung).95 It is, therefore, by way of inference that commentators say that the management board is responsible for directing the corporation and for managing the business of the corporation.96 Directing the corporation (Leitung) and managing the business of the corporation (Geschäftsführung) are usually discussed under one heading in textbooks.97 Commentators point out that the concept of Geschäftsführung is an abstract one98 and that there are no precise criteria available to distinguish between Leitung and Geschäftsführung.99 There are indeed several diverging academic views on the meaning of these two concepts.100 Aspects such as entrepreneurial or business planning, internal coordination and control, and the filling of management positions, are included under these concepts.101 These are seen as internal corporate activities and contrasted with external corporate activities.102 The German legislation also gives the power of externally representing the corporation, in other words external corporate activities, to the management board.103 These activities are so comprehensive that it is simply impossible for the management board as an organ to fulfil all of them. It is, therefore, common for the articles of incorporation or internal management (or 94

95 96 97 98 99 100 101

102 103

S 76(1) AktG. The phrase ‘die Gesellschaft zu leiten’ can also be translated as ‘the corporation to lead’, but it was considered to be more appropriate to use the better known Anglo-American terminology of ‘directing the corporation’. S 77(2) AktG. Hüffer (n 28) 365. Semler (n 29) 5–8, Hüffer (n 28) 365–66. Semler (n 29) 60. Hüffer (n 28) 366. Semler (n 29) 6 fn8. Hüffer (n 28) 366. Also Semler (n 29) 10–16; Bruno Kropff, ‘Zur Information des Aufsichtsrat über das interne Überwachungssystem’ (2003) 6 NZG 346; Ludger Wellkamp, Vorstand, Aufsichtsrat und Aktionär (2nd edn Verlag für Rechts und Wirtschaftsbücher, Bonn 2000) 3. Semler (n 29) 7. Ss 76(1), 77(1) and 78(1) AktG. There are, however, also specific instances where the approval of other organs is required before the management board can act on behalf of the company—see Kübler (n 1) 184–85. See in general Semler (n 29) 7; Hüffer (n 28) 365, 383–86.


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job) allocations to provide for the possibility of individual members of the management board executing certain specific managerial functions.104 In summary it could be said that the management board is responsible for directing the corporation, managing the business of the corporation and representing the corporation in its dealings with third parties. Although the responsibilities of directing the corporation and managing the business of the corporation cannot be delegated to any other organ or committee of such an organ,105 there are some very important qualifications to this statement that should be noted. The articles of incorporation or directives of the managing board (Geschäftsordnung des Vorstands) can contain specific arrangements as to how the business of the corporation should be conducted. The only restriction is that the articles of incorporation or a standing directive of the management board (Geschäftsordnung des Vorstands) may not prescribe that one or more members of the management board have the power to determine the outcome of differences of opinion against the majority of the members of the management board.106 In other words, it is prohibited to confer the ultimate power of the management board upon one person or in a minority of the management board—this is seen as an unlawful concentration of powers. The articles of incorporation may, however, give the power to manage the business of the corporation internally, or to represent the corporation externally, to specific members of the management board or to a number of the members of the management board.107 Generally speaking the management board can issue a business directive (Geschäftsordnung).108 However, two restrictions should be noted. Such directives may not be issued if the power to approve them was transferred to the supervisory board under provisions in the articles of incorporation. Also, the management board cannot issue such business directives if the supervisory board has already issued such a business directive.109 It should be noted that the GCGC suggests that the supervisory board must issue such business directives or explain why they have not issued them.110 Another safeguard to ensure that the management board only issues business directives after proper consultation and discussion is that such directives can only be issued on the basis of consensus amongst all the members

104

105

106 107 108 109 110

Kübler (n 1) 186; Semler (n 29) 10; Ernst Geßler et al, Aktiengesetz (Vahlen Verlag, Munich 1974) 4c para 5. Semler (n 29) 66; Jürgen Götz, ‘Corporate Governance multinationaler Konzerne und deutsches Unternehmensrecht’ (2003) 32 ZGR 11; Günter Langenbucher and Ulf Blaum, ‘Audit Committees—Ein Weg zur Überwindung der Überwachungskrise?’ (1994) 67 DB 2198. S 77(1) AktG. Ss 77(1)II and 78(3) AktG read together—see Semler (n 29) 17. S 77(2) AktG. S 77(2) AktG. Hüffer (n 28) 380. Art 5.1.3 GCGC.

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of the management board.111 This, as Hüffer puts it, encourages cooperation in the management board.112 3.3.3.2 Limits to the Powers of Management Board a) Overview As seen above, generally speaking, managing the business of the corporation is exclusively a responsibility of the management board,113 excluding direct interference over these matters by the supervisory board or the general meeting.114 The power to manage the business of the corporation is seen as an original and inalienable power of the management board, meaning that it is not derived from the supervisory board or the general meeting and it cannot be delegated.115 There are specific statutory provisions prohibiting the delegation of the power to manage the business of the corporation to the supervisory board116 or to any other person or organ.117 The respective statutory powers of the various organs of the corporation are seen as powers given to these organs exclusively, making it, as general rule, impossible for the general meeting to challenge the validity of resolutions taken by the management board or the supervisory board within the scope of their exclusive powers.118 However, these general statements require considerable further explanation since they conceal some of the most complex aspects as far as the German two-tier 111 112 113

114

115 116 117 118

S 77(2) III AktG. See further Hüffer (n 28) 380. Hüffer (n 28) 377 and 380. This is beyond dispute because of the ss 77(1), 76(1), 78 and 82(2) read together—see Immenga (n 3) 265; Mertens (n 8) 280–82, Semler (n 29) 9; Hüffer (n 28) 377; Kübler (n 1) 185–86. Hüffer (n 28) 365. See also Kübler (n 1) 185–86 and 410; Thomas J Andre (Jr), ‘Some Reflections on German Corporate Governance: A Glimpse at German Supervisory Boards’ (1996) 70 Tulane L Rev 1819 paras 1823–25; Andreas Rohde and Marcus Geschwandtner, ‘Zur Beschränkbarkeit der Geschäftsführungsbefugnis des Vorstands einer Aktiengesellschaft—Beschluss der Hauptversammlung nach § 119 II AktG und die Pflicht zur Ausführung durch den Vorstand’ (2005) 8 NZG 997. It is, however, interesting to note that this specific prohibition only applies to managing the business of the corporation (Geschäftsführung) and not to directing the corporation (Leitung), which leaves the question whether some of the aspects regarding directing the corporation could be transferred to the supervisory board. Or, to put it differently, if the legislature considered it necessary to provide specifically that participation in the management of the business could not be transferred to the supervisory board, why was it considered unnecessary to have a similar prohibition regarding aspects of directing the corporation? Is it because some of these aspects could be delegated to the supervisory board? Semler (n 29) 9. S 111(4) AktG. See further Hüffer (n 28) 366. Hüffer (n 28) 377. See OLG Frankfurt, 4. Feb 2003—5 U 63/01, (2003) 48 AG 276.


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board system is concerned.119 Firstly, as far as the powers of the management board vis-à-vis supervisory board are concerned, there are several qualifications and practical aspects that will be discussed in the next section. Secondly, there is a fundamental limitation of the powers of the management board vis-à-vis the general meeting, because of the important decision of Holzmüller (nowadays referred to as the Holzmüller doctrine). This doctrine is also discussed in some detail in the next section. b) Limitations Vis-à-Vis Supervisory Board In practice, as well as theoretically, the difficulty associated with the division of powers among the various company organs is to determine the exact scope of the management board and the supervisory board’s functions.120 Perhaps because of its complexity, this particular relationship has, to a large extent, been neglected in most of the current academic literature which purported to analyse the German two-tier system or the German system of employee participation at board level from a traditional Anglo-American perspective, where the so-called unitary board system is dominant.121 In the first instance, the right of the supervisory board to provide the management board with advice automatically imposes a duty on the management board to let the supervisory board provide them with advice.122 Secondly, although the management board has exclusive power to manage the business of the corporation, the supervisory board is specifically tasked to supervise or oversee the management of the corporation. The consequence of this is that in practice the supervisory board is not completely isolated from the management functions of the management board and can indeed, indirectly, influence decisions of the management board. Thirdly, although the general meeting cannot interfere with aspects regard-

119

120

121

122

Cf Lutter and Krieger (n 32) 35–36, 42 para 27; Hüffer (n 28) 531–32; Großfeld and Lehmann (n 4) 43; Klaus J Hopt, ‘Aktionärskreis und Vorstandsneutralität’ (1993) 22 ZGR 535, 538 ff; Mertens (n 8) 272 justly points out that the outcome of many intricate questions concerning the functions of the various corporation organs will depend on three basic questions: (a) how the role of the supervisory organ, as institution for supervisory codetermination, is perceived; (b) how the relationships between the various organs are defined; and (c) how one perceives the function of the articles of incorporation (Satzung) as a document in which internal matters can be regulated according to a corporation’s own needs. Hopt (n 119) 538 ff. Also J Shearman, ‘Controlling Directors the German Way’ (1997) 18 Company Lawyer 123–24. See further the discussion of normal scope and extended scope at 4.5.3.5 and 4.5.3.6. See, however, Jean J du Plessis, ‘Reflections on Some Recent Corporate Governance Reforms in Germany: A Transformation of the German Aktienrecht?’ (2003) 8 Deakin L Rev 380 at 382–84. Lutter and Krieger (n 32) 45 para 30.

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ing managing and directing the business of the corporation, the management board is not prohibited from referring such matters voluntarily to the general meeting.123 Fourthly, it should also be kept in mind that when a corporation experiences financial difficulties, the intensity of the supervisory board’s control functions over the management board becomes much higher, not only as far as controlling the activities of the management board is concerned, but also as far as the regularity of control is concerned. Fifthly, there is considerable scope for indirect control over the activities of the management board if the supervisory board itself insists, or the articles of incorporation prescribe, that certain matters could only proceed with the approval of the supervisory board.124 In the sixth instance, while Section 119(2) of the AktG specifically excludes the general meeting’s authority over matters pertaining to management and directing the business of the corporation, it provides for the possibility that the management board can voluntarily refer certain matters pertaining to managing the business of the corporation to the general meeting. The general meeting can then make a final ruling on such a matter pertaining to managing the business of the corporation.125 Finally, there will obviously be instances where various interests in the corporation can be in conflict, for instance, the interests of the shareholders and that of the employees. Under such circumstances the management board should consider the divergent interests and make a decision, but the decision should always be made with the overall business interests and general interests of the enterprise in mind.126 It should be clear from the points made above that the relationship amongst the various organs in the German two-tier system is far more dynamic than is the case with any traditional unitary board system. It is, however, unfortunate that this aspect is rarely appreciated by commentators analysing the German two-tier board system primarily with a view to emphasising its shortcomings. 3.3.3.3 Limitations Vis-à-Vis Supervisory Board: The Holzmüller Doctrine The powers of the management board to manage and direct the business of the corporation is furthermore limited because of the decision of the Federal Court of Justice (Bundesgerichtshof, BGH) in the Holzmüller case.127 This case dealt with the very important issue of the demarcation of powers between the management board and the general meeting and is probably one of the most disputed topics of corporate governance in Germany. 123 124 125 126 127

Hüffer (n 28) 366. S 111(4)2 AktG. See in particular Immenga (n 3) 261–62. Hüffer (n 28) 366–67. BGH, 25 Feb 1982 – II ZR 174/80, BGHZ 83, 122 ff.


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In the Holzmüller decision the BGH held that irrespective of the internal arrangements (including provisions in the articles of incorporation) regarding managing and directing the business of the corporation, the general meeting has some inherent powers when it comes to matters affecting the fundamental rights and property interests of shareholders. It was held that the management board owes a duty of care towards the shareholders when it comes to matters affecting the fundamental rights and property interests of shareholders. Therefore, in these matters the management board cannot rely on the usual internal arrangements regarding managing and directing the business of the corporation to alienate the rights and property interests of shareholders—the general meeting has the inherent powers to prevent being deprived of these rights and interests. These considerations together are known as the Holzmüller doctrine.128 In this case, the management board of a public company made a decision to transfer about 80 per cent of the company’s most valuable assets (the highly lucrative part of the business involved in seaports) to a subsidiary company which was founded and controlled by the public corporation. It was held in the case that the management board could not do this without approval of the general meeting and that the management board was compelled to transfer the spin-offs of this transaction to the general meeting in order to prevent liability. In other words, the management board would have been liable towards the general meeting for a breach of their duties towards the general meeting if they proceeded without the approval of the general meeting. The significance of the Holzmüller decision becomes most apparent when one is reminded, as mentioned before, that under Section 119(2) of the AktG the general meeting may under normal circumstances only decide on managerial aspects if the management board asks the general meeting to do so. Since the Holzmüller case was decided, the majority of legal authors have acknowledged this inherent power of the general meeting. The scope of the Holzmüller doctrine is, however, highly controversial and caused an excessive debate among scholars. Questions that arise, inter alia, are: under what circumstances will the general meeting be able to evoke this inherent power and to what extent does it really limit the usual powers of the management board to manage and direct the business of the corporation? Space will not allow us to discuss these intriguing questions in detail, but it can be accepted that the issue is controversial and that there are several aspects that have not been clarified yet.129 It is noteworthy to mention that not even the Government Commission on the GCGC was able to make a consensual recommendation on this issue.130

128 129

130

Ibid 122 (131). See, for a well-elaborated overview of the entire debate, Volker Emmerich and Mathias Habersack (eds), Aktien- und GmbH-Konzernrecht (3rd edn, CH Beck Verlag, Munich 2003); Introduction of s 311 AktG, paras 33–50. Theodor Baums (ed), Bericht der Regierungskommission Corporate Governance 2000 (Otto Schmidt Verlag, Cologne 2000) 118–123 paras 79–82.

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In the Gelatine decision,131 the BGH redefined and narrowed the Holzmüller doctrine and thereby improved its application. In this case, the general meeting of a public company (a producer and seller of gelatine) decided to transfer both a British and a Swedish subsidiary company under its complete control to another wholly owned subsidiary company. While the British company was of no economic importance, the Swedish company contributed 30 per cent to the pre-tax profit of the group and about 8.2 per cent to the consolidated balance sheet. For tax reasons the general meeting also made the decision to authorise the management board to transfer 49 per cent of a 100 per cent owned German private subsidiary company to another wholly owned public company. The private company had a profit share of 25 per cent of the group and about 31 per cent of the consolidated balance sheet. Both resolutions were approved by a majority of approximately 67 per cent at the general meetings where the resolutions were tabled. In order to illustrate the allocation of rights and duties between management board and general meeting more clearly, we will attempt to use a few illustrations. In the Gelatine decision, the BGH takes a rather subtle point of view, when it declares inherent powers as a result of an ‘open development in corporate law’.132 The practical relevance of this decision lies in the quantitative and qualitative prerequisites it laid down. The questions of which value (quantitative criterion) and which reference value (qualitative criterion) applied in the Holzmüller decision were debated in detail as criteria to determine the scope of the general meeting’s inherent powers in this regard. Based on historical construction of statutes governing the relationship between management board and general meeting, the court stated in the Gelatine decision that an impairment of the shareholders’ participation rights only necessitates the Holzmüller doctrine’s application when the impairment is material and the economic significance is comparable to the facts of the Holzmüller case.133 Thus, an important point for applying the Holzmüller doctrine is the transfer of 80 per cent of the company’s assets.134 This value is contrary to the thresholds discussed in the aftermath of the Holzmüller decision which range between 10 and 50 per cent.135 But eventually the comparability to the Holzmüller facts and therewith the doctrine’s applicability is a question of each individual case. In accordance with Fleischer, the reservation of Section 10.6 of the United Kingdom’s Listing Rules can be applied for the question of compara131

132 133 134

135

BGH, 26.04.2004– II ZR 154/02, (2004) 7 NZG 575 ff (so-called ‘Gelatine II’); BGH, 26.04.2004, II ZR 155/02, (2004) 57 NJW 1860 ff (so-called ‘Gelatine I’). See Andreas Pentz, ‘Übersicht zur höchstrichterlichen Rechtsprechung zum Aktienrecht 2004’ (2005) 60 BB 1401–03. BGH, 26.04.2004, – II ZR 155/02, 2004 reported in (2004) 57 NJW 1863. Ibid. Compare for detailed facts about the Holzmüller case the court of appeal OLG Hamburg, 5 Sept 1980 – 11 U 1/80, (1980) 1 ZIP 1000 ff. See for this discussion also Stefan Simon, ‘Von “Holzmüller” zu “Gelatine”—Ungeschriebene Hauptversammlungszuständigkeiten im Lichte der BGH-Rechtsprechung (Teil 1)’ (2004) 40 DStR 1484 ff.


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bility, meaning that ‘in circumstances where any of the above calculations produces an anomalous result or where the calculations are inappropriate to this sphere of activity of the listed corporation, the UK Listing Authority may disregard the calculation and may substitute other relevant indicators of size, including industry specific tests.’136 With respect to the question of whether a special majority is required (e.g. 75%) or a simple majority (more than 50%), the BGH insisted on a special majority. The analogy was used of shareholders’ resolutions amending the articles of incorporation (compare Sections 179 (2), 293 (1), 319 (2) of the AktG). Thus, a special resolution by the general meeting (75% of the share capital represented at the passing of the resolution) will be required under circumstances comparable to the Holzmüller case.137 Measured by the suggestions of some legal writers, the Court did not set up too tight provisions for the limitations by the general meeting on the powers of the management board to manage and direct the business of the corporation. Hence, there is still considerable scope for the management board to manage and direct the business of the corporation effectively even within the confines of the limitations introduced by the Holzmüller doctrine.138 Since the court explicitly disapproved any extensive interpretation of the Holzmüller doctrine, inherent powers of the general meeting are strict exceptions which, in principle, do not alter the allocation of powers within a German public corporation.139 Although the decision in Gelatine provides more legal certainty, there are still some issues related to the Holzmüller doctrine that are open to diverging interpretations.140 A third decision, apart from the Holzmüller and Gelatine decisions, that also deals with the inherent powers of the general meeting, is the Macrotron deci-

136

137

138

139 140

The UK Listing Rules are accessible online at . BGH, 26.04.2004, II ZR 155/02 (2004) 57 NJW 1864. By setting up this provision of a qualified majority decision, the court followed the majority opinion in literature concerning this question. The BGH takes a very realistic and practice-oriented point of view when it states ‘In a globally connected economy which requires to seize opportunites immediately and to avert dangers directly, a narrowly-tailored obligation to obtain a resolution of shareholders who are not permenantly present and whose convention is expensive and timeconsuming would be unhandy; it would palsy the entire corporation’. Cf BGH, 26.04.2004 – II ZR 155/02, (2004) 57 NJW 1864. Cf Simon (n 135) 1530 with a similar estimation of the Gelatine decisions. The unanswered questions mainly refer to the question which managerial measures require a shareholders’ resolution. For an overview of these unsolved issues see Cornelius Götze, ‘Gelatine statt Holzmüller—Zur Reichweite ungeschriebener Mitwirkungsbefugnisse der Hauptversammlung’ (2004) 7 NZG 588 ff. See further Michael Arnold, ‘Mitwirkungsbefugnisse der Aktionäre nach Gelatine und Macrotron’ (2005) 26 ZIP 1573 ff; Lars Böttcher and Sebastian Blasche, ‘Die Grenzen der Leitungsmacht des Vorstands’ (2006) 9 NZG 569 ff.

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sion.141 In this decision the BGH acknowledged an inherent power of the general meeting, but instead of relying on the Holzmüller doctrine, the court based this inherent power of the general meeting on the constitutional guarantee of the shareholders’ property rights according to Article 14 (1) Basic Law (Grundgesetz), as far as delisting of listed public corporations is concerned. Since the court did not base its reasoning on the Holzmüller principles, but referred to constitutional rights as another dogmatic foundation, the case created more legal uncertainty in this area. There are now some German commentators who express the view that the certainty created by the Gelatine case is to be preferred.142

3.3.4 Duties and Forms of Liability 3.3.4.1 Breach of Duties As office-bearers, occupying a position of trust, the members of the management board stand in a general relationship of good faith towards the corporation.143 Apart from this duty of good faith, strict statutory duties of care, skill and diligence are also expected of them.144 These duties are described in general terms,145 requiring of the members of the management board to manage the business of the corporation as decent and conscientious business leaders.146 These general duties

141 142

143

144

145 146

BGH, 25.11.2002, II ZR 133/01, (2003) 24 ZIP 387 ff. Cf the comment of Wulf Goette, ‘Anmerkungen zum Urteil des BGH vom 26.04.2004’ (2004) 40 DStR 927 ff; see also Georg Koppensteiner, ‘‘‘Holzmüller” auf dem Prüfstand des BGH’ (2004) 2 Der Konzern 381 ff with a rather critical view of the Gelatine decisions. S 242 BGB. See in particular Mertens (n 8) 308 para 57; Kübler (n 1) 185; Klaus J Hopt, ‘Self-Dealing and Use of Corporate Opportunity and Information: Regulating Directors’ Conflict of Interest’ in Klaus J Hopt and Gunter Teubner (eds), Corporate Governance and Directors’ Liability (de Gruyter Verlag, Berlin 1985) 285 ff; Harald Kallmeyer, ‘Pflichten des Vorstands der Aktiengesellschaft zur Unternehmensplanung’ (1993) 22 ZGR 104 ff. S 93 AktG. See further Semler (n 29) 23; Jens Buchta, ‘Haftung und Verantwortlichkeit des Vorstands einer Aktiengesellschaft—Eine Bestandsaufnahme’ (2006) 59 DB 1939 ff. See also Carsten Schäfer, ‘Effektivere Vorstandshaftung für Fehlinformationen des Kapitalmarktes’ (2005) 8 NZG 985 ff on management board members’ liability for misinformation about the capital market. Kübler (n 1) 187. S 93(1)1 AktG. They must, as some commentators put it, be responsible businessmen (pflichtbewußten Unternehmers)—Mertens (n 8) 289 para 6. Some commentators [eg Mertens (n 8) 296–315] have started to categorise these duties in ways quite similar to fiduciary duties in countries influenced by British company law (cf Jean J du Plessis, ‘The Duties of Directors with Special Reference to Deposit-Taking Institutions’ [1993] TSAR 56 at 58–65).


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are immediately followed by the duty of confidentiality147 regarding all business matters.148 All members of the management board (as well as the personnel director) fall under the provisions dealing with confidentiality.149 The importance of confidentiality is also stressed in the GCGC.150 Members of the management board who are in breach of their statutory duties are liable, as joint debtors,151 towards the corporation for all damages resulting from such a breach152 and the supervisory board has various statutory duties to ensure that proper action is taken to claim the damages suffered from a breach of these duties.153 The scope of this provision is widened even further by providing that if there is any dispute as to whether the members of the management board had acted as decent and conscientious business leaders, the burden of proof shifts to the defenders.154 The corporation carries the burden to prove the nature and extent of the damage, the specific act (deed) which constitutes the breach of the duty, and the link between the act (deed) and the damage (causation).155 It is also clear that the statutory duty of management board members to report on corporate governance practices under the GCGC in terms of Section 161 of the AktG,156 can potentially lead to liability for a breach of their duties towards the corporation. This is the case because it is conceivable that the company could suffer in several ways if the members of the supervisory board do not comply with the provisions of the Code or if they report incorrectly about the corporate governance practices followed in the corporation.157 Members of the management board are not only at risk of being liable for breaches of these general duties discussed so far, but can also be held liable for breaching any one of nine particular duties.158 These instances primarily deal with situations where payments are made without proper authorisation as prescribed in 147

148 149

150 151 152 153 154

155

156 157 158

General confidentiality and confidentiality as far as trade and business secrets are concerned, are mentioned. S 93(1)2 AktG. Hüffer (n 28) 454. The provisions which limited the duties of the person responsible for matters relating to labour relations (the Arbeitsdirektor), do not form part of the German law any longer—see Mertens (n 8) 287 para 1. Art 3.5 GCGC. See s 421 ff BGB for the meaning of joint debtors (Gesamtschuldner) in the German law. S 93(2)1 AktG. Lutter and Krieger (n 32) 170–71 para 421. S 93(2)2 AktG. See also Marcus Lutter, ‘Die Erklärung zum Corporate Governance Kodex gemäß § 161 AktG’ (2002) 166 ZHR 526. Hüffer (n 28) 456–58; Ulrich Eisenhardt, ‘Zum Problem der Haftung der Aufsichtsratsmitglieder von Aktiengesellschaft und GmbH der Gesellschaft’ [1982] Jura 300. See for example Art 3.10 GCGC. Lutter (n 158) 526. S 93(3) AktG.

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the Act, leading to the reduction of the corporation’s assets.159 Apart from civil liability, a breach of the duty of confidentiality is also a criminal offence.160 Furthermore, such a breach will serve as a compelling reason for the removal of the member by the supervisory board.161 Finally, members of the management board are defined as ‘insiders’ and may therefore be held criminally liable for insider trading if they deal in any one of a number of defined insider documents.162 3.3.4.2 Protection Against Liability: S 76(1) AktG and the German Business Judgement Rule There are certain circumstances where the management board members would be protected against liability. Firstly, Section 76 (1) of the AktG gives the management board ‘sole responsibility’ for managing and directing the business of the corporation. Secondly, case law established more explicitly a certain scope of actions which discharges management board members from liability, which could probably be called the German case-based business judgement rule. The BGH insisted, in its landmark decision of ARAG/Garmenbeck,163 that supervisory board members who are empowered to institute actions against members of the management board should allow the management board members considerable freedom to manage and direct the business of the corporation. Without such freedom, it would be impossible for them to manage and direct the business of the corporation in an innovative, business-like or entrepreneurial way. The management board will only be liable when its actions are clearly beyond the limits established by responsible conduct in the best interests of the enterprise; or they have been by far too willing to take business risks; or management board members have acted contrary to their duties in another way.164 This ‘safe harbour’ for managerial conduct has its basis in the Anglo-American concept of the ‘business judgement rule’. According to the Act on Enterprise Integrity and Modernisation of Avoidance Rules (Gesetz zur Unternehmensintegrität und Modernisierung des Anfechtungsrechts, UMAG)165 this business

159 160 161 162

163 164

165

See in particular Hüffer (n 28) 460 ff; Mertens (n 8) 315–16 paras 87–95. S 404(1) AktG. S 84(3) AktG. Ss 12–14 of the Gesetzes über den Wertpapierhandel (s 1 of the Zweites Finanzmarktförderungsgesetzes of 26 July 1994, Bundesgesetzblatt Teil I (BGBl I 1994, 1749). See Geßler (n 104) 4–4c. BGH, 21.04.1997 – II ZR 175/95, BGHZ 135, 244 ff. BGH, 21.04.1997 – II ZR 175/95 BGHZ 135, 244, 253 ff. Any other rule would lead to risk-averse behaviour of managers, which would cause negative allocation effects for employees and the entire national economy. Gesetz zur Unternehmensintegrität und Modernisierung des Anfechtungsrechts (UMAG) of 22 Sept 2005, Bundesgesetzblatt Teil I (BGBl I 2005, 2802).


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judgement rule is codified in Section 93(1)2 of the AktG.166 Therefore managerial conduct cannot be judicially reviewed, when four prerequisites are fulfilled: (1) the management board took a business decision; (2) the management board acted in good faith (or, in the words of the regulation: ‘reasonable assumption’); (3) the management board acted on the basis of adequate knowledge; and (4) the management board acted in the best interests of the corporation. 3.3.4.3 Matters Related to the Breach of the Statutory Duties There are also specific statutory arrangements pertaining to the indemnification and ratification by the corporation of members’ breach of their duties;167 the right of creditors of the corporation to initiate action against the members of the management board for corporation debts;168 and the period of prescription (five years) of 166

167 168

See for discussion of the codification Holger Fleischer, ‘Die “Business Judgment Rule”: Vom Richterrecht zur Kodifizierung’ (2004) 25 ZIP 685 ff; Peter Ulmer, ‘Haftungsfreistellung bis zur Grenze grober Fahrlässigkeit bei unternehmerischen Fehlentscheidungen von Vorstand und Aufsichtsrat?’ (2004) 57 DB 859 ff; Walter G Paefgen, ‘Dogmatische Grundlagen, Anwendungsbereich und Formulierung einer Business Judgment Rule im künftigen UMAG’ (2004) 49 AG 245 ff; Carsten Schäfer, ‘Die Binnenhaftung von Vorstand und Aufsichtsrat nach der Renovierung durch das UMAG’ (2005) 26 ZIP 1253 ff; Roderich Thümmel, ‘Organhaftung nach dem Referentenentwurf des Gesetzes zur Unternehmensintegrität und Modernisierung des Anfechtungsrechts (UMAG)—Neue Risiken für Manager?’ (2004) 57 DB 471 ff; Martin Kock and Renate Dinkel, ‘Die zivilrechtliche Haftung von Vorständen für unternehmerische Entscheidungen—Die geplante Kodizifierung der Business Judgment Rule im Gesetz zur Unternehmensintegrität und Modernisierung des Anfechtungsrechts’ (2004) 7 NZG 441 ff. S 93(4) AktG. S 93(5) AktG. See in particular Martin Peltzer, ‘Ansprüche der Gläubiger einer AG gegen Vorstands- und Aufsichtsratsmitglieder nach §§ 93 Abs. 5, 116 AktG im Falle eines gerichtlichen Vergleiches der AG’ (1976) 12 AG 100 ff. This provision only allows for the creditors to initiate action on behalf of the corporation for damages caused to the corporation and only for a maximum amount of damages sustained by them [Mertens (n 8) 327 para 141]. It does not allow creditors to sue the members of the management board directly for their own damages (other than those of the corporation). If they want to institute action against the members of the management board directly, they will have to rely on ordinary delictual (tort) claims—Carl H Barz et al, AktG: Großkommentar (de Gruyter Verlag, Berlin 1973) 742; Hüffer (n 28) 459–60. The question as to the personal delictual liability of the members of the organs of the corporation received considerable attention in Germany after the so-called BaustoffUrteil (BGHZ 109, 297)—see in particular Marcus Lutter, ‘Zur persönlichen Haftung des Geschäftsführers aus deliktischen Schäden im Unternehmen’ (1993) 157 ZHR 464; Barbara Grunewald, ‘Die Haftung von Organmitgliedern nach Deliktsrecht’ (1993) 157 ZHR 451.

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these actions.169 As far as ratification is concerned, the basic rule is that the members of the management board cannot be indemnified against liability for a breach of their duties by provisions in the articles of incorporation; their contracts of employment with the corporation;170 or by the supervisory board.171 It is only the general meeting that can ratify the members’ breach of duty and then only as far as their liability towards the corporation (and not towards creditors) are concerned.172 The members of the management board are only acquitted from liability if they have fully disclosed all relevant facts to the general meeting.173 The decision of the general meeting must also be lawful.174 The lawfulness of the decision will be judged against specific statutory grounds on which decisions of the general meeting can be declared void175 and also against certain statutory grounds on which the decisions of the general meeting can be opposed.176 It is interesting to note that the affected members of the management board may not vote, in their capacity as shareholders, if the vote at the general meeting concerns the ratification of their breaches of duty as members of the management board.177 It should be clear that this provision serves to prevent many of the daunting questions concerning ‘unratifiable wrongs’ in systems where the rule in Foss v Harbottle is still prevalent.178 3.3.4.4 Remarks from a Practice-Oriented Perspective The liability of management board members should, however, be seen in perspective.179 As pointed out above, complaints lodged by supervisory boards against 169 170 171

172

173 174

175 176 177 178

179

S 93(6) AktG. Mertens (n 8) 288 para 4; Hüffer (n 28) 453; Barz et al (n 168) 730. S 93(4)2 AktG. It also means that if a particular action (deed) is in breach of their duties, the members of the management board will not be protected against liability even if they have obtained the supervisory board’s permission before they have acted. They are responsible for managing the corporation, and cannot prevent liability by prior authorisation by the supervisory board—Barz et al (n 168) 735. Barz et al (n 168) 736. This ensures that ratification of a breach of duty cannot be obtained if it is to the detriment of the corporation’s creditors—Geßler (n 104) 6 para 15. Mertens (n 8) 321 para 116; Geßler (n 104) 5 para 10. S 93(4)1 AktG. See further Holger Fleischer, ‘Vorstandspflichten bei rechtswidrigen Hauptversammlungsbeschlüssen’ (2005) 60 BB 2025 ff. S 241 AktG. Ss 243 ff AktG. See further Mertens ( n 8) 322. S 136(1) AktG. See in particular Hüffer (n 28) 707–08. Jean J du Plessis, ‘Nominee Directors versus Puppet, Dummy and Stooge Directors: Reflections on these Directors and their Nominators or Appointors’ [1995] TSAR 312. Klaus J Hopt, ‘Stellungnahme zur Aktienrechtsreform 1997 von Prof Dr Klaus J Hopt’ (Special Edition) (1997) 42 AG 43. See also Marcus Lutter, ‘Defizite für eine effiziente Aufsichtsratstätigkeit und gesetzliche Möglichkeiten der Verbesserung’ (1995) 159


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management board members occur infrequently. The reasons for this are threefold: the huge legal obstacles in proving a breach of these duties; the procedural hurdles in bringing these actions; and some peculiarities associated with the German two-tier board system, making it unlikely for supervisory boards to initiate actions against members of the management board. There is little doubt that the potential of liability for members of the management board are vast. It is, however, significant to note that these measures have apparently little significance in practice. Kübler observes that although, according to the letter of the Act, the liability of management board members is extraordinarily wide, these provisions are considered to be insignificant in practice.180 The reason for this is apparently that action is very infrequently instituted against members of the management board for breach of their duties. According to Kübler,181 it seems that in many doubtful or delicate cases, the matter is normally solved through the supervisory board’s control functions over the management board,182 rather than through dragged-out legal proceedings against the members of the management board.183

3.4 Concluding Remarks There is a unique interaction between the various organs of German public companies. In this chapter we focused on the general meeting and the management board. The general meeting is no longer seen as the primary company organ in German corporations law, but it has some very important functions. In this regard the appointment and removal of the shareholder representatives on the supervisory board is probably one of the most important functions of the general meeting in Germany. However, we have seen that there are several practical considerations that make this function of theoretical importance only. Other functions of the general meeting include the power to amend the articles of incorporation by way of a special resolution (75% of the share capital represented at the passing of the resolution) and, within certain limits, to decide on the distribution of the corporation’s profits. The general meeting can also institute actions against the members of the supervisory and management boards for breaching their duties in so far as this is

180 181 182

183

ZHR 304; Marcus Lutter, ‘Stellungnahme zur Aktienrechtsreform 1997 von Prof Dr h c Marcus Lutter’ (Special Edition) (1997) 42 AG 55. Kübler (n 1) 187. Ibid. The supervisory board represents the corporation vis-à-vis the management board—s 112 AktG. It is, therefore, normally also the supervisory board who will claim damages from members in breach of their duties—see Kübler (n 1) 188. Also Hager (n 26) 352. See also Hans-Christoph Hirt, ‘The Review of the Role and Effectiveness of Nonexecutive Directors: A Critical Assessment with Particular Reference to the German Two-tier Board System (Part I)’ (2003) 16 ICCLR 251–52, 253.

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not regulated by other statutory provisions. This is only a minor function of the general meeting, as the removal of the members of these two other organs is regulated comprehensively in other statutory provisions. The management board, with a personnel director made compulsory for public corporations involved in certain industries, plays a pivotal role as company organ in German public corporations. It is the organ with the primary responsibility of managing and directing the business of German public companies. This power is almost unfettered, but certain decisions, particularly the Holzmüller decision, have eroded this power to a certain extent. Under the Holzmüller doctrine, the BGH held that the general meeting has some inherent powers regarding certain managerial decisions. These powers exist when matters affecting the fundamental rights and property interests of shareholders are at stake. In these matters the management board cannot simply rely on the usual internal arrangements (including arrangements in the articles of incorporation or internal business directives) regarding managing and directing the business of the corporation to alienate the rights and property interests of shareholders—the general meeting has the inherent powers to prevent being deprived of these rights and interests. This is a very controversial aspect that has received considerable attention in the German legal literature, but the scope of the doctrine still has not been determined exactly. In this chapter we have also dealt with the appointment, qualification, removal and remuneration of members of the management board. In the next chapter we will focus on similar themes, but the subject will be the role and functions of the supervisory board as an organ of some enterprises in Germany.

Chapter 4

The Supervisory Board as Company Organ Jean du Plessis and Ingo Saenger

4.1 Introduction In this chapter we focus on the supervisoruy board. A general overview of the supervisory board lays the foundation to a proper understanding of supervisory codetermination, the focus of Chapters 5 and 6. When one analyses the German two-tier board system one should never lose sight of the fact that the supervisory board was introduced into the German law of public corporations1 by the General German Commercial Code (Allgemeines Deutsches Handelsgesetzbuch, ADHGB) of 1861.2 In other words, more than 130 years of development and refinement have taken place since its origin. It is, therefore, no wonder that some commentators would perceive the German system as complicated or unnecessarily technical. This inception of the supervisory board, and also the later unfolding of this organ, was not at all without controversy.3 It was, for instance, generally accepted by the beginning of the 1900s that the supervisory board failed in its task of supervising and overseeing the management board.4 Somewhat later it was observed that the majority of supervisory boards did not actually fulfil their statutory duties.5 And even by the 1960s, it was stated by Wiethölter that although the supervisory board could not be viewed as insignificant, it had not overcome all its teething problems.6 1 2

3 4 5 6

See also 5.2.3.1. ADHGB 24 July 1861 with effect from 1 March 1862—see Rudolf Wiethölter, Interessen und Organisation der Aktiengesellschaft im amerikanischen und deutschen Recht (CF Müller Verlag, Karlsruhe 1961) 271. It is uncertain whether the requirement for having a supervisory board for AGs was influenced by developments concerning the Kommanditgesellschaft auf Aktien (KGaA)—see Wiethölter 281–85. In particular Wiethölter (n 2) 271 ff. Ibid 289. Ibid 290. Ibid 271.

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The debate on the role of the supervisory board is an ongoing one.7 There is an increasing amount of literature to support arguments for and against the supervisory board as an institution,8 as well as arguments for and against the effectiveness of supervisory boards.9 The importance of this institution is, furthermore, clearly illustrated by the fact that it has always been at the centre of discussions about corporate law reform in Germany.10 Although corporations with supervisory boards only account for 30 per cent of total turnover in Germany,11 there were approximately 8330 supervisory boards formed for large public corporations, city banks and cooperatives in 1996.12

4.2 Qualifications and Appointment of Supervisory Board Members The appointment and removal of the members of the supervisory board are nowadays13 closely linked with the concept of employee participation at supervisory board level, since the supervisory board serves as the forum where the interests of various interest groups are represented in the corporation. These aspects are discussed in detail later in this chapter,14 while we will now only point out some of the general principles applying to the appointment and removal of the members of the supervisory board.

7

8 9

10

11 12 13 14

In particular Marcus Lutter, ‘Defizite für eine effiziente Aufsichtsratstätigkeit und gesetzliche Möglichkeiten der Verbesserung’ (1995) 159 ZHR 288 ff and the latest sources quoted by him. Wiethölter (n 2) 270, 305, 314. Cf for example Marcus Lutter and Gerd Krieger, Rechte und Pflichten des Aufsichtsats (4th edn Otto Schmidt Verlag, Cologne 2002) 38 paras 95–96; Friedrich Kübler, Gesellschaftsrecht (5th edn CF Müller Verlag, Heidelberg 1998) 409–10; Ulrich Immenga, ‘Zuständigkeiten des mitbestimmten Aufsichtsrats’ (1977) 6 ZGR 250 ff; Wolfgang Röller, ‘Quo vadis Aufsichtsrat?’ (1994) 39 AG 333 ff. For a particularly sceptical analysis of the effectiveness of the supervisory board as institution, see Wolfgang Bernhardt, ‘Aufsichtsrat—die schönste Nebensache der Welt?’ (1995) 159 ZHR 310 ff. Wiethölter (n 2) 270; Thomas Raiser, ‘The Theory of Enterprise Law in the Federal Republic of Germany’ [1988] AJCL 120; Klaus J Hopt, ‘The German Two-Tier Board (Aufsichtsrat): A German View on Corporate Governance’ in Klaus J Hopt and Eddy Wymeersch (eds), Comparative Corporate Governance (de Gruyter Verlag, Berlin 1997) 6; Lutter and Krieger (n 9) 1 para 1. Hopt (n 10) 7. Carsten P Claussen, ‘Aktienrechtsreform 1997’ (1996) 41 AG 481 at 484. See, however, 5.2.4. See 4.5.

The Supervisory Board as Company Organ

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4.2.1 Conditions for Qualifications The following conditions apply for the appointment of members of the supervisory board: (a) Only fully competent, natural persons may serve as members of the supervisory board;15 (b) A person is disqualified from serving on more than ten supervisory boards at the same time;16 (c) A person cannot at the same time serve on the management board and supervisory board of a corporation;17 (d) Nobody can serve on the supervisory board if he is the authorised and lawful representative (e.g. member of the management board or a manager) of one of the corporation’s subsidiaries;18 (e) To prevent interlocking supervisory and management boards (Überkreuzverflechtung), a person may not be a member of a supervisory board who is the lawful representative (e.g. member of the management board or a manager) of another corporation whose supervisory board includes a member of the management board of the company.19 Apart from these prerequisites of German corporate law, there were, for a short period of time, also some recommendations at EU-level. These recommendations suggested that Member States of the EU, through listing rules (based on the principle of ‘comply or explain’) or through legislation, should have some arrangements in place dealing with the qualifications, commitment and independence of supervisory board members: 20 15 16

17

18 19

20

S 100(1) AktG. S 100(2)1 AktG. The norm for listed companies is that a person should not serve on more than five supervisory boards in non-group listed companies—see Art 5.4.3 of The German Corporate Governance Code (GCGC) 12 June 2006 . S 105(1)2 AktG. This prohibition became necessary, since without it the management board was only appointed from amongst the members of the supervisory board— Wiethölter (n 2) 288. S 100(2)2 AktG. S 100(2)3 AktG. However, the same individual may be on the management board of one or two companies and sit on several supervisory boards, thus extending an indirect influence over the management boards of several companies. See generally Lutter and Krieger (n 9) 8–9 paras 18–19. The ‘Draft of the Commission Recommendation […] on the role of non-executive or supervisory directors and on the committees of the (supervisory) board (Text with EEA relevance)’ is accessible online at . See for the impact on conflicts of

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(a) with regard to qualifications, the supervisory board should ensure that it is composed of members who, as a whole, have the required diversity of knowledge, judgement and experience to properly complete their tasks;21 (b) with regard to commitment, each director should devote to his duties the necessary time and attention, and should undertake to limit the number of his other professional commitments to such an extent that the proper performance of this duties is assured;22 and (c) with regard to independence, a director should be considered to be independent when he is free from any business, family or other relationship—with the company, its controlling shareholder or the management of either, that creates a conflict of interest such as to jeopardise exercise of his judgement.23 According to current German corporate law there is, however, no general prohibition24 preventing a person from sitting on supervisory boards of competing companies such as DaimlerChrysler and Audi, or Siemens and Bosch.25 This could lead to obvious conflicts of interest for a person sitting on the supervisory boards of competing companies.26 Because of this, the Baums Commission—the German Government Commission on Corporate Governance—recommended that no person should serve on the supervisory boards of two competing corporations.27 This recommendation currently occurs, in a somewhat watered down form, in the German Corporate Governance Code (GCGC). It is specifically required that all supervisory board members shall inform the supervisory board about any conflict of interest28 and the supervisory board shall inform the general meeting in its

21 22 23 24

25 26 27

28

interest of supervisory board managers Ingo Saenger, ‘Conflicts of Interest of Supervisory Board Members in a German Stock Corporation and the Demand for their Independence—An Investigation in the Context of the Current Corporate Governance Discussion’ [2005] Corporate Governance L Rev 147–189. The Recommendation is supposed to create pressure to adapt the GCGC; cf Mathias Habersack, ‘Der Aufsichtsrat im Visier der Kommission’ (2004) 168 ZHR 373; Silja Maul and Georg Lanfermann, ‘Europäische Corporate Governance—Stand der Entwicklungen’ (2004) 59 BB 1861 ff; Silja Maul and Georg Lanfermann, ‘EU-Kommission nimmt Empfehlungen zu Corporate Governance an’ (2004) 59 BB 2407 ff; Günther H Roth and Ulrike Wörle, ‘Die Unabhängigkeit des Aufsichtsrats—Recht und Wirklichkeit’ (2004) 33 ZGR 565, 610 ff. Art 11 Draft Commission Recommendation. Art 12 Draft Commission Recommendation. Art 13 Draft Commission Recommendation. For detailed information on the German corporate law governing conflicts of interest see Saenger (n 20). Lutter and Krieger (n 9) 9 para 20. Ibid 9–10 para 21. Theodor Baums (ed), Bericht der Regierungskommission Corporate Governance (Baums Report) (Otto Schmidt Verlag, Cologne 2001) 95–96 para 54. Art 5.5.2 GCGC.


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Annual Report to the general meeting of such conflict of interest situations.29 It is also prescribed in the Code that a material conflict of interest shall result in the termination of a person’s appointment as supervisory board member,30 and such a material conflict will also provide a compelling reason for the removal of such a member in terms of Section 103(3) of the Aktiengesetz (AktG).31 Some commentators distinguish between internal and external members of the supervisory board, referring to those not representing any specific interest group as outsiders and those who represent internal interests as insiders.32 Although there are no statutory provisions pertaining to the qualifications of members of the supervisory board, it is generally accepted that members should at least have some knowledge of the economics, basic legal knowledge and some understanding of accounting.33 It is not necessary that each individual member of the supervisory board have knowledge of all these areas, but commentators point out that each member should at least have the ‘financial literacy’ to basically understand the financial statements of the company.34 It is, for that reason, that it is common to appoint bankers, lawyers, and tax, financial or stock exchange experts to supervisory boards.35 The level of competency expected of supervisory board members is becoming greater because of concepts like internationalisation and globalisation.36 The GCGC introduced further guidelines regarding the qualifications and suitability of members of the supervisory board. Under the Code it is expected that care shall be taken that supervisory boards at all times consist of members who have the required knowledge, abilities, and expert experience to properly perform their tasks and that they are sufficiently independent.37 Aspects like the interna29 30 31

32

33 34

35

36 37

Art 5.5.3 GCGC. Ibid. Johannes Semler and Arndt Stengel, ‘Interessenkonflikte bei Aufsichtsratsmitgliedern von Aktiengesellschaften am Beispiel von Konflikten bei Übernahme’ (2003) 6 NZG 6. Maximillian Schiessl, ‘Deutsche Corporate Governance post Enron’ (2002) 47 AG 597; Konrad Berger, Die Kosten der Aufsichtsratstätigkeit in der Aktiengesellschaft (Peter Lang Verlag, Frankfurt 2000) 5. Berger (n 32) 5. Martin Peltzer, ‘Handlungsbedarf in Sachen Corporate Governance’ (2002) 5 NZG 597. See further Martin Peltzer, ‘Corporate Governance Codices als zusätzliche Pflichtenbestimmung für den Aufsichtsrat’ (2002) 5 NZG 12. Benno Heussen, ‘Interessenkonflikte zwischen Amt und Mandat bei Aufsichtsräten’ (2001) 54 NJW 708. Berger (n 32) 5–6. Art 5.4.1 GCGC. It is interesting to note that unlike the current UK Combined Code (see Code provision A.3.1 at ) and the Principles of Good Corporate Governance and Best Practices Recommendations by the Australian Stock Exchance’s ASX’s Corporate Governance Council (see Box 2.1 (page 20) at ), the GCGC does not have a comprehensive definition of independence. This is obviously

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tional activities of the enterprise, potential conflicts of interest, and any age limit specified for the members of the supervisory board, must be taken into consideration when supervisory board members are appointed.38 The Code also expects that it should be noted in the Annual Report of the supervisory board if a member of the supervisory board took part in fewer than half of the meetings of the supervisory board in a financial year.39 In addition to that, the Code suggests that no more than two former members of the management board shall be members of that corporation’s supervisory board. This is aimed at ensuring independent advice and supervision by the supervisory board over the management board40 and addresses the Achilles’ heel in German personnel policy,41 since it is quite usual to assign former management board members to the supervisory board. It is also not unusual for the former chairperson of the management board to take on the role as chair of the supervisory board.42 These practices have led to a kind of ‘social cohesion of elitist business people’. Although this practice conflicts with the mentioned recommendation of the GCGC, it does also offer advantages. The former management board member is experienced and has best knowledge of the trade within the company’s area of business. With this level of knowledge the new supervisory board member is not only competent to advise43 and to exchange experiences gained in the management

38 39 40 41 42

43

because there are employee representatives sitting on the supervisory boards of many listed corporations and because there are often representatives from the banks serving on the supervisory board of many large German corporations—see Klaus J Hopt, ‘Gemeinsame Grundsätze der Corporate Governance in Europa?’ (2000) 29 ZGR 786. On the other hand, it may not be such a bad idea not to define independence, as a comprehensive definition is hardly possible—see, for example, Hans-Christoph Hirt, ‘The Review of the Role and Effectiveness of Non-executive Directors: A Critical Assessment with Particular Reference to the German Two-tier Board System (Part I)’ (2003) ICCLR 245, 249 ff, although it seems as if Hirt has changed his mind on this issue (cf Hans-Christoph Hirt, ‘Germany: The German Corporate Governance Code: Co-determination and Corporate Governance Reforms’ (2002) 23 Company Lawyer 354). Art 5.4.1 GCGC. Art 5.4.6 GCGC. Art 5.4.2 GCGC. For detailed discussion see Saenger (n 20). Carsten Berrar, ‘Zur Reform des AR nach den Vorschlägen der Regierungskommission “Corporate Governance”‘ (2001) 4 NZG 1113, 1118; Oliver Lange, ‘Der Wechsel aus dem Vorstand in den Aufsichtsrat’ (2004) 7 NZG 265. BGH, 03.03.1991, II ZR 188/89, BGHZ 114, 127, 129 ff; affirmed by BGH, 15.11. 1993, II ZR 197/93, BGHZ 126, 340 ff; both judgements (with further bibliography) described the function of the supervisory board as follows: ‘According to s111 AktG the supervisory board is primarily responsible for monitoring the management. This control does not only relate to completed issues, but also to points of principles of the future business policy; [the control] is not limited to a review of legality, but must include the


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board, but is also able to pass on information to other members of the supervisory board.44 Thus, the supervisory board and the company as a whole are able to make well-informed decisions on the company’s well-being or fate. Personal continuity can provide a reliable corporate management and personal faith in the managers’ performance. Besides that, there is demand for a co-entrepreneurial role45 for the supervisory board in strategic decisions. A supervisory board with the knowledge of former management board members seems to be able to perform this role better than one without this knowledge. On the other hand, it is very doubtful whether the presence of former management board members is compatible with the supervisory board’s monitoring function and with the system of strict separation of the functions of supervisory and management boards. It is likely that the transition from the old to the new management is exacerbated due to a reciprocal dependence of both boards.46 There is also a danger of former management board members striving to correct or even to hide mistakes of the past.47 Negative effects are not only conceivable for the former management board member, but also for other members of the supervisory board, since they may rely in good faith on the former members’ advice. This would jeopardise an effective supervision and shatter the joint responsibility of all supervisory board members by creating a disparity. Therefore, in international comparison it is not surprising that the appointment of former management board members is strongly discouraged and that independence of supervisory board members is defined as being not affiliated with the company for the past five years.48 Since the GCGC only provides for numerical limitation of former management board members, but not for an intermission time, it does not provide enough independence of the supervisory board at this point.49

44 45

46

47

48 49

management’s expediency and thrift. Monitoring functions understood in this regard can only be effectively exercised by regular discussions with the management board and its ongoing consultancy; therefore, counselling is the leading instrument of a future-oriented management supervision.’ Besides that, Art 5.1.1 GCGC declares that advising the management board is a task of the supervisory board. Röller (n 9) 333, 335; Berrar (n 42) 1119; Schiessl (n 32) 593, 598. Marcus Lutter, ‘Auswahlpflichten und Auswahlverschulden bei der Wahl von Aufsichtsratsmitgliedern’ (2003) 24 ZIP 417, 418; Lutter and Krieger (n 9) 20 para 56 ff. Similarly Berrar (n 42) 1113, 1119; Christian Bender and Hendrik Vater, ‘Lückenhaft und unverbindlich—Der Deutsche Corporate Governance Kodex lässt auch nach der Überarbeitung wichtige Kernprobleme der Unternehmensüberwachung ungelöst’ (2003) 39 DStR 1807, 1808; Lange (n 42) 265, 267. Cf Bender and Vater (n 46) 1807,1808; Schiessl (n 32) 593, 598. See also Heinrich Götz, ‘Rechte und Pflichten des Aufsichtsrats nach dem Transparenz- und Publizitätsgesetz’ (2002) 5 NZG 599, 604, who points out that former management board members are inclined to develop a ‘self-service mentality’. Berrar (n 42) 1113, 1119 with further bibliography. Bender and Vater (n 46) 1807, 1808 (as well as other critics such as Wolfgang Bernhardt, ‘Der Deutsche Corporate Governance Kodex: Zuwahl (comply) oder Abwahl (ex-

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A few observations should be made regarding the maximum number of supervisory boards a person may serve on. In the case of a person acting as chair, it is considered to be equivalent to sitting on two supervisory boards.50 In other words, a person can only be the chair of a maximum of five supervisory boards. This proposal was introduced by the Gesetz zur Kontrolle and Transparenz im Unternehmensbereich (KonTraG) of May 199851 after it was widely endorsed by commentators.52 The limitation to be a member of no more than ten supervisory boards was introduced when it was realised (only 30 years after the supervisory board was made compulsory for German public companies) that only a very small number of people served on almost all the supervisory boards in Germany: 70 persons took up 1901 places on the supervisory boards of 1184 public companies and, in one case, a particular banker served on the supervisory boards of 35 corporations.53 To allow supervisory board members to pay more attention to their responsibilities, it has recently been suggested that nobody should be allowed to sit on the supervisory board of more than five corporations.54 This proposal was, however, criticised heavily and not adopted in the KonTraG of May 1998.55 The arguments were basically that some supervisory board members with support (back office) could fulfil their duties thoroughly in up to ten supervisory boards56 and that the quality of fulfilling their functions rather than the number of supervisory boards a person sits on should be the determining factor.57 It was also pointed out that the responsibilities associated with memberships of various supervisory boards vary

50 51 52

53 54

55 56 57

plain)?—Unternehmensführung zwischen “muss”, “soll”, “sollte” und “kann”’ (2002) 55 DB 1841, 1842) criticise the Code due to the composition of the German Commission on Corporate Governance especially in this regard by pointing out that the Commission’s Chairman Gerhard Cromme is the former chairperson of the management board and recent chairperson of the supervisory board of Thyssen-Krupp. S 100(2) AktG. Bundesgesetzblatt Teil 1 (BGBl I 1998, 786). Klaus J Hopt, ‘Stellungnahme zur Aktienrechtsreform 1997 von Prof Dr Klaus J Hopt’ (Special Edition) (1997) 42 AG 43; Friedrich Kübler, ‘Stellungnahme zur Aktienrechtsreform 1997 von Prof Dr Friedrich Kübler’ (Special Edition) (1997) 42 AG 48; Claussen (n 12) 484. See, however, Heinrich Götz, ‘Stellungnahme zur Aktienrechtsreform 1997 von Dr Dr h.c. Heinrich Götz’ (Special Edition) (1997) 42 AG 40–41. Wiethölter (n 2) 288; Claussen (n 12) 484–85. Lutter (n 7) 302–03; Marcus Lutter, ‘Das neue Gesetz für kleine Aktiengesellschaften und zur Deregulierung des Aktienrechts’ (1994) 39 AG 177; Marcus Lutter, ‘Stellungnahme zur Aktienrechtsreform 1997 von Prof Dr h.c. Marcus Lutter’ (Special Edition) (1997) 42 AG 54; Theodor Baums, ‘Stellungnahme zur Aktienrechtsreform 1997 von Prof Dr Theodor Baums’ (Special Edition) (1997) 42 AG 26–27. See also Schiessl (n 32) 598–99. For interlocking directorates see in general Roth and Wörle (n 20) 565, 587 ff. See generally Baums Report (n 27) 94–95 para 52. Claussen (n 12) 484; Röller (n 9) 334; Hopt (n 52) 43; Berger (n 32) 14. Röller (n 9) 334.


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considerably and that there may be circumstances where a person should not sit on more than two or three supervisory boards.58 In other cases a person could probably serve on more than ten supervisory boards.59 Hopt argued convincingly that, as in several other jurisdictions, German corporations should ensure proper performance of duties and responsibilities by removing incompetent supervisory board members and holding them liable for breaches of their duties.60 This was seen as a better solution for the German corporations law than limiting the number of supervisory boards a person could serve on.61 It was also pointed out that a person who serves on several supervisory boards is more likely to bring broader perspectives to the supervisory boards he or she serves on.62 There is a duty on every member of the supervisory board to ensure that he or she has sufficient time to perform his or her mandate. The GCGC also provides that members of the management board of a listed company shall not accept more than a total of five supervisory board mandates in non-group listed companies.63 In other words, it will have to be explained in the financial statements if these limits are exceeded.

4.2.2 Appointment Prerequisites The right to appoint members of the supervisory board varies according to the size of the corporation, according to the specific sphere of business the corporation is involved in, and also, to a certain extent, according to the provisions in the articles of incorporation (Satzung).64 There are basically four different systems through which the members of the supervisory board are appointed: (a) In public corporations where employee participation is not made compulsory, all members of the supervisory board are appointed by the general meeting or in accordance with provisions in the articles of incorporation.

58 59 60

61 62 63 64

Röller (n 9) 334. Also Baums (n 54) 26–27; Hopt (n 52) 43. Kübler (n 52) 48. Hopt (n 52) 43. Supervisory board members are very seldom held liable for a breach of their duties—see Michael Adams, ‘Stellungnahme zur Aktienrechtsreform 1997 von Prof Dr Michael Adams’ (Special Edition) (1997) 42 AG 10; Bernhardt (n 9) 315. Hopt (n 52) 43; Berger (n 32) 13–14. Röller (n 9) 334–35; Berger (n 32) 14. Art 5.4.3 GCGC. S 101(2) AktG. The articles of incorporation (Satzung) may also prescribe specific requirements or qualifications for the members of the supervisory board appointed by the general meeting—s 100(4) AktG. See generally Johannes Semler, ‘The Practice of the German Aufsichtsrat’ in Klaus J Hopt, Hideki Kanda, Mark J Roe, Eddy Wymeersch and Stefan Priggle (eds), Comparative Corporate Governance: The State of the Art and Emerging Research (OUP, Oxford 1998) 269–70.

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(b) For certain types of corporations65 it is required that one-third of the supervisory board must be appointed by the employees or their representatives and two-thirds by the general meeting or in accordance with provisions in the articles of incorporation or comparable documents (die Satzung, der Gesellschaftsvertrag or das Statut). (c) For other types of corporations66 half of the members are appointed by the employees67 or their representatives, the other half by the shareholders,68 and then one neutral member has to be appointed by the two groups together. (d) For a final group of corporations69 an equal number of representatives are appointed by the employees70 or their representatives and the shareholders.71 In addition, for the corporations falling under this system, the chairperson (with a casting vote) must be elected from the group of persons appointed by the general meeting, while the employee representatives must include at least one person from ‘the leading personnel’ (managers and executive employees).72 The usual period of appointment is five years.73 It is reported that the supervisory board members basically stay the same for many years as their terms of appointment are almost always automatically renewed and the removal or termination of their offices are of academic interest only.74 It is also interesting to note that the shareholder representatives on the supervisory board are in the majority of cases (up to 75%) elected to their positions based on proposals that come from the management board and not from the shareholders.75 Thus, in practice the management

65 66 67 68

69 70 71 72

73 74 75

See discussion in 5.2.3.4. See discussion in 5.2.3.2. The German law classifies the employees in different categories—see 5.4.2. These members will normally be appointed by the general meeting, but the articles of incorporation may provide for special procedures and requirements in this regard (s 8(1) MitbestG) such as the appointment by a specific person or institution (normally a major creditor). See discussion in 5.2.3.3. The German law classifies the employees in different categories—see 5.4.2. S 8(1) MitbestG. See generally the table by Brian Robinson, ‘Worker participation: Trends in West Germany’ in Mark Astey (ed), Worker Participation (Juta & Co Ltd, Durban 1990) 52. See also ‘Foreword’ to the GCGC. Lutter and Krieger (n 9) 11 para 25. Bernhardt (n 9) 314. Walther von Wietzlow and Jena Gemmecke, ‘Corporate Governance und die Praxis der gerichtlichen Bestellung von Aufsichtsräten—ein Problem?’ [2003] AG Report R302;


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board heavily influences the selection process and appointment procedure of shareholder representatives to the supervisory board.76 Another serious practical problem lies with the appointment of supervisory board members by the Court. In terms of Section 104 of the AktG the Court has the power to appoint a supervisory board if such appointment is required to comply with the statutory required minimum number of supervisory board members. This will often be used when a member of the supervisory board resigns before the end of his or her period of appointment. Proposals for filling these positions come, almost without exception, from the management board77 and it is a well-established practice that the Court will simply fill the vacancy based on the management board’s proposals.78 In actual fact, the shareholders have practically no way of influencing this process as the resignation of supervisory board members is done through the management board as the statutory managing organ of the corporation.79 Thus the shareholders will normally only become aware of the filling of such a vacant position in the supervisory board when the reconstituted supervisory board is published in accordance with Section 106 of the AktG.80 Two further practical difficulties also exist. The supervisory board members appointed by the Court cannot be removed by the general meeting as the meeting only has power to remove those members of the supervisory board it has appointed.81 Secondly, the power to convene a general meeting is an exclusive power of the management board. In other words, if the management board does not convene a general meeting to give the shareholders the opportunity to appoint a shareholder representative to the supervisory board, the shareholders have to rely on extraordinary procedures to convene a general meeting or to add the appointment of the shareholder representative to the agenda of the Annual General Meeting.82 Thus, it has been observed that it is highly problematic from a corporate governance perspective that there are so many statutory obstacles standing in the way of shareholders to influence the appointment of shareholder representatives to the supervisory board when vacancies occur.83

76 77

78 79 80 81 82

83

Klaus J Hopt, ‘The German Two-Tier Board: Experience, Theories, Reforms’ in Klaus J Hopt et al (n 64) 231–32. Hirt 2003 (n 37) 255. In practice the chair of the management board plays a huge role in several corporations as to who should be nominted as supervisory board members—see Schiessl (n 32) 599. Cf von Wietzlow and Gemmecke (n 75) R302. Ibid. Ibid. Ibid R303. These extraordinary procedures enable shareholders who hold 5% of the nominal share capital, or can raise 500 000 Euros, to initiate action on behalf of the corporation; cf von Wietzlow and Gemmecke (n 75) R302 at R303. Von Wietzlow and Gemmecke (n 75) R302 at R303. Peltzer (‘Corporate Governance Codices als zusätzliche Pflichtenbestimmung für den Aufsichtsrat’) (n 34) 12 points out

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It will, therefore, be clear from the preceding discussion that in practice the management board has a huge influence over the selection of shareholder representatives on the supervisory board. In short, there are two reasons for this. First, the majority of shareholder representatives are appointed based on nominations by the management board. Second, vacancies on the supervisory board are almost invariably filled by the court based on proposals made by the management board. The fact that in practice the management board has such a huge influence over the composition of the shareholder representatives on the supervisory board leaves some doubt whether the ‘shareholder representatives’ on the supervisory board can really be independent.84

4.3 Removal of Supervisory Board Members In principle the removal of the members of the supervisory board vests in the group of people who appointed them.85 For example, as a general rule the members of the supervisory board appointed by the general meeting can be removed by a three-quarter majority of the general meeting, even without cause or without compelling reasons.86 It is, however, possible that a corporation may, in its articles of incorporation, provide for a different majority and also for other requirements applicable to the removal of supervisory board members.87 For example, the articles of incorporation can determine a lower majority (ordinary resolution)88 for the removal of all shareholder representatives on the supervisory board and even for the employee representatives in the case of the Betriebsvefassungsgesetz (BetrVG), but not so for the employee representatives appointed under the Montan-Mitbestimmungsgestz (Montan-MitbestG) or the Mitbestimmungsgestz (MitbestG) where the required majority is laid down by law as a three-quarters majority.89 It is, however, also possible that the articles of incorporation could provide that removal of supervisory board members could only take place for compelling reasons (wichtiger Grund), thus making it more difficult to remove these supervisory board members than the statutory provisions require.90

84 85 86 87 88

89 90

that the power to co-opt members to the supervisory board is uncontroversial as long as the supervisory board consists of competent individuals. The difficulty, however, is to determine whether that is the case when the management board has indirectly influenced the filling of several shareholder representatives to the supervisory board. Hirt 2003 (n 37) 255. S 103 AktG. S 103(1) AktG. See further Lutter and Krieger (n 9) 7–8 paras 14–16. S 103(1) AktG. For example Hartmut Krause, ‘Prophylaxe gegen feindliche Übernahmeangebote’ (2002) 47 AG 151. Lutter and Krieger (n 9) 12 para 26. Ibid.


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Special provisions govern the removal of the employee representatives91 and also the removal of members of the supervisory board by the court when compelling reasons for such removal are present.92 As a general rule a three-quarter majority of the electing constituency, namely the employees, is required for the removal of the employee representatives on the supervisory board in all types of corporations where codetermination is compulsory.93 It is interesting to note that unlike the removal of members of the management board, there is no general requirement that the removal of supervisory board members could only take place for compelling reasons,94 although the articles of incorporation may make compelling reasons a condition of such removal.95 On the other hand, unlike several other jurisdictions where the general rule is that removal of directors can take place by ordinary resolution only,96 the German law still requires a special resolution with a three-quarters majority, which will make removal possible only under extreme circumstances. The complexity of the voting procedure is one of the reasons why the removal of the employee representatives on the supervisory board under Section 103 of the AktG is rarely used.

4.4 Remuneration of Supervisory Board Members The remuneration97 of the members of the supervisory board can be determined either by provisions in the articles of incorporation or by the general meeting.98 91

92 93 94 95 96

97

98

S 103(4) AktG. See also B Großfeld and U Lehmann, ‘Management Structures and Worker’s Codetermination in Germany with European Perspectives’ in 1 (1994) Corporate Law Development Series 46. S 103(3) AktG. Lutter and Krieger (n 9) 6–7. See 3.3.2.4. See discussion in 3.3.2.4. Jean J du Plessis, ‘Some Peculiarities Regarding the Removal of Company Directors’ (1999) 27 ABLR 6; Jean J du Plessis and James McConville, ‘Removal of Company Directors in a Climate of Corporate Collapses’ (2003) 31 ABLR 249. The average annual remuneration of supervisory board members in Germany was DM 13 000 in 1993; DM 16 000 in 1995; and DM 23 600 in 2001—see Lutter (n 7) 303; Lutter and Krieger (n 9) 2 para 2 (fn 5). As incentive for better performance, Lutter (n 7) 304 suggested that statutory provisions should be introduced to ensure that supervisory board members receive a basic remuneration as well as a portion of the corporation’s profits. See also Marcus Lutter, ‘Die Erklärung zum Corporate Governance Kodex gemäß § 161 AktG’ (2002) 166 ZHR 523 at 530–531; Schiessl (n 32) 597. S 113(1) AktG. Cf, however, Peltzer (‘Corporate Governance Codices als zusätzliche Pflichtenbestimmung für den Aufsichtsrat’) (n 34) 16, who argues that interesting and well-managed corporations will always find good people to serve as supervisory board members, irrespective of the remuneration. He also seems to be in favour of supervi-

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The remuneration can be either in the form of a specific sum, or by way of profitsharing, but it is specifically provided that the remuneration of the members of the supervisory board should be reasonable and proportionate with regard to the functions of each of the members of the supervisory board and also reasonable and proportionate with regard to the general (financial) position of the undertaking.99 These arrangements are confirmed in the GCGC.100 It is interesting to note that listed public companies not paying their supervisory board members fixed as well as performance-related remuneration101 will have to explain in their financial statements why both types of remuneration are not paid.102 As far as performance-related remuneration of supervisory members with share options is concerned, one has to take note of some recent case law and legislation.103 On the one hand, the economic rationale of share option plans—to achieve a shareholder-value driven conduct of the beneficiaries—is suitable not only for management board members, but also for supervisory board members.104 Furthermore, higher and performance-related remuneration would reflect the prominent role the supervisory board plays in German corporations.105 Thus, effective corporate governance with an emphasis on shareholder interests seems to demand share options for supervisory members. On the other hand, a form of remuneration tying in with the stock exchange price, which again is the parameter of the management board’s performance, is very likely to align the interests of both boards. As we have seen, it is fundamental to the German two-tier board system that different roles and functions are allocated to the supervisory and management boards, with the supervisory board having the primary task of supervising or overseeing the business of the corporation. To allow supervisory members to participate in share option plans undermines the fundamental function of supervisory board members to supervise or oversee the business of the corporation and not to manage the business of the corporation as that is

99

100 101

102 103 104

105

sory board members maintaining their independence by not being too dependent on the remuneration they receive as supervisory board members. S 113(1)3 AktG and Art 5.4.5 GCGC. This corresponds with the provision applying to the remuneration of the members of the management board—see s 87(1). Art 5.4.5 GCGC. See also s 113(3) AktG. If the members of the supervisory board are granted a share of the annual profit of the company, according to this section of the AktG such share shall be computed on the basis of distributable profit, reduced by an amount of not less than four per cent of the contributions made on the par value of the shares and any provisions to the contrary shall be null and void. Art 5.4.5 GCGC. Saenger (n 20). With the same estimation Konrad Bösl ‘Aktienoptionen für den Aufsichtsrat— Überlegungen zur Zweckmäßigkeit und zu Gestaltungsempfehlungen nach dem Urteil des BGH’ (2004) 4 BKR 474, 475. Lutter (n 45) 417, 418; Lutter and Krieger (n 9) 20 para 56 ff, explaining the coentrepreneurial role that supervisory boards should play. Cf Bösl (n 104) 474, 477.


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the primary function of the management board.106 With these perspectives in mind, the judgement of the Federal Court of Justice (Bundesgerichtshof, BGH) is not surprising. The judgement declared that a company may not purchase its own shares in order to distribute them to members of the supervisory board in order to provide a share option plan.107 In an obiter dictum the judgement doubted the possibility of supplying subscription rights of share option plans with convertible bonds and picked up the detrimental effect on the monitoring function of the supervisory board which share option plans might have.108 The inadmissibility is in line with the wording of the GCGC, which expressly mentions share options as a form of remuneration for the management board,109 while it only recommends performance-related remuneration for the supervisory board.110 The Act on Enterprise Integrity and Modernisation of Avoidance Rules (UMAG)111 prohibits the issuing of convertible bonds for supplying share option plans in general. This is in line with recommendations at EU-level.112 In order to obtain full advantage of the positive effects that performance incentive schemes have on the way in which organs perform, and in view of the in-

106 107

108

109 110

111 112

With a different view Bösl (n 104) 474, 475. BGH, 16.02.2004, II ZR 316/02, (2004) 59 BB 696 ff; (2004) 48 AG 265 ff; (2004) 25 ZIP 613 ff; (2004) 58 WM 629 ff. The judgement is scheduled to be published in the official collection of BGH judgements (BGHZ). Apart from the above-mentioned article by Saenger (n 20), for comments on this judgement see Mathias Habersack, ‘Die erfolgsabhängige Vergütung des Aufsichtsrats und ihre Grenzen—Zugleich Besprechung der Entscheidung BGH ZIP 2004, 613 (MobilCom)’ (2004) 33 ZGR 721 ff with further bibliography. BGH, 16.02.2004, II ZR 316/02. (2004) 59 BB 697; (2004) 48 AG 265; (2004) 25 ZIP 614; (2004) 58 WM 630. Art 4.2.3 GCGC. Art 5.4.5 GCGC. According to Bösl (n 104) 474 with further bibliography, the Government Commission does not reject share option plans in favor of supervisory board members. But this perspective does not explain the different wording of the GCGC. See 3.3.4.2. See the draft of the UMAG at s 193(2) No 4 AktG. The draft is accessible online at . The ‘Draft of the Commission Recommendation on the role of non-executive or supervisory directors and on the committees of the (supervisory) board (Text with EEA relevance)’, Annex II, 1., letter (c) [online accessible at ] negates a supervisory board member’s independence, if the person receives or has received significant additional remuneration from the company or an associated company apart from a fee received as non-executive or supervisory director; such additional remuneration is supposed to cover in particular any participation in a share option or any other performance-related pay scheme. See also Habersack (n 20) 373, 379; Maul and Lanfermann ‘Europäische Corporate Governance...’ (n 20) 1861, 1863; Maul and Lanfermann ‘EU-Kommission...’ (n 20) 2407 ff.

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creased demand for such schemes, it is not surprising to find other schemes113 which achieve the positive results of incentives while also conforming with the requirements of independence. Therefore the legislature will have to enact clear and undisputed guidelines which focus on the positive aspects of incentives, since at least an incentive-oriented design of parts of the remuneration scheme of supervisory board members is an acceptable remuneration practice.114 Another aspect of supervisory board members’ remuneration which also has to be seen in the context of the supervisory board’s independence deals with direct payments by the management board to supervisory board members. To prevent undue influence by the management board over the members of the supervisory board by paying them special high fees for consultation services,115 the approval of the supervisory board is required before such members can receive these fees from the corporation.116 Without such approval, these agreements are void and any payments made under them must be paid back to the corporation.117 The Chair receives double the remuneration of other supervisory board members. This is linked to the fact that the position of chairperson is counted as the equivalent of holding two supervisory board memberships.118

113

114 115

116

117

118

Another startling part of the court’s reasoning which cannot be followed up here because of limited space relates to the suitability of the share price as a parameter for performance. In the court’s view (BGH, 16.02.2004, II ZR 316/02, (2004) 59 BB 697; (2004) 48 AG 265; (2004) 25 ZIP 614; (2004) 58 WM 630) share prices can be influenced or even manipulated by legal or illegal means and therefore they do not necessarily reflect either the intrinsic value of the shares or the long-term success of the company. The reasons given for the draft of the KonTraG (Bundestags-Drucksache 13/9712, 23) are diametrically opposed, stating that ‘the share price reflects the amount of market expectations about the value of the company’. Moreover, the legislature confirms the suitability of the stock-exchange price parameter as a means for long-term supervision of managerial conduct. Cf Saenger (n 20); Bösl (n 104) 474, 477 ff. Uwe Hüffer, Aktiengesetz (5th edn CH Beck Verlag, Munich 2002) 548; Kübler (n 9) 191. It is important to note that not all types of contracts fall under these provisions, but only some as defined in ss 611, 631, 651 and 675 BGB—see Hüffer 548 para 3. S 114(1) AktG. Giving advice to the corporation forms part of all the supervisory board members’ statutory duties. A particular problem here evolves around the question whether the management board could still contract with the members of the supervisory board to give special advice or pay them for special consultations—see Marcus Lutter and Thomas Kremer, ‘Die Beratung der Gesellschaft durch Aufsichtsratsmitglieder’ (1992) 21 ZGR 87, 91 ff; Axel Beater, ‘Beratungvergütungen für Aufsichtsratsmitglieder’ (1993) 157 ZHR 420 ff. There were some proposals that these contracts should be approved by the general meeting and not by the supervisory board—see Baums (n 54) 27. S 114(2) AktG. Also Lutter and Kremer (n 116) 107–08; Kübler (n 9) 192; Beater (n 116) 421. Claussen (n 12) 484 (fn 43).


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4.5 Rights and Responsibilities of Supervisory Board Members 4.5.1 Appointment and Termination of Management Board Members The supervisory board’s right to appoint and to terminate the appointment of members of the management board forms one of the cornerstones of the two-tier system. These rights are hailed as one of the most effective ways of actively influencing policy decisions in public corporations119 and are also seen as some of the most important tasks fulfilled by the supervisory board.120 The power of appointing and removing the members of the management board is an exclusive power of the supervisory board and cannot be delegated.121 In practice the chair of the management board and the chair of the supervisory board will have a huge influence on the selection of management board members. The whole supervisory board will usually only be involved in the process of approving the appointment of the management board members proposed to them by the chairs of the management board and the supervisory board.122 Peltzer points out that this is the practice as it is hardly possible for a supervisory board consisting of up to 20 members to have an open discussion and to compare several management board nominations with each other.123 Whether a management board member is appointed from somebody working in the corporation (internally) or from external candidates, will also play a role in how the candidate is perceived and how the appointment is treated in the corporation.124 The GCGC confirms that the power of appointing and terminating the appointment of management board members are powers of the supervisory board and suggests that the supervisory board could use an appointment and remuneration committee to assist it with the task of appointing management board members and

119

120

121

122

123 124

Immenga (n 9) 251; Theodor Baums, ‘Corporate Governance in Germany: The Role of the Banks’ [1992] AJCL 514. Thomas Raiser, ‘Der neue Koalitionskompromiß zur Mitbestimmung’ (1976) 31 BB 145, 147; Dieter Reuter, ‘Der Einfluß der Mitbestimmung auf das Gesellschafts- und Arbeitsrecht’ [1979] AcP 525; Lutter and Krieger (n 9) 131 para 331. Ss 23(5) and 111(5) AktG. See also OLG Stuttgart,13. Mar 2002—20 U 59/01, (2003) 48 AG 212. Peltzer (‘Corporate Governance Codices als zusätzliche Pflichtenbestimmung für den Aufsichtsrat’) (n 34) 12. Ibid 12–13. Peltzer (‘Corporate Governance Codices als zusätzliche Pflichtenbestimmung für den Aufsichtsrat’) (n 34) 13. In larger organisations internal appointments would be the rule, while an external person should normally not be appointed at first for a period of longer than three years.

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determining their conditions of appointment.125 The practical significance of the supervisory board’s control over the appointment and removal of members of the management board becomes particularly apparent when it is realised how effectively the banks in Germany have employed these rights to establish their position of dominance in many public corporations in Germany.126 The influence of the supervisory board over the management board is further enhanced by the fact that it is the supervisory board that appoints the chair of the management board, not the management board members themselves.127 In public corporations where employee participation at supervisory board level is not required, the process of appointing management board members is reasonably straightforward. Each supervisory board member has the right to nominate management board members. The appointment is determined by a majority vote of the supervisory board. When more than one position at the management board is to be filled, each position should be voted on separately.128

4.5.2 Determination of the Remuneration of Management Board Members Closely linked with the appointment of the members of the management board is the remuneration of its members. Due to the ‘Mannesmann-case’ (see discussion in 5.3.3.1) which involved the grant of a thirty million Euro transaction bonus to the CEO of Mannesmann in the course of the tender offer by Vodafone plc, remuneration for management board members is one of the focal points of modern corporate governance discussion.129 In general, payments for the management board, authorised by the supervisory board, although the organ faces a decreasing enterprise value, causes amazement at best, but normally criticism of German monitoring institutions.130 125

126 127 128 129

130

Art 5.1.2 GCGC. See further Peltzer (‘Handlungsbedarf in Sachen Corporate Governance’) (n 34) 596. See Chapter 8. S 84(2) AktG. See further Immenga (n 9) 255–56. Lutter and Krieger (n 9) 137–38 para 343. Marita Körner, ‘Die Angemessenheit von Vorstandsbezügen in § 87 AktG’ (2004) 57 NJW 2697 ff; Marcus Lutter, ‘Corporate Governance und ihre aktuellen Probleme, vor allem: Vorstandsvergütung und ihre Schranken’ (2003) 24 ZIP 737 ff; Gregor Thüsing, ‘Auf der Suche nach dem iustum pretium der Vorstandstätigkeit—Überlegungen zur Angemessenheit im Sinne des § 87 Abs. 1 Satz 1 AktG’ (2003) 32 ZGR 457 ff; Michael Adams, ‘Aktienoptionspläne und Vorstandsvergütungen’ (2002) 23 ZIP 1325 ff. It has to be remarked that the debate on this topic is not only led by legal scholars, but also in public, mainly because the ‘Mannesmann-case’ is dealt with by criminal courts. Due to the intensive press coverage of the indictment the public became aware that criminal law governs managerial conduct, too. Consequently, the public also received the impression that ‘fat cats can be hung’. Roth and Wörle (n 20) 565, 569 ff.


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The supervisory board is responsible for determining the total sum of remuneration131 of the members of the management board. Originally, freedom of contract and the principle of private autonomy gave the supervisory board almost132 unfettered discretion in determining the aggregate remuneration of management board members. But according to Section 87(1) 1 of the AktG, in determining the remuneration, the supervisory board must ensure that the remuneration is reasonable and proportionate with regard to the functions of each of the members of the management board and also reasonable and proportionate with regard to the general (financial) position of the undertaking.133 These provisions are specifically aimed at protecting the corporation (as separate legal entity), the shareholders and the creditors against excessive remuneration of the members of the management board.134 In addition to that, limitations on payments for managers are supposed to create acceptance of the entire economic system and to prevent any destructive effects which excessive remuneration might have on investors’ confidence.135 In the case of an allocation of payments for managers which contradicts the principle of remuneration in proportion to performance, the motivation and cooperation of employees might be impaired.136 As far as the practical applicability of Section 87(1) of the AktG is concerned, the main problem is to define adequacy of the remuneration. It seems as if adequacy can only be judged by each individual case, in which both the management board member’s functions and the company’s financial condition must be considered. Although an iustum pretium for the activity of management board members is not yet defined,137 at least there are some acknowledged points of reference which help to assess the legal conformity of remuneration with both statutorily mentioned criteria. These are the management board member’s qualifications and

131

132

133

134

135 136 137

Specific items are listed, namely salary, profit-sharing, allowances (eg expense or entertainment), insurance, commissions and payment for extra services rendered. The use of the corporations’ aircraft, vehicle or living in a house provided by the corporation will also have to be calculated for purposes of the total sum of remuneration—Hüffer (n 115) 419. Thus, the statutory enumerated items are just examples. This is also the reason why share option plans which benefit management board members are governed by the decisive s 87 AktG. Beyond statutory provisions of corporate law, the only limits of manager remuneration are set up by s 134, 138 Civil Code (BGB). S 87(1) AktG corresponds with the provision applying to the remuneration of the members of the supervisory board—see s 113(1)3 AktG. Hüffer (n 115) 419–20; Körner (n 129) 2697, 2698. The small scope in which ss 134, 138 of the Civil Code (BGB) are applicable (as far as management board members remuneration is concerned) led in former time to high payments in lean times. Cf Körner (n 129) 2697, 2698. Cf Adams (n 129) 1325, 1332. Thüsing (n 129) 457 ff.

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market value, the negotiation situation at hand, duration of service for the company and the manager’s family circumstances.138 In general, excessive remuneration will not as such render the contract with the management board member void.139 However, the members of the supervisory board will be liable towards the corporation for a breach of their defined statutory duties towards the corporation if it is established that they have allotted excessive remuneration to the members of the management board.140 The GCGC now suggests that the supervisory board could use an appointment and remuneration committee to assist it with the task of appointing management board members and determining their conditions of appointment.141 The decisive point in time to apply Section 87 of the AktG is the moment when the payments are determined,142 but the supervisory board is also empowered to adjust (reduce) the remuneration of the members of the management board. The supervisory board may adjust the remuneration if circumstances in the corporation materially deteriorate,143 or where the remuneration originally allotted becomes grossly unfair towards the corporation.144 The supervisory board members will breach their duties towards the corporation if they do not make the necessary adjustments to the remuneration of the management board under these circumstances.145 All members of the management board should be affected equally by such an alteration.146 The original contracts with the members of the management board are not affected immediately. The members of the management board will be employed under the old agreements until the end of the next term (Kalendervierteljahr) and they are also allowed the opportunity to end their contract with a six 138 139

140 141 142 143

144

145 146

Cf BGH, 14.05.1990, II ZR 126/89, (1990) 43 NJW 2625 ff. Only if the provisions of violation of public policies according to s 138 Civil Code (BGB) are violated, the employment contract will be void. S 116, 93(2) AktG—see Hüffer (n 115) 421; Kübler (n 9) 184. Art 5.1.2 GCGC. Already the wording of s 87(1) AktG makes that clear. S 87(2) AktG. The position of the corporation as a whole will have to be considered. This section therefore cannot be employed to reduce the remuneration of the members of the management board if the supervisory board is not satisfied with their performance, since this will not be considered as the deterioration of the financial position of the corporation—see Hüffer (n 115) 421. See further Arnd Weisner, ‘Herausforderung für den Aufsichtsrat: Herabsetzung von Vorstandsbezügen in Zeiten der Krise’ (2003) 6 NZG 465 ff for a very interesting analysis of the practical difficulties for the supervisory board in determining whether the management board’s remunerations should be adjusted if circumstances in the corporation materially deteriorate. The meaning of ‘grossly unfair’ will have to be established according to the particular circumstances. Liquidation of a part of the undertaking will not suffice if there is still a good prospect of income from other sources—see Hüffer (n 115) 421. See further Weisner (n 143) 466–67. Weisner (n 143) 465. Hüffer (n 115) 421; Weisner (n 143) 467.


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weeks notice period.147 Members who do not make use of this six week period of notice for their resignation will automatically be bound by the new remuneration as determined by the supervisory board.148

4.5.3 Supervision 4.5.3.1 Necessity The supervisory board has a statutory duty to supervise or to oversee the management of the corporation (Überwachung der Geschäftsführung),149 and these functions cannot be delegated.150 It is important to note that this responsibility is a joint responsibility of the whole supervisory board and not one that can be exercised by individual members, or by the employee or shareholder representatives only.151 The supervisory board or the articles of incorporation may require that the management board must obtain the approval of the supervisory board for specific matters, but managing the business of the corporation cannot be delegated to the supervisory board or any committee of the supervisory board.152 The function of managing the business of the corporation belongs exclusively to the management board.153 The supervisory board is the organ responsible for supervising and overseeing the activities of the management board,154 with its otherwise almost unlim147 148 149

150 151

152 153 154

S 87(2) AktG. Hüffer (n 115) 421–22. S 111(1) AktG. Lutter and Krieger (n 9) 24 para 63 (fn 1) argue that the supervisory board’s supervisory functions should not be limited, as some commentators argue, to certain types of functions, since the intention of the legislature is supervision in the wide sense of the word. See further Manual R Theisen, ‘Zur Reforms des Aufsichtsrat—Eine betriebswirtschaftliche Bestandanalyse und Perspektive’ in Dietrich Dörner, Dieter Menold, Norbert Pfitzer and Peter Oser (eds), Reform des Aktienrechts, der Rechnungslegung und der Prüfung (2nd edn Schäffer-Poeschel Verlag, Stuttgart 2003) 433; Eberhard Scheffler, ‘Der Aufsichtsrat—nützlich oder überflüssig’ (1993) 22 ZGR 63, 65 ff; Reuter (n 120) 529–31. See generally Paul Davies, ‘Struktur der Unternehmensführung in Großbritannien und Deutschland: Konvergenz oder fortbestehende Divergenz?’ (2001) 30 ZGR 284. S 114(4) AktG. Thomas Raiser, ‘Klagebefugnisse einzelner Aufsichtsratsmitglieder’ (1989) 18 ZGR 52. This is so because the supervisory board is considered as a so-called collegial organ (Kollegialorgan), which can only act on the basis of collective responsibility—see Lutter and Krieger (n 9) 16 para 39. S 111(4)2 AktG. See 3.3.3.1 and 3.3.3.2. Johannes Semler, Leitung und Überwachung der Aktiengesellschaft (2nd edn Carl Heymanns Verlag, Cologne 1996) 60, 66 and 80. See also Ludger Wellkamp, Vorstand, Aufsichtsrat und Aktionär (2nd edn Verlag für Rechts und Wirtschaftsbücher, Bonn 2000) 23–24.

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ited powers to manage and direct the business of the corporation,155 but see again the discussion of the Holzmüller decision in Chapter 3.156 4.5.3.2 The Scope and Limits to Overseeing the Business of the Corporation There are differences of opinion whether overseeing deals primarily with overseeing the management board or controlling the functions of the management board. The fundamental question is this: If the supervisory board must oversee the management of the business of the corporation and the function of managing the business of the corporation is exclusively one of the management board157 how exactly is the supervisory board to oversee these functions without scrutinising the conduct of the management board? The two apparently opposing views are on the one hand that of UH Schneider, who is of the opinion that the supervisory board’s role is one of controlling the functions of the management board (Funktionskontrolle), and on the other hand the view of Semler, who is of the opinion that the supervisory board’s overseeing role under Section 111 of the AktG only deals with controlling the management board as an organ of the corporation (Organkontrolle).158 According to Semler, different institutions, groups of people and individuals can become the focus of overseeing or supervision by the supervisory board. In this regard the management board as organ would be an obvious focus point for the supervisory board, but also individual members of the management board or committees of the management board could be scrutinised by the supervisory board. Insofar as the general meeting could influence matters regarding managing the business of the corporation,159 it could theoretically become a responsibility of the supervisory board to oversee the general meeting,160 but only insofar as it deals 155

156 157 158

159 160

Wiethölter (n 2) 282, 286–87; Immenga (n 9) 250; Semler (n 154) 66. Also Lutter (n 7) 289, 290 ff; Hüffer (n 115) 531–32. See 3.3.3.3. See 3.3.3.1 and 3.3.3.2. Semler (n 154) 60. See also Hüffer (n 115) 531–32; Theodor Baums, ‘Der Aufsichtsrat—Aufgaben und Reformfragen’ (1995) 16 ZIP 16–17. It is not easy to translate the German word ‘Kontrolle’. On the one hand it could be translated as control in the strict sense of the word—see for instance Hanns P Kniepkamp, Rechtswörterbuch (Colloquim-Verlag, Berlin 1954) 161. On the other hand, it could also mean ‘checking, checkup, surveillance, supervision, inspection or screen’—see Alfred Romain, Wörterbuch der Rechts- und Wirtschaftssprache (CH Beck Verlag, Munich 1994) 472. The translation of ‘monitoring’ is, however, to be preferred—see Carsten Berrar, ‘Die zustimmungspflichtigen Geschäfte nach § 111 Abs. 4 AktG im Lichte der Corporate Governance-Diskussion’ (2001) 54 DB 2183 fn32. See 3.3.3.3. Semler (n 154) 60–61.


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with these matters—the supervisory board does not have a general responsibility to supervise or oversee the general meeting.161 The supervisory board’s overseeing or supervisory responsibilities do not extend to employees, as the supervisory board is primarily responsible for overseeing the management board, not groups of people like the employees appointed by the management board.162 It is submitted that the debate regarding exactly what the supervisory board should oversee should be seen as part of the wider, and perhaps more fundamental and controversial, debate regarding the distinction between overseeing the business of the corporation (Überwachung) and managing the business of the corporation (Geschäftsführung). Distinguishing between these two functions is causing considerable difficulties for the German corporations law.163 4.5.3.3 Approval of Supervisory Board Required for Certain Matters The supervisory board has several legal instruments available to control the management board or to sanction its activities.164 The right that they have to use these instruments implies a legal duty to use them in fulfilling their responsibilities (to oversee or supervise the business of the corporation) if so required.165 The possibility of sanctioning an activity of the management board occurs where the articles of incorporation prescribe or direct the approval of the supervisory board over certain matters166 or where the supervisory board requests that a particular matter must be approved by the supervisory board.167 Kübler points out that these matters should not be of such a broad nature that the supervisory board is practically participating in managing the business of the corporation168—that is and remains the responsibility of the management board.169 However, such provisions in the articles of incorporation or such requests provide additional instruments for the supervisory

161 162 163 164 165 166

167

168

169

Ibid 73–75. Ibid 69. Berrar (n 158) 2182. Berger (n 32) 7. Semler (n 154) 55. With regard to the limits of the matters which might be prescribed by the articles of incorporation, see Hans-Joachim Mertens, ‘Zuständigkeiten des mitbestimmenten Aufsichtsrats’ (1977) 6 ZGR 283–88. See generally Hopt (n 10) 6. S 111(4)2 AktG. See Heinrich Götz, ‘Zustimmungsvorbehalte des Aufsichtsrates der Aktiengesellschaft’ (1990) 19 ZGR 633; Lutter (n 7) 294; Günter Langenbucher and Ulf Blaum, ‘Audit Committees—Ein Weg zur Überwindung der Überwachungskrise?’ (1994) 47 DB 2198; Kübler (n 9) 409–10. See also Immenga (n 9) 265; Mertens (n 166) 280–82; Davies (n 149) 284. Kübler (n 9) 186. Also Götz (n 47) 602; Peltzer (‘Corporate Governance Codices als zusätzliche Pflichtenbestimmung für den Aufsichtsrat’) (n 34) 15. See 3.3.3.1 and 3.3.3.2.

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board in fulfilling its function of supervising and overseeing the activities of the management board.170 It is interesting to note that, unlike Statutory provisiors in Austria and the Netherlands,171 the German legislature does not define the specific instances where the management board must obtain the approval of the supervisory board. The possibility that the legislature should limit these instances to specific matters has been suggested by some German commentators172 and was also considered by the German Corporate Governance Commission,173 but these proposals were not accepted. Two reasons were given. Firstly, it was considered to be impossible to formulate the specific matters exactly. Secondly, it was considered that such a statutory list would lead to great uncertainty as it would make all the provisions in current articles of incorporation (Satzungen), not falling within these categories, null and void.174 These arguments were rejected by some commentators as unconvincing,175 but it was considered to be appropriate to allow corporations flexibility to determine the nature and scope of these matters through self-developed Codes of Best Practice.176 The GCGC suggests that the matters that will require the approval of the supervisory board include decisions or measures which fundamentally change the asset, financial or earnings situations of the enterprise.177 The problem currently is that there are huge difficulties in determining the exact scope and nature of the matters which the supervisory board could specify as matters where the management board must first get supervisory board approval before it could act.178 Withholding its approval for these matters is only possible if there is unanimous agreement in the supervisory board.179 Even a large majority in favour of such sanction will not suffice, thus making this form of control possible only under extreme circumstances.180 When such a matter is referred to the supervisory board for its approval and the supervisory board disapproves by unanimous agreement, a 170

171 172 173 174 175 176 177

178

179 180

Peltzer (‘Corporate Governance Codices als zusätzliche Pflichtenbestimmung für den Aufsichtsrat’) (n 34) 15. See further Götz (n 47) 602. See Baums Report (n 27) 76 para 34; Berrar (ng) 2/83. Immenga (n 9) 265 (fn 55), 265–66. Baums Report (n 27) 76 para 34; Berrar (n 158) 2183. Ibid 2183–2184. Ibid 2184. Ibid 2184. Art 3.3 GCGC. See further Axel von Werder, ‘Der Deutsche Corporate Governance Kodex—Grundlagen und Einzelbestimmungen’ (2002) 55 DB 805. In particular Götz (n 167) 633; Tobias Lenz, ‘Zustimmungsvorbehalte im Konzern’ (1997) 42 AG 448; Bruno Kropff, ‘Die Unternehmensplanung im Aufsichtsrat’ (1998) 1 NZG 613; Heinrich Götz, ‘Leitungssorgfalt und Leitungskontrolle der Aktiengesellschaft hinsichlich abhängiger Unternehmen’ (1998) 27 ZGR 534; Berrar (n 158) 2181. Raiser (n 151) 69. Berger (n 32) 7.


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final option is available to the management board, namely that it can insist that the matter be referred to the general meeting. In this case the general meeting can, with a three-quarters majority,181 overrule the supervisory board’s decision on the particular matter182 and the management board will then be bound by the outcome of the determination by the general meeting.183 The decision to refer a matter (which has been disapproved by the supervisory board) to the general meeting, is directly influenced by two specific attributes of the German corporations law, namely that the supervisory board’s control over the management board is accomplished through various channels184 and that the banks play a decisive role under German corporations law.185 In practical terms it means that the management board will be particularly hesitant to refer a matter which has been disapproved by the supervisory board to the general meeting, since this may not only jeopardise their relation vis-à-vis the supervisory board in general, but also put themselves at risk their reappointment by the supervisory board.186 It will, furthermore, require special circumstances to obtain the three-quarters majority required to overrule the decision of the supervisory board. The majority required is not only high, but the banks (commonly controlling the majority vote at the general meeting) will also be hesitant to vote against the decision of the supervisory board as this can indirectly jeopardise the relationship between the bank representatives and the employee representatives on the supervisory board.187 4.5.3.4 Complaints by Individual Members of the Supervisory Board The scope and extent of complaints by individual members of the supervisory board, for example the employee representatives, became quite prominent in 1988 when the employee representatives of the Adam Opel AG lodged complaints against the management board and the corporation.188 This complaint followed when the employee representatives were unsuccessful in obtaining enough votes to make a complaint (10:9) and tried to enforce their right of complaint by way of a court order.189 This sparked considerable debate regarding the relationship between the supervisory board and the management board, and in particular to what 181

182 183 184 185 186 187 188 189

In terms of s 111(4)5 AktG, the article of association may neither describe a different majority, nor provide for a different way of dealing with these matters. S 111(4)3 AktG. See Kübler (n 9) 186. S 8(2) AktG. Kübler (n 9) 186. See 4.5. See Chapter 8. See 4.5.1. As will be seen later, the shareholders’ representatives are normally bank representatives. Raiser (n 151) 44–46. Ibid 45.

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extent the powers of the supervisory board could be misused or to what extent these powers should be limited.190 The outcome of the cases was clear, namely that individual members of the supervisory board have no direct right to enforce disagreements with decisions of the management board.191 They will have to address their concerns to the supervisory board and only the supervisory board as a whole can act.192 The underlying principle applied here was the principle that an organ like the supervisory board can only act collectively and when decisions are taken by the board as a whole, not the individual members. Thus, the supervisory board is considered to be a so-called collegial organ (Kollegialorgan).193 Without strict adherence to this principle,194 the German two-tier board system will become unworkable as the German supervisory and management boards often consist of representatives coming from widely different backgrounds and representing divergent interests, namely those of the shareholders (banks) and those of the employees respectively.195 There are, however, several possibilities for individual members of all of the corporation’s organs (general meeting, management board and supervisory board) to lodge complaints against the conduct of these organs.196 4.5.3.5 Normal Scope As already mentioned in Chapter 3, demarcating the respective functions of the supervisory board and the management board is one of the most fundamental aspects of the German two-tier board system,197 but possibly also the most challenging and most difficult aspects to understand about the German two-tier board system and how it works in practice. For these reasons, there was a specific effort made in the GCGC to explain not only the cooperation between the management board and the supervisory board, but also the respective roles of the two boards.198 190

191

192 193 194

195

196 197 198

Ibid 47. Raiser (n 151) 48–51 analysed all academic views on this issue in detail and observed that they were by and large superfluous and unclear. Martina Deckert, ‘Klagemöglichkeiten einzelner Aufsichtsratmitglieder’ (1994) 39 AG 475 (fn 5). Raiser (n 151) 52, 70. Lutter and Krieger (n 9) 16 para 39. There seems to be just one exception to this, namely where the supervisory board has commissioned an individual member of the supervisory board to verify the financial statements on its behalf—see Lutter and Krieger (n 9) 16 para 16. The principle also applies to the management board as organ—see Michael Hoffmann-Becking, ‘Vorstandsvorsitzender oder CEO?’ (2003) 6 NZG 746–47. For example, the ‘Arbeitsdirektor’ (personnel director) sitting on management boards or the employee representatives sitting on supervisory boards. Deckert (n 191) 457 ff, but see in particular the summary on 465. See also Hopt (n 52) 43. Von Werder (n 177) 805. Pts 1–3 GCGC.


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Determining the exact boundaries of the supervisory board’s overseeing and supervisory responsibilities is not an easy task.199 It is perhaps best to explain these boundaries under two separate headings, namely what could generally be called the normal scope of the supervisory board’s responsibility to oversee or supervise the business of the corporation (discussed in this section) and the extended scope of their overseeing or supervisory responsibilities (discussed in 4.5.3.6).200 The scope of the duty to supervise or to oversee the management of the corporation has gradually been defined by commentators.201 It, inter alia, means that the supervisory board is responsible to:202 (a) compare the financial statements over a period of time; (b) act pro-actively by scrutinising the way in which the management board directs the business of the corporation; (c) allow for consultation with regard to the management board’s policy decisions; (d) ensure that the management board acts lawfully, orderly, according to acceptable business practices203 and appropriately as far as the business of the corporation is concerned; (e) scrutinise the information which it obtains from the management board; and (f) act promptly whenever they think that the management board does not act appropriately. However, this is not seen as an exclusive list of responsibilities, thus making the responsibilities of supervisory board members particularly demanding.204 Occupying 199 200

201

202

203

204

Semler (n 154) 61–66. Also Davies (n 149) 286–87. Semler (n 154) 131–32 distinguishes between three different forms of overseeing, namely complementary overseeing (begleitende Überwachung); supportive overseeing (unterstützende Überwachung), and moulding or shaping overseeing (gestaltende Überwachung). Lutter and Krieger (n 9) 27 para 71 ff; Hüffer (n 115) 532; Mertens (n 166) 278–82. Some commentators argue that the duties of the members of the supervisory board are too vague, and suggest that the legislature should give specific guidelines for supervisory board members—Thomas Raiser, ‘Weisungen an Aufsichtsratmitglieder?’ (1978) 7 ZGR 404; Raiser (n 120) 149–51. Lutter and Krieger (n 9) 27 para 71 ff; Hüffer (n 115) 532; Mertens (n 166) 278–82. The functions of the supervisory board can also be classified under broad categories— see Lutter (n 7) 289–90. In this respect the supervisory organ should specifically look at the corporation’s liquidity, its financing, and its returns in comparison with other competitors in the market— Lutter and Krieger (n 9) 32 para 83. Cf Lutter (n 7) 291–93.

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this office is no longer seen as simply a position of honour or prestige, but as a time-consuming position with huge responsibilities.205 The estimate is that in large corporations the supervisory board will in future meet between 24 and 32 days per year under normal circumstances.206 In the past the average number of meetings varied between two and five meetings per year that lasted between two and four hours.207 Semler points out that the overseeing responsibilities of the supervisory board should be exercised cautiously during the normal course of business and when the management board fulfils its duties diligently. When the business runs smoothly the supervisory board should not interfere unnecessarily or make unreasonable requests of the management board. This is called complementary overseeing (begleitende Überwachung).208 The way in which the supervisory board oversees the business of the corporation will change if, for instance, the management board does not fulfil its duties fully and diligently or the corporation is experiencing financial difficulties. 4.5.3.6 Extended Scope When the management board does not fulfil its duties fully and diligently, and the financial state of the corporation is likely to deteriorate, then more is required from the supervisory board. Under these circumstances the equality of the two organs is disturbed and the supervisory board then has a duty to play a more supportive role—supportive overseeing (unterstützende Überwachung). The supervisory board still cannot interfere with the management board’s responsibility to manage the business of the corporation, but must intensify its supervisory and overseeing activities. Even under these circumstances the supervisory board must be careful not to be excessive in requiring the management board to obtain the supervisory board’s permission, under Section 111(4)2 of the AktG, before they can proceed with certain matters.209 When a corporation goes through a period of crisis, the intensity of the supervisory board’s control functions becomes much higher, not only in controlling the activities of the management board, but also in the regularity of control.210 Semler refers to this as moulding or shaping overseeing (gestaltende Überwachung).211 It means that under these circumstances the management board will be much more likely to rely on the supervision of the supervisory board. During these difficult 205 206 207 208 209 210 211

Berger (n 32) 6–7, 10. Ibid 7. Theisen (n 149) 435. Also Berger (n 32) 7. Semler (n 154) 131. Ibid 131–32. Lutter and Krieger (n 9) 34–35 paras 87–91. See also Berger (n 32) 6. Semler (n 154) 132.


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periods, the supervisory board is more likely to change the allocation of the management board members’ duties; to appoint new members to the management board; or to remove some (or all) of the members of the management board.212 During times of crisis the members of the supervisory boards of large corporations will meet between 51 and 57 days per year. 213 However, even under these circumstances, the supervisory board may not usurp the management function of the management board:214 it is responsible for supervising or overseeing the way in which the management board manages and directs the business of the corporation; not for managing and directing the business of the corporation itself.215 From this it should be clear that the supervisory board fulfils its functions parallel to the management board even if the corporation experiences financial difficulties.216 It is also not possible for the general meeting to interfere with the managerial prerogative of the management board.217 Commentators warn that there should always be checks and balances to ensure that the supervisory board does not become the ultimate managing organ of the business of the corporation (Obergeschäftsführungsorgan).218 This is an important characteristic of the German two-tier board system and pivotal to maintaining a fine balance between the management board’s function of managing and directing the business of the corporation and the supervisory board’s function of supervising or overseeing the way in which the management board manages and directs the business of the corporation. 4.5.3.7 Statutory Provisions Complementing Supervisory Functions The German corporations law provides various mechanisms to assist the supervisory board in its duty to supervise or oversee the management of the corporation.219 These devices are primarily aimed at ensuring the free flow of information between the management board and the supervisory board. For example, the supervisory 212

213 214 215

216 217

218 219

Lutter and Krieger (n 9) 35 para 90. Lutter and Krieger explain that during a period of crisis, s 84(3) AktG (removal of the members of the management board for good cause) may be employed to remove members of the management board on the ground that they lack the competence to execute management functions in an orderly fashion. Berger (n 32) 7. Lutter and Krieger (n 9) 35 para 89; Lutter and Kremer (n 116) 89. Semler (n 154) 36, 60; Dietrich Hoffmann, Der Aufsichtsrat (3rd edn CH Beck Verlag, Munich 1994) 49 para 235: Lutter and Krieger (n 9) 42–43; Immenga (n 9) 264–65; Ulrich Eisenhardt, ‘Zum Problem der Haftung der Aufsichtsratsmitglieder von Aktiengesellschaft und GmbH der Gesellschaft’ [1982] Jura 291 ff; Hüffer (n 115) 364, 377, 532; Mertens (n 166) 279–80; Reuter (n 120) 527–28. Lutter (n 7) 291. Also Raiser (n 151) 53. S 119(2) AktG. See Hüffer (n 115) 365. See, however, again the Holzmüller decision discussed in 3.3.3.3. Berger (n 32) 10. Lutter and Kremer (n 116) 89. Also Immenga (n 9) 251; Scheffler (n 149) 66–67.

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board has the right to be informed fully and correctly220 by the management board about all business matters.221 In order to ensure that the supervisory board obtains the right information, the management board must report to it periodically on specific matters prescribed by the AktG.222 The matters they must report on are listed as follows: • the intended policy of the corporation and fundamental questions regarding the planning of the undertaking, in particular regarding finance, investments and staff development;223 • the profitability of the corporation and in particular the return on its own capital; • the performance of businesses and in particular their turnover and the financial state of the corporation; • transactions that are of vital importance for the corporation’s profitability and liquidity. The GCGC summarises these aspects as ‘all issues important to the enterprise with regard to planning, business development, risk situation and risk management’.224 All these specific matters on which the management board must report to the supervisory board also have specific provisions prescribing specific periods of time within which the reporting must take place.225 Furthermore, the supervisory board, or even an individual member of the supervisory board,226 may at any time ask for information on a particular aspect.227 The supervisory board also has the right to convene a general meeting at any time whenever the interest of the corporation so requires.228 The information obtained by the supervisory board cannot be distrib220 221 222

223

224 225

226

227 228

S 90(4) AktG. Großfeld and Lehmann (n 91) 43. S 90(1) AktG. See further Götz (n 47) 600–01; Peltzer (‘Corporate Governance Codices als zusätzliche Pflichtenbestimmung für den Aufsichtsrat’) (n 34) 14; Semler (n 154) 82 ff; Hüffer (n 115) 532; Harald Kallmeyer, ‘Pflichten des Vorstands der Aktiengesellschaft zur Unternehmensplanung’ (1993) 22 ZGR 104, 112–13. The fact that the management board must report to the supervisory board on finance, investments and staff development, was only added to the AktG in 1998 as part of the changes effected by the KonTraG. See generally Berrar (n 158) 2182; Kropff (n 178) 613 ff. Art 3.4 GCGC. S 90(2) AktG. Lutter has for many years suggested that every corporation should have a formal system in place to regulate the flow of information between the management board and the supervisory board—see Lutter (n 7) 295. S 5(b) of the Gesetz zur weiteren Reform des Aktien- und Bilanzrecht, zu Transparenz und Publizität (Transparenz- und Publizitätsgesetz)—Bundesgesetzblatt Teil I (BGBl I 2002, 2681 ff). See further Götz (n 47) 601. S 90(3) AktG. See also Lutter (n 7) 294; Baums (n 119) 510. S 111(3) AktG.


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uted amongst certain members of the supervisory board only (e.g. amongst the shareholder representatives only), since it is specifically provided that all its members have an equal right to information.229 Concerning the report on the profitability of the undertaking,230 the chairperson of the supervisory board has a statutory duty to inform the whole supervisory board about it not later than at the first meeting of the supervisory board after he or she received the information.231 All these measures make the flow of information between the management board and the supervisory board inevitable and also ensure that the information is accurate. When these measures are viewed in their entirety, it is clear that the devices employed earlier in Germany to isolate the labour representatives and to bypass serious decisions through committees or informal private gathering of insiders,232 is hardly possible anymore. The flow of information entitles all members of the supervisory board to fulfil their function to oversee or supervise the business of the corporation, but it does not entitle them to interfere with the management board’s power to manage and direct the business of the corporation.233 It should, however, be pointed out that there are some commentators who are still sceptical whether all these measures to ensure a free flow of reliable information to the supervisory board ensure that it happens in practice.234 Proposals of monthly reports to the supervisory board by the management board; confidential electronic access (Intranet-links) by the supervisory board to vital developments in the corporation; and e-mail messages to supervisory board members to inform them of relevant new information are suggested as possibilities to improve the flow of reliable and relevant information to supervisory board members.235 4.5.3.8 Central Position of Chairperson The position of chairperson of the supervisory board forms an important part of the supervisory board’s supervisory functions, since that person is expected to be in constant and close contact with the management board236 and that function has now been confirmed in the GCGC.237 This person’s influence is intensified, since he or she is responsible for preparing the minutes of the supervisory board meetings

229 230 231 232

233 234

235 236 237

S 90(5) AktG. S 90(1)2 AktG. S 90(5) AktG. See Wolfgang Spieker, ‘Möglichkeiten und Grenzen der Mitbestimmung im Aufsichtsrat’ 1962(4) Das Mitbestimmungsgespräch 54; Detlev F Vagts, ‘Reforming the “Modern” Corporation: Perspectives from the German’ (1966) 80 Harvard L Rev 66. See again 3.3.3.1. Kersten von Schenck, ‘Die laufende Information des Aufsichtsrats einer Aktiengesellschaft durch den Vorstand’ (2002) 5 NZG 65–67. Ibid 67. Baums (n 119) 510. Art 5.2 GCGC.

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and also has a casting vote in certain instances.238 Through this position there is a continuous interrelationship between the supervisory board and the management board, notwithstanding the fact that the supervisory board may only sit three or four times a year.239 4.5.3.9 Annual Financial Statements The annual financial statements and the directors’ report must be presented to the supervisory board immediately after they have been audited. The supervisory board must then audit these accounts and report in writing to the general meeting.240 The supervisory board must also examine the corporation’s financial statements and has a duty to report on the documents to the general meeting.241 4.5.3.10 Supervisory Board as Institutional Advisor and Consulting Partner It forms part of the supervisory board’s duties to provide the management board with advice (Beratung).242 It is, however, important to note that in practice this duty is not seen as one which is forced upon the management board. Quite to the contrary, vital business issues are often referred to the supervisory board by the management board, even under circumstances where the management board, having exclusive management powers,243 is under no duty to consult with the supervisory board or to obtain its approval.244 The fact that there should be open discus238

239 240 241 242

243 244

Kübler (n 9) 412. The chairperson was only given his casting vote in 1976, after considerable political deliberation on the issue [Kübler (n 9) 407]. The casting vote of the chairperson (elected by the general meeting) has tilted the power balance on the supervisory board slightly towards the shareholder [Kübler (n 9) 412], evoking considerable opposition from some corporations and also from labour organisations. The matter was referred to the constitutional court (Bundesverfassungsgericht, BverfG, 50, 290). The court found the amendment not to be unconstitutional [see Kübler (n 9) 407]. See also Raiser (n 120) 145. Baums (n 119) 510. See, however, Bernhardt (n 9) 311–12. S 191 AktG. S 170 AktG. See further Großfeld and Lehmann (n 91) 43. Lutter and Krieger (n 9) 36 para 94 ff; Lutter (n 7) 290 ff; Berger (n 32) 4. The exact scope of this duty is not very clear—see Beater (n 116) 424–25. For an extensive list of relevant material on this topic, see Lutter and Kremer (n 116) 88 (fn 1). The duty to give advice is also, sometimes, called the duty of prior or preventative supervision (vorausschauender oder vorbeugender Überwachung)—see Lutter and Kremer (n 116) 89. See 3.3.3.1 and 3.3.3.2. In other words, the management board will refer some matters to the supervisory board even where they are not, in terms of s 111(4) AktG, compelled to get the approval of the supervisory board. There is also no general prohibition on the management board having consultative meetings with sub-committees, for instance an executive committee, consisting of persons other than management board members—see Jürgen Götz, ‘Corporate Governance multinationaler Konzerne und deutsches Unternehmensrecht’ (2003) 32 ZGR 11–13.


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sions between the management board and the supervisory board and amongst the members of the various boards inter se is endorsed in the GCGC.245 The duty of providing the management board with advice became particularly prominent after Section 91 of the AktG was amended in 1998 by way of the KonTraG to include a duty for the management board to develop and have in place risk management policies.246 This particular duty of the management board automatically implies that the supervisory board has a duty to oversee the management board’s risk management policies.247 It led to considerable discussion as to the extent to which this apparently, but also necessarily, would get supervisory boards involved in aspects of managing the business of the corporation. It also led to lively discussion in Germany regarding the potential for friction between management boards and supervisory boards because of the difficulty of delineating their respective duties248 and the potential liability of the supervisory board if it does not oversee the management board’s risk management policy properly.249 Berrar observes that there is a blending of overseeing and advisory functions of supervisory boards.250 This development makes it even more difficult to distinguish between the function of providing the management board with advice (Beratung) and managing the business of the corporation (Geschäftsführung). In practice, it will often be seen as stubbornness for the management board not to consult with the supervisory board on these vital business issues because, in the first instance, this might put the members of the management board at risk as far as the renewal of their contracts of service are concerned.251 Secondly, and this will perhaps carry particular weight in practice, the supervisory board provides an excellent discussion forum for vital business issues. There are quite a few reasons why this is so: these boards consist not only of employees, but also of people with considerable business experience. 252 This forum does, therefore, allow the management board the opportunity of testing their decisions against the combined wisdom of people occupying different positions (including employee representatives); having different socio-economic backgrounds; and having experience and 245 246

247

248 249 250 251 252

Art 3.5 GCGC. See generally Theisen (n 149) 440–41; Bruno Kropff, ‘Zur Information des Aufsichtsrat über das interne Überwachungssystem’ (2003) 6 NZG 346 ff; Götz (n 244) 2–3. Kropff (n 246) 346; Anne-Kathrin Pahlke, ‘Risikomanagement nach KonTraG— Überwachungspflichten und Haftungsrisiken für den Aufsichtsrat’ (2002) 55 NJW 1680–85. Berrar (n 158) 2182 fn 20. Pahlke (n 247) 1685–87. Berrar (n 158) 2181. See discussion in 4.5.1. Supervisory board members elected by the shareholders are normally elected from the broad business community and may serve on the supervisory boards of up to nine different corporations. They are often elected by the banks, who have considerable experience in appointing competent people to supervisory boards.

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knowledge not only of its own undertaking,253 but also of undertakings involved in other fields. Indirectly the process through which the management board consults the supervisory board on a voluntary basis serves as a further form of control over business policy matters by a group of knowledgeable people,254 including experienced representatives from the banks,255 and also enhances the supervisory functions of the supervisory board.256 It is, therefore, common that in practice the members of the management board will be present at supervisory board meetings if matters not directly concerning them are discussed at a supervisory board meeting.257 All this means that the supervisory board’s functions are not only supervisory in the strict sense of the word, but that the board also serves as advisory or monitoring council.258 It is the institutional advisor and consulting partner (Gesprächspartner) of the management board.259 It also means that, notwithstanding the fact that the supervisory board is prohibited by statutory provisions from managing and directing the business of the corporation, there is a considerable potential for it to influence vital corporate decisions.260 Some commentators would summarise the functions of the supervisory board as a combination of overseeing, providing advice, decision making, cooperation and occasionally coordinating matters.261 As far as these aspects are concerned, the supervisory board does participate in entrepreneurial activities of the corporation, but not in managing the business of the corporation. 262

4.5.4 Reporting to the General Meeting The supervisory board has a specific statutory duty to report on an annual basis to the general meeting.263 This Annual Report of all supervisory boards (irrespective of the size of the corporation, industry or whether the corporation is listed or not) must be in writing and must deal at least with the following matters:264

253

254

255

256 257 258

259 260 261 262 263 264

It is often the case that managers or executive directors do not have wide experience outside their own companies. Bernhard Großfeld and Werner Ebke‚ ‘Controlling the Modern Corporation: A Comparative View of Corporate Power in the United States and Europe’ [1978] AJCL 397. Röller (n 9) 335–36; Martin Peltzer, ‘Empfehlen sich gesetzliche Regeln zur Einschränkung des Einflusses der Kreditinstitute auf Aktiengesellschaften?’ (1996) 51 JZ 850. Lutter and Krieger (n 9) 36 para 94. Hirt 2003 (n 37) 253. Mark J Roe, ‘Some Differences in Corporate Structure in Germany, Japan, and the United States’ [1993] Yale L J 1942. Lutter and Krieger (n 9) 36–37 para 94. Immenga (n 9) 250–51. Berger (n 32) 4. Ibid. S 171(2) AktG. Lutter and Krieger (n 9) 14–15 para 33.


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• its views regarding the financial statements of the corporation; • the nature and scope of how it fulfilled its task of supervising and overseeing the management board; • at the end of its Annual Report the supervisory board must also state that it has no objections against the financial statements presented by the management board and that it approves of them; • in the case of listed companies, the supervisory board is also under a statutory duty to report on the following matters: 265 – the number of meetings it held; – the existing or newly formed sub-committees; – the number of sub-committees and how often they met. For listed companies the GCGC also expects additional information in its Annual Report, namely a report on the corporation’s corporate governance practices266 and a note if a member of the supervisory board took part in less than half of the meetings of the supervisory board in a financial year.267 The company could, of course, choose to ‘explain’268 why they do not want to report on these matters, but it is highly unlikely that a company will choose to do so.

4.5.5 Instituting Action Against Members of the Management Board for a Breach of Their Duties Although this function of the supervisory board could possibly also be seen as part of its supervisory role, it seems to be such a drastic step that it deserves separate attention. The supervisory board is obliged to institute action against members of the management board who are in breach of their duties and cause the corporation damages.269 In deciding to proceed with such an action, the supervisory board must analyse the possible action carefully, taking into consideration aspects like procedural risks and whether there is a real possibility of claiming back the damages suffered by the corporation.270 In fact the supervisory board will only be excused for not proceeding with such actions if there are compelling reasons, based on the best interest of the corporation.271 That may include factors like the public’s opinion of the corporation, the negative effect such ac265 266 267 268 269

270 271

S 171(2)II AktG. See also Lutter and Krieger (n 9) 15 para 34. Art 3.10 GCGC. Art 5.4.6 GCGC. See discussion in 2.5 and 2.6.1. Lutter and Krieger (n 9) 170–71 para 421, 171 para 423; Schiessl (n 32) 602. See OLG Stuttgart, 13 Mar 2002—20 U 59/01, (2003) 48 AG 213 where it was ordered that a management board member whose appointment was terminated because he wrote out unauthorised cheques should pay these amounts (104 400 DM) back to the company. Lutter and Krieger (n 9) 171 para 422. Lutter and Krieger (n 9) 171 para 323; Schiessl (n 32) 602.

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tions could have on the productivity of members of the management board and general labour relations in the corporation.272 In practice, however, the complaints lodged by supervisory boards against management board members occur only infrequently.273 There are also huge procedural hurdles standing in the way of bringing these actions and proving them.274 Members of supervisory boards who must consider action against management board members may also sympathise with the wrongdoers as they would often be members of supervisory boards and management boards in several companies. Hans-Christoph Hirt puts it like this: Given that the business leaders who sit on the management and supervisory boards of listed companies are aware of the circumstances in which decision making in such companies takes place, they may have sympathy for members of administrative organs who take wrong decisions or make misjudgments. In other words, as a result of personal links, interlocking board memberships and the concentration of supervisory board positions, all of which create interdependencies, there may be a tacit agreement amongst the class of persons staffing the boardrooms in Germany (an ‘old boys club’ or ‘network’) that sympathetic supervision (‘mutual back-scratching’) is in everyone’s best interest. This is a significant problem with the German two-tier board system. The foregoing discussion suggests that one reason why members of the supervisory board are generally disposed against litigating executive directors is that many of them are executive directors of other companies and could therefore be in the wrongdoers’ shoes at any point in the future. It is not difficult to see that this may influence a non-executive director’s decision in respect of litigation against a wrongdoer. In fact, it seems likely that his or her decision will be based on how he or she would like to be treated, if in the wrongdoer’s place. 275 There are also situations where the same facts that will constitute a breach of the duties of the management board may also implicate a breach of duties of the supervisory board. Under these circumstances it is hardly likely that the supervisory board will initiate these actions as it could at the same time expose them to liability.276 These aspects are clear disincentives for instituting such actions.277 Thus, 272 273

274 275 276

Lutter and Krieger (n 9) 171–72 para 423. For an example where a management board member’s appointment was terminated for good cause and the court ordered him to pay compensation to the corporation because of the damages suffered from such a breach, see OLG Stuttgart, 13 Mar 2002—20 U 59/01, (2003) 48 AG 211. Götz (n 52) 38–39. Hirt 2003 (n 37) 253–54. Andreas Cahn, ‘Ansprüche und Klagemöglichkeiten der Aktionäre wegen Pflichtverletzungen der Verwaltung beim genehmigten Kapital’ (2000) 164 ZHR 119.


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Martin can observe that there is a considerably lower risk for management board members in German corporations to be held liable in comparison with board members in American corporations.278

4.6 General Duties and Forms of Liability The German legislature has, simply by referring back to the statutory duties of the members of the management board, equated the duties of the supervisory board members and those of the management board members.279 It means, in short, that the supervisory board members’ conduct must meet the standards of ‘decent and conscientious business leaders’.280 They also have a general duty of confidentiality as far as all business matters are concerned. It is not prohibited for ‘the leading personnel’ (managers and executive employees) to serve on the supervisory boards of their own companies. Commentators do, however, point out that it could, because of the particular knowledge that such a person has regarding the business of the corporation, put such a person in very difficult situations of conflict of interest and conflict of loyalty.281 This is obviously also the case where the same person serves on the supervisory board of a corporation and is also paid by the corporation for services rendered (consultants) to the corporation. In these cases there is real potential for a conflict between the duties owed to the corporation as a member of the supervisory board and the person’s personal interests as employee or provider of other services (consultants) to the corporation.282 According to the historical development of these duties, it seems that the members of the supervisory board are not only obliged to take into consideration the interests of the shareholders, but also the interests of the employees and other (general) interests.283 It is not necessary to prove causation or fault in holding a supervisory board member liable for a breach of his or her duties. 284

277

278

279 280

281 282 283

284

Michael Adams, ‘Die Usurpation von Aktionärsbefugnissen mittels Ringverflechtung in der “Deutschland AG”‘ (1994) 39 AG 155; Lutter (n 7) 305; Baums (n 54) 27; Lutter (n 54) 55. See further Hirt 2003 (n 37) 252, 253. Christopher Martin, ‘Das U.S. Corporate Governance System—Verlust der Vorbildfunktion’ (2003) 6 NZG 951. Ss 116 and 93(1) AktG. The legislature did not define this phrase any more precisely—see in particular Raiser (n 201) 391 ff. See further Adams (n 277) 155. Röller (n 9) 335. Heussen (n 35) 709. Kübler (n 9) 413. Kübler (n 9) 163 ff refers to the interests of creditors, investors, and other general interests. See also Ulrich Eisenhardt, Gesellschaftsrecht (6th edn CH Beck Verlag, Munich 1994) 294; Semler and Arndt (n 31) 4 fn 36. Claussen (n 12) 485.

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It is also clear that the statutory duty of supervisory board members to report on corporate governance practices under the GCGC in terms of Section 161 of the AktG285 can potentially lead to liability for a breach of their duties towards the company. This is the case because it is conceivable that the company could suffer damages in several ways if the members of the supervisory board do not comply with the provisions of the Code or if they report inaccurately about the corporate governance practices followed in the corporation.286 Commentators point out that supervisory board members could be liable towards the company or towards third parties if the Section 161 required reporting is not done or if it is done inaccurately.287 The exact scope of the liability for misleading or incorrect ‘comply or explain’ statements is, however, quite controversial and not yet been settled.288 It should also be pointed out that the precise scope of the supervisory board members’ duties is not certain.289 These uncertainties became particularly apparent when it was required of the BGH to distinguish between the duties of the employee representatives and other representatives of the supervisory board.290 In that particular case the court held that ‘the interest of the enterprise’ should serve as a guideline against which the supervisory board members should evaluate their

285 286

287

288 289 290

For example Art 3.10 GCGC. Lutter (n 97) 526 ff and 543. Also Peter Hommelhoff and Martin Schwab, ‘Regelungsquellen und Regelungsebenen der Corporate Governance: Gesetz, Satzung, Codices, unternehmensinterne Grundsätze’ in Peter Hommelhoff, Klaus J Hopt and Axel von Werder (eds), Handbuch Corporate Governance: Leitung und Überwachung börsennotierter Unternehmen in der Rechts- und Wirtschaftspraxis (Otto Schmidt Verlag, Cologne 2003) 51, 69, 70–72. Jochen Ettinger and Elke Grützediek, ‘Haftungsrisiken im Zusammenhang mit der Abgabe der Corporate Governance Entsprechenserklärung gemäß § 161 AktG’ (2003) 48 AG 353–57, 357–60. The liability towards the company is not simply because of non-reporting or inaccurate reporting, but will be based on a breach of the duties of care and diligence; the liability towards third parties is based on liability in tort (delictual liability) and will require fault in the form of negligence or intent. See further Hommelhoff and Schwab (n 286) 51, 69 ff. Hirt 2002 (n 37) 351. Also Hommelhoff and Schwab (n 286) 51, 56–58. Especially Eisenhardt (n 215) 289; Kübler (n 9) 413. BGHZ 64, 325 ff. In particular Peter Raisch, ‘Zum Begriff und zur Bedeutung des Unternehmensinteresses als Verhaktensmaxime von Vorstands- und Aufsichtsratmitgliedern’ in Robert Fischer, Ernst Gessler, Wolfgang Schilling, Rolf Serick and Peter Ulmer (eds), Strukturen und Entwicklungen im Handels-, Gesellschafts- und Wirtschaftsrecht—Festschrift für Wolfgang Hefermehl (CH Beck Verlag, Munich 1976) 347–48; Fritz Rittner, ‘Die Verschweigenheitspflicht der Aufsichtsratmitglieder nach BGHZ 64, 325’ in Robert Fischer, Ernst Gessler, Wolfgang Schilling, Rolf Serick and Peter Ulmer (eds), Strukturen und Entwicklungen im Handels-, Gesellschafts- und Wirtschaftsrecht—Festschrift für Wolfgang Hefermehl (CH Beck Verlag, Munich 1976) 365 ff.


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duties of care and diligence (Sorgfaltspflichten).291 This resulted in lively debates on, firstly, the question whether it was indeed correct to define the scope of the duties of the supervisory board members in terms of ‘the interest of the enterprise’ and, secondly, what should be understood under the ‘interest of the enterprise’. As far as the first aspect is concerned, two different trends can be identified. On the one hand it seems as if the courts and some theorists more readily tend to explain ‘the interest of the enterprise’ as only one essential element of the supervisory board members’ duties.292 On the other hand, there are those who argue that the duties of the members of the supervisory board become unmanageable if defined otherwise than in terms of the ‘interest of the enterprise’.293 Both trends do, however, have one thing in common, and that is that almost all sources dealing with these aspects differ in some or other respect in the way in which the ‘interest of the enterprise’ is comprehended.294 The consequence is that some commentators allude to the pluralistic nature of corporate interests,295 while others observe that the lasting impression with regard to the various corporate interests, is that these interests take a great variety of forms and that the complete picture is actually quite confusing.296 It is also interesting to note that the Commission for Corporate Law (Kunze Report),297 although seriously intending to give a more concrete definition to ‘the interest of the enterprise’,298 could only report that various meanings were expressed on the exact interpretation of the phrase.299

291

292

293

294

295 296 297

298 299

BGHZ 64, 325 329 ff. See Eisenhardt (n 283) 293–94; Eisenhardt (n 215) 289 ff; Semler (n 154) 33. Raisch (n 290) 364; Thomas Raiser, ‘Das Unternehmensinteresse’ in Robert Fischer, Ernst Gessler, Wolfgang Schilling, Rolf Serick and Peter Ulmer (eds), Strukturen und Entwicklungen im Handels-, Gesellschafts- und Wirtschaftsrecht—Festschrift für Wolfgang Hefermehl (CH Beck Verlag, Munich 1976) 101; Kübler (n 9) 413 (fn 20) and sources referred to in that note. Especially Mertens (n 166) 273–74, 275 ff; Stephen Laske, ‘Unternehmensinteresse und Mitbestimmung’ (1979) 8 ZGR 172, 184 ff; Eckard Rehbinder, ‘Das Mitbestimmungsurteil des Bundesverfassungsgerichts aus unternehmensrechlicher Sicht’ (1979) 8 ZGR 481. Especially Laske (n 293) 172, in particular 183 ff, where the views of various commentators on ‘the interest of the corporation’ are analysed. Also Rehbinder (n 293) 483; Eisenhardt (n 215) 294; Gunter Teubner, ‘Unternehmensinteresse—das gesellschaftliche Interesse des Unternehmens “an sich”‘ (1985) 149 ZHR 470 ff, 488. Raisch (n 290) 348. Kübler (n 9) 170 para 3. Bericht über die Verhandlung der Unternehmensrechtskommission (‘Kunze Report’), Bundesministerium der Justiz (ed) (1980). Ibid 139 para 132. Ibid. Also Eisenhardt (n 283) 247.

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In summary, the exact scope of the supervisory board members’ duties is not clear. Firstly, because it is uncertain whether the scope of their duties should be defined primarily in terms of the ‘interests of the enterprise’ and secondly, because there is little agreement on how the ‘interest of the enterprise’ should be defined. Apart from a breach of general fiduciary duties and duties of care and diligence, there is in principle considerable scope for holding members of supervisory boards liable for a breach of their statutory duties.300 A breach of duties may also lead to criminal prosecutions for supervisory board members.301 The provisions in the Betriebsvefassungsgesetz 1952 (Works Councils Act 1952),302 which made the duties of the employee representatives slightly different from other members of the supervisory board as far as the duty of confidentiality was concerned,303 do not apply any longer.304 All members of the supervisory board now have the same statutory duties under the Act.305 As ‘insiders’, the members of the supervisory board may also be held criminally liable for insider trading when they deal with any one of a number of defined insider documents.306

4.7 The Supervisory Board as Integral Part of the German Two-Tier Board System Any discussion about the supervisory board would be incomplete without also evaluating the merits of this institution. Even those who criticise the effectiveness of supervisory boards and who suggest solutions for improving the effectiveness of these institutions, do acknowledge the merits of the two-tier system.307 They emphasise the very important advisory role of the supervisory boards in many medium-sized and small corporations.308 It is also stressed that supervisory boards 300 301 302 303 304

305 306

307 308

Claussen (n 12) 481—see in particular ss 116, 93(1), 172 and 111(1) AktG. Ss 116, 93(1), 404(1)1 AktG. See in general Deckert (n 191) 457 ff. Ss 55, 76 BetrVG 1952. Spieker (n 231) 54–55. Cf Rittner (n 290) 365 ff. Hans-Joachim Mertens, in Carsten Peter Claussen et al (eds) Kölner Kommentar zum Aktiengesetz (Carl Heymanns Verlag, Cologne 1989) 287 para 1. Geßler AktG Service Issue 17 (1995) 3–4 para 3. Ss 12–14 Gesetz über den Wertpapierhandel (s 1 Zweites Finanzmarktförderungsgesetzes of 26 July 1994). See Geßler (n 305) para 4–4c; Heinz-Dieter Assmann, ‘Das neue deutsche Insiderrecht’ (1994) 23 ZGR 496; Karl-Burkhard Caspari, ‘Die geplante Insiderregelung in der Praxis’ (1994) 23 ZGR 530. Lutter (n 7) 295 301. Lutter and Krieger (n 9) 38 para 96. These authors point out that although there are roughly 750 German undertakings with more than 2000 employees, there are also 15000 GmbHs with between 500 and 2000 employees.


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play a useful role when competent people are elected to serve on them309 and when they deal with their task in an efficient way.310 Lutter311 also points out that many of the problems experienced in relation to the effectiveness of the supervisory boards are not because of deficiencies in the two-tier system as such, but because supervisory boards do not make use of the powers they actually have in terms of the AktG.312 As reasons for this he lists aspects like contentment, underpayment, an overload of work, a lack of professionalism, the ritualisation of supervisory board meetings and general human weaknesses.313 Already several years ago Lutter urged that these deficiencies should be addressed urgently and with conviction.314

4.8 Contrasting the One-Tier and Two-Tier Board Systems Since German corporate law is facing increasing competition within the European Union315 and since the Statute of the European Company (Societas Europaea, SE)316 grants the option to choose between a one-tier and a two-tier model,317 it is necessary to illustrate the advantages and disadvantages of both models. By contrasting both models the supervisory board’s functions become clearer. It is a matter of common knowledge that problems stemming from the separation of ownership and control are described by the theory of agency. From this perspective, it is one of the main tasks of corporate law to master these agency problems and the inevitable costs caused by these problems (agency costs). To 309 310 311 312

313 314 315

316

317

Lutter (n 7) 301. Scheffler (n 149) 76. Lutter (n 7) 295. See also Marcus Lutter, Marcus ‘Der Aufsichtsrat: Konstruktionsfehler, Inkompetenz seiner Mitglieder oder normales Risiko?’ (1994) 39 AG 176; Anonymous, ‘Pflichten und Kontrollmöglichkeiten der Aufsichtsratmitglieder’ [1994] AG-Report R 114. Lutter (n 7) 295. Ibid. Ingo Saenger, ‘Recent Developments in European Company and Business Law’ (2005) 10 Deakin L Rev 297, 309. Council Regulation (EC) 2157/2001 of 8 Oct 2001 on the Statute for a European company (SE). The document is online at . Cf Art 38(b) of the Regulation on the Statute for a European company; see Harald Kallmeyer, ‘Das monistische System in der SE mit Sitz in Deutschland’ (2003) 24 ZIP 1531. The French system provides this option between the one-tier board ‘Conseil d’administration’ and the two-tier board ‘Directoire/Conseil de surveillance’ in Art 225–58 and 225–68 Code de Commerce. Concerning the European company, two types of executive directors are possible—those from within the administrative board on the one hand and external executive directors on the other hand; cf Kallmeyer 1533.

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ensure that the management is submitted to an effective monitoring institution, in terms of formal corporate structures, two basic answers can be found in the European Union. Companies have either a one-tier board318 or a two-tier board.319 In a one-tier system, the board of directors is chosen as a general body which consists of executive or inside directors, who are engaged in the daily management of the company, and of non-executive directors, who are destined for specific supervisory tasks within the board. A two-tier system, on the other hand, is composed of a managing board which undertakes the daily management while the separate supervisory board is responsible for monitoring and advising the managing board and the appointment and removal of managing board members.320 Metaphorically speaking, the supervisory board serves as a ‘sparring partner’ of the management board, as it is—besides its advisory function—supposed to act as a counterbalance. Both systems have inherent strengths and weaknesses. While the one-tier system allows a flexible division of scopes of duties within the board and helps to put in place a common responsibility of executive and non-executive directors, the neutrality of supervisors can be questioned since the monitoring, appointment and removal processes have overtones of some kind of self-control and dubious selforganisation.321 Thus, it can be asked if the representation of shareholders’ interests is really guaranteed. But the joint responsibility of executive and nonexecutive directors ensures that the necessary information will be available to all members of the one-tier board, and this is seen as another advantage. 318

319

320

321

The one-tier system (also known as the ‘unitary board structure’) is present in England, Switzerland and in the majority of EU member states. Also outside the European Union the one-tier system is undisputedly far-reaching prevailing in all states of the United States. The two-tier system (also known as the ‘dual board structure’) is mandatory in continental states of Europe such as Germany, Austria, Denmark, Sweden, Finland and in large companies in the Netherlands. BGH, 03.03.1991, II ZR 188/89, BGHZ 114, 127, 129 ff; affirmed by BGH, 15.11.1993, II ZR 197/93, BGHZ 126, 340, 340 ff. Both judgements (with further bibliography) described the function of the supervisory board as follows: ‘According to s 111 AktG the supervisory board is primarily responsible for monitoring the management. This control does not only relate to completed issues, but also to points of principles of the future business policy; [the control] is not limited to a review of legality, but must include the management’s expediency and thrift. Monitoring functions understood in this regard can only be effectively exercised by regular discussions with the management board and its ongoing consultancy; therefore, counselling is the leading instrument of a future-oriented management supervision.’ See Lutter and Kremer (n 116) 87 ff for further details of these judgements. For questions of the supervisory board’s liability in this regard see Jens Buchta and Jürgen van Kann, ‘Die Haftung des Aufsichtsrats einer Aktiengesellschaft—aktuelle Entwicklungen in Gesetzgebung und Rechtsprechung’ (2003) 39 DStR 1665 ff. Cf Kerstin Hartmann, Die Aufsichtsratsvergütung als Erfolgsfaktor im deutschen Corporate-Governance-System (Peter Lang Verlag, Frankfurt 2003) 18, 31.


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In contrast to that, a high degree of neutrality and a very clear division of the respective duties of the two organs can be ascribed to the two-tier system, which is based on the idea of a separate outside board. But the two-tier system might suffer from rigidity and a rather remote form of control. In addition to that, the supervisory board is also often dependent on the management board, since former members of the management board often become members or even chairperson of the supervisory board.322 In general, the supervisory board is dependent on information from the managing board. Nevertheless, the kind of information typically provided by the management board to the supervisory board is also present in the one-tier system since there is a natural tendency to build an inner and outer circle of board members, in which the outer circle members are rather passive. These outer circle members have to face the same problems concerning their supervisory mandate as supervisory board members in a two-tier board.323 The two systems are extremes regarding possible corporate structures. There are also hybrid forms like the Societas Europaea which empowers the shareholders’ meeting to choose between the one-tier and two-tier system. However, it is not only this option which contributes to the long-lasting discussion about the convergence of the one-tier and two-tier system,324 but also the mixture of both which can be found in some countries trying to combine the strengths of both systems while excluding their respective weaknesses. Even the preamble of the GCGC acknowledges this development which is called ‘theory of convergence’.325 Nonetheless, the consultation document of the Services of the Internal Market Directorate General declares explicitly that both systems can achieve an effective and sufficiently independent oversight function and that neither of the two is preferable.326 322 323

324 325

326

Saenger (n 20) 147, 160. Peter Böckli, ‘Konvergenz: Annäherung des monistischen und des dualistischen Führungs- und Aufsichtssystem’ in Peter Hommelhoff, Klaus J Hopt and Axel von Werder (eds), Handbuch Corporate Governance: Leitung und Überwachung börsennotierter Unternehmen in der Rechts- und Wirtschaftspraxis (Otto Schmidt Verlag, Cologne 2003) 201, 214. Ibid 201 ff. The preamble states: ‘In practice the dual board system, also established in other continental European countries, and the internationally widespread system of management by a single management body (Board of Directors) converge because of the intensive interaction of the Management Board and the Supervisory Board, both being likewise successful.’ Apart from that, the GCGC pleads for convergence with its recommendations made in the third division. It is a point in fact that companies increasingly intensify the cooperation of the management; cf Hendrik-Michael Ringleb, Thomas Kremer, Marcus Lutter and Axel von Werder, Kommentar zum Deutschen Corporate Governance Kodex (CH Beck Verlag, Munich 2003) para 88 with further bibliography in footnotes 176–178. Recommendation on the role of (independent) non-executive or supervisory directors, 5 May 2004, 7; . Also Jean J du Plessis, ‘Reflections on Some Recent

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In at least two comprehensive analyses by American authors,327 the merits of the German two-tier system were identified and acclaimed.328 In both instances, however, these commentators concluded that the imitation of the German two-tier system should be done with circumspection.329 Taking into consideration that not all aspects of corporate governance in Germany have been fully researched, even German commentators warn that their system of corporate governance can hardly be seen as the ideal system for all countries.330 One is, therefore, in good company if one concludes, which we are not, that the German two-tier system is not worth following. From the heated debate on the effectiveness of German supervisory boards, one could easily gain the impression that the Germans are primarily dissatisfied with the two-tier system. It is, however, suggested that that is not the case. Concentrating on the deficiencies of a particular institution like the supervisory board is always more likely to provide for publishable material than simply explaining the merits of the two-tier system. In general, it seems that most German writers are reasonably satisfied with the two-tier system. The hammers and chisels are employed, sometimes delicately, sometimes with more vigour, for finesse, not to create a complete new model. This point will be clearly illustrated if the question is blatantly posed to German commentators: Do you think that the two-tier system should be abolished in Germany? The answer to this question would be, even by those in support of more drastic reforms to the supervisory board as institution,331 an overwhelming, ‘no’!332 It is, therefore, reasonably certain that one is also in good company when one suggests that the German two-tier system provides answers to many of the compelling problems associated with the unitary system: through such a system a broader

327 328

329 330

331

332

Corporate Governance Reforms in Germany: A Transformation of the German Aktienrecht?’ (2003) 8 Deakin L Rev 389, 390–92. Roe (n 258) 1927, 1979–80; Vagts (n 232) 59, 76, 87–88. Also Alfred F Conrad, ‘The Supervision of Corporate Management: A Comparison of Developments in European Community and United States Law’ [1984] Michigan L Rev 1459; Richard M Buxbaum, ‘Institutional Owners and Corporate Management: A Comparative Perspective’ [1991] Brooklyn L Rev 1. For an analysis of Conrad and Buxbaum’s insights, see Edward Rock, ‘America’s Fascination with German Corporate Governance’ (1995) 40 AG 291, 293, 296–98. Roe (n 258) 1995–1996; Vagts (n 232) 76–78, 87–88. Baums (n 119) 516 and 523. Also see Lutter (n 7) 287 ff; Bernhardt (n 9) 310 ff; Scheffler (n 149) 65 ff. Marcus Lutter, ‘Unternehmensplanung und Aufsichtsrat’ (1991) 38 AG 249, 250. Marcus Lutter, ‘Vergleichende Corporate Governance—Die deutsche Sicht’ (2001) 30 ZGR 226–27 points out two of the unique characteristics of the German corporate governance system, namely the two-tier board system and employee at supervisory board level. He is, however, adamant that none of these should be changed (at 227). Generally see Großfeld and Lehmann (n 91) 45.


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spectrum of interests in the corporation is formally recognised and it ensures that exclusive shareholder control is not the norm anymore.333

4.9 Concluding Remarks The appointment and removal of members of the supervisory board is regulated by detailed statutory provisions. The general meeting is allowed considerable freedom to determine the remuneration of supervisory board members. However, it is provided that such remuneration must be reasonable and proportionate with regard to the functions of each of the members of the supervisory board and also reasonable and proportionate with regard to the general (financial) position of the undertaking. The supervisory board fulfils some vital functions. These functions, inter alia, include the appointment, possible removal and remuneration of the members of the management board. The supervisory board also has a statutory duty to supervise or oversee the management of the corporation, and these functions cannot be delegated. However, the nature and scope of the board’s supervisory functions are not stereotyped. These may vary from undertaking to undertaking and also according to the specific circumstances prevailing in a particular undertaking. There are various statutory provisions complementing the supervisory board’s supervisory functions. These provisions are especially aimed at ensuring that there is a regular flow of accurate information from the management board to the supervisory board. Apart from this, the German legislation also provides for investigations by the supervisory board when it suspects that the management board has not provided it with adequate information. The supervisory board’s functions are, however, not limited to supervisory functions in the strict sense of the word. It may also fulfil an important role as institutional advisor and consulting partner for the management board. Or, as some commentators put it, as advisory or monitoring council. It should, however, be stressed that the effectiveness and significance of this ‘extended’ role of the supervisory board is not commonly accepted. Especially with regard to large, modern public corporations (where the management process becomes progres-

333

See Report of the Committee of Inquiry on Industrial Democracy (Bullock Report— Minority Report) 174 para 17, 177 para 36 and 189–91 (Appendix B); Wedderburn of Charlton, ‘Companies and Employees: Common Law or Social Dimension?’ [1993] LQR 230–38; Tom Hadden, Company Law and Capitalism (2nd edn Weidenfield and Nicolson, London 1977) 447–48; André C Côté, ‘Legal Regulation and Workers’ Participation in the Enterprise’ (PhD thesis, London School of Economics and Political Science 1973) 276–77. Also see Preamble to the 1st Draft Fifth Dir (1972 Bulletin of the European Communities (Supplement 10/72) 6–7); ‘Explanatory Memorandum’ [1972] Bulletin of the European Communities (Supplement 10/72) 33.

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sively complex), some critiques point out that the supervisory board can hardly be the ideal advisory forum. Not all problems have been solved in the German law as far as the duties of the members of the supervisory board are concerned. Firstly, the exact scope of the supervisory board members’ duties is not clear at all, because it is uncertain whether the scope of their duties should primarily be defined in terms of the ‘interest of the enterprise’ and because there is little agreement on how the ‘interest of the enterprise’ should be defined. It should, secondly, be observed that the duties of the members of the supervisory board are defined in terms of the duties of the members of the management board. The section dealing with the duties of the members of the supervisory board (Section 116 AktG) does not define the duties of the members of the supervisory board separately, but only makes the duties of the members of the management board (as defined in Section 93 AktG) applicable to the members of the supervisory board. Thus, it is also required of the members of the supervisory board to act as ‘decent and conscientious business leaders’. The obvious inconsistency with this approach is that in actual fact they cannot be ‘business leaders’ as they are prohibited, by statutory provisions, from managing and directing the business of the corporation. Furthermore, the duties of these two groups can never be exactly the same, since these two organs fulfil different functions: the supervisory board is primarily responsible for supervising or overseeing the management of the corporation, whilst the management board is primarily responsible for managing and directing the business of the corporation. It is suggested that there are areas where the duties of all fiduciaries (i.e. supervisory board and management board members) will be the same, but the differences will be accentuated every single time when supervisory functions are contrasted with the function to manage and direct the business of the corporation. The conceptual difficulties with the German legislature’s failure to distinguish between the duties of supervisory board and management board members has been emphasised by commentators, but has not yet been addressed by the German legislature.

Chapter 5

The German System of Supervisory Codetermination by Employees Jean du Plessis and Otto Sandrock

5.1 Introduction Chapters 3 and 4 dealt with the primary organs of German public corporations, namely the general meeting, the management board and the supervisory board. Since the German two-tier board system is founded on the management board and the supervisory board, most attention was devoted to these two organs. In this chapter the primary focus is on the German system of supervisory codetermination by employees, and so, again primarily on the supervisory board as it is on the supervisory board that employee representatives serve. This is such an important aspect that it deserves separate chapters. Discussion includes the historical development of codetermination in Germany, its application in various industries and corporations, and the role of trade unions. In Chapter 6 we examine some recent developments and recent perceptions of codetermination in Germany and the European Union. It could be said that in the European context codetermination is at the crossroads because of some fundamental decisions by the European Court of Justice (ECJ). Further, the German rules on codetermination are under serious threat of being eroded by some European Community legislation.

5.2 Historical Development of Codetermination (Mitbestimmung)1 5.2.1 Overview The different forms of codetermination in Germany are sometimes distinguished by employing terms like ‘management codetermination’ or ‘social codetermina1

This part is based on Jean J du Plessis and Otto Sandrock, ‘The rise and the fall of supervisory codetermination in Germany?’ (2005) 16 Intl Co and Commercial L Rev 67–79.

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Jean du Plessis and Otto Sandrock

tion’.2 Employee participation at supervisory board level is then equated with ‘management codetermination’, whilst employee participation at shop-floor level, through works councils, safety committees, productivity committees, job classification committees and so on3 are classified as forms of ‘social codetermination’. In this chapter, we use the term ‘social codetermination’ in this way. However, we prefer to use the term ‘supervisory codetermination’ rather than ‘management codetermination’ to denote employee participation at supervisory board level in the typical German two-tier board system, consisting of a management board (Vorstand) and a supervisory board (Aufsichtsrat).

5.2.2 Social Codetermination In Germany, codetermination was developed by both liberal and Christian theorists as a process necessitated by industrialisation and as an acceptable alternative to revolutionary employee practices.4 While the first practical examples of codetermination in Germany occurred long before the first statutory provisions,5 the first statutory provisions on social codetermination were in place by the end of the nineteenth century.6 Historically, the most important development concerning social codetermination was actually the Works Councils Act of 1920 (Betriebsrätegesetz, 1920), which was enacted soon after the German Revolution of 1918.7 That Act conferred upon employees certain rights of codetermination, but only in so-called works councils at shop-floor level, not at the supervisory board level.

2

3

4

5 6

7

See generally B Großfeld and U Lehmann, ‘Management Structures and Worker’s Codetermination in Germany with European Perspectives’ (1994) 1 Corporate Law Development Series 41–43. E Córdova, ‘Workers’ Participation in Decisions within Enterprises: Recent Trends and Problems’ (1982) 121 Intl Labour Rev 125, 127. For a different classification of the different forms of employee participation—see Michael Salamon, Industrial Relations: Theory and Practice (Prentice Hall, New York 1987) 300 ff. Thomas Raiser, ‘The Theory of Enterprise Law in the Federal Republic of Germany’ [1988] AJCL 111, 117. See also Friedrich Kübler, Gesellschaftsrecht (5th edn, CF Müller Verlag, Heidelberg 1998) 404; Mark J Roe, ‘Some Differences in Corporate Structure in Germany, Japan, and the United States’ (1993) 102 Yale L J 1927, 1970. Karl-Georg Loritz, ‘Sinn und Aufgabe der Mitbestimmung heute’ (1991) ZFA 1, 4 does, however, point out that it is extremely difficult to pinpoint the historical factors responsible for the development of codetermination, and in particular which general and corporate notions underlie the concept of codetermination. Loritz (n 4) 3. Kübler (n 4) 404. See also Press Release 6 Feb 2001 ‘Mitbestimmung im Betrieb—Die Geschichte des Betriebsverfassungsgesetzes’ 1–2. Raiser (n 4) 117; Loritz (n 4) 4. Also Press Release 6 Feb 2001 (n 6) 2.

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In Germany, the concept of social codetermination basically revolves around the idea of works councils (Betriebsräte) — a system where ordinary workers are actively involved in structuring their day-to-day environment in personal and social matters.8 All companies employing at least five people are required to establish a works council. The principal function of the works councils lies in the field of ‘social’ matters at plant level, but they are also tied into the structure for codetermination at board level.9 The works councils are powerful institutions in Germany, since they not only fulfil important functions but also have easy access to labour courts, which act as watch-dogs for social cooperation and which tend to favour employees.10 The idea of social codetermination was further refined through the Spokespersons’ Committee Act of 1989 (Gesetz über Sprecherausschüsse). The interesting thing here is that it is a committee for ‘the leading personnel’ (managers and executive employees) only and it functions independently of the works councils which are primarily the forum for the ordinary workers (the so-called ‘blue-collar’ workers).11 A spokespersons’ committee must be formed when there are more than ten such ‘leading personnel’ and if the majority of them are in favour of it. These bodies are primarily consultative, but they are empowered to sign agreements on the content of individual employment contracts for ‘the leading personnel’, and they can have an extensive say in matters relating to the removal of their constituents.12 This committee is, therefore, the works council’s equivalent, but only for ‘the leading personnel’.

5.2.3 Supervisory Codetermination 5.2.3.1 Early History The statutory history of supervisory codetermination only dates back to 1922, when the system was introduced13 for a short period.14 This was accomplished by 8

9

10 11 12 13

14

Großfeld and Lehmann (n 2) 41; Ulrich Eisenhardt Gesellschaftsrecht (6th edn CH Beck Verlag, Munich 1994) 308. See also Thomas Conlon, ‘Industrial Democracy and EEC Company Law: A Review of the Draft Fifth Directive’ [1975] ICLQ 352. S 6(1) Montan-MitbestG. See further Großfeld and Lehmann (n 2) 41–42; Brian Robinson, ‘Worker Participation: Trends in West Germany’ in Mark Anstey (ed), Worker Participation (Juta & Co Ltd, Cape Town 1990) 51. Großfeld and Lehmann (n 2) 42. Eisenhardt (n 8) 308. Robinson (n 9) 63. Official Journal of the former Reich (Reichsgesetzblatt, RGBI) XVII of 25 Feb 1922 (Part I) 209–10. These provisions were declared redundant in 1934—see Peter Hanau, ‘Einführung’ in Mitbestimmungsgesetze in den Unternehmen mit allen Wahlordnungen (4th edn Deutscher Taschenbuch Verlag, Munich 1991) VII.

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amendments to the Works Councils Act of 1920.15 The Amendment Act only applied to specified corporations.16 In cases where the supervisory board consisted of more than three members, two supervisory board seats were reserved for works council members,17 while in the case of all other specified corporations one seat was reserved for works council members.18 The works council members who represented the employees on the supervisory board were elected by secret ballot by the whole electorate.19 Also in conjunction with the general provisions of the Works Council Act of 1920, special provision was made to ensure that the rights of minority employees were not ignored in this election process.20 Raiser sees the admittance of representatives of the employees to the supervisory board not as a significant step in terms of the real influence of the representatives of the employees at supervisory board level, but rather as a major breakthrough with regard to the penetration of the supervisory board, viewed until then as the exclusive dominion of shareholders.21 The democratisation of employee participation was, however, ended after the National Socialistic (Nazi) Regime came to power. In 1934 all forms of employee participation in enterprises were abolished.22 The main impetus for supervisory codetermination by employees actually came much later when British occupation authorities and German trade unionists were determined to ensure that the nation would never again fall into the dictatorial pattern of the Third Reich.23 The specific method invented was to make it compulsory for labour and management to work together at the level of the supervisory board (codetermination!). This was then supposed to ensure that the very strict class distinction that existed in Germany would not emerge again.24 The government of the day campaigned for a one-third employee representative regime, but the trade unions got their way after a strike in the mining, iron, coal and steel industry.25

15 16 17 18 19 20 21 22 23 24

25

S 1, RGBl (n 13), part 1, affected the amendment of s 70 Works Council Act 1920. S 1 RGBl (n 13) part I. S 4 RGBl (n 13) part I. S 4 RGBl (n 13) part I. S 6 RGBl (n 13) part I. See also Press Release 6 Feb 2001 (n 6) 2. S 6 RGBl (n 13) part I contained a reference to s 16 Works Council Act 1920. Raiser (n 4) 117–18. Press Release 6 Feb 2001 (n 6) 2. Robinson (n 9) 49. Hellmut Wißmann, ‘Das Montan-Mitbestimmungsänderungsgesetz: Neuer Schritt zur Sicherung der Montan-Mitbestimmung’ (1982) 35 NJW 423. Ibid.


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5.2.3.2 Codetermination in the Mining (Including Coal), Iron, and Steel Industry: Full Parity Codetermination26 Through the Mining, Iron and Steel Industry Codetermination Act of 1951 (generally known as the Montan-Mitbestimmungsgesetz or Montan-MitbestG),27 the system of parity employee representation at supervisory board level was made compulsory for all industries involved in the mining (including coal), iron and steel industry.28 The Act distinguishes between three categories of companies: (1) Companies with a stated share capital up to 10 million Euros: Their supervisory boards must have eleven members of which five are representatives of the shareholders, to be elected in shareholder meetings; five are representatives of the employees, elected by the employees; and the final member has to be a ‘neutral person’, who serves as the chairperson of the board.29 (2) Companies with a stated share capital between 10 and 25 million Euros: Their supervisory board may be composed of eleven members in the same way described above under (1), but these companies may determine in their articles of association that their supervisory boards shall have fifteen members of which seven are representatives of the shareholders to be elected in shareholder meetings; seven are representatives of the employees, elected by the employees; and the final member to be a ‘neutral person’, who serves as the chairperson of the board.30 (3) Companies with a stated share capital of more than 25 million Euros: Again, these companies may be satisfied with a supervisory board composed of only eleven members as mentioned above under (1), but their arti26

27

28

29 30

Otto Sandrock, ‘The Colossus of German Supervisory Codetermination: An Institution in Crisis’ (2005) 16 European Business L Rev 86 ff. Gesetz über die Mitbestimmung der Arbeitnehmer in den Aufsichtsräten und Vorständen der Unternehmen des Bergbaus und der Eisen und Stahl erzeugenden Industrie vom 21 Mai 1951—see Kübler (n 4) 406 (fn 4). Normally, the Act requires the company to have more than 1000 employees (see s 1 para 2). Kübler (n 4) 405. Also Press Release 6 Feb 2001 (n 6) 3. S 1 para 1(a) of the Codetermination Act 1951 provides that the major activities of the company must be directed to these fields. Since one of the affected companies tried to evade the Codetermination Act of 1951 by transferring its management to a parent company which did not meet the criteria of the Act, the so-called Act Supplementing the Act of 1951 (MontanMitbestimmungs-Ergänzungs-Gesetz, commonly called ‘Holding-Novelle’) was passed in 1956 providing, inter alia, that a parent company which, in itself, would not fulfil the prerequisites of the Act, would nonetheless be subject to its regulations if its subsidiaries, looked at as a whole, would to a certain extent pursue the activities defined by the Codetermination Act of 1951. S 4 Codetermination Act. S 9(1) Codetermination Act.

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cles of association may also provide that their supervisory boards shall have twenty-one members of which ten are representatives of the shareholders to be elected in shareholder meetings; ten are representatives of the employees, elected by the employees; and the final member to be a ‘neutral person’,31 who serves as the chairperson of the board.32 The ‘neutral person’ is appointed by the shareholders meeting upon the recommendation of the supervisory board, while the Act ensures, by way of complicated provisions, that such a ‘neutral person’ also enjoys the confidence of the representatives of the employees.33 The representatives of the employees are appointed by way of complicated election procedures providing that the majority of the employees’ delegates are to be elected directly by their principals, while the minority of the seats must be filled by independent delegates.34 Since the number of companies active in the mining, coal, iron and steel industries has shrunk considerably during the past several decades,35 there are actually only about 40 companies with a total of at least 200 employee representatives serving on the supervisory boards of those companies.36 5.2.3.3 Codetermination in Other Fields of Commerce and Other Industries: Quasi-Parity Codetermination37 Through the Codetermination Act of 1976 (Mitbestimmungsgesetz, 1976) another kind of codetermination was introduced outside the mining, coal, iron and steel industries. The effect of this amendment was that all companies engaged in industry and commerce were now dragged in under the codetermination regime. All public limited companies (Aktiengesellschaften: AGs), private companies (Gesellschaften mit beschränkter Haftung: GmbHs), companies with one or more general partners but limited by shares (Kommanditgesellschaften auf Aktien: KGaAs), and cooperatives (Genossenschaften)38 are subject to the Codetermination Act of 1976

31

32 33 34 35

36

37 38

All ‘neutral persons’ under this Act have to enjoy the confidence of all members of the supervisory board. S 9(2) Codetermination Act. See the detailed provisions in S 8 Codetermination Act. See S 4(2) Codetermination Act. S 1(3) Codetermination Act provides that a company which no longer fulfils the criteria for the application of the Act is still bound by its provisions for the next six years. This information was obtained from the Association of German Steel Manufacturers in Duesseldorf (Wirtschaftsvereinigung Stahl). See also Anonymous‚ ‘Gewerkschafter in Aufsichtsräten’ Frankfurter Allgemeine Sonntagszeitung (weekly nationwide German journal) 26 Oct 2003, 37. See Sandrock (n 26) 87 ff. S 1(1) no 1 Codetermination Act.


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provided that they have more than 2000 employees.39 The Codetermination Act of 1976 therefore has the widest general application across German industry and commerce. Half of the seats on the supervisory board are reserved for the representatives of the shareholders, while the delegates of the employees take up the other half of the seats.40 The Act ensures that the chairperson is appointed by the representatives of the shareholders, while the employees’ delegates have the right to appoint the vice-chairperson.41 The chairperson was given a casting vote in 1976, after considerable political deliberation on the issue.42 The casting vote of the chairperson (elected by the general meeting) has tilted the power balance on the supervisory board slightly towards the shareholders,43 evoking considerable opposition both from the corporate side and from labour organisations. As a result of a petition by some well-known German companies, the matter was referred to the Federal Constitutional Court (Bundesverfassungsgericht: BVerfG).44 The Court found the provisions of the Codetermination Act of 1976 which, in the opinion of the plaintiffs, violated particularly their constitutionally guaranteed right of property, not to be unconstitutional.45 As it is clear that for these types of corporations the power balance is in favour of the shareholder representatives, commentators refer to this form of codetermination as ‘quasi-parity codetermination’ rather than ‘parity codetermination’.46 39

40

41

42 43 44

45

46

Exempt, however, from its application are companies in pursuit of the following purposes: political, trade union or employer oriented, religious, charitable, educational, scientific, scholarly or artistic. The same is true for press-related companies enjoying the freedom of information and freedom of opinion under Art 5 of the German Federal Constitution. See S 1(4) Codetermination Act. Similar to, but not because of the provisions of the MontanMitbestG 1951, the supervisory board has to be composed of (i) six representatives of the employees and six representatives of the shareholders if the company has less than 2000 employees, (ii) eight representatives of the employees and eight representatives of the shareholders if the company employs between 10 000 and 20 000 persons, and (iii) ten representatives of the employees and ten representatives of the shareholders if the company has more than 20 000 employees (S 7(1) Codetermination Act). In principle, all members of the supervisory board are entitled to participate in the election of the chairperson. But in case of a 50:50 vote, only the representatives of the shareholders may appoint the chairperson while the vice-chairperson will be elected exclusively by the employees’ delegates. See S 27 Codetermination Act. Kübler (n 4) 407. Ibid 412. Collection of Decisions of the German Federal Constitutional Court (BVerfGE) vol 50, 290. Kübler (n 4) 407. Also Thomas Raiser, ‘Der neue Koalitionskompromiß zur Mitbestimmung’ (1976) 31 BB 145. Klaus J Hopt, ‘The German Two-Tier Board: Experience, Theories, Reforms’ in K J Hopt, K Kanda, M J Roe, E Wymeersch and S Priggle (eds) Comparative Corporate Governance: The State of the Art and Emerging Research (OUP, Oxford 1998) 242, 246–47; Hans-Christoph Hirt, ‘Germany: The German Corporate Governance Code:

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In December 2003, a total of 767 German companies were governed by the Codetermination Act of 1976 and an aggregate number of 5410 seats on the supervisory boards of these companies were allocated to employees’ delegates.47 These delegates are, of course, earning considerable income from their activities as members of the supervisory boards.48 5.2.3.4 One-Third Codetermination: The Two Acts a) The Works Council Constitution Act (Betriebsverfassungsgesetz) 1952 In 1952, 24 years before the Codetermination Act of 1976, the Works Council Constitution Act, 1952 (Betriebsverfassungsgesetz,1952) had introduced yet another system of employee participation on the supervisory boards. AGs and GmbHs with more than 500 employees were then made subject to the Works Council Constitution Act. Since 1976, under the Codetermination Act, this has been increased to up to 2000 employees.49 The Act provides that only one third of the seats of those companies are reserved for the employees’ delegates while the other two thirds are filled by representatives of the shareholders to be elected in the shareholders’ meetings. b) The One Third Participation Act (Drittelbeteiligungsgesetz) 200450 In 2004, the Works Council Constitution Act was replaced by the One Third Participation Act (Drittelbeteiligungsgesetz) with similar but simplified rules. As the majority of the seats on these supervisory boards are held by the representatives of the shareholders, there is clearly no parity-codetermination in these corporations. Before the Act of 1952, only the Act on Public Limited Companies (Aktiengesetz 1965) made it mandatory for public limited companies (Aktiengesellschaften: AGs) to have supervisory boards. There was no such requirement in the Act regulating GmbHs (Gesetz über die Gesellschaften mit beschränkter Haftung, basically originating from 1892). But since the Works Council Act compelled certain GmbHs to have employee representatives on their supervisory boards, it became compulsory for them to form such supervisory boards.

47

48 49 50

Co-determination and Corporate Governance Reforms’ (2002) 23 Company Lawyer 349, 352. These numbers are taken from the Dec 2003 issue 64/12 of Die Mitbestimmung (Zeitschrift) stating the following numbers: 515 companies have a supervsory board with 12 members, 100 companies have a supervisory board with 16 members and 152 companies have a supervisory board with 20 members. See also Elke Bohl, ‘Die Mitbestimmung irritiert die ausländischen Investoren’ FAZ (nationwide German daily newspaper) 20 Sept 2003,14. For further details see 5.3.4, in particular the text accompanying footnotes 152–157. Großfeld and Lehmann (n 2) 50. For the specific statutes, see Loritz (n 4) 4. Sandrock (n 26) 89 ff; Rainer Huke and Thomas Prinz, ‘Das Drittelbeteiligungsgesetz lost das Betriebsverfassungsgesetz 1952 ab’ (2004) 59 BB 2633 ff.


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5.2.3.5 Preliminary Assessment In 1980, the Commission on Enterprise Law (Unternehmensrechtskommission) developed codetermination models for sole proprietorships and for partnerships, but these recommendations have never been implemented.51 It will be clear from the discussion above that the system of supervisory codetermination is a complicated one. Firstly, there are at least three different forms of supervisory codetermination, namely parity codetermination, quasi-parity codetermination and one-third codetermination. Secondly, to determine which system of supervisory codetermination applies and how many representatives of the employees must be, or may be, by virtue of the articles of the association of the company, appointed to the supervisory board, it is not only necessary to distinguish between the type of industry a corporation is involved in, but also the type of corporation (AG, GmbH, KGaA, Genossenschaft); the stated share capital; and the number of employees employed by the corporation.

5.2.4 The Two-Tier Board System and Supervisory Codetermination Contrasted The two-tier system and the system of supervisory codetermination by employees developed separately in Germany. The two-tier system had already been introduced by the General German Commercial Code (Allgemeines Deutsches Handelsgesetzbuch: ADHGB) of 1861 and was made compulsory in 187052 though only for AGs and not yet for GmbHs, which were regulated in a special statute of 1892 (i.e. about thirty years later).53 One thing is certain: even if the different explanations for introducing the supervisory board in German law are apprehended,54 the inception of the supervisory board was not motivated or even affected by the urge to recognise or to accommodate the interests of employees. In fact, the statutory history of supervisory codetermination by employees goes back to 1922 and that of parity employee representation at supervisory board

51 52

53

54

Raiser (n 4) 120–21. ADHB 24 July 1861 with effect from 1 March 1862—see Rudolf Wiethölter, Interessen und Organisation der Aktiengesellschaft im amerikanischen und deutschen Recht (CF Müller Verlag, Karlsruhe 1961) 271; Hopt (n 46) 227–28. It is uncertain whether the requirement for having a supervisory board for AGs was influenced by developments concerning the Kommanditgesellschaft auf Aktien (KGaA)—see Wiethölter 281–85. The statute is named ‘Act on Private Limited Companies’ (Gesetz betreffend die Gesellschaften mit beschränkter Haftung’). As to the reasons why the Aufsichtsrat was first introduced into the German law, Wiethölter (n 52) 271 refers to two completely contradictory conclusions reached by two commentators (Passow and Schumacher), relying on exactly the same research sources.

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level to 1951.55 This means that more than 80 years stand between the introduction of the two-tier system and the system of parity employee participation at supervisory board level. It is remarkable to note that the supervisory board, at its inception, served as an exclusive shareholders’ forum56 for supervising the activities of the management board.57 This is reflected by the original functions allocated to the supervisory board in 1861. Since then, the functions of the supervisory board have been defined as appointing and removing the members of the management board;58 representing the company in court and out of court in its relationship with the members of the management board;59 supervising and overseeing the management of the corporation; evaluating (studying) matters relating to the corporation; having insight into the corporation’s books and cash; approving the corporation’s financial statements; and reporting to the shareholders’ meeting.60 The original Act did not, as is still the case today, specifically state on behalf of whom this supervision was supposed to be executed. It is, however, reasonably certain that it inferred that supervision was originally intended to be done on behalf of the corporation, as personified by all the shareholders.61 Today, this interpretation has changed. The German Corporate Governance Code (GCGC), for example, provides that ‘[a]ll

55

56

57 58 59 60

61

Gesetz über die Mitbestimmung der Arbeitnehmer in den Aufsichtsräten und Vorständen der Unternehmen des Bergbaus und der Eisen und Stahl erzeugenden Industrie vom 21 Mai 1951—see Kübler (n 4) 406 (fn 4). The ADHGB of 1861, for instance, did not contain any provisions as to who was responsible for appointing the members of the supervisory board or the way in which the supervisory board was to be constituted. It was, apparently, left as a matter to be dealt with in the corporation’s constitution, but it seems as if the underlying idea was that they were supposed to be appointed by all the shareholders—Wiethölter (n 52) 280. Ibid 281. S 84 AktG. S 112 AktG. Under the title ‘Duties and prerogatives of the Supervisory Board’ (Aufgaben und Rechte des Aufsichtsrats) S 111 AktG provides: ‘(1) The supervisory board has to control the management. (2) The supervisory board may inspect and examine the books and documents of the company, in particular its financial means, its inventory of securities and commodities ... it commissions auditors to examine the annual accounts of the company and the group … (3) The supervisory board has to convene a shareholders’ meeting when the state of the company requires it. (4)The function of managing the business of the corporation cannot be conferred upon the supervisory board. The articles of the company or the supervisory board must, however, determine that certain transactions can only be carried out with its approval. If the supervisory board refuses its approval, the management board may demand that the shareholders’ meeting decides on the approval …’. Wiethölter (n 52) 280.


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members of the Supervisory Board are bound by the enterprise’s best interests’.62 And a well-renown German legal scholar63 specifies as a matter of course the duty of the management ‘to take into consideration the interests [not only] of the shareholders … [but also] of the employees’ when managing the company. If the management board has to pursue these interests, the supervisory board is also bound by that determination when carrying out its supervisory task.64 When parity employee participation became effective for an important part of the industry of that time in the early 1950s, it was merely interpolated onto the traditional two-tier system. The basic functions of the supervisory board were not adjusted at all. The practical consequence of this was that the employees were actually allowed seats in an institution (the supervisory board) primarily developed for supervision by the shareholders.65 Some of the later amendments to the Act on Public Limited Companies (Aktiengesetz, 1965) were affected by the lively debate on board level representation during the early 1960s.66 Similarly, the system of employee participation at supervisory board level was broadened and refined by the statutory provisions introduced by the Codetermination Act in 1976.67 In essence, however, the functions of the supervisory board (now consisting of shareholders’ representatives and representatives of the employees) do not differ remarkably from those that originated in 1861. The fact that the supervisory board was primarily intended to serve as a supervisory forum for the shareholders, combined with the fact that employee participation was only interpolated onto the two-tier system at a later stage, serve to explain why the effectiveness of the two-tier system, as well as of the two-tier system with employee participation at supervisory board level, was viewed with some, or even considerable, suspicion for a considerable period of time.68

62

63

64

65

66

67 68

Article 5.5.1 of the GCGC (June 2006 – ). Karsten Schmidt, Gesellschaftsrecht (4th edn Carl Heymanns Verlag, Cologne 2002) 805 para 28(II)(1)(a), comments on S 76 AktG: ‘Under its own responsibility, the management board has to govern the company.’ See also Wolfgang Koch, Das Unternehmensinteresse als Verhaltensmaßstab der Aufsichtsratsmitglieder im mitbestimmten Aufsichtsrat einer Aktiengesellschaft (Peter Lang Verlag, Frankfurt 1983). Wiethölter (n 52) 300: ‘Bei Einschluß der Mitbestimmung ist der Aufsichtsrat gesell.schaftsrechtlich ein Fremdkörper.’ For example, Wolfgang Spieker, ‘Möglichkeiten und Grenzen der Mitbestimmung im Aufsichtsrat’ (1962) 4 Das Mitbestimmungsgespräch 51 ff; Karl-Heinz Sohn, ‘Die Mitbestimmung und ihre Kritiker’ (1965) 7 Das Mitbestimmungsgespräch 195 ff. Also Raiser (n 4) 115, 119–20. In general Bernhard Großfeld and Ulrich Irriger, ‘Intertemporales Unternehmensrecht’ (1988) 11 JZ 531, 537. Raiser (n 4) 120; Roe (n 4) 1970. See Wiethölter (n 52) 295–97.

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5.2.5 Perceptions Regarding Codetermination in Germany from a Historic Perspective There is little doubt that the whole concept of parity employee representation at supervisory board level was observed with great scepticism when, in 1951, it was forced upon the German population by the Mining, Iron and Steel Industry Codetermination Act of 1951. In 1954, Schilling stated that there was hardly any other statute that had been met with so much rejection and distrust by the legal profession in Germany as the 1951 Act.69 He predicted that, as a political brainchild, forced upon the participants in the German economy without much thought going into it, the statute had little chance of any acceptance in the legal world.70 Sharp critique also came from industry itself71 as well as from management. Vagts comments: The reactions of management to the idea of codetermination are indicative of the problem; its original attitude was one of horrified outrage. It predicted that labor representatives would come blundering into management affairs like a herd of bulls in a china shop.72 However, the original scepticism about supervisory codetermination later turned into praise. Since the early 1960s until quite recently the concept of codetermination has been viewedʊat least publiclyʊquite positively in Germany, not only by labour but also ‘as a source of pride’ by managers and politicians.73 Whereas em69

70 71

72

73

Wolfgang Schilling, ‘Die Mitbestimmung im Lichte des Gesellschaftsrechts’ [1954] RdA 441. Ibid. Detlev F Vagts, ‘Reforming the “modern” corporation: Perspectives from the German’ (1966) 80 Harvard L Rev 23, 66: ‘[The statutes which introduced the system of employee participation at board level were] enacted over the protests and dire predictions of industry ...’ Ibid 68. Also, reading through the German sources, one is struck by the similarity between arguments raised in the UK and some earlier arguments presented by German commentators in condemning the system of employee participation at board level—eg Schilling (n 69) 442 ff. Paul Rose, ‘EU Company Convergence Possibilities after CENTROS’, (2001) 11 Transnat’l L & Contemp Probs, 133. See also Peter Ulmer, ‘Editorial: Paritätische Arbeitnehmermitbestimmung im Aufsichtsrat von Großunternehmen—noch zeitgemäß?’ (2002) 166 ZHR 271–72; Helmut Kohl, ‘Corporate Governance: Path Dependence and German Corporate Law: Some Skeptical Remarks from the Sideline’ (1999) 5 Colum J Eur L 189, 195; Großfeld and Lehmann (n 2) 50; Loritz (n 4) 5–6; Mitbestimmung im Unternehmen Bericht der Sachverständigenkommission zur Auswertung der bisherigen Erfahrungen bei der Mitbestimmung (Mitbestimmungskommission) (Biedenkopf Report) Drucksache VI/334 (1970) 56 par I(1); Stellungnahme der Bunderregierung zum Bericht der Mitbestimmungskommission Drucksacke VII/1551 (1970). See generally Jean J du Plessis, ‘Some Thoughts on the German System of Supervisory Codetermination by Employees’ in Ulrich Hübner and Werner F Ebke (eds), Festschrift für Bernard Großfeld (Verlag Recht und Wirtschaft, Heidelberg 1999) 875, 883 ff.


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ployee participation at supervisory board level was originally seen only as a method to impede revolutionary employee techniques,74 it was later identified75 and even praised as one of the most effective ways through which the valuable contribution of labour, as a production factor, could be recognized.76 It is significant to note that this realisation evoked considerable new interest in the role of the supervisory board, not only as an organ to supervise and oversee the functions of the management board, but also as an organ through which a broader spectrum of corporate interests was represented.77 These developments, which generated an independent velocity, in turn provide the reason why it is not so easy to draw sharp distinctions between the concept of supervisory codetermination and the concept of the two-tier board system in Germany nowadays—they developed separately, but are now almost inextricably linked to each other. During the 1970s and 1980s the concept of supervisory codetermination was hailed, even by the German judiciary, as a fundamental achievement in German socio-economic legislation. This becomes evident when one analyses a few basic judgements of the German superior courts immediately after the Codetermination Act of 1976 had been passed. A complaint against the Act was launched before the German Federal Constitutional Court by a number of the largest and most renowned German companies of that time.78 In their complaint the companies alleged that some provisions of the Codetermination Act of 1976 violated certain fundamental human rights guaranteed by the German Federal Constitution. They contended that the provisions of the Codetermination Act of 1976, conferring upon the representatives of the employees the right of parity codetermination, infringed above all the companies’ property rights guaranteed by the Federal Constitution.79 But the Constitutional Court dismissed these actions in a decision handed down in March 1979.80 74 75 76 77

78

79

80

See Raiser (n 4) 117. See in general Wiethölter (n 52) 300. Loritz (n 4) 4. Also Kübler (n 4) 404–05. Cf Wiethölter (n 52) 300–01; Hans-Joachim Mertens, ‘Zuständigkeiten des mitbestimmenten Aufsichtsrats’ (1977) 6 ZGR 272–75, 289; Stephen Laske, ‘Unternehmensinteresse und Mitbestimmung’ (1979) 8 ZGR 172–73, 200; Ulrich Immenga, ‘Zuständigkeiten des mitbestimmten Aufsichtsrats’ (1977) 6 ZGR 249, 252–53. Thomas Raiser, ‘Das Unternehmensinteresse’ in Fritz Reichert-Facilides, Fritz Rittner and Jürgen Sasse (eds) für Reimer Schmidt (Verlag Versicherungswirtschaft eV, Karlsruhe 1976) 103 ff provides an interesting exposition of the historical development and the importance the concept of ‘corporate interests’ in German law. The applicants were, inter alia, the Bayer AG, Daimler Benz AG, Hoechst AG, Robert Bosch GmbH. Art 14 paras 1 and 2 of the German Federal Constitution provide: ‘The property and the right of succession into a decendent’s estate are guaranteed. Their substance and limits are defined by statute. / Property obliges. Its use shall also serve the welfare of the community.’ Collection of Decisions of the German Federal Constitutional Court(BVerfGE) vol. 50 290 et seq. (at 250 et seq.); that decision is also published in Beilage 2 to Issue 7 of (1970) BB.

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The Constitutional Court held that the purpose of the Act, as was clear from the Explanatory Memorandum accompanying the original Bill, was to promote the common weal or common good by introducing parity codetermination in the governance of the larger German companies. Thus, the Codetermination Act of 1976 was held to be not only in conformity with the Federal Constitution, but also necessary for the promotion of the common weal or common good. The German Supreme Court in Civil Matters went even further in a judgement decided in 1982.81 While relying on the prior decision of the German Constitutional Court, it held that the provisions of the Codetermination Act 1976 had been passed in the public interest. The violation of these provisions by a company’s bylaws82 therefore was found to be susceptible to constituting a ground to declare the provisions of the by-laws null and void. The Court then continued:83 The Codetermination Act of 1976 must be allotted special importance in context of the politics relating to corporations since it represents the result of fundamental decisions reached after years of confrontation. The Act stretches beyond the interests of the persons immediately affected by it, the Act does indeed serve the common weal of the community (…) and, since it aims at the entire national economy, one must attribute to it, within the legal system, such importance that, without any doubt, the purpose of serving the public interest under Sec. 241 no. 3 of the Act on Public Limited Companies [Aktiengesetz] cannot be withheld from the provisions [of the Codetermination Act of 1976].84 81

82

83

84

Collection of Decisions of the German Federal Supreme Court in Civil Matters (BGHZ) vol. 83 106 et seq. (at 110 et seq.); also published in Beilage 4 to Issue 13 of (1982) BB. The by-laws of the Siemens AG provided that, within the supervisory board, a committee should be formed for the regulation of the relations of the company with the members of its board of directors; that, within that committee, the chairperson of the full supervisory board should also be the chairperson of that committee; and that such chairperson should have a casting vote in cases of an equal split of the votes (50:50). The Court found that particular provision in the by-laws not to violate the German Federal Constitution. The German version of that part of the judgement reads as follows: ‘Das Mitbestimmungsgesetz von 1976 hat als das Ergebnis grundlegender, nach langjährigen Auseinandersetzungen gefundener Entscheidungen ein besonderes gesellschaftspolitisches Gewicht. Es soll über das Interesse der unmittelbar Betroffenen hinaus dem Wohl der Allgemeinheit dienen (…) und nimmt mit seiner gesamtwirtschaftlichen Zielsetzung innerhalb der Rechtsordnung einen Rang ein, der es grundsätzlich ausschließt, einzelnen seiner materiell-rechtlichen Bestimmungen das öffentliche Interesse im Sinne von § 241 Nr. 3 AktG abzusprechen.’ We have translated this part freely to capture the spirit of the judgement. That Section provides as follows: ‘A resolution taken in the shareholders meeting is … only null and void when it …/3. is incompatible with the nature of the public limited company or when its substance violates statutory provisions aiming either exclusively or mainly at the protection of the creditors or of public interests.’


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Such solemn praise of an Act of Parliament by a courtʊcoming close almost to a canonisationʊis quite extraordinary. It clearly shows the overwhelming socioeconomic importance allotted to parity codetermination more than 20 years ago.

5.3 Current Practical Perspectives on Codetermination 5.3.1 General Concerns Recently, however, the star of codetermination has clearly started to wane85 as is illustrated by several articles reflecting quite negatively on the German system of codetermination. They include, inter alia, an editorial by an eminent academic, Peter Ulmer, in one of the leading academic commercial and business law journals (Zeitschrift für das gesamte Handelsrecht und Wirtschaftsrecht)86 and two articles in perhaps the leading corporate law journal in Germany (Die Aktiengesellschaft (Zeitschrift)).87 Moreover, other legal scholars and managers, experienced in codetermination matters, have published many comments during the last few years that point to at least the following shortcomings of parity codetermination.88 (1)

85

86

87

88

89

The German Act on Public Limited Companies (Aktiengesetz, 1965) assigns to the supervisory board the duty to oversee the management of the corporation (Geschäftsfürung zu überwachen).89 Instead of devoting its time and energy to that task, the main activity of the supervisory board

See the rather early critique by Christine Windbichler and Gregor Bachmann, ‘Corporate Governance und Mitbestimmung als “wirtschaftsrechtlicher ordre public”‘ in Harm Peter Westermann and Klaus Mock (eds) Festschrift für Gerold Bezzenberger (de Gruyter Verlag, Berlin 2000) 797 ff. Ulmer (n 73) 271–72. Also Peter Ulmer, ‘Der Deutsche Corporate Governance Kodexein neues Regulierungsinstrument für börsennotierte Aktiengesellschaften’ (2002) 166 ZHR 150, 180–81. Martin Veit and Joachem Wichert, ‘Unternehmerische Mitbestimmung bei europäischen Kapitalgesellschaften mit Verwaltungssitz in Deutschland nach “Überseering” und “Inspire Art” ‘ (2004) 49 AG 14, 17–18 with critical analyses of codetermination by leading commentators; and Otto Sandrock, ‘Gehören die deutschen Regelungen über die Mitbestimmung auf Unternehmensebene wirklich zum deutschen ordre public?’ (2004) 49 AG 57 ff. Also Hopt (n 46) 246–48. See Otto Sandrock, ‘Die Schrumpfung der Überlagerungstheorie’ (2003) 102 ZVgIRWiss 447, 490–93 who has tried to establish a comprehensive list of those shortcomings. See also the enumeration of such shortcomings by Maximilian Schiessl, ‘Leitungs- und Kontrollstrukturen im internationalen WettbewerbʊDualistisches System und Mitbestimmung auf dem Prüfstand’ (2003) 167 ZHR 235, 240 ff. See further the differentiating comments of a number of authors and participants in a discussion published in Arnold Picot (ed) Corporate Governance, Unternehmensüberwachung auf dem Prüfstand (Schaeffer-Poeschel Verlag, Stuttgart 1995). See the text of S 111 AktG para 1 cited in n 60 above.

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(2) (3)

(4)

(5)

90

91

92 93

94

95

often consists of discussing labour and social matters. The control of the management board is pushed to the background.90 Supervisory boards of large companies consist of up to 21 members. Cooperation in such large bodies can hardly be productive.91 The work of such a large body must be prepared very carefully, especially since the discussions must remain confidential. Such preparation is incumbent on the chairperson of the supervisory board and strengthens his/her position. ‘… no delegate of a shareholder … can unmask the management by asking it, in the presence of the employees’ delegates, too critical questions, even if this were necessary and justified in view of the particular circumstances of the company.’92 Thereby, the control of the board of directors shrinks considerably.93 In matters in which the members of the management board (Vorstand) are aware of the resistance of the representatives of the employees at the supervisory board, they will normally inform the supervisory board as late as possible. This will be the case in particular when the management board intends to restructure the company or to merge it with another company.94 When difficult problems have to be solved within the company, the trilateral interdependence among members of the management board, the representatives of the shareholders on the supervisory board and the representatives of the employees on the supervisory board often lead to agreements that burden the shareholders.95 In any case, an attempt is always

This conclusion follows inevitably if the many critical comments over the activities of codetermined supervisory boards are taken together—see Friedrich Kübler, ‘Aufsichtsratsmitbestimmung im Gegenwind der Globalisierung’ in Friedrich Kübler et al (eds), The International Lawyer, Freundesgabe für Wulf Henrich Döser (Nomos Verlagsgesellschaft, [Baden-Baden] 1999) 237 ff; Ulmer (n 73) 276; Schiessl (n 88) 240; Otto Sandrock, ‘Deutschland als gelobtes Land des Kapitalgesellschaftsrechts? ‘ (2002) 57 BB 1601, 1602 right col. Also Axel von Werder, ‘Überwachungseffizienz und Unternehmensmitbestimmung’ (2004) 49 AG 166, 171. See the in-depth examination of that aspect by von Werder (n 90) 170; Florian Schilling (member of the international personal services firm, Heidrick & Struggles, that identifies and recruits top-level managers), ‘Mitbestimmung und Corporate Governance’, FAZ 26 Nov 2001, p 25; Schiessl (n 88) 240 ff; Wolfgang Bernhardt, ‘Defizite für eine effiziente Aufsichtsratstätigkeit’ (1995) 159 ZHR 310, 316 ff. Schilling (n 91). See also Schiessl (n 88) 240. See also the critique by Peter Ruhwedel and Rolf Epstein, ‘Eine empirische Analyse der Strukturen und Prozesse in den Aufsichtsräten deutscher Aktiengesellschaften’ (2003) 58 BB 161 ff. See Klaus J Hopt, ‘Gemeinsame Grundsätze der Corporate Governance in Europa?’ (2000) 29 ZGR 779, 801. See the critique by the rekwnowned Belgian entrepreneur André Leysen, ‘Rufe nach Abschaffung der Mitbestimmung mehren sich’ FAZ 15 Dec 2003; Schilling (n 91); Martin T Roth, ‘Das Geld anderer Leute’ FAZ 28 March 2003, p13.


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96 97

98 99

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made to solve problems by the consent of all members of the supervisory board.96 In their endeavour to maintain such trilateral harmony, the representatives of the shareholders often compromise to the detriment of their principals (the shareholders) and the representatives of the employees let pass resolutions in stark contrast to the social interests under which they have been elected into their offices. This explains why rather often decisions were passed by supervisory boards, without encountering noticeable resistance from their members, that entitled resigning members of boards of directors to huge termination payments (so-called golden parachutes amounting to millions of Euros). Recently it became apparent that many of these termination payments were unlawful as they were not only excessive, but they were also not authorised, neither under any provision of statutory company law nor under any contractual arrangements in the service contracts between those members of the supervisory board and their companies.97 Criminal charges were brought because of misuse of power, that is embezzlement (Untreue) and convictions followed. These criminal proceedings attracted much public attention.98 Employees working abroad are not entitled to participate in the elections of the representatives of the employees to serve on the supervisory boards of some large German companies. This is peculiar because in the case of the Deutsche Bank, for example, there are more employees abroad than in Germany itself.99 The employee representatives on supervisory boards are sometimes faced with serious conflicts of interest, such as when they call for a strike against the company on whose supervisory board they are sitting.100

See the in-depth examination of that aspect by von Werder (n 90) 167 right col, 170. Two attorneys (Mark K Binz and Martin Sorg) who had promoted the indictment, bitterly commented upon the payments in an Editorial ‘Der Fall MannesmannʊLandung‚ in der Nähe des Bettvorlegers’ — in English: ‘The Mannesmann case: Landing close to a bedside rag’ (2003) 58 BB 20 Oct 2003. The facts of that case are expounded in detail in a legal opinion submitted by Uwe Hüffer in Beilage 7 to Issue 43 of (2003) BB. See 5.3.3.1. See Eberhard Schwark, ‘Globalisiertung, Europarecht und Unternehmensmitbestimmung im Konflikt’ (2004) 49 AG 173–74; Ulmer (n 73) 274; Schiessl (n 88) 240; Anonymous, ‘Breuer fordert kürzere Hauptversammlungen’ FAZ 27 Nov 2002; Anonymous, ‘Konzerne können deutsche Mitbestimmung umschiffen’ FAZ 21 Jan 2003; Anonymous, ‘Die Mitbestimmung der Arbeitnehmer am Pranger’ FAZ 27 June 2003. A spectacular example of such conflict came about when Frank Bsirske, chairman of the powerful Trade Union VERDI (Vereinigte Dienstleistungen) that volectively represents the employees working in all kinds of financial institutions; of healthservices; educational institutions; public services; media; telecommunication; and traffic, in summer 2003 called up its members for a strike against the Lufthansa AG on whose supervisory board Bsirske himself was sitting as an employee representative! Cf Gregor Bender, ‘Auch Gewerkschafter im Aufsichtsrat müssen Kodex befolgen’

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A considerable number of companies have fallen back on evasion strategies to avoid the application of the rules on codetermination101ʊa strategy that causes unnecessary transaction costs.102

(9)

Certain investors keep away from Germany because they are afraid of the German codetermination, which is largely unknown to them.103 However, there is also another interesting side of the coin. Foreign investment companies and foreign hedge funds are now coming to the German markets in unexpected numbers and buying up companies which, they think, are poorly managed. They show less consideration for the employees’ interests when reorganising those companies in their search for more profitability. Following an expression used by a German top politician, these foreign investment companies and hedge funds are now called ‘locusts’.104 That expression reflects apprehensions in Germany that such ‘locusts’ will carve up the companies acquired by them and will suck them dry with no regard for the interests of their employees before reselling them at huge profits to somebody else. In many cases this is a distorted picture of the role of investment companies and hedge funds.

(10) The German statutory regulations on codetermination have the effect of ‘poison pills’ on foreign companies that consider taking them over peacefully. As a result, the German market for amicable mergers is perceptibly restricted.105

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FAZ 9 July 2003, 17; Anonymous, ‘Wer einen Streik organisiert, gehört nicht in den Aufsichtsrat’ FAZ 27 March 2003; Christian Geinitz, ‘Possenspiel im Osten’ FAZ 12 June 2003, 13. See Volker Triebel, ‘Ein Bündel an Gesellschaftsformen steht zur Wahl’, FAZ 21 May 2003. As an example see Oberlandesgericht (Court of Appeals) Stuttgart, 1995 IPRax 397 with annotation by Herbert Kronke, Mehrstufiger grenzüberschreitender Konzern und mitbestimmter Aufsichtsrat, 377 ff. Cf Bohl (n 47) 14 as well as Bernhard Großfeld, ‘Rechnungslegung als Unternehmensverfassung’ (2003) 6 NZG 841, 843 ff with references to notably US sources. This expression was coined by Franz Müntefering, the former chairman of the large and important German Socialdemocratic Party, and it has established itself since then in the German public discussion. See, among many others, Michael Adams, ‘Was spricht gegen eine unbehinderte Übertragbarkeit der in Unternehmen gebundenen Ressourcen durch ihre Eigentümer?’ (1990) 35 AG 243, 250; Martina Röhrich, ‘Gleichbehandlungspflicht bei Kontrollaquisitionen’ (1993) RIW 93, 95 with further references; Lutz Michalski, ‘Abwehrmechanismen gegen unfreundliche Übernahmeangebote (unfriendly take-overs) nach deutschem Aktienrecht’ (1997) 42 AG 152, 156 (left col); Dietrich Becker, ‘Verhaltenspflichten des Vorstands der Zielgesellschaft bei feindlichen Übernahmen’ (2001) 165 ZHR 280.


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(11) The take-over market is even more affected when a foreign company considers the usefulness of taking over a German company in a hostile way by making a public offer to its shareholders. Many times when a foreign company refrains from such take-over, the chance is missed to replace an inefficient management with a competent one.106 There are several other deficiencies of the parity codetermination that fall beyond the scope of this chapter.107

5.3.2 The Dependancy of the Management Board on the Employee Delegates on the Supervisory Board 5.3.2.1 In General Apart from these special shortcomings, German codetermination is tainted with a general flaw: Candidates for the management board need to compete for the goodwill of the employee members on the supervisory boards to be appointed as management board members unless they are willing to run the risk of going through an embarrassing appointment procedure. The same is true of a renewal of their service contracts. Also, during their terms of service, members of management boards have to seek the goodwill of the employee delegates on their supervisory boards when managerial actions need supervisory board approval. That dependency cripples the initiatives of the management board whenever a company has to adapt itself to changes in the market—changes which often require sacrifices by employees, even if such changes are of a minor nature only.108 Further, a comparison of the share prices of companies with one-third codetermination and companies subject to quasi-parity codetermination revealed that the share market 106

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A particularly ‘bitter’ poison pill is now contained in S 33(1) sentence 2 third alternative of the Wertpapier-Übernahme-Gesetz (Act on Take-overs) of 20 Dec 2001, which entered into effect on 1 Jan 2002 but was repealed in July 2006. It allowed the board of directors of a company that was the target of a hostile take-over to take measures with the approval of the supervisory board to frustrate the take-over. This could provoke the formation of a calamitous alliance between the board of directors and a codetermined supervisory board which acted to the detriment of the shareholders. The provision also gave rise to doubts to its compatibility with the fundamental rights catalogue of the German Federal Constitution (guarantee of the protection of property). For further details see Michael Kort in Klaus J Hopt and Herbert Wiedemann (eds) Großkommentar zum HGB (4th edn issue 19 Berlin 2003) section 76 para 95. Parity codetermination is also a rather expensive exercise. Notably in large companies complicated elections have to be organised for the election of the employees’ delegates. These elections require considerable financial expenditure. See Otto Sandrock, ‘German Supervisory Codetermination and the Lesson to be Learned from it’ in Chinese Culture University, Taipei (ed), 8th International Conference on Multinational Enterprises, 14–16 March 2006, vol I, 122.

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values of the latter are almost 25 per cent lower than those of the former.109 This may provide a strong indication that the financial markets are not responding favourably towards companies where quasi-parity codetermination is required under the German law. 5.3.2.2 Suspicious ‘Cosiness’ Foreign observers share some of the criticism of German commentators. The Wall Street Journal Europe recently described the relationship between German boards of management and boards of supervisors as ‘cosy’ when referring to the remark by the former long time CEO of Volkswagen who is now the head of its supervisory board110 that he had ‘kept the management on a long leash’.111 The Wall Street Journal also criticised the requirement for members of the management board to seek the goodwill of the employees’ delegates for their reappointment for another term. The Journal went on to say that this creates a paralyzing mutual dependency, a problem for which bribery (which will be described later112) was sometimes seen as an easy fix. The English journal The Economist113 was no less blunt. Under the headline ‘Germany’s “co-determination” rules should go’ it argued that codetermination blocks firms from making the decisions they need to make to survive in tougher market conditions. When German companies try to stay competitive on world markets by cutting costs and shifting production to cheaper countries, they often meet fierce resistance from their own supervisory boards. The Economist comments ‘So, co-determination looks like the latest convenient example of what is wrong with business in Germany’ and goes on to ask: ‘Should the legal requirement for worker participation now be abandoned?’ Despite all these shortcomings, management and shareholders representatives have been generally reluctant to openly challenge the legitimacy and usefulness of parity codetermination. They have sought to avoid confrontations with the powerful German trade unions, confrontations that could have provoked strikes. Further, for fear of losing general political elections on the level of the federal German Union (i.e. the Federal Republic of Germany) or on the level of the important federal industrial states, most of the political parties did not lend any support to modifications, not even the most moderate ones. The German system of codetermination therefore was characterised as a matter of taboo114 or as a ‘dinosaur

109 110 111 112 113 114

Die Welt (German nationwide daily newspaper) 28 July 2005, 17. Ferdinand Piëch. As to his personality see below n 145. ‘Germany’s ‘cowboy capitalism’ Wall Street Journal 9 Aug 2005, A8. See 5.3.3 below. ‘Together they stand’, The Economist, 16 July 2005, 14. Expression used by Schiessl (n 88) 237.


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model’.115 It is only during the last few years that some voices from management and political parties are willing to call, in this respect, a spade a spade. Although it is far too soon to draw any definite conclusions from these developments, it is at least certain that the topic of codetermination has once again started to become a subject of lively political debates as it would be difficult to keep codetermination on the politically ‘not-to-be-discussed-now’ agenda for much longer.116

5.3.3 Some Recent Scandals Associated with Employee Representatives Serving on Supervisory Boards117 In addition to the shortcomings and flaws noted above, a dark shadow is currently thrown over codetermination at the supervisory level in Germany. That shadow stems from a series of scandals that have stirred up German public attention and have led to criminal litigations. These scandals are known as ‘The Mannesmann incident’ and ‘The Volkswagen incidents’. 5.3.3.1 The Mannesmann Incident In 2000, Vodafone plc took over, by way of a public offer, the former German Mannesmann AG which, at that time, had established a considerable mobile phone business in Germany and had acquired a large share of the German market. After the take-over had finally been sealed, a four-member committee within the supervisory board of the former Mannesmann AG decided to award, and did award, huge bonuses to some former members of the management and supervisory boards of the Mannesmann AG as well as to some of its former senior executives. Pursuant to the by-laws of the Mannesmann AG,118 that four-member committee was

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Expression used by Theodor Baums, a renowned German company law academic, according to a note in FAZ 27 June 2003. See in particular Ulmer (n 73) 272; and Klaus J Hopt, ‘Unternehmensführung, Unternehmenskontrolle, Modernisierung des Aktienrechts—Zum Bericht der Regierungskommission Corporate Governance’ in Corporate Governace: Gemeinschaftssymposion der Zeitschriften (ZHR/ZGR) (Verlag Recht und Wirtschaft GmbH, Heidelberg 2002) 42– 46, 66–67. The need for a basic reform has also been stressed by Abbo Junker, ‘Unternehmensmitbestimmung in Deutschland—Anpassungsbedarf durch internationale und europäische Entwicklungen’ (2005) 36 ZfA 1–44 (expert opinion prepared for the German Federal Association of Employers). This part is also based on the paper delivered by Otto Sandrock in Taipeh in March 2006 (see n 108). It is customary that the by-laws of German public limited companies provide for a committee to be set up within their supervisory boards which is in charge of the relations between the companies and the individual members of their managing boards, in particular of the service contracts of the latter. The regulation of all financial matters

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vested with the power to regulate the relations between that company, on the one hand, and the members of its board of directors, on the other, including all financial matters. But the bonuses awarded by that committee amounted to an aggregate sum of more than 100 million Euros. The former CEO of Mannesmann alone was granted a total of about 30 million Euros. Neither those by-laws, however, nor the employment contracts that the recipients had entered into with their company, provided for any such bonuses.119 Within the four-member committee, the bonus resolution was passed, partly by phone calls, with the approval of all its members, with only one exception. This exception was the only employee delegate on the committee who abstained from voting and thereby let the resolution pass. That delegate was the former chairperson of the mighty metal workers’ trade union.120 One would have expected that he would have opposed the grant of these very generous bonuses, but contrary to those expectations, he let the resolution pass without raising any objection.121 The payment of the bonuses was, of course, to the detriment of the Vodafone shareholders (who did not complain). The members of the committee were indicted in 2003 and had to stand trial for misuse of power, that is embezzlement (Untreue). They were acquitted by the first level criminal court essentially for the reason that the accused had acted in an excusable error in law.122 However, when a review was launched against that acquittal by the public prosecutor, the German Supreme Court in Criminal Matters re-heard the case and, with instructions, remanded it to another first level court.123 After a hearing in that court which aroused much public attention,124 the criminal proceedings were finally terminated by a covenant between the first level court, the public prosecutor and the accused.125 In that covenant of November 2006, the accused agreed to pay to the

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also falls within the competence of these committees. sUually an employee delegate is a member of such committees. See FAZ 20 Sept 2003, 11; 22 Sept 2003, 11; 25 Sept 2003, 18; 6 March 2004, 13. Cf also Jürgen Dunsch, ‘Das Millionenspiel bei Mannesmann’, FAZ 22 Sept 2003, 11; U lmer (n 73) 276; also Jürgen Dunsch, ‘Das Millionenspiel auf den Chefetagen’ FAZ 5 May 2003, 13; Anonymous, ‘Der Telekom-Vorstand gibt Ron Sommer Rückendeckung’ FAZ 12 July 2002; ‘Showdown im Aufsichtsrat’ FAZ 16 July 2002. See FAZ 20 Sept 2003, 11; 22 Sept 2003, 11; 25 Sept 2003, 18; 6 March 2004, 13). Cf also Dunsch (n 119) 22 Sept 2003 and 5 May 2003; lUmer (n 73) 276; Anonymous (n 119) 12 July 2002 and 16 July 2002. See U lmer (n 73) 276. See FAZ 17 Jan 2004, 15; 23 Jan 2004, 13; 24 Jan 2004, 18; 29 Jan. 2004, 15; 10 Feb 2004, 12. See FAZ 10 (Oct) 2005, 13; 13 Oct 2005, 17; 18 Oct 2005, 16; 21 Oct 2005, 1; 22 Oct 2005, 13; 20 Dec 2005, 14; 22 Dec 2005, 1. See also the commentaries by Jürgen Dunsch, ‘Der Richterspruch’ in FAZ 22 Dec 2005, 1; Walter Grasnick, ‘Nach Gutsherrenart verteilt’ FAZ 9 Jan 2006, 33; Mark Binz and Martin Sorg, Editorial: ‘Ackermann & Co.: Gutsherren oder Gutsverwalter?’, (2006) 6 BB 1. See FAZ 27 Oct 2006,1 and 14; 2 Nov 2006, 13; 3 Nov 2006, 13 and 20; 4 Nov 2006, 13. See FAZ 25 Nov 2006, 1, 13, 17.


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Federal Republic and to charities a grand total of 5.8 million Euros, and the public prosecutor and the court recognised that, in view of the costs that a completion of the trial would have caused, it was no longer in the public interest to continue the trial.126 This scandal clearly demonstrates that the employees’ delegate on the company’s above-mentioned committee had failed to avert harm from his company. He willingly and deliberately had let the opportunity slip to stop the unlawful payments and thereby fulfil his supervisory and overseeing functions properly. It was a clear case of outright neglect of the ‘watchdog-functions’ incumbent upon him. Certainly, in terms of criminal law, he could not be blamed more than the other members of the supervisory committee, but he was after all the chairperson of one of the most militant and most powerful German trade unions. The fact that he considered these bonuses justifiable reveals his lack of care for the interests he represented within the committee. Furthermore, his behaviour accentuates the ‘cosy’ relationship between the management and supervisory boards of Mannesmann and its trade unions—a kind of relationship that fosters the abuse of power. 5.3.3.2 The Volkswagen (VW) Incidents The German parent company of the worldwide Volkswagen group is registered in Wolfsburg, Lower Saxony, Germany where it also operates its main fabrication plant. The federal state of Lower Saxony now holds 18.64 per cent of its common shares and 18.2 per cent of the votes in the VW shareholders’ meetings. The company is governed by a special federal statute of 1960 which prohibits any shareholder from casting more than 20 per cent of its votes at their meetings127 and, in addition, authorises the appointment of two members of its supervisory board by the state of Lower Saxony.128 Since it is common for large companies with thousands or tens of thousands of shareholders that smaller shareholders do not normally attend shareholder meetings, these regulations always have enabled the majority shareholder (formerly the different governments of Lower Saxony and

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See FAZ 30 Nov 2006, 13 and 20; 4 Dec 2006, 4. See also Holger Steltzner, ‘Lehren aus dem Mannesmann-Prozeß’ FAZ 30 Nov 2006, 1. These and other regulations of the Volkswagen Act 1960 are now under attack from the Commission of the EC which argues justifiably that they impede the freedom of establishment within the EC. See FAZ 8 Aug 2004, 11 and the materials published by the EC Commission on the Internet. This peculiar kind of legislation stems from the period after the Second World War when it was disputed between the federal union and the federal state of Lower Saxony which of them was the owner of the company’s shares. When resolving that dispute, the above-mentioned special Act was passed. The Federal Republic later sold its shares in the company leaving only the state of Lower Saxony as controlling shareholder.

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now the Porsche AG)129 to control the appointment of the members of the supervisory board, and thereby also of the management board. It was, therefore, not surprising that these legal provisions (formerly) ensured that the respective governments of Lower Saxony, on the one hand, and the Volkswagen supervisory and management boards, on the other, established and maintained a very good and cooperative working relationship.130 In the spring of 2005, it became known, for example, that two members of the parliament of Lower Saxony, who had been employees and shop stewards of Volkswagen, continued to receive their salaries from Volkswagen though, allegedly, they no longer performed any services at all for the company. In addition, these parliamentarians had not disclosed their continued payments from Volkswagen.131 It is also not surprising that the member of the management board, who was in charge of the labour and social affairs of Volkswagen (later condemned in a criminal trial)132, always sought to maintain close and amicable (almost cosy) relations with the employees’ delegates on the supervisory board. Since several shop stewards were also sitting on the supervisory board, the management board member organised meetings of shop stewards in luxurious places all over the world, in particular in Brazil.133 He then took care, during those excursions, that prostitutes and other amenities were provided in abundance for the shop stewards. The bills for these amenities were presented to, and readily paid by, the accountant of the management board.134 A special prostitute had even been flown in from Brazil to Germany for the

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See below the text accompanying footnotes 145–150. As to the interrelationship between the State of Lower Saxony and Volkswagen see ‘Dark days for Volkswagen’ The Economist 16 July 2005, 55; Siegfried Thielbeer, ‘Schröder, Wulff und das System Volkswagen’ FAZ 6 July 2005, 3; Johannes Ritter, ‘Wolfsburger Filz’, FAZ 8 July 2005, 11; Carsten Germis, ‘Die politische Verantwortung’ FAZ 9 July 2005, 17; Johannes Ritter and Henning Peitsmeier, ‘Machtkampf in Wolfsburg’ FAZ 19 Oct 2005, 20; and Anonymous, ‘Das Denkmal bröckelt’ FAZ 12 July 2005, 16 and ‘VW-Betriebsrat stärkt Piëch den Rücken’ FAZ 11 Oct 2005, 17. See FAZ 16 July 2005, 16; and 17 July 2005, 17. It was Peter Hartz, whose name is connected with important federal legislation, who reformed the German labour markets and who is well known in the German public. Peter Hartz was the so-called ‘Arbeitsdirektor’ of the Volkswagen AG. For a comprehensive report of these different incidents see Henning Peitsmeier and Johannes Ritter, ‘Das System VW vor Gericht’ FAZ 15 Jan 2007, 12. German tabloids have taken up that subject publishing pertinent pictures, see for example ‘Stern’ no 40, 29 Sept 2005, 26–40. See also FAZ 30 Sept 2005, 11; and 8 Oct 2005, 11. When these payments were covered up, the accountant (Joachim Gebauer) was immediately laid off by Volkswagen. Gebauer challenged his dismissal before a labour court of first instance. His claim, however, was dismissed. See FAZ 18 Nov 2006, 13.


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shop steward’s chairman. Invoices for more than 1 million Euros135 were reported to have been paid by the Volkswagen company for the pleasure of that shop steward alone.136 When these incidents became known, the public prosecutor of Wolfsburg started criminal investigations against several of the persons involved. The member of the management board who had covered up these payments137 was indicted for misuse of his powers (embezzlement (Untreue)).138 So was the shop stewards’ chairman who had largely benefited from these payments.139 In January 2007, the criminal proceedings against the member of the management of board were closed by a covenant between the public prosecutor, the court and the accused. The latter accepted his conviction and two years on parole and agreed to pay to the receiver of revenue and charities 576,000 Euros.140 The criminal proceedings against the shop stewards’ chairman have not yet come to end. In addition, a corruption affair at the Czech ǅkoda subsidiary of Volkswagen came to light in the beginning of 2005. A now dismissed member of the ǅkoda management board, together with a shop steward from Wolfsburg, is accused of embezzlement for having built up a system of dummy firms in India, Angola, Czechia, Luxemburg and Switzerland to camouflage bribes paid by Volkswagen dealers.141 It is probably an understatement to say that these scandals rocked the foundations of the German system of codetermination. Fundamental questions arise as to how effective employee representatives can really be in their intended role as a check or a balance to shareholder representatives or supervising and overseeing the way in which the management board manages or directs the business of the corporation. According to a public poll conducted by a well-esteemed demographic institute, the reputation of trade unions had sunk to an all time low of 5 per cent in mid-2005, certainly also as a consequence of these disgraceful

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139 140 141

The criminal court dealing with the indictment of Peter Hartz ascertained damages in the amount of a grand total of 2.6 million Euros to have been caused.to the Volkswagen AG. See Bernd Rüthers, ‘Betriebsräte bei VW—ein unentgeltliches Ehrenamt?’ FAZ 19 July 2005, 18. See further FAZ 6 July 2005, 13; 17 July 2005, 11; 25 July 2005, 17; 18 July 2005, 40; 8 Aug 2005, 12; 17 Oct 2005, 16. See supra footnote 134. See Stefan Seitz, Editorial ‘Auf eine vertrauensvolle Zusammenarbeit’ (2005) 32 BB 8 Aug 2005; Volker Rieble, ‘Betriebsräte geraten ins Visier der Strafrechtler’ FAZ 17 Aug 2005, 21. See further FAZ 26 July 2005, 11; 22 July 2005, 13; 10 Aug 2005, 10; 20 Aug 2005, 11. See FAZ 17 Aug 2005, 21; 20 Aug 2005, 11; and 10 Oct 2005, 16. That covenant was heavily criticised in public; see, for example, FAZ 27 Nov 2006, 11. Christoph Hein, ‘VW und Indien tricksen sich gegenseitig aus’ FAZ 19 July 2005, 20. See further FAZ 5 July 2005, 11; 7 July 2005, 10; 12 July 2005, 11; 5 Aug 2005, 18; 10 Aug 2005, 9; and 10 Aug 2005, 14.

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events.142 Employee participation at supervisory board level dominated the entire corporate law debate during the 1970s and early 1980s,143 and it was observed by some commentators in the mid-1990s that the whole matter has actually been settled in Germany, not only in practice, but also as far as academic discussions are concerned.144 However, the topic of codetermination is back as a high priority on the corporate law agenda in Germany. Ferdinand Piëch, the former chairperson of Volkswagen’s management board, who is now the chairperson of its supervisory board,145 is also criticised for having violated, and still violating, Germany’s principles of good governance. First, he was elected as chairperson of Volkswagen’s supervisory board irrespective of the fact that he had formerly been the chairperson of its management. This is disregarding Article 5.4.4 of the German Code of Good Governance (GCGC), that provides that as a general rule the former management board chairperson must not become supervisory board chairperson unless special reasons are presented to the annual general meeting. Second, Piëch also managed (in November 2006 with the support of the employees delegates146 and against the votes of Lower Saxony and other representatives of the shareholders on the VW supervisory board) to dismiss the then chairperson of Volkswagen’s management board as well as other leading managers and to replace them with managers favoured by him.147 In view of that shake-up of Volkswagen’s management, The Economist asked under the headline ‘The backseat driver gets his way’: ‘What on earth is going on at Volkswagen?’148 Third, Piëch also holds a 10 per cent share in the Porsche AG and is the chairperson of its supervisory board; as such he initiated the purchase by the Porsche AG of about 30 per cent of Volkswagen’s general stock.149 That double chairpersonship is seen by many to cause conflicts of interest. Piëch is still considered to be the real mastermind behind Volkswagen.150 He enjoys the support of the employees’ delegates on the supervisory board and that enables him to interfere on a large scale with the management. But his behaviour has caused wide objection from and 142

143 144 145

146 147

148 149 150

See . See also the article ‘There’s life in the old dinosaur yet’ The Economist 18 Feb 2006, 27. See Eisenhardt (n 8) 307. Loritz (n 4) 1 ff. He is a grandson of the legendary designer of the Volkswagen ‘beatle’, Ferdinand Porsche, who was the founder of the famous car-making company. As to his personality see ‘Face value—Volkswagen’s Ferdinand Piëch is fanatical about cars and ruthless towards people’ The Economist 2 Dec 2006, 72. See FAZ 9 Jan 2007, 9. See FAZ 19 Apr 2006, 22; 3 May 2006, 13; 4 May 2006, 15; 11 Oct 2006, 22; 9 Nov 2006, 13; and 9 Jan 2007, 9. The Economist 11 Nov 2006, 72. See FAZ 16 Nov 2006, 1 and 11; 17 Nov 2006, 16. See FAZ 9 Nov 2006, 16; 17 Nov 2006, 16. See also Johannes Ritter, ‘Der Schatten über Wolfsburg’ FAZ 13 Jan 2007, 11.


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disapproval among many shareholders of VW and their representatives on the supervisory board.

5.3.4 Remuneration of the Employee Representatives Serving on Supervisory Boards Trade unions still have a large influence over the German economy in socioeconomic terms. That power also translates into financial terms. Most of the employee representatives, though not all of them, are members of trade unions. It should be remembered that more than 5000 seats on the supervisory boards of the largest German companies are in the hands of trade unionists.151 Under all three Acts on Codetermination, the employees’ representatives enjoy the same rights and duties as the other members of such boards.152 They are therefore entitled to receive, and do receive, the same remuneration for their activities as the shareholders’ representatives. In practice, however, the employee representatives are asked153 to pass on154 to a foundation155 all remuneration received by them exceeding a certain maximum amount156 (which, on a remuneration of 40,000 Euros and above, is limited to 4,600 Euros157). These fees are earmarked for the training of those union members who are to be appointed to supervisory boards. It will, therefore, be clear that German trade unions receive millions of Euros from the activities of their members on supervisory boards, which may 151

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155

156 157

This is the aggregate number when one adds, as of 31 Dec 2003, the 200 odd seats in the mining, coal, iron and steel industry under the Mining, Iron and Steel Act of 1951, the 5410 seats assigned to them by the general Codetermination Act of 1976 and the seats reserved for them by the former Works Council Constitution Act 1952, now replaced by the One Third Participation Act of 2004 – see 5.2.3.4(b). See S 4(3), 13(1) Codetermination Act for the Mining, Iron and Steel Industry 1951; Ss 26, 33(1) general Codetermination Act 1976; S 9 One Third Participation Act 2004. A resolution of the Federal Committee (Bundesausschuß) of the Federation of the German Trade Unions (Deutscher Gewerkschaftsbund) passed on 10 Oct 2000 for the years 2001 and after regulates the ‘Transfer of Remunerations resulting from Activities in Codetermination or similar Activities’ (Abführung von Vergütungen aus der Wahrnehmung von Mitbestimmungsfunktionen oder ähnlichen Aufgaben). A copy of that resolution has been forwarded to the author of this article by the Hans Böckler-Stiftung. This represents, however, only a moral obligation which is legally not enforceable since a legally binding obligation would encroach upon the independence of the respective member of the supervisory board. Hans Böckler-Stiftung, named after a famous chairman of the German Trade Unions, in office immediately after the second world war. The so-called ‘Eigenbehalt’. With respect to fees up to an amount of 3500 Euros, 10% may be retained. 95% of all fees exceeding of 3500 Euros shall be transferred, but always limited to a personal retention of 3500 Euros. A detailed scale of fees and personal retention is attached to the resolution.

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explain why they are guarding so jealously their rights to appoint these members to supervisory boards.

5.3.5 Recent Attempts to Modify the System of Codetermination In recent years, two attempts were made to amend the present German system of codetermination. 5.3.5.1 The Proposals of the So-Called Biedenkopf Commission In 2005, the Federal Government, under former Chancellor Gerhard Schröder, appointed a Commission to revise the system of codetermination on supervisory boards. The Commission’s chairperson was Kurt Biedenkopf, a former Prime Minister of Saxony and one of the architects of the Codetermination Act of 1976.158 According to the terms of reference of that Commission, the associations of employers and enterprises, on the one side, as well as the labour unions, on the other, each appointed three members to the Commission. The Commission was further composed of two neutral scholars. The Commission had been assigned the task to develop the German system of codetermination to enable it to meet the challenges of today and those emanating from European law.159 In November 2006, the representatives of the employees and the enterprises, as well as those of labour, declared that the Commission was unable to fulfil its task.160 While the representatives of labour had worked towards a refinement of German codetermination, the representatives of the employers and enterprises had pleaded for the decrease to one third of the employees participation. In view of that deadlock, the strongly truncated (three member) Commission presented its report in December 2006.161 It recommended a few minor changes of the present system.162 In summary, therefore, the Commission was unable to present persuasive proposals to the German legislature for an amendment to the present system of codetermination in Germany.

158 159

160 161 162

See Rainer Hank, ‘Vater der Mitbestimmung’ FAZ 15 Nov 2006, 18. See the article by Philipp Neumann in Die Welt (German nationwide daily neswpaper) 30 Aug 2006. Further details can be found on the Internet (keyword ). See FAZ 15 Nov 2006, 14. See FAZ 21 Dec 2006, 11. See also the Editorial by Wolfgang Bernhardt, ‘Mitbestimmung zwischen Juristentag und Biedenkopf-Kommission’ (2006) 51/52 BB DIE ERSTE SEITE and his comments, BB-Forum: Unternehmensmitbestimmung nach Biedenkopf’, (2007) BB 381 et seq.


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5.3.5.2 The Deliberations of the German Lawyers Forum Codetermination was also the subject of a convention held on 19–22 September 2006 by the German Lawyers Forum (Deutscher Juristentag). That nationwide organisation represents more than 8000 registered members from all branches of law (such as judges, public prosecutors, attorneys, in-house counsel, law officers in public administrations, lawyers working in industrial organisations, labour unions and organizations of similar kind, law teachers, legal apprentices and law students). It holds plenary meetings every second year during which specific new developments or tasks of the legislature are discussed. Its bi-annual plenary sessions are split into different sections (for example, on private law, criminal law, public law) which, at the end of their deliberations, vote on the proposals submitted to them by their reporters. One of its sections devotes itself to labour law, including codetermination. During its September session 2006, the Section on Labour Law debated the issue of ‘Codetermination on company level in view of developments in the context of European law’. A reporter163 had submitted an extensive analysis of that issue.164 In his paper he reached the conclusion that the present rules on codetermination lack flexibility and make it hard for companies subject to them to adapt their individual structures and entrepreneurial needs to the challenges of today. The reporter therefore recommended to open up the hitherto rigid rules for conventional solutions between employees and their companies. As a model for that kind of convention, the reporter referred to the solutions adopted by the European Community Directive 2001/86/EC supplementing the Statute of the European Company165 and by the Directive 2005/56/EC on cross-border mergers of limited companies.166 In September 2006, however, the approximately 300 delegates of the Section on Labour Law waived the vote on the proposals submitted by its reporter. The purpose of that waiver was to avoid an éclat imminent between the delegates representing employees and other lawyers close to them, on the one hand, and the delegates representing their companies or their sympathisers, on the other. That resolution to waive the vote was inspired by the close of the last meeting of that section during the bi-annual congress of 2004. At that meeting, the delegates representing their companies and their sympathisers had won the votes on similarly disputed issues. Thereupon the delegates representing employees and their sympathisers had left the conference hall, protesting that their adversaries

163 164

165 166

The reporter was Thomas Raiser, a law professor at the Humboldt University in Berlin. The paper comprises 116 pages and is published in Deutscher Juristentag (ed) Verhanldungen des 66. Deutschen Juristentages Stuttghart 2006, vol I Gutachten, Munich 2006, pp.B1–B116. See 6.3.2.1. See 6.4.2.

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had in an unfair manner infiltrated that section of the Forum to tilt the outcome of the votes in their favour.167

5.4 Issues Related to Supervisory Codetermination 5.4.1 Codetermination in the Management Board—the Personnel Director In certain companies, it is compulsory for the supervisory board to appoint a specific person on the management board to be responsible for matters relating to labour relations—the personnel director (Arbeitsdirektor).168 In Germany, the appointment of this person is seen as a refined form of employee participation at board level and also as part of the general concept of codetermination.169 Although designated as responsible for matters relating to labour relations, this person is considered to be a fully-fledged member (gleichberechtigtes Mitglied) of the management board in all respects170 and does not serve on the management board as a special appointment to represent the rights of the employees.171 This point is emphasised by the fact that even in corporations where there is a personnel director, all members of the management board are still jointly responsible for managing and directing the business of the corporation.172 In this sense the personnel director does not occupy any special position different from all the other members of the management board. 173 Two separate requirements apply to this person’s appointment and removal,174 namely that it must be executed in the ordinary way prescribed for all members of the management board175 and that it must be supported by an ordinary majority of the employee representatives on the supervisory board.176 This obviously provides for various possibilities. For example, the appointment or removal of this particular person will be void even if all the shareholders’ representatives (five), but only 167

168 169

170 171 172 173

174 175 176

See the brochure edited by the 66th German Lawyers Forum Stuttgart 19–22 Sept 2006, p.6 as well as FAZ 22 Sep 2006, 6. Art 33 MitbestG and Art 13 Montan-MitbesG. See Heinz Seidel, ‘Um die Ausweitung der qualifizierten Mitbestimmung (I)’ [1966] Das Mitbestimmungsgespräch 95. Art 33(1) and (2) MitbestG and Art 13(1) Montan-MitbesG. Immenga (n 77) 258. See Ss 76, 77, 78, 93 AktG. Uwe Hüffer in Kommentar zum Aktiengesetz (5th edn Verlag CH Beck, Munich 2002) 376. See also Bundesverfassungsgericht (BVerfG) (1979) 32 NJW 699, 711. See in particular Immenga (n 77) 257–58. Kübler (n 4) 406.


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two of the employee representatives, vote in favour of this appointment or removal, since the majority of the employee representatives voted against it. If three employee representatives are in favour of the appointment of a particular person, at least another four votes (from the shareholder representatives and/or the neutral person) will be required for the first round of election or removal before the person can be appointed or removed. The process of satisfying two constituencies (the supervisory board and the employee representatives on the supervisory board) ensures that the appointment and removal of these persons is acceptable to both constituencies.177 It is, however, particularly aimed at ensuring that the appointment or removal is not done against the wishes of the majority of the employee representatives on the supervisory board. This does, however, make the already complicated election process for the members of the management board even more complicated in the case of the election of the personnel director.178 In practice, this director’s position as a working member of the management board and as an indirect representative of employees (responsible for the social and personal needs of the employees),179 has not created untenable conflict of interest situations. This is apparently the case because these directors have not, in fact, sided with unions or employees against the collective view of the management board.180

5.4.2 Classification of Employees For purposes of codetermination, the German law still draws a distinction181 between two types of employees, namely: (a) Arbeitnehmer: employees; and (b) leitenden Angestellten: ‘the leading personnel’ (managers or executive employees) .182

177 178 179

180

181

182

Ibid. Cf Immenga (n 77) 257–58; Kübler (n 4) 406. BVerfG (1979) 32 NJW 699, 711. See also Peter Hanau, ‘Die arbeitsrechtliche Bedeutung des Mitbestimmungsurteils des Bundesverfassungsgerichts’ (1979) 8 ZGR 545–46. Tom Hadden Company Law and Capitalism (2nd edn Weidenfield and Nicolson, London 1977) 450. Other distinctions which are also relevant for purposes of codetermination are the distinction between male and female employees; between trade union members and nontrade union members; and between people with an interest in the corporation and those completely unrelated to the corporation. See s 28(1) Erste Wahlordnung zum Mitbestimmungsgesetz (1. WOMitbestG v. 27. Mai 2002 (BGBI. I S. 1682)).

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In the past there was also a distinction between Arbeitern: workers, labourers or workmen (so-called ‘blue-collar workers’); and Angestellten: salaried employees (so-called ‘white-collar workers’), but this distinction was abolished in 2002.183 This classification of employees is relevant to the concept of social and supervisory codetermination because German law classifies the specific persons for purposes of social codetermination (works councils and spokespersons’ committees),184 as well as for purposes of the type of employees to be elected as employee representatives to the supervisory board.185

5.4.3 The Role of Trade Unions Apart from social and supervisory codetermination, the relationship between the employer and employee is also influenced by collective bargaining. In other words, the collective interests of the employees are actually promoted along three different channels, namely social codetermination, collective bargaining and supervisory codetermination.186 Since the early 1960s the effectiveness of employee participation at board level has been realised by German trade union movements.187 In 1967, after a process of deliberation, the German Trade Union Movement (Deutschen Gewerkschaftsbundes, DGB) expressed its views on codetermination and corporation law reform.188 It aspired to achieve parity employee participation in the supervisory boards of almost all large public corporations.189

183

184 185 186

187

188

189

Press Release 15 May 2002 ‘Wahl von Arbeitnehmervertretern in Aufsichtsräte wird einfacher’ . See 5.2.2. See discussion 6.6. For academic purposes the Germans distinguish between collective bargaining (Tarifvertrag); codetermination in the enterprise (Mitbestimmung im Unternehmen); and codetermination at shop-floor level or in business (Mitbestimmung im Betrieb)— see Hanau (n 179) 540. Another distinction which is sometimes made is between workplace codetermination (betrieblichen Mitbestimmung) and enterprise or corporate codetermination (unternehmerische Mitbestimmung)—Loritz (n 4) 3; Eisenhardt (n 8) 307. The different forms of codetermination are, however, also linked to each other—Hanau (n 179) 541. See also Hanau (n 14) VII. See especially Heinz Seidel ‘Um die Ausweitung der qualifizierten Mitbestimmung (II)’ [1966] Das Mitbestimmungsgespräch 115–16. Aktienrechtsreform und Mitbestimmung—Stellungnahmen und Vorschläge, Bundesvorstand des Deutschen Gewerkschaftsbundes (1962). See Seidel (n 169) 95 (fn 3). At first, corporations were classified as large public corporations if they complied with any two of three stated requirements, namely employing more than 2000 employees, with a balance sheet sum of more than DM 50 million, and with a turrnover of DM 100 million—see Seidel (n 187) 95–96. After some further deliberation, these requirements were eventually fixed in 1966 at 2000 people employed, a balance sheet sum of more than DM 75 million, and a yearly turrnover of DM 150 million.


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Furthermore, it proposed a neutral chairperson and the appointment of a personnel director on the management board.190 The advantages of such a system of employee participation were listed as follows:191 (a) A corresponding development between the expansion of the enterprise and basic working conditions for employees; (b) ensuring that the hopes and aspirations of the employees are not neglected when the enterprise experiences financial difficulties; (c) preventing speculative over-expansion; (d) supervisory control over management by employees; and (e) the potential of directly influencing policy decisions in the undertaking. As pointed out before, the provisions of the Codetermination Act of 1976 have tilted the power balance on the supervisory board slightly towards the shareholders.192 This means that the trade unions are still not really satisfied with the Codetermination Act of 1976 and have actually drafted many concepts to express their views on codetermination.193 The dissatisfaction prevailing amongst German trade unions is based on the fact that they strive for parity employee participation, not on the fact that they do not form part of the mechanics of the system of board level representation. The current position is that the role of trade unions is recognised, since section 7(2) of the former Mitbestimmungsgesetz, 1976 and the rules of the present One Third Participation Act of 2004 provide that all companies with more than 2000 employees must have at least two or three trade union nominees on the supervisory board. In terms of Section 76(2) of the Betriebsverfassungsgesetz, 1952, companies with fewer than 2000 employees may also have an outside official on the board if the board has nine or more members.

5.5 Concluding Remarks In this chapter we have discussed the German system of supervisory codetermination by employees with a particular focus on Germany. We have explained the historical development of supervisory codetermination and how it works in practice. We have also pointed out how perceptions of codetermination have changed over time in Germany and outlined some of the fundamental and practical problems associated with codetermination. Some recent scandals like the Mannesmann 190 191 192 193

Seidel (n 169) 96. Seidel (n 187) 116–17. See 5.2.3.3, in particular footnote 43. Raiser (n 4) 122 (fn 54).

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incident and the Volkswagen incident also played a role in changing perceptions on the virtues of codetermination. In the next chapter, we continue to discuss codetermination, but the focus will shift slightly to the impact of European developments on German codetermination. Chapter 6 will serve as a bridging chapter and broad introduction to Chapter 9, where the focus will be on other developments in the European Union as well as on corporate governance in other selected jurisdictions.

Chapter 6

The Impact of European Developments on German Codetermination Otto Sandrock and Jean du Plessis

6.1 Introduction There have been some far-reaching developments in the area of corporations law in the European Union (EU) since 2001. They include: several leading decisions by the European Court of Justice (ECJ);1 the adoption of the European Council Regulation of 8 October 2001 for the establishment of the European Company (SE) accompanied by a Council Directive on employee codetermination of the same day;2 the adoption of the Directive on Cross-Border Mergers of limited liability companies of 26 October 2005;3 and the European Commission’s Action Plan of May 20034. At the same time there were some remarkable refinements of the corporate governance model in Germany. These refinements were made in anticipation of developments in the European Union. They included intense discussions on the role and effectiveness of the two-tier board system during the middle and late 1990s; reports by several commissions on corporate governance practices in Germany; the creation of a Standing Corporate Governance Commission5; several amendments to the German legislation on public limited companies (Aktiengesetz (AktG)) in 1998, 2002, and 2005; and the introduction of a German Corporate Governance Code on 22 February 2002.6 1 2 3 4 5

6

See 6.2. See 6.3. See 6.4. See 6.5. On the level of the EU, the Commission has also established the ‘European Corporate Governance Forum’ by its Decision of 15 Oct 2004 (Official Journal of the European Union 22 Oct 2004, L 321/53). See Jean J du Plessis, ‘Reflections on Some Recent Corporate Governance Reforms in Germany: A Transformation of the German Aktienrecht?’ (2003) 8 Deakin L Rev 389 ff; Jean J du Plessis, ‘The German Two-Tier Board and the German Corporate Governance Code’ (2004) 15 European Business L Rev 1139.

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Otto Sandrock and Jean du Plessis

In this chapter we consider how general company law developments, national as well as European, and in particular the striving for company law harmonisation in the European Union, have already had an impact on the German corporate governance model or could potentially exert such an impact.

6.2 Recent Decisions by the European Court of Justice (ECJ) and Their Impact on German Codetermination7 6.2.1 The Enforcement Under the Common Market Treaty of the Freedom of Settlement During recent decades the German system of codetermination has been shielded against any erosions coming from abroad by a basic German rule of conflict of laws. That conflict of laws firewall is, however, now slowly breaking down under the rulings of the ECJ. 6.2.1.1 Common Law Theory of Incorporation versus Seat Theory In this respect one has to take into account the differences regarding the rules on national conflict of laws as far as they govern commercial companies. Here we have Great Britain and most other states of the European continent at opposite ends of the scale. The theory of incorporation has for centuries been recognised in England and in most, if not all, common law states. That doctrine does not need any explanation here. In contrast to that, the so-called seat theory is prevalent in many states of the European continent, among them Germany. That doctrine has recently come under attack by Art. 43 of the European Common Market Treaty which guarantees the freedom of settlement for all EU companies, that is, for companies that can claim protection under Article 48 of that Treaty. On the basis of these provisions, several remarkable decisions have been handed down during the past years by the ECJ. The so-called seat theory had shielded, within many states on the European continent, the rules on supervisory codetermination by employees against any attempts which could possibly have been launched against them from abroad. For about a century, that theory was firmly entrenched within the rules on conflict of laws in many states of continental Europe,8 particularly within Germany.9 Any

7

8

This section is based on Otto Sandrock and Jean J du Plessis, ‘The German Corporate Governance Model in the Wake of Company Law Harmonisation in the European Union’ (2005) 26 Company Lawyer 88–95. That theory is followed, eg in France, Belgium, Luxemburg, Austria, Portugal, Spain and Greece. Cf Bernhard Großfeld, ‘Internationales Gesellschaftsrecht’ in Jan Kropholler (ed) Staudinger, Kommentar zum Bürgerlichen Gesetzbuch (de Gruyter Verlag, Berlin

The Impact of European Developments on German Codetermination

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attempts from abroad to erode the German system of supervisory codetermination by employees were therefore made pointless. Thus, until recently, that theory did an excellent job as a firewall against any attacks from outside. In a nutshell, the theory may be summarised as follows: Since the beginning of the twentieth century, German courts and the prevalent German doctrine held that a company is governed not by the law under which it has been incorporated (theory of incorporation as in English law), but by the law in effect at the place where its main (or factual) administrative headquarters is seated. The reason supporting that theory was the attempt to protect the German domestic market against companies organised under abusive foreign rules, and to have some form of control over all companies conducting their business from inside Germany. So-called pseudo-foreign companies, therefore, organised under the laws for example of Liechtenstein, Guernsey, Delaware or the Bahamas had no chance of being recognised as legal entities in Germany as long as they were administered from outside their state of incorporation, in particular from Germany itself.10 In order, for example, to acquire legal standing in German courts, those companies had to be reorganised under the laws of Germany. This also effectively barred all companies from transferring the seats of their administrations into another state without reincorporating themselves under the laws in effect at their new places of administration. When a German company, for example, wanted to transfer the seat of its administrative headquarters from Düsseldorf to a place in the Netherlands or in England where less rigid or no rules at all of codetermination are in effect, the respective shareholders’ resolution was regarded as a resolution of dissolution of the company. As a consequence of such dissolution, all hidden reserves became subject to taxation and the company had to re-organise itself under the laws of the Netherlands or of England to regain its capacity as a legal entity. All these steps made it

9

10

1998) paras 153 ff; Peter Behrens, Die Gesellschaft mit beschränkter Haftung im internationalen und europäischen Recht (2nd edn de Gruyter Verlag, Berlin 1997) 4 ff. The German courts have applied that theory since the beginning of the twentieth century, and the majority of the German legal authors applauded it. See Peter Kindler, ‘Internationales Handels- und Gesellschaftsrecht’ in Hans-Jürgen Sonnenberger (ed), Münchener Kommentar zum Bürgerlichen Gesetzbuch: Internationales Handels- und Gesellschaftsrecht, (vol 11, CH Beck Verlag, Munich 2006) paras 433 ff, 493 ff. Also Paul Rose, ‘EU Company Law Convergence Possibilities after CENTROS’ (2001) 11 Transnat’l L & Contemp Probs 126. A plethora of German legal writings on that doctrine itself and on its shortcomings has emerged in recent years. A description of its basic rules may be found in some handbooks like Gerhard Kegel and Klaus Schurig, Internationales Privatrecht (9th edn CH Beck Verlag, Munich 2004) 575 ff; Christian von Bar, Internationales Privatrecht, Volume I (vol 1, CH Beck Verlag, Munich 1991) 449 ff; Karl Firsching and Bernd von Hoffmann, Internationales Privatrecht (7th edn, CH Beck Verlag, Munich 2002) 268 ff; Jan Kropholler, Internationales Privatrecht (5th edn, Mohr and Siebeck Verlag, Tuebingen 2004) 557 ff; Kurt Siehr, Internationales Privatrecht (CF Müller Verlag, Heidelberg 2001) 304 ff. For a more detailed description Cf Großfeld (n 8) paras 141 ff; Behrens (n 8); Kindler (n 9) paras 312 ff.

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virtually impossible for a company to emigrate into another state as it was terribly uneconomical to do so.11 It is, therefore, evident that seat theory also provided to German codetermination a safe haven, providing considerable protection against all attempts by the shareholders of a company to evade the German laws. The reason is simply that if the shareholders of a company wanted to avoid German codetermination, it was useless for them to go abroad and to incorporate their company under foreign laws which would have granted to the employees of their company less codetermination or no codetermination at all, if the factual seat of the company’s administration was located within Germany. Thus companies administered in Germany (though registered abroad), had to abide by the German laws of codetermination without any chance to avoid having representatives of the employees on their supervisory boards. 6.2.1.2 Article 43 of the Common Market Treaty and Some Decisions of the European Court of Justice This state of paradise for German trade unions has recently come under attack. While some members of Germany’s business community, scholars12 and political parties had previously criticised the rigid regimes of German codetermination, this was to no avail.13 Germany was unable to modify those regimes of its own accord. It required a strong external onslaught. This onslaught came from Article 43 of the European Common Market Treaty and from some decisions of the ECJ which deeply affect the ambit and application of the German codetermination rules. Article 43(1) of the European Common Market Treaty provides that all European companies shall enjoy the right of free establishment.14 In recent years, the ECJ 11

12 13

14

And mirror-image rules had to be followed when a foreign company intended to immigrate into Germany. Some of them will be cited below in this chapter. See Jean J du Plessis and Otto Sandrock, ‘The Rise and the Fall of Supervisory Codetermination in Germany’ (2005) 16 Intl Company and Commercial L J 67–79. Art 43 of the Treaty needs to be read with Art 48 of the Treaty. Art 43 provides as follows: ‘Within the framework of the provisions set out below, restrictions on the freedom of establishment of nationals of a Member State in the territory of another Member State shall be prohibited. Such prohibition shall also apply to restrictions on the settingup of agencies, branches or subsidiaries by nationals of any Member State established in the territory of any Member State. Freedom of establishment shall include the right to take up and pursue activities as self-employed persons and to set up and manage undertakings, in particular companies or firms within the meaning of the second paragraph of Article 48, under the conditions laid down for its own nationals by the law of the country where such establishment is effected, subject to the provisions of the chapter relating to capital. ‘ Art 48 provides as follows: ‘Companies or firms formed in accordance with the law of a Member State and having their registered office, central administration or principal place of business within the Community shall, for the purposes of this Chapter, be treated in the same way as natural persons who are nationals of


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has started to enforce that Article which, until that time, had been dormant. Five decisions of the ECJ have to be mentioned in this respect: the decisions in the matters of Centros,15 Überseering,16 Inspire Art,17 Lasteyrie du Saillant,18 and Sevic.19 a) The Centros Decision In its Centros decision of 1999 the ECJ had to decide on the following facts. A Danish couple had incorporated and obtained the registration in London of Centros, a private limited company (Ltd.). The Danish promoters never had the slightest intention to do business in England. Instead they had organised Centros for the exclusive purpose to use it as a vehicle for the registration of a branch of Centros in Denmark. Through that branch the Danish couple planned to do business in Denmark. This construction had the following advantage: The two promoters avoided the payment in Denmark of a minimum share capital of about 20,000 Euros otherwise incumbent on them if they had registered their company in Denmark. With the incorporation of it in London they only had to sign up there for £100ʊand even that they did not have to pay. Despite the obvious intention of the promoters to evade the application of Danish company law, the ECJ found the incorporation of their company in London was justified under EC law and held the promoters of Centros to be entitled to register their branch in Denmark. Thereby the ECJ had assured the recognition of so-called pseudo-foreign companies within the European Community. This decision created a first challenge to the future of codetermination in Germany.20 Does that decision mean that

15

16

17

18

19 20

Member States. ‘Companies or firms’ means companies or firms constituted under civil or commercial law, including cooperative societies, and other legal persons governed by public or private law, save for those which are non-profit-making.’ ECJ 9 Mar 1999 (Case C-212/97) Centros Ltd v Erhvervs-og Selskabsstyrelsen, 1999 ECR 1–1459 (1999) 54 BB 809. ECJ 5 Nov 2002 (Case C-208/00) Ueberseering BV v Nordic Construction Company Baumanagement GmbH (NCC), (2002) 57 BB 2402. ECJ 30 Sept 2003 (Case C-167/01) Kamer van Koophandel en Fabrieken voor Amsterdam v Inspire Art Ltd, (2003) 58 BB 2195. ECJ 11 Mar 2004 (Case C-9/02) Hughes de Lasteyrie du Saillant v Ministère de l’Économie, des Finances et de l’Industrie, [2004] RIW 392. See 6.2.1.2(e). Among the great number of commentaries on this decision see Peter Kindler, ‘Niederlassungsfreiheit für Scheinauslandsgesellschaften?’ (2000) 53 NJW 1993; Heribert Hirte, ‘Die Entwicklung des Unternehmens- und Gesellschaftsrechts in Deutschland in den Jahren 1998 und 1999’ (2000) 53 NJW 3321; Horst Eidenmüller, ‘Wettbewerb der Gesellschaftsrechte in Europa’ (2002) 23 ZIP 2233; Christian Kersting, ‘Corporate Choice of LawʊA Comparison of the United States and European Systems and a Proposal for a European Directive (2002) 28 Brooklyn J Intl L 1, 13 ff; Marc-Philippe Weller, ‘Scheinauslandsgesellschaften nach Centros, Überseering und Inspire Art’ (2003) 23 IPRax 207; Peter Kindler, ‘Auf dem Weg zur Europäischen Briefkastengesellschaft?’

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companies incorporated, for example, under the laws of Englandʊa state whose laws do not have a rigid codetermination arrangement like the German law21ʊwere entitled to do business exclusively through a branch registered in Germany without being subject to the German laws of codetermination?22 It seemed that the ECJ had answered that question in the affirmative.23 For the ECJ had ruled: … the fact that a national of a Member State who wishes to set up a company chooses to form it in the Member State whose rules of company law seem to him the least restrictive and to set up branches in other Member States cannot, in itself, constitute an abuse of the right of establishment. The right to form a company in accordance with the law of a Member State and to set up branches in other Member States is inherent in the exercise, in a single market, of the freedom of establishment guaranteed by the Treaty.24 But some opponents of such a sweeping interpretation of the Common Market’s right of establishment argued that the application of the dicta of the Centros decision had to be restricted to those factual situations in which a company incorporated in one state intended to carry on business in another through a branch, and other opponents tried to limit the purview of that decision to cases where the state of incorporation, as well as the state in which the branch had been registered, were following the theory of incorporation as is the case in England as well as the Netherlands.25

21

22 23

24

25

(2003) 56 NJW 1073; Otto Sandrock, ‘Die Schrumpfung der Überlagerungstheorie’ (2003) 102 ZvglRWiss 447, 452 ff. As to the different national regimes established in the member states of the EU with regard to employees’ codetermination, see the collection of articles in Theodor Baums and Peter Ulmer (eds), Unternehmensmitbestimmung der Arbeitnehmer im Recht der EU-Mitgliedstaaten/ Employees’ Co-Determination in the Member States of the European Union (Verlag Recht und Wirtschaft GmbH, Heidelberg 2004). The Centros decision was open to several interpretations. See Rose (n 9) 121. Jens C Dammann, ‘The Future of Codetermination after CENTROS: Will German Corporate Law Move Closer to the US Model?’ (2003) 8 Fordham Journal of Corporate and Financial Law 607, para 617 summarises the Centros judgement as follows: ‘It is contrary to Articles [43 (ex-Article 52)] and [46 (ex-Article 58)] of the EC Treaty for a Member State to refuse to register a branch of a company formed in accordance with the law of another Member State in which it has its registered office but in which it conducts no business where the branch is intended to enable the company in question to carry on its entire business in the State in which that branch is to be created, while avoiding the need to form a company there, thus evading application of the rules governing the formation of companies which, in that State, are more restrictive as regards paying of a minimum share capital.’ ECJ 9 Mar 1999 (Case C-212/97) Centros Ltd v Erhvervs-og Selskabsstyrelsen, 1999 ECR 1–1459 no 27 (1999) 54 BB 809. See, among others, Kindler 2000 (n 20) 1993; Kindler 2003 (n 20) 1073.


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b) The Überseering Decision The ECJ confirmed the line of jurisprudence which its Centros decision had taken, in its Überseering decision handed down more than three years later, in 2002.26 In that case, the Dutch shareholders of Überseering, a Dutch limited company carrying on business in Germany, had sold the shares in their company to German nationals. The purchasers were residents of Düsseldorf. They continued to carry on Überseering’s business from their residence in Düsseldorf. The German Supreme Court in Civil Matters had to decide on a complaint raised by Überseering against one of its customers. The defendant had argued that Überseering lacked legal standing since it was incorporated in the Netherlands, but administered from within Germany. The Court until then had followed the seat theory. Under that theory it would have had to deny the legal standing of the plaintiff. The Court was in doubt, however, as to whether that conclusion was compatible with the freedom of settlement under the Common Law Treaty. It therefore requested the ECJ pursuant to Article 234 of the Treaty to give a preliminary ruling on that question.27 The ECJ found that Überseering had not lost, but kept its juristic personality when it started to be managed from Germany. During the proceedings before the ECJ, the German Governmentʊin a kind of amicus curiae briefʊhad argued against the legal standing of Überseering that the seat theory followed by Germany was supposed to protect also the interests of the employees in their codetermination at supervisory board level and that this principle should not be eroded. The ECJ commented as follows on that argument of the German Government.28 Application of the company seat principle is also justified by employee protection through the joint management of undertakings on conditions determined by law. The German Government argues that the transfer to Germany of the actual centre of administration of a company incorporated under the law of another Member State could, if the company continued to be a company incorporated under that law, involve a risk of circumvention of the German provisions on joint management, which allow the employees, in certain circum26

27 28

ECJ 5 Nov 2002 (Case C-208/00) Ueberseering BV v Nordic Construction Company Baumanagement GmbH (NCC), (2002) 57 BB 2402. Published in (2000) 20 IPRax 423 and [2000] RIW 555. See the commentaries by Werner Ebke, ‘Überseering: Die wahre Liberalität ist Anerkennung’ (2003) 58 JZ 927; Daniel Zimmer, ‘Wie es Euch gefällt? Offene Fragen nach dem Überseering-Urteil des EuGH’ (2003) 58 BB 1; Erich Schanze and Andreas Jüttner, ‘Anerkennung und Kontrolle ausländischer GesellschaftenʊRechtslage und Perspektiven nach der Überseering-Entscheidung des EuGH’ (2003) 48 AG 30; Stefan Leible and Jochen Hoffmann, ‘Überseering und das (vermeintliche) Ende der Sitztheorie’ [2002] RIW 925; Wienand Meilicke, ‘Die Niederlassungsfreiheit nach ‘Überseering’ (2003) 94 GmbHR 793; Walter G Paefgen, ‘Auslandsgesellschaften und Durchsetzung deutscher Schutzinteressen nach ‘Überseering’ (2003) 56 DB 487.

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stances, to be represented on the company’s supervisory board. Companies in other Member States do not always have such a body. It is true that the ECJ, in responding to the German Government’s response, was cautious in pointing out as follows:29 It is not inconceivable that overriding requirements relating to the general interest, such as the protection of the interests of … employees ... may, in certain circumstances and subject to certain conditions, justify restrictions on freedom of establishment. But, with respect to the case before it, the ECJ concluded in no uncertain terms:30 Such objectives cannot, however, justify denying the legal capacity and, consequently, the capacity to be a party to legal proceedings of a company properly incorporated in another Member State in which it has its registered office. Such a measure is tantamount to an outright negation of the freedom of establishment conferred on companies by Articles 43 EC and 48 EC. After Überseering, it became evident that, in the opinion of the ECJ, the guarantee of the freedom of establishment enshrined in Article 43 of the Common Market Treaty could override the German rules on codetermination. Thus the advocates of the seat theory could no longer assert that a company registered abroad but administered from within Germany, would under all circumstances whatsoever be subject to the German regimes of codetermination. That assertion had certainly become untenable. But it was still an open question as to whether, in certain cases, Germany’s general interestʊwhatever that notion would includeʊwould justify the application of the German rules on codetermination on a company registered abroad. c) The Inspire Art Decision The codetermination à la Germany got another blow with the decision of the ECJ in the matter of Inspire Art.31 That judgement was handed down in September 2003 on the following facts.32 Inspire Art Ltd had been incorporated and registered 29

30 31

32

ECJ 5 Nov 2002 (Case C-208/00) Ueberseering BV v Nordic Construction Company Baumanagement GmbH (NCC), no 92 (2002) 57 BB 2402. Ibid. ECJ 30 Sep 2003 (Case C-167/01) Kamer van Koophandel en Fabrieken voor Amsterdam v Inspire Art Ltd, (2003) 58 BB 2195. See the commentaries on that decision by Christian Kersting and Clemens Ph. Schindler, ‘The ECJ’s Inspire Art Decision of 30 September 2003 and its Effects on Practice’ (2003) 4 German L J 1277; Peter Behrens, ‘Das Internationale Gesellschaftsrecht nach dem Überseering-Urteil des EuGH und den Schlußanträgen zu Inspire Art’ (2003) 23 IPRax 193; Daniel Zimmer, ‘Nach ‘Inspire Art’: Grenzenlose Gestaltungsfreiheit für deutsche Unternehmen?’ (2003) 56 NJW 3585; Gerold Spindler and Olaf Berner, ‘In-


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in England where, however, it did not deploy any business activities. But it conducted its business, trading in objects of art, exclusively in the Netherlands where it had established a branch and applied for the registration of this branch. Its only director was a resident of The Hague. The Netherlands follow the theory of incorporation with the modification, however, that foreign companies which conduct their business exclusively or preponderantly in the Netherlands without having any ties to their country of incorporation, have to comply with some special duties imposed upon them by the Wet op de Formeel Buitenlandse Vennootschappen (WFBV) (Statute on Formal Foreign Companies). These duties provide, inter alia, that the business name of such a company must contain the addendum ‘foreign in form’; that such a company must quote this addendum on all its business letters; that such a company has to possess a registered minimum capital which would correspond to the minimum capital required under Dutch law. Inspire Art Ltd regarded these special duties as a violation of its freedom of establishment under the Common Market Treaty. The ECJ held in favour of Inspire Art Ltd. It found as follows:33 The answer to be given … must therefore be that the impediment to the freedom of establishment guaranteed by the Treaty constituted by provisions of national law, such as those at issue, relating to minimum capital and the personal joint and several liability of directors cannot be justified under Article 46 EC, or on grounds of protecting creditors, or combating improper recourse to freedom of establishment or safeguarding fairness in business dealings or the efficiency of tax inspections. Although the ECJ in the case of Inspire Art did not directly deal with any subject of codetermination, it clearly appears from the spirit of the rulings that laws which would impose codetermination on a foreign company which, by its law of incorporation, would not be subject to such a regime, would restrict the freedom of establishment guaranteed by Article 43 of the Common Market Treaty; that such restriction could hardly be justified by any pursuit of the common weal; and that any regime of codetermination could therefore not be imposed, by German legislation, on a company incorporated under a foreign law.

33

spire ArtʊDer europäische Wettbewerb um das Gesellschaftsrecht ist endgültig eröffnet’ [2003] RIW 949; Stefan Leible and Jochen Hoffmann, ‘Wie inspiriert ist ‘Inspire Art’?’ (2003) EuZW 677; Erich Schanze and Andreas Jüttner, ‘Die Entscheidung für Pluralität: Kollisionsrecht und Gesellschaftsrecht nach der EuGH-Entscheidung ‘Inspire Art’ (2003) 48 AG 661; Silja Maul and Claudia Schmidt, ‘Inspire ArtʊQuo vadis Sitztheorie?’ (2003) 58 BB 2297. ECJ 30 Sep 2003 (Case C-167/01) Kamer van Koophandel en Fabrieken voor Amsterdam v Inspire Art Ltd, no 142 (2003) 58 BB 2195.

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d) The Lasteyrie du Saillant Decision In March 2004, the ECJ handed down another decision34 which has still further invigorated the freedom of establishment under Article 43 of the Common Market Treaty. Though it deals only with taxation matters, it leaves no doubt that the ECJ intends to continue its course of clearing away as much as possible all obstacles still impeding freedom of establishment.35 The plaintiff, Hughes de Laysteyrie du Saillant, a Frenchman hitherto residing in France, had moved to Belgium in September 1998. Together with members of his family he held more than 25 per cent of the shares in a French company. Upon his move to Belgium, the French tax authorities imposed a capital gains tax on him calculated on the difference between the price for which the claimant had bought the shares and the market value of the shares at the time of his move to Belgium. The ECJ held that such taxation was violating Article 43 of the Common Market Treaty and stated: A taxpayer wishing to transfer his tax residence outside French territory, in exercise of the right guaranteed to him by Article 52 [now 43] of the Treaty, is subjected to disadvantageous treatment in comparison with a person who maintains his residence in France. That taxpayer becomes liable, simply by reason of such a transfer, to tax on income which has not yet been realised and which he therefore does not have, whereas, if he remained in France, increases in value would become taxable only when, and to the extent that, they were actually realised. That difference in treatment concerning the taxation of increases in value, which is capable of having considerable repercussions on the assets of a taxpayer wishing to transfer his tax residence outside France, is likely to discourage a taxpayer from carrying out such a transfer. e) The Sevic Decision On 13 December 2005, the ECJ handed down a judgement in the matter of SEVIC Systems AG.36 That judgement deals with the freedom of European companies to perform cross-border mergers. Cross-border mergers will, however, be the subject 34

35

36

ECJ 11 Mar 2004 (Case C-9/02) Hughes de Lasteyrie du Saillant v Ministère de l’Économie, des Finances et de l’Industrie, [2004] RIW 392. See the commentaries by Gerhard Kraft and Markus Müller, ‘Schlußfolgerungen aus der EuGH-Entscheidung zur französischen Wegzugsbesteuerung (Saillant) für die internationale Steuerberatungspraxis aus deutscher Sicht’ [2004] RIW 366; Klaus Eicker, ‘Commentary’ [2004] EWS 186. In Germany, the taxation of persons transferring their residence abroad is framed similarly. As a consequence of the ECJ decision, the European Commission has demanded the German Government to change its laws accordingly (FAZ 20 April 2004, 12. Case C-41/03, [2005] ECR I-10805.


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of a subsequent section of this chapter.37 Further details of this judgement are provided in that section.

6.2.2 The Impact of These Decisions on the National Laws of the European Community Member States Obviously, the ECJ is determined to enable all EU citizen companies to freely excise their right of settlement within the European Union irrespective of the obstacles impeding that fundamental right. It can hardly be doubted that it would also declare the German legislation on codetermination by employees as incompatible with Article 43 of the Common Market Treaty wherever that legislation would encroach upon the freedom of settlement. It seems, therefore, now well established in the European Union that if a company was incorporated in one Member State, but conducting its main business in another Member State, the Member State in which the country conducts its main business cannot enforce its own law, for example the law applicable to codetermination, on that company.38 6.2.2.1 The Conversion of German Courts to the Doctrine of Incorporation German courts have already drawn a basic conclusion from the jurisprudence of the ECJ, as can be seen from the following judgement of the German Surpeme Court in 2005. a) The judgement by the German Supreme Court in Civil Matters (‘Bundesgerichtshof (BGH) in Zivilsachen’) of 14 March 2005 In a judgement of 14 March 2005,39 the German Supreme Court in Civil Matters (BGH) followed the jurisprudence of the ECJ in such a sweeping way that the conclusion is inevitable that it will, in general, apply the law of incorporation in the future. It is therefore not exaggerated to say that the BGH has converted to the theory of incorporation.40

37 38

39

40

See 6.4.1. Otto Sandrock, ‘Gehören die deutschen Regelungen über die Mitbestimmung auf Unternehmensebene wirklich zum deutschen ordre public?’ (2004) 49 AG 57, 65; Martin Veit and Joachem Wichert, ‘Unternehmerische Mitbestimmung bei europäischen Kapitalgesellschaften mit Verwaltungssitz in Deutschland nach “Überseering” und “Inspire Art”‘(2004) 49 AG 14–15, 17. See (2005) 60 BB 1016 ff; (2005) 58 NJW 1648 ff; [2005] RIW 542 ff. The BGH was followed by the Court of Appeals (Oberlandesgericht) Hamm, (2006) 61 BB 24 ff which extended the purview of the theory of incorporation even to companies from non-EU-States. See Otto Sandrock, ‘Niederlassungsfreiheit und Internationales Gesellschaftsrecht’ [2005] EWS 529 ff.

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The BGH had to decide on the following facts: An English letter-box firm (‘Briefkastengesellschaft’), incorporated as a limited public company, had the seat of its administration in Germany where it also carried on its business exclusively. The public company had been registered in England in February 2000. Soon thereafter it became insolvent. A German creditor had acquired a claim against it from a transaction he had entered into with the managing director of the public company. He had submitted a motion to a German court for opening up insolvency proceedings. That motion had been dismissed for want of assets. The German creditor therefore had introduced that claim against the managing director before the appropriate German court. The BGH chose not to follow the seat doctrine, hitherto acknowledged by German courts, and did not apply German company law to the question as to whether the managing director was liable or not. Instead, it remanded the case to the lower court to enable the claimant to base its claim on the pertinent rules of English company law. In its judgement the BGH referred to the recent jurisprudence of the ECJ and made a few important remarks. As to the argument that the promoters of the public company had incorporated it merely with the intention to avoid having to pay up the considerable minimum capital required under German law, the Court explained as follows41: … making consciously use of different systems of law does not in itself represent an abuse [of the freedom of establishment], even if that action is solely and openly aimed at gaining a ‘maximum of freedom’ and if it is carried out with the intention to circumvent mandatory domestic rules by organising a foreign letter-box company. As to the requirement to pay a minimum capital under the otherwise applicable German company law, the BGH made the following remarks42 In consequence, neither Art. 46 of the Common Market Treaty nor the need to protect the creditors of the company, the struggle against the abusive utilization of the freedom of establishment or the need to maintain a fair trade justify a restriction of the freedom of establishment guaranteed by the Treaty, restrictions that would otherwise result from the application of the domestic rules on the minimum capital and the personal … liability of the managing director. b) Consequences flowing from that decision This new jurisprudence by the BGH would indeed make it possible for a German corporation, not wanting to adopt a two-tier board system or not wanting to be regulated by the German law regarding codetermination, to incorporate in a Member State where a two-tier board system and codetermination are not required, but still 41 42

Sub II 2 b of the reasons of the judgement. Ibid.


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to conduct its business primarily in Germany. This interpretation of the European Union law, and the fact that international investors are often discouraged from investing in large German corporations because of codetermination,43 provide some serious challenges for the German two-tier board and codetermination by employees at supervisory board level in future.44 6.2.2.2 German Companies Transform Themselves into English Public Limited Companies (PLCs) Germany already has seen two spectacular cases of transformation into English public limited companies (PLCs): The two German airlines ‘Air Berlin’ and ‘Alltours’, formerly organised as Aktiengesellschaften (AGs) under German law, have transformed into English PLCs with the explicit purpose of avoiding the rigid and complicated rules of German codetermination which, in the minds of their shareholders, hampered their managements too much in their freedom of action.45 It is to be expected that other companies will follow suit, but probably trying to prevent drawing too much attention to these moves as the German Trade Unions have already reacted to the moves of ‘Air Berlin’ and ‘Alltours’: they have prohibited their officers from using these airlines.46 It therefore seems the logical thing to take a low-profile approach in order to prevent waking up sleeping dogs! It is true that there is now a trend among German businesspeople to organise limited companies in accordance with English law. Thirty thousand English limited companies are reported to have been incorporated during recent years by German craftspeople and businesspeople. But as a rule these companies are small and therefore do not have, and cannot have, a supervisory board. The main motivation behind this emigration to England and other foreign countries is not to avoid German rules of codetermination, but rather to evade the German rules on the minimum capital which has to be paid if incorporated under German law.47 43

44

45

46 47

Elke Bohl, ‘Die Mitbestimmung irritiert die ausländischer Investoren’ FAZ 20 Sept 2003, 14. See also Veit and Wichert (n 38) 17 (fn 39); Peter Ulmer, ‘Editorial: Paritätische Arbeitnehmermitbestimmung im Aufsichtsrat von Großunternehmen—noch zeitgemäß?’ (2002) 166 ZHR 271, 273–274; Hans-Christoph Hirt, ‘Germany: The German Corporate Governance Code: Co-determination and Corporate Governance Reforms’ (2002) 23 Company Lawyer 349, 355. Dammann (n 23) 607 paras 685–86 argues that there are ways in which the German legislature could circumvent the negative consequences of the Centros decision on codetermination. See Volker Triebel and Christopher Horton, ‘Will more English plcs take off in Germany?’ [2006] Intl Financial L Rev 35 ff; FAZ 18 Aug 2006, 14; FAZ 13 Sept 2006, 22. See previous footnote. There is a vast literature on this topic in Germany. Among many others see Klaus J Müller, ‘Die englische Limited in Deutschland—für welche Unternehmen ist sie tatsächlich geeignet?’ (2006) 61 BB 837 ff; Jochen Dierksmeyer, ‘Die englische Ltd in Deutschland—Haftungsrisiko für Berater’ (2006) 61 BB 1516, 1518 ff; Gerhard Wegen/Johannes

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6.2.2.3 The Proposal by a German Government Commission for New Statutory Regulations on International Company Law In matters of conflict of laws, the German Federal Government often asks to be advised by the ‘German Council for Conflicts of Laws’ (Deutscher Rat für Internationales Privatrecht). That organisation works under the auspices of the German Federal Ministry of Justice and is composed mostly of German law teachers and of the officers of the Ministry who are in charge of the respective issue. In 2003 the German Ministry initiated the formation of a special Committee to work out a draft, not only for domestic rules of conflict of laws applicable to companies and partnerships, but also a proposal for a for regulation at the European level.48 At the beginning of 2006, the Commission tabled its draft for an autonomous German ‘Regulation of International Company Law’ (including partnerships) as well as its ‘Proposal for a Regulation of the European Parliament and the Council on the law applicable to companies’.49 The contents of both proposals are almost identical. In the following part, therefore, we deal only with the proposal relating to German domestic law which is proposed to be inserted into the Introductory Act to the German Civil Code. The numbers of the draft articles therefore correspond to that Introductory Act. Article 10 paragraph (2) of the draft provides that companies shall be subject to the law of the country in which they have incorporated and where they were entered into a public register. Since such a register is commonly held at the place of incorporation, this article represents a clear and unmistakable conversion to the doctrine of incorporation. Article 10a of the Proposal defines a wide scope of application for the rules in effect at the place of incorporation.50 It is true that the issue of codetermination is not expressly dealt with by these rules, but it follows from the entire context of the Proposal that the composition of the supervisory board of a company is also governed by the law in effect at the place of incorporation. This means that companies registered abroad but administered from within Germany are subject to the codetermination rules at their foreign places of incorporation but not to the domestic German rules of codetermination, that is, not by the rules in effect at their administrative headquarters (Germany). This has to be noted as a remarkable step in Germany’s path towards more liberal labour—and codetermination—rules.

48

49

50

Schlichte, ‘GmbH oder EU-inländische Gesellschaft—die Qual der Wahl für Unternehmer und Berater in der Praxis’ (2006) 52 RIW 801 ff. The German co-author of this Chapter, Otto Sandrock, has been a member of that Committee. Both Proposals with the reasons attached to them by the Commission are published in (2006) RIW, Beilage 1 to issue 4, April 2006. It provides that, inter alia, the following shall be ruled by the law in effect at the place of incorporation: a company’s legal nature and legal capacity; its formation, reorganisation, and dissolution; its name or company name; its organisational and financial constitution; the power of representation of its bodies.


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6.3 The Creation of the European Company (SE) and the Regulation of Its Codetermination 6.3.1 Stormy History The creation of the European Company (SE) and the regulation of its codetermination are embedded in the general history of European company harmonisation. That harmonisation had a stormy history, in particular because of the concept of employee or worker participation and the conflict between the traditional UK onetier board system and the two-tier board system in effect in some states on the European continent.51 These different approaches were the primary reason why the Draft Fifth Directive was never implemented in the European Union.52 Further, since 2001 there have been several developments in the European Union creating new challenges for the future existence of the two-tier board system and employee participation. In this regard we have to deal with the adoption of the European Council Regulation of 8 October 2001 for the establishment of the European Company (SE) accompanied by a Council Directive on codetermination by employees of the same day,53 with the Directive on Cross-Border Mergers with Share Capital of 26 October 200554 and, finally, with the European Commission’s Action Plan of May 2003.55

6.3.2 European Companies and Codetermination— Specific Arrangements 6.3.2.1 The Pertinent Rules The European Council Regulation of 8 October 2001 on the Statute for a European company (SE) (hereinafter SE Regulation) has the potential of affecting views on the two-tier board system and codetermination in the European Union.56 The Regulation became operative on 8 October 2004.57 Article 1 paragraph 4 of 51

52

53 54 55 56

57

For a survey on some member states of the European Union see Peter Ulmer, ‘Generalbericht’ in Baums and Ulmer (n 21) 59 (fn 17) and 166 ff. Jean J du Plessis and J Dine, ‘The Fate of the Draft Fifth Directive on Company Law: Accommodation instead of Harmonisation’ (1997) JBL 23 ff. See also Judith Marychurch, ‘Harmonisation or Proliferation of Corporations Law in the European Union?’ (2002) Australian Intl L J 80, 82–83 and 94. See 6.3.2.1. See 6.4.2. See 6.5. Council Regulation (EC) 2157/2001 on the Statute for a European Company (SE), 8 Oct 2001 OJ L294/1. See Marychurch (n 52) 80–84 for the historical development of the SE. See Art 70 of the SE Employees’ Directive (see below fn 58). See also George F Thoma and Dieter Leuering, ‘Die Europäische Aktiengesellschaft—Societas Europaea’

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that Regulation provides: ‘Employee involvement in an SE shall be governed by the provisions of Directive 2001/86/EC.’ Accordingly, a Directive supplementing the Statute for the SE with regard to the involvement of employees was passed on the same day (hereinafter SE Employees’ Directive).58 That latter Directive whose addressees are the Member States of the EU59 came into effect on 10 November 2001.60 Germany implemented the SE Regulation and the Directive by a Statute of 22 December 2004.61 The primary aim of the Regulation and the Directive is to ensure that different employee participation models of the different Member States are protected.62 In this regard, the basic provision of Article 38(b) of the SE Regulation leaves the Member States the choice between ‘either a supervisory organ and a management organ (two-tier system) or an administrative organ (one-tier system) depending on the form adopted in the statutes’ of the SEs. Under the regime of the two-tier system, Article 40(3) of the SE Regulation provides that ‘[t]he number of members of the supervisory organ or the rules for determining it shall be laid down in the statutes’ of the SEs. A similar rule is laid down, for one-tier systems in Article 43(2) of the SE Regulation. Thus, the SE Regulation respects the wide diversity between the laws of the Member States, not only with regard to the basic organisation of the supervisory boards (one-tier versus

58 59

60 61

62

(2002) 55 NJW 1449. In Germany the enabling legislation for the SE was first considered on 28 Feb 2003—see Diskussionsentwurf ‘SE-Einführungsgesetz (SEEG)’ (2003) 7 NZG (Sonderbeilage); Johannes Gruber and Marc-Philippe Weller, ‘Societas Europaea: Mitbestimmung ohne Aufsichtsrat?’ (2003) 6 NZG 297. Official Journal of the European Union no. 294 of 10 Nov 2001, 22–33. See SE Employees’ Dir Art 17. On 26 May 2004 the German Federal Government submitted to the Parliament a voluminous bill for the introduction of the SE in Germany: ‘Gesetz zur Ausführung der Verordnung (EG) Nr. 2157/2001 des Rates vom 8. Oktober 2001 über das Statut der Europäischen Gesellschaft (SE)ʊ(SEAusführungsgesetzʊSEAG)’. See SE Employees’ Dir Art 16. See Bundesgesetzblatt (Official Journal of the Republic of Germany) 2004 part I, 367 ff. The Statute’s Art I implements the SE Regulation (‘SE-Ausführungs-Gesetz’) while its Art II deals with the codetermination of the employees (SE-.BeteiligungsGesetz). As to a general survey on the SE Directive see Andreas Kellerhals and Dirk Trüten, ‘The Creation of the European Company’ (2002) 17 Tulane European and Civil Law Forum 71; Peter Hommelhoff, ‘Einige Bemerkungen zur Organisationsverfassung der Europäischen Aktiengesellschaft’ (2001) 46 AG 279; Günter Christian Schwarz, ‘Zum Statut der Europäischen Aktiengesellschaft’ (2001) 22 ZIP 1847; Hartwin Bungert and Constantin H Beier, ‘Die Europäische Aktiengesellschaft’ (2002) EWS 1; Heribert Hirte, ‘Die Europäische Aktiengesellschaft’ (2002) 5 NZG 1; Christoph Teichmann, ‘Die Einführung der Europäischen AktiengesellschaftʊGrundlagen der Ergänzung des Europäischen Statuts durch den deutschen Gesetzgeber’ (2002) 31 ZGR 383; Thoma and Leuering (n 57) 1449.


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two-tier system), but also with regard to the codetermination rules established in each Member State of the European Union. Based on that openness, the SE Employees’ Directive63 even enhances the freedom of the SEs to choose the individual shapes of their codetermination systems. Article 3(1) of the SE Employees’ Directive obliges the management (in a one-tier system) or the administrative organ (in a two-tier system) to start negotiations with the representatives of the companies’ employees on arrangements for the involvement of employees in the SE. For that purpose, a Special Negotiating Body representative of the employees of the participating companies shall be created under Article 3(2) of that Directive. Special rulesʊbordering on the ridiculousness64ʊhave been laid down in provisions prescribing the further composition of the Special Negotiating Body, its proceedings and its functioning (Article 3). Other aspects that are also regulated include the mandatory contents of the agreements to be negotiated with the competent organs of the participating companies, which must include the number of members and the allocation of its seats (Article 4); the duration of the negotiations (Article 5); the legislations applicable to the negotiation procedure (Article 6); and the standard rules to be issued by the Member States of the European Union on employees’ involvement (Article 7) which as a general rule has to satisfy the respective provisions set out in the Annex of the Directive. Finally, the SE Employees’ Directive specifically provides in Article 3 paragraph 7 that ‘any expenses relating to the functioning of the special negotiating body and, in general, to negotiations shall be borne by the participating companies so as to enable the special negotiating body to carry out its task in an appropriate manner.’ If no agreement can be reached by the deadline laid down in Article 5,65 then the Standard Rules contained in the Annex to the Directive would apply. The Annex to the Directive contains provisions on the composition of the Representative Body (Part 1); standard rules for information and consultation with the Representative Body (Part 2); and standard rules for employee participation in cases where there is already such participation under the local laws of one of the Member States (Part 3).66

63

64

65 66

As to a general survey on the SE Employees’ Directive—see Meinhard Heinze, ‘Die Europäische Aktiengesellschaft’ (2002) 31 ZGR 66; Sorika Pluskat, ‘Die neuen Vorschläge für die Europäische Aktiengesellschaft’ (2001) EuZW 524; Ebba HerfsRöttgen, ‘Arbeitnehmerbeteiligung in der Europäischen Aktiengesellschaft’ [2001] NZA 424; Manfred Weiß, ‘Arbeitnehmermitwirkung in Europa’ [2003] NZA 177. Friedrich Kübler, ‘Leitungsstrukturen der Aktiengesellschaftz und die Umsetzung des SE-Statuts’ (2001) 165 ZHR 224 characterises these provisions as ‘mit einer die Grenzen der Skurrilität streifenden Akribie festgelegt’. For further details see SE Employees’ Directive Art 7 para 1 sub-para 2. See generally Veit and Wichert (n 38) 19.

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The last-mentioned Rules in Part 3 are most interesting. Article 3(a) provides, first, that, in the case of an SE established by transformation, all aspects of employee participation shall continue to apply to the SE, if the rules of a Member State relating to employee participation in the administrative or supervisory body applied to the former company before its transformation into the SE. Reference is made in this respect to the most important Article 3(b) which, secondly, though embodied in the almost last paragraph of the rather voluminous Directive, contains its most important rule by determining as follows: In other cases of the establishing of an SE, the employees of the SE, its subsidiaries, and establishments and/or their representative body shall have the right to elect, appoint, recommend or oppose the appointment of a number of members of the administrative or supervisory body of the SE equal to the highest proportion in force in the participating companies concerned before registration of the SE. In this sentence the words ‘equal to the highest proportion’ reveal the whole truth. They leave no doubt: If the negotiations between the companies and the employees’ representatives fail, then the employees’ codetermination will not be curtailedʊin comparison to the state before the formation of the SEʊby the creation of an SE provided that the employees’ representatives reach no agreement in their negotiations within the Special Negotiating Body. Thus, in the last resort, the employeesʊparticularly of German SEsʊcan never lose. They may let the negotiations come to nothing and remain happy on the return of the kind of codetermination in effect before the SE was formed. 6.3.2.2 Initial Assessment In summary, this means that it is inevitable that there will be at least some form of employee participation for all SEs, either as agreed upon67 or contained in the Annex to the Directive. The interesting aspect is that the SE Regulation and the Employees’ Directive enshrined some form of codetermination, but did not do so specifically in the context of the typical German two-tier board system. It is thus 67

The agreement could apparently be to exclude any form of codetermination, which will probably be the case with most non-German SEs, but it will hardly be possible for a dominant German company to escape a German-type of codetermination as it is unlikely that the Trade Unions will agree that codetermination is excluded completely. Klaus J Hopt, ‘Unternehmensführung, Unternehmenskontrolle, Modernisierung des Aktienrechts—Zum Bericht der Regierungskommission Corporate Governance’ in Peter Hommelhoff, Marcus Lutter, Karsten Schmidt, Wolfgang Schön, Peter Ulmer (eds) Corporate Governance: Gemeinschaftssymposion der Zeitschriften ZHR/ZGR (Verlag Recht und Wirtschaft GmbH, Heidelberg 2002) 42 argues that this may once again give dominant German SEs a disadvantage in comparison with other SEs in the European Union.


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possibleʊthough rather improbableʊeven for German corporations that want to convert into an SE, that agreement could be reached with the Special Negotiating Body not to use a two-tier board system. Companies cannot, however, opt out of some form of employee participation, clearly with the German codetermination model in mind.68 It is because of this arrangement that it has been argued that the SE is a corporate form that will have codetermination without necessarily having a supervisory board.69 6.3.2.3 The Acceptance by National Companies in Europe of the SE The SE has not been a great legislative success so far. National companies in Europe hesitate to transform into that form of company. Certainly, the lengthy and difficult rules on codetermination exert a deterrent effect on prospective national companies.70 The first to incorporate as an SE was the company which is to build and operate the tunnel over the Brenner pass between Austria and Italy. Its incorporation as an SE had been agreed on by an international convention between the two states. A series of other companies hitherto organised as national companies have either already carried out their transformation into an SE or have announced their intention to do so in the near future.71 But their number is rather low: altogether there are only about fifteen. It seems that some national companies intend to transform into an SE because this would enable them to have a small one-tier board (though that board would have to include one or more employee representatives). Obviously, this appears as an advantage which would compensate the unavoidable disadvantages connected with the rules on codetermination. A small one-tier board which would replace not only a management board but also a large supervisory board indeed seems to be an attractive feature of the SE.

68 69 70

71

See Hopt (n 67) 42. Gruber and Weller (n 57) 297 ff. See Jens Wagner, ‘Praktische Erfahrungen mit der Europäischen Aktiengesellschaft’ [2005] EWS 548 ff. See also FAZ 2 Feb 2005, 23; and 5 Aug 2005, 11. As far as can be seen, the following companies have to be mentioned: (i) from Germany: Zoll Pool Hafen Hamburg (the customs authority at the seaport of Hamburg); Go-East-Invest Co: the large Allianz AG as the holding of its many insurance subsidiaries; the Fresenius AG (a worldwide provider of medical services); (ii) from Austria: the STRABAG AG (a holding of construction companies); the Neumann Partners AG (a management consulting company); (iii) from Scandinavia: the Nordea (a finance company) and the Alfred Berg (ABN Amro) (a bank); from (iv) France: The Mazars company (an accounting company); (v) from Great Britain: the Schering Plough Clinical Trials (a pharmaceutical company); (vi) from the Netherlands: the MPIT Structure Financial Services; and (vi) from Finland: the Elocteq Network Corporation (an electrical equipment company. See FAZ 5 Aug 2005, 11.

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6.4 Cross-Border Mergers of Limited Companies Cross-border mergers of limited companies have been fostered by two events almost at the same time: by the judgement of the European Court of Justice of 13 December 2005 in the matter of SEVIC Systems AG72 and by the Directive 2005/56/EC of 26 October 2005 on cross-border mergers of limited companies.73

6.4.1 The Sevic Decision by the European Court of Justice74 The facts upon which the ECJ had to decide were as follows: The German SEVIC systems AG had agreed to merge with the Security Vision Concept SA organised and seated in Luxembourg. But the German court at the seat of the SEVIC AG refused to enter the merger into the register. The court pointed out that the German Act on Transformation of Companies (Umwandlungsgesetz) indeed allowed a company to dissolve without liquidation and to transfer the whole of its assets to another company but that such a merger was permissible only between German companies whereas it was not allowed where a foreign company was involved in the merger. The district court, on appeal, asked the ECJ to decide as to whether the different treatment of German and foreign companies was compatible with Articles 43 and 48 of the Common Market Treaty. The ECJ first stated that the German Act did not apply to transformations resulting from cross-border mergers; that consequently, in Germany, there were no general rules, analogous to those laid down by that statute, which would apply to cross-border mergers; and that Germany therefore treated internal and crossborder mergers differently. The ECJ further found that cross-border mergers respond to the needs for cooperation and consolidation between companies established in different EC States. It concluded: that treatment of foreign companies constituted a restriction in the meaning of Articles 43 and 48 of the Common Market Treaty which was not justified by any circumstances of the case. In terms of corporate practice, the judgement illustrates clearly that mergers between German and foreign companies were already permissible under the German Act on Transformation of Companies,75 before Germany implemented the Directive 2005/56/EC on cross-border mergers of 26 October 200576 (see discussion in the 72 73 74

75

76

See 6.2.1.2(e). See 6.4.2 . Case C-411/03 [2005] ECR I-10805. The decision is also reprinted in (2006) 26 IPRax 596 ff and also in [2006] EWS 27 ff. See Hartwin Bungert, ‘Grenzüberschreitende Verschmelzungsmobilität—Anmerkung zur Sevic-Entscheidung des EuGH’ (2006) 61 BB 54 ff. See German act on Transformation of Companies no 26: ‘It should be noted in that respect that, whilst Community harmonisation rules are useful for facilitating cross-border mergers, the existence of such harmonisation rules cannot be made a precondition for the implementation of the freedom of establishment laid down by Articles 43 EC and 48 EC …’.


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next part) by passing a new Act on Transformation of Companies. Still, it must not be overlooked that the judgement of the ECJ concerned a case only where a German company had absorbed a foreign German EC company, that is, a case of inbound merger (Hineinverschmelzung nach Deutschland). The reverse case however— when a foreign EC company would absorb a German company (‘Herausverschmelzung aus Deutschland’), that is, an outbound merger—has not been an issue in the SEVIC case. Nevertheless one can derive from the sweeping language of the judgement that such absorption would also be permissible under the present German Act on Transformation of Companies77 which, according to general rules of construction, has to be interpreted with a view to making it compatible with EC law (europafreundliche Auslegung). Considered in context of codetermination, these principles lead to the following conclusions: In a case of an inbound merger (i.e. where a German company absorbs a foreign EC company) the German company continues to exist and the German rules on codetermination remain in effect.78 That group of cases therefore does not pose a problem. But in the reverse case of an outbound merger (i.e. where a foreign EC companies absorbs a German company) the question arises as to whether the German rules on codetermination which possibly apply to the German company still remain applicable to the foreign EC company. That question clearly has to be answered in the negative. The absorbing foreign company is governed by its foreign law of incorporation. It is, therefore, submitted that the German laws on codetermination therefore do not apply to it.79

6.4.2 The Directive on Coross-Border Mergers of Limited Companies The German rules on codetermination are also under a serious threat of erosion by Directive 2005/56/EC of the European Parliament and of the Council of 26 October 2005 on Cross-Border Mergers of limited liability companies.80 The Directive follows a Proposal by the European Commission81 issued on 18 November 2003.82 77

78

79 80 81 82

See Peter Behrens in a comment on this case in (2006) 43 Common Market L Rev 1686 ff. See Kai-Peter Ott, ‘Die rechtsüberschreitende Verschmelzung nach Centros, Überseering und Inspire Art’ in Otto Sandrock and Christoph Wetzler (eds), Deutsches Gesellschaftsrecht im Wettbewerb der Rechtsordnungen (Verlag Recht und Wirtschaft, Heidelberg 2004) 212; Volker Triebel and Karl von Hase, ‘Wegzug und grenzüberschreitende Umwandlungen deutscher Gesellschaften nach “Überseering” und “Inspire Art”‘ (2003) 58 BB 2416. Ott (n 78); Triebel and von Hase (n 78). Official Journal of the European Union 25 Nov 2005 L 310/1. COM(2003) 703 [2003/0277(COD)]. For details see Georg Wenglorz, ‘Die grenzüberschreitende “Heraus”-Verschmelzun einer deutschen Kaiptalgesellschaft: Und es geht doch!’ (2004) 59 BB 1061 and further sources referred to in that article.

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The substance of the Proposal was maintained although it has been changed in minor respects.83 The Directive is addressed to the European Union Member States. Its Article 19(1) provides that the Member States shall bring into force the laws, regulations and administrative provisions necessary to comply with the Directive by 15 December 2007.84 In an ‘Explanatory Memorandum’85 preceding the Proposal, the European Commission points out that employee participation in a company created by crossborder merger was the reason for the deadlock over the original Proposal of 1984 for such a Directive. The overriding fear concerning cross-border mergers was that the process might be hijacked by companies which, faced with having to live with employee participation, might try to circumvent it by means of such a merger. The solution found by the SE Regulation of 8 October 2001 and by the SE Employees’ Directive of the same day was used, mutatis mutandis, also with a view to solving the problem of codetermination in the proposed Directive. The Commission admits that the context in which the SE Regulation and the Employees’ Directive operate is different from that surrounding the application of this Directive. By virtue of its European Community status, the SE is not subject to any existing national rules on compulsory participation in the Member State in which its registered office is situated. By contrast, companies created by the crossborder merger operations covered by the present Directive will be companies governed by the law of a Member State. Such companies will accordingly remain subject to the compulsory participation rules applicable in that Member State. It may well be, however, that, following a cross-border merger, the registered office of the company created by the merger is situated in a Member State which does not know this kind of codetermination, while one or more of the companies taking part in the merger were operating under a more rigorous participation system before the merger. To deal with this eventuality, provision is made for extending to companies covered by the present Directive the same protection of rights acquired with respect to participation as is granted under the system set up by the SE Regulation and the Employees’ Directive. In the opinion of the Commission the protection of ‘acquired rights of participation’ is entirely justified in this case. However, where the national law of the Member State by whose law the company created by the merger is governed does have comparable rigorous rules on compulsory employee participation, such specific protection is unnecessary as the company in question will be subject to those rules. 83

84

85

See Hans Werner Neye, ‘Die neue Richtlinie zur grenzüberschreitenden Verschmelzung von Kapitalgesellschaften’ (2005) 26 ZIP 1894. See Hans-Friedrich Müller, ‘Die grenzüberschreitende Verschmelzung nach dem Referentenentwurf des Bundesjustizministeriums’ (2006) 8 NZG 286 ff; Christoph Louven and Michael Dettmeier, ‘Optionen grenzüberschreitender Verschmelzungen innerhalb der EU—Gesellschafts- und steuerrechtliche Grundlagen,’ (2006) 3 BB Spezial 13 March 2006, 1 ff. COM(2003) 703 [2003/0277(COD)] sub no. 3.3.


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It is thus evident that the Directive on Cross-Border Mergers of Companies follows the same pattern as the SE Regulation and the SE Employees’ Directive as far as the codetermination rights of employees, acquired under the laws of one of the leges societatis, are concerned: those rights shall not be curtailed in the slightest way by cross-border mergers.86

6.5 The European Commission—Action Plan of May 2003 A further recent development that will probably provide, over the medium term, some challenges to the German two-tier board system and codetermination is the so-called Action Plan of the European Commission adopted on 21 May 2003.87 This Action Plan followed on the Report of a High Level Group of Company Law Experts (the Winter Commission, report released on 10 January 2002)88 to the European Commission on harmonisation of the European takeover law.89 The Winter Commission accepted that the examination of the protection of employees’ rights was not in the mandate of the group,90 but still recognised that the European takeover law should protect the right of third parties (e.g. employees) under the company law of Member States to nominate a certain number of board members.91 This was clearly done to accommodate countries, like Germany, where codetermination is an integral part of the current law and also to ensure that the codetermination model developed for SEs (see discussion above) would not be jeopardised. Codetermination was, however, specifically mentioned in the list of the most important barriers to takeover bids in the European Union.92 86 87

88

89

90 91 92

For details see Müller (n 84) 289 ff; Louven and Dettmeier (n 84) 15 ff. Commission of the European Communities (Communication from the Commission to the Council and the European Parliament), ‘Modernising Company Law and Enhancing Corporate Governance in the European Union—A Plan to Move Forward’ COM (2003) 284 Final . The members of the Commission were Jaap Winter (Chair); Jan Schans Christensen; José Maria Garriddo Garcia; Klaus J Hopt; Jonathan Rickford; Guido Rossis; and Joëlle Simon. Winter Report, Report of the High Level Group of Company Law Experts on Issues Related to Takeover Bids, Jan 2002 . See Klaus J Hopt, ‘Die rechtlichen Rahmenbedingungen der Corporate Governance’ in Peter Hommelhoff, Klaus J Hopt and Axel von Werder (eds) Handbuch Corporate Governance: Leitung und Überwachung börsennotierter Unternehmen in der Rechts- und Wirtschaftspraxis (Otto Schmidt Verlag, Cologne 2003) 38–41 for a to-the-point discussion of these developments. Winter Report (n 89) 6. Ibid 33. Ibid 74 (Annex 4).

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6.5.1 The Action Plan: Consequences After the release of its Report, the Winter Commission was requested by the European Union’s Competitive Council to organise an in-depth discussion of its Report and to develop an Action Plan to modernise company law and to enhance corporate governance in the European Union.93 The European Commission responded to proposals and recommendations of the Winter Commission by way of a Communication (the Action Plan) released on 21 May 2003.94 The Action Plan endorses most of the recommendations of the Winter Commission. One of the recommendations, with the potential to affect the German two-tier board system considerably, was made under the heading ‘Modernising the board of directors’. The European Commission proposed that the following recommendation of the Winter Commission should be followed up in the medium term: The High Level Group further recommended that at least listed companies in the EU should generally have the option between a one-tier board structure (with executive and non-executive directors) and a two-tier board structure (with managing directors and supervisory directors). The Commission welcomes the idea to offer additional organisational freedom to listed companies, but recognises that the implications of such a proposal should be carefully studied. Much has to be learned in this respect from the adaptation of national law to the Regulation and the Directive on the European Company Statute. The Commission therefore proposes that this recommendation from the High Level Group should be followed up in the medium term.95 It became apparent from the responses to the Action Plan that a majority of respondents supported the European Commission’s approach to allow for greater freedom of publicly listed companies in the European Union to have flexibility in choosing either a one-tier board or a two-tier board. It was, however, also pointed out that because of the significant differences in some cases between Member States’ legal regimes, particularly in the area of employee participation, that it should be left to national legislatures to decide whether or not to open national company law to both types of board systems.96

93 94 95 96

Commission of the European Communities (n 87) 4. Ibid. Ibid 15–16. A Working Document of DG Internal Market, Synthesis of the Responses to the Communication of the Commission to the Council of European Parliament—’Modernising Company Law and Enhancing Corporate Governance in the European Union—A Plan to Move Forward’, Nov 2003 14.


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If all listed companies in the European Union have a choice in future between a one-tier and a two-tier board system, it would at least put all listed companies in Germany under pressure to make a choice between their existing two-tier board system currently required by the German law for public corporations or to adopt a one-tier board system under the European Union arrangement. This will surely not only lead to very interesting discussions as far as the German two-tier board structure is concerned, but would automatically also drag codetermination into the debate as the German system of codetermination is nowadays specifically linked to employee participation at supervisory board level. The pressure for German companies to opt for a one-tier system may be accelerated if some of the current frustrations with codetermination continue in the market.97

6.5.2 Harmonisation versus Practical Realities It is not hard to predict that the combined effect of the factors mentioned in Parts 3 and 4 above will generate momentum that will put the traditional German two-tier board system and supervisory codetermination under some strain. It is, however, difficult to predict exactly how these factors would result in Germany moving away from aspects like the two-tier board system and codetermination, both aspects imbedded firmly in German society and German corporate law.98 All previously mentioned factors have the potential to steer the German corporate law in a different direction and to change general perceptions regarding the two-tier board system and codetermination, but only time can tell where these developments will lead.

6.6 Concluding Remarks In light of the changed perceptions and shortcomings regarding supervisory codetermination discussed in Chapters 5 and 6, the question could be asked what the future holds for the German two-tier board and supervisory codetermination. We are of the opinion that it is unlikely that perceptions in Germany on the two-tier board or supervisory codetermination will change vastly or rapidly over the short tem. In our view there are at least three practical factors, all directly or indirectly linked to each other, that will make it very difficult for Germany to move away from the traditional German corporate governance model. Firstly, such a move will probably be met with considerable opposition by representatives of the employees currently serving on supervisory boards and by most employees entitled to elect representatives to supervisory boards. Secondly, the Trade Unions, entitled to nominate a certain number of representatives to the supervisory boards of a vast

97 98

Bohl (n 43) 14. See also Hirt (n 43) 355 and the discussion in 5.3. Du Plessis and Sandrock (n 13) 71 ff.

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number of corporations, among them the most important companies,99 will hardly be willing to lose their right of codetermination, especially parity and quasi-parity codetermination,100 for which they campaigned so intensely during the 1970s.101 Thirdly, it would be political suicide for the government of the day or for any other political party to fight any election on the basis of abolishing the German two-tier board system or codetermination.102 It is obviously for this last reason that until very recently the government has considered codetermination as a very important and distinctive part of the German culture and German society. Irrespective of all the negative developments mentioned above, codetermination was still described for example by the former German chancellor, Gerhard Schröder, as ‘a product for the future’.103 The concept of codetermination has also been vigorously promoted under various new catchy slogans like ‘to have and to have a say’ (Haben und Sagen)104 and ‘to have part in having a say’ (Teilhabe am Sagen).105 It was a priority of the German Government under the former chancellor Gerhard Schröder to ensure that people were made aware of the development and history of codetermination in Germany.106 Schröder also made strong political statements in defending the unique aspects of German codetermination and was adamant that even in the European context the German

99

100 101

102

103

104 105

106

S 7(2) Gesetz über die Mitbestimmung der Arbeitnehmer (MitbestG) 1976. See Bohl (n 43) 14 for a useful diagram illustrating the composition of supervisory boards in certain large German corporations. Hirt (n 43) 352 (fn 37). Hellmut Wißmann, ‘Das Montan-Mitbestimmungsänderungsgesetz: Neuer Schritt zur Sicherung der Montan-Mitbestimmung’ (1982) 35 NJW 423. Peter Ulmer, (n 43) 277; Peter Ulmer, ‘Der Deutsche Corporate Finance Kodex-ein neues Regulierungsinstrument für börsennotierte Aktiengesellschaften’ (2002) 166 ZHR 180; Hirt (n 43) 355; Helmut Kohl, ‘Corporate Governance: Path Dependence and German Corporate Law: Some Skeptical Remarks from the Sideline’ (1999) 5 Colum J Eur L 195. See Hopt (n 67) 27 for a very interesting analysis of how party politics affect the current corporate law reforms in Germany. Press Release 12 Feb 2001 ‘Die Mitbestimmung hat Deutschland stärker gemacht’ 2; Press Release 19 Dec 2000 ‘Reform des Betriebsverfassungsgesetzes ist ein Beitrag zur Modernisierung Deutschland’ 1. Press Release 19 Dec 2000 (n 103). Press Release 29 May 2002 ‘Rede von Bundeskanzler Schröder anlässlich des 17 Ordenlichen Bundeskongresses des Deutschen Gewerkschaftsbundes’ 1. Press Release 6 Feb 2001 ‘Mitbestimmung im Betrieb—Die Geschichte des Betriebverfassungsgesetzes’ 3.


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system of codetermination should not be swept aside.107 He explicitly pointed out that it was the German system of codetermination that made Germany a stronger country and that codetermination was a German model of success that should be retained and developed further.108 The new federal government under the chancellor Angela Merkel (supported by a coalition between Christian Democrats and Social Democrats), which has been in power since November 2005, does not endorse codetermination in such strong language. In any case, it is submitted that all this boils down to two basic reasons why the German two-tier board system and codeterminations will probably remain part of the German corporate governance model for the foreseeable future: firstly, because of the disastrous political consequence that any attempt to abolish the twotier board system or codetermination will have for any political party and, secondly, because of the fact that the two-tier board system and codetermination form such an integral part of German society (so-called ‘path dependency’).109 These two aspects are, of course, intertwined and together they provide formidable obstacles for any significant change to the current corporate governance model in Germany. The irony is that even though codetermination clearly does not belong to the German ‘ordre public’,110 it seems as if it will be almost impossible to change customs and perceptions about it in Germany overnight. It is furthermore submitted that there is little or no chance that Germany would easily forfeit the time and energy that went into refining the traditional two-tier board system over the past ten years or so in favour of a unitary board system.111 There is still too much evidence, even from academic circles,112 that the two-tier 107

108 109

110 111

112

Press Release 12 Dec 2000 ‘Rede von Bundeskanzler Gerhard Schröder anlässlich der Vertrauensleute—Vollversammlung bei der BASF AG’ 1. Press Release 12 Feb 2001 (n 103) 1. Kohl (n 102) 195. See also Thomas MJ Möllers, ‘Gesellschaftliche Treuepflicht contra arbeitnehmerrechliche Mitbestimmung’ (2003) 6 NZG 701. Regarding the theory of ‘path dependency’ in context of the German system of codetermination—see Mark J Roe, ‘Path Dependency, Political Options, and Governance Systems’ in Klaus J Hopt and Eddy Wymeersch (eds) Comparative Corporate Governance (de Gruyter Verlag, Berlin 1997) 167–68, 178. See Sandrock (n 38) 66. See also Ulmer (n 43) 272–73. Marcus Lutter, ‘Vergleichende Corporate Governance—Die deutsche Sicht’ (2001) 30 ZGR 224, 227; Klaus J Hopt, ‘The German Two-Tier Board: Experience, Theories, Reforms’ in K J Hopt, K Kanda, M J Roe, E Wymeersch and S Priggle (eds) Comparative Corporate Governance: The State of the Art and Emerging Research (OUP, Oxford 1998) 254–55. Lutter (n 111) 227; Klaus J Hopt, ‘Gemeinsame Grundsätze der Corporate Governance in Europa?’ (2000) 29 ZGR 784–85; Carsten Berrar, ‘Die zustimmungspflichtigen Geschäfte nach § 111 Abs. 4 AktG im Lichte der Corporate Governance-Diskussion’ (2001) 54 DB 2185–86; Hopt (n 111) 254–55; Carsten P Claussen, ‘Aktienrechtsreform 1997’ (1996) 41 AG 484; Theodor Baums, ‘Der Aufsichtsrat—Aufgaben und Reform-

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board system is considered to be the preferred corporate governance model for Germany.113 It is also unlikely that German corporations will readily agree to replace their two-tier board structure (with managing directors and supervisory directors) with a one-tier board structure (with executive and non-executive directors). Firstly, because there are several indications that the modern German twotier board and the reinvented one-tier board have converged. Secondly, because of this convergence, it is an oversimplification, and also misleading, to create the impression that the choice between a ‘two-tier board structure (with managing directors and supervisory directors)’ and a ‘one-tier board structure (with executive and non-executive directors)’ is a choice between vastly different board structures.114 A careful analysis of the modern German two-tier board system and the reinvented one-tier board system115 will reveal that in fact the most distinctive aspect of the two system is codetermination and not the board structures as such. The politically sensitive issue in Germany is not the two-tier board structure, but codetermination. However, for the reasons stated above, it is unlikely that there will be huge changes to either the two-tier board structure or codetermination in Germany in the near future. We would like to predict that the debate on refining the German two-tier board and codetermination will continue and even intensify in Germany.116 In this regard we are of the opinion that the focus in the short term will probably be on aspects like the size of supervisory boards; the

113

114

115

116

fragen’ (1995) 16 ZIP 15; Marcus Lutter, ‘Defizite für eine effiziente Aufsichtsratstätigkeit und gesetzliche Möglichkeiten der Verbesserung’ (1995) 159 ZHR 289, 301; Eberhard Scheffler, ‘Der Aufsichtsrat—nüztlich oder überflüssig?’ (1993) 22 ZGR 63, 76. See also Maximillian Schiessl, ‘Deutsche Corporate Governance post Enron’ (2002) 47 AG 598. See Klaus Pohle and Axel von Werder, ‘Die Einschätzung der Kernthesen des German Code of Corporate Governance (GCCG) durch die Praxis’ (2001) 54 DB 1103 ff, 1107 for an interesting survey demonstrating that German public corporations are largely satisfied with the two-tier board system and codetermination, but that modernisation of the system was considered to be imperative. See further Wolfgang Röller, ‘Quo vadis Aufsichtsrat?’ (1994) 39 AG 334; Günter Langenbucher and Ulf Blaum, ‘Audit Committees—Ein Weg zur Überwindung der Überwachungskrise?’ (1994) 47 DB 2197–98; Stefan Grundmann and Peter Mülbert, ‘Corporate Governance—Europäische Perspektiven’ (2001) 30 ZGR 221–22. See Weil, Gotshal and Manges (on behalf of the European Commission, Internal Market Directorate General), Comparative Study of Corporate Governance Codes Relevant to the European Union and its Members (hereafter European Commission Comparative Study) (Jan 2002) 4–5; and The German Corporate Governance Code (GCGC) 12 June 2006 1. See further Henry Hansmann and Reiner Kraakman, ‘The End of History for Corporate Law’ (2001) 89 Georgetown L J 456. Jean J du Plessis, ‘Reflections on Some Recent Corporate Government Reforms in Germany : A Transformation of the German Aktienrecht?’ (2003) 8 Deakin L Rev 391. See in particular Hopt (n 67) 43–48.


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number of representatives of the employees on supervisory boards; better training for supervisory board members; the most effective ways supervisory board members could fulfil their duties; refining the duties of supervisory and management board members more exactly in the Act on Public Limited Companies (Aktiengesetz, 1965); ensuring that effective remedies are available if supervisory and management board members are in breach of their duties; improving the law as far as the removal of supervisory and management board members are concerned; and introducing an effective system of disqualification (on application) of supervisory and management board members. The necessity, however, to substantially amend, in the long term, the different regulatory codetermination regimes, has become more evident by the recent jurisprudence of the European Court of Justice. That Court has in a series of judgements during recent years (particularly in the matters of Centros117, Ueberseering118, Inspire Art119, Hughes Lasteyrie du Saillant120 and SEVIC121) made a point of enforcing, to the benefit of all EU companies, the freedom of settlement enshrined in Articles 43 and 48 of the Common Market Treaty. From that jurisprudence it follows that companies incorporated under the laws of any EU state outside Germany but managed from within Germany, must be recognised in Germany as such foreign companies. Since all other EU States do not have codetermination systems as far-reaching as Germany, such recognition would imply that foreign European Union companies with less codetermination may do business in Germany without being bound by the strict German rules.122 Moreover, the European Commission has published its intention to authorise the European companies in its forthcoming 14th Directive on the Cross-Border Transfer of the Registered Office of Limited Companies123 to transfer their registered seats from one EU-country to another without losing its juristic personality or its identity with a change only to 117

118

119

120

121 122

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ECJ 9 Mar 1999 (Case C-212/97) Centros Ltd v Erhvervs-og Selskabsstyrelsen, 1999 ECR 1–1459. See 6.2.1.2(a). ECJ 5 Nov 2002 (Case C-208/00) Ueberseering BV v Nordic Construction Company Baumanagement mbH (NCC). See 6.2.1.2(b). ECJ 30 Sep 2003 (Case C-167/01) Kamer van Koophandel en Fabrieken voor Amsterdam v Inspire Art Ltd. See 6.2.1.2(c). ECJ 11 Mar 2004 (Case C-9/02) Hughes de Lasteyrie du Saillant v Ministère de l’Économie, des Finances et de l’Industrie. See 6.2.1.2(d). ECJ 13 Dec 2005 (Case 411/03) SEVIC Systems AG. See 6.2.1.2(e) and 6.4.1. As to these developments see Du Plessis and Sandrock (n 7); Kersting (n 20) 1 ff; Sandrock (n 20) 447 ff; id., Was ist erreicht? Was bleibt zu tun?, in Sandrock and Wetzler (n 78) 33 ff. In 1997, the Commission had already presented a Proposal for such a Directive. The German version of it has been reprinted in (1997) 18 ZIP 172 ff; as well as in (1999) 28 ZGR 157 ff with comments by Giuseppe di Marco, Hans-Werber Neye, Karsten Schmidt, Hans-Joachim Priester, Christoph Hirschmann, Hanns F Hügel, Harry Rajak, Eddy Wymeersch, Levinus Timmerman – ibid at 3-156.

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its law of incorporation.124 For example, if a German public limited company (AG), heretofore existing as an Aktiengesellschaft, would transfer its registered seat to the Netherlands, it would neither lose its juristic personality nor its identity, but only automatically acquire the status of a Dutch naamlooze vennootschap which is the counterpart of the German Aktiengesellschaft. It is apparent that, under the effect of these developments on the European Union level, foreign European Union companies doing business in Germany could in the future manage their affairs from within Germany without being bound by any German codetermination rules. Furthermore, German companies would be enabled to avoid the far-reaching regimes of German codetermination by submitting themselves to a parent company seated outside Germany; and, finally, that such German companies could even transfer their seats into a foreign European Union country with less rigid rules of codetermination, while preserving their juristic personalities and identities. Rolf Breuer, the former chairman of the board of the management of the Deutsche Bank Aktiengesellschaft, now the chairman of its supervisory board, has become the harbinger of such development by publicly announcing in June 2004125 that, first, the Deutsche Bank, under the pressure of the international banking and financing markets, would have to seek a foreign partner for a merger to enhance its market capitalisation; that, secondly, such a merger would have to be effected under the umbrella of a holding company; and that, thirdly, such a holding company could not be registered in Germany because of its excessive codetermination system, but that its registered seat would have to be located in a state outside of the Deutsche Bank’s home-country where the legal system is more favourable to such a reorganisation. Rolf Breuer added that the future foreign partner of the Deutsche Bank would never accept the German codetermination regulations. That statement aroused great public attention, in some circles even indignation. The Deutsche Bank, in German public opinion one of Germany’s holiest national corporate gems, under the direction of a foreign company? Will the unthinkable really come true? The event shows that the German way to regulate codetermination, has come under much pressure, at presentʊa pressure which will certainly lead to substantial reforms at one or other stage in future. Future reforms will probably include a considerable simplification of the concept of codetermination—not only does it apply vastly differently in different industries, but it also differs depending on the type of corporation and the number of employees. The election process of the representatives of the employees to supervisory boards has been simplified in May 2002, inter alia by introducing the

124

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These details have been taken from a consultation paper presented, on 3 March 2004, by the General Direction for the Internal Market on its intended 14th Directive. The English version of that paper is available on the internet at . See the article ‘Deutsche Bank sichtet Fusionskandidaten’ FAZ 5 June 2004, 14.


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possibility of electronic election processes,126 but the election process for the representatives of the employees is still by no means a simple one.127 The election regulations, issued under section 39 of the Mitbestimmungsgesetz, consist of three sets of regulations and are contained in more than 200 pages.128 In short, in our view there is little chance of the German corporate governance system being abolished or changed drastically overnight, but there are many reasons to believe that the German corporate governance model will be refined further in the short and the medium term. Such refinement is probably inevitable to ensure the future of the German corporate governance model over the long term, and the long term consequences may well be far more radical than some German commentators would be prepared to admit at this stage.

126

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Press Release 15 May 2002 ‘Wahl von Arbeitnehmervertretern in Aufsichtsräte wird einfacher’ . Marcus Lutter and Gerd Krieger, Rechte und Pflichten des Aufsichtsrats (4th edn Otto Schmidt Verlag, Cologne 2002) 6 para 9. See Erste Wahlordnung zum Mitbestimmungsgesetz (1. WOMitbestG v. 27. Mai 2002 (BGBI. I S. 1682)); Zweite Wahlordnung zum Mitbestimmungsgesetz (2. WOMitbestG v. 27. Mai 2002 (BGBI. I S. 11708)), and Dritte Wahlordnung zum Mitbestimmungsgesetz (3. WOMitbestG v. 27. Mai 2002 (BGBI. I S. 1741)).

Chapter 7

Accounting as the Documentary Proof of Good Corporate Governance* Claus Luttermann

7.1 Handling the ‘Invisible’ According to Friedrich Carl von Savigny, the corporation is a mere fiction of law.1 As a separate legal person the corporation (company) is ‘invisible, intangible, and existing only in contemplation of law’ (John C. Marshall).2 That is the case worldwide. No one ever has seen, for example, the ‘DaimlerChrysler AG’, the ‘BHP Billiton Corp.’ or the ‘Vodafone plc’. Thus, corporate governance and the law associated with corporate governance deal with an ‘artificial being’. So, how can we deal with something ‘invisible’? Accounting gives us the necessary and only instrument to do so: by means of the financial statements, stating in numbers and words the corporation’s assets, liabilities and performance, a picture of the corporation evolves. Such a picture is fundamentally the subject of company law and capital markets law, and it also embraces the governance of the corporation. That makes accounting the documentary proof of good corporate governance. In this chapter we highlight basic aspects of accounting as the documentary proof of some aspects of corporate governance. Our main focus is on Germany, a country which operates within the European Community and the international legal environment. Obviously, in corporate accounting the ‘German task’ is to a large extent determined internationally, according to the evolution of accounting. We commence our discussion by having a deeper look at a key question of corporate governance: What is accounting all about? *

1

2

For the reader’s convenience, we have included English translations of some of the European provisions – see Appendix, “English Translations of Some European Provisions” for Purposes of Chapter 7” at 257–273. Friedrich C von Savigny, System des heutigen römischen Rechts (Veit Verlag, Berlin, 1840), Vol. II, ss 85, 236, 239. In Dartmouth College v Woodward, 4 Wheat. 518, 636 (1819) = 17 U.S. 518, 636 (1819).

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7.2 Accounting Law3 7.2.1 Accountability Accounting is simply a means of reporting about ‘other people’s money’! This phrase, well known as the title of Louis D Brandeis’ book from 1914 about misuses of corporations and markets,4 is still at the core of today’s corporate governance standards. Since ancient times5 accounting has been the figurative expression of accountability. ‘Account’ (from Latin accomp[u]tare) means to give a counting, a reckoning of something (e.g. money). In German such an action is called Rechenschaft geben or Rechnung legen (to make account). The noun is Rechnungslegung (accounting) synonymous with ‘financial reporting’, from Old French raport and Latin reportare. It should be noted at the outset that it is those responsible for directing and managing the business of the corporation who are collectively responsible for the financial statements (accounts) of a corporation. The proposed amendment of the European Accounting Directives6 explicitly states: Member States [like Germany] shall ensure that the members of the administrative, management and supervisory bodies of the company are collectively responsible towards the company for ensuring that the annual accounts and the annual report are drawn up and published in accordance with the requirements of this Directive [ (EEC) 78/660, rsp. (EEC) 83/349].7 As explained in Chapters 3 and 4, Germany adheres to a two-tier board system for public companies (Aktiengesellschaften): a supervisory board (Aufsichtsrat) and a 3

4 5

6

7

See Bernhard Großfeld and Claus Luttermann, Bilanzrecht (Accounting Law): Die Rechnungslegung in Jahresabschluß und Konzernabschluß nach Handelsrecht und Steuerrecht, Europarecht und IAS/IFRS (4th edn CF Mueller Verlag, Heidelberg 2005). Louis D Brandeis, Other People’s Money and How to Use it (Stokes, New York 1914). Robert Mattessich, Critique of Accounting: Examination of the Foundations and Normative Structure of an Applied Discipline (Quorum Books, Westport Conn. 1995) 15– 40; Claus Luttermann, ‘Über Buchführung und Bilanzrecht: 502 Jahre nach Erscheinen der “Summa de arithmetica, geometria, proportioni et proportionalita” von Lucas Paciuolo’ in Jörg Baetge, Dietrich Börner, Karl-Heinz Forster, Lothar Schruff (eds), Festschrift für Rainer Ludewig (IDW-Verlag, Düsseldorf 1996) 595–626. New Art 50b of Council Dir (EEC) 78/660 [1978], new Art 36a of Council Dir (EEC) 83/349 [1983]: responsibility and liability for drawing up the annual accounts and the annual report. EC Commission, Proposal for a Directive of the European Parliament and the Council amending Council Directives (EEC) 78/660 and (EEC) 83/349 concerning annual accounts of certain types of companies and consolidated accounts, 27.10.2004 COM(2004) 725 final (2004/0250(COD)). About sanctions see 7.5.3.

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management board (Vorstand). The legal representatives of the public company are the members of the management board. They have to comply with the basic act regulating public companies in Germany, namely the Aktiengesetz 1965 (AktG), and with the German Commercial Code (Handelsgesetzbuch, HGB). They are responsible for the bookkeeping (Buchführung)8 as well as for the annual accounts/financial statements (Jahresabschluss) and the consolidated accounts/consolidated financial statements (Konzernabschluss) pursuant to the legal requirements.9 As part of that duty, the members of the management board have to sign the annual financial statements and the consolidated financial statements.10 This signature serves as approval for the financial statements and the consolidated statements and is the step required to make them available to others, in other words, authorising them to be made known publicly. The signature could be electronic under current German law.11 The documents signed are central. They have to give the legally required ‘picture’ of the corporation, that is, a statement of the previous business year’s corporate governance. As part of the annual financial report an issuer’s statement (Erklärungen) is required by the persons responsible for the financial statements. The issuer’s statement must state that the financial statements give ‘a true and fair view’ (ein getreues Bild, Bilanzwahrheit) of the corporation’s financial position. Apart from that, the financial statements can form the basis of a civil claim or for government sanctions against the corporation if they do not give ‘a true and fair view’ of the corporation’s financial position.12 The financial statements enable markets and investors to evaluate the corporation, including its shares, bonds and credit standing generally.13 A complete set of financial statements comprises a balance sheet (Bilanz), a profit and loss account (Gewinn- und Verlustrechnung, also known as an income statement), and notes (Anhang—explanatory supplement). These documents constitute a composite whole. An annual review (Lagebericht, also known as a directors’ financial review) required by Section 289 of the HGB has to be added.14

8 9 10 11

12

13 14

S 91 AktG. Ss 264 and 290, 315a HGB. Ss 245, 315a(1) HGB. For details of the German Signaturgesetz see Großfeld and Luttermann (n 3), paras 221–29. For electronic disclosure see <www.unternehmensregister.de>. See 7.3 and 7.5.3. Council Dir (EEC) 2001/34 Art 4(2)(c), 5(2)(c). Cf Transparenzrichtlinie-Umsetzungsgesetz (German Act of Transfer on the Harmonisation of Tansparency Requirements) Art 5 (reforming HGB ss 264(2), 289(1), 297(2), 315(1)) and US Sarbanes-Oxley Act 2002, s 302. See 7.4.1. S 264(1)(1) HGB.

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7.2.2 European Law and IAS/IFRS German Accounting Law for corporations15 is an integral part of the Law of the European Community (EC, Europäische Gemeinschaft).16 The Member States are bound by given standards of the Community Laws. Directives (Richtlinien) and Regulations (Verordnungen) are the instruments. Both are directed towards achieving the aims of the Treaty of Rome (1957), complemented by the Treaty of Maastricht (1992): to establish a common internal European Community market (Binnenmarkt) with the free movement of persons, goods and services, and capital.17 That includes the harmonisation of company law and financial reporting (accounting) within the Member States. In order to attain harmonisation focused on freedom of establishment (Niederlassungsfreiheit)18 the European Council has acted by means of Directives.19 The most important Directives are:20 the Fourth Council Directive on the annual accounts of certain types of companies21 and the Seventh Council Directive on consolidated accounts22. These Directives coordinate national provisions in respect of companies with limited liability (Kapitalgesellschaften). The Fourth directive deals specifically with the protection of members and third parties, while the Seventh Directive covers company groups (members of bodies of undertakings, Unternehmenszusammenschlssen). In order to achieve the objectives of comparability and equivalence of the information that companies must publish within the European Community,23 the Accounting Directives are subject to reform.24 According to global financial markets, the European Community is establishing the application of international accounting standards. IAS/IFRS Regulation (EC) 15 16 17 18 19 20

21

22

23 24

See 7.2.3. Großfeld and Luttermann (n 3) paras 7–26. EC Treaty, Art 2. EC Treaty, Art 44(2)(g) and 48; EC Treaty (old version) Art 54(3)(g) and 58. EC Treaty Art 249(3). See, for example, also Council Dir (EEC) 91/674 on the annual accounts and consolidated accounts of insurance undertakings [1991] OJ L 374/7; Council Dir (EEC) 86/635 on the annual accounts and consolidated accounts of banks and other financial institutions [1986] OJ L 372/1; Council Dir (EEC) 2003/51 on modernisation and updating of accounting rules [2003] OJ L 178/16. Council Dir (EEC) 78/660 [1978] OJ L 222/11, consolidated text 1978L0660—EN— 01.05.2004— 006.001—1. Council Dir (EEC) 83/349 [1983] OJ L 193/1, consolidated text1978L0660—EN— 01.05.2004—006.001—1. See 7.3.4. EC Commission, Proposal for a Directive of the European Parliament and the Council amending Council Directives (EEC) 78/660 and (EEC) 83/349 concerning annual accounts of certain types of companies and consolidated accounts, 27.10.2004 COM(2004) 725 final (2004/0250(COD)).


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1606/200225 prepares the Community for International Accounting Standards (IAS), renamed as International Financial Reporting Standards (IFRS). It reinforces the freedom of movement of capital in the internal market and helps to enable EC companies to compete on an equal footing for financial resources worldwide. IAS/IFRS should, providing that they ensure a high degree of transparency and comparability for financial reporting in the Community,26 be made obligatory for all publicly-traded EC companies. The regulation aims to protect investors, to maintain confidence in the financial markets in the ‘post-Enron era’, and to contribute to the efficient and cost-effective functioning of the capital markets.

7.2.3 German and European Law (IAS/IFRS) Germany, as a Member State of the European Union, is governed by European Law. This legislation has to be observed and transposed. The IAS/IFRS Regulation (EC) 1606/2002 is binding in its entirety and directly applicable in all Member States.27 Therefore, consolidated accounts of publicly-traded companies for each financial year starting on or after 1 January 2005 are to be prepared in conformity with the IAS/IFRS adopted by the European Community.28 Meanwhile, the European Community has adopted most of the International Accounting Standards/International Financial Reporting Standards.29 The treatment of financial instruments (IAS 36—recognition and measurement) shows some omissions, where some rules of the standard have not been adopted in the European Union.30 The Member States have options in relation to annual accounts (annual financial statements, also ‘separate financial statements’, Einzelabschluß), and whether or not the standards should apply to non- publicly-traded companies. They may permit or require companies to prepare their annual and/or consolidated accounts in conformity with the adopted IAS/IFRS.31 The German legislature has transmitted those options partly to the companies.32 Note, however, that a German company with limited liability has to provide its legally prescribed annual accounts in accordance with the Handelsgesetzbuch (HGB), the German Commercial Code.33 25

26 27 28 29

30 31 32 33

On the application of international accounting standards [2002] OJ L 243/1. Legal basis for the regulation (Verordnung) is Art 249 (2) of the EC Treaty. See Großfeld and Luttermann (n 3) paras 146–68. See 7.2.3. EC Treaty, Art 249 (2)(1). IAS/IFRS Reg (EC) 1606/2002, Art 4; s 315a HGB. See Großfeld and Luttermann (n 3) para 174 ff and tables 2–5 (Annex 484–88). For updates <www.europa.eu.int> (Internal Market/Financial Reporting). IAS 39 [2004] paras 9b, 35 and 81A. IAS/IFRS Reg (EC) 1606/2002 Art 5. Ss 315a(3) and 325(2a) HGB. Ss 264–89 HGB.

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These and other paragraphs of the HGB transpose the Fourth Council Directive on the annual accounts of certain types of companies.34 The company is free to conduct extra reporting according to IAS/IFRS. This regulation preserves the traditional link between commercial law (Handelsrecht) and tax law (Steuerrecht): generally the commercial accounts (Handelsbilanz) are authoritative (maßgeblich) for the tax accounts (Steuerbilanz).35 So the legislature has fixed the key role of the annual accounts—the basis of trading profits—for the taxation and the corporate law of a company.36 Accordingly, the European Court of Justice has given preliminary rulings, requested by German tax courts.37

7.2.4 Regulatory Interactions The IAS/IFRS Regulation (EC) 1606/2002 is directly applicable to the company drawing up accounts, while the Accounting Directives apply to companies through their transposition into the national (in this case German) law.38 In relation to the consolidated accounts of listed German companies, that means: in addition to the process of adoption and practice due to Article 3(2) of IAS/IFRS Regulation (EC) 1606/200239 there is primarily an interaction of the German national law (HGB) and the IAS/IFRS Regulation to the extent that both deal with the same subject matter. The EU Commission40 explained: No transposed provision of the Accounting Directives may restrict or hinder a company’s compliance or choice under adopted IASs/IFRSs, further to the IAS/IFRS Regulation (EC) 1606/2002. So, in Germany a company applies endorsed IASs/IFRSs to its consolidated accounts irrespective of any contrary, conflicting or restricting requirements in the national law (e.g. Ss 290-315 HGB). Matters that are outside the scope of IAS/IFRS Regulation (EC) 1606/2002, like publication (Offenlegung), and audit (Prüfung), are subject to national rules by means of the Accounting Directives.41 Member States must ensure that no additional element of national law is contrary to, conflicting with or restricting a company’s compliance with the adopted IASs/IFRSs, further to IAS/IFRS Regulation (EC) 1606/2002. 34 35

36

37

38 39 40 41

Council Dir (EEC) 78/660. Einkommensteuergesetz (German Income Tax Code) s 5(1) with Körperschaftsteuergesetz (German Corporation Tax Code) s 8(1). Deutscher Bundestag to the Bilanzrechtsreformgesetz, Bundestags-Drucksache 15/3419, 24 June 2004, 23–24 (argumentation of the bill). European Court of Justice, cases DE + ES Bauunternehmung GmbH [1999] ECR I5331, and BIAO [2003] ECR I-1. See Großfeld and Luttermann (n 3) para 300, 313–16. EC Treaty, Art 249(2) and (3). See 7.3.3. Comments concerning certain Articles of the Reg (EC) 1606/2002 (Nov 2003) 10–12. See particularly in Germany ss 315a and 316–335b HGB.


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This interaction is the same for unlisted companies that use the option of drawing up accounts according to the adopted IASs/IFRSs; the relevant rule in Germany for consolidated accounts is Section 315a(3) HGB. Drawing up their annual accounts, the companies in Germany must continue to comply with the national accounting requirements derived from the Accounting Directives (e.g. the Handelsgesetzbuch; see discussion above in 7.2.1). They then take precedence over any IASs/IFRSs. But the company is free to draw up an extra set of annual financial statements to comply with IASs/IFRSs.42

7.2.5 Corporate Governance Statement (Directive 2006/46/EC) Companies with their registered office in the European Union, whose securities are admitted to trading on a regulated market, are obliged to disclose an annual corporate governance statement in its annual report as a specific section.43 One of the main objectives is to strengthen public confidence in financial statements and reports. The corporate governance statement shall contain as a minimum specific information, that is enumerated in Directives 2006/46/EEC and 78/660/EEC.44 Among those duties are: • A reference to the corporate governance code to which the company is subject and/or which the company may have voluntarily decided to apply; additional all relevant information about practices applied beyond the requirements under national law.45 • An explanation by the company as to which parts of the corporate governance code, in accordance with national law, it departs from and the reasons for doing so.46 • A description of the main features of the company’s internal control and risk management systems in relation to the financial reporting process.47 • The composition and operation of the administrative, management and supervisory bodies and their committees.48 The Member States are free to permit that as well as the information required to be set out in a separate report, companies may also give ‘an analysis of environmental and social aspects necessary for an understanding of the company’s devel42 43

44 45 46 47 48

See 7.2.3. Council Dir 2006/46/EEC [2006] OJ L 224/1, Art 1.7. (Amendment to Dir 78/660/EEC, Art 46a). Ibid. Council Dir 78/660/EEC, new Art 46a(a). Council Dir 78/660/EEC, new Art 46a(b). Council Dir 78/660/EEC, new Art 46a(c). Council Dir 78/660/EEC, new Art 46a(f).

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opment, performance and position’.49 In Germany, for example, a lot of companies publish environmental reports. Member States will bring into force the laws and regulations necessary to comply with Directive 2006/46/EC at the latest by 5 September 2008. This will include rules on penalties that must be effective, proportionate and dissuasive.50 Directive 2006/46/EC aims at promoting harmonised credible financial reporting processes across the European Union. Therefore in accounting matters it focuses on the members of the company body that is responsible for the preparation of the company’s financial reports.51 The reasoning of the Directive52 emphasises the company’s ‘duty to ensure that the information included in a company’s annual accounts and annual reports gives a true and fair view’. So again, we see the foundation of accounting as a cornerstone for good corporate governance.

7.3 Financial Statements: ‘A True and Fair View’ 7.3.1 International Focus and Comparative Law International financial markets generally call for ‘international standards’ for financial statements. However, it should be noted at the outset that the imaginary concept of ‘accounting as the international language of finance’53 is a dangerous phantom, comparable to the shreds of the ‘Continental’ or ‘German’ style of accounting as ‘inscrutable’,54 ‘arcane’ or ‘murky’55 and the crushed myth of ‘U.S. GAAP’ as the ‘investors’ best protection’.56 In practice, there are also different ‘languages’ within so-called ‘international standards’. Nevertheless, there is a common measure: the general rule (Generalnorm), named the principle of ‘a true and fair view’ (ein getreues Bild, Bilanzwahrheit).57 First of all, after ‘Enron’ and other scandals of manipulated accounts worldwide (e.g. WorldCom, Xerox, AIG, Nortel Networks, Ahold, Parmalat, Bankgesellschaft Berlin, SK Group/South Korea), everyone should be aware that accounting is not about ‘the numbers’. It is about giving a reasonable picture of the corporation by means of its financial statements. The number is ‘the sign of the

49 50 51 52 53

54 55 56 57

Council Dir 2006/46/EC (n 43), see the tenth rectical in the preamble. See for sanctions 7.5.3. See also 7.5.3. Council Dir 2006/46/EC (n 43), see the fourth rectical in the preamble. See, for example, Michael Bormann, ‘Internationale Harmonisierung der Rechnungslegung’ [1996] RIW 35; Großfeld and Luttermann (n 3) paras 169–72. Wall Street Journal Europe (1995) 15 March, 1. Wall Street Journal Europe (2000) 22 Feb, 4. See also 7.7. See 7.3.2.


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completed limitation’.58 Only the names of and the notes to the items (Bilanzposten) give meaning to the numbers. Hence it is ‘numbers and words’ that have to be carefully considered by the responsible board members and their auditors—and of course by the investors. Since words and the law itself exist in a living language, the cultural aspects are essential for reporting in international markets. The ‘numbers and words’ in financial statements are the result of a wide variety of different influences. They derive from the active parties’ views of chances, risks and uncertainties, and the environment—we can say altogether from the specific ‘view of the World’ (Weltanschauung). However, nationally-based standards are still the active and often prevailing forces.59 Hence comparative law is the key for a common basis as shown by the multilingualism of the law of the European Community and the need of translations within international environments.60

7.3.2 European Court of Justice The decisions of the European Court of Justice take precedence over national law. The Court has jurisdiction to give preliminary rulings concerning, among other things, the EC-Treaty and the validity and interpretation of acts of the institutions of the Community.61 That embraces the Directives and Regulations concerning accounting and auditing.62 Any court of a Member State where such a question is raised may request the Court of Justice to give a ruling thereon; if there is no judicial remedy under national law, that national court shall bring the matter before the Court of Justice.63 The Court’s rulings on accounting matters give a fixed point of reference: the principle of ‘a true and fair view’. According to Article 2(3) and (5) of Directive (EEC) 78/66064 the annual accounts must give ‘a true and fair view of the company’s assets, liabilities, financial position and profit or loss’. The Court of Justice has firmly established that compliance with that principle ‘is the primary objective of the Directive’.65 To reflect that general provision, the 58

59 60

61 62 63 64 65

Oswald Spengler, Der Untergang des Abendlandes: Umrisse einer Morphologie der Weltgeschichte (CH Beck Verlag, reprint of the 33–47 edn 1918, Munich 1990) 77. See 7.4.2. Claus Luttermann, Bilanzrecht in den USA und internationale Konzernrechnungslegung (Mohr and Siebeck Verlag, Tuebingen 1999). Großfeld and Luttermann (n 3) paras 86– 110. On reforms Claus Luttermann and Karin Luttermann, ‘Ein Sprachenrecht für die Europäische Union’, (2004) 59 JZ 1002; Karin Luttermann, Multilingualism in the European Union—Status Quo and Perspectives: The Reference Language Model (forthcoming). EC Treaty, Art 234(1)(a) and (b). See 7.2.2 and 7.5.1. EC Treaty, Art 234(2) and (3). See also Council Dir (EEC) 78/660, fourth rectical in the preamble. Case C-234/94 Tomberger [1996] ECR I-3133, para 17; Case C-275/97 DE + ES Bauunternehmung GmbH [1999] ECR I-5331, para 26; Case C-306/99 BIAO [2003] ECR I-1, paras 72–76.

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German legislature has transposed Article 2(3) of Directive (EEC) 78/660 into Section 264(2)(1) HGB: ‘ein den tatsächlichen Verhältnissen entsprechendes Bild’;66 that is called, in the German ruling of the Court of Justice, ‘Bilanzwahrheit’! So too, the legislatures of the other Member States have transposed this into their national provisions. The meaning of ‘a true and fair view’ (ratio legis) is firmly imbedded by way of localised terminology in several jurisdictions, for example ‘ein getreues Bild’ (Austria),67 ‘une image fidèle’ (France), ‘een getrouw beeld’ (The Netherlands), ‘una imagen fiel’ (Spain).68 The interpretation in the Member States has to be made in conformity with the European Law, that is in the multilingual Community by means of the comparative method.69 We have to keep records as the Court of Justice requires: financial statements (annual or consolidated accounts) must give ‘a true and fair’ record. To give ‘a true and fair view’ is the legal measure of accounting practice. It governs the interpretation of every accounting rule and controls every accounting practice. Financial statements must be clear (klar) in form and true (wahr) in their contents. Facing that high standard, the biblical question may commonly arise: ‘What is truth?’ (John, 18, 38). Surely it is not about something mystical or supernatural. Accounting is a human discipline with ‘true and fair accounting’ as the ethical standard.70 ‘Truth’ is a human dimension, nothing of a mythological or divine approach, and hence accounting is naturally limited.71 With that in mind, the phrase ‘a true and fair view’—like its synonyms in other languages—is a panEuropean term. Fundamentally, it is the idea, the aim and the measure of accounting, nationally and internationally.72 In practice, the responsible accountant has to apply the general provision of ‘a true and fair view’73 in the light of the rulings of the European Court of Justice. The European Judges have determined that the principle of ‘a true and fair view’ ‘requires, first, that the annual accounts of companies should reflect the activities and transactions which they are supposed to describe and, secondly, that the accounting information be given in the form judged to be the soundest and most 66 67

68 69

70 71 72

73

See 7.3.5. For details of the relationship to the German text, see Claus Luttermann, in Bruno Kropff and Johannes Semler (eds) Münchener Kommentar zum Aktiengesetz (2nd edn CH Beck Verlag, Munich 2003) vol 5/1 (s 264 HGB) 774 paras 34–36 and about the rulings of Court of Justice paras 83–105. European Court of Justice (n 65). See for example European Court of Justice, Case 236/97 Codan [1998] ECR I-8679. Claus Luttermann, ‘Rechtssprachenvergleich in der Europäischen Union. Ein Lehrbuchfall’ [1999] EuZW 401. See 7.4.2. See Luttermann (n 67) s 264 HGB paras 19–21 and 121–28. See Luttermann (n 67) 787 paras 83–105; Robert H Parker and Christopher W Nobes, An International View of True and Fair Accounting (Routledge, London 1994). Council Dir (EEC) 78/660 Art 2(3); s 264(2)(1) HGB.


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appropriate for satisfying third parties’ needs for information, without harming the interests of the company’.74 The same applies to consolidated accounts.75 In the light of this, the focus is clearly on legal aspects. There is an old and widespread conviction among accountants, feeling themselves entitled to decide on their own about the measure and rules of accounting. This conception, though still fostered by members of the accounting profession along with distorting kinds of ‘dynamic concepts’ of accounting76 for obvious business reasons, is fundamentally misleading. To put it colloquially, ‘a story of asking the fox to look after the geese’. But the measure is not what accountants or their profession may deem as a general usage (standard). By means of the principles of a constitutional state the measure is what is legally necessary. Accordingly, at the end of the day, Judges have to decide about the practice of ‘a true and fair view’.77 For all of the European Community the Judges of the Court of Justice determine the common meaning. We provide further practical guidance below.78

7.3.3 IAS/IFRS, Company Law and Tax Law The measure of ‘a true and fair view’ applies as well to the process of endorsement of IAS/IFRS into European Law as to the application of the adopted IASs/IFRSs within the European Community, and consequently also to the financial statements of German listed companies.79 The application of international accounting standards (IAS/IFRS) is regulated by IAS/IFRS Regulation (EC) 1606/2002. According to its Article 3(2) an international accounting standard can only be adopted by the European Community, if it is not contrary to the ‘true and fair’ principle set out in Article 2(3) of Directive (EEC) 78/660 (annual accounts) and in Article 16(3) of Directive (EEC) 83/349 (group accounts). Attention has to be paid to the legal standing of IASs/IFRSs within the European Community and in Germany. The adoption of international accounting standards is regulated by Articles 3(1) and 6 of IAS/IFRS Regulation (EC) 1606/2002. At the end of the explanation of the process for adopting these standards, Article 3(4) of IAS/IFRS Regulation (EC) 1606/2002 states: ‘Adopted international ac74

75 76

77

78 79

Case C-275/97 DE + ES Bauunternehmung GmbH [1999] ECR I-5331, paras 26 and 27; Case C-306/99 BIAO [2003] ECR I-1, para. 72. Council Dir (EEC) 83/349 Art 16(3); s 297(2)(2) HGB. See for example Christopher W Nobes, ‘Revenue Recognition and EU Endorsement of IFRS’ (2006) 3 Accounting in Europe 81, 85, referring to Mary Arden, ‘The True and Fair Requirement, Counsel’s Opinion’ (Foreword to Accounting Standards Board, Accounting Standards, London 1993). On German accounting principles see (Grundsätze ordnungsmäßiger Buchführung— GoB) Bundesfinanzhof (I 208/63), Bundessteuerblatt (BStBl) III 1967, 607. Luttermann (n 5) 613. See especially 7.4.2. See 7.2.3.

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counting standards shall be published in full in each of the official languages of the Community, as a Commission Regulation, in the Official Journal of the European Communities’. By means of that procedure the IASs/IFRSs adopted and published in the 23 official languages of the European Community are part of the European Law. With the said Accounting Regulations and Directives, they are subject to the authority and rulings of the European Court of Justice.80 International accounting standards also influence the relationship between company law and tax law. We will deal with that later81, but the key point has to be emphasised right away. The said principle of ‘a true and fair view’ is the common measure of accounting. There are widespread attempts to differentiate purposes and sub-purposes of accounting, especially in relation to tax accounts and commercial accounts. These differentiations are will-o’-the-wisps. It is fundamental that company law and tax law are about the same corporation. Jurisprudence has to handle and show that single corporation as the invisible entity82 in a reasonable way. Regardless of ‘purposes’, that is always by means of the said principle of ‘a true and fair view’.83 This will be looked at more closely in 7.3.4.

7.3.4 Rules of Accounting Accounting is about valuation and information. Rules of accounting, originating in the general provision of ‘a true and fair view’,84 guide the practice of financial reporting. Article 3(2) of IAS/IFRS Regulation (EC) 1606/2002 designates four criteria for the adoption of international accounting standards (IAS/IFRS) in compliance with the IASB Framework: understandability (IASB F.25, Verständlichkeit), relevance (IASB F.26–30; Relevanz), reliability (IASB F.31–38; Verläßlichkeit) and comparability (IASB F.39–42; Vergleichbarkeit). In that context, overall considerations are given in IAS 1.13–41 (2003). They are fundamentally far-reaching, corresponding with rules, especially Article 31 of the Fourth Directive (EEC) 78/660, and hence the Handelsgesetzbuch (HGB).85 Foremost is ‘clearness’ (Klarheit, Bilanzklarheit)86 as the ‘stylistical’ companion of ‘a true and fair view’ (Bilanzwahrheit): the accountant shall give reliable information in plain words and fair presentation,87 with no marketing puffs. Among 80 81 82 83

84 85

86 87

See Luttermann (n 67) 306 paras 163 and 329 paras 250–51. See 7.4.4. See 7.1. See Luttermann (n 67) 338 para 282, 343 para 299 and 414 paras 11–15; Großfeld and Luttermann (n 3) paras 314, 62. See 7.3.1. For a discussion of the qualitative characteristics of accounts, see Großfeld and Luttermann (n 3) paras 317–37. Fourth Directive (EEC) 78/660 Art 2(2); s 243(2) HGB. IASB F.25 and 46, IAS 1.13–22 (2003).


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the considerations are also: going concern (Unternehmensfortführung)88; accrual basis (Periodenabgrenzung)89 and comparability (Vergleichbarkeit), including consistency of presentation (Stetigkeit).90 Aggregation (Gebot der Einzelbewertung)91 and offsetting (Verrechnungsverbot)92 are only allowed for immaterial amounts or items.93 Both aspects point to the overall concept of materiality (Wesentlichkeit). It is a practical guideline for faithful (getreues) reporting in the sense of providing ‘a true and fair view’.94 A vivid description is given in IAS 8.5 (2003): Omission or misstatements of items are material if they could, individually or collectively, influence the economic decisions of users taken on the basis of the financial statements. Materiality depends on the size and nature of the omission or misstatement judged in the surrounding circumstances. We have to discuss this vast area in greater detail.

7.3.5 Expectation Gaps and Procedural Law According to the International Accounting Standards Board (IASB) the qualitative characteristics of the IASs/IFRSs are intended to ‘determine the usefulness of information’ in financial statements.95 This is a broad description that has to be refined. Financial statements are directed towards the common need that a wide range of users (including shareholders, creditors, employees and the public at large) have to obtain more information about the company.96 The financial statements should provide information about ‘the financial position, financial performance and cash flows of an entity’ for those users ‘in making economic decisions’.97 The all-embracing term ‘decision usefulness’ tends to be meaningless. We have to consider the object and the boundaries of accounting.98 88 89 90 91 92 93 94 95 96 97 98

S 252(1) No 2 HGB. Ss 242(1)(1), 252(1) HGB. S 252(1) No 1 HGB. S 252(1) No 3 HGB. S 246(2) HGB. Ss 256, 240 HGB. S 264(2)(1) HGB. IASB Framework 5. IFRS Preface 10. IAS 1.7 (2003), sentence 2. Luttermann (n 67) 295 paras 123–33; for further information about the ‘decisionusefulness concept’ see Wolfgang Ballwieser, ‘The Limitations of Financial Reporting’ in Christian Leuz, Dieter Pfaff and Anthony Hopwood (eds), The Economics and Politics of Accounting (OUP, Oxford 2004) 58–77.

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The accountant has to report faithfully (getreu), according to the governing measure of ‘a true and fair view’. And the law fixes as the object that the accountant has to render an account that demonstrates good corporate governance of other people’s money.99 Financial statements have to ‘show the results of management’s stewardship of the resources entrusted to it’.100 In form and content, the reporting is directed to the so-called ‘recipients’ horizon’ (Empfängerhorizont). German courts, when deciding cases in the area of capital markets law, often employ the standard of an ‘average informed’ (durchschnittlich informierten) and ‘reasonable, intelligent’ (verständiger) investor (in other words: ‘verständiger Durchschnittsanleger’)101. These are the legal standards commonly used for ‘the average consumer’, ‘the ordinary man’ (Leitbild des Normalverbrauchers).102 Basically, the role of the law in this area is to set the borders of accounting. The German version of Article 2(3) of Directive (EEC) 78/660 states that the accounts shall give ‘ein den tatsächlichen Verhältnissen entsprechendes Bild’ (see 7.2.1 and 7.3.2) of the company.103 Translated literally, this means ‘a picture in accordance with the factual relations’. That view, supported by the mathematical approach to accounting (the said focus on the numbers), can be misleading with the result of creating expectation gaps. A ‘fact’ (Tatsache) is an event of the past or the present that is accessible by proof. But keep in mind that accounting is principally a valuation under the general guideline of a going concern.104 Hence accounting embraces the uncertain dimension of the ‘future’ and cannot be treated as something merely statistical.

7.4 Valuation 7.4.1 Financing and the 'Numbers Game' Valuation is the essence of corporate accounting and financing. And it is, though not commonly realised, a key matter of jurisprudence. Members of the management board are responsible for the corporation’s finances since they have to lead the corporation.105 If insolvency (Zahlungsunfähigkeit) or over-indebtedness (Überschuldung) occurs, they have to call for bankruptcy procedures (Insolvenzverfahren);106 and the information provided to shareholders must include 99 100 101

102

103 104 105

106

See 7.2.1. IAS 1.7 (2003), sentence 3. Bundesgerichtshof (I ZR 252/01), (2004) 25 ZIP 184, 186 (regarding an investment, misleading sales promotion). Bundesgerichtshof (I ZR 22/02), [2005] WRP 480, 483; Großfeld and Luttermann (n 3) paras 97–99, 255–68 (Empfängerhorizont). S 264(2)(1) HGB. S 252(1) No 2 HGB. S 76(1) AktG. Original text: ‘Der Vorstand hat unter eigener Verantwortung die Gesellschaft zu leiten.’ Ss 17–19 Insolvenzordnung (German Code of Insolvency).


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heavy losses according to the stated capital (Grundkapital) on the balance sheet.107 These examples have some special significances. But financing, accounting and valuation are generally interlinked. On capital markets, especially stock exchanges, participants are focused on ‘the numbers’. In financial reporting, meeting or missing the so-called ‘consensus estimates’ of shady qualified ‘analysts’ (whatever that term means!) immediately causes sharp rises and falls in a corporation’s shares and hence its valuation. Corporate directors therefore try to meet or even beat the estimates. In 1998, Arthur Levitt, then SEC Chairman, in a speech titled ‘The Numbers Game’, criticised the manipulation of figures that is commonly referred to as ‘earnings management’.108 Corporate managers, auditors, and analysts are still playing that numbers game, as shown by recently uncovered manipulations of financial statements by major companies like American International Group (AIG). It is a worldwide game. A wide variety of techniques are still used as part of this game, including things like ‘big bath’ restructuring charges, acquisitions and mergers, ‘magic accounting’, off-balance-sheet finance etc. Such window dressing, played down as ‘creative accounting’, is the gateway to fraud (Betrug) and dishonesty, or in German ‘unfaithfulness’ (Untreue). German cases and court rulings confirm that.109

7.4.2 The Legal Focus of Accounting Practice The Court rulings against ‘creative accounting’ underline the outstanding importance of the duty to provide ‘a true and fair view’. As the ethical basis of accounting, this principle has to guide each accounting decision. Of course, ‘valuation’ sounds subjective. International comparison shows, too, that there are different concepts and perceptions of risk and uncertainties at work here. Fundamentally, we can see the differences in different accounting systems, at least since the listing of the then Daimler-Benz AG (now DaimlerChrysler AG) on the New York Stock Exchange. The same company is shown differently in its financial statements according to the German Handelsgesetzbuch (European Law) versus the US ‘GAAP’.110 107 108

109

110

S 92 AktG. Arthur Levitt, ‘The ‘Numbers Game’ 28 Sept 1998, speech at NYU Center for Law and Business, <www.sec.gov/news/speech/speecharchive/1998/spch220.txt>. For examples see Großfeld and Luttermann (n 3) eg paras 89–90, 647, 757–58, 1530–32, 1661–63. Some examples are: Balsam AG, Bankgesellschaft Berlin AG, Flowtex AG, Comroad AG. See also, for example, BGH (1 StR 420/03), wistra [2005], S 139 (S 400(1) No. 1 AktG); BGH (4 StR 364/96), wistra 348 (S 331 No 4 HGB, S 266 StGB); OLG Frankfurt (2 Ws 36/02 (S 400(1) No 1 AktG), wistra [2003] 196; FG München (7 K 499/96) EFG [1998] 1481. For some comparative ‘numbers’, see Claus Luttermann, Unternehmen, Kapital und Genußrechte: Eine Studie über Grundlagen der Unternehmensfinanzierung und zum internationalen Kapitalmarktrecht (Mohr and Siebeck, Tuebingen 1998) 25.

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We have to keep those differences in mind when talking about ‘international’ standards of accounting. The core is, that accounting is basically valuation. Therefore standards of accounting are standards of valuation. Different kinds of cultural influences or, to put it differently, Weltanschauungen are in actual fact powerful forces at work in this area.111 The European Court of Justice, authoritative for Germany as a Member State of the European Union, is setting the stage. When valuing items, the Judges have determined that prudence (Vorsicht) must always be observed. But, for example, the amount of provisions (Rückstellungen) for liabilities and losses ‘must not exceed what is needed’.112 Based on the true facts, the accountant has to fix a reasonable amount for every item in the financial statements. In this regard the accountant is guided by the principle of benchmarking, in other words, to look at similar transactions or at competitors in the particular area of business. The requirement is always to objectify as far as possible. Necessary predictions are to be made in accordance with the acknowledged rules of probability (Wahrscheinlichkeitsrechnung—probability calculus). This underlines the outstanding importance of the general norm of accounting, to give ‘a true and fair view’. In practice this measure is the guide used to determine how to account for the company’s assets, liabilities, financial position and profit or loss. By no means is it, as some commentators would suggest, ‘effectively meaningless as a restriction’113 or ‘so vague that other arguments would be more pertinent’.114 Such wording shows a substantial lack of understanding of basic legal principles. The European Court of Justice has shown the interplay of the general norm and other rules of accounting, for example, in the case of DE & ES Bauunternehmung GmbH about global provisions for a number of potential liabilities.115 The Court rejected a result that would not only be incompatible with the rule of making valuations on a prudent basis, but also ‘with the principle of the ‘true and fair view’, compliance with which is the primary objective of the Directive [78/660/EEC]’.116 The rulings of the European Court of Justice document the complementary relationship (Komplementärverhältnis) between the general rule (Generalnorm), 111 112

113

114 115

116

See 7.3.1. Case C-306/99 BIAO [2003] ECR I-1, para 75, regarding Art 31(1)(c) and 42(1) of the Fourth Dir (EEC) 78/660. David Alexander, ‘Legal Certainty, European-ness and Realpolitik’ (2006) 3 Accounting in Europe 65, 70. See on that Jens Wüstemann and Sonja Kierzek, ‘True and Fair View Revisited: A Reply to Alexander and Nobes’ (2006) 3 Accounting in Europe 92, 101–2. Nobes (n 76) 81, 84. Council Dir 78/660/EEC, Art 2(3) and (5), 20(1), 31(1)(c). See German law: ss 264(2)(1), 249(2), 252(1) No 3 HGB. See with details European Court of Justice, Case C-275/97 DE + ES Bauunternehmung GmbH [1999] ECR I-5331, paras 24–40 (26). Claus Luttermann, ‘Pauschalrückstellung für potentielle Gewährleistungsverbindlichkeiten’ (1999) 2 NZG 1039.


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named the principle of ‘a true and fair view’, and the other rules of accounting (Einzelregeln).117 ‘Complementary’ belongs to the noun ‘complement’ (from Latin complementum), that means completeness, fullness, that is, a thing which, when added, completes or makes up a whole.118 The general norm, stating the objective and rationale of accounting, influences the other rules, giving the keynote for reasonable treatment of single items. The general rule is embodied systematically and becomes even clearer in terms of practical guidance if considered with the other rules in their totality. Both categories in their complementary interaction in practice enrich and complement each other. But we must note: This shall not be misinterpreted as something of arbitrariness (Willkür). The legal measure is ‘a true and fair view’, ultimately linked with the concept of materiality.119 In focusing on a particular case, the Court is evaluating whether a separate valuation of potential liabilities in that case is necessary, using the standard ‘a true and fair view’ as a measure.120 The procedural law also gives a substantial clue to what is ‘a true and fair view’ for single items. The German Code of Civil Procedure (Zivilprozeßordnung, ZPO) is representative for handling the questions at issue. This Code, applying also to disputes about matters of financial accounting, generally requires true statements before the court.121 The judges have to decide on independent conviction (freier Überzeugung), if they consider a factual allegation (tatsächliche Behauptung) to be true.122 Estimations, as far as they are necessary, have to be reasonable.123 So, as a rule, the accountant again must objectify as far as possible. If a factual allegation is ‘true’, this can be decisive for the individual case. Concerning that judicial core question of what is true, the Bundesgerichtshof wrote about the judge’s conviction mutatis mutandis: what is required is a level of certitude, that commands silence on doubts without ruling them out in full.124 We now can determine the legal measure for the practice of corporate directors, their accountants, and auditors. According to the explained meaning of ‘truth’ (Wahrheit—and note again Bilanzwahrheit is used above as a synonym of ‘a true and fair view’) it is not about metaphysics or philosophic proportions (‘What is truth?’, John 18, 38). The requirements are appropriate to human capacities and to speak in terms of modern physics as the essence of the exact sciences, the measure of accounting (‘a true and fair view’) must be that accountants do not have to state 117 118 119 120 121 122 123 124

Großfeld and Luttermann (n 3) para 230. The New Shorter Oxford English Dictionary (vol 1 Clarendon Press, Oxford 1993) 460. See 7.3 and 7.5.1. European Court of Justice (n 116), paras 28–40. S 138(1) ZPO. S 286(1) ZPO. S 287 ZPO. Bundesgerichtshof (VI ZR 221/92), [1994] NJW-RR 567, 568. Equally Bundesverfassungsgericht (1 BvR 1273/96), (2001) 54 NJW 1640.

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how the world (the company) is, but they have to state what can be told about the world (the company).125 That needs to be done in a clear way within the financial statements of the company.

7.4.3 Consolidated Financial Statements126 The above-named characteristics apply also to consolidated financial statements (Konzernabschlüsse). The accounts shall be drawn up clearly127 and they shall give ‘a true and fair view’.128 This measure has also to be observed when the consolidated financial statements are drawn up in terms of IASs/IFRSs. Article 3(2) of IAS/IFRS Regulation (EC) 1606/2002 refers explicitly to Article 16(3) of the Seventh Directive (EEC) 83/349. Commonly, corporate directors, accountants and investors have to pay attention to the special quality of consolidated accounts. In Germany, consolidated financial statements were legally established with Section 329 AktG 1965. Foreign affiliated companies were not required to comply, which was an expression of the precariousness of addressing unfamiliar conditions abroad. Basically, the same problem still exists. Valuation is often a difficult task in familiar surroundings, and it is all the more difficult in view of different foreign patterns of time, language, public and private order, and standards of value. Since 1985, Section 290 HGB requires from every (parent) company with a subsidiary (Mutterunternehmen) to draw up consolidated accounts and a consolidated annual report (Konzernlagebericht) in accordance with the Seventh Directive (EEC) 83/349. The parent company shall be consolidated with all of its subsidiaries (Tochterunternehmen), regardless of where the registered offices of the subsidiaries are situated.129 The assets, liabilities, financial positions and profits or losses of the undertakings (Unternehmen) shall be shown as if the parent and its subsidiaries were ‘a single undertaking’.130 In complying with that fictional requirement, the accountant has to take care in how far adjustments are to be made resulting from the consolidation’s particular characteristics (Eigenart).131 A complete set of consolidated accounts comprises a consolidated balance sheet (Konzernbilanz), a consolidated profit and loss account, the notes on the accounts (Konzernanhang), a cash flow statement (Kapitalflußrechnung), and a consolidated account of changes in equity (Eigenkapitalspiegel). Those documents—together 125 126

127 128 129 130 131

See Luttermann (n 67) 770 paras 19–21 and 799 paras 121–28. See Großfeld and Luttermann (n 3) paras 1229–1447 (general rules), paras 1448–1560 (HGB/European Law), and paras 1561–1730 (IAS/IFRS). S 297(2)(1) HGB. S 297(2)(2) HGB; see Seventh Dir (EEC) 83/349 Art 16(2) and (3). S 294(1) HGB. S 297(3)(1) HGB based on Seventh Dir (EEC) 83/349 Art 26(1). S 298(1) HGB. See especially Art 17 and 29 of the Seventh Dir (EEC) 83/349.


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with the consolidated annual report132—are mandatory.133 Segment reporting (Segmentberichterstattung) can be added.134 The consolidation procedures for the parent company and its subsidiaries as ‘a single undertaking’135 are focused on four elements: the ‘equity of the group’ (Kapitalkonsolidierung), intragroup balances (Schuldenkonsolidierung), intragroup transactions (Zwischenergebnisse), and intragroup income and expenses (Ertrags- und Aufwandskonsolidierung).136 Consolidated accounts of publicly-traded companies (stocks, bonds) governed by the law of a Member State of the European Union (such as Germany) shall be prepared in conformity with the IASs/IFRSs adopted as European Law.137 Some companies, such as those whose securities are listed on the New York Stock Exchange,138 have to apply the IASs/IFRSs only for each financial year starting on or after 1 January 2007.139 Accordingly, and due to the concept of ‘control’,140 the accountant has to present financial information about the group as ‘a single economic entity’.141 To be legally precise, we should say ‘a single enterprise’,142 or ‘a single undertaking’.143

7.4.4 Liability, International Taxation and Cash Pooling Consolidated financial statements are of increasing practical importance. Participants of capital markets are often focused on them since many companies are subsidiaries or a parent of a group of affiliated companies (Konzern). In terms of valuation, too, the whole seems to be more than the sum of its pieces. Hence, investors like to see the ‘whole thing’. But that can cause dangerous erosion of other aspects, for example, in terms of liability. We have to consider that in greater detail. A company with limited liability as a separate legal person is structured, of course, simply to limit liability.144 Consolidated accounts ignore that. By means of 132 133 134 135 136 137 138 139

140

141 142 143 144

Ss 290(1), 315 HGB. S 297(1)(1) HGB. S 297(1)(2) HGB. Seventh Dir (EEC) 83/349 Art 26(1). For details see Großfeld and Luttermann (n 3) paras 1448–1560. S 315a HGB. Based on Art 4 of Reg (EC) 1606/2002. For example: DaimlerChrysler AG, Deutsche Telekom AG, SAP AG. Details in Art 57 of the Einführungsgesetz zum (Introductory Act to the) HGB (EGHGB), based on Art 9 of Reg (EC) 1606/2002. IAS 27.12–21 (2003). Likewise with the concept of ‘control’ consolidation pursuant to s 290(2) HGB. IAS 27.4 and 22 (2003). IAS 27.6 and 15 (2000). Seventh Dir (EEC) 83/349 Art 26(1). S 1(1)(2) AktG.

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the law in the consolidated financial statements, the assets, liabilities, financial positions and profits or losses of the companies included in a consolidation shall be shown as if those companies were ‘a single enterprise’.145 Limitations on liability may suffer harm from the ‘single enterprise’ approach which may lead to a liability incurred by one company becoming a liability of the group (Konzernhaftung).146 And from regarding a group of affiliated companies as ‘a single economic entity’,147 it may be only a small step to a variety of unitary taxation of a ‘unitary business’ (Einheitsunternehmen), particularly in an international arena.148 The concept of the separate legal entity (Juristische Person) is not infinite (see, for example—though very rare—cases of ‘lifting the corporate veil’)149. But it is fundamental and far-reaching for the western order of business and society. In Germany, a group of affiliated companies is not a taxable person (Steuersubjekt).150 Therefore, the concept of ‘unitary taxation’, with its reality of many years’ standing in the United States of America,151 actually seems to be only a thread, if someone’s’ business is taxable in the United States.152 But as explained, changes may occur. At least we have to report that the ‘unitary business’ approach is already part of the discussions about a harmonised tax system for the European Union.153 So far, in Germany it is not consolidated financial statements, but the annual results of the financial statements of the single company that are the legal basis for tax purposes and distribution of profits. In the realm of corporate finance, in relation to cash pooling between affiliated companies, the Bundesgerichtshof as the highest federal court of civil jurisdiction ruled that the managing director (Geschäftsführer) of a private company (Gesellschaft mit beschränkter Haftung (GmbH)) is under a legal duty to run the business of the company with the degree of skill, care and diligence required of a decent business person.154 Thus, if the subsidiary is a private company, he is obliged to 145 146 147 148

149

150

151

152 153

154

Council Dir 83/349/EEC, Art 26(1), s 297(3)(1) HGB. Oliver Rieckers, Konzernvertrauen und Konzernrecht (CH Beck Verlag, Munich 2004). IAS 27.4 and 22 (2003). Claus Luttermann, ‘Besteuerung multinationaler Konzerne in den Vereinigten Staaten von Amerika’ [1996] RIW 935, 947. Charles EF Rickett and Ross B Grantham (eds), Corporate Personality in the 20th Century (Hart Publishing, Oxford 1998). See Einkommensteuergesetz (German Income Tax Code) s 1 and Körperschaftsteuergesetz (German Corporation Tax Code) s 1(1). Claus Luttermann, ‘Unitary Taxation und U.S. Supreme Court. Die Entscheidung Barclays Bank PLC/Colgate-Palmolive Company v. Franchise Tax Board of California’ [1994] IStR S 489–93. Luttermann (n 148). See for example Joann M Weiner, Formulary Apportionment and Group Taxation in the European Union: Insights from the United States and Canada (Working Paper, EUCommission, March 2005—Doc. TAXUD/2005/2601—EN). Ss 43(1) and 35(1) GmbHG read together.


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ignore any directives or instructions from the management board of the parent company if such directives or instructions would not be in the best interest of his company (the subsidiary), particularly if such directives or instructions would threaten the continued existence of the subsidiary.155 This seems to illustrate clearly that there are fundamental exceptions to the common ‘single entity’ approach. Looking at the complete picture, we need to say that the ‘single entity’ approach to consolidated financial statements is the exception. The standard by means of the law is still the corporation (company) as a separate legal person. And this will be the standard until some other concept has proven to be superior in order to regulate reasonable business and society.

7.5 Auditing, Control and Sanctions 7.5.1 About Watchdogs and Materiality The annual accounts/financial statements of a company with limited liability are subject to a statutory audit;156 so are the consolidated accounts/financial statements.157 An independent auditor (Abschlußprüfer) shall conduct the audit, providing the statutory rules and additional terms of the memorandum of association (Gesellschaftsvertrag) or of the articles of incorporation (Satzung) have been observed. That includes the bookkeeping.158 The measure is the general provision of ‘a true and fair view’—just as for the accounting.159 The auditor shall carry out the audit in a conscientious manner to identify material errors (Unrichtigkeiten) and violations (Verstöße) according to the measure of ‘a true and fair view’ and in accordance with the rules applying to audits.160 The auditor gives an account of his audit and findings in an audit report (Prüfungsbericht).161 In conclusion, the auditor gives an audit opinion (Bestätigungsvermerk). Different categories have been in international usage since 2005:162 the audit opinion is unrestricted in the absence of objections, or restricted in the case of objections. If those objections are material (wesentlich) or if it is not possible to give an opinion based on the examination, the auditor refuses to give an audit opinion. Materiality (Wesentlichkeit), referring to the 155

156 157 158 159 160 161 162

BGHZ 149, 10 (I.1.). See Claus Luttermann, ‘Unternehmensfinanzierung, Geschäftsleiterpflicht und Haftkapital bei Kapitalgesellschaften’ (2001) 56 BB 2433, 2435. Under criminal law Bundesgerichtshof (5 StR 73/03), BGHSt 49, 147. S 316(1) HGB. S 316(2) HGB. See also Großfeld and Luttermann (n 3) paras 1767–97. Ss 317(1)(1) and 238–41 HGB. See 7.2.3. S 317(1)(3) HGB. S 321 HGB. S 322(2) HGB.

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measure of ‘a true and fair view’,163 has to be specified in the light of the circumstances of a particular case. The Bundesgerichtshof, for example, ruled that a profit-reducing accounting fault of 44.186 DM (Deutsche Mark) is an ‘infinitely small item’ (ein verschwindend geringer Posten) when considered in relation to 32.75 million DM consolidated profit.164 Taken as a whole, the financial statements must be reasonable (angemessen). The auditor should not be too pedantic, but should be aware that some minor omissions or misstated items can add up to a material objection. The Eighth Directive (EEC) 84/253 has been subject to reform designed to improve and harmonise the quality of statutory audits throughout the European Union.165 The modernised, principle-based Directive includes: public oversight, external quality assurance, auditor independence, code of ethics, auditing standards, disciplinary sanctions and the appointment and dismissal of statutory auditors. The European Union is going to implement International Standards on Auditing (ISAs) for all statutory audits; these would be relevant in Germany too as part of the European Law.166 The audit standards of the Institut der Wirtschaftsprüfer (IDW), the German professional organisation of auditors, are already adjusted to ISAs.

7.5.2 Disclosure and Enforcement The annual accounts, duly approved, and the annual report, together with the auditor’s opinion, shall be published in accordance with the laws of the Member State in accordance with Council Directive (EEC) 2003/58 and Council Directive (EEC) 2004/109.167 The same applies to consolidated accounts, especially in accordance with the adopted IASs/IFRSs. In Germany, details are laid down in the Sections 325–29 HGB. Some differences are made according to the size of the company.168 Basically, the accounts shall be submitted to the commercial register (Handelsregister)169 at the local court (Amtsgericht). Everyone is allowed to view these to gain information.170 163 164 165

166 167

168 169 170

Ss 264(2)(1) and 297(2)(2) HGB. BGHZ 148, 123, 128–9 (MLP AG). Council Dir (EEC) 2006/43 on statutory audits of annual accounts and consolidated accounts, amending Council Dir (EEC) 78/660 and (EEC) 83/349 and repealing Council Dir (EEC) 84/253 [2006] OJ L 157/87. Cf 7.2.3. For Germany`s former law according to Art 3 of Council Dir (EEC) 68/151 see Großfeld and Luttermann (n 3) paras 1798–1803. Recently ‘Gesetz über elektronische Handelsregister und Genossenschaftsregister sowie das Unternehmensregister’ (EHUG), 10 Nov 2006, Bundesgesetzblatt Teil 1 (BGBl. I 2553) – electronically disclosed since 01.01.2007 <www.unternehmensregister.de>. S 267 HGB. S 8 HGB. S 9(1) HGB.


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Misuse and manipulation of corporate accounts have urged the German legislature to introduce a two-tier enforcement system.171 The Financial Reporting Enforcement Panel (Deutsche Prüfstelle für Rechnungslegung, DPR) has been established as a private-law organisation, dominated and financed by market participants (companies, auditors etc.). The Panel examines, on concrete indication or spotcheck, the financial reporting of companies.172 It is a legal requirement that incorrect reporting identified in these examinations must be reported to the Bundesanstalt für Finanzdienstleistungsaufsicht (BaFin), the German regulatory authority for capital markets and services. The incorrect reporting is subject to further official proceedings, including sanctions and—upon reasonable suspicion—criminal prosecution.173

7.5.3 Liability and Sanctions Pursuant to the Action Plan of the European Commission, members of the administrative, management and supervisory bodies of a company with limited liability are collectively responsible towards the company for drawing up and publishing annual accounts and annual reports. Thus the Member States are refrained from opting for a system of responsibility limited to individual board members. It is analogous to members of a group drawing up consolidated accounts and consolidated reports.174 But Member States remain free to set rules to impose penalties on an individual board member by rulings of a court or other enforcement bodies (e.g. in Germany the BaFin). A public company or other companies with limited liability will be liable for the acts of the members of the management and the supervisory boards if the members of the management board act as company organs. In other words, when they act as company organ and cause third parties to suffer damages by contract, tort and other reasons, the public company is liable. This is based on the concept of liability of the company for the acts of its organs (Organhaftung).175 The public company’s liability for the acts of the members of the management and supervisory boards includes their acts associated with financial reporting. The responsibility of members of the management and supervisory boards for financial statements (accounts), and key non-financial information, needs clarification. In its Action Plan, the European Commission proposed as follows:176 171 172 173 174

175 176

Ss 342b–342c HGB. S 342b(2)–(4) HGB. S 342b(5)–(8) HGB. Council Dir 2006/46/EEC [2006] OJ L 224/1, Art 2.3. (Amendment to Dir 83/349/EEC, Art 36a, referring to Dir 78/660/EEC, Art 46a, and Reg (EC) No 1606/2002 on IAS/IFRS. S 31 BGB (Bürgerliches Gesetzbuch). EC Commission, Proposal for a Directive of the European Parliament and the Council amending Council Directives (EEC) 78/660 and (EEC) 83/349 concerning annual accounts of certain types of companies and consolidated accounts, 27.10.2004 COM(2004) 725 final (2004/0250(COD)).

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Member States [like Germany] shall ensure their laws, regulations and administrative provisions on liability apply to the members of the administrative, management and supervisory bodies referred to in [Article 50b of Directive 78/660/EEC, Article 36a of Directive 83/349/EEC]177. Similar provisions had been enacted by way of Directive 2006/46/EC. Member States have to ensure that their laws on liability apply to the members of those bodies towards the company, for breach of the duty referred to in Directive 78/660/EEC, Article 50b, and in Directive 83/349/EEC, Article 36b. Some sanctions are already contained in Sections 331–35b HGB. In particular, any untrue or incorrect presentation (unrichtige Darstellung), such as the falsification or concealment of the company’s financial position by a member of the management or the supervisory board, can result in fines or imprisonement for up to three years for these members.178 Wrong information given by the auditor is treated in the same way.179 Criminal liability is based on the duty that those who are responsible to give statements (Bilanzeid) have to state, to the best of their knowledge, that the financial statements give a true and fair view. This rule had been drafted on the model of the United States Sarbanes-Oxley Act of 2002, Section 302.180 The European Commission, without prejudice to the Member States’ sovereign criminal law, in principle states: ... the Member States shall lay down the rules on penalties applicable to infringements of the national provisions adopted pursuant to [Directives 78/660/EEC, rsp. 83/349/EEC] and shall take all measures necessary to ensure that they are implemented. The penalties and measures provided for must be effective, proportionate and dissuasive. 181 Apart from criminal sanctions, a non-criminal fine (Bußgeld)182 or a coercive payment (Zwangsgeld)183 can be imposed in a case where accounting rules are violated. Simultaneous general statutory rules may apply, for example, concerning 177 178 179 180

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182 183

New Art 50c of Council Dir (EEC) 78/660; new Art 36b of Council Dir (EEC) 83/349. S 331 HGB. S 331 No 4 HGB. Thereto Bundesgerichtshof (4 StR 364/96), [1996] wistra 348. Ss 264(2)(3), 289(1)(5) HGB, Transparenzrichtlinie-Umsetzungsgesetz, BGBl 2007 I at 10 (Bundestags-Drucksache 16/2498, Bundesrat-Drucksache 579/06). But see Council Dir 2004/109/EC, Art 4(2)(c), 5(2)(c), already s 331 No 1 HGB. EC-Commission, Proposal for a Directive of the European Parliament and the Council amending Council Directives (EEC) 78/660 and (EEC) 83/349 concerning annual accounts of certain types of companies and consolidated accounts, 27.10.2004 COM(2004) 725 final (2004/0250(COD)); now Dir 78/660/EEC, Art 60a, and in Dir 83/349/EEC, Art 48. S 334 HGB. S 335 HGB.


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compensatory damages (Schadensersatz, e.g. Section 331 No. 1 HGB with Section 823(2) BGB the German Civil Code)184 or criminal breach of trust (Untreue, Section 266 StGB the German Criminal Code).185 But it should be kept in mind that a criminal charge is always ultima ratio (the last resort).186

7.5.4 Judicial Relief and International Court of Accounting A legal system needs a strong system of judicial relief (Rechtsschutz). Within the European Union such a system has been institutionalised, based on the national jurisdictions of the Member States. In Germany, that is the jurisdiction of the Civil Procedure Law (Zivilprozeßordnung, ZPO) and of non-contentious proceedings (Freiwillige Gerichtsbarkeit). Financial reporting may also be subject to international187 arbitration (Schiedsgerichtsbarkeit).188 Where a question of European Law (e.g. concerning the Directives or Regulations)189 is raised before any court or tribunal of a Member State (e.g. Germany), that court or tribunal may, if it considers that a decision on the question is necessary to enable it to give judgement, request the Court of Justice to give a ruling thereon. If there is no judicial remedy against the court’s decision under national law, that court shall bring the matter before the Court of Justice.190 Concerning that matter the preliminary ruling of the Court of Justice is binding on all courts, government bodies, and so on, in the European Union. The adopted IASs/IFRSs, as a part of the European Law,191 are subject to that juridical system.192 This ensures an important way of safeguarding a high level of quality and comparability in financial reporting in the internal European Community market. By means of the principles of the Treaty this is promoting throughout the Community ‘a harmonious, balanced and sustainable development of economic

184

185

186

187 188 189 190 191 192

See Bundesgerichtshof (II ZR 54/03) [2005] DStR 933, 936 (co-operative). Cf personal liability of board members in cases of deficient ad-hoc-information Bundesgerichtshof (II ZR 402/02, 217/03 and 218/03) (2004) 57 NJW 2668, 2664 and 2971 (Infomatec AG). See also s 265b StGB (obtaining credit by false pretences—Kreditbetrug) and—in the case of insolvency—ss 283, 283a StGB (bankruptcy—Bankrott), s 283b StGB (breach of the requirement to keep accounts—Verletzung der Buchführungspflicht). See Bundesgerichtshof (1 StR 280/99), (2000) 23 ZIP 1210 with comment by Luttermann; also Bundesgerichtshof (5 StR 73/03), BGHSt 49, 147. For more details about sanctions see Luttermann (n 67) s 264 HGB paras 19–21, 121–28, and 165–69. S 1061 ZPO. S 1025 ZPO. See 7.2.2. EC Treaty, Art 234. See 7.2.2. See Großfeld and Luttermann (n 3) paras 168, 204–5; see also paras 150–1 (European ‘Ordre Public’).

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activities’.193 Since the European Law is officially recorded in more than twenty official languages, the linguistic approach is fundamental. The European Court of Justice’s requirement of a uniform interpretation of all of the language versions is a major task for everyone in the Member States. The law therefore makes it necessary to compare the legal terminologies due to the ratio legis with all the rules of accounting in the process of implementation and practice.194 This is a blueprint for the international harmonised development of accounting as the documentary proof of good corporate governance. The global spread and implications of IASs/IFRSs beyond the European Union should always be kept in mind. The influences of different jurisdictions worldwide have a high potential to give more or less obvious or creeping change to practices and ‘realities of laws’ under the overall label ‘IAS/IFRS’. So in the longer term an international court for accounting matters (Internationales Bilanzgericht)195 could establish and safeguard a harmonised practice of international standards of accounting (IASs/IFRSs), auditing (ISAs), and valuation (IVSs). This type of development seems to demonstrate the inevitable result of globalisation and internationalisation on accounting standards or, to put it differently, the convergence of accounting standards that were, not so long ago, perceived as quite different. It leads us to important conclusions for the handling of accounting matters.

7.6 Strategic Governance and Audit Committee Accounting is a legal duty. But the responsible corporate directors and their accountants and auditors should see financial reporting much more as an entrepreneurial opportunity. Giving ‘a true and fair view’ of the company every business year in the accounts/financial statements is the best evidence of sound business practice and opening up potential investment opportunities. Telling the investors clearly the whole story (‘the good, the bad, and the ugly’!) creates confidence, even in a year of minor success, in the light of substance and sustainability. Such corporate governance is necessary for the success of a company in the longer term and for the integrity of capital markets worldwide.196 True and fair accounts are at the same time the documentary proof for corporate directors as responsible accountants.197 The accounts/financial statements can prove whether a corporate director has carried out his duties, that is, whether he or she simply has done a good job of providing good corporate governance. And if he or she has done so there is no reason to hide. So again: tell the true story clearly. Then the accounts/financial statements are a protection against unrealistic expecta193 194 195 196 197

EC Treaty, Art 2. See 7.3.1–3.3 and 7.4.2. See proposal by Luttermann, Bilanzrecht (n 60) 134–36. See Großfeld and Luttermann (n 3) paras 86–96. See 7.2.1.


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tions and claims.198 Therefore, the strategic formula for far-sighted fair corporate governance is ‘protection and confidence through true information’; economists may call that a typical ‘win–win situation’. On the other hand, shady areas and marketing puffs in accounts/financial statements should always on first sight send out an alarm signal, above all for the members of the supervisory board and for the external auditor. That alarm signal should trigger deeper and more penetrating investigation into the actual financial position of the corporation by those supervising and overseeing the business of the corporation and acting as watchdogs (i.e. the members of the supervisory board and for the external auditor). Corporate governance must recognise accounting matters as vital. Pursuant to the significance of good corporate governance, an audit committee (Prüfungsausschuß) should be established. Conventionally, it is a committee of the board of directors that is charged with matters relating to financial reporting and audit. The European Commission is going to strengthen the status of the audit committee and has made a recommendation that includes the role and operation of the audit committee with respect to the internal policies adopted by the company and to the external auditor engaged by the company. The committee members ‘should, collectively, have a recent and relevant background in and experience of finance and accounting for listed companies appropriate to the company’s activities’.199 For this reason, each company in Germany should establish by means of the law (publicly-traded companies) or on a voluntary basis, in its own best interest, an audit committee as a committee of the supervisory board.200 It is essential that independent financial experts (Bilanzexperten) are appointed to that committee.201 The European Commission recommends: ‘A director should be considered to be independent only if he is free of any business, family or other relationships with the company, its controlling shareholder or the management of either, that creates a conflict of interest such as to impair his judgement.’202 Foremost and ultimately, independence is the essence of the poise of one’s self (innere Haltung).

198 199

200

201

202

See 7.3.5 and 7.5.2. Also Luttermann (n 67) 295 paras 123–33 and 798 paras 119–69. Commission Recommendation 15 Feb 2005 on the role of non-executive or supervisory directors of listed companies and on the committees of the (supervisory) board (EC) 2005/162, OJ L 52, 25.2.2005, section III (11.2.) and Annex 1 (4.). See with s 161 AktG the German Corporate Governance Codex 5.3.2 and 7.1; s 314(1) No 8 HGB (declaration of compliance). Claus Luttermann, ‘Unabhängige Bilanzexperten in Aufsichtsrat und Beirat’ (2003) 58 BB 745–50. Commission Recommendation (n 199) section III (13.1). With international comparison Lutgart van den Berghe and Liesbeth de Ridder, International Standardisation of Good Corporate Governance (Kluwer, Boston 1999).

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7.7 Concluding Remarks Accounting (financial reporting), deriving from accountability (Rechenschaft), is internationally the embodiment and the proof of good corporate governance. Corporate directors have a legal duty to inform the investors about their money (investment). Also in order to give substance to the concept of ‘going concern’, the information must give ‘a true and fair view’ (ein getreues Bild) of the company, including forecasts (Prognosen). With the adoption of IASs/IFRSs, elements of forecasts will become increasingly precarious in the European Union, and hence in Germany. Most importantly, companies with a concept of ‘fair value’, that allows questionable, often estimated ‘values’ that have not been proved by a market transaction, will risk penalties. As far as possible, ‘soft information’ should be avoided so as not to slide from accounting into meaningless forms and fortune telling (Wahrsagerei). For accounting, the general measure of ‘true and fair’ (Bilanzwahrheit) is the fundamental maxim to act on. Global markets deal with present and future wealth. In international competition, political catchphrases abound. A prominent one is ‘hidden reserves’ as a verdict on ‘German accounting’, although in the United States this is also widely practised, but played down as ‘cookie jar reserves’. Comparative work can unmask such tricks and strengthen the common idea of true and fair accounting.203 The foundation of true and fair accounting is firmly imbedded for German companies with limited liability powerfully imprinted by the European Law and its Court of Justice. Harmonisation of the accounting law is the bridge to international capital markets law204 and common standards of good corporate governance. At the core worldwide is the integrity of capital markets. In the light of natural limits, we should further develop jointly a language of accounting and auditing, and hence of valuation. International standards for accounting and corporate governance are evolving. Even cultural differences may fade in the longer term. Misuse and fraud can not be eliminated in full, but we must sanction them rigorously if they occur. However, we should not make accounting and auditing too hazardous for responsible individuals and companies.205 Jurisprudence is drafting legal rules based on the model of the decent individual.

203 204

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Levitt (n 108). For more examples see Luttermann (n 67) 781 paras 62–82. Claus Luttermann, ‘Mit dem Europäischen Gerichtshof (Centros) zum Internationalen Unternehmens- und Kapitalmarktrecht: Kollisionsrecht in den Zeiten des Internet’ [2000] ZEuP 907–21. Cf Judge L Hand in Dabney v Chase National Bank, 196 F.2d 668, 675 (2nd Cir. 1952), and Bundesregierung, Entwurf (bill) eines Gesetzes zur Unternehmensintegrität und Modernisierung des Anfechtungsrechts (UMAG), Bundesrats-Drucksache 3/05 and Bundestags-Drucksache 15/5092.

Chapter 8

The Dominant Role of the German Banks and New Players in the German Financial Sector Jean du Plessis and Claus Luttermann

8.1 Introduction Traditionally corporate law systems based on common law are also very much based on the concept of ‘ownership’ of the company by the shareholders—the idea that the shareholders ‘own’ the company and that they can control the company through their voting power at the general meeting.1 They cast their vote personally or by proxy and can employ this means to determine the destiny of the company. The voting right of a shareholder is seen as a personal right and, generally speaking, can be cast according to the shareholder’s perception of what is in his or her own best interest.2 In Germany, however, due to unique conditions during the nineteenth century, the banks play an important role in corporations’ internal affairs. Banks, directly or indirectly, control various enterprises through their unique position as the enterprises’ creditors or as owners of the equity interests.3 The control of the banks over German corporations once again came under sharp attack in 1996–1997 when several changes were proposed to the Aktiengesellscahftgesetz (AktG).4 Most of these changes became law after the Gesetz zur 1

2

3

4

For a succinct exposition of this concept, see Report of the Committee of Inquiry on Industrial Democracy (Bullock Report) Cmnd 6706 (HMSO, London 1977) 59 para 2. Wedderburn of Charlton, ‘Companies and Employees: Common Law or Social Dimension?’ [1993] LQR 230. Also AJ Boyle, ‘Draft Fifth Directive: Implications for directors’ Duties, Board Structure and Employee Participation’ (1992) 13 Company Lawyer 9. Theodor Baums, ‘Corporate Governance in Germany: The Role of the Banks’ [1992] AJCL 503. Also Martin Peltzer, ‘Empfehlen sich gesetzliche Regeln zur Einschränkung des Einflusses der Kreditinstitute auf Aktiengesellschaften?’ [1996] JZ 842 ff; Thomas J Andre (Jr), ‘Some Reflections on German Corporate Governance: A Glimpse at German Supervisory Boards’ (1996) 70 Tulane L Rev 1819 para 1834 ff. Carsten P Claussen, ‘Aktienrechstreform 1997’ (1996) 41 AG 482–84. See generally [1997] AG (Special Edition) 7–8.

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Kontrolle and Transparenz im Unternehmensbereich (KonTraG) was adopted in May 1998, but whether the dominant role played by the banks was diminished by these changes is questioned by some commentators.5 Claussen refers to the numerous academic materials on the the German banks’ influence over corporations, but points out that the same debate over the same issues was already at least 70 years old.6 At the time when proposals to diminish the banks’ influence over German corporations were debated in all seriousness, Pelzer pointed out that there were far more important political items for the Government, for example tax reforms and public health insurance.7 He also questioned whether it was correct to focus on the infleunce of banks only and not also on the influence, for instance, of large insurance companies.8 It is, however, important to have at least a basic appreciation of the influence of the banks in Germany to better understand practices relating to public corporations, and in particular listed public corporations.

8.2 The Traditional Position 8.2.1 Control Through the General Meeting Theoretically speaking the German shareholder is also ‘owner’ of his or her shares, but the practical situation differs slightly. The shares of the typical large German stock corporation are held in voting blocks of up to 30 per cent or more.9 For various reasons, shares or share certificates ‘owned’ by individuals have since the nineteenth century been deposited with banks and other institutions,10 and the banks hold these shares as custodians for their clients.11 First and foremost this is for security, since the overwhelming mass of German shares are in bearer

5

6 7 8 9

10 11

See Helmut Kohl, ‘Corporate Governance: Path Dependence and German Corporate Law: Some Skeptical Remarks from the Sideline’ (1999) 5 Colum J Eur L 197. Claussen (n 4) 482–84. See also Peltzer (n 3) 841 (fn 1). Peltzer (n 3) 851. Ibid 843. Baums (n 3) 505. This is remarkable when compared with the position in America, where the five largest shareholders together rarely control as much as 5% of a large firm’s shares—see Mark J Roe, ‘Some differences in corporate structure in Germany, Japan, and the United States’ [1993] Yale L J 1936–93. Baums (n 3) 503; Wedderburn (n 2) 237. Baums (n 3) 505–506; B Großfeld and U Lehmann, ‘Management structures and worker’s codetermination in Germany with European perspectives’ (1994) 1 Corporate Law Development Series 47; Bernhard Großfeld and Werner Ebke, ‘Controlling the Modern Corporation: A Comparative View of Corporate Power in the United States and Europe’ [1978] AJCL 397.

The Dominant Role of the German Banks

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form.12 However, it is apparantly also for reasons of tax advantages when shares are sold. As Roe explains: German banks held customers’ stock in the banks’ name and issued receipts to the retail owner. Then, when one customer sold stock to another customer, the banks argued that no taxable transfer occured, because a bank was still the record holder. The taxing authorities agreed. Thereafter, stock owners preferred to deposit stock with bigger banks, which could best match customers’ sales and purchases, thus giving banks control over the proxy machinery.13 Holding shares as custodians is a service provided at a fee by the German banks to their shareholder-clients. As part of this service, but free of any charge, they offer the service to vote on behalf of the shareholder-client at shareholder meetings. The shareholder-clients normally give the banks the authority to vote (it may not be given for longer than fifteen months and can be revoked at any time) on his or her behalf.14 Before a shareholder meeting the banks advise their clients how to vote and ask for special instructions from the clients. If no such instructions are received (and they are seldom received),15 the banks vote (on behalf of the clients) as they have advised.16 Thus, the banks often control a major part of the voting power at the shareholder meetings via their shareholder-clients. This provides the first method of controlling the votes at the general meeting. This system has been criticised as the banks do not own the shares; carry no real risks; and would exercise these voting rights without providing any service to the shareholders in return. This in turn leads to particularly disinterested shareholders and poor representation of shareholders views at general meetings,17 where several vital decisions are taken, for instance the ultimate approval of the financial statements; mattters reserved for the approval of the general meeting under Section 119(1) of the AktG; the compulsory ratification of certain tasks performed by the management board and supervisory board under Section 120 of the AktG; appointment of the shareholder representatives to the supervisory board; and appointment of the auditors.18 A second method of controlling the votes at the shareholder meeting is constituted by the fact that the banks may also trade in shares on their own account. This

12

13 14 15 16 17 18

See Detlev F Vagts, ‘Reforming the ‘Modern’ Corporation: Perspectives from the German’ (1966) Harvard L Rev 53–54. Roe (n 9) 1971. Ss 135(1)-(2) AktG. See further Peltzer (n 3) 844. For statistics in this respect, see Baums (n 3) 507–08. Baums (n 3) 506–07. Claussen (n 4) 482–83. See also Peltzer (n 3) 844. Peltzer (n 3) 845–46.

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enables them to control even more of the voting rights at shareholder meetings.19 A third way of controlling votes at shareholders’ meetings is through the control the banks have over their investment companies which own shares in various public companies.20

8.2.2 Control Through the Supervisory Board In practical terms the three methods by which banks control the voting power in shareholder meetings of many public companies in Germany,21 mean that the banks and other institutions often hold enough votes to enable them to appoint all the shareholder representatives on the supervisory board in corporations where codetermination is not required. Baums provides statistics, showing that in 31 of the 32 biggest public companies in Germany, the banks control more than 50 per cent of the voting powers at shareholder meetings. In 22 of those companies the banks’ voting power was 75 per cent or higher (enabling them to carry a special resolution).22 Controlling voting rights also means that the banks,23 almost always,24 have the potential to appoint their own representatives, or individuals with an inclination to favour bank interests, to the supervisory board.25 In 1993 the banks did indeed hold 99 (6%) of the 1561 supervisory board positions in the 100 largest public corporations. This percentage is considered to be high, given that many of these positions are reserved for employee representatives under the German codetermination legislation.26

8.2.3 Control over the Management Board Although the first step in influencing the day to day management of a public corporation is to have adequate voting power at the shareholders’ meeting, the real influence is actually exercised much more subtly and seemingly far removed from 19 20 21 22 23

24 25

26

Baums (n 3) 508–09. Baums (n 3) 505 (fn 16). See in general also Roe (n 9) 1930, 1936 ff. See 7.2.1. Baums (n 3) 507. Also Vagts (n 12) 58. These representatives have indeed been appointed by the shareholders, but as explained above, they are actually bank representatives, since the banks very often control the votes at the shareholder meetings. Baums (n 3) 504–05. See also Peltzer (n 3) 844. Peltzer (n 3) 844 points out that the possibility of misuse of their dominant position lies in the fact that banks may appoint their own representatives to supervisory boards or ensure that supervisory boards are filled with people who will sympathise with bank interests. Peltzer (n 3) 850.


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the general meeting. In this respect the interrelationship between the management board and the supervisory board is of particular importance.27 Having adequate representation on the supervisory board enables the banks, indirectly, to influence the day to day management of a corporation in at least two very specific ways.28 In the first instance, the members of the management board are appointed and can be dismissed by the supervisory board.29 As seen above, the banks normally have adequate representation on the supervisory boards of many public companies in Germany and this also means that in these companies the managment boards can hardly ignore the wishes of the banks. Baums explains as follows: Influence on management, its decisions, its appointment and dismissal is not exercised directly by the shareholders but by the supervisory board. Therefore, seats on the supervisory board are crucial for every shareholder or institution that wants to have a say in corporate governance, obtain information, etc.30 Baums contends that it is in identifying and appointing competent persons as members of the management board that the banks play a vital role, not in the power they normally have to dismiss a member of the management board before the expiration of his or her period of office.31 He explains that the banks are in an ideal position to appoint the best possible managers for a particular corporation, since the banks are experienced creditors; they often act as shareholders and proxy holders; and they are experienced (through their decisive role as controllers of the majority vote at shareholders’ meetings in many public companies in Germany) in appointing members of the management board.32 Apart from the initial appointment of the members of the management board, the banks’ influence over the the supervisory board is of a continuous nature. As discussed before, 33 the members of the management board may not be appointed for longer than five years and it is the supervisory board that is responsible for extending management board members’ contracts with the corporation. This gives the supervisory

27 28

29 30 31

32 33

See in particular 4.5. Baums (n 3) 513 ff also discusses other control mechanisms, but considers these methods to be the most important ones. See 4.5.1. Baums (n 3) 509. In terms of s 50(3) AktG a member of the management board can only be dismissed by the supervisory board for cause (eg in the case of a criminal offence committed by a member of the management board). Apart from criminal cases, dismissal for other causes rarely occurs as it will reflect very negatively on the company’s ‘reputation’— see Baums (n 3) 515. Baums (n 3) 514. Also Großfeld and Lehmann (n 11) 48. See 4.5.1.

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board considerable influence through the (obviously subtle and publicly unannounced) threat of not extending a particular manager’s contract.34 Secondly, as the position of chairperson of the supervisory board is such an influential position35 substantial influence over management can be generated if this position is held by a representative of a particular bank.36 The influence of the chairperson stems from the fact that he or she is responsible for preparing the minutes of the meetings; that he or she is expected to be in close and continuous contact with management; and that he or she has a casting vote in certain specified instances.37 According to former statistics, bank representatives had occupied the position of chairperson in at least 14 of the 100 largest AGs in Germany.38 In these instances the banks’ influence over management is intensified through the presence of the ‘banks’ representatives’ on the supervisory board and by having one of their representatives as chairperson.

8.3 International Influences 8.3.1 The Wind of Change The dominat role of traditional banks is fading. New players are in town. Basically that is a global phenomenon. It should be noticed that a new generation of banks has emerged, although they are commonly not called ‘banks’. The power of pension funds like CALPERS, with broad corporate portfolios, is huge. They are progressively prepared to execute their powers as shareholders and even as major bondholders within corporations. The internet and biotechnology revolutions should also be taken into consideration. They brought a new kind of ‘bank’, focusing on special sector industries. Their names are Microsoft, Intel, Cisco or Amgen, each of them controlling thousands of corporations worldwide in key high tech industries, forming our present and future developments39. International capital markets, with a fast free-flow of private capital around the world, are changing the landscape in Germany too. Institutional investors (e.g. banks, insurance companies and pension funds) from other countries are investing extensively in German corporations. Also the vast range of private equity funds, including hedge funds, is acquiring impressive stakes in corporate Germany. One example is the Deutsche Börse AG, the main operater of stock exchanges in 34 35 36 37 38 39

Großfeld and Lehmann (n 11) 43. See 4.5.3.8. Peltzer (n 3) 844. See 4.2.2, 4.5.3.9 and 5.2.3.3. Baums (n 3) 511. Claus Luttermann, in Bruno Kropff and Johannes Semler (eds), Münchener Kommentar zum Aktiengesetz (2nd edn CH Beck Verlag, Munich 2003) vol 5/1 (s 264 HGB) 786 para 79.


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Germany. Although a hostile takeover bid, led by Anglo-American hedge funds, failed, the number of Deutsche Börse AG’s foreign shareholders is up to 90 per cent.40 Additional data shows the wind of change. To illustrate the point one can focus on the development of structure of the shareholders of some eminent German corporations; and the percentage of foreign shareholders in German corporations, as shown below. Table 7.1. Percentage of foreign shareholders in German corporations 1996/1997

2000/2001

2005/2006

BASF AG

Ɣ

37,8

52,4

Bayer AG

15,0

44,0

39,0

DaimlerChrysler AG

46,6

45,0

52,5

Ɣ

42,0

41,1

Deutsche Telekom AG

10,0

19,5

56,0

Lufthansa AG

36,1

37,9

37,3

Ɣ

50,0

Eon AG

Siemens AG Ɣ means: no data available

67,1 41

Data by Deutsches Aktieninstitut

8.3.2 Controlling German Banks An even sharper shift has happend to the German banks themselves. Talking about ‘German’ banks and their control of corporate Germany (the so-called ‘Deutschland AG’) we must ask: Who is controlling the German banks? This simple question has obviously not been in the mainstream discussion, nor even asked. The answer is given by some data. Take for example the former circle of four major banks that were the centre of corporate Germany: Deutsche Bank AG, Dresdner Bank AG, Commerzbank AG, HypoVereinsbank AG.42 The Dresdner Bank AG has been aquired in a takeover by the Allianz AG, which has 49.3 per cent of foreign shareholders.43 The HypoVereinsbank AG is now a member of the Italian UniCredit Group (Milan/Italy) that holds more than 93 per cent of the share capital.

40 41

42

43

Deutsches Aktieninstitut (DAI) 08.5–1, 2006. Data by Deutsches Aktieninstitut (DAI), DAI-Factbook 2006 (Oct 2006) 08.5–1, 1996 to 2006. The merger of the former Bayerische Vereinsbank AG and the Bayerische Hypothekenbank AG. Deutsches Aktieninstitut (n 40) 08.5–1, 2006.

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In short, there are today just two ‘independent’ major banks based in Germany: The Commerzbank AG which has 51.5 per cent of foreign shareholders in 2006, up from 40 per cent in 2000.44 The foremost bank is still the Deutsche Bank AG, but that former incarnation of corporate Germany now has 48 per cent of foreign shareholders, compared with just 18 per cent of foreign shareholders in 1996.45 In addition, the Deutsche Bank AG has an experienced chief operating officer from Switzerland, an outstanding branch in New York (former Bankers Trust Corp.) and a very strong investment arm based in London with considerable influence on the corporate policies of the Deutsche Bank AG. It could, therefore, again be asked whether referring to ‘German banks’ is not perhaps a misnomer. The numbers and circumstances are sending a strong message: Obviously the once-bright glory of German banks controlling corporate Germany has gone. The banks, if they are still around at all, have to share the globalised playground with a variety of very strong international competitors.

8.4 Concluding Remarks Banks, but to a lesser extent ‘German banks’, still have control over many supervisory boards, giving them indirect control over the managing board, and this form of control is obviously refined by their ability to appoint the ‘right’ persons in the right positions. Control is further enhanced where the chairperson is also a bank representative. It is clear, therefore, that the banks’ control over the appointment of the members of the management board, their control over extending the management board members’ contracts after five years, and also their ability to have a bank representative as chairperson of the supervisory board, enhance the potential of banks to have real influence over corporations. Considerable criticism has been directed against the banks’ dominant role in many German corporations and many proposals have been made to rectify this.46 In reality the dominant position of the banks, resulting in various potential forms of conflict of interest,47 militates against the theoretical basis of the two-tier system where the supervisory board should serve as the forum where the interests of various interest groups are represented. Vagts points out that there might be a possible conflict between the interests of the banks and those of the shareholders and creditors: 44 45 46 47

Ibid 2005 and 2000. Ibid 2006 and 1996. Peltzer (n 3) 846–48. See also Großfeld and Lehmann (n 11) 48; Vagts (n 12) 57. Peter Raisch, ‘Zum Begriff und zur Bedeutung des Unternehmensinteresses als Verhaltensmaxime von Vorstands- und Aufsichtsratmitgliedern’ in Robert Fischer et al (eds), Strukturen und Entwicklungen im Handels-, Gesellschafts- und Wirtschaftsrecht— Festschrift für Wolfgang Hefermehl (CH Beck Verlag, München 1976) 350. See also Peltzer (n 3) 844, 845–46.


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As underwriters for the company, it [the bank] may vote for a new stock issue which disinterested analysts would find unnecessary. As creditor of the company, it may prefer to see its debtor’s earnings retained to give it additional security rather than paid out as dividends to the shareholders it is supposed to represent ... How can [the Banks] advise individual client-shareholders on buying and selling shares, protect their own shareholders by maintaining good relations with corporate managers and defending their interests as creditors and underwriters, and also act as voting representatives? 48 This situation also allows for considerable influence by a group (the banks) with little or no real financial interest in the corporation in comparison with the interests of the providers of capital (the shareholders)49 or the providers of labour (the employees), since the banks’ influence simply stems from the unique share-depositing system in Germany.50 However, as pointed out above, it is debatable whether these influences really come from ‘German banks’ and it should be taken into consideration that there are influential new players in the German financial sector. Although the de facto situation is considered unsatisfactory,51 it is still seen by some German commentators as superior to the ordinary proxy system,52 which is based on the fallacy that shareholders in large public companies are active participants in corporations’ affairs. It has also been questioned whether in practice the banks really misuse their powers to such an extent that statutory intervention is required.53 Furthermore, the influence of the banks is seen as a positive balance for the influence of labour in codetermined corporations.54 It is also true that the appointment of management board members by the supervisory board is not only a simple process of counting heads in the supervisory board. Practical realities play an important role in this respect. As Baums points out, the shareholders’ representatives (often the banks’ representatives) will ‘think long and hard before they push a candidate through against the vote [wish?] of the employees’.55 The discussion above also shows that the banks have played a very important role in Germany’s corporations law. They are still key players, but more and more as only one of the influential players in the financial sector. It is, therefore, important to ask what conclusions should be drawn from this fact. It is suggested that it

48 49 50 51 52 53 54 55

Vagts (n 12) 57, 63. Peltzer (n 3) 844. Großfeld and Ebke (n 11) 95. Vagts (n 12) 57. Großfeld and Lehmann (n 11) 48; Großfeld and Ebke (n 11) 96. Peltzer (n 3) 843. Ibid 844. Baums (n 3) 514–15.

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is unfounded to use the banks’ position of influence in many German corporations to discredit the two-tier system as such or as a reason not to emulate other useful and clever inventions from the German corporate law system. The banks’ dominant role in Germany is fading. Therefore it is even more unlikely that the same situation will prevail in other corporate law systems when they introduce the twotier system, as other corporate law systems are not exposed to the same conditions with regard to shareholdings which prevailed in Germany during the end of the nineteenth century.

Chapter 9

Corporate Governance in the EU, the OECD Principles of Corporate Governance and Corporate Governance in Selected Other Jurisdictions Jean du Plessis and Claus Luttermann

9.1 Introduction Good corporate governance is a top priority in business worldwide. We have witnessed corporate scandals like ‘Enron’, ‘WorldCom’, ‘Parmalat’ and others in many countries. When financing companies in global markets, the temptations of corporate corruption have to be viewed from an international perspective. In the aftermath of the ‘Enron’ era we see a powerful global tide towards higher standards in corporate governance. Germany, as we have seen, is part of that movement. To put German law into context, some additional international perspectives are given in this chapter. In the global financial and regulatory community things are inevitably interlinked. Comparative law, therefore, is indispensable, and calls for an intensive dialogue between cultures.1 A wide range of reforms has already been adopted; other reforms are being discussed or on their way. In this chapter we focus first on the corporate governance debate in the European Union, as that is the environment in which the German corporate governance model has to operate. We then discuss the OECD Principles of Good Corporate Governance and then examine the corporate governance debate in the United States, the United Kingdom and Australia.

1

Claus Luttermann, ‘Dialog der Kulturen’ in Ulrich Hübner and Werner F Ebke (eds), Festschrift für Bernhard Großfeld (Verlag Recht und Wirtschaft, Heidelberg 1999) 771–89.

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9.2 European Union (EU) 9.2.1 Enhancing Corporate Governance As shown in previous chapters, corporate governance in Germany is part of the law of the European Community. In its Action Plan ‘Modernising Company Law and Enhancing Corporate Governance in the European Union—A Plan to Move Forward’2 the European Commission has defined as its main objectives: (a) to strengthen shareholders’ rights and (b) protection for employees, creditors and other parties with which companies deal. The Commission set out to adapt company law and corporate governance rules appropriately for different categories of companies; in addition, it aimed to foster the efficiency and competitiveness of business, with special attention to crossborder issues. The European Parliament welcomed these basic objectives, which still remain valid. The overall goal is to achieve and secure good corporate governance within the internal market3 as a result of the Treaty establishing the European Community.

9.2.2 Projects (IAS/IFRS Etc.) The European Commission is continuing to work through the Action Plan of 2003.4 At the core of European law concerning corporate governance is the broad field of financial information. The IAS/IFRS Regulation (EC) 1606/2002 requires listed companies to prepare their consolidated accounts in accordance with the adopted International Accounting Standards/International Financial Reporting Standards (IAS/IFRS); other companies are free to prepare consolidated and/or annual accounts according to those standards.5 The International Accounting Standards Board (IASB), the London-based standard setter, is proactively working on the IAS/FRS standards.6 Corresponding to the output from the IASB of new, amended or revised IAS/IFRS, the procedure of adoption within the European Union is working;7 hence, this is almost a ‘never-ending story’. Members of the administrative, management and supervisory bodies, as well as accountants and auditors, are all keeping a keen eye on the process of adoption in the European Union. In view of possible liability8 all interested parties should

2

3 4 5 6 7 8

COM(2003) 284 final. European Parliament resolution on that topic: OJ C 104 E 30 Apr 2004, 0714. See EC Treaty Art 14. COM (2003) 284—see (n 2). IAS/IFRS Reg (EC) 1606/2002, Art 4 and 5; see 7.2.2–7.2.4. For IASB and IFRIC Projects see . See 7.2.3. See 7.2.1, 7.5.3 and 7.4.4.

Corporate Governance in the EU

217

ensure that they are up to date with all recent developments at any particular time.9 This European ‘IAS/IFRS-project’ is about to broaden. The discussion is in progress, to extend the IAS/IFRS as mandatory for annual accounts and other companies. A set of IAS/IFRS rules, especially for so-called ‘small and medium-sized entities’ (‘non-listed companies’ or—in terms of the IASB—‘non-publicly accountable entities’) is currently under consideration.10 There are hundreds of thousands of such companies in Germany, the Netherlands and other European countries. At this point it is still not clear where the journey is heading and to what extent it will change the national laws of the Member States. In Germany, the special relationship in accounting between tax law and company law is at stake.11 Corporate governance is about accounting as a means of financing a company most efficiently. Therefore, the free flow of capital12 is one of the advantages of the European Union establishing a common market among the Member States and their companies. European capital markets should also be more easily used by third country issuers. Directive 2003/71/EC13 concerns information contained in prospectuses to be published when securities are offered to the public or admitted to trading in accordance with IAS/IFRS. A draft by the European Commission14 now proposes to accept, that the historical information required in a prospectus is prepared in accordance with the Generally Accepted Accounting Principles (GAAP) of either Canada, Japan or the United States of America. The accounting standards of those countries are considered to converge with the IAS/IFRS. Those who use other standards have to prove that they are of equivalent quality and that the financial statements have been filed with ‘a competent authority’. Accordingly, this Regulation, once enacted, would exempt third country issuers from the obligation to restate historical financial information that was drawn up according to national accounting standards. This is going to be an important step 9

10

11

12 13 14

For updates see . Valuable information on that topic also from the European Financial Reporting Advisory Group: . The IASB has announced an Exposure Draft for the third quarter 2007. About the project: (Small and Medium-sized Entities). See 7.2.3. On IAS/IFRS for SME see Werner F Ebke, Claus Luttermann and Stanley Siegel (eds), Internationale Rechnungslegung für börsenunabhängige Unternehmen (Nomos Verlag, Baden-Baden 2007). EC Treaty Art 56. OJ L 345, 31 Dec 2003, 64, amending Dir 2001/34/EC. EC Commission, Draft Commission Reg, amending Commission Reg (EC) 809/2004 of 29 Apr 2004 implementing Dir 2003/71/EC of the EP and of the Council as regards information contained in prospectuses as well as the format, incorporation by reference and publication of such prospectuses and dissemination of advertisements, Working Document ESC/23/2006–rev3. On the implementation of financial services legislation OJ C 284 E 21 Nov 2002, 115 (Lamfalussy report).

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to harmonise the international context for companies. Of course, reciprocity is necessary, especially in the case of the United States of America to accept IAS/IFRS for entry into the United States capital markets.15 Further projects are on the European agenda.16 These include the Commission proposal for a Directive on the exercise of shareholders’ voting rights, the role of voting agencies with a view to corporate governance in listed companies, directors’ remuneration, independent directors and Board Committees,17 the companies’ capital formation, maintenance and alteration, takeover bids and cross-border mergers of companies with share capital. As well, the spectrum includes, for example, the central discussion about freedom of establishment18 and a European tax law, both decisively driven by judgements of the European Court of Justice.19

9.2.3 Future Priorities Meanwhile, the European Commission is focusing on future priorities. The core aim is to ensure a comprehensive and strong strategy that boosts the competitiveness of Europe’s businesses on global markets. As to due process, consultation and a public hearing took place on four topics: (a) shareholders’ rights and obligations; (b) the modernisation and simplification of European Company Law; (c) the responsibility of directors and internal control; and (d) corporate mobility and restructuring. Approximately 270 interested parties from all around the European Union and third countries (United States, Japan, Switzerland) took part. The report on the outcome of the consultation and hearing gives valuable insight for further discussions, as it shows split views on corporate governance issues. Summing up,20 the results include a clear support for addressing the ‘one share, one vote’ issue at the level of the European Union. As to the form of potential 15

16

17

18 19

20

On that topic Claus Luttermann, Bilanzrecht in den USA und internationale Konzernrechnungslegung (Mohr and Siebeck Verlag, Tuebingen 1999) 134–6 (calling for an ‘International Court of Accounting’). Overview and updates: European Corporate Governance Forum, . Commission Recommendation, OJ L 52, 25 Feb 2005, 51. Claus Luttermann, ‘Unabhängige Bilanzexperten in Aufsichtsrat und Beirat’ (2003) 58 BB 745–50. EC Treaty, Art 44(2)(g) and 48. See for example Court of Justice, Case C-196/04 Cadbury Schweppes plc [2006] OJ C 281 of 18 Nov 2006, 5; Case C-9/02 de Lasteyrie du Saillant [2004] ECR I-02409; Case C-212/97 Centros [1999] ECR I-1459. Claus Luttermann, ‘Mit dem Europäischen Gerichtshof (Centros) zum Internationalen Unternehmens- und Kapitalmarktrecht. Kollisionsrecht in den Zeiten des Internet’ [2000] ZEuP, 907–21. EC-Directorate General for Internal Market and Services (Ed), Consultation and Hearing on Future Priorities for the Action Plan on Modernising Company Law and Enhancing Corporate Governance in the European Union, 2006.


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intervention, a Directive seems to be of nearly equal preference with a Recommendation;21 at least a fact-finding study should be made. Regarding the rights of shareholders, some initiatives are recognised as adding value. That includes initiatives on the establishment of a mandatory special investigation right, on the nomination and dismissal of directors, and on shareholder communication rules. Opponents argue that European and national legislation of the Member States already secures sufficient protection of shareholders’ interests. Another prominent issue is the disclosure of institutional investors’ voting policies. But opinions on this topic seem to be very diverse. While some considered that intervention by the European Union should create ‘a level playing field’, others opposed such action. Some considered that a rule set by the European Union would ‘create excessive burdens for investors’. Others recommended that this matter should be left to the parties’ contractual arrangements. There is a significant demand to impose transparency and disclosure obligations on institutional investors. But there seems to be no clear preference as to the appropriate instrument. Further aspects include legislation of the European Community on: (a) transparency requirements for legal entities; (b) disqualification of directors, an area of substantial differences between the national systems of the Member States; and (c) a wrongful trading rule if there are substantial cross-border problems.

9.2.4 Regulatory Basics and Outlook ‘Come what come may’,22 there are basics to obey. We are talking about corporate governance in Germany, within the European Union, and abroad on global capital markets. The regulatory task is fundamental. Internationally, good corporate governance is essentially about building on the integrity of each of the acting parties. Ultimately, it is dependent on the poise of one’s self, as has been shown with the financial reporting.23 Regulation is always a question of ‘measures’. For the European Union that is, foremost, how far harmonised rules are needed or how far regulatory competition should be used for best efficiency. Even the launch of a European codification or consolidation of the existing company law is under review. Proposals24 focus (a) on lifting obstacles to the free flow of capital between the Member States and to the right of establishment; and (b) on granting additional flexibility to companies. After the massive regulatory action of recent years, some kind of ‘regulatory fatigue’ is calling for a period of stabilisation (moratorium). Since time won’t stand still, it is always about evolution. Corporate governance is not a static position but a process. We can state that the ‘Royal merchants’ defi21 22 23 24

See EC Treaty Art 249(3) and (5). William Shakespeare, Macbeth. See 7.6. EC-Directorate General for Internal Market and Services (n 20) 3 (No 13).

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nitely passed away. But that does not mean their good attitudes have passed away too. To speak generally: Isn’t there a vibrant relationship between actions of the regulatory and the corporate establishments? It will be interesting to see how the international challenges for good corporate governance within the European Union will be handled.25

9.3 OECD Principles of Corporate Governance26 9.3.1 Background to the OECD Principles of Corporate Governance The Organisation for Economic Co-operation and Development (OECD) consists of a group of 30 member countries sharing a commitment to democratic government and a market economy. It has a global reach with active relationships with about 70 other countries, non-government organisations and civil societies. The OECD plays a prominent role in fostering good governance in the public service and in corporate activity. It helps governments to ensure the responsiveness of key economic areas through sectoral monitoring.27 One of the OECD’s projects was to develop a set of principles of corporate governance. The first such set was completed in 1999 under the title ‘OECD Principles of Corporate Governance’.28 These principles set minimum requirements for best practice and were not aimed at promoting a single corporate governance model for all OECD countries, but rather principles that could apply in all OECD and non-OECD countries. On 22 April 2004 the 30 OECD countries approved the 2004 ‘OECD Principles of Corporate Governance’.29 These principles confirm several sound corporate governance practices already identified and explained in the 1999 Principles, but they also contain some refinement in light of the corporate scandals of the late 1990s and early 2000s: The OECD Principles of Corporate Governance were originally developed in response to a call by the OECD Council Meeting at Ministerial level on 27–28 April 1998, to develop, in conjunction with national governments, other relevant international organisations and the private sector, a set of corporate governance standards and guidelines. Since the Principles were agreed in 1999, they have 25

26

27

28 29

Updates on EU policies on company law and corporate governance are available at . Jean J du Plessis, James McConvill and Mirko Bagaric, Principles of Contemporary Corporate Governance (CUP, Sydney 2005) 314–18. See ‘About OECD’ . OECD, OECD Principles of Corporate Governance (1999). OECD, OECD Principles of Corporate Governance (2004) .


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formed the basis for corporate governance initiatives in both OECD and non-OECD countries alike. Moreover, they have been adopted as one of the Twelve Key Standards for Sound Financial Systems by the Financial Stability Forum. Accordingly, they form the basis of the corporate governance component of the World Bank/IMF Reports on the Observance of Standards and Codes (ROSC).30

9.3.2 Broad Aims and Application The OECD Principles are aimed at assisting governments in their efforts to evaluate and improve the legal, institutional and regulatory framework for corporate governance and to provide guidance and suggestions for stock exchanges, investors, corporations, and other parties that have a role in the process of developing good corporate governance.31 One of the unique aspects of the OECD Principles is that they operate across borders and without any preference for any particular corporate law system or any particular board structure.32 They focus, in the true sense of the word, on ‘the principles of corporate governance’. Thus, an openminded approach to corporate governance is adopted: Corporate governance is one key element in improving economic efficiency and growth as well as enhancing investor confidence. Corporate governance involves a set of relationships between a company’s management, its board, its shareholders and other stakeholders. Corporate governance also provides the structure through which the objectives of the company are set, and the means of attaining those objectives and monitoring performance are determined. Good corporate governance should provide proper incentives for the board and management to pursue objectives that are in the interests of the company and its shareholders and should facilitate effective monitoring.33

9.3.3 Parts and Layout The document containing the OECD Principles is divided into two parts. The first part only contains the core principles, while the second part has the Principles, supplemented by annotations that contain commentary on the Principles and are intended to help readers understand their rationale. The annotations also contain descriptions of dominant trends and offer alternative implementation methods and examples that may be useful in making the Principles operational. The Principles 30 31 32 33

Ibid 9. Ibid 11. Ibid 13. Ibid 11.

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presented in the first part of the document cover the following areas: I) Ensuring the basis for an effective corporate governance framework; II) The rights of shareholders and key ownership functions; III) The equitable treatment of shareholders; IV) The role of stakeholders; V) Disclosure and transparency; and VI) The responsibilities of the board. Each of the sections is headed by a single Principle that appears in bold italics and is followed by a number of supporting sub-principles.34 In this part we will focus only on Part I and Part V.

9.3.4 Ensuring the Basis for an Effective Corporate Governance Framework The basic principle is expressed as follows: The corporate governance framework should promote transparent and efficient markets, be consistent with the rule of law and clearly articulate the division of responsibilities among different supervisory, regulatory and enforcement authorities.35 Four specific aspects are mentioned to ensure the implementation of this principle: A. The corporate governance framework should be developed with a view to its impact on overall economic performance, market integrity and the incentives it creates for market participants and the promotion of transparent and efficient markets.36 B. The legal and regulatory requirements that affect corporate governance practices in a jurisdiction should be consistent with the rule of law, transparent and enforceable.37 C. The division of responsibilities among different authorities in a jurisdiction should be clearly articulated and ensure that the public interest is served.38 D. Supervisory, regulatory and enforcement authorities should have the authority, integrity and resources to fulfil their duties in a professional and objective manner. Moreover, their rulings should be timely, transparent and fully explained.39 The OECD Principles emphasise the point that a corporate governance framework typically comprises elements of legislation, regulation, self-regulatory arrangements, voluntary commitments and business practices that are the result of a coun34 35 36 37 38 39

Ibid 14. Ibid 29. Ibid 30. Ibid. Ibid 31. Ibid.


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try’s specific circumstances, history and tradition. One of the specific dangers warned against is over-regulation. The costs and benefits of laws and regulations should be considered carefully before they are implemented, otherwise overregulation will be the result or even creating unenforceable laws. Any corporate governance model should support the exercise of entrepreneurship.40 It is stressed that the regulatory and legal environment within which corporations operate is of key importance to overall economic outcomes. A corporate governance model is typically influenced by several legal arrangements such as company law, securities regulation, accounting and auditing standards, insolvency law, contract law, labour law and tax law. However, these laws will require effective enforcement. The allocation of responsibilities for supervision, implementation and enforcement among different authorities should be clearly defined so that the competencies of complementary bodies and agencies are respected and used most effectively. If this is not done, overlaps can occur or, even worse, create ‘regulatory vacuums’.41

9.3.5 Disclosure and Transparency The basic principle is expressed as follows: The corporate governance framework should ensure that timely and accurate disclosure is made on all material matters regarding the corporation, including the financial situation, performance, ownership, and governance of the company.42 Four specific aspects are mentioned to ensure the implementation of this principle: A. Disclosure should include, but not be limited to, material information on43: 1. The financial and operating results of the company. 2. Company objectives. 3. Major share ownership and voting rights. 4. Remuneration policy for members of the board and key executives, and information about board members, including their qualifications, the selection process, other company directorships and whether they are regarded as independent by the board. 5. Related party transactions. 6. Foreseeable risk factors. 7. Issues regarding employees and other stakeholders. 40 41 42 43

Ibid 29. Ibid 29–31. Ibid 49. Ibid 50–53.

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8. Governance structures and policies, in particular, the content of any corporate governance code or policy and the process by which it is implemented. B. Information should be prepared and disclosed in accordance with high quality standards of accounting and financial and non-financial disclosure.44 C. An annual audit should be conducted by an independent, competent and qualified, auditor in order to provide an external and objective assurance to the board and shareholders that the financial statements fairly represent the financial position and performance of the company in all material respects.45 D. External auditors should be accountable to the shareholders and owe a duty to the company to exercise due professional care in the conduct of the audit.46 It was noted that in most OECD countries both mandatory and voluntary disclosure arrangements were already in place. The main advantage of a strong disclosure regime is that it promotes real transparency; ensures effective monitoring of companies; and is central to shareholders’ ability to exercise their ownership rights on an informed basis. Disclosure is also a powerful tool for influencing the behaviour of companies and for protecting investors.47 The advantages of an effective disclosure regime versus the disadvantages of a poorly developed disclosure regime is summarised neatly as follows: A strong disclosure regime can help to attract capital and maintain confidence in the capital markets. By contrast, weak disclosure and non-transparent practices can contribute to unethical behaviour and to a loss of market integrity at great cost, not just to the company and its shareholders but also to the economy as a whole … Insufficient or unclear information may hamper the ability of the markets to function, increase the cost of capital and result in a poor allocation of resources.48 It is, however, important that disclosure requirements should not place unreasonable administrative or cost burdens on enterprises or require of companies to disclose information that may endanger their competitive position. The principle adopted in most OECD countries to ensure that the right kind of information is disclosed is the principle of ‘materiality’—‘material information can be defined as

44 45 46 47 48

Ibid 54. Ibid 54. Ibid 56. Ibid 49. Ibid.


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information whose omission or misstatement could influence the economic decisions taken by users of information’.49

9.4 United States50 9.4.1 Background to the Corporate Governance Debate in the United States Corporate governance formed the topic of discussion in the United States for a very long time and the materials on corporate governance in the United States are extensive. Being such a dominant world economy, United States debates on corporate governance will almost invariably influence corporate governance debates in other jurisdictions. It is therefore important to deal with corporate governance debates in the United States to lay the basis for understanding the corporate governance models in other parts of the world. The debate on corporate governance in the United States started as early as 1932 when Berle and Means published their book, The Modern Corporation and Private Property.51 The importance of this debate was emphasised further by Mace’s book, Directors: Myth and Reality,52 which was published in 1971, but the discussion became really heated in 1982 with the publication by The American Law Institute (ALI) of their Principles of Corporate Governance and Structure: Restatement and Recommendations. This project that started off rather modestly resulted in a stream of publications on the topic of corporate governance in the United States. The Proposed Final Draft (later termed Principles of Corporate Governance and Structure: Analysis and Recommendations) was approved in May 1992. However, the publications on this topic did not stop. In 1993 alone there were 73 articles published in American law review journals which dealt directly with the topic of corporate governance. One commentator justly alluded to ‘The Emergence of Corporate Governance as a New Legal Discipline’,53 while another commentator remarked that between 1990 and 1993 ‘events have moved at light-

49 50 51

52

53

Ibid 49–50. This part is based on Du Plessis, McConvill and Bagaric (n 26) 292–301. Klaus J Hopt, ‘Preface’ in Theodor Baums, Richard M Buxbaum and Klaus J Hopt (eds), Institutional Investors and Corporate Governance (de Gruyter, Berlin 1994) i; Adolf A Berle and Gardiner C Means, The Modern Corporation and Private Property (Harcourt Brace & World, New York 1932). Myles L Mace, Directors: Myth and Reality (Harvard Business School Press, Harvard 1971). E Norman Veasey, ‘The Emergence of Corporate Governance as a New Legal Discipline’ (1993) 48 The Business Lawyer 1267.

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ning speed for the world of corporate governance’.54 That speed seems to have accelerated considerably after huge corporate collapses like Enron and WorldCom. Studying corporate governance developments in the United States is important since some people apparently only became aware of the corporate governance debate when the Cadbury Report was published in 1992 in the United Kingdom, and, there are still some who believe that corporate governance was an invention of the Cadbury Report.55 This is definitely a wrong perception. It is also noteworthy that the Cadbury Report only dealt with a rather limited area of corporate governance, namely with ‘Financial Aspects of Corporate Governance’. In the United States, theories of shareholder primacy and profit maximisation are still dominant in expressing ‘the objective and conduct of the corporation’. This becomes clear by looking at the central expression of ‘the objective and conduct of the corporation’ in the American Law Institute’s Principles of Corporate Governance: The objective and conduct of the corporation56 § 2.01(a) Subject to the provisions of Subsection (b) … a corporation should have as its objective the conduct of business activities with a view to enhance corporate profit and shareholder gain. (b) Even if corporate profit and shareholder gain are not thereby enhanced, the corporation, in the conduct of its business: (1) Is obliged, to the same extent as a natural person, to act within the boundaries set by law; (2) May take into account ethical considerations that are reasonably regarded as appropriate to the responsible conduct of business; and (3) May devote a reasonable amount of resources to public welfare, humanitarian, educational, and philanthropic purposes. The only qualifications to shareholder primacy and profit maximisation are that these aims should be achieved within the boundaries of the law, taking into consideration ethical considerations ensuring responsible conduct of business, and that a reasonable amount of resources should be given to public welfare, humanitarian, educational, and philanthropic purposes.

54

55

56

Irna M Millstein, ‘The Evolution of the Certifying Board’ (1993) 48 The Business Lawyer 1485, 1489. See generally Nigel Kendall and Arthur Kendall, Real-World Corporate Governance (Pitman, London 1998) 22; and Bob Garratt, The Fish Rots from the Head (Harper Collins Business, London 1997) 123. American Law Institute, Principles of Corporate Governance and Structure: Analysis and Recommendations (2004), s 2.01(a).


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9.4.2 The American Law Institute’s Involvement in the Corporate Governance Debate 9.4.2.1 Basic Aims of the Project In its project, Principles of Corporate Governance and Structure: Restatement and Recommendations (1982), the American Law Institute aspired to extract from the corpus of American corporations law a set of generalised propositions that would instruct managers and directors about their duties and to provide criteria for judgement by courts in cases involving allegations of improper conduct by managements and directors.57 It was hoped to extract the basic corporate governance principles applicable in the United States from court cases and other sources and to restate the law.58 9.4.2.2 Impact and Importance of the Project The project was supposed to be finished in two years, but eventually took 15 years because of the sensitivities involved in the topics discussed and the huge vested business interests involved in the discussion.59 One commentator observes that ‘it is fair to say that the successive drafts of the Principles received more intensive review, by a greater number and wider variety of persons and over a longer period of time, than any other project in the history of corporate law’,60 while another commentator observes that ‘the Project’s work … has occupied the time and effort of leaders of the corporate bar and respected academicians for over a decade of intense work, debate, and drafting.’61 One thing is certain and that is that the ALI project shaped views on corporate governance and laid the foundations for many of the current discussions and debates regarding corporate governance in the rest of the world. This area is of great complexity and many issues discussed by the ALI are still considered to be quite controversial.62 9.4.2.3 Some of the Key Aspects Addressed The key topics addressed by the ALI were: 57

58 59 60

61 62

Bayless Manning, ‘Principles of Corporate Governance: One Viewer’s Perspective on the ALI Project’ (1993) 48 The Business Lawyer 1319, 1320. Ibid 1319, 1324. Ibid 1319, 1325. Melvin Aron Eisenberg, ‘An Overview of the Principles of Corporate Governance’ (1993) 48 The Business Lawyer 1271, 1295. Veasey (n 53) 1267. See in particular Stephen M Bainbridge, Corporation Law and Economics (Foundation Press, New York 2002) 218; Eisenberg (n 60) 1273–4; and Manning (n 57) 1319, 1321, 1328–1329.

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• the objectives and conduct of the corporation • the structure of the corporation • the duty of care • the duty of fair dealing • tender offers • remedies. The stakeholder debate was to a large extent ignored by the ALI. The reason for this is because the theories of shareholder primacy and profit maximisation were adopted by the ALI as their point of departure. There are certain statutes in some American states that allow corporations specifically to consider the interests of other stakeholders like employees, suppliers and customers, but the exact nature and scope of these provisions are still uncertain.63 The ALI Report also looked at the structure of the corporation. It is very interesting to study this part of the ALI Report as it illustrates clearly how the corporate governance debate in the United States shaped corporate governance debates in several other jurisdictions. Section 3.01 on management of the corporation’s business provided that ‘the management of the business of a publicly held corporation should be conducted by or under the supervision of such principal senior executives as are designated by the board of directors, and by those other officers and employees to whom the management function is delegated by the board or those executives, subject to the functions and powers of the board in Section 3.02 ... ’.64 This description recognises the ‘supervisory role’ of the board. The board’s function is primarily to ‘direct, govern, guide, monitor, oversee, supervise and comply’.65 It differs from the traditional formulation of the board’s function, namely that the business of the corporation ‘shall be managed by [its] board …’66 The new description of the board’s functions provides another indication that it is impossible for the board of a large corporation to manage the day-to-day business of the corporation. That task must of necessity be left to senior executives and other employees of the corporation. Section 3.02(a) on functions and powers of the board of directors allocates five primary functions to the board67:

63 64

65 66 67

Manning (n 57) 1278. S 8.01(b) of the Model Business Corporations Act (1984 and Supplement) reads as follows: ‘All corporate powers shall be exercised by or under the authority of, and the business affairs of the corporation managed by or under the direction of, its board of directors …’ Du Plessis, McConvill and Bagaric (n 26) 56–57. Bainbridge (n 62) 195. Du Plessis, McConvill and Bagaric (n 26) 55–56.


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(1) Select, regularly evaluate, fix the compensation of, and, where appropriate, replace the senior executives; (2) Oversee the conduct of the corporation’s business to evaluate whether the business is being properly managed; (3) Review and, where appropriate, approve the corporation’s financial objectives and major corporate plans and actions; (4) Review and, where appropriate, approve major changes in, and determinations of other major questions of choice respecting, the appropriate auditing and accounting principles and practices to be used in the preparation of the corporation’s financial statements; (5) Perform such other functions as are prescribed by law, or assigned to the board under a standard of the corporation. It will once again be clear that the board’s functions of ‘directing, governing, guiding, monitoring, overseeing, supervising and complying’ are foremost, while the task of managing the day-to-day business of the corporation is left to senior executives and other employees of the corporation. Thus it should be clear that there is in the United States a clear recognition of the distinction between supervisory function and managerial functions. This recognition makes it inevitable to make a few observations regarding the debate on a unitary versus a two-tier board structure. 68 It is misleading to express a preference for ‘a unitary board’ or ‘a two-tier board’ without clarifying what is meant by these terms. In a corporation where the business of the corporation is not managed by the board, but ‘under the direction of the directors’;69 with a majority of independent (or outside) non-executive directors; a senior independent director; an independent non-executive director as Chair; and several sub-committees70 it can hardly be said that such a corporation has a ‘unitary board’ comparable to the ‘unitary board’ that was the focus of atten-

68

69

70

See further Jean J du Plessis, ‘Reflections on Some Recent Corporate Governance Reforms in Germany: A Transformation of the German Aktienrecht?’ (2003) 8 Deakin L Rev 381; and 4.8. S 198A(1) Australian Corporations Act 2001. See further AWA Ltd v Daniels (Trading as Deloitte Haskins & Sells & Ors) (1992) 10 ACLC 933. Financial Reporting Council (FRC) The Combined Code on Corporate Governance (hereafter the UK Combined Code) (July 2003) ; and The Australian Stock Exchange (ASX): Corporate Governance Council Principles of Good Corporate Governance and Best Practice Recommendations (March 2003) . Also Higgs Report Review of the Role and Effectiveness of Non-Executive Directors (Jan 2003) .

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tion of many studies over many years.71 It is beyond dispute that the modern, or should we say reinvented, unitary board has much more in common with the traditional two-tier board than many would be prepared to admit.72 If one looks at the modern unitary board it does not look so one-dimensional as some would believe. On the other hand, the modern German two-tier board is not always as twodimensional as some would make it out to be.73 Because of the way the traditional unitary board was reinvented, we will probably have a score slightly in favour of the two-tier board system if we really must select a winner in ‘the unitary board’ versus ‘the two-tier board’ contest, but at the end of the day it is perhaps best simply to realise that the so-called ‘fit-all board structure’ does not exist and will probably never exist.74 9.4.2.4 The Sarbanes-Oxley Act of 2002—The United States Response to Collapses like Enron and WorldCom The passing of the Sarbanes Oxley Act 2002 should be seen against the backdrop of several huge corporate failures in the United States. These collapses caused serious concern and became such a political issue that the Bush administration had no choice but to act quickly and radically. Whether that was an overreaction is open to debate and will obviously depend on one’s personal political views on how far a regulatory system of corporate governance should go. What is certain is that it was the best way the government of the day thought to deal with the issue in the United States. As was explained by Commissioner Paul Atkins:

71

72

73

74

Robert I Tricker, International Corporate Governance (Prentice Hall, New York 1994) 44–45. Also Kesteven and Associates Corporate Governance Documentation for Web links to almost all available corporate governance reports. Weil, Gotshal and Manges (on behalf of the European Commission, Internal Market Directorate General), Comparative Study of Corporate Governance Codes Relevant to the European Union and its Members (hereafter European Commission Comparative Study) (Jan 2002) 4–5; and The German Corporate Governance Code (hereafter the German Code) (May 2003) 1. Also Henry Hansmann and Reiner Kraakman, ‘The End of History for Corporate Law’ (2001) 89 Georgetown L J 439, 456. Carsten Berrar, ‘Die zustimmungspflichtigen Geschäfte nach § 111 Abs. 4 AktG im Lichte der Corporate Governance-Diskussion’ (2001) 54 DB 2181, 2185–86. As Paul Davies, ‘Employee Representation and Corporate Law Reform: A Comment from the United Kingdom’ (2000) Comp Lab L & Policy J 135, 137 points out ‘there is no “one best” system of corporate governance’. See also Lauren J Aste, ‘Reforming French Corporate Governance: A Return to the Two-Tier Board?’ (1999) 32 George Washington J of Intl L and Economics 1.


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Last year [2002], in fact, the market decline and large corporate failures led to just such a general sense that politicians should ‘do something’. The impending November 2002 congressional elections, which had been said to be very close, gave added urgency to legislative action. Because these corporate failures stemmed from lax accounting and corporate governance practices, ‘Corporate Responsibility’ became an important political issue in the United States, for the first time in perhaps 70 years. In late July of 2002, Congress passed the Sarbanes-Oxley Act, with only 3 members voting ‘no’. Corporate responsibility is still a critically important political issue in America. Just last week in his State of the Union address, the President, referring to Sarbanes-Oxley, said that ‘tough reforms’ were passed to ‘insist on integrity in American business’.75 The United States Securities and Exchange Commission’s (SEC) Summary of the Sarbanes-Oxley Act76 illustrates the aims and objectives of the Act very clearly: • restoring confidence in the accounting profession; • improving the ‘Tone at the Top’; • improving disclosure and financial reporting; • improving the performance of ‘gatekeepers’; and • enhancing enforcement tools. The Sarbanes-Oxley Act is indeed a blunt statutory instrument with sharp civil and criminal sanctions for contraventions. As illustration of this point one can just look at some of its provisions77: Section 3(b)(1): A violation by any person of this Act, any rules or regulation of the Commission issued under this Act or any rule of the Board shall be treated for all purposes in the same manner as a violation of the Securities Exchange Act of 1934 or the rules and regulations issued thereunder … Section 102(a): Beginning 180 days after the determination by the Commission it shall be unlawful for any person that is not a registered public accountant firm to prepare, or issue, or participate in the preparation or issuance of, any audit report with respect to any issuer.

75

76 77

George Bush, address delivered at the University of Cologne 5 Feb 2003 (). Securities and Exchange Commission, . Sarbanes-Oxley Act 2002, .

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Section 105(c)(4): If the Board finds, based on all of the facts and circumstances, that a registered public accounting firm or associated person thereof has engaged in any act or practice, or omitted to act, in violation of this Act [or any other relevant rule or regulation] … the Board may impose such disciplinary or remedial sanctions as it determines appropriate, subject to applicable limitations under paragraph (5), including(D) A civil money penalty for each violation, in an amount equal to– (i) not more than $100,000 for a natural person or $2,000,000 for any other person; and (ii) in any case to which paragraph (5) applies, not more than $750,000 for a natural person or $15,000,000 for any other person. Under Section 101 a five-member Public Company Accounting Oversight Board, with extensive powers, was established. This Board has regulatory and enforcement powers comparable to the Securities and Exchange Commission itself. The tentacles of the Sarbanes-Oxley Act stretch all over the world as no distinction is made between United States and non-United States ‘Issuers’ (s 106). Foreign companies issuing securities on United States markets are brought under the umbrella of the Sarbanes-Oxley Act through the definition of ‘Issuer’ in Section 2— basically including all institutions that issue securities on United States markets. Title II of the Sarbanes-Oxley Act attempts to ensure ‘auditor independence’ by prohibiting auditors from delivering certain non-audit activities to entities they audit, inter alia78: • legal services and expert services unrelated to the audit; • management functions or human resources; • book-keeping or other services related to the accounting records or financial statements of the audit client. Section 303 of the Sarbanes-Oxley Act aims at preventing improper influence on the audit process by making it ‘unlawful … to fraudulently influence, coerce, manipulate, or mislead any auditor engaged in the performance of an audit for the purpose of rendering the financial statements materially misleading’. This overview provides more than enough evidence of the evils the SarbanesOxley Act aims at preventing.79 Or, to put it differently, the misuses and abuses related to audits that occurred in the past. These misuses and abuses of the audit process were the main reasons why many of the recent corporate collapses occurred and why the actual (poor!) financial position of these corporations could not be detected by investors. 78 79

S 201(a) Sarbanes-Oxley Act 2002. See also Robert AG Monks and Nell Minow, Corporate Governance (3rd edn, Malden 2004) 248–49; Richard Smerdon, A Practical Guide to Corporate Governance (2nd edn, Sweet & Maxwell, London 2004) 364–66.


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9.4.2.5 NYSE: Sections 303 and 303A—Corporate Governance Rules The SEC approved the New York Stock Exchange rules on corporate governance on 4 November 2003. Some amendments were made on 3 November 2004, primarily dealing with the definition of independence. All listed companies, except for a few, must comply with certain standards regarding corporate governance as codified in Section 303A.80 The most important exception is that foreign private issuers (defined in Rule 3b-4 under the Exchange Act) are permitted to follow home country practice in lieu of the provisions of section 303A, except that such companies must comply with the following rules: 81 They must have an audit committee that satisfies the requirements of Rule 10A-3 under the Exchange Act;82 They must disclose any significant ways in which their corporate governance practices differ from those followed by United States companies under the NYSE listing standards;83 Each such company’s CEO must promptly notify the NYSE in writing after any executive officer of the listed company becomes aware of any material non-compliance with any applicable provisions of Section 303A;84 and Each such company must submit an executed Written Affirmation annually to the NYSE. In addition, each such listed company must submit an interim Written Affirmation each time a change occurs to the board or any of the committees subject to Section 303A.85 The annual and interim Written Affirmations must be in the form specified by the NYSE.86

80

NYSE Corporate Governance Rules (3 Nov 2004) 1.

81

Ibid 3.

82

Ibid s 303A.06.

83

Ibid s 303A.11.

84

Ibid s 303A.12(b).

85

Ibid s 303A.12(c).

86

See for the ‘Foreign Private Issuer Annual Written Affirmation Form’.

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9.5 United Kingdom87 9.5.1 Background to the Corporate Governance Debate in the United Kingdom Corporate governance in the United Kingdom became a prominent issue after the release of the Cadbury Report in 1992. As mentioned before, the Cadbury Report had a rather narrow focus on the financial aspects of corporate governance. The Cadbury Report was followed by several other corporate governance reports, like the Greenbury Report (1995), the Hampel Report (1998), the Smith Report (2003) and the Higgs Report (2003). It is interesting to note that, unlike the ALI’s comprehensive investigation of corporate governance within the context of corporate law generally, all the United Kingdom Reports dealt with specific aspects of corporate governance only. These include the disclosure of remuneration of directors and executive officers, audit committees and the role and effectiveness of nonexecutive directors.

9.5.2 The Cadbury Report and the Unfolding of the Concept of ‘Corporate Governance’ in the United Kingdom 9.4.2.1 Context of Cadbury Report The Cadbury Committee was set up by the Financial Reporting Council, the London Stock Exchange (LSE), and the accountancy profession in May 1991 in order to address the financial aspects of corporate governance.88 The main reason for conducting such an enquiry was to take action in respect of the perception that the United Kingdom was slipping down the league table of international business competitiveness. The second reason was to show the financial community that some of the major parties involved in the financial markets were greatly concerned about unexpected company failures and cases of fraud in England, particularly after the Maxwell and BCCI scandals.89

87 88

89

This part is based on Du Plessis, McConvill and Bagaric (n 26) 301–06. The Financial Aspects of Corporate Governance: Draft Report (hereafter ‘Cadbury Report (Draft)’) Committee on the Financial Aspects of Corporate Governance (1992) 7 para 2.1; Charlotte Villiers, ‘Draft Report by the Cadbury Committee on the Financial Aspects of Corporate Governance’ (1992) 13 Company Lawyer 214. John C Shaw, ‘The Cadbury Report, Two Years Later’ in Klaus J Hopt, Hideki K Kanda, Mark J Roe, Eddy Wymeersch and Srefan Prigge (eds), Comparative Corporate Governance: The State of the Art and Emerging Research (OUP, Oxford 1998) 21, 23; Christopher Stanley, ‘Corporate Accountability: Cadbury Committee: Part 1’ (1993) 11 Intl Banking and Financial L 104.


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The draft report was issued for public comment on 27 May 1992, whilst the final report90 was released on 1 December 1992. The essence of a system of good corporate governance was explained as follows: The country’s economy depends on the drive and efficiency of its companies. Thus the effectiveness with which their boards discharge their responsibilities determines Britain’s competitive position. They must be free to drive their companies forward, but exercise that freedom within a framework of effective accountability. This is the essence of any system of good corporate governance.91 These objectives are not unique to the United Kingdom. They are essential for any country seriously striving to be competitive in international business. Thus, the importance of corporate governance for most established and developing economies. 9.4.2.2 Code of Best Practice At the heart of the committee’s recommendation was a Code of Best Practice, designed to achieve high standards of corporate behaviour.92 Whereas the Code sets out the general principles,93 the committee made various recommendations on specific aspects, that is the composition of the board of directors;94 the establishment of auditing committees;95 and the role of a company’s shareholders.96 The committee believed that had a Code of Best Practice been in existence, a number of unexpected company failures and frauds which occurred in the United Kingdom could have been avoided.97 The principles on which the Code is based are those of openness, integrity and accountability.98 It is basically aimed at all listed companies,99 with compliance to be ensured by the London Stock Exchange, making acceptance of the Code one of its listing requirements.100 However, the

90

91 92 93 94 95 96 97 98 99 100

Report of the Committee on the Financial Aspects of Corporate Governance (hereafter Cadbury Report (1992)) Committee on the Financial Aspects of Corporate Governance (1992). Cadbury Report (Draft) (n 88) 5 para 1.1. Cadbury Report (1992) (n 90) 11 para 1.3. Ibid 58 ff. Ibid 20 ff. Ibid 36 ff. Ibid 48 ff. Ibid 12 para 1.9. Ibid 16 para 3.2. Ibid 16 para 3.1. Ibid 17 paras 3.7–3.9.

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committee specifically encouraged as many other companies as possible to aim at meeting the Code’s requirements.101 The Code of Best Practice was published as a separate document accompanying the final report. It dealt with general aspects concerning the board of directors, non-executive directors, executive directors and financial reporting. It is clear that the basic aim was to promote useful checks and balances within the corporate structure. According to the Code of Best Practice, there should be a clearly accepted division of responsibilities, which will ensure a balance of power and authority at the head of a company such that no single individual has unfettered powers of decision. The role of the non-executive director is to bring an ‘independent judgement’ on issues of strategy, performance, resources, key appointments, and standards of conduct. Concerning executive directors, the Code made it clear that they should, in principle, not be protected against removal by long-term service contracts. Their contracts of service should not exceed three years without shareholders’ approval. Disclosure of the emolument of executive directors constituted an important part of the Code, whilst executive directors’ pay should be subject to the recommendations of a remuneration committee made up wholly or mainly of nonexecutive directors. The Code also contained various reporting controls. It was noted that it was the responsibility of the board of directors to present a balanced and understandable assessment of the company’s position, to maintain an objective and professional relationship with the auditors and to establish an audit committee, consisting of at least three non-executive directors with written terms of reference dealing clearly with its authority and duties. A set of ‘Notes’ accompanied the Code of Best Practice, but it was explicitly stated that these notes did not form part of the Code. The ‘Notes’ only ‘included further recommendations on good practice’. Note 5, aiming to ensure the independence of non-executive directors, is of particular interest: ‘The Committee regards it as good practice for non-executive directors not to participate in share option schemes and their services as non-executive directors not to be pensionable by the company, in order to safeguard their independent position.’ The presumption of the Committee was clearly that share option schemes and pension schemes for non-executive directors may tend to make the non-executive director dependent on the company and this would jeopardise the basic objective of the non-executive director, that is to bring an ‘independent judgement’ on issues of strategy, performance, resources, including key appointments, and standards of conduct. The four primary principles promoted by the Cadbury Report were summarised as follows by John C Shaw:102

101 102

Ibid 16 para 3.1. Shaw (n 89) 24.


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1. A clear division of responsibilities at the head of a company to ensure a balance of power and authority, such that no one individual has unfettered powers of decision. 2. Every board should include non-executive directors of sufficient calibre and number for their views to carry significant weight in decisions. 3. Institutional investors should take a positive interest in the composition of boards of directors, with particular reference to avoiding unrestrained concentration of decision making. 4. The Board structure should clearly recognise the importance and significance of the financial function. 9.4.2.3 Further Developments The Financial Reporting Council (FRC) is the United Kingdom's independent regulator for corporate reporting and governance and has ultimate responsibility for maintaining and updating the so-called ‘UK Combined Code’.103 In June 2004, the FRC committed itself to conducting a regular review of the Combined Code, and has since established several operating bodies to achieve their goals.104 In November 2006 the FRC issued an important policy statement on ‘The UK Approach to Corporate Governance’.105 In December 2006 the FRC also released a ‘Draft Updated Regulatory Strategy and Plan & Budget 2007/08’.106 The FRC has set six objectives to achieve their primary aim of promoting confidence in corporate reporting and governance. There six objectives are: 1. high quality corporate reporting 2. high quality auditing 3. high quality actuarial practice 4. high standards of corporate governance 5. the integrity, competence and transparency of the accountancy and actuarial professions 6. our effectiveness as a unified independent regulator 107 The functions that the FRC exercise in pursuit of its six objectives are summarised as follows:

103 104 105 106

107

See . See . Ibid. See . See .

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• promoting high standards of corporate governance • setting, monitoring and enforcing accounting and auditing standard • setting actuarial standards • statutory oversight and regulation of auditors • operating an independent investigation and discipline scheme for public interest cases • overseeing the regulatory activities of the professional accountancy and actuarial bodies108 The basis on which the Government reached their decisions about the role of the FRC was set out in two reports from the Consultative Group on Audit and Accounting (CGAA)109 and the Government “Review of the Regulatory Regime of the Accountancy Profession”.110 In the past the FRC amended the UK Combined Code after investigations and Reports by specialised Committees. The Greenbury Report (1995), the Hampel Report (1998), the Smith Report (2003) and the Higgs Report (2003) are examples of such Reports that led to some amendments to the UK Combined Code.

9.5.3 The Greenbury Report (1995), the Hampel Report (1998), the Smith Report (2003) and the Higgs Report (2003) Richard Smerdon points out that no subject in recent years has aroused more controversy than the question of remuneration and that some commentators sometimes portray it as the only governance issue.111 The Greenbury Report (1995) had a very specific focus on executive remuneration and for this reason its recommendations dealt primarily with the establishment of remuneration committees for listed companies and the role and function of the remuneration committee.112 It also made several recommendations regarding the disclosure of executive remuneration113 and remuneration policy that listed companies should adopt.114 The final part of the Greenbury recommendations dealt with service contracts and what entitlements directors would have in the event of early termination.115 This investigation was considered to be necessary as there were concerns that executive remuneration was excessive and that shareholders should know exactly what executives 108 109 110 111 112 113 114 115

Ibid. See . See . Smerdon (n 79) 115. UK Combined Code Recommendations Para A. Ibid Para B. Ibid Para C. Ibid Para D.


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earned and what a company’s liability would be if executive directors were removed or if an executive contract were terminated prematurely. The Hampel Report (1998) was to a large extent a continuation of the work already done by the Cadbury and Greenbury Reports. The Hampel Report is probably one of the most balanced United Kingdom reports on corporate governance in the sense that it concentrated on broad trends and commented on some incorrect perceptions on corporate governance. One of Hampel’s main aims was, as Kendall and Kendall point out, ‘to calm the situation down’.116 A few examples will illustrate the point. It was one of the main aims of the Hampel Committee ‘to restrict the regulatory burden on companies’, and ‘to substitute principles for detail wherever possible’.117 This particular focus was possible because the Hampel Commission was not established to focus on bad corporate governance practices, but rather on the positive contribution which good corporate governance could make.118 The focus was on corporate governance guidelines and principles rather than ‘boxticking’ to determine whether good corporate governance practices identified in Cadbury and Greenbury were followed or not.119 The Hampel Report is also one of the few United Kingdom corporate governance reports where the importance of the stakeholder debate was recognised.120 Perhaps one of the most controversial aspects of the Hampel Report was its criticism that the monitoring role of the board became ‘overemphasised’ because of the focus on the role of non-executive directors and in particular the role of ‘independent non-executive directors’. Hampel saw the role of non-executive directors as clearly linked to ‘a strategic and monitoring function’ and as ‘mentors to relatively inexperienced executives’.121 The Higgs Report (2003) had a primary focus on the role and effectiveness of non-executive directors. The most significant change effected by this report was the recommendation that at least half of the board of directors (excluding the Chairperson) should be independent non-executive directors and the term ‘independence ‘ was defined in great detail. At the same time that the Higgs Committee conducted its work, the Smith Committee (2003) conducted its work on accounting standards. Both the Higgs Report and the Smith Report were to some extent a result of collapses like Enron and WorldCom and the United States reaction to these collapses, namely the Sarbanes-Oxley Act 2002. The most distinguishing factor between the United Kingdom and United States approaches is, however, that in the United States the Sarbanes-Oxley Act 2002 is a statutory instrument 116

Kendall and Kendall (n 55) 23.

117

Hampel Commission Corporate Governance (Hampel Report 1998) para 1.6.

118

Ibid para 1.7.

119

Ibid paras 1.12–1.14. See also Smerdon (n 79) 17–18.

120

Hampel Report (1998) (n 117) para 1.16.

121

Ibid paras 3.7–3.8.

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that makes several accounting standards and practices compulsory. In the United Kingdom good corporate governance practices are still primarily self-enforced arrangements that are promoted through the listing rules for listed public companies. It is the Code Provisions contained in the Combined Code in particular that set the standards for good corporate practices.

9.5.4 The UK Combined Code As pointed out above, the United Kingdom Combined Code is ultimately the responsibility of the Combined Code. The Combined Code represents the combined wisdom of the Reports discussed above and currently serves as the norm of good corporate governance practices for listed public companies in the United Kingdom. Voluntary compliance with the Combined Code is ensured through the Listing Rules of the London Stock Exchange, which requires that as a general rule listed public companies must comply with the Code or explain why they are not complying—the so-called principle of ‘comply or explain’.122 The effect of this approach, although classified as ‘soft law’, is not insignificant as there are powerful market forces at work to ensure compliance rather than allowing listed public companies to explain why they are not complying. The 2003 Combined Code123 was amended in June 2006124 to ensure the following changes: • to amend the existing restriction on the company Chairman serving on the remuneration committee to enable him or her to do so where considered independent on appointment as Chairman (although it is recommended that he or she should not also chair the committee); • to provide a ‘vote withheld’ option on proxy appointment forms to enable shareholders to indicate if they have reservations on a resolution but do not wish to vote against. A ‘vote withheld’ is not a vote in law and is not counted in the calculation of the proportion of the votes for and against the resolution; and • to recommend that companies publish on their website the details of proxies lodged at a general meeting where votes are taken on a show of hands.125

122

123

124

125

This is ensured through the London Stock Exchange Listing Rule 12.43A—see generally Smerdon (n 79) 19–20. UK Combined Code 2003: . UK Combined Code 2006: . See .


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9.6 Australia 9.6.1 Background to the Corporate Governance Debate in Australia126 John Farrar reflects as follows on perceptions regarding corporate governance and corporate law in Australia: Every country approaches corporate governance from the background of its own distinctive culture. New Zealand has tended in the past towards a pragmatic adaptation of the UK model but has recently adopted a more North American approach. In the case of Australia one sometimes has the impression that this is based on either Ned Kelly or his jailer. We love a larrikin but we are inclined to come down heavily on ‘tall poppies’ and to be excessively penal in our approach. The attitude to the excesses of the 1980s and their aftermath reflects this. We also have a tendency to over-legislate and the result is obese and user-unfriendly legislation’.127 The ‘excesses of the 1980s’ were emphasised prominently in corporate governance reports in the early 1990s.128 Having some knowledge of these excesses is indeed essential to understand and explain many of the statutory provisions in the Australian Corporations Act and to appreciate prevailing perceptions regarding corporate governance in Australia. Trevor Sykes’ fascinating account of the abuses of the 1980s in his book, The Bold Riders,129 reveals many of the evils that flourished then and is a good starting point to obtain a deeper insight into current Australian corporate law and corporate governance. Names like Christopher Skase, Alan Bond, John Friedrich and Abe Goldberg are often mentioned in corporate law discussions130 and, as if these characters have an omnipresence, names like Ray Williams, Rodney Adler, Dominic Fodera, Brad Cooper, Jodee Rich, Brad Keeling, John Greaves, Rene Rivkin, Bill Howard and John Elliot were mentioned regularly in the financial and other press between 2001 and 2004. The importance of interpreting legislation in a broader context and in particular in context of the rationale for the legislation and the abuses it aims at preventing 126

127

128

129 130

This part is based on Jean J du Plessis, ‘Reverberations after the HIH and other Recent Australian Corporate Collapses: The Role of ASIC’ (2003) 15 Australian J C L 225, 227–30. John H Farrar, Corporate Governance in Australia and New Zealand (OUP, Melbourne 2001) 6. Frederick G Hilmer, Strictly Boardroom: Improving Governance to Enhance Company Performance (Hilmer Report) (Australian Print Group, Melbourne 1993), 1, 4. Trevor Sykes, The Bold Riders (Allen & Unwin, St Leonards 1996). See Rick Sarre, ‘Responding to Corporate Collapses: Is there a Role for Corporate Social Responsibility?’ (2002) 7 Deakin L Rev 1.

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was recently emphasised by Justice Kirby in his minority judgement in Rich v ASIC.131 With specific reference to the abuses of the 1980s, Justice Kirby echoed the sentiments that the legislation was intended to address the negative consequences of those abuses and to improve the standards of corporate governance in Australia. He argued that because of that, remedies like disqualification orders and civil penalty orders should not be interpreted narrowly, but rather in context of the intention of the legislature, and in particular as remedies aimed at particular evils.132 With spectacular corporate collapses like HIH, Harris Scarfe, One.Tel, Pasminco, Centaur and Ansett in mind, it is certain that it is not the existence of ‘obese … legislation’ that prevents corporate collapses and that it was a misconception to rely on Corporate Law Simplification or Corporate Law Economic Reform Programs (CLERP) to provide the answer to the ‘excesses of the 80s’.133 There is also very little use in governments constantly acting on an ad hoc basis to deal with specific problems. This makes the law ‘too cumbersome’ and, as Bob Baxt also points out fittingly, ‘make[s] it more and more difficult to discern a clear theme underpinning the legislation, and to provide a clear message to the courts in deciding cases that are brought before them’.134 It is true that the breadth and depth of the provisions in the Corporations Act 2001 covering directors’ duties and responsibilities and remedies available for these breaches are impressive. The Corporations Act 2001 has imbedded in it a very finely woven legislative net that will catch even the smallest fish, but it will be very interesting to conduct some research in order to establish whether the bulky Australian corporations legislation is more fool-proof than core Corporations Acts like the ones in New Zealand or Canada.135 In Australia corporate governance was, in the late 1990s, almost considered to be an unnecessary burden upon Australian businesses. Strict corporate governance rules have even been blamed for the under-performance of Australian companies.136 David Knott, the then Chairman of ASIC, neatly captures the prevailing 131 132 133

134

135

136

Rich v ASIC [2004] HCA 42 (9 Sept 2004) [62]. Ibid [117]–[118]. See generally HIH Royal Commission Final Report, xiii–xiv; and F Clarke and G Dean, ‘Corporate Collapses Analysed’ in Collapse Incorporated: Tales, Safeguards & Responsibilities of Corporate Australia (CCH Australia Ltd, Sydney 2001) 72, 89. Robert Baxt, ‘The Necessity of Appropriate Reform’, in Collapse Incorporated: Tales, Safeguards & Responsibilities of Corporate Australia (CCH Australia Ltd, Sydney 2001) 329 (see also Baxt’s critical comments of several recent pieces of legislation on 329–334). It is promising to note that there seems to be some mention of a core and modern corporate law—Baxt (n 134) 335. Sarre (n 130) 1; Rick Sarre, ‘Risk Management and Regulatory Weakness’, in Collapse Incorporated: Tales, Safeguards & Responsibilities of Corporate Australia (CCH Australia Ltd, Sydney 2001) 295. See also David Knott, ‘Protecting the Investor: The Regulator and Audit’ Address to the CPA Congress 2002 Conference, Perth Western Australia, 15 May 2002, (Speeches) 4.


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mood of the late 1990s: ‘Directors started to question [corporate governance’s] relevance. Corporate governance became formalistic, even ritualistic. It lost momentum as an effective program for corporate risk management. We probably paid a price for that.’137 But, in the early 2000s corporate governance was once again back on the front pages of newspapers and uppermost in the minds of directors and most regulators in Australia.138 The corporate collapses in Australia between 2000 and 2003 also brought a sudden end to the complacency that prevailed about corporate governance in Australia after many years of sustained growth in Australia and Australia’s remarkable survival of the Asian financial crisis.139 Solutions to ‘bad corporate governance’ were sought along a broad and varied front, including continuous disclosure; codes of good practice; disqualification of auditors; and the role and functions of the auditor, audit committees, independent directors, and non-executive directors.140 Many of these mechanisms to curb bad corporate governance practices were implemented between 2000 and 2004, with CLERP 9 probably the best example with its aims of restoring confidence in the accounting profession; improving disclosure and financial reporting; and protecting those who reveal and report contraventions of the Corporations Act 2001. Almost ‘forgotten’ debates have been reopened, including the debate on board structures, in particular the two-tier board system versus the unitary board system and it is clear that, as in the ‘old days’, the strong preferences for the one or the other board structure still exist among commentators.141

137 138

139 140

141

Knott (n 136) 4. See David Knott, ‘Corporate Governance: The 1980s Revisited?’ Monash Law School Foundation Lecture 23 Aug 2001, (Speeches) 3–4; Jillian Segal, ‘Corporate Governance: Substance over Form’ (2002) 25 UNSW L J 320. Knott (n 138) 11. For two excellent addresses covering almost all relevant aspects of good corporate governance, see Pat Barrett, ‘Corporate Governance—More Than a Passing Fad’ Alfred Deakin Club Luncheon, 12 June 2002 — address obtained through a search of The Attorney-Generals Information Service (AGIS), Feb 2003; and Pat Barrett, ‘Expectations, and Perceptions, of Better Practice Corporate Governance in the Public Sector from an Audit Perspective’ CPA Australia’s Government Business Symposium, Melbourne, 20 September 2002 . Cf Jillian Segal, ‘The Future of Corporate Regulation in Australia’ Address to the 18th Annual Company Secretaries’ Conference Surfers Paradise 19 Nov 2001 (Speeches) 3; Jillian Segal, ‘Everything the Company Director Must Know about Corporate Financial Disclosure and Continuous Disclosure’ Address to the Australian Institute of Company Directors Conference, Governance & Disclosure—A Forum for Company Directors, Sydney 31 Oct 2001 (Speeches) 11–12; and Knott (n 136) 4–7.

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9.6.2 The Bosch Reports142 9.6.2.1 The Three Editions of the Bosch Report In or around 1990 a Working Group, chaired by Henry Bosch AO (former chairman of the National Companies and Securities Commission, NCSC), was established by several leading players in the Australian financial markets. These included the Australian Merchant Bankers Association, the Australian Stock Exchange Limited, the Australian Institute of Company Directors and the Securities Institute of Australia. This Working Group released a paper on ‘Corporate Practices and Conduct’ in June 1990 and it was widely discussed before its first report was published in 1991 under the same title.143 There are often references to ‘the Bosch Report’, but in fact there were three Bosch Reports, the original one appearing in 1991 and then two Reviews of the 1991 Report, namely in 1993 and 1995 (with a 1996 Reprint). Although all three Reports deal with ‘Corporate Practices and Conduct’ or corporate governance as it is now more generally known, the three Reports differ considerably in detail and it could lead to confusion if the particular year of the Report is not mentioned. We will refer to the original Bosch Report as the Bosch Report (1991) and to the 1993 and 1995 Reviews as respectively the Bosch Report (1993)144 and the Bosch Report (1995).145 It was pointed out that the original Bosch Report (1991) represented ‘wide consensus in the corporate community of the substantive issues’ and that the Report attempted ‘only to set out general principles of practice and conduct’. A strong call was made for the corporate sector to establish its own framework for acceptable standards of behaviour, irrespective of existing or prospective regulatory and legislative rules.146 Four aspects of the Bosch Report (1991) deserve special mention. First, it should be noted that its release in 1991 was ahead of the United Kingdom where the Cadbury Committee was only established in May 1991, released its draft report in May 1992, and its final report in December 1992. 147

142

143

144

145

146 147

The following two parts are based on Chapter 5 of Du Plessis, McConvill and Bagaric, (n 26). Business Council of Australia, Corporate Practices and Conduct (hereafter referred to as the Bosch Report (1991)). Business Council of Australia, Corporate Practices and Conduct, 2nd edn (hereafter referred to as the Bosch Report (1993)). Business Council of Australia, Corporate Practices and Conduct, 3rd edn (hereafter referred to as the Bosch Report (1995)). Bosch Report (1991) (n 143), ‘Foreword’. Report of the Committee on the Financial Aspects of Corporate Governance (hereafter ‘Cadbury Report’) Committee on the Financial Aspects of Corporate Governance (1992).


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Secondly, although the abuses of the 1980s surely contributed to the establishment of the Working Group, it does not seem that it was specific scandals like Maxwell and BCCI148 in the United Kingdom that triggered this self-regulatory move by the business community in Australia. However, the Working Group’s main and general aim with its Report, namely ‘to improve the performance and reputation of Australian business by encouraging and assisting the general adoption of the highest standards of corporate conduct’,149 suggests at least that there were concerns about the ‘underperformance’ of Australia’s businesses and that Australian businesses had a ‘bad reputation’. The last-mentioned aspect could surely be traced back to the abuses of the 1980s. Thirdly, the term ‘corporate governance’ is only mentioned once as one of three main headings (the other two main headings were ‘Company Code of Ethics’ and ‘Guidelines for Conduct of Directors’) in the Bosch Report (1991). There is, however, little doubt that what was then understood as ‘Corporate Practices and Conduct’ (the title of the Bosch Report (1991)), would nowadays sit comfortably under the title ‘Corporate Governance’. One wonders what the impact of the Bosch Report would have been if the term corporate governance was used as was the case with the Cadbury Report in the United Kingdom. Fourthly, whereas the Cadbury Report is hailed for its clarity of expression,150 it would not be an overstatement to say that the original Bosch Report (1991) should be recognised not only for its clarity of expression, but also for its brevity and being at the forefront of introducing several principles of good corporate governance that only became the standard of good corporate governance practices in other countries several years later. By reading the ‘Foreword’ to the Bosch Report (1993), the impact of the United Kingdom Cadbury Report (1992) is immediately apparent, as is the huge impression that the concept ‘corporate governance’ has made upon the Working Group.151 ‘Corporate governance’ is also no longer a term used only once as part of three main headings, but is pivotal—used four times in the ‘Foreword’ and the heading ‘Corporate Governance’ is now supplemented with a definition of corporate governance—‘the system by which Companies are controlled’ and with a very specific message, namely that ‘[t]he essence of any system of good corporate governance is to allow Directors the freedom to drive their Companies forward but to exercise that freedom within a framework of effective accountability’.152 The desire to keep adherence to good corporate governance practices within the realm of self-regulation is again expressed in no uncertain terms: 148

149 150 151 152

John C Shaw, ‘The Cadbury Report, Two Years Later’, in Klaus J Hopt et al (n 89) 21, 23; Stanley Christopher, ‘Corporate Accountability: Cadbury Committee: Part 1’ (1993) 11 Intl Banking and Financial L 104. Bosch Report (1991) (n 143), ‘Foreword’. HIH Royal Commission Final Report, Vol I, Part III, 102. Bosch Report (1993) (n 144) 1–2. Ibid 9.

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[T]he corporate sector is making a significant effort to create its own framework of acceptable standards of behaviour irrespective of existing or prospective legislation ….153 The second edition of the Corporate Practices and Conduct booklet represents a continuing commitment by Australia’s leading business and professional organisations to lift the standards of corporate governance which will enhance investor confidence both here and overseas.154 The order of the organisations that produced the booklet changes slightly. The Australian Institute of Directors, which was mentioned in the third last position in 1991, now moved to the top of the list. The Australian Investment Managers’ Group was added to the list, while the Australian Merchant Bankers Association was replaced by the International Banks and Securities Association of Australia. It is unnecessary to say much about the Bosch Report (1995), as in substance there was little added to the Bosch Report (1991) and the Bosch Report (1993). This is so notwithstanding the fact that the objectives with the Bosch Report (1995) were articulated specifically155—there can be little doubt that in essence these objectives underlie the Bosch Report (1991) and Bosch Report (1993) as well. The Bosch Report (1995) once again grew in size (now 58 pages in comparison with the 22 pages of the Bosch Report (1991) and 39 of the Bosch Report (1993)); the formatting and presentation was improved slightly (probably because of the involvement of a commercial publisher); and the Report became more tiresome to apprehend because some further explanations and specific ‘considerations’, ‘beliefs’ and ‘general comments’ were added by the Working Group in paragraphs highlighted by way of horizontal lines in the page margins. The ‘considerations’, ‘beliefs’ and ‘general comments’, in particular, leave some impression of tugs-of-war between influential role players in the financial and securities markets. In this regard it is interesting to note that of the nine organisations that contributed to the Bosch Report (1993), only six were left—the Australian Investment’s Group; Australian Stock Exchange Ltd; and International Bankers and Securities Association of Australian either ran out of steam or lost interest in the process. The Bosch Report (1995) also has some hallmarks of a Report that lost its original focus on core principles of corporate practice and conduct. This is probably so because it was work that evolved over a period of approximately 6 years (1990–1995). It also attempted to accommodate and reflect rapidly changing and expanding international developments in the area of corporate governance.156 The Working Group seemed slightly overwhelmed by developments in the area of corporate governance—‘[s]ince the first edition of this book was published in 153 154 155 156

Ibid 1. Ibid 2. Ibid 1. See Bosch Report (1995) (n 145) 4–5.


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1991, there have been many new laws and regulations, and many court judgements, that have made the task of governing corporations more complex and difficult’.157 Several of the recommendations, suggestions and proposals of the Bosch Report (1991) and Bosch Report (1993) either disappeared from the Bosch Report (1995) or were modified in ways that made it difficult to recognise them or trace them back to the original Report. It is also interesting to note that ‘the Bosch Report’ now receives only scant attention in most of the leading Australian corporate governance and corporate law textbooks.158 All this said, there is no doubt that the Bosch Report (1995) was another wellintended effort to promote good corporate governance practices in Australia and to keep corporate governance self-regulated. 9.6.2.2 Divergence from UK Practice: 1995 Till Early 2003 On 1 July 1995 a rule (originally Rule 3C(3)(j) and later Rule 4.10.3) was introduced into the ASX Listing Rules,159 requiring of listed companies to disclose in their Annual Reports (applied to reporting periods ending on or after 30 June 1996) the main corporate governance practices that they had in place during the year. In an Appendix to the Listing Rules (originally Appendix 33 and later Appendix 4A) there was a list of typical matters (a so-called ‘indicative list of corporate governance matters’) that companies could take into consideration in complying with Listing Rule 3C(3)(j) / 4.10.3.160 Phillip Lipton explains the differences, at that stage, with the United Kingdom’s approach and also what was hoped to be achieved by the Australian approach: The Australian approach does not require specific corporate governance practices to be adopted by listed companies. Rather, there is a list of indicative practices and it is up to individual companies to establish their own effective system of governance and disclose it to the market. This approach seeks to ensure that corporate governance practices evolve and improve over time to meet the needs and expectations of the market and companies. Best practices do not become rigid and formulaic and it is hoped that thought is given by boards as to what is appropriate and why, 157 158

159

160

Ibid 1. Cf (for example) Farrar (n 127) 337–39; RP Austin, HAJ Ford and IM Ramsay, Company Directors: Principles of Law and Corporate Governance (LexisNexis/Butterworths, Chatswood 2005) 15–17. Bosch Report (1995) (n 145), 3; Phillip Lipton, ‘The Practice of Corporate Governance in Australia: Regulation, Disclosure and Case Studies’ in Low Chee Keong (ed), Corporate Governance: An Asian-Pacific Critique (Sweet & Maxwell, Hong Kong 2002) 105, 131. See Lipton (n 159) 132–33 for the matters listed in Appendix 4A.

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rather than a checklist approach involved in ticking off prescribed practices in a non-analytic way. A prescriptive approach could discourage innovation and development of better practices by setting a minimum standard. A non-prescriptive approach also tries to ensure that smaller companies do not have unrealistic compliance burdens imposed upon them.161 It was only after the establishment of the ASX’s Corporate Governance Council in August 2002 and the release of its Principles of Good Corporate Governance and Best Practice Recommendations in March 2003 that the corporate governance practices in the United Kingdom and Australia converged again.

9.6.3 The Hilmer Report The case of AWA Ltd v Daniels (Trading as Deloitte Haskins & Sells & Ors)162 caused quite a bit of anxiety in Australia amongst directors. The reason for this was that it was required in AWA Ltd v Daniels (Trading as Deloitte Haskins & Sells & Ors) of Rogers CJ to consider, in a practical context and in a complicated factual context, what the duties and responsibilities of directors really were. Rogers CJ himself had to admit that the theories regarding directors’ duties and responsibilities were not always easy to apply in practice. For this very reason he approached ‘The Sydney Institute’ to facilitate discussions on corporate governance. The Hilmer Report (1993) was the outcome of these discussions, after a Working Group, under Chairmanship of Fredrick G Hilmer, released its Report, Strictly Boardroom: Improving Governance to Enhance Company Performance, in 1993.163 In hindsight, the Hilmer Report (1993) was indeed particularly appropriate as the appeal of AWA Ltd v Daniels (Trading as Deloitte Haskins & Sells & Ors), namely Daniels v Anderson,164 emphasised the point that the Australian courts were prepared to expect high standards of care and diligence of directors, including non-executive directors. In AWA Ltd v Daniels (Trading as Deloitte Haskins & Sells & Ors) Rogers CJ suggested that non-executive officers may only be expected to pronounce on matters of policy and may rely on management to inform them of anything important. The Royal Commission into the Tricontinental Group of Companies165 believed such was not sufficient to satisfy the director’s duty of care, asserting that the director must provide an independent enquiring mind. For this reason, the Commission questioned the authority of AWA Ltd v Daniels, suggesting that subsequent ‘courts are likely to examine critically any failure by directors to be 161 162 163 164 165

Ibid 131–32. AWA Ltd v Daniels (1992) 7 ACSR 759. Hilmer Report (1993) (n128) 1–3. Daniels v Anderson (1995) 13 ACLC 614. Final Report of the Royal Commission of Inquiry into the Tricontinental Group of Companies, 1992, vol 2, ch 19, paras 19.53–19.56.


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sufficiently well-informed about matters affecting the financial performance and health of their corporations, even if they are non-executive directors’. This proved to become the norm. In Daniels v Anderson, Clarke and Sheller JJA specifically referred to Rogers CJ’s views on the duties of non-executive directors. They refer, inter alia, to Roger CJ’s views that ‘a director is justified in trusting [officers of the company] to perform duties that, having regard to the exigencies of business, the intelligent devotion of labour and the articles of association, may properly be left to them’; and ‘that a director is entitled to rely on the judgement, information and advice of the officers so entrusted and on management to go through relevant financial and other information of the corporation and draw to the board’s attention any matter requiring their consideration’. Clarke and Sheller JJA said in no uncertain terms that they did not think that inter alia these statements of Rogers CJ ‘accurately state the extent of the duty of directors whether non-executive or not in a modern company’. 166 Their own view that there was a positive duty on directors to investigate and to query management, especially when there is notice of mismanagement, and that directors are under a continuing obligation to keep informed about activities of the corporation,167 caused alarm bells to go off, especially for non-executive directors. Rogers, commenting on their decision in a paper included as part of the Hilmer Report (1993), said that they had ‘struck out a radically different direction’ as far as directors’ duties were concerned generally and in particular their approach that no distinction should be drawn between the obligations of executive and non-executive directors.168 The concerns surrounding the New South Wales Court of Appeal’s approach in Daniels v Anderson were of such a nature that amendments to the Corporations Act were required to make it clear under which circumstances directors could delegate powers to others and when they will be protected for relying on the information provided to them by those to whom they delegated certain powers.169 One of the key aspects the Hilmer Report (1993) emphasised was that poor corporate performance, not fraud or misconduct, should be the main contemporary concern of corporate governance.170 For this reason a whole chapter was dedicated to the functions of the board171 and another chapter to improving governance.172 Several international developments in the area of corporate governance after 1993 resulted in a second report in 1998 under the same title: Strictly Boardroom:

166 167 168 169

170 171 172

Daniels v Anderson (1995) 13 ACLC 663. Ibid 663–64. Andrew Rogers, ‘Update’, in Hilmer Report (1993) (n 128) 77. See Explanatory Memorandum to the CLERP Bill 1998, paras 6.98–6.105; and the current ss 189–190 and 198D Corporations Act. Hilmer Report (1993) (n 128) 4. Ibid ch 3. Ibid ch 4.

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Improving Governance to Enhance Company Performance.173 There were no radical changes in approach between the 1993 and 1998 Hilmer Reports. The same sentiments underpinned the Hilmer Report (1998)174 and there were hardly any changes to the twelve numbered paragraphs under the heading ‘summary of recommendations’.175 It is, however, interesting to note that an extract of a publication by Frederick G Hilmer and Lex Donaldson on ‘The Fallacy of Independence’ was included as Appendix 1 to the Hilmer Report (1998). In this article the two authors make it clear that the real challenge for boards was not independence, but performance.176 They also pointed out that research has failed to support the idea that a large number of independent directors leads to fewer illegal acts by corporations.177 This conclusion seems to be supported by several of the corporate collapses in Australia and other parts of the world where there were indeed several independent directors serving on the boards of the majority of these companies, but still bad corporate governance practices and contraventions of the corporations laws thrived. The corporate governance watchdogs—the outside and nonexecutive directors as well as independent outside and non-executive—were obviously fast asleep.

9.6.4 The Virtues of Good Corporate Governance in Australia Between 1991 and 1998 The excellent intentions of the Bosh Reports (1991 and the 1993 and 1995 Reviews) and the Hilmer Reports (1993 and 1998) to promote good corporate governance principles did not, unfortunately, pay the dividends one would have expected of them as was so cruelly illustrated by the investigations into and court cases dealing with the spate of collapses of large Australian public corporations between 2000 and 2003. Several reasons could probably be given for the bad corporate governance practices identified in reports and court cases following these collapses, for example the lack of vigorous scrutiny whether professed good corporate governance practices were actually followed; poor accounting standards; lack of independence of auditors; lack of proper disclosure of material price-sensitive information; lack of statutory provisions to protect those who knew about bad corporate governance practices to bring those practices to light and so on. However, it is probably the complacency that prevailed about corporate governance after many years of sustained growth in Australia in the middle to late 1990s and early 2000s that was one of the biggest contributing factors allowing 173

174 175

176 177

Frederick G Hilmer, Strictly Boardroom: Improving Governance to Enhance Company Performance (Hilmer Report 1998) i–ii. Ibid 1–7. Frederick G Hilmer and Lex Donaldson, ‘The Fallacy of Independence’ in Hilmer Report (1998) (n 173) 81. Hilmer Report (1998) (n 173). Hilmer and Donaldson (n 175) 58, 86.


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bad corporate governance practices178 to thrive again in an environment where there was surely no lack of appreciation of the virtues of good corporate governance practices, as is so strikingly illustrated by the commendable recommendations of the Bosch and Hilmer reports released between 1991 and 1998.

9.6.5 The IFSA Blue Book The Australian Investment Managers’ Association (AIMA) or Investment and Financial Services Association Ltd (IFSA) as it is now known, developed a guide on good corporate governance practices for investment managers in 1995 under the title Corporate Governance: A Guide for Investment Managers and A Statement of Recommended Corporate Practice.179 A second edition of the Guide appeared in July 1997.180 This Guide was developed further and a third edition was released in July 1999 under the name IFSA Guidance Note No. 2.00: Corporate Governance: A Guide for Investment Managers and A Statement of Recommended Corporate Practice.181 A fourth edition was published in December 2002 as IFSA Guidance Note No. 2.00: Corporate Governance: A Guide for Fund Managers and Corporations or commonly known as the IFSA Blue Book.182 The fifth edition of this Guide was released in October 2004.183 Several significant changes were made to the IFSA Blue Book (2004) as a result of amendments to the Corporations Act 2001 affected by the Corporate Law Economic Reform Program (Audit Reform and Corporate Disclosure) Act 2004 and also the release in March 2003 of the ASX’s Principles of Good Corporate Governance and Best Practice Recommendations.184 178 179

180

181 182

183

184

See Du Plessis (n 126) 229 and Rich v ASIC [2004] HCA 42 (9 Sept 2004) [117]. As referred to in Ian Ramsay and Richard Hoad, Disclosure of Corporate Governance Practices by Australian Companies, Research Paper (Centre for Corporate Law and Securities Regulation, University of Melbourne (1997) 3 10 (fn 25) – also published as Ian M Ramsay and Richard Hoad, ‘Disclosure of Corporate Governance Practices by Australian Companies’ (1997) 15 Company and Securities L J 454. IFSA Guidance Note No. 2.00: Corporate Governance: A Guide for Investment Managers and A Statement of Recommended Corporate Practice (3rd edn July 1999) (hereafter referred to as IFSA Guidance Note No 2.00 (1999)) 5 para 8.3 . IFSA Guidance Note No 2.00 (1999), 1. IFSA Guidance Note No 2.00: Corporate Governance: A Guide for Fund Managers and Corporations (Dec 2002) (hereafter referred to as IFSA Blue Book (2002)). IFSA Guidance Note No 2.00: Corporate Governance: A Guide for Fund Managers and Corporations (Oct 2004) (hereafter referred to as IFSA Blue Book (2004)) . IFSA Media Release 21 Oct 2004 ‘Enhanced Corporate Governance Guidelines Issued by IFSA: Proxy Voting Summary to Appear on Member Company Websites’, .

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It was only in 2002 that the IFSA Blue Book started to include a definition of ‘corporate governance’.185 The definition IFSA uses is, for understandable reasons, very much focused on shareholders and management: Corporate Governance concerns the conduct of the board of directors and the relationship between the board, management and shareholders. The transparency of major corporate decisions and accountability to shareholders is at the core of governance issues. Shareholders should be treated equitably and there should be the appropriate distribution of risks and rewards between shareholders and company management.186 It is interesting to note that there is only one reference to the term ‘stakeholder’ in the IFSA Blue Book (2004). This occurs under Guideline 10 (Performance Evaluation) where it is stated that the board should consider establishing ‘policies where the interests of shareholders and other stakeholders require them to limit the discretion of management to act in particular areas such as legal compliance and environmental policy’.187 The way in which the IFSA Guidelines have been presented since 1999 was to divide the Guidelines into two categories. First, some guidelines are given specifically for ‘Fund Managers’ regarding their approach to corporate governance, voting and other issues proposed by public companies in which they invest. Secondly, there are some general guidelines for ‘Corporations’, that is, IFSA’s outlines what it believes are best practice corporate governance standards for companies in which its fund manager clients have invested.

9.6.6 The Australian Stock Exchange Ltd (ASX)188 9.6.6.1 Slow to Get Out of the Blocks The ASX was slow in following the examples of other Stock Exchanges in the world to develop and promote good corporate governance through a Code of Good Corporate Governance Practices and to promote compliance with such a Code by including a provision in its Listing Rules that companies that do not comply with such provisions should explain non-compliance in their Annual Reports. Both the London Stock Exchange and the Johannesburg Stock Exchange included a Listing Rule to ensure compliance or an explanation of non-compliance with a Code of Best Practice in 1993 and 1994 respectively. Until early 2003 the ASX chose to be

185 186 187 188

IFSA Blue Book (2002) 9, para 9/2/1. IFSA Blue Book (2004) 9 para 9.2.1. IFSA Blue Book (2004) 26 para 11.11. This part is based on Chapter 7 of Du Plessis, McConvill and Bagaric (n 26).


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‘less prescriptive’,189 and resisted any change in its approach notwithstanding the fact that it was criticised by the Australian Securities and Investments Commission (ASIC) for not following the example of several other Stock Exchanges.190 ASX Listing Rule 4.10, originally introduced on 1 July 1996 as Listing Rule 3C(3)(j),191 provided as follows: 4.10 An entity must include the following information in its annual report. The information must be current at a date specified by the entity which is no more than 6 weeks before the report is sent to security holders … 4.10.3 A statement of the main corporate governance practices that the entity had in place during the reporting period. If a practice had been in place for only part of the period, the entity must state the period during which it had been in place. In 1997 there was vigorous debate between the Australian Investment Managers’ Association ) and the ASX whether listed companied did indeed comply with the Rule. The ASX alleged that every one of the largest 150 companies listed on the Exchange complied with Listing Rule 4.10.3, while AIMA showed that very few of the listed companies had a clear understanding of what really should be disclosed.192 Whether the ASX or AIMA (now IFSA) was right in their claims is to a large extent irrelevant today, but it did require several huge corporate collapses between 2000 and 2003 to make the ASX realise that its ‘less prescriptive’ approach was probably not the right one. The ‘less prescriptive’ arrangement was in place until March 2003. Until then listed companies had to rely on the ‘indicative list in Appendix 4A (originally Appendix 33) to the Listing Rules to guide them in the type of matters considered to be corporate governance practices they had to report on. Guidance Note 9 of the ASX provided guidance on the disclosure of corporate governance practices under Listing Rule 4.10.3. Guidance Note 9 cited Listing Rule 4.10 and then explained several aspects such as the role of the ASX; disclosure in annual reports; corporate governance matters generally; and the way in which the indicative list should be used to comply with the disclosure required under Listing Rule 4.10.3.193 Until March 2003 listed companies were assisted in two other ways (apart from the indicative list) in complying with Listing Rule 4.10.3. First, the 1996 Reprint 189

190

191 192 193

See Paul Redmond, Companies and Securities Law (3rd edn, LBC Information Service, Sydney 2000) 268 and Lipton (n 159). Phillip Lipton and Abe Herzberg, Understanding Company Law (11th edn, Thomson Lawbook Co, Sydney 2003) 296. Bosch Report (1995) (n 145) 3. Ramsay and Hoad (n 179) 1–2. ASX Guidance Note 6, ‘Disclosure of Corporate Governance Practices: Listing Rule 4.10’, issued Sept 2001, .

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of the Bosch Report (1995), specifically mentioned the introduction of the disclosure requirement on corporate governance practices in Listing Rule 4.10.3 and also discussed the corporate governance matters to be reported on in Part II.194 Secondly, listed companies could use the AIMA Guidelines and later the IFSA Blue book as a guide for good corporate governance practices and to comply with Listing Rule 4.10.3. 9.6.6.2 Rapid Change in Attitude Since the End of 2002 The whole face of corporate governance in Australia started to change very quickly with the collapses of HIH, Harris Scarfe, One.Tel, Pasminco, Centaur and Ansett between 2000 and –2003, and after the ASX established the Corporate Governance Council (CGC) on 15 August 2002.195 The CGC is comprised of representatives of the most important players in the financial markets.196 Its first task was to produce a set of consolidated and up-to-date standards of best practice. The CGC developed these guidelines with great speed, approving the Principles of Good Corporate Governance and Best Practice Recommendations in March 2003. Even before the approval of this document by the CGC, Listing Rule 4.10.3 was amended on 1 January 2003 to read as follows: 4.10 An entity must include the following information in its annual report. The information must be current at a date specified by the entity which is no more than 6 weeks before the report is sent to security holders … 4.10.3 A statement disclosing the extent to which the entity has followed the best practice recommendations set by the ASX Corporate Governance Council during the reporting period. If the entity has not followed all of the recommendations the entity must identify those recommendations not followed and give reasons for not following them. If a recommendation had been followed for only part of the period, the entity must state the period during which it had been in place. Introduced 1/7/96. Origin: Listing Rule 3C(3)(j). Amended 1/1/2003. Note: The corporate governance statement may be given to ASX as a separate report but must be given to ASX at the same time as the annual report and be clearly identified as the corporate governance report.

194 195

196

Bosch Report (1995) (n 145) 3. The CGC had its 5th meeting on Thursday 20 Feb 2003—Alan Kohler, ‘Directors Face D-day as Old Rules go by the Board’ Australian Financial Rev, 20 Feb 2003. The Council consists of representatives of 20 business and investor groups. The investor groups are: the Australian Shareholders Association; the Investment & Financial Services Association; the Association of the Superannuation Funds of Australia; the Australian Institute of Superannuation Trustees and the Australian Council of Superannuation Investors.


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In March 2003 a new Guidance Note 9A on ‘Corporate Governance—ASX Corporate Governance Council—Principles of good corporate governance & Best practice recommendations’ was issued.197 That is the current document guiding companies to comply with Listing Rule 4.10.3. It cites the current Listing Rule 4.10.3; explains that any deviation from the CGC’s ‘Principles of good corporate governance and Best practice recommendations’ should be explained on the basis of the principle of ‘if not, why not?’; and contains a condensed version of the ‘Principles of good corporate governance and Best practice recommendations’. 9.6.6.3 ASX Corporate Governance Council’s Principles of Good Corporate Governance and Best Practice Recommendations Apart from the ‘Foreword’, the ASX Corporate Governance Council’s Principles of Good Corporate Governance and Best Practice Recommendations consist of four other parts, namely a description of ‘Corporate governance in Australia’; ‘The essential corporate governance principles’; ‘Best practice recommendations’ and two ‘Attachments’, one dealing with guidelines for notices to meetings and the other one with disclosure. The explanatory part of the document is contained under the heading ‘Best practice recommendations’. This part consists of ten chapters, one for each of the ten essential corporate governance principles. Each chapter repeats the relevant essential corporate governance principle and then typically has three different parts: Recommendations on the essential principle, marked with a large Ź in the margin; Commentary and guidance on the particular recommendation; Boxed-in paragraphs, giving some practical guidance on what the content of certain documents should contain, suggestions on how the recommendation should be implemented, or how certain aspects should be assessed (e.g. assessing the independence of directors). In November 2006, the ASX Corporate Governance Council announced a revision of the November 2003 Principles of Good Corporate Governance and Best Practice Recommendations. The intention is to reduce the number of principles and to simplify the principles. The proposed effective date for the revised Principles is the first financial year commencing after 1 July 2007.198

197

198

ASX Guidance Note 9A . See ASX for the latest version of the Principles and Recommendations.

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9.7 Concluding Remarks When doing comparative corporate governance research, including comparing alternative board structures, one should always keep a few basic things in mind.199 Firstly, as Paul Davies points out, it is unwise to look for solutions ‘in other countries’ corporate governance systems simply because one’s own economy is doing badly in the current phase of an economic cycle.’200 Secondly, corporate governance, including the particular board structure used, should be viewed very specifically in context of a country’s own tradition, history, culture and corporate law system.201 The simple reality that we have different corporations laws for all major economies should tell us that there will always be fundamental aspects distinguishing corporate law systems from each other, irrespective of the so-called ‘convergence theory’.202 There is nothing wrong in recognising and accepting these differences as was so appropriately illustrated by the excellent recent assessment of different corporate governance systems applicable in the European Union.203

199 200 201 202

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See Du Plessis (n 68) 382–83. Davies (n 74) 135, paras 135–36. Farrar (n 127) 6. See and compare John C Coffee Jr, ‘The Future as History: The Prospects for Global Convergence in Corporate Governance and its Implications’ (1999) 93 Northwestern U L Rev 641 ff; Hansmann and Kraakman (n 72) 439 ff; Douglas M Branson, ‘The Very Uncertain Prospect Of “Global” Convergence In Corporate Governance’(2001) 34 Cornell Intl LJ 321 ff; Kwek Mean Luck, ‘The End of History for Corporate Governance or just another Moment in Time? (2001) 19 Company and Securities L J 305 ff; Paul von Nessen, ‘Corporate Governance in Australia: Converging with International Developments’ (2003) 15 Australian J of Corp Law 189, 206 (fn 72); Bernhard Großfeld, ‘Rechnungslegung als Unternehmensverfassung’ (2003) 6 NZG 842, 844–45. European Commission Comparative Study (n 72) 6–7.

Appendix

English Translations of Some European Provisions for Purposes of Chapter 7

I. European Community Law1 1. EC Treaty2 Article 2 The Community shall have as its task, by establishing a common market and an economic and monetary union and by implementing common policies or activities referred to in Articles 3 and 4, to promote throughout the Community a harmonious, balanced and sustainable development of economic activities, a high level of employment and of social protection, equality between men and women, sustainable and non-inflationary growth, a high degree of competitiveness and convergence of economic performance, a high level of protection and improvement of the quality of the environment, the raising of the standard of living and quality of life, and economic and social cohesion and solidarity among Member States. Article 44 1. In order to attain freedom of establishment as regards a particular activity, the Council, acting in accordance with the procedure referred to in Article 251 and after consulting the Economic and Social Committee, shall act by means of directives. 2. The Council and the Commission shall carry out the duties devolving upon them under the preceding provisions, in particular: (a) by according, as a general rule, priority treatment to activities where freedom of establishment makes a particularly valuable contribution to the development of production and trade; (b) by ensuring close cooperation between the competent authorities in the Member States in order to ascertain the particular situation within the Community of the various activities concerned;

1 2

This is the original text. Source: Official Journal C 325, 24 Dec 2002.

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(c) by abolishing those administrative procedures and practices, whether resulting from national legislation or from agreements previously concluded between Member States, the maintenance of which would form an obstacle to freedom of establishment; (d) by ensuring that workers of one Member State employed in the territory of another Member State may remain in that territory for the purpose of taking up activities therein as self-employed persons, where they satisfy the conditions which they would be required to satisfy if they were entering that State at the time when they intended to take up such activities; (e) by enabling a national of one Member State to acquire and use land and buildings situated in the territory of another Member State, in so far as this does not conflict with the principles laid down in Article 33(2); (f) By effecting the progressive abolition of restrictions on freedom of establishment in every branch of activity under consideration, both as regards the conditions for setting up agencies, branches or subsidiaries in the territory of a Member State and as regards the subsidiaries in the territory of a Member State and as regards the conditions governing the entry of personnel belonging to the main establishment into managerial or supervisory posts in such agencies, branches or subsidiaries; (g) by coordinating to the necessary extent the safeguards which, for the protection of the interests of members and other, are required by Member States of companies or firms within the meaning of the second paragraph of Article 48 with a view to making such safeguards equivalent throughout the Community; (h) by satisfying themselves that the conditions of establishment are not distorted by aids granted by Member States. Article 48 Companies or firms formed in accordance with the law of a Member State and having their registered office, central administration or principal place of business within the Community shall, for the purposes of this Chapter, be treated in the same way as natural persons who are nationals of Member States. “Companies or firms” means companies or firms constituted under civil or commercial law, including cooperative societies, and other legal persons governed by public or private law, save for those which are non-profit-making. Article 234 The Court of Justice shall have jurisdiction to give preliminary rulings concerning: (a) The interpretation of this Treaty; (b) The validity and interpretation of acts of the institutions of the Community and of the ECB;


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(c) the interpretation of the statutes of bodies established by an act of the Council, where those statutes so provide. Where such a question is raised before any court or tribunal of a Member State, that court or tribunal may, if it considers that a decision on the question is necessary to enable it to give judgment, request the Court of Justice to give a ruling thereon. Where any such question is raised in a case pending before a court or tribunal of a Member State against whose decisions there is no judicial remedy under national law, that court or tribunal shall bring the matter before the Court of Justice. Article 249 In order to carry out their task and in accordance with the provisions of this Treaty, the European Parliament acting jointly with the Council, the Council and the Commission shall make regulations and issue directives, take decisions, make recommendations or deliver opinions. A regulation shall have general application. It shall be binding in its entirety and directly applicable in all Member States. A directive shall be binding, as to the result to be achieved, upon each Member State to which it is addressed, but shall leave to the national authorities the choice of form and methods. A decision shall be binding in its entirety upon those to whom it is addressed. Recommendations and opinions shall have no binding force. 2. EC Regulation Regulation (EC) No 1606/2002 of the European Parliament and of the Council of 19 July 2002 on the application of international accounting standards3 THE EUROPEAN PARLIAMENT AND THE COUNCIL OF THE EUROPEAN UNION, Having regard to the Treaty establishing the European Community, and in particular Article 95(1) thereof, Having regard to the proposal from the Commission(1), Having regard to the opinion of the Economic and Social Committee(2), Acting in accordance with the procedure laid down in Article 251 of the Treaty(3), Whereas: 3

Source: Official Journal L 243, 11.09.2002, 0001–0004.

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(1) The Lisbon European Council of 23 and 24 March 2000 emphasised the need to accelerate completion of the internal market for financial services, set the deadline of 2005 to implement the Commission's Financial Services Action Plan and urged that steps be taken to enhance the comparability of financial statements prepared by publicly traded companies. (2) In order to contribute to a better functioning of the internal market, publicly traded companies must be required to apply a single set of high quality international accounting standards for the preparation of their consolidated financial statements. Furthermore, it is important that the financial reporting standards applied by Community companies participating in financial markets are accepted internationally and are truly global standards. This implies an increasing convergence of accounting standards currently used internationally with the ultimate objective of achieving a single set of global accounting standards. (3) Council Directive 78/660/EEC of 25 July 1978 on the annual accounts of certain types of companies(4), Council Directive 83/349/EEC of 13 June 1983 on consolidated accounts(5), Council Directive 86/635/EEC of 8 December 1986 on the annual accounts and consolidated accounts of banks and other financial institutions(6) and Council Directive 91/674/EEC of 19 December 1991 on the annual accounts and consolidated accounts of insurance companies(7) are also addressed to publicly traded Community companies. The reporting requirements set out in these Directives cannot ensure the high level of transparency and comparability of financial reporting from all publicly traded Community companies which is a necessary condition for building an integrated capital market which operates effectively, smoothly and efficiently. It is therefore necessary to supplement the legal framework applicable to publicly traded companies. (4) This Regulation aims at contributing to the efficient and cost-effective functioning of the capital market. The protection of investors and the maintenance of confidence in the financial markets is also an important aspect of the completion of the internal market in this area. This Regulation reinforces the freedom of movement of capital in the internal market and helps to enable Community companies to compete on an equal footing for financial resources available in the Community capital markets, as well as in world capital markets. (5) It is important for the competitiveness of Community capital markets to achieve convergence of the standards used in Europe for preparing financial statements, with international accounting standards that can be used globally, for cross-border transactions or listing anywhere in the world. (6) On 13 June 2000, the Commission published its Communication on “EU Financial Reporting Strategy: the way forward” in which it was proposed that all publicly traded Community companies prepare their consolidated financial statements in accordance with one single set of accounting standards, namely International Accounting Standards (IAS), at the latest by 2005.


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(7) International Accounting Standards (IASs) are developed by the International Accounting Standards Committee (IASC), whose purpose is to develop a single set of global accounting standards. Further to the restructuring of the IASC, the new Board on 1 April 2001, as one of its first decisions, renamed the IASC as the International Accounting Standards Board (IASB) and, as far as future international accounting standards are concerned, renamed IAS as International Financial Reporting Standards (IFRS). These standards should, wherever possible and provided that they ensure a high degree of transparency and comparability for financial reporting in the Community, be made obligatory for use by all publicly traded Community companies. (8) The measures necessary for the implementation of this Regulation should be adopted in accordance with Council Decision 1999/468/EC of 28 June 1999 laying down the procedures for the exercise of implementing powers conferred on the Commission(8) and with due regard to the declaration made by the Commission in the European Parliament on 5 February 2002 concerning the implementation of financial services legislation. (9) To adopt an international accounting standard for application in the Community, it is necessary firstly that it meets the basic requirement of the aforementioned Council Directives, that is to say that its application results in a true and fair view of the financial position and performance of an enterprise – this principle being considered in the light of the said Council Directives without implying a strict conformity with each and every provision of those Directives; secondly that, in accordance with the conclusions of the Council of 17 July 2000, it is conducive to the European public good and lastly that it meets basic criteria as to the quality of information required for financial statements to be useful to users. (10) An accounting technical committee should provide support and expertise to the Commission in the assessment of international accounting standards. (11) The endorsement mechanism should act expeditiously on proposed international accounting standards and also be a means to deliberate, reflect and exchange information on international accounting standards among the main parties concerned, in particular national accounting standard setters, supervisors in the fields of securities, banking and insurance, central banks including the ECB, the accounting profession and users and preparers of accounts. The mechanism should be a means to foster common understanding of adopted international accounting standards in the Community. (12) In accordance with the principle of proportionality, the measures provided for in this Regulation, in requiring that a single set of international accounting standards be applied to publicly traded companies, are necessary to achieve the objective of contributing to the efficient and cost-effective functioning of Community capital markets and thereby to the completion of the internal market.

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(13) In accordance with the same principle, it is necessary, as regards annual accounts, to leave to Member States the option to permit or require publicly traded companies to prepare them in conformity with international accounting standards adopted in accordance with the procedure laid down in this Regulation. Member States may decide as well to extend this permission or this requirement to other companies as regards the preparation of their consolidated accounts and/or their annual accounts. (14) In order to facilitate an exchange of views and to allow Member States to coordinate their positions, the Commission should periodically inform the accounting regulatory committee about active projects, discussion papers, point outlines and exposure drafts issued by the IASB and about the consequential technical work of the accounting technical committee. It is also important that the accounting regulatory committee is informed at an early stage if the Commission intends not to propose to adopt an international accounting standard. (15) In its deliberations on and in elaborating positions to be taken on documents and papers issued by the IASB in the process of developing international accounting standards (IFRS and SIC-IFRIC), the Commission should take into account the importance of avoiding competitive disadvantages for European companies operating in the global marketplace, and, to the maximum possible extent, the views expressed by the delegations in the Accounting Regulatory Committee. The Commission will be represented in constituent bodies of the IASB. (16) A proper and rigorous enforcement regime is key to underpinning investors' confidence in financial markets. Member States, by virtue of Article 10 of the Treaty, are required to take appropriate measures to ensure compliance with international accounting standards. The Commission intends to liaise with Member States, notably through the Committee of European Securities Regulators (CESR), to develop a common approach to enforcement. (17) Further, it is necessary to allow Member States to defer the application of certain provisions until 2007 for those companies publicly traded both in the Community and on a regulated third-country market which are already applying another set of internationally accepted standards as the primary basis for their consolidated accounts as well as for companies which have only publicly traded debt securities. It is nonetheless crucial that by 2007 at the latest a single set of global international accounting standards, the IAS, apply to all Community companies publicly traded on a Community regulated market. (18) In order to allow Member States and companies to carry out the necessary adaptations to make the application of international accounting standards possible, it is necessary to apply certain provisions only in 2005. Appropriate provisions should be put in place for the first-time application of IAS by companies as a re-


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sult of the entry into force of the present regulation. Such provisions should be drawn up at international level in order to ensure international recognition of the solutions adopted, HAVE ADOPTED THIS REGULATION: Article 1 – Aim This Regulation has as its objective the adoption and use of international accounting standards in the Community with a view to harmonising the financial information presented by the companies referred to in Article 4 in order to ensure a high degree of transparency and comparability of financial statements and hence an efficient functioning of the Community capital market and of the Internal Market. Article 2 – Definitions For the purpose of this Regulation, “international accounting standards” shall mean International Accounting Standards (IAS), International Financial Reporting Standards (IFRS) and related Interpretations (SIC-IFRIC interpretations), subsequent amendments to those standards and related interpretations, future standards and related interpretations issued or adopted by the International Accounting Standards Board (IASB). Article 3 – Adoption and use of international accounting standards 1. In accordance with the procedure laid down in Article 6(2), the Commission shall decide on the applicability within the Community of international accounting standards. 2. The international accounting standards can only be adopted if: – they are not contrary to the principle set out in Article 2(3) of Directive 78/660/EEC and in Article 16(3) of Directive 83/349/EEC and are conducive to the European public good and, – they meet the criteria of understandability, relevance, reliability and comparability required of the financial information needed for making economic decisions and assessing the stewardship of management. 3. At the latest by 31 December 2002, the Commission shall, in accordance with the procedure laid down in Article 6(2), decide on the applicability within the Community of the international accounting standards in existence upon entry into force of this Regulation. 4. Adopted international accounting standards shall be published in full in each of the official languages of the Community, as a Commission Regulation, in the Official Journal of the European Communities.

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Article 4 – Consolidated accounts of publicly traded companies For each financial year starting on or after 1 January 2005, companies governed by the law of a Member State shall prepare their consolidated accounts in conformity with the international accounting standards adopted in accordance with the procedure laid down in Article 6(2) if, at their balance sheet date, their securities are admitted to trading on a regulated market of any Member State within the meaning of Article 1(13) of Council Directive 93/22/EEC of 10 May 1993 on investment services in the securities field(9). Article 5 – Options in respect of annual accounts and of non publicly-traded companies Member States may permit or require: (a) the companies referred to in Article 4 to prepare their annual accounts, (b) companies other than those referred to in Article 4 to prepare their consolidated accounts and/or their annual accounts, in conformity with the international accounting standards adopted in accordance with the procedure laid down in Article 6(2). Article 6 – Committee procedure 1. The Commission shall be assisted by an accounting regulatory committee hereinafter referred to as “the Committee”. 2. Where reference is made to this paragraph, Articles 5 and 7 of Decision 1999/ 468/EC shall apply, having regard to the provisions of Article 8 thereof. The period laid down in Article 5(6) of Decision 1999/468/EC shall be set at three months. 3. The Committee shall adopt its rules of procedure. Article 7 – Reporting and coordination 1. The Commission shall liaise on a regular basis with the Committee about the status of active IASB projects and any related documents issued by the IASB in order to coordinate positions and to facilitate discussions concerning the adoption of standards that might result from these projects and documents. 2. The Commission shall duly report to the Committee in a timely manner if it intends not to propose the adoption of a standard. Article 8 – Notification Where Member States take measures by virtue of Article 5, they shall immediately communicate these to the Commission and to other Member States.


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Article 9 – Transitional provisions By way of derogation from Article 4, Member States may provide that the requirements of Article 4 shall only apply for each financial year starting on or after January 2007 to those companies: (a) whose debt securities only are admitted on a regulated market of any Member State within the meaning of Article 1(13) of Directive 93/22/EEC; or (b) whose securities are admitted to public trading in a non-member State and which, for that purpose, have been using internationally accepted standards since a financial year that started prior to the publication of this Regulation in the Official Journal of the European Communities. Article 10 – Information and review The Commission shall review the operation of this Regulation and report thereon to the European Parliament and to the Council by 1 July 2007 at the latest. Article 11 – Entry into force This Regulation shall enter into force on the third day following that of its publication in the Official Journal of the European Communities. This Regulation shall be binding in its entirety and directly applicable in all Member States. Done at Brussels, 19 July 2002. For the European Parliament The President P. Cox For the Council The President T. Pedersen (1) OJ C 154 E, 29.5.2001, p. 285. (2) OJ C 260, 17.9.2001, p. 86. (3) Opinion of the European Parliament of 12 March 2002 (not yet published in the Official Journal) and Decision of the Council of 7 June 2002. (4) OJ L 222, 14.8.1978, p. 11. Directive as last amended by European Parliament and Council Directive 2001/65/EC (OJ L 283, 27.10.2001, p. 28). (5) OJ L 193, 18.7.1983, p. 1. Directive as last amended by European Parliament and Council Directive 2001/65/EC. (6) OJ L 372, 31.12.1986, p. 1. Directive as last amended by European Parliament and Council Directive 2001/65/EC. (7) OJ L 374, 31.12.1991, p. 7. (8) OJ L 184, 17.7.1999, p. 23. (9) OJ L 141, 11.6.1993, p. 27. Directive as last amended by European Parliament and Council Directive 2000/64/EC (OJ L 290, 17.11.2000, p. 27).

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3. EC Council Directives a) Fourth Council Directive of 25 July 1978 based on Article 54 (3) (g) of the Treaty on the annual accounts of certain types of companies (78/660/EEC)4 SECTION 1. GENERAL PROVISIONS Article 2 1. The annual accounts shall comprise the balance sheet, the profit and loss account and the notes on the accounts. These documents shall constitute a composite whole. 2. They shall be drawn up clearly and in accordance with the provisions of this Directive. 3. The annual accounts shall give a true and fair view of the company's assets, liabilities, financial position and profit or loss. 4. Where the application of the provisions of this Directive would not be sufficient to give a true and fair view within the meaning of paragraph 3, additional information must be given. 5. Where in exceptional cases the application of a provision of this Directive is incompatible with the obligation laid down in paragraph 3, that provision must be departed from in order to give a true and fair view within the meaning of paragraph 3. Any such departure must be disclosed in the notes on the accounts together with an explanation of the reasons for it and a statement of its effect on the assets, liabilities, financial position and profit or loss. The Member States may define the exceptional cases in question and lay down the relevant special rules. 6. The Member States may authorize or require the disclosure in the annual accounts of other information as well as that which must be disclosed in accordance with this Directive. b) Seventh Council Directive of 13 June 1983 based on Article 54 (3) (g) of the Treaty on consolidated accounts (83/349/EEC)5 Article 16 1. Consolidated accounts shall comprise the consolidated balance sheet, the consolidated profit-and-loss account and the notes on the accounts. These documents shall constitute a composite whole. 2. Consolidated accounts shall be drawn up clearly and in accordance with this Directive. 4 5

Source: Official Journal L 222, 14.08.1978, 0011–0031. Source: Official Journal L 193, 18.07.1983, 0001–0017.


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3. Consolidated accounts shall give a true and fair view of the assets, liabilities, financial position and profit or loss of the undertakings included therein taken as a whole. 4. Where the application of the provisions of this Directive would not be sufficient to give a true and fair view within the meaning of paragraph 3 above, additional information must be given. 5. Where, in exceptional cases, the application of a provision of articles 17 to 35 and 39 is incompatible with the obligation imposed in paragraph 3 above, that provision must be departed from in order to give a true and fair view within the meaning of paragraph 3. Any such departure must be disclosed in the notes on the accounts together with an explanation of the reasons for it and a statement of its effect on the assets, liabilities, financial position and profit or loss. The Member States may define the exceptional cases in question and lay down the relevant special rules. 6. A Member State may require or permit the disclosure in the consolidated accounts of other information as well as that which must be disclosed in accordance with this Directive.

II. German Commercial Code6 Third Book, Accounting Records Part One. Provisions for all Merchants Subpart One. Accounting Records. Inventory SECTION 238. DUTY TO KEEP ACCOUNTING RECORDS (1) Every merchant shall keep accounting records and shall record in them his business transactions and his financial position in accordance with [German] “generally accepted accounting principles”. The accounting records shall be maintained in such a way that they give an insight into the business transactions and the position of the business to an expert third party within a reasonable time. The business transactions shall be traceable from their origins through to their settlement. (2) (…) 6

Notice: This is a translation. The only official version is the German version – see Section 184 German Code on Court Constitution and the official version: Handelsgesetzbuch in der im Bundesgesetzblatt Teil III, Gliederungsnummer 4100–1, veröffentlichten bereinigten Fassung, zuletzt geändert durch Artikel 1 des Gesetzes vom 10. November 2006 (BGBl. I S. 2553). The authors do not represent or warrant that the information provided in this text is accurate or complete and will not be responsible for any damage resulting directly or indirectly from the use of any information provided in this text, including information which is inaccurate or incomplete, whether such inaccuracy or incompleteness is caused by negligence or otherwise. See also: G Fey and G Fladt, Deutsches Bilanzrecht, Deutsch-Englische Textausgabe, 4. Auflage, Düsseldorf, 2006, E183–E229; M Peltzer and E A Voight, Handelsgesetzbuch, Deutsch-englische Textausgabe, 5. Auflage, Cologne 2003.

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Subpart Two. Opening Balance Sheet. Annual Financial Statements First Title. General Provisions SECTION 242. DUTY TO PREPARE (1) Upon the establishment of the business and at the end of each financial year, the merchant shall prepare financial statements (opening balance sheet, balance sheet) showing the relationship between his assets and liabilities. The provisions applicable to annual financial statements shall also apply to the opening balance sheet to the extent that they relate to the balance sheet. (2) At the end of each financial year, the merchant shall prepare a comparison of charges and income for the financial year (income statement). (3) The balance sheet and the income statement comprise the annual financial statements. SECTION 243. PRINCIPLE OF PREPARATION (1) The annual financial statements shall be prepared in accordance with [German] “generally accepted accounting principles”. (2) They shall be drawn up clearly. (3) The annual financial statements shall be prepared within a period that is consistent with orderly business conduct. SECTION 244. LANGUAGE. CURRENCY The annual financial statements shall be prepared in German language and in Euros. SECTION 245. SIGNATURE The financial statements shall be signed and dated as of by the merchant. If there is more than one general partner, all shall sign. Second Title. Recognition SECTION 246 COMPLETENESS. OFFSETTING PROHIBITED (1) The financial statements shall include all assets, liabilities, deferred items, charges and income, except as provided otherwise by law. (…) Any set-off between asset and liability items, or between income and expenditure items, or rights in and charges on real property, shall be prohibited. Third Title. Measurement SECTION 252 GENERAL PRINCIPLES OF VALUATION (1) The following principles apply in particular to the valuation of assets and liabilities in annual financial statements:


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1. The carrying amounts in the opening balance sheet for the financial year must correspond to the closing balance sheet for the preceding financial year. 2. The valuation must presume the company to be carrying on its business as a going concern unless otherwise indicated by constructive or legal evidence. 3. The components of asset and liability items must be valued separately at the balance sheet date. 4. Valuation must be made on a prudent basis, and in particular, amount must be taken of all liabilities arising in the course of the financial year concerned or of a previous one, even if such liabilities become apparent only between the date of the balance sheet and the date on which it is drawn up; only profits made at the balance sheet date may be included. 5. Account must be taken of charges and income relating to the financial year, irrespective of the date of the related payments. 6. The methods of valuation must be applied consistently from one financial year to another. (2) Departures from the principles set out in subsection (1) above are permitted only in justifiable exceptional circumstances. Part Two. Supplementary Provisions for Corporations (Stock Corporations, Partnerships Limited by Shares and Limited Liability Companies) and for Certain Commercial Partnerships Subpart One. Annual Financial Statements of the Corporation and Annual Report First Title. General Provisions SECTION 264 DUTY TO PREPARE (1) The legal representatives of a corporation shall supplement the annual financial statements (section 242) by notes that constitute an integral part of these financial statements together with the balance sheet and the income statement, and shall prepare an annual report.7 The annual financial statements and annual report shall be prepared by the legal representatives within the first three months of the financial year in respect of the preceding financial year. (…) (2) The annual financial statement of the corporation shall give a true and fair view of the corporation’s assets, liabilities, financial position and profit or loss in accordance with [German] “generally accepted accounting principles”. Where special circumstances result in the annual financial statements not giving a true and fair view within the meaning of sentence 1 above, additional information must be given in the notes. The legal representatives of a corporation which is a 7

Directors’ Financial Review.

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national issuer within the meaning of section 2(7) of the German Securities Trading Act, and is not an investment corporation within the meaning of section 327a, shall declare in writing when signing that according to the best of their knowledge, the annual financial statements give a true and fair view within the meaning of sentence 1 or that the notes contain information according to sentence 2. (3) (…) Subpart Two. Consolidated Financial Statements and Group Annual Report First Title. Scope of Application SECTION 290. DUTY TO PREPARE (1) If the companies of a group are under the uniform control of a corporation (parent) that is domiciled in Germany, and if the parent holds an equity investment within the meaning of section 271(1) in one or more companies under uniform control (subsidiaries), the legal representatives of the parent shall draw up consolidated financial statements and a group annual report (…). (2) A corporation domiciled in Germany (parent) is always required to draw up consolidated financial statements and a group annual report if, in respect of a company (subsidiary): 1. it has the majority of the shareholders’ voting rights; 2. it has the right to appoint or remove a majority of the members of the administrative, management or supervisory body, and is at the same time a shareholder; or 3. it has the right to exercise a controlling influence persuant to a control agreement entered into with that company or on the basis of the articles of association of that company. (3) (…) Second Title. Companies to be Included in the Consolidated Financial Statements SECTIONS 294. COMPANIES TO BE CONSOLIDATED. DUTY TO SUPPLY INFORMATION (1) The consolidated financial statements shall include the parent and all of its subsidiaries, regardless of the domicile of the subsidiaries, unless their inclusion is not required under section 296. (2) (…)


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Third Title. Contents and Form of Consolidated Financial Statements SECTION 297 CONTENTS (1) The consolidated financial statements comprise the consolidated balance sheet, the consolidated income statement, the notes, the cash flow statement and the statement of changes in equity. They may be supplemented by segment reporting. (2) The consolidated financial statements shall be drawn up clearly. In compliance with [German] “generally accepted accounting principles”, they shall give a true and fair view of the assets, liabilities, financial position and profit or loss of the group taken as a whole. Where special circumstances result in the consolidated financial statements not giving a true and fair view within the meaning of sentence 2 above, additional information must be given in the notes. The legal representatives of a parent which is a national issuer within the meaning of section 2(7) of the German Securities Trading Act, and is not an investment corporation within the meaning of section 327a, shall declare in writing when signing that according to the best of their knowledge, the consolidated financial statements give a true and fair view within the meaning of sentence 2 or that the notes contain information according to sentence 3. (3) The assets, liabilities, financial position and profit or loss of the companies included in the consolidated financial statements shall be presented in the consolidated financial statements as if all these companies constituted a single enterprise. The consolidation methods applied to prior consolidated financial statements should be retained. (…) SECTION 298 APPLICABLE PROVISIONS. EXEMPTIONS (1) Sections 244 to 247(1) and (2), 248 to 253, 255, 256, 265, 266, 268 to 272, 274, 275, 277 to 279(1), 280(1), 282 and 283 relating to annual financial statements and the provisions governing the legal form and business segment of the companies included in the consolidated financial statements domiciled within the geographical area of this law, to the extent that they apply to large corporations8, shall apply mutatis mutandis to the consolidated financial statements, unless their nature requires a departure or the preceding provisions stipulate otherwise. (2) (…)

8

See S 267 HGB.

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Tenth Title. Consolidated Financial Statements in Accordance with International Accounting Standards SECTION 315A (1) If a parent is required to prepare consolidated financial statements under the provisions of the first title and is obliged by Article 4 of Regulation (EC) No. 1606/2002 of the European Parliament and of the Council of 19 July 2002 on the application of international accounting standards (OJ L 243, p.1), as amended, to apply the international accounting standards adopted in accordance with Articles 2, 3 and 6 of that Regulation, only sections 294(3), 298(1) shall be applied, but in the case of the latter only combined with sections 244 and 245, section 313(2) to (4), section 314(1) nos. 4, 6, 8 and 9, as well as the provisions of the ninth title and the provisions relating to consolidated financial statements or group annual reports not contained in this subsection. (2) Parents that are not subject to subsection (1) above shall prepare their consolidated financial statements in accordance with the international accounting standards and provisions listed in that section if, by the relevant balance sheet date, an application has been filed to admit a security within the meaning of section 2 (1) sentence 1 of the German Securities Trading Act to trading on a regulated market within the meaning of section 2(5) of the German Securities Trading Act. (3) Parents that are not subject to subsections (1) or (2) above may prepare their consolidated financial statements in accordance with the international accounting standards and provisions listed in subsection (1) above. Parents exercising this option are required to apply in full all of the standards and provisions listed in subsection (1) above. Subpart Three. Audit SECTION 316 AUDIT REQUIREMENT (1) The annual financial statements and the annual report of corporations, that are not classified as small within the meaning of section 267(1), shall be audited by an auditor. The annual financial statements are permitted only to be adopted if they have been audited. (2) The consolidated financial statements and the group annual report of corporations shall be audited by an auditor. The consolidated financial statements are permitted only to be approved if they have been audited. (3) If the annual financial statements, the consolidated financial statements, the annual report or the group annual report are modified after submission of the audit report, the auditor shall re-examine these documents to the extent required by the modification. He shall report on the findings of his audit; the auditors’ report shall be modified as appropriate.


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SECTION 317 SUBJECT AND SCOPE OF THE AUDIT (1) The accounting records shall be included in the audit of the annual financial statements. The audit of the annual financial statements and the consolidated financial statements shall establish whether the statutory provisions and the supplementary provisions of the shareholder agreement or the articles of association have been complied with. The audit shall be performed such that misstatements and violations of the provisions of sentence 2 above that materially affect the presentation of a true and fair view of the assets, liabilities, financial position and profit or loss within the meaning of section 264(2) are detected if professional diligence is exercised. (2) (…) SECTION 321 AUDIT REPORT (1) The auditor shall report in writing and with the required clarity on the nature, scope and findings of his audit. (2) (…) SECTION 322 AUDITORS’ NOTICE OF CONFIRMATION (1) The auditor shall summarise the findings of the audit in an auditors’ notice of confirmation on the annual financial statements or the consolidated financial statements. The auditors’ notice of confirmation shall describe the subject, nature and scope of the audit and disclose the accounting and auditing standards applied; it shall also contain an assessment of the results of the audit. (2) The assessment of the results of the audit shall indicate unambiguously whether: 1. an unqualified auditors’ notice of confirmation has been issued; 2. a qualified auditors’ notice of confirmation has been issued; 3. a non-affirmative auditors’ notice of confirmation has been issued because of reservations; or 4. a non-affirmative auditors’ notice of confirmation has been issued because the auditors are not in a position to express an opinion. The assessment of the results of the audit shall be generally understandable and issues-oriented, and shall consider the fact that the legal representatives are responsible for the financial statement. Risks that jeopardise the existence of the company or a group company as a going concern shall be discussed separately. Risks that jeopardise the existence of a subsidiary as a going concern do not need to be described in the auditors’ notice of confirmation on the parent’s consolidated financial statements if the subsidiary is not significant for the presentation of a true and fair view of the assets, liabilities, financial position and profit or loss of the group. (3) (…)

About the Authors

Prof, Dr. Jean du Plessis Born 1959. Qualifications: BProc (1981), LLB (1986) LLM (1986) LLD (1991). Career: Admitted as Advocate of the High Court of South Africa (1986). Senior Lecturer and Associate Professor at the University of the Orange Free State (UOVS, 1986-1991). Professor of Mercantile Law at the Rand Afrikaans University (Johannesburg, 1991-1999). Alexander-von-Humboldt Scholar (1995 and 2003). Visiting Professor at Deakin University (Australia, 1998); after migration to Australia Associate Professor (1999) and Professor of Law at Deakin University (2000-); Head of the Deakin School of Law (2000-2002). President of the Corporate Law Teacher Association (CLTA, 2007-2008). Prof. Dr. Bernhard Großfeld Born 1933. Qualifications: Studied Jurisprudence at the Universities of Freiburg, (Breisgau), Hamburg and Muenster. First and Second State Examinations; LLM (Yale); Dr. jur. (Juris Doctor, Unversity of Muenster) and Dr. jur. habil. (Habilitation, University of Tuebingen). Career: Professor of Law, University of Goettingen (1966-1973). Professor of Law, Civil Law, Corporation Law and Comparative Law, University of Muenster (1973-). Dir. em. of the Institute for International Business Law and the Institute for Cooperatives Member Academy of Science Visiting Professor in the USA, China, Japan and South Africa. Prof. Dr. Claus Luttermann Born 1964. Qualifications: Studied Jurisprudence and Economics at the Schools of Law and Business at the University of Muenster and the University of Cologne, and at UC Berkeley (USA). First and Second State Examinations; Dr. jur. (Juris Doctor) and Dr. jur. habil. (Habilitation) at the University of Muenster. Career: Associate Professor of Law at the Universities of Munich (LMU), Konstanz and Bielefeld; Professor of Law and Chair, Civil Law, German and International Commercial Law and Business Law at the Catholic University of EichstaettIngolstadt, Business Faculty (2001-); Head of the European Documentation Centre; Founder and Director of the Centre for Corporation Finance and Law.

276

About the Authors

Prof. Dr. lngo Saenger Born 1961. Qualifications: Studied Jurisprudence and History at the University of Marburg. First and Second State Examinations; Dr. jur. (Juris Doctor) at the University of Marburg, Dr. jur. habil. (Habilitation) University of Jena. Career: Academic assistant at the Law Schools of the Universities of Marburg (1987-1990) and Jena (1993-1996); Professor of Law and Chair, Civil Law, Law of Civil Procedure and Corporate Law at the University of Muenster, Law Faculty (1997-); Co-Director of the Institute for International Business Law and the Centre for European Private Law; Head of the Post-graduate Program on Mergers & Acquisitions. Judge at the Court of Appeals, Hamm (1999-2006). Prof. Dr. Otto Sandrock Born 1930. Qualifications: Studied Jurisprudence at the Universities of Goettingen, Lyon (France) and Yale (USA). Diplôme de Langue et Civilisation Françaises at the University of Lyon; First and Second State Examinations; Dr. jur. (Juris Doctor) at the University of Goettingen; LLM (Yale); Dr. jur. habil. (Habilitation) at the University of Bonn. Career: German Foreign Office (1958/59); lecturer University of Bonn; Professor of Law at the University of Bochum (1967-1980), Professor of Law and Chair, Civil Law, Commercial Law and Business Law, International Private Law and Comparative Law at the University of Muenster, Law Faculty (1980-1995); Dir. em. of the Institute of international Business Law; Professor at the University of Muenster (1995-) Admitted as attorney to the Court of Appeals of Duesseldorf. Partner in the law firm Hoelters & Elsing. International and national arbitrator for 30 years in ad hoc tribunals and under rules of the ICC, UNCITRAL, DIS, AAA, and the French-German Chamber of Commerce.

German Corporate Governance in International and European Context

Corporate Governance and International Business

Handbook on International Corporate Governance

Handbook on International Corporate Governance

Corporate Ethics and Corporate Governance

Corporate Ethics and Corporate Governance

Corporate Ethics and Corporate Governance

Corporate Governance: Accountability, Enterprise and International Comparisons

Cases in Corporate Governance

Corporate Governance in Asia

Corporate governance in Japan

Corporate Governance

Corporate Governance

Corporate Governance

Tax and Corporate Governance

Corporate Governance

Corporate Governance and Accountability

Corporate Governance Around the World (Routledge Studies in Corporate Governance)

International Corporate Governance: A Case Study Approach

International Corporate Governance: A Case Study Approach

Corporate governance in financial institutions

Convergence and Persistence in Corporate Governance

Corporate Governance and Managerial Reform in Japan

Corporate Governance and Sustainable Prosperity

Foreign Investment and Corporate Governance in China

Corporate Governance Survey

Corporate Governance (1995)

A Blueprint. Corporate Governance

Corporate Governance (2003)

Behaviour and Rationality in Corporate Governance (Routledge Series in Corporate Governance)

Perspectives on Corporate Governance

German Corporate Governance in International and European Context

Corporate Governance and International Business

Handbook on International Corporate Governance

Handbook on International Corporate Governance

Corporate Ethics and Corporate Governance

Corporate Ethics and Corporate Governance

Corporate Ethics and Corporate Governance

Corporate Governance: Accountability, Enterprise and International Comparisons

Cases in Corporate Governance

Corporate Governance in Asia

Corporate governance in Japan

Corporate Governance

Corporate Governance

Corporate Governance

Tax and Corporate Governance

Corporate Governance

Corporate Governance and Accountability

Corporate Governance Around the World (Routledge Studies in Corporate Governance)

International Corporate Governance: A Case Study Approach

International Corporate Governance: A Case Study Approach

Corporate governance in financial institutions

Convergence and Persistence in Corporate Governance

Corporate Governance and Managerial Reform in Japan

Corporate Governance and Sustainable Prosperity

Foreign Investment and Corporate Governance in China

Corporate Governance Survey

Corporate Governance (1995)

A Blueprint. Corporate Governance

Corporate Governance (2003)

Behaviour and Rationality in Corporate Governance (Routledge Series in Corporate Governance)

Perspectives on Corporate Governance

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