Company & Commercial - Germany

Background

German stock corporations have long been vulnerable to the phenomenon of the 'professional' or 'predatory' plaintiff shareholder. These shareholders file frivolous actions to set aside often crucial transactions and measures undertaken by stock corporations. Specifically, the actions exploit a weakness in the formal requirements for the implementation of measures voted on by the shareholders and seek to delay important transactions. In a new development, one such professional plaintiff was recently ordered to pay damages for commencing an action to block a stock corporation from increasing its stated capital.(1) The decision offers judicial support to German stock corporations targeted by such plaintiffs and may encourage corporations to defend actively against such actions. Whether it will discourage predatory plaintiffs remains to be seen.

The German statute which regulates stock corporations, the Stock Corporation Act, provides that certain important corporate measures (ie, capital increases and amalgamations) requiring shareholder approval must be registered with the Commercial Register in order to be effective.

Where an action to set aside such a measure has been commenced by a shareholder, the Commercial Register will almost always postpone the registration of the measure until the dispute has been resolved - for example, adjudicated or otherwise settled. The purpose of this practice is twofold. The Commercial Register serves as the formal registry of company information upon which third parties, such as creditors and business partners, are entitled to rely. The register does not allow for entries to be registered with the qualifier "subject to a pending challenge to have the matter set aside". Hence, only those matters which can be asserted unconditionally will be registered. In addition, this practice aims to avoid the complicated unravelling of subsequent transactions following an earlier measure being deemed ineffective - for example, due to an invalid decision by a corporation's general meeting, which may emerge only years after the fact.

Professional Plaintiff Shareholders

Professional plaintiff shareholders exploit this system by acquiring a (typically small) shareholding in a stock corporation. They then file actions to set aside corporate measures, frequently on grounds of technicalities or for essentially spurious reasons. The delay caused by a postponement of the effective registration of such a measure can be disastrous for a corporation which may be under intense time pressure to fulfil requirements to complete a major deal, such as a merger in the context of a financing round.

Corporations therefore have a strong incentive simply to settle the action by paying the predatory plaintiff shareholder a settlement amount to withdraw the action. Frequently, such payments are formally structured as the reimbursement of legal costs incurred by the plaintiff. Predatory plaintiff shareholders most commonly target medium-sized and smaller stock corporations which may be unable or unwilling to litigate the action. A recent study of this phenomenon revealed that predatory plaintiff shareholders have evolved into a small industry with more than 40 individuals and companies (often interrelated) regularly filing such actions with respect to hundreds of different stock corporations.(2) The success rate for achieving a settlement - presumably profitable - exceeds 80%.(3)

In November 2005, the Act to Promote Business Integrity and Modernization of the Right to Rescission took effect. The act promotes greater transparency by requiring the disclosure and publication of all such actions to set aside corporate measures, including the financial advantages obtained by the plaintiff. 'Repeat offenders' - in some cases responsible for over 25 separate actions - can now be identified by name. It was precisely one of these who was ordered to pay damages in the recent judgment discussed in the following.

Decision

In its decision the Frankfurt am Main Regional Court granted a claim for damages asserted against professional plaintiff Klaus Zapf (according to one study, one of Germany's most prolific professional plaintiffs).(4) In this action, the plaintiff stock corporation Real Estate International Investments AG (formerly Nanoinvests AG), alleged that shareholder Zapf's commencement of an action to set aside a capital increase approved by the corporation had caused damage to the corporation. Among other things, Zapf had substantiated his action by contesting the corporation's decision to hold its annual general meeting in Düsseldorf. The two decisions were contained in the same resolution posed to the shareholders.

Typical for such a situation, Zapf had offered to withdraw his action in exchange for subscription rights to 3,500 new shares in the corporation. The court saw that this behaviour was contrary to public policy and designed to cause injury, giving rise to a claim in tort under Section 826 of the Civil Code and permitted the corporation's claims.

Comment

This judgment may offer some hope to stock corporations which have been unlucky enough to have attracted the attention of a professional plaintiff shareholder. Such hope is limited, since the ultimate aim - the execution of a particular transaction - may still be thwarted, and the affected corporation may have only questionable proof of discrete damages resulting from the plaintiff's action. Such litigation also remains a costly and time-consuming matter for smaller stock corporations. Therefore, the incentive to settle will remain and collective action problems undermine broader and coordinated efforts to claim damages consistently.

It is more likely that accumulated disclosure with respect to such 'repeat offender' plaintiff shareholders will lessen the credibility of such shareholders when they are eventually brought before a court and that this judgment may sensitize other courts to previously unnoticed issues presented by such shareholders. One other benefit may also be that smaller stock corporations pay closer attention to strict compliance with the requirements of the Stock Corporation Act, thus presenting predator plaintiff shareholders with fewer legitimate grounds to file actions for setting aside a corporate measure.

The Act to Promote Business Integrity and Modernization of the Right to Rescission offers some relief, as does Section 246a of the Stock Corporation Act. As of 2005, this section offers stock corporations a limited method of appeal to have an action to set aside a corporate measure disregarded for the purposes of registration. However, this section applies only to certain types of corporate measure and will not apply where the professional plaintiff's action is aimed at an unquestionable (but technical) defect in procedural or substantive compliance with the regulations pertaining to stock corporations - for example, the management's reporting obligations or the appointment of an auditor.

Endnotes

(1) Decision by the Frankfurt am Main Regional Court dated October 2 2007 (3 - 5 0 177/07), to date not yet binding, published in BB 2007, 2362.

(2) Frankfurter Allgemeine Zeitung business section, July 30 2007, p 9 (version obtained from http://www.reii.de/ on November 28 2007).

(3) Id.

(4) Baums, Keinath, Gajek, Empirical Study (Working Paper No 65) prepared for the Institute of Law and Finance, Frankfurt am Main.

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