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Cash Pooling – Part I

  • Germany
  • Banking and finance
  • Corporate
  • Restructuring and insolvency

18-05-2020

COVID-19-related risks for corporate bodies and shareholders of German limited liability companies

General

In economically and financially challenging times, cash pools in groups of companies bear significant risks. This applies in particular to managing directors who may, in certain situations, find themselves exposed to personal and even criminal liability, for example if they fail to observe and/or comply with, inter alia, capital maintenance rules and obligations to file for insolvency in the context of continued cash pooling. While all incorporated companies face the same risks in principle, even stricter rules apply for public limited companies (AG) than for limited liability companies (GmbH).

It is therefore highly recommended to review the risks associated with existing cash pool and compliance systems and to develop action plans for potential sudden losses of liquidity, insolvency scenarios and/or cash maintenance problems.

1. Typical cash pooling structures and risks

Cash pools are generally established as "physical cash pools" (also referred to as zero balancing or target balancing) where the credit and/or debit balances on the (subsidiary)accounts of the companies participating in the cash pool are pooled and balanced in a central account of the cash pool leader on a daily basis.

The role of the cash pool leader may be taken by the parent company of the group (cash pool parent) or by a group company which was established as a financing company for the group (treasury company).

1.1. Classification as a loan; capital maintenance

In case of physical cash pooling, the credit and debit balances are continuously set off in a current account. This means that

  • upstream loans and
  • downstream loans

are granted between the companies on a daily basis.

As with all upstream loans within a group of companies, questions therefore arise with respect to

  • the recoverability of the repayment claim (where the companies involved in the cash pool have not concluded a controlling agreement),
  • the recoverability of the loss compensation claim (where the companies involved in the cash pool have concluded a controlling agreement),
  • the solvency of the respective debtor,
  • the provision of securities, and
  • the appropriate interest rate.

In case of downstream loans, shareholders may be faced with the questions of subordination (under insolvency law) and/or of contested transactions in the context of insolvency proceedings with respect to any repayments already received, if under insolvency law the loans can be classified as shareholder loans or equivalent claims.

1.2. Obligation to maintain the capital; obligation to organise; obligation to perform a solvency check

Obligation to maintain the capital

Managing directors are generally obliged to ensure that the company's assets which are required to maintain the nominal capital are not paid out to the shareholders (obligation to maintain the capital).

If no controlling agreement or profit transfer agreement is in place between the company and the parent company, the managing director must ensure for all (direct or indirect) payments to the shareholder that the repayment claim against the shareholder is fully recoverable, i.e. that the shareholder is and will be able to repay the respective amount.

If a controlling agreement or a profit transfer agreement is in place between the (dependent) company and the parent company, the managing director is entitled to also disburse the nominal capital to the shareholder but must ensure that, rather than the repayment claim, the loss compensation claim under the controlling agreement or the profit transfer agreement is fully recoverable.

While, generally speaking, only the loan amount plus interest (if applicable) is relevant for the repayment claim, the loss compensation claim refers to the compensation of all losses of the (dependant) company and may therefore extend far beyond the repayment claim.

Furthermore, managing directors are subject to a number of duties which serve the protection of both the company's assets (company protection) and the company's creditors (creditor protection).

Obligation to organise

Managing directors have an obligation to ensure compliance with all capital maintenance rules. Mostly, managing directors use a finance/controlling department for this purpose. In order to guarantee that the managing directors are informed about the financial situation of the company and, if applicable, of the other group companies in a timely and continuous manner, they must establish an operational organisation structure which provides monitoring and early detection of risks (obligation to organise). Particularly if the cash pool is managed by a bank, it is recommended to agree upon regular reports and inspection rights as well as specific credit limits and conditions for all cash pool companies.

Supervisory board members and managing directors of the shareholder must also ensure that a corresponding compliance organisation is established in the subsidiaries as they have a monitoring obligation in this respect and may be held liable both by the subsidiaries and the shareholders if they fail to comply with this obligation.

Solvency forecast

In order to ensure compliance with all capital maintenance rules, the managing directors of the cash pool subsidiary, the managing directors of the cash pool parent and the managing directors of the treasury company must proactively obtain information about the financial situation of all companies involved in the cash pool and of the group parent.

Specifically, this requires a solvency forecast. The exact requirements of such forecasts are unclear. Based on the IDW S11 standard, it is recommended to prepare a financial status and, on this basis, a financial plan for the current and the following business year. It makes sense to base the forecast on a "best case", a "base case" and a "worst case" scenario.

The required frequency of such solvency forecasts depends on the individual case. The rule is:

  • No crisis indicators whatsoever: Quarterly updates and forecasts should be sufficient.
  • Acute crisis: Weekly to daily check.

During times of COVID-19, such a solvency forecast should be performed at least weekly, unless the group is in acute crisis and it may thus be necessary to check the financial status on a daily basis.

The solvency forecasts must therefore be carried out by all shareholders involved in a cash pool and their managing directors. This in turn must be monitored by the supervisory boards and shareholders. If supervisory board members fail to comply with their monitoring obligation, they may become personally and potentially even criminally liable.

In certain cases, shareholders of a GmbH may also become personally and criminally liable, i.e. the injured company but also the creditors may be entitled to assert compensation claims directly against shareholders despite the fact that the legal form of a GmbH limits liability. Only recently, the German Federal Supreme Court (BGH) again confirmed a direct liability for shareholders who had not only improperly withdrawn assets from the company but also overburdened the company with liabilities.

2. Virtual cash pooling

"Virtual cash pools" (also referred to as notional cash pooling) remain less common, involving a mere virtual set-off of the balances on the various accounts. Consequently, while the interest advantage is considerably lower, the problems described above are avoided if and insofar as no upstream securities are provided. Virtual cash pools are mostly managed by banks rather than group companies.