No safe harbour: Claw back of shareholder dividends
The German Federal Supreme Court (Bundesgerichtshof, BGH) recently had the opportunity to revisit the controversial discord between corporate and insolvency laws on the issue of claw back of shareholder dividends. In principle, the provisions of the German Stock Corporation Act (Aktiengesetz, AktG) protect shareholders from reimbursement claims in the event that they receive dividend payments, which later turn out to have been illegal. However, this only applies if the shareholders did not have knowledge about the unlawfulness of the dividend payments. In its judgement of 30 March 2023 (IX ZR 121/22), the BGH ruled that this does not extend to a protection from insolvency related claw back claims.
Background to the judgement
The case entailed legal action by the insolvency administrator of a German stock corporation against one of its shareholders. The insolvency administrator pursued the return of dividends paid to the shareholder between 2009 and 2012 based on the claw-back provisions of the German Insolvency Code (Insolvenzordnung, InsO). The dividend payments were based on appropriation resolutions regarding profits determined in the approved annual financial statements of the company. The insolvency administrator later successfully claimed the invalidity of the resolutions and partly of the financial statements by way of declaratory relief. The claw back claims raised against the shareholder were based on Sec. 134 InsO. Under this law, transfers made from a debtor's assets without compensation (unentgeltlich) are subject to claw back.
Disharmony or synchronism of corporate and insolvency law?
The BGH judges upheld the opinion expressed by the higher regional court of Frankfurt in the prior instance and finally upheld the claw back claim by the insolvency administrator. The shareholder was required to repay a five-figure sum in dividends based on Sec. 134 InsO. The BGH found the dividends were paid "without compensation", because the underlying legal acts (the appropriation resolutions) were invalid and the debtor did not have a reimbursement claim against the beneficiary. The reason for the lack of a reimbursement claim lies in the initially referenced provisions of the AktG, specifically Sec. 62 para. 1. This provides that shareholders do not have to pay back unlawfully received dividends if, at the time, they had no knowledge of the fact that the distribution of dividends was made without a valid legal basis. As a consequence, the judges ruled that the privilege to ultimately retain dividends if they were received in good faith does not translate into an absolute protection. Therefore, it does not extend to protection under insolvency law provisions.
In principle, such protection of the bona fide receipts of dividends should strengthen investor confidence in the integrity and stability of the capital market. This is a common argument in favour of a general "safe harbour" approach, which seeks to extend the privilege to claw back in insolvency proceedings. In its judgement, the BGH interestingly takes note of the manifold criticism of its claw back friendly approach and the disharmony it arguably inflicts on the legal system. However, the judges dismissed the criticisms and maintained that the principles set out in corporate and general civil law provisions do not necessarily run in parallel with insolvency law.
Consequences for shareholders
Although the judgement may have caused some shareholders to gasp in anticipation of being subject to claw back of payments received years ago, its effect may not be as far-reaching as it seems at first glance. First, Sec. 134 InsO only allows the insolvency administrator to contest transfers made up to four years prior to the filing for insolvency. Secondly, it is important to note that claw back may only become relevant if the dividends were paid in violation of the statutory rules for their payment. In this case, such violations were found in the fact that the former management had engaged in fraudulent activities, as a part of which the annual financial statements contained profits which had never actually been generated. Moreover, the company had operated at a loss for many years. Dividends received lawfully and honestly are generally not subject to claw back in insolvency proceedings at a later stage.
Moreover, the disharmony of corporate or civil law on the one hand and insolvency law on the other hand is not an isolated example but occurs where interests shift when a company becomes insolvent. In insolvency proceedings, the insolvency administrator must primarily consider the interests of creditors which often works to the detriment of the shareholders.