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The Germany content consists of this summary page, and separate pages for Preferred Shares in a German Limited Liability Company (“GmbH”), Silent Partnership in a Corporation, and Debt.
Silent Partnership in a Corporation Germany Revenue Based Finance1
Investment Structure Summary
The following proposal for the structuring of a revenue-based financing investment is based on a silent partnership of the investor in a German limited liability company (Gesellschaft mit beschränkter Haftung – “GmbH”) or German stock corporation (Aktiengesellschaft – “AG”, each of the GmbH and the AG, also the “Company”) which enables the investor to participate in the Company’s profits, without being granted any shares in the share capital of the Company.
A silent partnership constitutes a non-public civil law partnership between the investor and the Company. As a silent partner of this undisclosed civil law partnership, the investor is generally not entitled to any membership rights in the Company, as the investor does not qualify as a shareholder of the Company. However, statutory law provides for limited information rights of the silent partner pertaining to the business of the Company.
Under German law, the silent partnership can be structured as a so-called typical silent partnership, i.e., essentially, a silent partnership in which the investor solely participates in the Company’s profits without having any other membership rights (the “Typical Silent Partnership”), or an atypical silent partnership, i.e., a silent partnership in which the investor does not only participate in the Company’s profits but is also entitled to participate in the Company’s hidden reserves and/or is granted certain membership rights (the “Atypical Silent Partnership”).
The silent partnership can be structured so that the silent partner’s participation is limited to the Company’s profits and excludes any participation in the Company’s losses.
Category
Debt
If the parties to the silent partnership have not agreed on certain contractual agreements regarding the terms of the silent partnership (i.e., inter alia, agreement on (i) subordination, (ii) certain entrepreneurial control/participation rights of the silent partner, and/or (iii) participation in losses), which may qualify the contribution of the investor under the silent partnership as equity, the Typical Silent Partnership is to be qualified as a debt instrument.
Category for tax purposes
Tax law distinguishes between (a) the Typical Silent Partnerships which are considered to be debt instruments and (b) the Atypical Silent Partnerships which are considered to be equity. The determination is to be made in the individual case and depends, inter alia, on the rights of the silent partner and its loss participation: If the silent partner is entitled to participate in the built-in gains of the Company and/or participates in the Company’s losses, then a treatment as equity is likely.
Governance Rights
A Typical Silent Partnership does not grant any membership rights, except for limited information rights. The silent partner is not entitled to any voting, veto or approval rights, or basically any other membership rights, unless those are explicitly provided for in the partnership agreement. If such further rights are granted, the silent partnership may qualify as an Atypical Silent Partnership.
Investor Qualification Requirements
Besides of laws and regulations which apply in any case of investments by certain foreign entities/individuals, no specific requirements need to be complied with due to the revenue-based financing.
Currency Considerations
Partnership contribution can be made in any currency which is provided for under the partnership agreement.
Collateral
n/a
Priority Payment Rights
Due to statutory provisions and the characteristics of a silent partnership, the silent partner’s participation is limited to the Company’s profits. Therefore, any participation based on a profit-independent assessment basis, such as a profit-independent guaranteed dividend, a profit-independent participation in the Company’s revenues or a fixed interest on the investment bear the risk that the structure will no longer be considered a silent partnership for tax purposes, but rather be qualified as a mere loan.
If, however, certain payments shall be guaranteed (e.g., by way of a minimum amount to be paid periodically or a fixed interest), it is necessary that these payments are distributed out of the profits generated by the Company or, if that is not possible at the time of distribution, such payment will be set-off against any subsequent profit participation right. Thus, payments under the silent partnership can be based on the revenue generated by the Company, but such payments will in any case need to be made by way of a corresponding profit distribution or subsequent set-off against profit participation rights.
Distribution and Redemption Limitations
Timing and frequency of payments in the silent partnership are subject to negotiation between the silent partner and the Company.
Legal limitations to pricing or total return
Customary statutory limitations (violation of bonos mores, bad faith and appropriateness of profit share) can apply and are subject to the specifics of each individual case.
Status in Insolvency Proceedings
If the investor’s contribution into the silent partnership was repaid within one year prior to the insolvency, the repayment may be contested according to the rules of the German Insolvency Code. In case of insolvency, the silent partnership will be dissolved and the silent partner’s claim for repayment of its contribution (subject to any participation in the losses if agreed in the silent partnership agreement) would (i) in a Typical Silent Partnership constitute an ordinary, unsecured insolvency claim, and (ii) in an Atypical Silent Partnership constitute a subordinated claim.
An ordinary, unsecured insolvency claim would be eligible to participate in any distributions of the insolvency quota (i.e., any distributions of the proceeds from the liquidation of the insolvency estate to the ordinary, unsecured insolvency creditors after satisfaction of all liabilities which are preferred by law such as costs of the insolvency proceedings and liabilities incurred by the insolvency administrator) whereas a subordinated claim would only be eligible to participate in any distributions after all unsecured insolvency claims and other prior-ranking claims have been discharged in full.
Limitation of Liability
The liability of the partners of a civil law partnership (Gesellschaft bürgerlichen Rechts), which is the legal form of the relationship between the Company and the investor due to the silent partnership, is not limited with regard to the creditors of the silent partnership. However, since the silent partnership forms a non-public civil law partnership, generally, no external contractual obligations will be entered into. Therefore, the silent partnership has no third-party creditors. Further, the investor as silent partner cannot be held liable for any claims of third parties against the Company. Liability vis-à-vis the Company may arise from violation of contractual obligations under the partnership agreement and any such liability is not statutorily limited to the contributed amount.
Transfer Restrictions
The silent partnership can be transferred by way of contract assumption involving the old and new silent partner and the Company. If the identity of the silent partner is of no particular interest for the Company, it may be obliged to approve the contract assumption.
Critical Tax Considerations
The below presents certain high-level tax consequences for a Typical Silent Partnership only. Please note that tax consequences of an Atypical Silent Partnership differ.
Any payments to the investor are tax deductible at the level of the Company subject to general limitations (such as the German interest barrier rule (Zinsschranke) and the add-back provisions under German trade tax).
Payments to the investor are generally subject to a 26.375% withholding tax, i.e., the Company has to make a respective withholding from any (interest) payments “on” the contribution of the silent partner (but not on the repayment of the principal amount).
The taxation of payments in the hands of the investor depends on a number of different factors, including the investors tax residence and the eligibility of the investor under an applicable double taxation treaty. This is also true for a potential withholding tax refund from the German tax authorities. However, without going into details, please note that German domestic law generally imposes strict substance requirements for such a refund so that the withheld tax might become final and could become a cost item for the investor.
- Note: As an alternative to the investor’s silent participation, (i) the Company could issue participation rights (Genussrechte) regarding its future profits as consideration for the contribution by the investor, or (ii) the investor could grant a participating loan (partiarisches Darlehen). As the key characteristics and the pros and cons of such participation rights/participating loans are similar to the silent partnership, we have limited the presentation herein to the silent partnership. Any possible upsides of participation rights or participating loans compared to the silent partnership should be reviewed based on the specifics of the individual case on a case-by-case basis. ↩︎ ↩︎