With consideration for the founders: Liability risks for start-up companies

Encouragingly, the scene for young and innovative companies has seen considerable movement over recent years in Germany as well. In the business world, the term “start-up” has long been established for such companies, although there is no generally applicable definition or even a legally independent form of company. A start-up is essentially characterised by an attempt to develop innovative products or services to market maturity through a newly conceived business model and consciously focusing on investment and growth along the way, while inevitably profitability aspects fall by the wayside at first.

Losses in the start-up phase of such companies are therefore calculated in and require financing, which, for lack of alternatives, is provided by venture capitalists. These often join the company in the early phase of the start-up and in several financing rounds with debt or equity capital or through mezzanine forms of financing in the hope of a future share in exit proceeds (after a sale or even an IPO). Financiers are not only institutional venture capital companies, but also private investors (so-called business angels) or are recruited from alternative forms of financing, such as crowdfunding. The volume of investments in start-ups has recently soared in Germany. After an average of about EUR 4.5 bn p.a. in the years 2015 to 2020, the investment volume in 2021 most recently jumped to a level of about EUR 17 bn. In Germany, the start-up scene is particularly active in the business areas of information and communication technology (about 30 % of all relevant companies) and medical technology and biomedicine (about 10 %).

Start-ups do not represent an independent legal form, but organise themselves in familiar legal structures, especially as a limited liability company or small public limited company. The statutory liability regulations applicable to this legal form provide, inter alia, a duty to compensate for managing directors or board members regarding payments that were still made to third parties, e.g. suppliers, service providers or licensors, after the occurrence of insolvency or over-indebtedness in disregard of the duty to file for insolvency. However, a decision of the Dusseldorf Higher Regional Court (OLG Düsseldorf, resolution of 20.07.2021, I 12 W 7/21) illustrates that the special features of the business and financing model of start-ups must be taken into account. In the case in question, the insolvency administrator of a start-up that had already failed in the initial phase and whose business model was geared towards setting up a sales portal for used and commercial vehicles claimed reimbursement from the managing director for payments made after the company had become insolvent. He argued that the company had already been over-indebted at the time of the payments, whereby the purely mathematical over-indebtedness of the start-up as a result of the losses already incurred was undisputed between all parties to the proceedings.

Therefore, the decisive question was whether the managing director, at the time of the payments, could have justifiably assumed a so-called positive going concern prognosis for the start-up that would have precluded his liability. Such a going concern prognosis includes the prediction of the future course of business and the future, at least medium-term (at least one year) ability of the company to meet its maturing liabilities. Ultimately, this raises the question of the financial strength and economic viability of a company. Normally, the earning capacity, i.e. the company’s ability to make a profit on the market through its business activities, must also be taken into account. In the absence of this, a positive going concern prognosis can no longer be assumed. Accordingly, the plaintiff insolvency administrator assumed that a positive going concern prognosis no longer existed for the start-up, as it had permanently generated losses. In contrast, the managing director argued that he had been able to rely on the sole investor’s constant willingness to provide financing, which had also been put into practice. The latter had continued to provide the start-up with financial resources after submitting updated business figures and concretising the business model.

The OLG Düsseldorf followed the defendant’s line of argument. Deviating from the principles also approved by the supreme court, the court assumed for a start-up that the earnings capacity, i.e. the self-financing capacity of the company, could not be decisive for the assessment of the going concern prognosis, since it was in the nature of the business model of a start-up not to be able to generate profits, at least in the start-up phase. Rather, the decisive factor should be whether the sufficient degree of probability for the company’s ability to survive resulted from viable plans for the business model, related to the relevant period of the going concern forecast, and the investors’ willingness to continue to support the company with debt and/or equity capital, which could be assumed with the same degree of probability. In the case decided, the OLG Düsseldorf considered it proven in view of the concrete circumstances that the start-up had been able to present convincing and resilient plans and assumptions for the further development of the company, on the basis of which the investor had then made and implemented further financial commitments. From the point of view of the managing director, this justifiably allowed the assessment that the company could continue its business model in the future, at least until the investor gave up his willingness to invest further in the start-up.

This decision reaffirms the assessment criteria for profitless companies with a future-oriented business model, which had already been established in the well-known “Dornier” decision of the Federal Court of Justice (judgement of 13.07.1992, II ZR 269/91). It is expressly welcomed that the particularities of the development phases of start-up companies have now also found their way into the case law of the courts and that liability risks for managing directors and founders are thus subject to a more practice-oriented assessment. However, the decision should not lead to negligence in managing the relevant risks. In the future, only those who carefully document sufficiently meaningful business plans at an early stage for the determination of the positive going concern prognosis and who also take care to ensure their continued willingness to financially support the start-up in a constant exchange with their investors will be able to benefit from the principles.