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Course: Comparative Company Law (the US, Germany and the UK)

The Author: Zokirjon Abdusattarov

Case Briefs
I.S.M. GmbH, Plaintiff v. ARGE W.u.a.


a) A civil law partnership that engages in outward dealings with third parties
((Außen)Gesellschaft) has legal capacity to the extent it engages in such dealings to
establish rights and duties in its own name.
b) To this extent, such a partnership also has the capacity to sue and be sued in civil
c) As far as a partner of a civil law partnership is personally liable for the obligations of the
partnership, the relationship b/w the obligations of the partnership and the liability of the
partner corresponds to the relationship of secondary liability (Akzessorietät) found in a
commercial partnership (Offene Handelsgesellschaft)


a) An important practical advantage that results from a civil law partnership having an
enduring legal capacity in dealings with third parties, as described above, is that a change
of partners will not affect the continued existence of contracts with the partnership.
b) Strict application of the traditional view required that contracts with the “partnership” be
newly concluded or confirmed each time there was a change of partners. If the partnership
only presented an obligatory relationship to third parties, the obligations existing with two
different sets of partners would not be identical. However, there is no logical reason why
continuing contracts should be newly concluded upon every change of partners; this
would significantly impair the ability of the partnership to take part in commercial
dealings. The usual explanation is that every new partner enters through a type of
universal succession “into all existing legal and contractual relationships”; this is
fundamentally inconsistent with the view of the partnership as a purely contractual
relationship among the partners.

Meinhard v. Salmon et al.

Court of Appeals of New York
Dec. 31, 1928

Plaintiff - Meinhard, responsible for funding the lease
Defendant – Walter J. Salmon, the lessee, and others (Midpoint Realty Company).

In 1902 Louisa M.Gerry leased to the defendant Salmon the premises of Hotel Bristol in NY
for 20 years (till May, 1922). Meinhard agreed to pay Salmon half of the moneys required for
reconstruction of the property and running the business. It was a joint venture with terms
embodied in a writing. Salmon was to pay certain ratio of net profits. If there were losses, each
party was to bear them equally. Just before the end of the contract, in Jan, 1922, Gerry
approached Salmon and offered Midpoint Realty Company, which is owned by Salmon,
neighboring complex of buildings together with the existing leased property. Salmon accepted
the offer but didn’t tell anything about it to Meinhard. Meinhard learned about it later and then
made demand on the defendants that the new lease to be held in trust as an asset of the venture
upon sharing obligations.

Do joint adventurers have the duty of disclosure of an opportunity, which was an incident of the
enterprise, to one to another?

Yes, joint adventurers, like copartners, owe to one to another, while the enterprise continues the
duty of the finest loyalty, which includes the duty of disclosure.


The pre-emptive opportunity, that was thus an incident of the enterprise, Salmon appropriate to
himself in secrecy and silence. He might have warned Meinhard that the plan had been
submitted, and that either would be free to compete for the award. The trouble about his
conduct is that he excluded his coadventurer from any chance to compete, from any chance to
enjoy the opportunity for benefit that had come to him alone by virtue of his agency. This
chance, if nothing more, he was under a duty to concede.

A man obtaining his locus standi, and his opportunity for making such arrangements, by the
position he occupies as a partner, is bound by his obligation to his copartners in such dealings
not to separate his interest from theirs, but, if he acquires any benefit, to communicate it to

W.J. v. S.Sch.
High Federal Court
March 17, 1966
Plaintiff: W.J., a creditor
Defendant: S.Sch., a limited partner, also, a school principal

In 1957, the Defendant established a limited partnership together with Mrs. E, who was a
destitute, whose husband filed a declaration of bankruptcy. . He became a limited partner with a
capital contribution of DM 10,000 and Mrs. E became the general partner, who gave her labor
as her contribution. In 1958, the Plaintiff after discussion with the Defendant granted the
partnership a credit of up to DM 5,000. The Plaintiff asserts that the Defendant may not take
recourse to the limit defined by his capital contribution because he only used the partnership to
conduct his own business and Mrs. E. is destitute. The Plaintiff also alleges that the Defendant
more than once offered to guarantee the debts of the partnership.
Can a limited partner be liable without limit for the obligations of the partnership simply
because he was the sole economic owner of the commercial partnership and set up a destitute
person as the general partner?


1. A limited partner will not be subjected to unlimited liability in all cases when,
from an economic point of view, he is the sole owner of the commercial partnership and the
general partner is destitute.
2. Provisions of law regarding the link b/w managerial power and unlimited liability
are not mandatory but only optional. It is only the case of GmbH and AG.
3. It will be argued that there an abuse of the legal form of the limited partnership
when a person is a limited partner but in reality runs the business and presents a destitute
person as the general partner; thus, such a limited partner must certainly be liable without
limit regardless of the registration as a limited partner. But this argument can’t be accepted
because the law itself makes such a structure available.
It is not correct to conclude a limited partner who holds the managerial powers of a general
partner pursuant to the partnership agreement must be liable without limit.
4. It is argued that the Defendant made reference to his good credit standing and his
position as a school principal, as well as to his good name and reputation, and presented
himself as the real owner of the partnership, thereby inducing the Plaintiff to increase the
amount of the credit granted. However it is irrelevant whether the Plaintiff knew that the
Defendant had ultimate management authority in the partnership. The important thing for
the creditor is to know who is liable for the partnership’s debts and the extent of such
liability. The Defendant could only be liable if his behavior at negotiations can be regarded
as an assurance of guaranty or suretyship.

In re Barnard, Martins Bank v. Trustee

Chancery Division
20 November 1931
Barnard established two partnerships (Barnard Firm and Scrap Metal Company). He was the
sole general manager in both partnerships and there were several limited partners. When
Barnard was declared bankrupt and a trustee was appointed, the Scrap Metal Company owed
GBP 98681 to creditors.


Limited partnership is not a legal entity.

The signature of the name of a firm is equivalent to the signature by the person so signing off
all persons liable as partners in that firm. In this case, the partnership’s debt is Barnard’s debt.
Rule 286 provides that a receiving order made against a limited partnership firm shall operate a
receiving order against each general partner.

Now if the separate debts of Barnard as individual are payable in the first instance out of the
Barnard Firm assets a grave injustice might result to the limited partners. Subject to the
payment of the firm’s debts and liabilities out of the firm’s assets, the limited partners are
entitled to recover their own contributions; and if the general debts of Barnard, the individual,
including his separate debts and debts incurred by him on behalf of some other limited
partnership, are payable out of the Barnard Firm assets, the limited partners in that firm may be
seriously prejudiced. Is there any provision to avoid that?

Sect. 33, sub-s. 6, provides that:

- in the case of partners the joint estate shall be applicable in the first instance in payment of
their joint debts, and
- the separate estate of each partner shall be applicable in the first instance in payment of his
separate debts.
- If there is a surplus of the separate estates, it shall be dealt with as part of the joint estate.
- If there is a surplus of the joint estate, it shall be dealt with as part of the separate estates in
proportion to the right and interest of each partner in the joint estate.

Additional Useful Information:

A limited partner shall not take part in the management of the partnership business, and shall
not have power to bind the firm: provided that he may at any time inspect books and examine
into the state and prospects of the business and advise with partners thereon. If he takes part in
the management of the partnership business, he shall be liable for all debts and obligations of
the firm incurred as though he were a general partner.

The Company Law Directives:

The First Company Law Directive adopted in 1968 and consolidated with amendments in 2005:
- imposed a harmonized system of register disclosure for companies to publish facts
regarding their incorporation, legal capital and financial results, as well as to specify
those persons authorized to represent the company in dealings with third parties.

The Second Company Law Directive adopted in 1976, provided harmonized rules for the
incorporation of public companies and the maintenance of their capital, including:
- a procedure for auditing the value of in-kind contributions to capital,
- restrictions on dividend distributions and share repurchases,
- a prohibition of “financial assistance”,
- mandatory preemptive rights, and
- a required shareholder vote for certain changes in the company’s capital.

Centros Ltd. V. Erhervs- og Selskabsstyrelsen

The ECJ found that Denmark must allow a UK private limited company freely to establish
itself in its territory, even if Danish citizens used the company for the sole purpose of
evading Denmark’s stricter laws on capital adequacy and conducted none of the company’s
business in the UK.

Überseering VB v. Nordic Construction Company Baumanagement GmbH

The ECJ found Germany’s conflict of laws rules as they had been applied to a Dutch
company impede freedom of establishment. Unlike the US, which applies the “incorporation
theory”, meaning that the internal affairs of a corporation are governed by the laws of its state
of incorporation, Germany has traditionally applied the “real seat” theory, meaning that the
internal affairs of corporation are governed by the laws of the state where it has its center of
administration. The application of the real seat theory to a Dutch company whose shares came
to be owned by Germans and which was operated in Germany, resulted in the German courts
applying German law to the company, finding that it was not properly constituted and
registered as a German corporation, and then denying it the legal capacity to sue in a court of
law. The ECJ, following its decision in Centros, found that denying a company duly formed
in another member state legal capacity to be a party to legal proceedings was “tantamount to
an outright negation of the freedom of establishment conferred on companies by Art. 43 and
48 of the EC Treaty. The Court rejected Germany’s argument that application of its own
company law to pseudo-foreign corporations was justified because it enhanced legal
certainty, and the protection of creditors and minority shareholders.
The seat theory will remain for companies incorporated outside of the EU unless a friendship
treaty applies, or legislation currently being discussed in Germany to adopt the incorporation
theory also applies to non-EU companies.

Kamer van Koophandel en Fabrieken voor Amsterdam and Inspire Art Ltd.

Are Articles 43 EC and 48 EC to be interpreted as precluding legislation of a MS, such as the
WFBV (Dutch Law), which attaches additional conditions, such as those laid down in
Articles 2 to 5 of that law, to the establishment in that MS of a company formed under the
law of another MS with the sole aim of securing certain advantages compared with
companies formed under the law of the MS of establishment which imposes stricter rules than
those imposed by the law of the MS of formation with regard to the setting up of companies
and paying up of shares?

It is contrary to Article 2 of the 11th Directive for national legislation such as the WFBV to
impose on the branch of a company formed in accordance with the laws of another MS
disclosure obligations not provided for by that directive.

It is contrary to Articles 43 and 48 EC for national legislation such as the WFBV to impose
the exercise of freedom of secondary establishment in that State by a company formed in
accordance with the law of another MS certain conditions provided for in domestic company
law in respect of company formation relating to minimum capital and directors’ liability. The
reasons for which the company was formed in that other MS, and the fact that it carries on its
activities exclusively or almost exclusively in the MS of establishment, do not deprive it of
the right to invoke the freedom of establishment guaranteed by the EC Treaty, save where the
existence of an abuse is established on a case-by -case basis.

The ECJ held that a Dutch outreach statute against pseudo-foreign corporations was
inconsistent with the EC Treaty. The statute required the branches of companies incorporated
abroad make disclosures beyond those provided for in the 11th Company Law directive, and
imposed unlimited liability as a penalty for failure to comply with these and other
requirements, such as a minimum capital requirement. From the perspective of a comparative
analysis with US federalism, the Inspire Art decision is interesting in that it is based both on
freedom of establishment (which is not guaranteed for companies in the US Constitution),
and the theory that member state action has been expressly preempted by an EU Directive,
which is the strongest theory for invalidating state law under the US Constitution.

Gebhard v. Consiglio dell’Ordine degli Avvocati e Procuratori di Milano

Under the ECJ decision in the cass such as Centros, Überseering and Inspire Art, member
state laws will be unlawful if they place any legal requirement on the free establishment of a
company formed under the laws of another member state, unless the laws of the host state
remain with the following criteria set forth:
- applied in a non-discriminatory manner;
- justified by imperative requirements in the public interest;
- suitable for securing the attainment of the objective which they pursue, and
- not go beyond what is necessary in order to attain it.

Daily Main and General Trust Plc

This case was cited by the German government in Überseering to support their position.
However the ECJ rejected it. Daily Main and General Trust Plc, a company formed in
accordance with the law of the UK and having both its registered office and actual center of
administration there, wished to transfer its center of administration to another MS without
losing its legal personality or ceasing to be a company incorporated under English law. This
required the consent of the competent UK authorities, which they refused to give. The
company initiated proceedings against the authorities before the High Court of Justice,
Queen’s Bench Division, seeking an order that Articles 52 and 58 of the EEC Treaty gave it
the right to transfer its actual center of administration to another MS without prior consent
and without loss of its legal personality.

VantagePoint Venture Partners 1996 v Examen, Inc.

Supreme Court of Delaware

Plaintiff – Examen, Inc.
Defendant – VantagePoint Venture Partners, a Delaware Limited Partnership and an Examen
Series A Preferred shareholder.

Examen was a Delaware Corporated. VantagePoint, a major venture capital firm that owned
83 % of Examen Series A Preferred Stock and no shares of Common Stock. Examen and
Reed Elsevier entered into talks of merger. Under the DGCL and Examen’s Certificate of
Incorporation adoption of the Merger Agreement required the affirmative vote of the holders
of a majority of the issued and outstanding shares of the Common Stock and Series A
Preferred Stock, voting together as a single class. Holders of Series Preferred Stock had the
number of votes equal to the number of shares of Common Stock they would have held if
their Preferred Stock was converted. VantagePoint acknowledged that, if DCGL applied, it
would not have a class vote.

Was VantagePoint entitled to a separate class vote of the Series A Preferred Stock on the
merger under California Corporation Code which provides for approval of reorganization of
the corporation by the shares of each class separately and outreaches to foreign corporations,
of which more than one half of outstanding voting securities held by persons having
addresses in California and which meet certain other criteria?

The California courts would “apply DGCL [demand] to the internal affairs of a Delaware
corporation, given the vitality and constitutional underpinnings of the internal affairs doctrine.

Based on the constitutional imperativeness of the internal affairs doctrine, the court came to
this conclusion.
The internal affairs doctrine is a long standing choice of law principle which recognizes that
only one state should have the authority to regulate a corporation’s internal affairs – the state
of incorporation.
The internal affairs doctrine developed on the premise that, in order to prevent corporations
from being subjected to inconsistent legal standards, the authority to regulate a corporation’s
internal affairs should not rest with multiple jurisdictions. It is now well established that only
the law of the state of incorporation governs and determines issues relating to a corporation’s
internal affairs.

Marleasing SA v La Comercial Internacional de Alimentacion SA


Plaintiff – Marleasing SA
Defendants – La Comercial Internacional de Alimientacion SA (La Comercial). It was
established in the form of a public limited company by three persons, including Barviesa SA,
which contributed its own assets.

It is apparent from the grounds set out in the order for reference that Marleasing’s primary
claim based on Articles 1261 and 1275 of the Spanish Civil Code, according to which
contracts without cause or whose cause is unlawful have no legal effect, is for a declaration
that the founders’ contract establishing La Comercial is void on the ground that the
establishment of the company lacked cause, was a sham transaction and was carried out in
order to defraud the creditors of Barviesa SA, a cofounder of the defendant company.

Is Article 11 of Council Directive 68/151/EEC of 9 March 1968, which has not been
implemented in national law, directly applicable so as to preclude a declaration of nullity of a
public limited company on a ground other than those set out in the said article?

Ruling (Holding):
A national court hearing a case is required t interpret its national law in the light of the wording
and the purpose of that directive in order to precludea declaration of nullity of a public limited
company on a ground other than those listed in Article 11.

A declaration of nullity of a company cannot be made on the basis of the activity actually
pursued by it, for instance defrauding the founders’ creditors. (*note: courts in the Delaware
can declare the nullity of a company based on defrauding. )
As is clear from the preamble to the Directive, its purpose was to limit the cases in which
nullity can arise and the retroactive effect of a declaration of nullity in order to ensure
‘certainty in the law as regards relations between the company and third parties, and also
between members’. Furthermore, the protection of third parties ‘must be ensured by
provisions which restrict to the greatest possible extent the grounds on which obligations
entered into in the name of the company are not valid’. Each ground of nullity provided for in
Article must be interpreted strictly.

Kelly A. Cleary v. North Delaware A-OK Campground, Inc., et al.

Superior Court of Delaware

Plaintiff – Kelly A. Cleary
Defendant - Thomas and Betty Htchens, as owners and operators of Double J Riding Stables
and et al.

Double J Riding Stables began operating on or about April 21, 1983. The principals
immediately took steps to have the business incorporated. Apparently, due to the
unavailability of the corporate name, “Double J, Inc.,” the business’ accountant failed to file
the Certificate of Incorporation the with Secretary of State until December 16, 1983,
approximately two months after Ms. Cleary was injured. Still, defendants claim a de facto
corporation existed at the time of the accident, insulating defendant Thomas Huthchens from
personal liability.

Was there a corporation which insulates incorporators from unlimited personal liability?

In Delaware, a business organization seeking de facto status must meet three general
- there must be a “general law under which a corporation may lawfully exist;
- a bona fide attempt to organize under the law and colorable compliance with the statutory
- actual use or exercise of corporate powers in pursuance of such laws.
There was a good faith attempt to incorporate here, and colorable compliance with the
statutory requirements. Double Jay made a bona fide attempt to incorporate on April 21,
1983, under the name Double J Inc. After a two-month delay, the parties were informed that
the name was unavailable, and the accountant filed for a corrected name. Another delay
regarding filing fees, which was apparently not the principal’s fault, occurred. The Certificate
of Incorporation was not filed until December 16, 1983.

Timberline Equipment Co., Inc. v. Davenport

Supreme Court of Oregon. 1973.

Plaintiff –
Defendant - Dr Bennett, an incorporatr, director and shareholder of purported de facto
corporation Aero-Fabb Corp.

On January 22, 1970, Dr. Bennett signed articles of incorporation for Aero-Fabb Co. The
original articles were not in accord with the statutes and, therefore, no certificate of
incorporation was issued for the corporation until June 12, 1970.

1. Is there a de facto corporation which estops the plaintiff denying corporate veil?
2. Can the plaintiff recover against Dr. Bennett individually?

1. No.
2. Yes.

1. When a defendant seeks to escape liability to a corporation plaintiff by contending that the
plaintiff is not a lawful corporate entity, courts readily apply the doctrine of corporation by
estoppel. Thompson Optical Institutte v. Thompson well illustrates the equity of the doctrine
in this class of cases. Thompson carried on an optical business for years. He then organized a
corporation to buy his optical business and subscribed to most of the stock in this corporation
He chaired the first meeting at which the Board resolved to purchase the business from him.
The corporation and Thompson entered into a contract for the sale of the business which
included a covenant by Thompson not to compete. The corporation brought suit to restrain
Thompson from competing. Thompson defended upon the ground that the corporation had
not been legally organized. We held, “The defendant cannot be heard to challenge the validity
of the contract or the proper organization of the corporation.”
The fairness of estopping a defendant such as Thompson from denying the corporate
existence of his creation is apparent.
On the other hand, when individuals such as the defendants in this case seek to escape
liability by contending that he debtor is a corporation, Aero-Fabb Co., rather than the
individual who purported to act as a corporation, the courts are more reluctant to estop the
plaintiff from attacking the legality of the alleged debtor corporation.

2. As to the personal liability, the Model Act provides that “persons who assume to act as a
corporation” are personally liable. However, it doesn’t include those whose only connection
with the organization is as an investor. On the other hand, the restriction of liability to those
who personally incurred the obligation sued upon cannot be based upon logic or the realities
of business practice.
When several people carry on the activities of a defectively organized corporation, chance
frequently will dictate which of the several active principals directly incurs a certain
obligation or whether an employee, rather than an active principal, personally incurs the

Kelner v. Baxter and Others

Court of Common Pleas. 1866

The plaintiff was a wine merchant, and the proprietor of the Assembly Rooms at Gravesend. In
August 1865, it was proposed that a company should be formed for establishing a joint-stock
hotel company at Gravesend, to be called The Gravesend Royal Alexandra Hotel Company,
Limited, of which the plaintiff was one of the directors and the manager. One part of the scheme
was that the company should purchase the premises of the plaintiff for a sum of 50001., of which
30001. was to be paid in cash and 20001. in paid up shares, the stock, &c., to be taken at a
valuation; and this was carried into effect and completed, the other defendant (Baxter) being the
nominal purchaser on behalf of the company. In December a prospectus was settled. On the 9th of
January, 1866, a memorandum of association was executed by the plaintiff and the defendants
and others. And there was an agreement on January 27 according to which the plaintiff sells
certain goods to the company and receives certain number of stocks on February 28. The
agreement signed b/w the the Plaintiff and Baxter, Calisher, and Dales, the latter acting on behalf
of the company.
The company obtained the certificate of incorporation on February 20.
Issue: Can the defendants be held personally liable?

Holding: the holding was missing…probably b/c it wasn’t important.

Reasoning: I have no clue what was the majority opinion, there were different opinions by
different judges… whose opinion to take? …Sorry I give up…
The main thing in this case: if a person contracted on behalf of a company which was non-
existent, he himself would be liable on the contract.

Phonogramm Ltd. V. Lane

Court of Appeal. 1981.
Plaintiff – Phonogram Ltd., the lender.
Defendant – Mr.Lane, who borrowed money for the purpose of establishing a company.
In 1973 there was a group of pop artists. A company was going to be formed to run the group.
It was to be called “Fragile Management Ltd.”. Before the company was formed it was
financed with the money provided by Phonogram Ltd. But the new company was never formed
and the received 6 000 pounds wasn’t returned. Phonogram Ltd discovered that Mr. Lane acted
on behalf of Fragile Management and was responsible for the payment.

Can Mr. Lane be held personally liable for the payment of the debt when he acted on behalf of
the company which hasn’t been incorporated?

Yes, where a contract purports to be made by a company, or by a person as agent for a
company, at a time when the company has not been formed, then subject to any agreement to
the contrary the contract shall have effect as a contract entered into by the person purporting to
act for the company or as agent for it, and he shall be personally liable eon the contract

The contract purports to be made on behalf of Fragile Management, at a time when the
company had not been formed. It purports to be made by Mr. Lane on behalf of the company.
So he is to be personally liable for it.

Jacobson v. Stern
Supreme Court of Nevada, 1980

Plaintiff – Jacobson
Defendant - Stern
Jacobson acted on behalf of Kings Castle, Limited Partnership, and concluded a contract in
February 1969 with Martin Stern to render architectural services on the premises of Kings
Castle. But Kings Castle did not exist until May 9, 1969. In 1969 there were four payment
made to the account of Stern. All of the checks were drawn on the account of A.L.W., Inc,;
only one of the checks was signed by Jacobson. In 1972 A.L.W., Inc, as owner of Kings Castle,
filed its petition for arrangement under Chapter XI.
1. Is Jacobson personally liable? 2. The obligations of Jacobson were adopted by A.L.W.,
Inc., and did such adoption constitute a novation?

Holding: 1. Yes. 2. No.

1. In the presence of testimony by Stern that he thought he was dealing with Jacobson as an
individual, the contract was made b/w Jacobson, as promoter of the Kings Castle project,
and Stern. A contract with the promoter is not one with the corporation absent some
subsequent corporate act or agreement.
2. The intent of the parties to cause a novation must be clear. Stern never agreed to release
Jacobson from his obligation.

The Ooregum Gold Mining Company of India, Ltd. V. Roper

All you need to know is that issuing shares at discount is not allowed.

In Re Scandinavian Bank Group Plc.

Scandinavian Bank Group wanted to change its existing shares with different classes of shares in
different currencies. They referred to court to check if it will be lawful for them to do so. The
court then discussed whether it is possible to issue multi-currency shares in different classes and
the answer was yes.

Lewis v. Scotten Dillion Co.

I wonder how this case could be relevant to this chapter. I regret the time I wasted in reading it.

Jump to the end of book!

Royal British Bank v. Turquand

Turquand is a general director of the Joint Stock Company. The deed settlement of the joint stock
company, i.e., a founding document of the Joint Stock Company, allowed directors from time to
time borrow such sums of money as authorized by a resolution passed at a general meeting. By a
bond under the seal of the company and signed by two directors, the company has acknowledged
the indebtedness of 2000 pounds to the Royal British Bank. When the bank sought payment, the
company argued that there was no resolution issued as to the issuance of bond and therefore the
company is not bound by the debt.

The issue here was whether a bond under the seal of company and signed by two directors is
binding on the company where the deed of settlement requires a resolution to be passed thereto to
authorize the transaction.

The Court held that the company will be bound by the debt because the third parties dealing with
the company are entitled to presume that the persons acting on the behalf of the company have
the necessary authority to do so. The third parties who are dealing with the company are only
required to read the statutes and deed of settlement. Since the deed of settlement allows
borrowing money under certain conditions, on the face of documents the third parties would have
a right to assume that a resolution authorizing that is legitimately issued.

In the UK, debentures – secured obligations, loan stock – unsecured obligations.

Thw two leading hypotheses for 20 years have been the “pecking order hypothesis” and the
tradeoff model”.
The tradeoff model sees companies working to set an optimal target ratio of debt and equity, and
the pecking order framework assumes an order of preferences among sources of financing,
internally generated financing is preferred first, followed by debt (safe and then risky) and lastly
outside equity.

Regardless of whether bonds are sold on the open market, however, the laws of our European
jurisdictions require shareholder approval of bond issues when the instruments resemble, or can
be converted into shares.

In Delaware the management has sole discretion whether to declare dividends, subject only to the
threat of not being reelected, in Germany, where shareholders control the distribution of
dividends by resolution, subject only to the figure for distributable profits, which is usually
determined by directors.

Thus, as mentioned above, because German shareholders control the payout of dividends, a
condition in a loan contract or bond under which the board commits the company not to pay out
dividends cannot bind the shareholders be without effect.

Three important questions:

1. How must the issue of new shares be approved?
2. How may the shares be paid for?
3. Do existing shareholders have a right to purchase the new shares in an amount necessary
to protect their current economic stake and influence in the company (preemptive rights)?

“effective capital increase” means an actual payment of funds to the company in exchange for
the issue of shares and “nominal capital increase” means a use of reserves to pay for stock that
is issued as “bonus” shares to shareholders.
A nominal capital increase is thus a form of internal financing that capitalizes reserves, and
would increase the “share capital” without changing the capital assets available for funding.
An effective capital increase brings fresh funds into the company, and thus the primary difference
from a nominal increase is that the company must receive payment for the new shares.