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Piercing the Veil of AssociationsFirst published June 6, 2006 An August 9, 2005 judgment by the Dresden Appellate Court, Oberlandesgericht, OLG, in the matter 2 U 897/04 may have a dramatic effect on non-profit incorporated associations in Germany if upheld by the Federal Supreme Court, Bundesgerichtshof. The court ruled that members of an association may be liable for the debts of an association that engages in business activities. Importance of Incorporated Associations for Non-Profit Sector In Germany, government supports the non-profit sector by tax privileges for entities pursuing public utility, charitable, and religious aims. The tax preferences are available, on the one hand, to the non-profit organization directly by way of an income tax exemption and, on the other hand, to charitable donors through deductions from their taxable income. The tax law affords such benefits only if the non-profit organization is an entity within the meaning of the corporation tax law, Körperschaftsteuergesetz. Most of such entities require substantial registered capital. For instance, the limited liability company, Gesellschaft mit beschränkter Haftung, GmbH, needs a minimum registered capital of 25,000 Euros. The only entities taxable under the corporation tax law without a minimum capital requirement are incorporated associations, eingetragener Verein, e.V. As a result, they make up the overwhelming number of non-profit organizations. Liability of Members of Incorporated Associations Before Dresden In general, neither members nor board members are liable for liabilities of the incorporated association. This applies for contractual liabilities as well as for those arising from tort, see §§ 26(2), 31 Civil Code Bürgerliches Gesetzbuch, BGB, providing a corporate veil for those engaged in activities of an incorporated association. Judgment of OLG Dresden of August 9, 2005 Charting a new course, the Dresden appellate court ruled that members of an incorporated association may be personally liable for the association's debts. The facts are as follows: An incorporated association, Kolping-Bildungswerk Sachsen e.V. was composed of members all of which are incorporated and uncorporated associations. KBS e.V. entered into a long-term real estate lease with a real estate fund. Subsequently, it failed to generate sufficient income to meet its obligations under the lease agreement, and became bankrupt. The lessor sued its members for damages. The appellate court found in favor of the fund on the issue of liability and reasoned as follows: The law provides for two kinds of incorporated associations. The altruistic incorporated association, Idealverein, established under §21 BGB obtains its charter and legal capacity by registration in the register of associations, Vereinsregister. By contrast, the incorporated business association, wirtschaftlicher Verein, §22 BGB, requires for its legal existence a bestowal of authority granted by a governmental authority. Due to restrictions, there are few economical incorporated associations. The altruistic incorporated association is charactarized by purposes that exclude doing business. This limitation to altruistic objectives compensates for the fact that there are no rules for the protection of creditors in such associations. Unlike business entities such as GmbH and stock corporations, Aktiengesellschaft - AG, no provisions for minimum capital and its preservation, or requirements for publication, accounting, and audits apply to altruistic associations. Altruistic associations may engange in business activities only in order to support their altruistic purposes. If an association acts beyond these limitations for economical activities, personal liability for its members may follow. The law provides certain corporate forms, such as GmbH and AG, for collective business activities and provides for limited liability of its owners. Persons intending to run a business collectively may not choose - according to the court - the legal form of an altruistic association and must instead select one that sets forth stronger creditor protection provisions. How the business activity qualifies for tax purposes is irrevelevant. If one opts for an altruistic association when intending to engage in business, the decision constitutes an abuse of the organizational form. Therefore, the privilege of limited liability does not apply, and, the corporate veil may be pierced by creditors. In order to avoid such far-reaching liability, members are required to take action against business activities that the the association may contemplate. The defendant in this matter had unusual characteristics and is not typical for associations in Germany: Its members developed group-like structures and the association became massively active in business. In the event that the highest court in civil matters, the Bundesgerichtshof in Karlsruhe, should uphold the decision, an important factor to consider is whether the ruling reaches beyond this particular defendant and will become a principle of corporate law. Arguably, because of the limited number of members in this particular case, each member was able to recognize the business activities of the association and of the management by the board and could have taking corrective steps through votes or other action. Therefore, the Dresden court holds the members responsible for their failure despite an ability to intervene. Consequences from the Judgment Numerous incorporated associations are engaged in business activities, running residential homes for the elderly or operating sheltered workshops. As a result, the Dresden decision could develop major impact if upheld. That would mean a major blow for the non-profit sector in Germany. In order to avoid personal liability of their members, these associations will either have to convert into other legal forms, such as a GmbH, or to transfer their business activities to newly established subsidiaries. This development will probably accelerate the recent trend toward the professionalisation of non-profit institutions whose new entities will likely replace volunteers with experienced full-time management. * The author is a German lawyer who worked for several years in the German Mergers & Acquisitions department of a New York-based law firm after, among other steps, an internship in Washington. In 2005, he joined Boos Rechtsanwälte, Münster, a law firm affiliated with BPG Beratungs- und Prüfungsgesellschaft BPG mbH Wirtschaftsprüfungsgesellschaft. Gunnar Pietsch is specialized in corporate and tax law focused on the non-profit sector. He can be reached at [email protected]. Main Page | Current News |