Cash settlement in case of squeeze-out

In its decision dated 12 January 2016 (file no. II ZB 25/14) the German Federal Court of Justice had the opportunity to comment on the appropriateness of a cash settlement in case of an exclusion of minority stockholders (squeeze-out).

Up to date it had not been clear whether in case of an entity that is party to a profit and loss transfer agreement as transferring entity only the cash compensation under the profit and loss transfer agreement should be taken into consideration for cash settlements paid to excluded minority stockholders in case of a squeeze-out or whether (at least) the proportionate corporate value should (also) be drawn on.

Under a profit and loss transfer agreement, the transferring entity has to transfer all profits to the receiving company, which also agrees to assume all losses of the transferring entity. In exchange, the outstanding shareholders must be made an offer to sell their shares and, for those not willing to sell their shares, a recurring cash compensation (similar to a guaranteed dividend) must be paid.

The starting point for the deliberations of the Federal Court of Justice is the case law of the Federal Constitutional Court (Bundesverfassungsgericht). According to this case law, in case of a squeeze-out, the minority stockholder must be compensated in full for the loss of its member status and the detrimental effect on its proprietary status by economic means, whereas the compensation shall reflect the “real” and “true” value of the property embodied in the stock (cp. Federal Constitutional Court 100, 289, 306).

Within this context, the question arises whether, due to their guaranteed dividend, the value of the holdings of the minority shareholders is limited to the earnings related to them in form of the compensation payments under the profit and loss transfer agreement and, thus, whether these truly reflect the “full, real” value targeted in the evaluation or whether the minority shareholding can have a value beyond that which can only truly be mapped in the proportionate corporate value.

The Federal Court of Justice has answered this question to the extent that at least the proportionate corporate value needs to be drawn on in addition. The proportion in the corporate value falling to the share held by the minority stockholder is relevant for the appropriateness of the cash settlement in case of a squeeze-out of minority stockholders pursuant to Sections 327a, b German Stock Corporation Act (Aktiengesetz, AktG) if this proportion exceeds the cash value of the compensation payments the minority stockholder is entitled to due to the profit and loss transfer agreement. In other words, the value of the shares held by the minority shareholders calculated on the basis of the recurring cash compensation under the profit and loss transfer agreement serves as lower limit to the cash settlement payable to the shareholders under a squeeze-out.

As a holding in a company also comprises, besides the prospect of a dividend, a share in the available assets the stockholder has a claim to in case of dissolution and liquidation, a cash settlement calculated by means of the compensation payments under the profit and loss transfer agreement may not cover the full, “true” value of the holding. According to the Federal Court of Justice this is the case if the corporate value has increased since the effective date the appropriate compensation payments under the profit and loss transfer agreement have been calculated for. The reason given is that, due to the stockholder’s decision to keep the stocks despite the profit and loss transfer agreement and not to leave the company against compensation to be paid under Section 305 AktG, the holding in the company has not changed to the effect that its value is only determined by the compensation payments and the stockholder no longer has a share in the corporate value beyond that.

The decision reads that the compensation payments are only a temporary flat-rate compensation for the dividend received otherwise. If the dependent (and transferring) company develops positively after concluding the profit and loss transfer agreement and if the dividend turns out to be higher than the compensation under such agreement after termination of the intercompany agreement, the (outside) stockholder can benefit from the decision to stay in the company beyond the compensation payment. This chance is taken from the stockholder when being squeezed out of the company. In determining the ��true” value of the holding, the minority stockholder’s participation rights, despite being limited due to the profit and loss transfer agreement, continue to be a factor that needs to be considered.

So far, the Federal Court of Justice had only ruled that the stock-exchange price constitutes the lower limit of the cash settlement when the market value is being calculated (company valuation). Now, a valuation on the basis of the compensation under a profit loss and transfer agreement provides another lower limit.