Three problems regarding liability for wage tax when a company is in crisis

Under former law (until 2021), liability for payments reducing the insolvency estate was dealt with in certain special laws. The relevant provisions had largely the same wording.

Once the company has become insolvent or its over-indebtedness has been established, the management board/managing director may not make any payments. The foregoing shall not apply to payments which, even if made thereafter, are compatible with the due care of a prudent and conscientious manager. (Section 64 German Limited Liability Companies Act, old version; Section 92 German Stock Corporation Act, old version)

All payments were basically prohibited, the exception was stipulated in, for example, Section 64, second sentence, German Limited Liability Companies Act, old version. This exception was interpreted in so restrictive a manner that the permitted payments made it de facto impossible for operations to continue, even though the purpose of the exception was to ensure that the business could continue to be carried on during the application period. However, there was a uniform standard of liability under former law, which means that it was irrelevant for liability purposes whether the application had been filed in due time.

The conflict of duties existed also under former law: representative bodies are and have been obliged to pay taxes on behalf of the legal person they represent and are personally liable for failure to do so due to gross negligence, Sections 34, 69 German Fiscal Code. The conflict of duties was ultimately resolved by the courts, which held that tax payments did not give rise to liability under Section 64 German Limited Liability Companies Act, old version (to this effect, for example, German Federal Court of Justice, judgment of 14 May 2007 - II ZR 48/06 (KG)).

The obligation to pay tax was thus given priority over the prohibition on payments under insolvency law, which meant in practice that tax authorities – as otherwise unsecured creditors – were granted preferential treatment.

Section 15b German Insolvency Code was introduced into the German Insolvency Code by the German Act on the Further Development of Reorganisation and Insolvency Law (SanInsFoG), and the provisions regarding the representative body’s liability were deleted from the special laws. As a result, the Insolvency Code now contains central liability provisions, which makes sense from a systematic point of view and has helped clear up many other misunderstandings as well.

The wording of Section 15b (1) German Insolvency Code essentially still corresponds to the wording of Section 64 German Limited Liability Companies Act, old version, and Section 92 German Stock Corporation Act, old version. However, Sections 15b (2) to 15b (8) now contain many detailed provisions with additional rules.

The first sentence of Section 15b (8) German Insolvency Code reads as follows:

If, during the period between the commencement of insolvency according to Section 17 or over-indebtedness according to Section 19 and the insolvency court’s decision on the application to open insolvency proceedings, claims arising from the tax debtor-creditor relationship are not settled, or are settled late, this shall not constitute a violation of tax payment obligations, provided that the persons obliged to file the application comply with their obligations under Section 15a.

The conflict of duties has thus been newly regulated in Section 15b (8). The legislative bodies were obviously aware of the aforesaid decision of the Federal Court of Justice and its meaning and wanted to codify this matter (report by the Committee on Legal Affairs and Consumer Protection, printed matter 19/25353, pages 11 et seq.).

The rulings according to which the payment of taxes takes priority over the prohibition on payments should thus be obsolete. The prohibition on payments under insolvency law now explicitly takes priority over tax obligations; however, this order of priority only applies if an application to open insolvency proceedings was filed in due time.

First problem:

The wording “claims arising from the tax debtor-creditor relationship” is surprising. The employer does not pay the wage tax on any of its own tax labilities, but on the tax liability of the employee. The tax authorities only demand that this portion be transferred directly by the employer, rather than being paid via the employee. The tax debtor-creditor relationship exists with the employee – the employee is liable to pay the tax.

This leads some people to believe that the priority rule defined in Section 15b (8) German Insolvency Code does not sufficiently protect a company’s management. However, this view contradicts the legislative aim of giving priority to the non-payment of taxes during the application period. What is more, the wording of the priority rule corresponds in this respect to the wording of Section 69 German Fiscal Code, which also makes mention of “claims arising from the tax debtor-creditor relationship”. Therefore, should the tax authorities take the view that this wording does not include wage tax, they would have no basis on which to hold management liable. It is hence quite evident that the priority rule defined in Section 15b (8) German Insolvency Code also applies to wage tax.

Second problem:

Another problem results from the fact that an obligation to file for insolvency must have arisen in order for the priority rule to apply. Yet, whether an obligation to file for insolvency exists may not always be clear – for example, when trying to assess in accordance with Section 19 German Insolvency Code whether it is highly likely that the undertaking will continue to be carried on. As the priority rule also ceases to apply upon expiry of the deadline for filing for insolvency, the point in time at which the positive forecast as to the continued operation of the undertaking ceases to apply or the obligation to file for insolvency arises must be determined as precisely as possible in order to avoid liability risks. This is often a difficult task.

Tax authorities could take a tactically clever approach when asserting claims against a management body under Section 69 German Fiscal Code and deny the existence of grounds for filing for insolvency. In this case, the opposing party would be required to prove those grounds in sufficient detail. The authorities could then use the information provided to try and find indications that the obligation to file for insolvency might have arisen at an earlier point in time – with the result that the management body would be subject to the same liability risk.

Third problem:

The third problem arises from the fact that there have so far been good arguments in favour of regarding a wage tax payment due made despite the prohibition as a transaction giving rise to liability under Section 15b (1) German Insolvency Code. This is because, after all, Section 15b (8) German Insolvency Code expressly gives priority to non-payment. Consequently, management bodies can no longer argue there was a conflict of duties. It is doubtful whether such payments would nevertheless be consistent with the “care” required according to Section 15b (1) or at least “proper” within the meaning of Section 15b (2). Once the application period has expired and the priority rule does not apply (anymore), a payment made despite the prohibition might be permitted again as a result of the reviving conflict of duties, so the problem only exists “within” the application period. However, at least in cases where the point in time at which the obligation to file for insolvency arises is unclear, paying taxes despite the prohibition is not a solution for how to remove uncertainties.

It has become even more important to determine the precise point in time at which the obligation to file for insolvency arises. If a company is in crisis, there are normally certain turning points that could convincingly be used for a “cut”. As always, it is necessary to carry out a detailed analysis of the company’s liquidity situation and prepare a meaningful, far-reaching liquidity plan, even if this means – especially in times of crisis – having to do tiresome additional work.

Moreover, at the latest when a company is in crisis, its managers should carefully document their thoughts on whether there are grounds for filing for insolvency and retain these documents for a minimum of five years (limitation period for claims under Section 15b German Insolvency Code), as it will normally be difficult to recall the precise details relevant for, for example, a positive business continuation forecast according to Section 19 German Insolvency Code over a period of five years.