Business Risks as Legal Problem. Risk Management as Obligation for the Management

Table of Contents

TABLE OF FIGURES

TABLE OF CHARTS

TABLE OF ABBREVIATIONS

1 INTRODUCTION

2 DEFINITIONS AND REFERENCES
2.1 THE KONTRAG
2.1.1 Requirement of a Reform
2.1.2 Development and intention of the KonTraG
2.2 RISK MANAGEMENT - ORGANISATIONAL ENTITY

3 RISK MANAGEMENT - A LEGAL ISSUE
3.1 RISK MANAGEMENT BEFORE THE INTRODUCTION OF THE KONTRAG
3.2 RISK MANAGEMENT AFTER KONTRAG

4 SUMMARY

APPENDIX

BIBLIOGRAPHY

Table Of Figures

Pic. 1: German Company Insolvencies

Pic. 2: Risk Management Process

Table Of Charts

Tab. 1: The first preliminary issue regarding the risk management

Tab. 2: RefE of the 22nd of November 1996

Tab. 3: Final article §91 II AktG

Tab. 4: Der erste Entwurf zum Risikomanagement

Tab. 5: RefE vom 22. November 1996

Tab. 6: Endgültiger §91 II AktG

Table Of Abbreviations

illustration not visible in this excerpt

1 Introduction

“In the strict reflection there is no difference regarding the legal basis of risk management between now and yesterday, also according to the old law the management was obligated to recognize developments which were threatening to the existence of the company”¹ is the comment of the minister of justice to the debate of the “Gesetz zur Kontrolle und Transparenz im Unternehmensbereich (KonTraG)”.

Due to the raising rate of insolvencies (Pic. 1), increasing number of com- pany crises and because of the “corporate governance” discussion, the leg- islator recognized the need to develop a new law. The KontraG was intro- duced at the 5th of March 1998,² which mainly influenced the “Aktien- and Handelsgesetzbuch”.

The consequences of this law are discussed highly controversal by experts.³ There is no general opinion, particularly in terms of the commitment of the introduction of a risk management according to the §91 Abs.2 AktG. The following analysis of the legal basis specifies the de facto obligations of a stock corporation management in regards to risk management. Chapter 2 gives a theoretical and historical introduction into the topic of risk management. It is essential to understand the meaning of risk management in terms of how a manager, opposed to a lawyer, would define it. Chapter 3 discusses the legal foundation of risk management. In order to understand the different obligations required by the new law, the chapter is separated into the analysis of the old legal foundation then the new.

2 Definitions and References

The following chapter gives a theoretical foundation to better understand and classify terms used in risk management. The historical consideration of the development of KonTraG will provide a deeper understanding about the public discussion of the KonTraG and the legal foundation of risk manage- ment.

2.1 The KonTraG

KonTraG, introduced on the 5th March 1998, is a prescription to modify and complement other laws.⁴ Many experts are convinced, that the new legal bases forces the management to set up risk management systems. The following chapter describes the historical development of the prescription.

2.1.1 Requirement of a Reform

The requirement of a reformation in the legal basis is justified by the government due to the “weaknesses and malpractices” in the German system of company and corporate control.⁵ This is in response to the increasing rate of insolvencies (Pic. 1) and company crises⁶ and takes into account the rise of German companies into the capital markets.⁷

The starting point of this debate was due to the companies` crisis suffered by “Metallgesellschaft” and “Balsam/Procedo”. Metallgesellschaft suffered a 2,5 billion DM loss in 1992/1993 with risky oil futures in the USA.⁸ The crisis caused the reorganization of the company⁹ to the “MG Technologies AG”, whereby thousands employees lost their jobs and a huge part of the company was sold to Outokumpu.

illustration not visible in this excerpt

Pic. 1: German Company Insolvencies

Source: “Verband der Vereine Kreditreform e.V” The analysis of the past situation lead once again to the problem of the “Erwartungslücke” .¹⁰ Many discussed possible reasons why the supervisory board (German: “Aufsichtsrat”) could not prevent the negative development from occurring, as well as the value of the annual report, in terms of whether or not to report upcoming or possible negative trends in a company`s situation.¹¹

2.1.2 Development and intention of the KonTraG

§ 91 II AktG “ The board of executives has to provide tools, particular a supervisory system, which are allowing to realize developments that are threatening the existence of the company, in time ” After KonTraG was introduced the regulation of §91 II AktG caused an unexpected public controversy among many experts.¹² In regards this clause it is alleged, that a risk management is nowadays ob- ligated. To better understanding the controversy surrounding this regulation, it is useful to remember the historical development, as well as, the prelimi- nary versions.

Regarding reasons expressed in chapter 2.1.1., the Federal Ministry of Justice (German: “Bundesministerium der Justiz”) called an interdivisional meeting for the “improvement of the annual account” (German: “Verbesserung der Abschlussprüfung”), which issued an internal proposal on the 8th of September 1995. This suggestion contained a new clause §264 VII HGB for the “Handelsgesetzbuch” (Tab. 1).¹³

Legal representatives are required to implement arrangements/tools in regards to the size of the company and corporation, that

1. are recognizing developments which are threatening the existence of the company in time,
2. risky transactions and businesses are restricted by rules, so that these businesses can not threaten the existence of the company, and
3. mistakes and false prognosis, which influences the assets and the profitability of a company are detected.

Also a personal and material equipped supervising system, which is directly under control of the legal representatives, which is monitors the arrangements stated in sentence one.

illustration not visible in this excerpt

Tab. 1: The first preliminary issue regarding the risk management

Source: Translated from Seibert (a) (2000), p.429, original see Tab. 4 In this meeting it was discussed that an accountant should oversee the in- ternal auditing system (German: “Interne Revision”). This is only feasible, if there is a legal requirement for company leaders to install an internal audit- ing system, since the annual accountant can not control something what barely or simply does not exist. According to the preliminary issue, the internal auditing has to monitor the correct implementation of the arrangements, which have to be able to detect threatening developments and restrict risky transactions if they are threatening to the existence of the company, as well as, recognize mistakes and false estimations if they are significant to the profitability of the company. Regarding the suggestion it is noteworthy that the clause would have been placed in the “Handelsgesetzbuch” which means, it would have influenced all capital companies, not only stock companies.

A main issue of this first proposal was, number 2; “risky businesses are re- stricted, if they are threatening the existence of the company”. That means, that per definition, these sort of transactions are not allowed. This is a mas- sive cut into corporate freedom (administrative discretion). The Argument was that to be successful in business it is necessary to accept risks.¹⁴ This first issue was then forwarded to the committee “Control and Transpar- ency in Companies/Banks. The primary concern of this meeting was to pre- vent further burden on the companies and the “not-GmbH” regulation. Based on the decisions made in this meeting, RefE was issued on the 22nd of No- vember 1996.¹⁵

Now the issues of the risk management are no longer in the “Handelsge- setzbuch”, but in the “Aktiengesetzbuch” in clause §93 AktG (Tab. 2), mean- ing, only stock companies have to consider this prescription. Furthermore, the issue of the risk management is alleviated. Now the clause only requires recognizing threatening risks, not to restrict them.¹⁶ This RefE was also heavily criticized because of its vagueness, to extended and inconsistent verbalisation. Lutter responded to this problem by saying, “…the art of the creation of a law is in the aggregation not in annotation..”.¹⁷

They (the board of manager) have to implement proper arrangements while taking the type and size of the company and group corporations according to §290 HGB in account, that ensure, that developments, which are threatening the existence of the company, such as risky transactions, mistakes and false accounting and violations against laws, which are significant to the assets and profitability of the company or corporation, are discovered early.

This also includes a supervisory system, with the task of ensuring the implications as mentioned in sentence 2.

illustration not visible in this excerpt

Tab. 2: RefE of the 22nd of November 1996

Source: Translated from Seibert (a) (2000), p.432, original Tab. 5 The criticism of the “DAV” finally caused the prescription to be implemented in §91 II AktG, in the extremely condensed wording that exists today (Tab. 3).

The board of executives is required to provide tools, particularly a supervisory system, which allow developments recognized, if they are threatening the existence of the company, in time.

illustration not visible in this excerpt

Tab. 3: Final article §91 II AktG

Source: Translated from Handelsgesetzbuch, 40. Aufl., München (2003), original Tab. 6 It is remarkable, that the clause does not further mention any sort of risks. Furthermore, there is no consideration of corporate groups, or contempt of the accounting included.

Recapitulating, with the KonTraG, the legislator was pursuing to solve the explained weaknesses described in Chapter 2.1.1 with improvement of the control potentials of the supervisory board and modifications regarding to the annual accounting. ¹⁸ To achieve this goal, it was necessary to introduce a clause, which obligated the manager to establish an internal system of con- trol.

The question of whether the executive board is still liable for the set up of a risk management according the shortened version of §91 II AktG, especially in connection with other articles of the KonTraG, will be answered in the chapter 3.

[...]

¹ Däubler-Gmelin (1999), p.135

² Semmler (2000), p.394

³ AnwaltsKomm/ Heidel (2003), § 91 Rn6, p. 483

⁴ The main modifications were applied in: “Aktien- und Handelsgesetzbuch”, but there are also influences to the: “Publizitäts-, Genossenschafts-, Wertpapierhandels-, GmbH-Gesetz” and to the “Gesetz über Kapitalgesellschaften”, “Angelegenheiten der freiwilligen Gerichtsbarkeit”, and the “Börsenzulassungs-, Wirtschaftsprüfer-Verordnung”.

⁵ Lück (a)(1998), p.8

⁶ Götz (2000), p.394

⁷ Brebeck (1997), p.381

⁸ Albers (2002), p.226ff

⁹ Wolf (2001), p.17

¹⁰ The “Erwartungslücke” is the problem of the lack of satisfaction of the expectations of the public by the accountants, shortly the lack of information for the share and stakeholder, given in the annual accounts.

¹¹ Ernst (a)(1999), p.3

¹² Seibert (a)(2000), p.428

¹³ Seibert (a)(2000), p.428

¹⁴ Seibert (a) (2000), p.431

¹⁵ Albers (2002), p.155

¹⁶ O.V. (a)(1996), p.2129

¹⁷ Seibert (a)(2000), p.434

¹⁸ Lehner (1999), p.25