The digitization of German corporate law has been discussed for more than 20 years and has now, as a result of recent legislation, arrived in legal practice. From a management perspective, digitization offers significant opportunities and challenges. This article provides a brief overview of the potential use of digital tools, the resulting opportunities and requirements for action.
The term digitization is used in different ways – the interpretation changes with the technical progress achieved. Currently, digitization is understood to be a software based process which creates or mirrors analogue workstreams reflecting the human learning.
Opportunities and Challenges
The innovative and future viability of businesses as well as the innovation portfolio and innovative strength of management are increasingly important and have become a relevant element in company valuation.
Digitization can simplify, (partially) automate and increase efficiency of certain processes and tasks, in particular those accessible to standardization, i.e. documentation for mergers/demergers, transformations, but also for the creation of companies or drafting of contracts. While using digital tools for these activities will in principle improve speed, efficiency and can also assist in eliminating mistakes, it does not change the legal framework and the application of the law as such.
Holding virtual board meetings still qualifies as having used digital tools to facilitate processes, but the remote passing of resolutions already goes one step further. Using digital tools to perform or assist with certain management tasks, e.g. in the decision making process and to partly replace such management tasks by the results derived, has material legal impact. In particular, artificial intelligence (AI) cannot only facilitate the decision-making process, but can also be an important element in complying with the principles of the Business Judgement Rule and thus release management from liability. AI as used herein means a software code for the reproduction of human, experience-based learning behavior. An algorithm deserves the predicate “AI” and is “intelligent” to the extent that it develops new process steps for the solution on the basis of feedback it determined to be appropriate for the relevant task (so-called machine learning).
In the foreseeable future, the use of digital tools will become a regular component of good corporate governance and risk management. Consequently, the importance of IT systems and their protection as well as the protection of corporate data and secrets against cybercrime (IT-Security) becomes more and more apparent as so-called cyber attacks on IT systems are being reported to have significant impact on companies. IT-Systems and IT-Security are increasingly becoming a matter for CEO attention in the sense that management is obliged to establish an IT compliance department that is directly subordinated to the management body and tasked with taking the appropriate technical and organizational precautions, including training and educating the company’s personnel. While the appointment of a robot as member to management or supervisory boards remains fiction, the appointment of a Chief Information Officer (CIO) as member of the management board is recommended to quickly react and appropriately manage opportunities and challenges of digitization. Also, supervisory boards will have to ensure that the relevant competence is either represented or readily available for advice if required for the due exercise of the supervision.
Virtual General or Shareholders’ Meetings
The economic potential of virtual general or shareholders’ meetings and corresponding resolutions became obvious during the Covid-19 pandemic. The Covid-19 Act has now introduced the fully virtual execution of the annual general meeting for German stock corporations (Aktiengesellschaft, AG) and has facilitated virtual shareholders meetings for German limited liability companies (Gesellschaft mit beschränkter Haftung, GmbH), the latter by allowing text form or written vote without requiring the consent of all shareholders. Although, the general option to hold virtual general meetings existed prior to the Covid-19 situation, only few companies made use of this option as companies feared an increase in shareholder litigation on the count of a violation of the shareholders’ right to participate in the general meeting due to technical malfunctions. The burden of proof for the establishment of sufficient technical precautions was with the company. The technical issue as such, the risk that a resolution be challenged due to a technical malfunction in the decision making process, was secondary. This uncertainty has been reduced by the Covid-19 Act. The most prominent recent examples of virtual general meetings are the ones held by Bayer AG and BMW AG. Both companies reported significant cost savings.
The simplifications for virtual general or shareholders’ meeting are available to meetings in 2020; an extension to 2021 by statutory order is possible. Although the provisions of the Covid-19 Act have not cleared all ambiguities – companies for example still have to counteract the collection, storage and processing of personal data in a legally compliant manner and the failure of technical data transmission – they provided increased legal certainty for the companies when holding virtual meetings. Consequently, with the expiry of the provisions of the Covid-19 Act and unless the legislator transforms the learnings from this phase into applicable company law, the number of virtual meetings may again decline.
Scope and Use of Digital Tools, primarily AI, by the Management Board
German corporate law does not allow the substitution of management by AI. However, today’s technical possibilities, which have received a further push during the Covid-19 pandemic, allow virtual meetings of management without physical presence. For virtual meetings, secure communication must be ensured and, if required for written decisions, the members of the management board must be clearly identified, while respecting the principle of equal treatment.
The use of digital tools is required when they directly serve to strengthen competition and thus indirectly assist in maximizing profits. However, in line with the above principle, their implementation must not exceed the limits of a delegation of management tasks, so that only preparatory and execution measures can be digitized. In exceptional cases, the use of digital tools may even be mandatory, for example if it is dictated by the company’s object, e.g. in case of a securities services company that pursues algorithmic trading strategies or a bank that prepares financial plans using forecasting methods and instruments (so-called Robo Advice). Robo Advisors are also used for standardized asset management where a customer is assigned to a risk class on the basis of his personal data so that his assets are invested in a sample portfolio assigned to the investor category that matches the customer’s risk class. From this point on, investment decisions for the sample portfolios are made automatically by algorithms.
When using digital tools, management is responsible to ensure that appropriate risk provisioning and monitoring is carried out. While the question of “whether” to set up a risk provisioning and monitoring system constitutes a binding decision of management and thus cannot be avoided, management has discretion with regard to the specific form of such system.
Scope and Use of Digital Tools, primarily AI, by the Supervisory or Advisory Board
Neither for a supervisory or advisory board nor for another facultative body can the primary obligations or the board members themselves be substituted by AI. AI-based executive search engines and compensation consultants can and are likely to be used, where relevant, under stock corporation law to support the selection process for management board members and determination of their remuneration, but they will not be able to bring about complete substitution due to the lack of an AI that makes human verification of the proposed solution superfluous.
Virtual meetings and passing of resolutions of the supervisory board or that of facultative bodies (e.g. advisory board) are possible from both a technical and legal perspective. However, to avoid potential discussions, in particular in relation to fundamental decisions (e.g. in questions of trust), it is advisable to oblige the supervisory or advisory board to hold a physical meeting in case of fundamental decisions, at least once a year.
The supervisory board may reduce its liability exposure under its duty to effectively supervise by using AI to organize the information flow between management board and supervisory board (reporting system). This is because an automated plausibility and completeness check of the management board reports within the reporting system can enable the supervisory board to efficiently design its monitoring process (i.e. reduction of time and information losses).
Compliance with Duty of Care and Liability Reduction through the Use of Digital Tools
Digital tools, primarily AI, when used in the decision making process may also be applied to reduce the general liability exposure of the relevant board member, the three main aspects of which are highlighted in the following:
- With increasing digitization, compliance with the duty of care will require members of corporate bodies, in particular an appointed CIO, to keep a constant eye on technological innovation and potential use cases for his or her respective business.
- The use of AI may become mandatory in the context of the Business Judgment Rule when it comes to the requirement that all legal and factual sources of information that could reasonably have been taken into account for the cost-benefit analysis have been exhausted prior to deciding on the specific individual matter to ensure that an appropriate basis of information had been established. AI is to be used in each case where access to data for the creation of an adequate information basis is thereby greatly facilitated.
- According to the principles of the ISION case law as developed by the German Supreme Court (Bundesgerichtshof, BGH), a board member can avoid liability for a – potential – breach of duty if he or she (i) obtains a written opinion from an expert (e.g. a specialized lawyer), (ii) which was drawn up on the basis of the relevant facts, (iii) checked for plausibility and (iv) has thereon come to a reasonable position. If AI is to be used instead of the expert, it would have to meet the expert qualification under case law. In addition, the plausibility check of a statement generated by AI still raises open questions as it would be necessary to understand the results generated by AI, the so-called AI black box, in order to determine that no errors have been made. The discussion in this area has only just begun. At present, it can only be recommended that a qualified person (e.g. a specialized lawyer with a tech background) should be consulted to check the results when using AI.
Digitization of Company Register and Online Formation, Use of Smart Contracts
Finally, digitization can assist and change the existing processes for company registration and formation:
- The German commercial register already offers an electronic register and online access. On the European level, the Business Register Interconnection System (BRIS) opens up cross-border electronic access to information stored in the respective registers of the member states and to electronically register. BRIS is particularly attractive in cross-border M&A transactions or where a contract partner is in another EU member state. In future, the German legislator must implement the digitization directive to provide for acceptance of national identification particularities for electronic registrations and filings.
- Further, the German legislature will have to enable the formation of a GmbH (and possibly also an AG), without the founding shareholders being physically present at the notary as from August 2021. Irrespective thereof, Germany notaries and lawyers will continue to play an important role as they can and should be involved in the preparation of the required documentation and to avoid invalidity or liability risks.
Although from today’s perspective it is still a long way to go, we think it is worth considering the opportunities that blockchain technology (beyond the crypto currency Bitcoin) offers for contract initiation and processing. It is conceivable, for example, to process transactions using so-called smart contracts. Smart contracts are – simplified – self-executing contracts based on blockchain technology. Even if transactions based on company law may not be the primary area of application and even if an additional mechanism to map any form requirements outside the blockchain must be implemented (e.g. when transferring shares in a GmbH or listed shares), smart contracts may in future also provide for viable options in certain transactions or situations. Today, we see the beginning of an influence on corporate law via the company object where such technology results in the emergence of new business models (e.g. DriveNow). Blockchain technology can in principle also become relevant for public registers or these can be based on blockchain technology. While such tendency is not to be expected in Germany for the commercial register, it may be in other legal systems or for other types of register, one will see such applications in the future, requiring international players to deal with them.