Why more than 95% of managing partners lose their pension

A ruling by the BGH (Federal Court of Justice) dated 1 April 2013 (ref. IX ZR 176/76) shows that managing partners and controlling directors often face the complete or predominant loss of their pension as a retirement benefit – despite “pledging the reinsurance for supposed insolvency protection”.

Right of recovery lies solely with the insolvency administrator

If a GmbH or AG becomes insolvent, only the insolvency administrator is entitled to collect the reinsurance funds – in particular the life insurance policy taken out for old-age provision, § 173 InsO (German Insolvency Code). The insurer is no longer required to make payments jointly to the company and to the person to be provided for.

For the time being, the assets are gone

The former director or managing director may initially demand “security on the basis of a security interest by way of pledge”. The insolvency administrator, however, will first deduct from the assets a 4% assessment charge and a 5% realisation charge, in each case plus value added tax, §§ 170, 171 InsO. The right to collect remains with the insolvency administrator even where individual instalments or pension payments fall due month after month – whether these are then actually paid out by the administrator is often anyone’s guess.

Total loss of the old-age pension, with good prospects only of social security benefits

The insolvency administrator will dutifully examine whether a claim can be brought against the former director or board member on the grounds of organ liability or manager liability. In more than 95% of cases, the insolvency petition is filed too late or other management errors are present, so that personal liability for the conduct of business opens the door for the administrator to set off claims.

Roughly every second pension commitment lacks assets to cover the pension

According to expert experience, about every second pension commitment to a managing director comes onto the radar of the tax audit because there is simply no reinsurance to finance it. The same applies in the frequent case where the company’s principal bank has secured first-ranking access to the reinsurance assets as loan collateral through its general terms and conditions, without the management noticing. In that case, even an otherwise valid pledge of the reinsurance policy is of no help, because the bank’s claim takes precedence.

Life expectancy and occupational disability risk often not covered

Where cover capital is available at all, it is of course far from sufficient to provide for an average life expectancy – if only because of the contributions that are no longer paid in the event of insolvency up to the start of the pension. This is particularly true if the managing director lives longer, which, given a remaining life expectancy of 7 years or more, is to be expected in 50% of cases. If he becomes unable to work and therefore also has claims under the pension commitment, the capital will often be used up long before the retirement pension begins – the surrender value for the occupational disability (Berufsunfähigkeit) benefit, if any, is very low. This is all the more so where the insolvency administrator deducts his costs and then earns far less interest on the remainder than the insurer would have done. If the administrator cancels the reinsurance policy, protection in the event of invalidity – and, in many cases, any protection for widows and orphans – ceases abruptly.

Even a premature departure alone can lead to total loss

Managing partners regularly receive what is known as an immediately vested pension commitment from the outset. For tax reasons, however, the amount may only relate to the period between the granting of the commitment and departure from the company, owing to the prohibition on subsequent funding (BMF letter dated 9 December 2002, Federal Tax Gazette I 2002, p. 1393). In many cases, tax auditors and insolvency administrators will identify a flaw in the pension commitment that gives rise to a hidden distribution of profits (verdeckte Gewinnausschüttung, vGA).

A hidden profit distribution leads to tax damage and manager liability

A vGA will be assumed in particular where the amount of the pension entitlement recognised for tax purposes is lower than the entitlement granted under civil law in the company pension commitment. In many cases this means that, objectively, the elements of a breach of trust are present – a classic case of directors’ and officers’ liability. There is then “double” taxation as quantifiable damage. In other cases there is, for example, a lack of the formal shareholder resolutions, so that no vesting occurs at all – something that will not escape the insolvency administrator, with the result that the managing director then receives no pension whatsoever; and without a pension entitlement, the pledge securing it likewise comes to nothing. In hindsight, the former board member or managing director would have done better to have his pension commitment reviewed year by year for its effectiveness.

Effective domestic asset protection?

Occupational pension (bAV) schemes are particularly prone to errors and losses. Being self-employed for a good 30 years means, statistically, that every third person will already have experienced an insolvency. Added to this are the risks of arrangements that are defective from the outset, as well as the failure to take account of changes in the law and unexpected turns in case law. More effective protection of assets for old-age provision (asset protection) is more often achievable within the framework of private pension schemes. In many cases, the asset protection of occupational and private pensions works better abroad.