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I remember a long time ago, I was playing the Axis and the Italians surrendered. At the time, I had many German formations in Italy, all of which were immediately taken out of Italy when the Italians surrendered.

I think there was talk of changing this so that German formations would NOT be removed from Italy should the Italians surrender(which I think makes more sense).

Was this ever done? Or do all the German units magically get transported out of Italy if the Italians give up the ghost?

In my last game with PL1 a year ago, the German units stayed there. Ideally Germany should send a few before to immediately take control of ports and strategic locations if Italy Surrenders (as in history; close to 20 division I think). The Italian surrender procedure similar to France so it does also allow for a one turn delay to send troops for occupation or even, with troops already there, give a chance for counter-attack to cancel the surrender.

Hum... I must say that the question itself worries me

Italy stays in German hands...all except what the Allies take...prior Italy would become UK but they did not get kicked out...though they were out of supply if not in a port.

Yes, this is much better now.