Exclusion of shareholders in Venture Capital

Court in Munich sets narrow limits for exclusion of shareholders

An article by Dr. Boris Jan Schiemzik, certified specialist for Business and Corporate Law in Hamburg

Venture capital investors try to secure their investments through complex contract structures in the VC investment contract. If major disputes arise among the shareholders or if a manager involved in equity wants to resign from his position as managing director, termination mechanisms should enable a complete separation from opposing shareholders.

Prohibition of termination in case law

Even before venture capital has gained a foothold in Germany, the Federal Supreme Court in Germany (BGH) has set narrow limits to the dismissal of shareholders in a GmbH. Today, there is a traditional case law prohibiting the unfounded termination of a partnership, which influences the venture capital investment practice.

Recently the OLG Munich in its judgement of 13.05.2020 (7 U 1844/19) dealt with the question relevant in practice, when a partner can be excluded on the basis of a vesting agreement in the participation contract. The court has set narrow limits to the so-called manager model, under which the BGH allows the exclusion of a shareholder.

Shout out contractual practice

Shareholders can be forcibly excluded in a GmbH in various ways. Common to all coercive measures is that the exclusion of a shareholder or group of shareholders is carried out against the will of the shareholders concerned. The excluded shareholders receive a compensation claim or a purchase price claim for the lost company share.

In venture capital practice, so-called call option models are very often used. According to these models, a shareholder loses his participation - sometimes even without a shareholders' resolution - if certain conditions precedent occur and options are triggered by investors or co-shareholders. In investment agreements, shout-out mechanisms are very often standardized for the case of premature termination of the management position in favor of the VC investors. According to these mechanisms, a shareholder loses his start-up participation if he resigns his position as managing director or terminates his managing director contract.

In some cases, such call option models are supported by collection systems. With a forced withdrawal, company shareholdings can be destroyed. The affected shareholders then lose their shareholding not through a forced transfer, but through the destruction of the GmbH shares. However, the forced redemption always requires a resolution of the shareholders' meeting.

The so-called manager model of the BGH

According to the constant jurisdiction of the BGH, cancellation regulations are void according to § 138 BGB, if they lead to the fact that partners can be excluded from a company without any reason. It is irrelevant whether these termination provisions are agreed in the partnership agreement or in the participation agreement.

However, the BGH recognizes exceptions to the nullity of the termination notice: An important exception is the manager model. The court affirmed the termination of a shareholder-manager who held a share of approx. 10 %. This was sold to him at nominal value and was intended to incentivise him as manager of the company to participate in profits. The company also distributed the profits in full.

In this case the majority shareholder - according to the opinion of the BGH - was able to withdraw the manager's participation in the company when he gave up his position as managing director. The BGH assessed the company participation itself only as a "better" bonus. In particular, in the decided case the manager was never able to enforce his own position against the majority shareholder with his participation in the shareholders' meeting.

OLG Munich prevents cancellations

With its new decision of 13.05.2020 the OLG Munich strictly follows the guidelines of the BGH. It wants to make a notice of termination possible and thus only affirm the existence of a manager model if the shareholder concerned has been granted a low shareholding and a shareholding structure exists which does not allow the shareholder concerned to exercise entrepreneurial influence. Whoever takes on risks as a shareholder and raises significant capital for the investment would have a "normal investment", which should not be taken away from him without good reason - so the result of the OLG Munich.

In the present case, the managing director had a 25 % shareholding, for which he paid over EUR 290,000.00 into the capital reserves in excess of the nominal value. Since a total of 17 shareholders were involved in the GmbH, the shareholder who was terminated had a considerable entrepreneurial influence with his 25 %.

In contrast to the manager model decided by the BGH, the OLG Munich is of the opinion that the participation of the affected shareholder was not a mere annex to his management activities. The participation was not granted to him as a mere instrument similar to a bonus and could therefore not be withdrawn without good reason.

Judgement analysis and conclusion

The judgement of the OLG Munich, which draws very close borders for the manager model, has an important meaning for termination clauses in GmbH partnership contracts, participation contracts and partner agreements - especially when it comes to the financing of startups.

In particular in the private Equity and venture capital investment business, extensive termination clauses can be found, which collide with the new OLG Munich jurisdiction. At the latest after this ruling, which strongly limits the possibility of termination, the contractually agreed "free exclusion possibilities" must be put to the test.

In particular in the case of cancellations that are linked to Bad Leaver compensation clauses, which place the compensation payments far below market value, affected shareholders will increasingly seek opposition and take legal action against the cancellations. In corporate litigation practice, it can be observed that opposition to the expulsion itself already drives up the prices of the compensation. The VC and PE practice must adjust to this. Quick exclusion for small money is only possible to a limited extent under company law in Germany - until the Federal Supreme Court extends the possibility of termination.