Severance pay regulations - what is valid under german law?
A review by attorney Fiona Schönbohm
In venture capital investment, so-called "leaver clauses" are common practice. These clauses limit a compensation of participating shareholders for their shares in the event of their withdrawal within a certain period of time (so-called vesting) to amounts that are often far below market value.
However, the provisions adopted from the US legal system are sometimes difficult to reconcile with many german laws. Especially in the case of the financing of start-ups, the regulations are often illegal and therefore invalid due to the important position of founders in the company. In the following, the legal framework to which severance pay restrictions and leaver clauses in Germany must adhere will be briefly outlined.
The prohibition of dismissal
In partnerships and in the GmbH, according to the constant case law of the Federal Court of Justice (german: Bundesgerichtshof, short: BGH), regulations which grant a partner, a group of partners or the majority of partners the right to exclude a co-partner from the company without an objective reason (so-called "termination clauses") are generally invalid under § 138 (1) BGB.
However, this principle does not apply without exception. A termination clause is valid if it is objectively justified by special circumstances. In the so-callled "Manager Model Verdict" of the BGH, which is fundamental in this respect, the court denies a violation of § 138 BGB with the following argumentation, the criteria of which can be used to assess proportionality in individual cases:
- Economically, the participation in the profit of the society stands - in this particular case - in the foreground. Thus the managing director is granted a source of income - co-dependent on his skills in managing the company and reflecting this success - in addition to his salary.
- In contrast to this, the possibilities of the managing director to enforce his ideas against the will of the defendant in the shareholders' meeting are practically excluded. All legal and statutory majorities lie elsewhere.
- On the other hand, the financial risk of the managing director is low. He had been hired from outside and had not had to pay more than the nominal value to acquire his share in the company.
- As a result, the manager involved in this way attained a position similar to that of a trustee, the economic value of which - with a conceivably low risk of his own - lay in the considerable potential for profit distribution during the period of his commitment to the company under the terms of his executive body and service contract.
Whether or not the regulation violates the prohibition of termination depends on the individual case on the position of the person concerned and his or her opportunities to participate in the company. However, for founders of start-ups who subject themselves to such regulations vis-à-vis investors in Venture Capital investment agreements, the majority of such clauses based on these criteria are invalid. This is because they
- have already invested a considerable amount of work in the company,
- hold not inconsiderable shareholdings and
- have taken on a not inconsiderable financial risk with the foundation.
The prohibition of the obstruction of termination
The mere loss of company shares may also violate the prohibition of the obstruction of termination under § 723 III BGB. This is in any case applicable as a prohibition law via § 134 BGB. The prohibition of the obstruction of termination does not only apply to restrictions with direct effect, but also to those which have an indirect or consequential effect and lead to such serious disadvantages that they prevent the person concerned from exercising his or her right of termination.
According to the established case law of the Federal Court of Justice (BGH), such a disadvantage includes, among other things, an unreasonable limitation of the shareholder's right to compensation. A weighing of the proportionality of the regulation must be made here under consideration of the above mentioned criteria of the manager model decision of the BGH.
The prohibition of the limitation on termination
The Federal Labor Court derived the general principle from the prohibition of § 622 VI BGB that it is inadmissible to create an unequal termination situation to the detriment of one of the parties to the employment relationship, above all the employee, by contractual agreements, in particular to agree a unilateral pecuniary disadvantage of the employee in the event of a termination declared by him. This is intended to protect the employee's freedom of decision with regard to the termination of his employment relationship.
According to settled case law, the prohibition of restrictions on termination of employment according to §§ 622 VI, 134 BGB is not without limits. What is decisive is an assessment of the overall circumstances, taking into account the principle of proportionality. In the proportionality test, the manager model decision