Managing Directors: Rights and Obligations in Germany

Managing Directors: Rights and Obligations in Germany

Managing directors of companies have a vital job when it comes to the successful running of businesses in Germany. Although it is a role that is coveted by many, it also comes with great responsibility. Without competent leadership, an entire business operation can suffer hugely. Being a managing director can be a stressful role and especially at a big company, therefore, it is vital to know your legal rights and obligations.

Should you need the advice of an employment law specialist, please make sure to contact our firm directly. At Schlun & Elseven Rechtsanwälte, our legal team will provide the representation and counsel you require.

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Drafting and Reviewing Managing Directors Contracts

Managing directors are crucial to providing leadership within a company. Without a reliable and competent leader, an enterprise may face serious difficulties.

The managing director’s contract should clearly define the managing director’s area of responsibility (e.g. finance, sales, production, etc.). Additionally, the rights of representation should be precisely regulated within the contract. In principle, the law provides for joint representation, according to which, in the case of several managing directors, only all of them have joint power of representation.

It is therefore advisable to also deal with the partnership agreement before signing the managing director agreement. This caution is especially true since the provisions in the partnership agreement take precedence over those in the managing director agreement.

The legal status of a managing director is unusual as they are not recognised as “employees” under employment law. Yet, in some cases, they are under social security law. If their shareholding within the company is less than 50 per cent, they must be part of the statutory health insurance scheme.

The lack of employee status under employment law has several important points. In concrete terms, it means the following:

  • No automatic entitlement to unfair dismissal protection: managing directors are not simply provided with the same statutory employment law protection granted to employees in this field.
  • Statutory minimum holiday: similarly, managing directors are not automatically entitled to statutory minimum paid holiday time.
  • No automatic right to maternity leave: The protection granted by the Maternity Protection Act in Germany does not automatically extend to managing directors as they are not viewed as employees.

However, these issues should be resolved in the service agreement negotiated between the company and the managing director.

Since the managing director does not enjoy protection against dismissal under the Unfair Dismissals Act (KSchG), this must be contractually compensated. This is usually done using long contract terms and excluding prior termination possibilities. If, however, termination is not excluded, long periods of notice are regularly granted. In practice, a term of at least two years is usual.

If the contract can be appropriately terminated, managing director contracts usually provide a notice period of at least three or six months to the end of a calendar quarter. It is therefore not advisable to sign an agreement that falls considerably short of these guidelines or even provides for a probationary period.

Neither the protective norms of the Continued Remuneration Act (EFZG) nor those of the Federal Leave Act (BUrlG) applies to the managing director. Thus, the law does not allow the managing director to be entitled to continued remuneration in case of illness. There is also no statutory holiday entitlement. To compensate for this and prevent complicated legal disputes, it is necessary to provide the managing director’s contract with appropriate regulations.

In practice, managing director contracts often provide for continued payment of remuneration for at least three months from the beginning of the illness. The leave is usually granted for 30 working days. Do not get involved with less!

As well as these issues, other factors such as confidentiality agreements, pension rights and exclusion clauses (from working with competition) can be inserted. Negotiating a fair service agreement is more than achievable with the proper legal assistance in your corner. Having reliable legal counsel means that you can rest assured regarding your entitlements as a managing director.

Duties towards the Company as a Managing Director

Managing directors are expected to perform their role in the manner of a prudent businessperson. This is laid out in law by § 43 Limited Liability Companies Act. In terms of making business decisions and entering contracts, the managing director is expected to assess the risk involved and act accordingly.

Managing directors have considerable power in decisions about the company’s running. However, they are expected to take advice and counsel on board, especially regarding essential business decisions. If they conflict, they should put the company’s interests first, ahead of their own interests. Poor decision-making resulting in financial losses for the company can mean answering to the shareholders.

As a managing director, there is an obligation not to disclose essential information concerning the company to rival enterprises. Disclosure of business secrets can result in criminal charges depending on the circumstances. The managing director must also ensure that the company does not breach German competition law. Antitrust practices can lead to heavy financial sanctions for the company.

The complete duties of the managing director should be outlined in the Articles of Association and the service agreement. These documents will act alongside their other legal obligations.

Financial Management Obligations

The managing director is responsible for overseeing the financial running of the company. Although there may be a financial manager overseeing the finances, the managing director is ultimately responsible for ensuring that the bookkeeping records of the company are accurate.

Ensuring that the appropriate taxes are paid and that shareholders receive their entitlements in the correct manner is an important aspect of the role. One element of this responsibility is ensuring that the annual financial statements are submitted on time and in the right manner.

It is in the financial running of the company that the threat of accusations of white-collar crime offences can emerge. Should a managing director be found guilty of crimes such as embezzlement, fraud or incorrect filing they can face losing their role, being barred from future directorships and in some cases even prison sentences.

At Schlun & Elseven Rechtsanwälte, our business criminal lawyers advise managing directors in all matters relating to such cases.

Liability and Insurance for Managing Directors

A susceptible area in the context of management is liability. The managing director must continuously make risky decisions and ultimately be responsible for them. These affect numerous areas of law. For example, consequences can occur concerning competition law, the tax authorities or environmental law. The responsibility for manufactured products, subsidies or other grants carries an immense liability risk.

A specific liability limit can be set during contract negotiations as a preventive measure. In the course of this, there is a great interest of the managing director, but also of the company, to define responsibilities precisely. Taking into account the interests of creditors, liability towards the company can be limited to gross negligence and intent. Furthermore, a reduction of the five-year statutory limitation period for claims for damages can also be agreed. The limitation period can also be shortened (e.g. to six months).

Concerning the agreement on clauses limiting liability, it is advisable to seek legal advice given the expected resistance of the partners and the conditions for effectiveness to be observed. The invalidity of the clauses may result from the fact that they place too significant a burden on the company’s creditors or are not per the principles of capital maintenance.

Due to the high risk of the managing director, there is still increasing use of so-called D&O insurances. The company takes such Directors and Officers Insurance in favour of the managing director. It guarantees sufficient coverage in the event of claims for damages from outside parties (such as health insurance companies or the tax office).

Social Insurance Obligations of Managing Directors

A managing director is generally not considered an employee; however, employee status is a prerequisite for many social security regulations. According to § 2 (2) SGB IV, persons employed for remuneration or their vocational training are covered by social insurance. § 7.1 SGB IV defines employment as non-independent work, especially in an employment relationship. In this context, the obligation to follow instructions and integration into the work organisation are indications of such employment (§ 7.1 SGB IV).

According to Federal Social Court case law, the external managing director of a GmbH is, in principle, considered an employee. An external managing director is a managing director without an equity interest who is, in principle, subject to a certain degree of dependency within the scope of his employment.

However, even if instructions concerning work organisation do not bind them, a dependent employment relationship can be affirmed if they do not bear any entrepreneurial risk (BSG, BB 1973, 1310). This is usually the case if the external managing director receives a remuneration which does not depend on the profit made by the company but is fixed from the outset.

Due to the resulting employee status, the latter is subject to insurance and contribution obligations. In the case of social contributions in arrears, the health insurance company can assert claims for damages against the managing director. In case of doubt, it may be advisable to carry out a so-called status determination procedure to ensure that social security contributions are correctly assessed in the payroll.

Outside managers are regularly considered employees and subject to the corresponding social security obligation. Under certain circumstances, however, employee status can be denied, so the social security obligation does not apply.

This may be the case, among other things, if:

  • they can freely design the activity of the external managing director,
  • the articles of association limit the shareholders’ obligation to audit and monitor the external managing director (46 No.6 GmbHG – Limited Company Act),
  • the prohibition of self-contracting according to § 181 BGB was waived,
  • the external managing director has superior knowledge in relation to the shareholders,
  • the management in a family GmbH is characterised by family consideration.

Because of the far-reaching financial consequences connected with the obligation to pay social security contributions, it may be advisable in case of doubt to have it determined whether or not the individual case is a dependent employment relationship. Our attorneys will be pleased to assist you in this.

Shareholders: Relationship and Conflicts with Managing Directors

One of the managing director’s roles is coordinating with the shareholders. A company is not the private fiefdom of a managing director, and they are responsible for acting in the interests of the shareholders. This obligation does not extend to actions that would be in breach of the law. Otherwise, the managing director(s) should have the shareholders’ goals in mind when carrying out the company’s running.

It is also their responsibility to arrange shareholders’ meetings when appropriate. Shareholders have the right to information about the running of the company and to monitor the performance of the managing director. How this interaction with the shareholders is conducted can be of vital importance to the successful running of the company.

Shareholders or designated bodies can appoint managing directors at general meetings. This body will act in the interests of the shareholders. Under § 6(5) Limited Liability Companies Act, in some cases, shareholders can be held liable for appointing a managing director who should not hold the role.

It is of considerable advantage to a managing director if the contract contains a change of control clause. A good relationship with the shareholders is essential for successful company management for a managing director. However, company shares are often sold, so the managing director constantly faces new contacts. The carefully cultivated relationships with the former ones lose their importance and must be reestablished with the new shareholders. A change of shareholders can also change the objectives and make it more difficult for the managing director to fulfil their duties.

A change of control clause, therefore, provides for a special right of termination in case of a change of shareholders. A change of control clause grants the managing director shorter notice periods and may provide a severance payment.

If the managing director does not wish to accept the changed circumstances, they can choose to resign from the position at an early stage. As a rule, the amount of the severance payment is based on the amount of the remuneration that would fall on the remaining term of the contract.

Termination of Service Agreements

As managing directors are not seen as employees in the traditional sense, they are not provided with the protections available to employees under the Protection Against Unfair Dismissals Act. However, elements of such an Act can be negotiated within the service agreement agreed upon between the company and the managing director. Alternatively, they can be placed within the Articles of Association regarding how the company operates.

Contracts can be for a defined time or an undefined period. Most jobs in Germany are for an unspecified length of time. If the service agreement is for a defined period, and a notice period is not specified within the contract, then the contract will end at the expiry of the term. For contracts of indefinite duration, the statutory notice periods apply if there is no stated notice period within the service agreement.

Shareholders have the right to dismiss managing directors, and as the Protection Against Unfair Dismissals Act does not automatically apply, no reasoning is required. However, there must be proof that it is the shareholders’ desire. This can be in the form of a written statement signed by the shareholders’ representative. Should a director be found to have acted fraudulently or been involved with embezzlement or other white-collar crimes, they can be disqualified as a director.

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Practice Group: German Employment Law

Practice Group:
German Employment Law

Dr. Thomas Bichat

Certified Specialist Lawyer in Employment Law

Jens Schmidt

Certified Specialist Lawyer in Employment Law