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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. Our team will provide the legal representation and counsel you require.

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Being a managing director comes with great responsibility

At Schlun & Elseven we provide comprehensive support to managing directors in Germany

The Job description of the Managing Director?

First of all, the managing director’s contract should clearly define the managing director’s area of responsibility (e.g. finance, sales, production, etc.). Furthermore, the rights of representation should be precisely regulated. 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. However, this is often deviated from in the articles of association.

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


Who can hold the Role of Managing Director?

A managing director must be a natural person with full legal capacity over the age of 18. They can be male or female and there is no requirement that they need to be German. They should, however, be able to work in Germany and be able to avail of appropriate visas. Furthermore, there is no specific qualification required for the role of managing director. However, they have to be able to work in the profession and not have any ban preventing them from working in the industry or disqualified from holding a directorship. Should the appointed managing director not be able to work in the industry, and shareholders knowingly appoint them to the role, the shareholders can be held liable for the losses incurred.

A company can also appoint more than one, as some companies require more depending on their size. These directors should however make sure that they are working in tandem as coherent leadership is important for success. The interests of the company should come first when it comes to planning and implementing strategies.


The Legal Status of a Managing Director

Managing directors are key to providing leadership within a company. Without a reliable and competent leader, an enterprise may face serious difficulties. The legal status of a managing director is an unusual one 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 percent, then 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. As well as these issues other factors such as confidentiality agreements, pension rights and exclusion clauses (from working with competition) can be inserted. With the right legal assistance in your corner from experienced employment law professionals negotiating a fair service agreement is more than achievable. Having reliable legal counsel means that you can rest assured when it comes to your entitlements as a managing director.


Was there a Prior Employment Relationship?

If someone becomes managing director of a company for which he/she previously worked on the basis of an employment relationship, it can be contractually agreed that the previous employment relationship is only to be suspended and not terminated for the duration of the managing director’s activity. Such a clause in the managing director’s contract can protect the managing director from losing his or her job completely upon termination of the managing director’s activity. With the dismissal as managing director, the previously existing employment relationship is revived.


Length of Contract and Periods of Notice

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 by means of long contract terms and the exclusion of 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 terminated properly, managing director contracts usually provide for a notice period of at least three or six months to the end of a calendar quarter. It is therefore not advisable to sign a contract that falls considerably short of these guidelines or even provides for a probationary period.


Continued remuneration and holiday entitlement

Neither the protective norms of the Continued Remuneration Act (EFZG) or those of the the Federal Leave Act (BUrlG) apply to the managing director. Thus, the law does not provide for the managing director to be entitled to continued remuneration in case of illness. There is also no statutory holiday entitlement. As a compensation for this and to 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 illness. The leave is usually granted for 30 working days. Do not get involved with less!


Change of Control – Clause

It is of considerable advantage to a managing director if the managing director contract contains a change of control clause. For a managing director, a good relationship with the shareholders is essential for successful company management. However, company shares are often sold, so that the managing director is constantly facing new contacts. The carefully cultivated relationships with the former ones lose their importance and have to 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 the event of a change of shareholder. A change of control clause grants the managing director shorter periods of notice and may provide for 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.


Compliance with the Law: Obligation of Managing Director

As the managing director of the company, you are held responsible for ensuring that the company is compliant with company law in Germany. It is vital to ensure that there is a structure in place to prevent breaches of the law within the company. Ensuring that the right managers are in place in different parts of the company structure will help on this front. As well as the company itself, the managing director should be aware that their responsibility further extends to subsidiaries of the company. Once again, this is where a good management structure, putting steps in place to ensure that the employees are aware of legal elements in their field and having steps in place to monitor output is vital.

In order to ensure that this takes place it is vital that your company has legal advice and assistance from experienced German business lawyers. Our employment law team provide in-house advice to companies while we also provide advice on corporate law in Germany.


Specific Risks and Defence Options

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

As a preventive measure, a certain liability limit can be set during contract negotiations. 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 then 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 (e.g. to two years). The limitation period can also be shortened (e.g. to six months).

With regard to the agreement on clauses limiting liability, it is advisable to seek legal advice in view of 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 great a burden on the company’s creditors or are not in accordance with the principles of capital maintenance.

Due to the high risk of the managing director there is still an increasing use of so-called D&O insurances. Such Directors and Officers insurance is taken out by the company 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).


Financial Management of the Company: Obligation of Managing Director

The managing director is responsible for overseeing the financial running of the company. Having competent financial assistance is vital to ensure that the financial transactions are all above board. 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.


Duty Towards 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 properly assess the risk involved and act accordingly. In decisions about the running of the company, managing directors have considerable power. However, they are expected to take advice and counsel onboard especially when it comes to important business decisions. They should put the interests of the company first, ahead of their own interests if they conflict. Poor decision making that results in financial losses for the company can mean having to answer to the shareholders.

As s managing director there is an obligation to not disclose important information concerning to company to rival enterprises. Disclosure of business secrets can result in criminal charges depending on the circumstances. The managing director also has to ensure that the company does not breach German competition law. Practices that are antitrust in nature can lead to heavy financial sanctions for the company.

The full 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.


Managing Directors and Shareholders

One of the roles of the managing director is to coordinate with the shareholders. A company is not the private fiefdom of a managing director and they have a responsibility to act 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 goals of the shareholders in mind when carrying out the running of the company. 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.

Managing directors can be appointed at general meetings by the shareholders or in some cases by a body designated to do so. 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.


The Social Insurance Obligation of the Managing Director

As already mentioned above, a managing director is generally not considered an employee. However, the employee status is a prerequisite for many social security regulations. According to § 2 (2) SGB IV, persons who are employed for remuneration or for their vocational training are covered by social insurance. § 7.1 sentence 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 sentence 2 SGB IV).

According to the case law of the Federal Social Court, 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 they are not bound by instructions with regard to the organisation of work, a dependent employment relationship can be affirmed if they do not bear any entrepreneurial risk of his own (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 therefore be advisable to carry out a so-called status determination procedure to ensure that social security contributions are correctly assessed in the payroll.


Exceptions to the Social Security Obligation

As mentioned in the previous section, outside managers are regularly considered as employees and are therefore subject to the corresponding social security obligation. Under certain circumstances, however, employee status can be denied, so that the social security obligation does not apply.

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

  • the activity of the external managing director can be freely designed by him
  • 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 characterized 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.


Termination of a Service Agreement

As stated above, managing directors are not seen as employees in the traditional sense. Therefore, 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 between the company and the managing director. Alternatively, they can be placed within the Articles of Association as to how the company operates.

Contracts can be for a defined period of time or for an undefined period of time. Most jobs in Germany are for an unspecified length of time. If the service agreement is for a defined period of time, 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, if there is no stated notice period within the service agreement then the statutory notice periods apply.

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 desire of the shareholders. This can be in the form of a written statement signed by the representative of the shareholders. Should a director be found to have acted fraudulently, have been involved with embezzlement or other white collar-crimes, they can face disqualification as a director.


Does a Managing Director Need to Live in Germany?

A managing director in Germany does not need to be German and they do not need to have their primary residence in Germany. In fact, the only thing that needs to be shown is that the managing director is not banned from visiting Germany. However, should the managing director not have their main residence in Germany the company could face questions relating to tax issues. If the company is not operated from inside Germany, then it faces questions as to whether it is really a German company at all.

Steps should be taken by the managing director to ensure that the company is in fact primarily run and organised from Germany for it to remain a German company. This may mean that the appointment of someone within Germany to oversee the German section of operations may be prudent. However, this will depend on the circumstances surrounding the company.


Does a Managing Director in Germany Need to Speak German?

We have had inquiries from clients in important roles seeking the answer to this question. Some have been offered to opportunity to manage companies in Germany based on their skill as a manager and not for their German language skills. The answer to this question is no, German language skills are not a requirement to be a manager in Germany. However, it is of course beneficial to have German language skills for living in Germany and for operating a business in the country, but it is not a requirement. It should be noted that if you do not have German language skills, or if your German is not at a high professional standard upon taking up the managing director role, it is advisable to get documents translated and have help from a translator readily available. Limited language skill is not a valid excuse in legal issues.

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Jens Schmidt

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Martin Halfmann, LL.M.

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