The office of managing director in a German company is highly coveted due to its prestige, but it is also associated with a great deal of responsibility. Wrong decisions and hesitant or hasty actions entail considerable risks for the company and its employees. Logically, the managing director bears a high degree of accountability. Therefore, anyone seeking such a position in Germany should have a precise overview of the scope of obligations that arise to avoid unnecessary pitfalls and minimise liability risks.
Have you been offered the position of managing director of a company in Germany, or do you intend to terminate such an employment relationship and need clarification on meeting all the legal and contractual requirements under German law? Whether your concern is drafting your management contract, liability issues, or any other matter relevant to German corporate law, our German corporate law team at Schlun & Elseven Rechtsanwälte will be happy to assist you with their expertise built on extensive experience. They will be glad to show you how to effectively use existing leeway and minimise liability risks when taking on the role of managing director in Germany.
Drafting and Reviewing Managing Directors Contracts
Given the prominent role of the managing director in the management, representation and turnover of a company in Germany, the shareholders’ agreement is also of particular importance. Provisions should be made in five different areas to avoid ambiguity and legal disputes:
- Reducing and preventing the managing director’s liability,
- transactions requiring consent,
- scope of the managing director’s rights and duties,
- termination options for shareholders,
- non-competition clauses and customer protection clauses.
First, the managing director’s contract should clearly define the managing director’s area of responsibility (e.g. finance, sales, production, etc.) and the scope of their powers of representation.
Since the managing director is not considered an employee under labour law, there are:
- no protection against dismissal under the Dismissal Protection Act (Kündigungsschutzgesetz),
- no continued payment of wages in the event of illness under the Continued Payment of Wages Act (Entgeltfortzahlungsgesetz),
- no entitlement to statutory minimum annual leave, and
- no entitlement to annual leave under the Maternity Protection Act (Mutterschutzgesetz).
Therefore, precise provisions regarding these aspects should be negotiated between the company and the managing director in the employment contract. Nevertheless, it should be noted that in some cases, managing directors in Germany are subject to social security contributions. If their stake in the company is less than 50 per cent, they must also have statutory health insurance.
Long contract durations and a termination exclusion, which are typical in practice, can protect the potential managing director against dismissal. If termination is not excluded, long notice periods are regularly granted. Typically, a period of at least two years is usual.
If the contract can be terminated with notice, it can be provided 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 well short of these requirements or even provides for a probationary period. As a substitute for missing regulations on the continued payment of wages during illness and on holidays, continued payment of salary for at least three months from the beginning of the illness and a holiday for 30 working days are often negotiated. In addition, further aspects, such as confidentiality agreements and pension entitlements, can be included.
Compensation Payments for Non-Competition Clauses
A competition clause is often included in managing director contracts to protect the business against the loss of know-how and inside knowledge, including trade and business secrets. This clause contains a prohibition on competing with the company managed by the managing director. While such a prohibition is clearly provided by law regarding the period of contractual cooperation, a post-contractual competition clause must be explicitly regulated by contract.
The absence of compensation tends to argue against the validity of such a provision, but – unlike in employment contracts – it does not rule it out from the outset. In the case of a post-contractual non-competition clause, the managing director is advised to negotiate compensation in the contract to avoid the risk of not being gainfully employed without monetary compensation.
Special Termination Rights through Change-of-Control Clauses
Finally, change-of-control clauses offer the managing director a special right of termination in the event of a change of shareholders, granting them shorter notice periods and a severance payment. The amount of the severance payment is usually based on the amount of remuneration that would have been due for the remaining term of the contract. If shares in the business are sold, this enables them to resign from office at short notice – for example, if the new shareholder has different objectives for the company or if it becomes more difficult for the managing director to fulfil their duties.
Duties and Liability of a Managing Director towards the Company
In addition to managing the operative business, the managing director has far-reaching responsibilities towards the company, the shareholders, and third parties. Personal liability in the areas of tax and insolvency law carries high risks.
The most important duties of a managing director include:
- Fulfilling tax obligations to authorities – including social security authorities and the tax office,
- Judicial and extrajudicial representation of the company,
- Strict duties of care: The GmbH managing director must always exercise the diligence of a prudent business person, i.e. carry out comprehensive research and risk assessments before making a decision. If this is violated, the managing director is liable to the company for any damages – without limit and personally. However, not every decision the managing director makes that is subsequently proven to be wrong results in a liability for damages to the company. If they have obtained comprehensive information and acted in the company’s best interests, such errors are within the scope of their broad discretion. Liability arises only if the managing director can be accused of acting in breach of duty. These duties of care include, for example, constantly monitoring the company’s economic and financial situation.
- Tax law: The managing director is liable under German tax law if the company’s taxes have not been paid due to their fault – this includes corporate income tax, trade tax, value-added tax, payroll taxes, and other levies. In this context, it is recommended, in addition to careful control and monitoring of all tax obligations, to precisely document all processes for possible review by the tax office and to pass on the activity to internal or external tax law experts.
- Insolvency application obligation: In the event of impending or actual insolvency and over-indebtedness, an insolvency application must be filed for the company’s assets without delay – within a maximum period of three weeks. However, this only applies if restructuring efforts with real prospects of success are made; otherwise, the insolvency application must be filed immediately. In the event of a violation, in addition to personal civil liability, a prison sentence of up to three years may be imposed.
This extensive catalogue of duties can only be partially inferred from the law, so it makes sense to obtain comprehensive clarification before commencing management activities – especially since liability begins in the formation phase. If the managing director in Germany conducts business in the company’s name before the company is entered into the commercial register, they are personally liable to the creditors. For example, legal transactions in which the managing director exceeds their power of representation or carries out legal transactions without the required consent of the shareholders are subject to a high degree of liability.
Measures to Reduce Liability for Managing Directors in Germany
However, if no comprehensive risk assessment has been carried out, liability for damages to the company can quickly become an existential threat. To reduce these risks, managing directors in Germany should always document the bases for their decisions in detail and protect themselves by consulting with tax advisors and lawyers. For particularly extensive or unusual transactions, shareholder resolutions can be obtained for reinsurance. Finally, directors and officers liability insurance (D&O insurance) is recommended – the company typically bears the insurance premiums.
Liability and Insurance of Managing Directors | Manager Liability D&O
Liability is considered an area of particular risk in management. Risky decisions that the managing director has to make on a daily basis to fulfil their duties often have consequences under competition, tax, or environmental law. Responsibility for manufactured products, subsidies, or other grants also entails immense liability risk.
A certain liability limit can be set during contract negotiations as a preventive measure. It is in the best interest of the managing director and the company to precisely define the responsibilities. Considering the interests of creditors, liability to the company can be limited to global negligence and intent. In addition, a reduction of the five-year limitation period for claims for damages can be agreed upon. The limitation period can also be shortened, for example, to six months.
When negotiating liability limitation clauses, it is advisable to seek legal advice, given the likely resistance of shareholders and the conditions for effectiveness that must be observed. The clauses may be ineffective if they place too significant a burden on the company’s creditors or do not comply with the principles of capital maintenance.
Due to the high risk, D&O insurance is increasingly being used in addition to individual contractual clauses. The company takes out such a directors and officers insurance policy in favour of the managing director. In particular, it guarantees sufficient coverage for claims for damages from third parties (e.g., health insurance companies or the tax office).
One of the managing director’s tasks is to coordinate with the company’s shareholders. Actions relevant to the company should always be taken in the shareholders’ interest – this does not, of course, extend to actions that would violate the law. However, the managing director must always consider the shareholders’ objectives when conducting business. It is also the responsibility of the managing director to call shareholder meetings as necessary. The shareholders have the right to receive information about the company’s management and monitor the managing director’s performance. How this interaction with the shareholders is structured can be crucial to the company’s successful management.
The shareholders or their appointed bodies can appoint managing directors at the shareholders’ meeting. These bodies act in the interests of the shareholders. According to § 6(5) GmbHG, the shareholders can, if applicable, be held liable for appointing a managing director who should not perform this function.
A good relationship with the shareholders is essential for a managing director to be able to manage the company successfully. However, company shares are often sold, meaning the managing director constantly deals with new contacts. A change of shareholders can also alter the objectives and make it more difficult for the managing director to fulfil their tasks.
Termination of the Contractual Relationship
Since the managing director is not an employee but an organ of the company, the dismissal of the managing director is possible at any time without justification – unless otherwise stipulated in the statutes. There can be many reasons for dismissal, for example, if the managing director has acted with fraudulent intent or is involved in embezzlement or other economic crimes. The dismissal, which results in the loss of the power of management and representation, must be entered in the commercial register. Otherwise, there continues to be a refutable presumption that the managing director has the power of management and representation. Therefore, the shareholders should have the dismissal entered in a notarial form as soon as possible.
However, the dismissal does not affect the employment relationship between the company and the managing director, so this employment contract must be terminated in the same way as a standard employment contract. For fixed-term contracts, an ordinary right of termination can be agreed upon in the employment contract. If this is not the case, only extraordinary termination for good cause is permissible, for example, in the event of misappropriation of company assets. For contracts of indefinite duration, the notice period is governed by the statutory provisions unless a different period is specified in the employment contract itself.
Entry into the Commercial Register Requirement
A managing director in Germany also has the right to resign from office, thus ending their position on the board. No important reason is required for this unless the articles of association stipulate otherwise. However, this right to resign may not be exercised in an abusive or untimely manner – otherwise, recourse claims may arise against the managing director. This can be assumed, for example, if, as a result of resigning from office, the company can no longer fulfil certain public law obligations, such as filing a tax return correctly and on time.
The resignation must always be recorded in the commercial register. However, the former managing director loses the right to file for termination with the registry court. It is advisable to resign from office subject to a condition precedent linked to the receipt of the application at the registry court to prevent the managing director from being dependent on the shareholders’ termination filing. This allows the outgoing managing director to control the registration of his departure. In addition to resigning from office, the managing director must always terminate their service contract – in the case of good cause, they may even terminate the contract without notice.
Practice Group: German Employment Law
Practice Group:
German Employment Law
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