GmbH-Managing Director Service Agreement under German Law

Legal advice by English-speaking Attorneys and Lawyers

Managing directors have an outstanding position in their respective companies. They represent and manage the company and assume responsibility for commercial decisions. They can play a significant part in the company's success and failure. Managing directors, shareholders and supervisory bodies should therefore thoroughly deal with the content and provisions of management service contracts. This applies initially to situations in which a new management service agreement is to be concluded. In addition, however, this also applies in situations in which a further managing director is to be appointed, an existing managing director contract is to be adapted or amended due to changed circumstances, changes in responsibilities of individual board members, restructuring or transformation processes or simply whenever a managing director contract is to be terminated. 

Legal expertise in the field of management contracts

Our specialised team of lawyers has extensive experience in rendering advice to both managing directors or board members and companies in connection with the appointment and employment of managing directors or board members. Our certified specialist attorneys advise on all questions relating to management service agreements under German law. Our expertise particularly includes:

1. Drafting and adaptation of managing director contracts and service agreements
2. Examination of management service agreements and their optimisation with regard to German corporate, tax, social security and employment law
3. Advice and support in contract negotiations on new and amended management contracts
4. Termination of existing management contracts, in particular by notice of termination
5. Drafting and adaptation of rules of procedure for management, coordination of rules of procedure with existing management contracts, shareholder agreements
6. Dispute settlement, mediation or litigation regarding claims arising from or in connection with contracts of employment of managing directors, if necessary also by effective measures of interim legal protection (injunctive relief)

Typical Contents of German Law Managing Director Agreements

Service contracts of managing directors of German limited liability companies (GmbH) contain various clauses regarding the rights and duties of the managing director and the company. Each managing director contract follows its own rules - depending on the business sector, company size, business area and shareholder structure. Nevertheless, some topics typically should be thought of when drafting a managing director’s service agreement:

1. Pre-existing employment relationships
2. Relationship of managing directors' agreement to articles of association, rules of procedure, shareholder resolutions and their subsequent amendments
3. Scope of the power of representation and potential subsequent amendments
4. Scope of the power of management (including departmental responsibility) and potential subsequent amendments
5. Remuneration (fixed, variable) and other benefits (e.g. healthcare, pension, company car, D&O insurance)
6. Duration of contract, possibilities for termination of employment contract, garden-leave provisions
7. (Post-contractual) non-compete obligations

In case of a shareholder-director the issue of hidden profit distributions, tax and (non-)liberation of social security contributions should be taken into account when drafting a service agreement under German law.

Executive Remuneration

Remuneration of executives in contemporary service contracts often consists of a fixed remuneration, variable remuneration components and other benefits, such as pension and healthcare provision, privately used company cars, mobile phones, laptops and tablets. In case of variable remuneration, a profit-related bonus may be agreed in order to create incentives for successful corporate management. Additionally, exit-based bonuses, virtual and actual share option plans and management participation programs have become increasingly popular in recent years. More traditional clauses such as revenue- and event-dependent (milestones) remuneration are still a part of many management service agreements under German law. From the company's point of view, discretionary bonus schemes - i.e. bonuses that are more or less at the discretion of the company usually seem preferable.

As a rule of thumb, the amount of the individual remuneration components does not only depend on the type and scope of the managing director's activity and his or her individual performance but is significantly affected by the size of the company and the industry. The amount of a managing director's remuneration also has a direct influence on corporation tax and trade tax the company has to pay. The remuneration is a business expense for tax purposes and therefore reduces the tax base. The higher the total remuneration, the lower the corporate taxes. For this reason, pension systems that lead to an effective tax reduction for German limited liability companies (GmbH) are quite common and may especially be viable in case of rather small companies with shareholder-managing directors.

However, in such a case of a managing director who is also a shareholder, it should be noted that both the fixed remuneration and the variable remuneration, supplemented by other remuneration components, must be appropriate. Inappropriate remuneration that does not stand up to arm's length comparison inevitably leads to tax problems (hidden distribution of profits). In addition, the tax authorities have established further conditions under which the remuneration of the shareholder-managing director is recognised as an operating expense (including the ratio of fixed and variable remuneration). The details of the remuneration package in the employment contract must therefore be carefully drafted. 

Term, Notice Period, Extraordinary Termination for Cause

Another central aspect of the management contract is its duration. All parties involved should know that the duration of the management service agreement and, to a large extent, the notice periods are freely negotiable under German law. Managing director employment contracts, for example, can be limited or unlimited in time. In particular, the contracts of external managing directors often provide for a fixed term of 2 or 5 years and automatic termination thereafter. It should be noted that even in fixed-term contracts (ordinary) reasons for termination may be provided for in order to allow a premature termination of the management contract.

If the contract is concluded for an indefinite period of time, a clause explicitly containing the relevant notice period is recommended for reasons of legal certainty. The specific point in time at which notice of termination can be given (e.g. end of a month, end of a quarter) and the period of notice which must be observed for the notice of termination (e.g. 4 weeks prior written notice with effect as of the end of a month, 6 weeks prior written notice with effect as of the end of a quarter) must be specified. If the notice period is not expressly stipulated in the contract, under German law a statutory notice period of four weeks initially applies to the external managing director. This period increases – although only very slightly – with continuing employment (§ 622 German Civil Code, BGB). When calculating the notice period, the following applies to both parties: a longer period of notice provides greater planning security but at the same time makes it more difficult to terminate the contract prematurely should this become the desired course of action.

An extraordinary termination for cause cannot be excluded by the contracting parties under German law. It is mandatory law. Nevertheless, the parties may negotiate certain material reasons, which entitle one or both of the parties to an extraordinary termination for cause. Typical examples of such material reasons for a termination for cause are change of control clauses (i.e. significant changes in the shareholder base of the company) and violations of a contractual non-compete clauses.

Some managing director service agreements contain so-called tying clauses. These clauses provide that the managing director contract ends automatically if the managing director is removed from office or his office ends otherwise. This is significant especially for clients not used to the particularities of German law – in other jurisdictions, the termination of a managing director’s service contract with the company may simultaneously lead to the removal from office. Under German law, a separate shareholder resolution is required to remove the director from office. Whether such tying clauses are effective under German law must be assessed on a case-by-case basis. Quite extensive case law has developed in this regard.