The Role of Managing Director – Classic Areas of Regulation in the Managing Director Employment Contract

The role of a managing director is central to the success of a company. It involves managing, representing, and acting on behalf of the company both internally and externally. A managing director plays a crucial role in shaping the strategic direction and operational implementation of the company’s objectives, thereby significantly contributing to the company’s success or failure.

Due to this level of responsibility, it is essential to establish clear contractual regulations that protect both the managing director and the company. Therefore, concluding a managing director employment contract, also known as a managing director agreement, is a prudent step in defining these legal and operational parameters. 

However, depending on the industry, company size, and structure, these parameters can vary greatly. This makes it all the more important that the managing director employment contract is tailored and customized to the individual situation.

As specialists in corporate law and labor law, we see it as our task to advise and support you during the preparation, negotiation, and drafting of the contract. 

Learn more below about the fundamentals and classic areas of regulation of this particular employment relationship.

Overview:

1. What is a Managing Director Employment Contract?
2. Are Managing Directors Employees?
3. From Employee to Managing Director
4. Contents of a Managing Director Contract
5. Our Advisory Services
6. Conclusion
7. FAQ's

1.  What is a Managing Director Employment Contract?

Managing directors of an organization are subject to a range of rights and duties that are legally established and relate to their legal status as an organ of a company. For instance, the German Limited Liability Companies Act (GmbHG) serves as the legal basis for the powers and obligations of a managing director of a GmbH.

However, the underlying laws do not regulate all aspects relevant to the practical exercise of the managing director’s duties. Important points such as the definition of tasks, powers, compensation, regulations on vacation and illness, pension provisions, as well as conduct in crisis situations, are not detailed in the German Limited Liability Companies Act (GmbHG).

To ensure mutual security, it is advisable to conclude a managing director employment contract or managing director agreement. This is a contract for services under the meaning of Section 611 of the German Civil Code (BGB).

The managing director employment contract ensures that the relationship between the managing director and the company is legally clear and comprehensively regulated. This is not only in the interest of the company but also of the managing director himself, to avoid misunderstandings and conflicts. The contract serves to establish clear regulations regarding the powers and duties of the managing director and to define responsibilities concerning the management of the company.

Another important aspect is the avoidance of conflicts of interest. The contract can include specific clauses that ensure the managing director does not act in a way that conflicts with the company's interests. This may include provisions that prevent the managing director from engaging in business with competing companies without the shareholders' consent.

2. Are Managing Directors Employees?

In principle, any natural person can hold the position of managing director, provided they are neither a minor nor legally incapacitated.

Are managing directors comparable to employees in the true sense, or are they considered as such? Let’s take a closer look:

In fact, case law takes different approaches on this point. According to the Federal Court of Justice, a managing director, as the representative body of a company, is never an employee. He is the 'jointly bound organ' of the company and, therefore, not a simple employee but holds a special legal status. The Federal Labor Court, however, assesses the employee status of managing directors more differently and considers two essential aspects in its evaluation:

1. Shares in the company and influence

The Federal Labor Court grants employee status to a managing director if their shares in the company amount to less than 50 percent. Such a managing director is generally unable to determine the course of the company on their own and is therefore more dependent on the instructions of the shareholders or the approval of the shareholders' meeting.

At the same time, their influence is assessed. That is, if the managing director has significant influence over the decisions of the shareholders' meeting, it is assumed that the managing director will not be granted employee status.

2. Independence

As a second important aspect in assessing employee status, the Federal Labor Court considers the managing director's scope for independently determining the content, time, and place of their work. The greater the freedom, the less likely it is that employee status will be recognized.

Consequently, this means that only a managing director who has little or no shares in the company and is regulated in terms of the conditions of their work will be granted employee status, along with all applicable protective laws such as the Employment Protection Act (KSchG) and the Continued Payment of Remuneration Act (EFZG).

In general, managing directors do not possess employee status. Therefore, concluding a managing director employment contract is also advisable regarding mutual protection agreements.

3. From Employee to Managing Director

Before we move on to potential contract contents, we would like to briefly examine the following, not uncommon, scenario:

An employee already working in the company is appointed as managing director.

This promotion is usually associated with a salary increase; however, the dissolution or modification of the existing employment contract does not necessarily occur.

Does the appointment as managing director terminate the existing employment relationship, or does it continue?

The Federal Labor Court answers this question negatively, contrary to Section 623 of the German Civil Code (BGB), which requires written form for the termination of employment relationships. This means that once an employee signs a managing director employment contract with the company, the existing employment relationship is considered to be mutually terminated, unless something else is explicitly agreed upon.

When an employee is promoted to managing director, it is advisable to clearly regulate the transition and make the necessary contractual adjustments. In particular, it should be examined whether the employee continues to have a claim to employee protection rights or whether these cease with the assumption of the managing director position. Clear regulation in the new contract can prevent misunderstandings or legal disputes.

4. Contents of a Managing Director Contract

The contents of the managing director contract can generally be determined individually. Similar to any employment contract, the following points should necessarily be included:

• The contracting parties
• Start of the service relationship
• Compensation of the managing director
• Place to work and working hours
• Confidentiality clause for the protection of trade secrets
• Signatures of the contracting parties

In addition, the contract should also reflect the points for which the managing director, similar to an employee, is particularly deserving of protection. The specific characteristics of the contractual relationship should also be taken into account.

Below is a list of recommended provisions to safeguard both the managing director and the company:

Provisions regarding existing employment relationships

As mentioned in point 3, it is highly advisable to establish rules on how previously existing employment relationships should be handled. Otherwise, these will be considered terminated upon the conclusion of the managing director employment contract. This provision prevents misunderstandings and provides clarity regarding the employment law status of the managing director after their appointment.

Protection against dismissal and duration of the service relationship

Since statutory protection against dismissal does not apply, the establishment of notice periods is an important part of a managing director employment contract. To protect the managing director in the event of dismissal or termination, generous notice periods should be agreed upon. The standard minimum is three months to the end of the calendar quarter, although longer periods of six to twelve months are not uncommon.

Special Termination Rights and Severance Arrangements

It is also possible to include special termination rights in the managing director's employment contract. These rights may apply if certain conditions are met, such as in the case of a company sale, serious breaches of duty, or a change of control within the company. Such provisions offer the managing director additional security and flexibility.

Furthermore, it may be advisable to establish severance arrangements in the contract. If the managing director leaves the company without being at fault, a severance payment could be agreed upon to compensate for the loss of their position. This severance payment can either be a fixed amount or calculated based on the remaining term of the contract.

Continued Payment of Wages in Case of Illness

Managing directors can also be absent due to illness. To ensure financial security in such cases, a provision for continued payment of wages in the event of illness should be included in the contract. We recommend following the minimum standard of wage continuation of up to 6 weeks, similar to that of an employee. The right of an employee to continued payment is established in the Continued Payment of Wages Act (EntgFG).

Vacation Leave

When it comes to paid vacation leave, the minimum standard set by the Federal Vacation Act should also be applied. This would mean an entitlement of 4 weeks. However, considering a respectful work environment, we recommend setting a higher value.

In addition to the statutory minimum vacation, additional vacation days could be agreed upon in the contract, reflecting the importance of the managing director’s position. It is not uncommon for managing directors to be entitled to up to six weeks of vacation, especially in companies with a high workload and significant responsibilities.

Furthermore, the contract could include provisions for special leave for significant occasions such as weddings, births, or the death of a close relative. Sabbaticals or extended unpaid leave could also be arranged to allow the managing director to recuperate in certain life situations or after intense work periods.

Health Insurance

It is usually stipulated that the company covers the amount of the subsidy for health insurance that would typically be paid for employees. In addition to the standard subsidy for health insurance, the contract can also include provisions for the company to cover additional benefits, such as a private supplementary insurance or specialized health care programs.

Additional Benefits

Managing directors often receive additional benefits such as a company car, disability insurance, life and pension insurance, as well as a company mobile phone. These additional benefits can be specified in the employment contract to avoid misunderstandings and clearly define the scope of compensation.

Authority of Representation and Management, as well as Prohibition of Self-Dealing

A key component of the managing director's employment contract is the regulation of authority of representation and management. This includes provisions regarding individual or joint representation, meaning the determination of which signatures are required for legal transactions. It is advisable to design the authority of representation and management as openly as possible.

It is also common to exempt the managing director from the prohibition of self-dealing according to Section 181 of the German Civil Code (BGB). This means that the service contract explicitly allows the managing director to enter into legal transactions with themselves.

Limitation of Liability and Discharge

In the managing director's contract, care should be taken to limit liability—excluding creditor protection—to cases of intent and gross negligence, as well as to a specified maximum amount.

We also recommend including a provision for regular discharge to reduce the liability risk from the managing director's perspective. Additionally, it is advisable to take out a Directors & Officers (D&O) insurance policy, which limits the managing director's liability to a maximum sum.

Transactions Requiring Approval

The managing director's employment contract can also specify transactions that require mandatory approval from the shareholders. This is particularly relevant for strategically significant decisions such as real estate purchases, taking out loans, or making large investments. Such approval requirements serve to protect the company and ensure that important decisions are made in consensus with the shareholders.

Post-Contractual Non-Compete Clause

In principle, the non-compete obligation of the managing director ends with the termination of their role. However, the position of a managing director inherently involves access to extensive business secrets and the acquisition of insider knowledge.

By agreeing to a post-contractual non-compete clause, the legitimate interests of the company are protected, and the loss of trade secrets and customer contacts is safeguarded.

However, it is important to ensure that the former managing director is not disproportionately restricted in their professional and economic freedom. This means that the post-contractual non-compete clause must be limited to the necessary scope; only then is it lawful.

In connection with the post-contractual non-compete clause, the contract may also stipulate penalties for violations of the clause. These penalties should be proportionate to the severity of the breach and have a deterrent effect.

5. Our Consulting Services

As specialists in corporate and employment law, we provide advice both to prospective managing directors before they assume their duties and to companies in designing the contractual framework. Given the individualized nature of managing director employment contracts, we review your specific needs and offer proposals that consider both corporate and personal claims, rights, and obligations.

If there are any uncertainties in evaluating the employment relationship and the execution of the managing director position, we examine each case individually. Upon request, we can draft legally sound contract templates.

We strongly recommend that you seek the assistance of a specialized employment lawyer as soon as possible, ideally before the contract is finalized. Legal advice is crucial due to the complexity of the regulations and the potentially far-reaching consequences of poorly coordinated contractual arrangements in the event of a dispute. Please feel free to contact us.

6. Conclusion

• Managing directors play a crucial role in a company, as they are responsible for its management, representation, and overall direction.
• It is advisable to enter into a managing director service contract to protect both the individual in the role and the organization.
• Whether managing directors are considered employees depends on various factors and can be assessed differently in each case.
• When transitioning from an employee to a management position, it is important to address contractual aspects to clarify the existing employment relationship.
• The managing director's contract should be tailored to the individual and include key points such as protection against dismissal, continued payment of wages in the event of illness, and provisions regarding the authority of representation. Generally, such a contract is considered complex.
• Specialized employment lawyers offer advice both to prospective managing directors and to companies, assisting in the creation of legally sound contract templates.

7. FAQ's

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