German Federal Court of Justice Rules on the Reduction of Executive Board Compensation in the Event of an Economic Decline of the Company

If the economic situation of a stock corporation declines to such a level that it would be unreasonable to maintain the agreed executive board compensation, the advisory board has the right and the duty to reduce compensation to an appropriate level. The German Federal Court of Justice (Bundesgerichtshof – “BGH”) has now determined that such unilateral adjustment is by all means justified, if the member of the executive board contributed to the company’s insolvency.

Background

The plaintiff had been the chief financial officer of a stock corporation since spring 2011. According to his employment contract, with a term until the end of 2012, he was eligible for a fixed compensation in the amount of approximately 188,000 euros, as well as other benefits. During 2011, the economic situation of the company declined. Therefore, the advisory board dismissed the plaintiff from the executive board in 2011 and released him, first with, and then as of January 2012 without continued payment of compensation.

After the opening of insolvency proceedings, the plaintiff registered his salary entitlements for January to March 2012 and "damages for early release" for the months July to December 2012 in the insolvency table. The insolvency administrator contested the claims, whereupon the plaintiff took recourse to legal action. The Higher Regional Court of Stuttgart (Oberlandegericht – “OLG”) granted the claim in the court of appeals.

The judgment of the BGH, ref. II ZR 296/14

The BGH set aside the judgment of the OLG Stuttgart. In particular, it said that the OLG should not have granted the claim in its full amount.
The BGH considered the conditions of Sec. 87 para. 2 of the German Stock Corporation Act (Aktiengesetz – “AktG”) to be fulfilled: a "decline in the economic situation" in the sense of the law would in any case apply, if the company became eligible for insolvency, as was the case here. In that case, moreover, the continued payment of remunterations in the previous amount would be unreasonable, not only if the member of the executive board had acted contrary to his duties, but even if, despite the fact that he could not be accused of any actions in violation of his duty, the decline in the economic situation of the company occurred during the period of his responsibility for the board, and were thus attributable to him.

Therefore, pursuant to the AktG, the advisory board was legally obliged, to reduce the compensation to a level that could no longer be seen as unreasonable in view of the decline in the economic situation. However, the BGH did emphasize that the stock corporation could not lower compensation further than required in view of the decline in the economic situation. However, the BGH rejected to lower the limit to the amount of the compensation for executive staff - which the OLG had assumed.

Comment

The judgment of the BGH once again illustrates that special rules apply in insolvency advice provided to organs of a stock corporation. Whereas in general the principle is "pacta sunt servanda" (or: contracts must be fulfilled), the opposite may apply if the company falls into economic difficulties. In such cases, the advisory board has the right, and the duty (!) to reduce the compensation of members of the executive board appropriately. The idea behind this duty is to allow the executive board to take part in the fate of the company within the framework of its fiduciary duties.

For managing directors of a German limited liability company (Gesellschaft mit beschränkter Haftung – “GmbH”) there is no such regulation as Sec. 87 para. 2 AktG, i. e., the GmbH must generally continue to pay its directors their compensation in the agreed amounts, even if the economic situation of the company has declined during their term in office. This difference in treatment between GmbH managing directors and AG members of the executive board with regard to compensation is instituted intentionally by the legislator. It is established on the grounds that managing directors of a GmbH - unlike members of the executive board of a stock corporation - are bound by the directives of the shareholders, and thus do not bear sole responsibility if the company falls into economic difficulties.