Admissibility of the so-called Manager Model

The so-called manager model is a popular incentive for managing directors based on the following concept:  The external managing directors receive shares in the company in order to deepen their ties to the company and to allow them to participate in the company's success. In order to ensure coherence between the position of managing director and shareholder, it is agreed that the managing director must return his shares if he loses his position as managing director by resignation or dismissal.

The "manager model" frequently encountered in practice collides with the principle established by the Federal Court of Justice (Bundesgerichtshof) in its settled case law that a shareholder cannot be "dismissed" from the company by his co-partners without an objective reason. However, in its ruling of September 19, 2005 (II ZR 173/04), the Federal Court of Justice made an exception to the prohibition of free dismissal of shareholders. The exception applies to manager models if certain conditions are met.

Background: Standard investment vs. manager participation

In a recent decision of May 13, 2020, the Munich Higher Regional Court (Oberlandesgericht / OLG) specified the conditions under which management participation, i.e. temporary shareholder participation, is permissible. The court came to the conclusion that the shareholding of a managing director of a limited liability company (GmbH) does not fall under the so-called manager model if he holds 25% of the share capital and assumes an economic risk. This rather corresponds to a "standard" investment in a company. In this case, a provision according to which the managing director loses his or her position as a shareholder when he or she leaves the company as managing director is inadmissible and invalid.

The judgment of the OLG Munich of May 13, 2020, file no. 7 U 1844/19

In the case decided by the OLG Munich, a managing director held a 25% stake in a GmbH. In addition to share capital in the amount of 6,250 Euro, he made a contribution to the capital reserve of the GmbH in the amount of 293,750 Euro. In a separate shareholders' agreement, he and his 16 co-shareholders agreed that in the event of his resignation as managing director, the company could take over his shares in return for payment of a purchase price corresponding to the market value of the share, or at least to the amount of his investment ("CEO purchase price"). Approximately one and a half years after the conclusion of the shareholders' agreement, the shareholders' meeting passed a resolution to dismiss the CEO and asserted that the company could take over his shares in exchange for payment of his investment in the amount of EUR 300,000.

In its decision, the OLG Munich specified the principles developed by the Federal Court of Justice (BGH) to the effect that the conditions for a manager model permissible under company law were not met in the case decided for the following reasons:

In contrast to the case decided by the Federal Court of Justice (BGH), in which the manager had a stake of less than 10% and there was only one other shareholder in addition to him, in the case decided by the OLG Munich the manager had 25%; apart from him there were 16 other shareholders. His voting power was therefore considerably stronger than in the case decided by the Federal Court of Justice, especially as it was to be expected that the 16 shareholders would not always vote in the same way, but that some of them would form a coalition with him on a case-by-case basis.

Moreover, the managing director-shareholder had assumed a considerable economic risk in the case of a total investment of 300,000 EUR and the obligation to provide additional funds in the event of further capital requirements of the company by way of a loan. This distinguishes his participation from a manager participation, in which the managing director usually acquires shares at nominal value.

Note: Requirements for a successful contract design of the Manager Model

The manager model - the participation as a temporary shareholder - is permissible as an incentive for managing directors under certain conditions. However, caution should be exercised when determining the modalities of management shareholdings in concrete terms:

The amount of the shareholder's participation and the participation structure of the company are decisive. However, there is no rule of thumb up to which amount a temporary participation is permissible under the manager model. Rather, it depends on the possibilities of exerting influence in the shareholders' meeting which the participation offers in the concrete individual case. Furthermore, the manager must not assume any economic risk. If he acquires the share at nominal value, this is not problematic at all. If he makes additional contributions to the capital reserve, the situation might be different.

Only if these criteria are met in an overall assessment of each individual case, management participation for a limited period is permissible. Otherwise, as in the case decided by the OLG Munich, the "mace" of immorality strikes with full force. In this case, the agreements made for the case of the managing director's resignation are null and void and the dismissed managing director remains a shareholder. Such adverse consequences can only be avoided by an individually suitable contract design.