The scene is all too common—the shareholders of a German company lose trust In the company’s Managing Director. As a result, the shareholders—as is their Right—decide to remove the Managing Director from his statutory executive position. This removal, however, does not directly impact the contractual relationship the Managing Director may have with the company. If, as is often the case, the Managing Director and company also concluded a service agreement setting forth the rights and duties of the Managing Director, the shareholders will also need to terminate this agreement in order to sever their relationship with the Managing Director in its entirety. The termination must, of course, be in accordance with the provisions of the agreement.

If the actions which caused the shareholders to lose their trust in the Managing Director warrant a termination for cause, German law sets forth that the shareholders must terminate the Managing Director’s service agreement within two weeks of learning of the event which served as the basis for the termination. If they fail to terminate a Managing Director within this two-week period, then the shareholders have waived their right to terminate the Managing Director for cause.

To reiterate: German law distinguishes between the statutory appointment of a Managing Director and a contractual relationship between the company and the Managing Director.

A Managing Director’s service agreement, for example, may set forth that the Managing Director is entitled to a six-month termination notice period and that any such termination may be effective only at the end of a calendar year. Accordingly, if the shareholders terminate the Managing Director on July 14, 2005, the termination will not become effective until december 31, 2006, i.e., the Managing Director is entitled to almost an 18-month termination notice period. During this period, the Managing Director must continue to provide his services to the company in accordance with the provisions of the service agreement and the company must pay him his full compensation, plus any benefits.

Such an arrangement will, in all likelihood, not be viewed favorably by the company nor by the terminated Managing Director. Accordingly, the shareholders may decide to "release" the Managing Director from his work obligations, i.e., the Managing Director will continue to receive his pay and other benefits from the company, but he is not to appear for work. The obvious downside for the company is that it must continue to pay the Managing Director for the duration of the release period. However, when this is weighed against the benefits, it may make sense to release the Managing Director. The primary benefits are (i) the company will not have an otherwise influential person appear for work who may not necessarily have the best interests of the company in mind, and (ii) since the released Managing Director is still bound to the company and on its payroll, he may not compete with the company.

However, a recent court decision has caused some consternation among employers because, according to this decision, it appears that released Managing Directors (as well as released employees) may, in fact, engage in some activities during the release period which many would deem to be in violation of the duty not to compete.

In the past, German courts—including Germany’s highest labor court—have consistently held that a Managing Director owes a duty of loyalty to the company as long as he is still bound to the company and on the company’s payroll. However, quite surprisingly, a court of appeals recently ruled that since the service agreement of a particular released Managing Director only had a few months to run before the termination notice period expired, the Managing Director was entitled to engage in "preliminary" activities in terms of setting up a new business without running afoul of the prohibition on competition. In this case, the Managing Director planned on becoming self-employed and had admittedly contacted a couple of his current employer’s customers to discuss doing business with these customers in the future.

Not surprisingly, as soon as the Managing Director’s employer learned that the released Managing Director was contacting customers, the shareholders terminated the Managing Director for cause effective immediately as they felt that these "preliminary" activities crossed the line in terms of competing with the company. The question presented to the court was whether the Managing Director’s activities warranted a termination for cause.

The court held that there were not sufficient grounds for termination for cause reasoning that the Managing Director’s activities were only "preliminary" that did not go beyond the "idea stage" and did not constitute "doing business for profit". The court continued by stating that since the termination notice period for the ordinary termination was to expire within a few months anyway, the company had a higher burden of proving that the released Managing Director’s activities, in fact, constituted competing with the company. Finally, the court held that to not permit the Managing Director to engage in the above-mentioned preliminary activities would be unconstitutional since, according to Germany’s constitution, all persons have the right to develop themselves, including professionally (article 2) and to choose their trade or profession (article 12).

Needless to say, both the court’s decision and reasoning did not sit well with a number of commentators. First, German courts have consistently held in the past that as long as an individual is still employed with a company, regardless whether he has been released, that person may not compete with his employer. If such a person contacts the company’s customers to discuss possibly working together in the future, then this has always been held to constitute a violation of the obligation not to compete. To hold otherwise would mean that a company must accept that Managing Directors (or employees) whose relationship with the company have not yet ended are actually entitled to solicit the company’s customers for future business plans.

Commentators also argued that since Managing Directors have such an influential position with the company, it only makes sense that Managing Directors, of all people, must be prohibited from engaging in any activities which constitutes or comes close to soliciting the company’s customers. Accordingly, a Managing Director, in particular, must be prohibited from being permitted to contact the company’s customers to discuss working together in the future.

The court’s decision also met with incredulation among practitioners since it was held that because the termination notice period was due to expire "already" within four months, it would be unreasonable to terminate the Managing Director for cause at this time. Following this reasoning, Managing Directors would actually continue to receive payment from the company while simultaneously being able to solicit customers. This decision is fortunately an anomaly from earlier decisions; it is only hoped that this decision is not a sign of things to come.

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