Germany: New Developments in Management Board Compensation

Last Updated: 30 November 2010
Article by Ralf Ek

GERMAN M&A AND PRIVATE EQUITY NEWS - 4TH QUARTER 2010

On August 5, 2009, the German Act on the Appropriateness of Management Board Compensation (Gesetz zur Angemessenheit der Vorstandsvergütung; "VorstAG") became effective. This legislative amendment has had such a major impact that most stock corporations are currently reviewing their compensation systems. A mandatory adjustment obligation exists in case new employment contracts for management board members are concluded. Moreover, listed stock corporations must consider the recommendations of the German Corporate Governance Code, particularly with a view to caps on severance pay. In addition, in the future, a deductible in the D&O insurance will generally become mandatory for management board members. The following is an overview of the consequences that the VorstAG has had on management board compensation.

Amendment of Section 87 of the German Stock Corporation Act (Aktiengesetz; "AktG")

By virtue of the VorstAG, the notion of "appropriateness" of management board compensation has been specifically defined. Section 87, para. 1, AktG now reads as follows:

When fixing the total remuneration of an individual management board member (salary, profit participation, expense allowances, insurance premiums, commissions, incentive-based remuneration commitments like, e.g., stock options and fringe benefits of any kind), the supervisory board shall make sure that the remuneration is in adequate proportion to the duties and responsibilities and the performance of the management board member as well as to the situation of the company and does not exceed the customary remuneration without particular reasons. The remuneration structure for listed stock corporations shall be geared towards a sustainable development of the company. Variable components of the remuneration shall therefore be based on a perennial assessment; the supervisory board shall agree on means of limitation in case of extraordinary developments. Sentence 1 applies mutatis mutandis for retirement pay, survivors' pensions, and related benefits.

Furthermore, a reduction of the remuneration is possible pursuant to Section 87, para. 2, AktG if the company's situation deteriorates and a continued granting of the remuneration would be unreasonable. However, in the case of retirement pay, widows' pensions, and related benefits, this is possible only within the first three years after withdrawal from the company.

The Major Criteria

The appropriateness of the total remuneration of the individual management board members is therefore based on the member's duties, responsibilities, and performance, as well as on the situation of the company. Furthermore, the remuneration of the individual members must not exceed the remuneration customary in the industry or country without particular reasons.

With respect to the term "situation of the company," there is consensus that this term must be construed in a very broad sense so that, for instance, the supervisory board, despite a difficult economic situation, would have the option of paying a high remuneration for a management board member specifically appointed for the purpose of restructuring the company, particularly with a view to the difficulty of the task and the risk of failure. When fixing the management board compensation, the supervisory board must ensure that such compensation is on a level with that of companies of the same trade with comparable size and complexity, but it should also take into account the particular salary and wage structure within the company. In addition, the supervisory board must consider what salary is deemed " customary" within the statute's area of application. Remuneration in excess of such customary levels requires an explanation by the supervisory board. But since "customary" remuneration is not always deemed to be adequate, it is advisable to always provide the reasons for exceeding those customary levels.

In the case of listed stock corporations, the remuneration structure shall be geared towards the sustainable development of the company through variable components in the remuneration with long-term assessment indicators. Bonuses and special payments shall not depend on certain due dates, such as the end of a calendar quarter or the end of the year. Rather, sustainable development of a company shall be achieved by rewarding its continuous improvement and development. The long-term assessment indicators are intended to result in payment at a later point in time; according to the legislators, the relevant time period should be up to four years. Through this time lag, a company's potential negative developments can also be incorporated into the assessment.

Legal practice has not yet clarified when management board remuneration is inappropriate in the individual case within the meaning of Section 87, para 1, AktG. Empirical figures for management board remuneration actually paid in Germany can be found in the surveys on remuneration issued on a regular basis by human-resources consulting companies.

Liability Risks for the Management Board

A violation of the supervisory board's obligation to determine appropriate management board compensation does not lead to the invalidity of the employment or remuneration agreement. Rather, the management board member is entitled to compensation in the full amount agreed. Invalidity comes into question only if the amount of the remuneration is contrary to public policy pursuant to Section 138 of the German Civil Code (Bürgerliches Gesetzbuch). However, the fixing of an inappropriately high remuneration constitutes a breach of duty of the supervisory board, with the consequence that the members of the supervisory board become personally liable for reimbursement of the damage the company has incurred as a result of the fixing of the excessive management board compensation. Accordingly, if the management board member does not (voluntarily) repay the excessive portion of the compensation, this portion has to be compensated for by the members of the supervisory board.

Management Board Compensation and the Shareholders' Meeting

The VorstAG further provides for a legally nonbinding vote at the shareholders' meeting regarding the "acceptance of the system for the compensation of management board members" (Section 120, para. 4, AktG) for listed stock corporations. This measure was intended to give the shareholders a tool to control the existing compensation system. The legislature is of the hope that a disapproving vote at the shareholders' meeting regarding the compensation system will lead to public pressure on the management, which shall be urged to fix the management board compensation. However, resolutions regarding the specific amount of the management board compensation, particularly the fixing of an upper limit, are inadmissible. The management has the right, but not the obligation, to include on the agenda a "vote regarding the management board compensation system." If it fails to do so, the item may be placed on the agenda only by virtue of a minority request pursuant to Section 122, para. 2, AktG. Otherwise, no vote regarding the management board compensation can be cast at the shareholders' meeting.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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