Germany: Transfer Of Business And § 613 Of The Civil Code

Last Updated: 23 January 2008
Article by Felix Laumen

§ 613a of the Civil Code is the party pooper par excellence when it comes to transfers of business: when such transactions fail, it is because of this clause. It is no accident that it has a very poor reputation in restructuring transactions, since it prevents dismissals due to the sale of the company regardless of whether the company is in crisis, even if the company is in . However, this should not keep anyone from considering a transfer of business if this would enable the buyer to effectively expand its business or if it would prepare the way for new investments or succession on the part of the seller.

The statute states, roughly speaking, that no one may be dismissed due to transfer of business; that the buyer and seller are jointly liable to the employees for a certain period of time; that employees must be accurately informed; and that the employees may object to the transfer and may be able to stay with their old employer.

I. Fundamental Prior Considerations

The buyer must ask itself first whether it only plans to acquire a business, i.e. a production site, sales location or the like, or if it intends to acquire the company as a whole, whether in the form of a sole proprietorship or a limited liability company. This decision is of some importance for the fate of the employment relations and of considerable importance in connection with the buyer's risks and liability. After all, if the buyer acquires the company as a whole, it also gets the skeletons in its closet from the seller's past. Accordingly, utmost caution is necessary: acquiring a company without a tax advisor/attorney may be tantamount to a suicide mission.

The situation is different if just one business unit or division of the company is acquired. In that case, the buyer acquires only the obligations arising from employment relations, meaning that problems in tax and corporate law are largely avoided, as well as additional social security claims. There is much to be said for contending with the difficulties posed by § 613a of the Civil Code in preference to running unpredictable liability risks.

It is often said that the rules of § 613a of the Civil Code do not apply for small businesses, and that it is therefore much easier to transfer a small business. Not true, since § 613a of the Civil Code makes no distinction in this regard: dismissals due to transfer of business are prohibited even in small businesses. However, this prohibition can be easily circumvented by simply avoiding any reference to the transfer of business in the dismissal letter.

Remember: a company is only considered to be a "small business" if it has less than ten employees and if the employees affected by the dismissal were hired after 1 January 2004. Employees hired before 1 January 2004 are protected by the Unfair Dismissal Act unless the business has five or less employees at the time of the dismissal. Insofar as they come into play, the special rules applicable to small business will be noted below.

The situation is also no different if the business was transferred by way of succession. In that case, the company is inherited, meaning that the heir takes over the company as the successor of the testator. This is not considered to be a transfer of business: rather, the case of succession is more consistent with the aforementioned case of acquisition of a company as a whole. Accordingly, § 613a of the Civil Code doesn't apply at all, since there is no transfer of business, and the employment relations are continued unchanged and without limitation.

II. Solutions for Specific Situations

The standard problem associated with the pure acquisition of a business is that too many employees are on board and only a certain percentage can actually be absorbed. However, § 613a of the Civil Code specifically prohibits dismissals due to transfer of business. This is true for both the seller and the buyer: the staff must stay together, so to speak, until the transfer has taken place, and only then may the buyer carry out necessary rationalization measures. In doing so, however, it must comply with the notice periods stipulated by contract and all provisions of labor law which apply to the employees of the old business, including the rules of social selection, of course.

If the buyer takes on these burdens, however, it must expect increased wage costs for a certain period of time, and may have to provide funds for a social compensation plan if, for example, the dismissals exceed a certain percentage of the overall work force. Accordingly, this course is slow and expensive. In general, the buyer will only swallow it if the purchase price is suitably low or if funds for a social compensation plan are provided up front.

A second possibility would be for the seller to make the necessary changes prior to the transfer. Of course, it must do so exclusively with profitability in mind, and not just because it intends to sell and has already agreed with the buyer that not all employees will be absorbed. Such models work only if the acquisition was planned long in advance and if the seller can count on the buyer to actually acquire the business. It becomes problematic above all if the buyer is unable to pay for the business at the end of the restructuring phase. On the other hand, the seller would then have a profitable business to offer, and should be able to find another buyer. In view of these imponderables, this model is appropriate only in extraordinary cases.

As another option in restructuring scenarios, the courts have allowed the sale of a company based on the so-called "buyer model," in which the seller discusses with the buyer in very great detail which actions need to be taken in order to make the sale possible, including actions which relate to the company's employees. This sounds at first like a gross circumvention of § 613a of the Civil Code: after all, that statute states that no one may be dismissed due to transfer of business. However, the courts place much greater emphasis on the restructuring aspect than on the transfer aspect. The decisive factor is if a restructuring situation exists. Only then may the buyer model be applied, and then only if the prospect exists that the reduced number of jobs will be permanently maintained. Accordingly, this model is unsuitable for all companies which are not in need of restructuring, where the buyer ultimately has no choice but to accept the acquired business as is and to wait until after the acquisition to implement its plans.

Once the buyer has decided to make the acquisition, it must decide whether it intends to integrate the business into its existing company or form a separate company to absorb the acquired business.

This question is of decisive importance with respect to which measures are planned for the acquired business. If the latter is to be integrated into an existing business, there will at first be different employment contracts, the content of which may not be modified to the detriment of the absorbed employees for one year, not even by dismissal with the option for altered conditions of employment. Works agreements in the old business generally continue to apply for the absorbed employees insofar as their content pertains to them individually. This includes works agreements relating to vacation time, overtime compensation, compensatory time off, etc. These rules continue to apply. The only exception is if the same circumstances are already regulated by works agreement in the absorbing business, in which case that company's works agreement applies immediately.

What gets people most upset is when "the new guys" get paid better for the same work. The company may theoretically credit the transferred employees with longer length of service, so that the staff of the absorbing business may be harder hit by dismissals. In these cases, integrating the two business may be extremely problematic.

Accordingly, it may make sense to organize the acquired business as a separate company at first and not to combine it with the other business until equivalent conditions are created. If that is done, the synergies which made the acquisition attractive in the first place cannot be immediately exploited. Measuring the relative weight of these two problems is not easy. There is no rule of thumb in these cases: a decision must be made on a case-by-case basis.

Is all this true for small businesses as well?

The short answer is yes. The problem of liability for pre-existing obligations of the acquired business is the same as if the company as a whole were sold. The limitation to liabilities arising from employment contracts is also the same, comparable to a situation in which only one business or business unit is acquired. However, the problem of adjusting the size of the business to the buyer's specifications is easier to get a hold of as a result of the fact that the Unfair Dismissal Act doesn't apply to small businesses, so that small businesses may dismiss their employees without citing grounds, as long as they are not due to a transfer of business. Accordingly, they must be very careful not to cite any grounds in the dismissal letter, and they must be able to cite grounds in the subsequent unfair dismissal procedure which have nothing to do with the transfer of business. These may be the traditional grounds for dismissal, such as lack of work, the discontinuation of a certain product on which the employee was working, general downsizing in order to remain competitive or the outsourcing of the employee's work to another company, as long as a connection with the transfer of business cannot be deduced.

III. Major Liability Questions and the Duty to Provide Accurate Information

Regardless of the form in which the acquired business is integrated, obligations and liabilities exist on both the seller's and the buyer's side. The most important obligation is to provide accurate information as to the transfer of business. § 613a(5) of the Civil Code states that employees must be fully informed of the planned transfer of business, particularly as to the impact on their employment contracts. If errors are made in this respect, such as if the information is incomplete or factually incorrect, the seller may face a challenge with respect to the transfer of the employment contract even long after the transfer. In a ruling just a few months old, the Federal Labor Court clarified that erroneous information does not set the challenge period into motion. Meanwhile, the question of precisely when the employee loses the opportunity to file a challenge has not yet been decided. While the typical limitation periods in this respect are three years long, there is considerable risk potential in this regard.

If the seller thinks that its liability ends once the transfer is made, it is mistaken. The seller is liable only for the claims of existing occupational pension recipients and for claims arising from vested rights of departing employees. This means that, in case of doubt, these claims must be satisfied by the seller even if they are transferred to the buyer by contract. This is particularly problematic if the buyer goes bankrupt years later: while occupational pension claims are insured by the Pension Assurance Association, the latter will take recourse against the original business owner.

Together with the new employer, the seller is liable for all obligations arising in the final year prior to the transfer. The old employer is not liable for claims arising from employment relations which were established only after the transfer of the business. However, in case of obligations which do not mature until after the transfer of business but which were created both before and after the transfer, the former employer is liable for "its" part. This is particularly the case for profit share rules and periodic performance-based compensation schemes. Vacation claims, which are also created periodically, of course, are to be satisfied by the buyer alone. In general, the latter is liable for all obligations arising from the employment relations as long as they were created after the time of transfer. In addition, the buyer and seller both may be liable for obligations up to one year prior to the transfer, as stated above.

Works agreements may contain risks which are not to be underestimated. In principle, the buyer is obligated to perform works agreements for employees added in the transfer, but only if the circumstances underlying this agreement are not covered by a different works agreement in the buyer's business.

If both businesses are bound by collective bargaining agreements, that of the absorbing business takes effect automatically upon transfer. The most the employees can do is object to their classification, in which case they must initiate a classification procedure. This situation is relatively unproblematic. It is up to the courts to decide how the position is to be classified.

The situation is different if a collective bargaining agreement was used in the old business but not in the new one. In such a case, § 613a of the Civil Code states that the agreement applies for those employees in the new business. However, rights under the old agreement are only carried over to the new business insofar as they existed at the time of the transfer. This means that future wage increases provided for in the collective bargaining agreement of the old business no longer apply. Depending on this difference, the transferred employees may have a head start in salary over the employees of the absorbing business.

The situation becomes truly problematic when the new business does not have a collective bargaining agreement and the transferred employee has a so-called "reference clause" in his employment contract, referring to a specific collective bargaining agreement. In that case, rights and duties are in accordance with the collective bargaining agreement stipulated in the old employment contract, in this case including all future increases. It is nearly impossible for the absorbing business to cancel these terms through dismissal with the option of altered conditions of employment (Änderungskündigung). The importance of careful analysis is particularly evident in this case.

It should be noted once again that, in principle, all of the rules described above apply to small businesses as well. All employee claims derived from the employment contract or from old works agreements must be accepted in the new business, at least until a modification can be made through Änderungskündigung or by similar means.

IV. Conclusion and a Look Ahead

A loosening of the restrictions in § 613b of the Civil Code in the buyer's favor cannot be expected in the near future. If anything, the Siemens/BenQ incident has strengthened the hand of those who argue that the protection of employees should be expanded even further. Accordingly, buyers should first consider very carefully whether the acquisition makes sense for their business. The manner of acquisition should then be defined, followed by an agreement with the seller as to an acceptable spreading of risks. No general advice can be given for transfers of business, since each case is different.

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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