The Executive Remuneration Review, 10th Edition

Employment law

i Severance payments

Executives do not generally have a statutory severance claim upon termination of their service or employment relationships; any entitlements in this respect need to be stipulated in their individual service or employment agreements.

Executive employees

Agreements with employees with management functions within the meaning of the Works Constitution Act (executive employees) will only occasionally include severance clauses, because this group of executives is subject to statutory protection against wrongful dismissal under German labour law. Accordingly, a termination by an employer requires a justified reason, such as behavioural reasons (e.g., severe misconduct), personal reasons (e.g., continuing incapacity) or operational reasons (e.g., redundancy, in particular in connection with the shutdown of a department or site). Absent such justified reason, an employer will have to reach a settlement with an employee in the course of legal proceedings that employees in Germany typically initiate after receiving notice of termination from their employers, or enter into a termination agreement with an employee (which requires the employee's consent). The severance amount to be paid to make the employee accept his or her dismissal is subject to negotiation, and usually depends on how the parties evaluate their chance of succeeding in the (pending) legal proceedings. Generally, severance payments by employers in Germany range between half and one full month's salary (including pro rata variable payments) for each completed year of employment, but may actually be significantly higher if an employer has a weak case.

For executive employees, protection against dismissal is limited to a certain extent: in cases where an employee qualifies as an executive employee within the meaning of the Dismissal Protection Act, the employer may request that the labour court dissolves the employment relationship with the employee against appropriate severance payment without providing any justification.44 An employee is only considered as an executive employee within the meaning of the Dismissal Protection Act if he or she is authorised to hire or dismiss employees independently.45

To increase the attractiveness of the German market for financial institutions considering relocating in the wake of Brexit, the German legislator enacted Section 25a(5a) of the German Banking Act. Pursuant to this new provision, the above-described arrangements with respect to the dissolution of the employment relationship by labour courts applicable to executive employees within the meaning of the Dismissal Protection Act apply mutatis mutandis to risk-takers in the financial sector provided they are employed at a significant institution (e.g., financial institutions with total assets on average of at least €15 billion in the past four financial years).46 As a result, an employer may request the German labour court to dissolve the employment relationship with a risk-taker against severance payment without providing any justification. In this context, employees are considered risk-takers if their professional activities have a material impact on their institution's risk profile and their annual fixed remuneration amounts to at least three times the applicable social security contribution ceiling (i.e., currently an aggregate amount of €240,300).

Management board members of non-listed companies

While not unheard of, it is not very common that service agreements with management board members of non-listed companies provide for severance payments or change in control provisions. Although management board members do not benefit from statutory protection against wrongful dismissal, their service agreements frequently run for a fixed term during which they can only be terminated for good cause, which is a rather strict test under German law.47 A company intending to terminate the service relationship with a management board member prematurely without good cause will have to negotiate a termination agreement with the management board member, including offering him or her a severance package. The outcome of the negotiations will largely depend on the remaining term of the service relationship.

Management board members of listed companies

Notwithstanding the fact that service agreements with management board members of listed companies are typically entered into for a fixed term of up to five years, these types of executives are more commonly entitled to severance payments under their service agreements upon a termination without good cause. Pursuant to recommendation G.13 of the German Corporate Governance Code (GCGC),48 any payments to a management board member due to early termination of their management board activity shall be capped at the lower amount of two times the management board member's last annual remuneration (severance pay cap) or the remuneration that the management board member would have earned during the remaining term of the service agreement. In case post-contractual non-compete provisions apply, any severance payment shall be taken into account in the calculation of any compensation payments – that is, any post-contractual non-compete compensation for the period for which the management board member receives a severance payment shall be settled by the relevant severance payment.

ii Change in control provisions

Under German law, there is no statutory termination right on the part of a company or an executive if the ownership structure of the company significantly changes. Both parties continue to be bound by the terms and conditions of the existing service or employment agreement, including any fixed term agreed therein.

Listed companies often used to grant their management board members the right to terminate a service relationship prematurely within a certain time frame following a change in control event, and to collect a predefined severance. However, according to suggestion G.14 of the GCGC, benefit commitments made in connection with the early termination of a management board member contract by the management board member due to a change of control should not be agreed upon.49

In addition, the terms of share-based compensation and retirement benefit plans may provide for a vesting or acceleration of rights if the service relationship with a management board member is terminated as a result of a change in control.

iii Confidentiality

Executives in Germany are by virtue of German law required to treat as confidential all trade and business secrets that they become aware of during the term of their service or employment relationship. This duty of confidentiality generally does not cease to exist when the service or employment agreement ends, but its scope is disputed.

Thus, the particulars of a confidentiality obligation are typically stipulated in greater detail in an executive's service or employment agreement. It is customary in Germany that employers impose continued confidentiality obligations on their executives that shall also survive the termination of the service or employment relationship. While this practice is generally acknowledged, the relevant confidentiality covenants will only be enforceable if their scope is very precise and if they do not impede an executive's professional advancement in an unreasonable manner. As a consequence, employers intending to protect their customer or personnel base or market share from poaching attempts of a former executive will usually have to make the executive accept a post-termination non-compete undertaking (or, at least, a post-termination non-solicitation undertaking) (see Section III.v).

Remedies for breach of the confidentiality obligation concerning trade secrets during and after the employment or service relationship include civil claims for injunction, removal and damages. In implementation of the EU Directive (EU) 2016/943 on protecting trade secrets, the German Trade Secrets Act entered into force in April 2019, providing for a detailed regime on protecting trade secrets against unlawful obtainment, use and disclosure. Depending on the circumstances of the individual case, the intentional disclosure of business secrets also qualifies as a criminal offence punishable with up to two or three years of imprisonment (or even up to five years for severe breaches).50

iv Non-compete obligations during the term of service or employment

During the term of their service or employment relationships, executives are generally not permitted to engage in competition with their employer (even in case no explicit provisions are in place).51 From a general point of view, the existence (or even the initiation) of a competitive situation between an employee and an employer may result in a conflict of interest on the part of the executive.52

Accordingly, executives must not do business, carry out transactions or support any activities in the employer's line of business on their own behalf or on behalf of third parties without the prior consent of the employer. Executives violating this obligation may face disciplinary actions (up to and including dismissal) and become liable for damages.

In addition to the statutory rules, it is customary (and prudent) to emphasise and further specify the statutory obligations in an executive's service or employment agreement by means of explicit non-compete or non-solicitation clauses. Further, service or employment agreements may contain provisions on contractual penalties in the case of breaches of statutory or contractual obligations contained in such clauses (to facilitate damage claims against a breaching employee, since otherwise the proof of the exact amount of damages may be difficult for the employer).

v Post-termination non-compete clauses

Apart from generally applicable unfair competition rules, executives in Germany are, as a matter of German statutory law, not bound by competition restrictions after termination of their service or employment relationships. Any such restrictive covenants therefore need to be put on a contractual basis by entering into a post-termination non-compete or non-solicitation arrangement, or both, with the executive.

German courts take the view that post-termination non-compete clauses are only enforceable if and to the extent there is a legitimate business interest on the part of the employer, and the further professional career of the executive is not unreasonably restricted by the territorial and temporal scope of such non-compete obligation.53 Any post-termination non-compete clause has to be balanced between the employee's interest in his or her professional advancement and the employer's legitimate business interests. When assessing whether a post-contractual restrictive covenant is valid and binding for an employee, it has to be taken into account that such covenant interferes with an employee's right to freely choose an occupation, profession and place of work and can consequently impede the employee's occupational freedom (which is protected under German constitutional law).

While the German Commercial Code sets a specific legal framework for post-termination non-compete arrangements with regular employees (including employees with management functions),54 the relevant rules do not apply to management board members. As a practical matter, however, any post-termination non-compete clauses in service agreements of management board members are typically drafted along the lines of the statutory provisions in the German Commercial Code.

Post-termination non-compete arrangements usually run for a period of between one and two years following the termination date of an executive's service or employment agreement (two years being the maximum post-termination non-compete period permitted under German employment law). In general, any period spent on garden leave will not be taken into account for purposes of calculating such period, since the employment relationship itself (including the non-compete obligation applicable during the period of employment) remains in place during such period (see Section III.iv). However, in certain extraordinary cases, an extended garden leave period (in particular, such leave of an extraordinary long duration) that immediately precedes the termination date may actually require a shorter non-compete period or may even render a post-termination non-compete undertaking entirely unenforceable if the aggregate period of time during which an executive was kept out of business would practically put an end to his or her professional career in the relevant industry. In this context, it needs to be considered that there are no strict legal guidelines as to when a garden leave that is forced on an executive would affect the scope and substance of a subsequent post-termination non-compete undertaking. Rather, any potential risks in this respect will have to be assessed based on the facts and circumstances of each individual case, and in particular the situation in the market or business area concerned as well as the activities, experience and functions of the respective executive.

To be valid and enforceable, a post-termination non-compete arrangement must provide for an adequate financial compensation to be paid to an executive during the non-compete period. German mandatory law55 requires a minimum non-compete compensation for regular employees that is equal to 50 per cent of their last total remuneration under the employment agreement (including all monetary and non-monetary benefits).56 As stated above, this legal requirement is not relevant for post-termination non-compete arrangements with management board members; however, there is a common understanding among legal practitioners that non-compete compensation must be offered to these persons as well. The non-compete compensation provided in post-termination non-compete arrangements with management board members typically varies between 50 per cent of their last fixed salary (excluding other benefits) and as high as the full amount of their last total remuneration (including all monetary and non-monetary benefits). It is also not uncommon to link the non-compete compensation to the reason for termination and grant a higher amount if the termination of the service relationship had not been caused by behaviour of the management board member to the detriment of the company (also referred to as a good-leaver situation).

Other work-related income that an executive earns during the non-compete period may, to a certain extent, be deducted from the non-compete compensation, and the executive must regularly inform his or her previous employer about such earnings.57 According to recommendation G.13 of the GCGC, severance payments made to management board members due to premature termination of their activity shall be taken into account in the calculation of the non-compete compensation (see also Section III.i).

Owing to the significant costs associated with a post-contractual non-compete obligation, the use of such obligations should be carefully considered and generally be implemented only for employees considered as key or crucial for the business.

An employer may waive the post-contractual non-competition covenant at any time until the contractual relationship is terminated. Such waiver (which has to be declared in written form) releases the employee from the post-contractual non-compete obligation with immediate effect, but the employer is released from its obligation to pay compensation only after the lapse of a period of one year following the receipt of the waiver by the employee; that is, unless the waiver is declared at least one year prior to the end of the employment relationship, the employer must pay compensation from the date on which the employment relationship is terminated until the lapse of such one-year period without having the benefit of a non-compete covenant.58