GERMAN LABOR AND EMPLOYMENT NEWS the scene is all too commonthe - - PDF document

second Quarter 2005

GERMAN LABOR AND EMPLOYMENT NEWS

SOLiciTATiON Of cuSTOMERS: A RiGhT Of RELEASED MANAGiNG DiREcTORS?

By Jörg Rehder

Frankfurt attorney at Law; solicitor (england and Wales) jrehder@jonesday.com ++49 69 9726-3122

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 posi-

• tion. 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 share- holders 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 share- holders have waived their right to terminate the Managing director for cause.

Contents

solicitation of customers: a right of released Managing directors? 1 German Federal Labor court Facilitates the termination of employees Who Perform Poorly 3 the Legal aspects of the “release” of an employee during the employment relationship 4

2 However, a recent court decision has caused some con- sternation 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 high- est 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 par- ticular 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. to reiterate: German law distinguishes between the statutory appointment of a Managing director and a contractual rela- tionship 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 termi- nation 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 com- pany 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.

shareholders may decide to “release” the Managing director from his work obliga- tions, 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.

3 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 busi- ness 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, regard- less 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 com- pany 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 consti- tutes 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 termi- nation 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.

GERMAN fEDERAL LABOR cOuRT fAciLiTATES ThE TERMiNATiON Of EMPLOYEES WhO PERfORM POORLY

By oliver Heeder

Munich German attorney at Law; certified Labor and employment Lawyer

• heeder@jonesday.com

++49 89-20 60 42 211

It has been a lingering problem in Germany to terminate an employee based on an employee’s poor performance. German law sets forth that an employee must only pro- vide work of an average kind and quality. Precisely what constitutes “average work” has understandably not been specifically defined by the Federal Labor court. However, during the last couple of years the Federal Labor court has

• pined on to what extent an employee’s substandard perfor-

mance may justify a termination. In its decision of december 11, 2003, the Federal Labor court held that if an employee performs at only 40% to 50%

• f the performance of the other employees, this may justify

a termination due to poor performance. this is the first time that the Federal Labor court set forth specific criteria that would justify a termination based on the conduct or the employee’s personal characteristics. an employer may be able to terminate an employee if the employee’s actual per- formance is lower than the employee’s target performance taking into consideration the employer’s ability to instruct

• r influence the employee. If an employee’s performance is
• nly 40% to 50% of the average performance of the other

employees, then this may be grounds for termination based

• n the employee’s conduct unless that employee can dem-
• nstrate that the lower performance is as a result of the

personal characteristics of the employee and he is working at the average level of a person with similar personal char-

• acteristics. If the employee fails to meet his performance

standards, and he is not able to improve his performance to the average level of similar employees, then the employer may terminate that employee. It would be unreasonable to expect the employer to continue employing that employee if the employee cannot improve his performance.

4 similarly, in a decision dated June 3, 2004, the Federal Labor court approved the termination of an employee based on his personal characteristics because that employee—a member of the sales staff—had significantly lower sales figures than other members of the sale staff. these two decisions will make it easier for employers to determine which employees are performing at an unsatis- factory level. the employer can then document this poor performance and compare it to the performance of the

• ther employees. employers should consider reviewing

the employees’ performance on a regular basis and docu- menting it accordingly. If a particular employee performs poorly over a long time period, the employee will need to put the employee on notice several times regarding this

employers should consider reviewing the employees’ performance on a regular basis and documenting it accordingly. If a particular employee performs poorly over a long time period, the employee will need to put the employee on notice several times regarding this poor performance and then—depending

• n the situation—may terminate the employee

either for reasons of conduct or the employ- ee’s personal characteristics.

poor performance and then—depending on the situation— may terminate the employee either for reasons of conduct

• r the employee’s personal characteristics.

to the delight of many employers, the Federal Labor court has finally given some direction with respect to the termina- tion of employees due to their poor performance.

ThE LEGAL ASPEcTS Of ThE “RELEASE” Of AN EMPLOYEE DuRiNG ThE EMPLOYMENT RELATiONShiP

By Georg Mikes

Frankfurt German attorney at Law; certified Labor and employment Lawyer gmikes@jonesday.com ++49 69 9726-3939

• ften employers may decide to release an employee (or to

use the British parlance: put an employee on “garden leave”) during the employee’s termination notice period. during the release period the employee is not obligated to work but is still entitled to all of his benefits, including, of course, the right to continue earning his salary. the employer may want to release the employee for any number of reasons, e.g., the employer may fear that the employee will disclose con- fidential information about the company, decide to engage in sabotage by destroying data such as customer lists or form agreements or try to solicit customers or colleagues to join him at his next employer. the motives for releasing an employee may be as varied as the legal considerations involving such a release. this article will discuss a number

• f these legal considerations.

n tHe RiGHt to Release an eMployee the essence of a release is that the employer waives the employee’s requirement to provide his work obligations during the release period. not surprisingly, during this period the employee is required to observe all other obliga- tions vis-à-vis the employer, such as the obligation not to

• compete. under German law, an employer may not have a

unilateral right to release an employee since an employee has a statutory claim to be engaged with work obligations during the course of his employment relationship. this claim also applies during the termination notice period.

5

• f course an employee and employer may mutually agree

to the release of the employee. similarly, an employer may release an employee unilaterally as long as the employee does not raise any objections. However, in the past, employ- ees have filed an objection against a release because the employee had an interest in continuing to work during the termination notice period. If the employee files a legal action against a release it will typically be in the form of a temporary injunction requiring the employer to continue allowing the employee to work. In such a case the court will weigh the parties’ interests against one another. typically, the court will review whether it would be unreasonable for the employer to permit the employee to continue showing up for work during the ter- mination notice period, e.g., if the employer fears that the terminated employee will disclose trade secrets. Based on case law, the employee must satisfy a relatively high bur- den to prevail on his injunction claim. n ContRaCtual Release Clauses For the reasons discussed above, an employer is well- advised to include a clause in employment agreements whereby he may release an employee from his work obli-

• gations. a word of caution: German courts in the past

have typically been amenable to clauses that permit an employer to release an employee during the termination notice period; however, whether that right also extends to a period other than the termination notice period is not as clearly settled. accordingly, the employer should consider including a separate clause that sets forth not only that the employer may release the employee during the termina- tion notice period, but also at other times. this minimizes the risk that a court will hold a broad release clause to be unenforceable.

• n a related note, some aspects of German employment

law were codified in Germany’s civil code in 2002. one such matter is the concept of “standardized agreements”. as discussed in the second Quarter, 2004 German Labor and employment newsletter (contractual Penalties in standardized employment agreements: are they still enforceable?) many employers prefer to use standardized employment agreements because this often saves time and money—not to mention the fact that they have already gained practical experience with such agreements. the basic premise of “standardized agreements” is that such agreements will typically be interpreted against the user

• f the standardized agreements (generally the employer) if

any clauses are vague or are deemed to be too one-sided. the question that has not yet been resolved by statute or case law is whether release clauses—whether relating only to termination notice periods or otherwise—in standardized agreements are enforceable. some legal commentators have expressed reservations about the enforceability of such clauses. as a result, employers using standardized agreements must be willing to assume some risk when including a release clause in a standardized agreement. though courts are more likely to permit the release of a more senior-level employee than lower or mid-level employ- ees, employers should not rely on this per se. n senioR paRt-tiMe eMployMent as part of its effort to combat Germany’s unemployment rate, the government introduced the concept of senior Part-time employment in 1996. under this program, a senior employee generally works full time for only the first half of the duration of the senior part-time employment arrange- ment and is released entirely from his work obligations thereafter, e.g., if the parties enter into a six-year agreement, the employer will work full time the first three years and be released from any work obligations the final three years. during this period, the employee will earn approximately 50% of his salary from his employer plus an additional step-up contribution causing the employee to earn approxi- mately 70%–80% of his net salary in the aggregate. the step-up contribution will initially be paid by the employer; however, the local labor office will reimburse the employer for the step-up if the employer hires either an apprentice

• r an unemployed individual to “replace” the employee

who entered into the senior part-time employment agree-

• ment. this program is to motivate older employees to

pursue a senior part-time employment relationship (as they will receive approximately 70%–80% of the net salary, but

• nly work 50%) and simultaneously put some pressure
• n employers to hire apprentices or the unemployed (as

the step-up contribution is otherwise not subject to reim- bursement). one other aspect of this model is that after the expiration of the senior part-time status, the senior part- time employee will enter into early retirement and receive a statutory pension.

6 In a 2004 case, an employer released an employee who had concluded such a senior part-time employment agree-

• ment. the employee sought compensatory damages from

the employer because early retirement was no longer avail- able to the employee because the release caused him to no longer satisfy the prerequisites for early retirement. the court disagreed with the employer’s assertion that the early retirement was still available to the employee. as a result, the court ordered the employer to compensate the employee for the resultant damages. n loCk-out peRiod though not commonly known, the release of an employee may actually benefit the employee in terms of social bene-

• fits. an employee and employer may enter into a settlement

agreement ending the employment relationship, and calling for the employee to be released duration a relatively long termination notice period. typically, the local labor office interprets such a settlement agreement to be a voluntary agreement to give up a job; such a voluntary move by the employee means that, if the employee applies for unem- ployment benefits, then he will be subject to a lock-out period of twelve weeks. However, Germany’s Federal social court has held in the past that the lock-out period—as a result of voluntarily giv- ing up a job—begins as soon as the employee actually discontinues working, regardless of whether an employ- ment relationship is still in place. this means that the lock-

• ut period will be covered, at least in part, by the release

period while the employee is still earning his pay. as a result, the employee and employer may mutually agree to end the employment relationship in such a manner that the employee will not be subject to a lock-out from unemploy- ment benefits. However, what often goes unheeded is that if such a lock-out is imposed, the duration of the unem- ployment benefits will also be reduced for the same time period as the lock-out period. this means that, although the employee may have initially avoided the lock-out from unemployment benefits, if the employee is unemployed for an extended period of time, then this will catch up with him in the end. as a result, employees who wish to end the employment relationship will seek to circumvent this sce- nario by having the employer terminate the employee, then file an action challenging the termination and then reach an in-court settlement with the employer rather than agreeing to a settlement agreement. In-court settlements are generally not subject to the lock-out of unemployment benefits. n involveMent of WoRks CounCil If the company has a works council, the employer is not required to give the works council an opportunity to be heard prior to releasing the employee. However, the employer must bear in mind that if the works council

• bjects to an ordinary termination, and the employee files

an action to challenge the termination, the employer may not be able to release the employee. If the employee, as part of his legal claim, demands that he be able to work, then the employer must continue to keep the employee

• ccupied not only for the period of the termination notice

period, but also for the period needed by the court to issue a legally-binding decision. only in certain circumstances— e.g., if the employee challenges the termination in bad faith

• r if the continued occupation of the employee would be

an unreasonable financial burden on the employer—may the court, upon the filing of an injunction by the employer,

• rder that the employer not be required to keep the

employee occupied.

the content of this newsletter is intended to convey general information about changes in German labor law. It should not be relied upon as legal advice. It is not an offer to represent you, nor is it intended to create an attorney-client relationship.

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FrankFurt Hochhaus am Park Grüneburgweg 102 60323 Frankurt Germany tel.: ++49 69 9726 3939 Fax: ++49 69 9726 3993 Georg Mikes German attorney at Law; certified Labor and employment Lawyer gmikes@jonesday.com MunIcH

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80538 Munich Germany tel.: ++49 89 2060 42 200 Fax: ++49 89 2060 42 293 ansgar rempp German attorney at Law; attorney at Law; certified Labor and employment Lawyer arempp@jonesday.com