MD Contract in a German LLC: Appointment, Duties, and Legal Essentials Explained

What is an MD contract?

The employment contract for a managing director (MD) 💬Geschäftsführer is a complex matter that touches on numerous areas of law. This is because the MD of a GmbH is not a regular employee. As a rule, the contract between a GmbH and its managing director is not an employment contract but a service contract. That is, the German labour law only applies in certain circumstances.

The law doesn’t make the drafting of a written contract mandatory. Nevertheless, it is highly recommended. Not having everything set in stone is a risk not worth taking.

An employee and not an employee at the same time

The exact status of a GmbH managing director can be confusing because of contrasting rulings from two key courts: the federal supreme court and the federal labour court.

The main issue arises from the fact that the position of a managing director – unlike all other employee positions – is an executive or “corporate-body” part of a company which is generally appointed via shareholder resolution and the articles of association.

Because of this, the Bundesgerichtshof has ruled that the position is incompatible with an employment relationship. In other words, a managing director cannot be an employee. However, under certain circumstances, the federal labour court does recognise the managing director as an employee.

Who can be a GmbH managing director?

The position of managing director in a GmbH is a corporate body of the company. Shareholders of a GmbH must fill this position with a natural person who has full legal capacity.

For example, you can appoint a shareholder or an external person as a managing director, but not minors, persons with limited legal capacity or a company.

Furthermore the law rules out anyone who has gotten into legal trouble. That is, anyone convicted of insolvency offences, breach of trust or fraud with a custodial sentence of more than one year. Also, delaying filing for insolvency, providing false information in breach of the Records Act, or failing to comply with previous employment disclosure obligations are likewise grounds that prevent a person’s appointment as a managing director. Every MD candidate should be aware of the responsibilities that come with the role.

Be careful: It can be particularly tricky if a shareholder intentionally or grossly negligently appoints a person as managing director who isn’t legally suitable for the position of managing director. In this way, shareholders risk being held financially accountable by other shareholders if this person becomes a liability for the GmbH.

MD appointment

A viable managing director is a prerequisite for a GmbH’s entry in the commercial register. If the GmbH is without a managing director due to incapacity, dismissal, a termination agreement or death, all shareholders must manage the business jointly.

You can make a precautionary provision for this case in the shareholder agreement. One or even all shareholders can be entrusted with managing a GmbH using the standard articles 💬Musterprotokoll when forming the company. They then become managing shareholders / managing partners. However, if there are more than two partners, it is not always practical for all shareholders to be managers at the same time. For one, this shifts the shareholder meeting to that of management, which can be a hindrance in day-to-day business.

It is advisable to regulate the appointment of the managing director in the customised articles 💬Satzung. Here, you determine with which majority of the voting shares the managing director must be elected.

If a managing director resigns, the shareholders have to appoint a new managing director. The new MD must always be entered in the commercial register and named on business documents and in the imprint of print and online material.

The shareholders of GmbH may also appoint an external managing director who then becomes a salaried member of its workforce. You can learn more about a managing director’s salary in Germany here.

When is a managing shareholder en employee?

In Germany, if shareholders of a GmbH take up a management role, they are called managing shareholder 💬geschäftsführende Gesellschafter.

If a managing shareholder holds a majority of the shares in the GmbH, the federal labour court classifies him or her as an employee, as he/she has a decisive influence on decisions of the shareholders’ meeting. Therefore such a contract is not an employment contract, but merely a service contract.

If a managing shareholder owns only a small amount of shares or none at all, the employee status can kick in if this person is not contractually and factually allowed to decide independently the time and place of work performance, or “personally dependent” on the company.

Given this, most managing directors don’t have an employee classification or status.

Limited labour protection for non-employee managing shareholders

For non-employee GmbH managing shareholders  some protective employment laws don’t apply. For example, non-employees can not automatically claim paid sick leave in the event of illness, as the EFZG (continued payment of remuneration act) only applies to employees. Likewise, managing directors without an employment contract cannot claim protection against dismissal. Therefore, prospective GmbH managing directors should make sure their contracts have provisions that entitle them to the following:

• Continued payment of remuneration in the event of illness
• recreational leave
• payment of health insurance costs
• life or pension insurance
• occupational disability insurance coverage
• generous notice periods in the event of termination

GmbH managing directors with an employment contract

A managing director who owns only a small stake in the company may have employee status. This depends on whether the person in this position is not contractually allowed to decide when and where work performance takes place or is “personally dependent” on the company.

The employed MD needs an employment contract

Like any employment contract, the MD employment contract begins by stating the parties entering into the contract and when the work started/will start. Further parts include:

• Scope of management authority
• Authority to manage and represent the company
• Regulations for transactions requiring consent
• If applicable, exemption from restrictions on insider dealings under § 181 BGB
• Determination of rights and duties
• Liability
• Requirements regarding the place of employment and working hours
• Holiday entitlement
• Non-competition clause
• Remuneration regulations and bonuses
• Remuneration in the event of illness
• Duration of contract
• Notice periods

External employed managing director

Generally, external managing directors are employed like salaried employees. They have to turn up at a particular place and time and follow instructions. However, there is a key point of difference: They don’t have a regular employment contract but rather a service contract. But, despite this, external managing directors usually have to make social security contributions as well. This means that just like a regular employee in Germany, the GmbH has to pay the social security contributions on their behalf. In other words, most external managing directors are legally considered to be employees – but not a regular type of employee with a regular employment contract.

Transitioning from employee to managing director

What happens when an employee gets promoted to managing director? The employee – let’s call her Maria – goes through a change in employee status. That is, Maria loses her protective rights as a regular employee, which is a disadvantage, especially as she has been with the company for years. For example, if she’s been an employee of the company for more than ten years she enjoys extensive protection against dismissal.

For this reason, Maria should require contract clauses that protect her entitlements. Specifically, there should be an agreement in the employment contract that she – as the external managing director – may return to her former status as an employee when she no longer holds the position.

Rules of procedure

Don’t forget to include rules of procedure in the managing director’s contract. These rules can be agreed to by resolution of the shareholders’ meeting and then attached to the employment contract as an appendix. These rules should address the following things:

• The GmbH managing director’s powers of representation
  Up to what amount may the managing director enter into a contract without the shareholders’ consent?
• Exemption from §181 BGB
  This prohibits the managing director from entering into a legal transaction with the GmbH personally (self-dealing or self-contracting).
• Duties of the managing director in the internal relationship
  Earlier preparation of the Jahresabschlusses (“annual accounts”) and Lageberichts (“management report”) than prescribed by the GmbHG
• Liability of the GmbH managing director in cases of gross negligence and wilful intent
• Taking out mandatory financial loss liability insurance

Does the MD have to pay social insurance?

Whether managing directors of a GmbH are liable for social insurance depends greatly on their employee status. Here the labour courts and social courts have different opinions. While the labour court generally classifies the GmbH managing director as an employer, the social court sees him as an employee.

Under section 7 (1) 8 of the SGB IV (social security code), there is an obligation to pay social security if a non-self-employed activity is carried out. Moreover, the person carrying out this activity must be in an employment relationship. Employment is defined as “work according to instructions and integration into the work organisation of the person giving the instructions”.

However, this cumbersome formula fails to define precisely whether the GmbH managing director fits into this definition of an employee. That is, as a leader of a company, the managing director operates independently but is also subject to instructions. Because, on the one hand, the position has the power to hire and fire personnel, give instructions to employees and decide on investments. On the other hand, the GmbH managing director must follow the instructions of the shareholders and implement them. Below we take a closer look at this seeming conundrum.

Managing shareholder

The obligation for a GmbH managing partner to pay social security insurance depends on whether the position is effectively under the control of the other shareholders or not.

As soon as a managing shareholder owns more than half of the equity shares, she is not subject to instructions and therefore doesn’t have to pay social security contributions. A managing partner with less than 50% equity may be subject to social security contributions, but not necessarily in all cases.

The managing partners with less than 50% equity are exempt from social security contributions is a legal grey area. But, again, the key factor is whether the managing partner is subject to instructions. If she is an independent managing director – that is, she is not integrated into the work organisation in terms of substance, time or place and is only accountable to the shareholders’ meeting – the obligation to pay social insurance may not apply.

Managing directors who are not shareholders

Unlike managing shareholders, external managing directors usually do not have a direct shareholding in the company for which they work. For this reason, they are often classified as employees and are liable for social insurance contributions. But, many factors come into play when determining an individual’s employment status as we’ll explore below.

Reasons that the social security obligation doesn’t apply to external managing directors

Much of the criteria that classify someone as self-employed – and therefore exempt from the social insurance obligation – are evident in how a managing director operates. The following points, in particular, point to a self-employed status:

• The legally effective external representation of the company (sole representation)
• Free determination and arrangement of own working hours as well as the type and location of activities
• The managing director is the only one with decision-making powers on-site, e.g. due to a high degree of physical distance.
• The company has emerged from a sole proprietorship or partnership of the external managing director.

Reasons that the social security obligation applies to external managing directors

If an external managing director is employed by a company she has no stake in and partly receives remuneration independent of profits and losses she is classified as an executive. This applies even if a managing director’s work performance is largely free from instructions and controlled by the GmbH shareholders to a limited extent. This is because, within the GmbH structure, supervision exercised by the shareholders is seen in the eyes of the law to be dependent employment in terms of social insurance. Thus, external managing directors regularly hold positions that obligate them to make social insurance contributions, even if they perform employer functions. (This is not offset by any bonuses or profit-sharing agreements.)

This view is regularly taken by the relevant authority – the Clearing House of the German pension insurance association 💬Deutsche Rentenversicherung Bund.

How to get official clarification

Overall, such a decision is made on a case-by-case basis. The social court has the ultimate power to determine if a managing director is liable for social security contributions.

If there are any doubts about the managing director’s status, going through a status determination procedure.

This can be particularly advantageous if you want to check if a contract meets the requirements for exemption from social insurance. By undergoing this procedure according to § 7a SGB IV at the German pension insurance fund 💬Deutsche Rentenversicherung Bund, you can get binding clarification on whether or not someone is a dependent employee in the sense of social security law. In this way, you gain legal certainty.

Termination, dismissal and end of the contract

The managing director may be dismissed within the standard contractual time limits. There are several ways to terminate the relationship:

Dismissal by the shareholder meeting

The managing director may be dismissed at any time at the shareholder meeting. A simple majority is enough for this. A shareholder-director may also vote personally on the decision unless there is an important reason for the dismissal. The dismissal becomes effective as soon as the managing director has been notified.

The managing director resigns

The managing director of a GmbH may resign at any time, even without good cause. However, this resignation must not be untimely, otherwise, the managing director may be liable for damages. The resignation must be declared at the shareholder meeting, whereby a written statement is not required but recommended.

Other types of termination

The managing director’s position may end after a defined period has elapsed. It also ends in the event of death or conversion.

Becoming a GmbH managing director without a written contract?

To appoint or employ a managing director, business owners need a contract, which may also be entered into orally. Surprisingly, this means it’s possible to work as a GmbH managing director without a written contract. In general, however, it is advisable in any case to put the managing director’s contract in writing.