GERMAN LABOR AND EMPLOYMENT NEWS

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1 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 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 position. This removal, however, does not directly impact the contractual relationship 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 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 shareholders 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 shareholders have waived their right to terminate the Managing Director for cause.

2 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. To reiterate: German law distinguishes between the statutory appointment of a Managing Director and a contractual relationship 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 termination 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 company 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. However, a recent court decision has caused some consternation 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 highest 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 particular 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. 2

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 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. beyond the idea stage and did not constitute doing business 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). 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 oheeder@jonesday.com It has been a lingering problem in Germany to terminate an employee based on an employee s poor performance. 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, regardless 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 German law sets forth that an employee must only provide 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 opined on to what extent an employee s substandard performance may justify a termination. 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 company have not yet ended are actually entitled to solicit the company s customers for future business plans. In its decision of December 11, 2003, the Federal Labor Court held that if an employee performs at only 40% to 50% of 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 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 constitutes 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. employee s personal characteristics. An employer may be able to terminate an employee if the employee s actual performance is lower than the employee s target performance taking into consideration the employer s ability to instruct or influence the employee. If an employee s performance is only 40% to 50% of the average performance of the other employees, then this may be grounds for termination based on the employee s conduct unless that employee can demonstrate that the lower performance is as a result of the The court s decision also met with incredulation among practitioners since it was held that because the termination 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 personal characteristics of the employee and he is working at the average level of a person with similar personal characteristics. 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. 3

4 poor performance and then depending on the situation may terminate the employee either for reasons of conduct or the employee s personal characteristics. 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 on the situation may terminate the employee either for reasons of conduct or the employee s personal characteristics. To the delight of many employers, the Federal Labor Court has finally given some direction with respect to the termination 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 Often 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 confidential 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 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 an employee may be as varied as the legal considerations involving such a release. This article will discuss a number of these legal considerations. employee a member of the sales staff had significantly lower sales figures than other members of the sale staff. n The Right to Release an Employee The essence of a release is that the employer waives the These two decisions will make it easier for employers to determine which employees are performing at an unsatisfactory level. The employer can then document this poor performance and compare it to the performance of the other employees. 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 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 obligations 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. 4

5 Of 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, employees 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 termination 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 burden to prevail on his injunction claim. n Contractual Release Clauses For the reasons discussed above, an employer is welladvised to include a clause in employment agreements whereby he may release an employee from his work obligations. 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 termination notice period, but also at other times. This minimizes the risk that a court will hold a broad release clause to be unenforceable. On a related note, some aspects of German employment law were codified in Germany s Civil Code in 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 of 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 employees, 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 Under this program, a senior employee generally works full time for only the first half of the duration of the senior part-time employment arrangement 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 approximately 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 or an unemployed individual to replace the employee who entered into the senior part-time employment agreement. 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 only work 50%) and simultaneously put some pressure on employers to hire apprentices or the unemployed (as the step-up contribution is otherwise not subject to reimbursement). One other aspect of this model is that after the expiration of the senior part-time status, the senior parttime employee will enter into early retirement and receive a statutory pension. 5

6 In a 2004 case, an employer released an employee who had concluded such a senior part-time employment agreement. The employee sought compensatory damages from the employer because early retirement was no longer available 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 benefits. 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 unemployment 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 giving up a job begins as soon as the employee actually discontinues working, regardless of whether an employment relationship is still in place. This means that the lockout 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 unemployment benefits. However, what often goes unheeded is that if such a lock-out is imposed, the duration of the unemployment 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 scenario 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 objects 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 occupied 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 or 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, order that the employer not be required to keep the employee occupied. 6

7 Lawyer contacts FRANKFURT Hochhaus am Park Grüneburgweg Frankurt Germany Tel.: Georg Mikes German Attorney at Law; Certified Labor and Employment Lawyer Munich Prinzregentenstr Munich Germany Tel.: Fax: Ansgar Rempp German Attorney at Law; Attorney at Law; Certified Labor and Employment Lawyer Fax: jones day global locations Atlanta Beijing Brussels Chicago Cleveland Columbus Dallas Frankfurt Hong Kong Houston Irvine London Los Angeles Madrid Menlo Park Milan moscow Munich New Delhi New York Paris Pittsburgh San Diego San Francisco Shanghai Singapore Sydney Taipei Tokyo Washington 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.