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Special employment law aspects for employee-shareholders

Expert article in corporate law and labor law

I. Introduction

When shareholders of a GmbH actively participate in the company but do not assume the role of managing director, the question arises as to the legal classification of their activities. While a shareholder-managing director is not considered an employee due to their position as a corporate body, working shareholders without a managing director function are not automatically considered employees. If an employment relationship exists in an individual case, further questions arise: To what extent does their status as a shareholder influence the protection of the employment relationship, and which legal recourse should be chosen in the event of a dispute?

II. Status of working partners

1. Compatibility of shareholder status and employee status

Shareholders of a GmbH who are also managing directors are traditionally classified as employers due to their position as an officer and are not considered employees. Furthermore, they do not have recourse to the labor court due to the negative fiction in Section 5 (1) Sentence 3 of the ArbGG (German Employment Court Act), since representative bodies of legal entities or groups of persons are not considered employers. They also have no statutory protection against dismissal under Section 14 (1) No. 1 of the KSchG (Contract Protection Act). However, if shareholders work in the company without a managing director function, for example as authorized signatories (Prokurists), the exclusion criterion of legal representation no longer applies. In this case, the status of shareholder does not, in principle, preclude employee status. A shareholder can therefore also have an employment relationship with his or her company.

2. Demarcation criteria for employee-shareholders

This does not apply, however, if a shareholder has so much influence on the company's management that they also exercise management power through their status as a shareholder. The employment relationship is characterized by the employee's personal dependence. The right to give instructions, which underlies the employment contract, is a crucial feature of an employment relationship. A shareholder who, through their participation in the company, can prevent instructions regarding their work performance is not in a state of personal dependence. Whether the shareholder status is sufficient to block instructions depends primarily on the voting rights. A shareholder who holds more than 50% of the votes cannot therefore simultaneously be an employee of the company, even if they are not a managing director. Shareholders who hold a blocking minority are also not considered employees. The question of whether a working shareholder is considered an employee is essentially assessed according to the same criteria as the social security law distinction between self-employment and dependent employment. The Federal Social Court considers whether the shareholder's status as a shareholder gives the shareholder the legal power to prevent the company's instructions. If blocking instructions is not possible due to a low number of voting rights or a lack of a blocking minority, the shareholder is considered an employee.

III. Protection of the employee-shareholder’s rights

1. Impact of shareholder status on grandfathering

An employee-shareholder is considered a "genuine" employee and thus falls within the personal scope of the Dismissal Protection Act. However, their status as a shareholder can provide additional protection. According to the case law of the Federal Labor Court (BAG), a restriction on termination under company law exists for employee-shareholders if the termination of the employment relationship constitutes a measure requiring the approval of the shareholders' meeting. If the management has a catalog of transactions requiring approval that presumes the termination of the employee-shareholder's employment is subject to the prior approval of the shareholders' meeting, a termination that violates this provision is inadmissible under company law. In such a case, the BAG determines the violation of the articles of association as the reason for the invalidity of the termination, and the employee-shareholder can successfully invoke this deficiency in the dismissal protection proceedings. The BAG has also recognized this invalidity if the employee-shareholder's employment contract refers to the articles of association, which requires shareholder approval for the dismissal of particularly qualified employees. In a later decision, however, the Federal Labor Court ruled that it was not necessary for an express consent requirement to be included in the partnership agreement as long as the employment contract of the authorized representative of the shareholder was of outstanding importance to the shareholders' meeting and the termination was therefore considered an unusual legal transaction requiring the consent of the shareholders' meeting.

2. Requirements for special protection against dismissal under company law

The managing director's fundamentally unlimited power of representation pursuant to Section 37 (2) of the GmbHG does not alter the invalidity of a termination if it violates the articles of association, as this provision only protects "third parties." The company cannot invoke the unlimited power of representation vis-à-vis its shareholders, as otherwise it would benefit from its managing director's violation of the articles of association. Such an approach would contradict the principles of good faith. Therefore, the employee-shareholder has the right to invoke the lack of approval by the shareholders' meeting as a reason for invalidity. In the event of termination of their employment relationship, the employee-shareholder should therefore review the articles of association, rules of procedure, and managing director contracts to determine whether the termination of their employment relationship requires the approval of the shareholders' meeting. There is no need for an explicit provision in the articles of association specifying the consent requirement for the termination of the employee-shareholder; it is sufficient for the management to obtain the approval of the shareholders' meeting for unusual transactions. The termination of a shareholder's employment relationship always represents an unusual legal transaction that falls under the special protection against dismissal under company law.

IV. Legal recourse for claims by employee-shareholders

1. Expanded jurisdiction of labor courts

If a shareholder is also an employee, according to Section 2 Paragraph 1 No. 3 of the ArbGG, the labor courts have jurisdiction over all civil legal disputes between them and the employer arising from the employment relationship as well as concerning the continued existence of the employment relationship. However, the question arises as to whether the employee-shareholder can also assert claims arising from their corporate relationship with the employer before the labor court. In practice, employee-shareholders often attempt to enforce not only their employment law claims but also their corporate law claims before the labor court. This not only saves them the need to pay advance court costs but also the reimbursement of their opponent's costs in the event of a loss. Section 2 Paragraph 1 No. 4a ArbGG extends the jurisdiction of the labor courts to legal disputes between employees and employers and concerning claims that have a legal or direct economic connection with the employment relationship. Clarifying whether there is a legal connection with the employment relationship is relatively unproblematic: Such a connection exists if the claim is based on the employment relationship or is conditioned by it.

2. Criterion of direct economic connection

However, determining a direct economic connection with the employment relationship is more complex. The Federal Labor Court (BAG) assumes such a connection if the claim is based on the same economic relationship or represents an economic consequence of the same facts. Furthermore, it requires that the claims be closely related internally, i.e., arise from a single factual situation. The BAG specified this by stating that a direct economic connection generally exists when a service not resulting from the employment relationship can be provided or claimed with regard to the employment relationship. The connection becomes particularly clear when the service is intended to bind the employee to the company. The lower courts have often applied these rather abstract requirements of the BAG using a conditio sine qua non formula. For example, the Higher Regional Court of Karlsruhe ruled in one case that a direct economic connection existed if a former employee was able to purchase goods from their employer at reduced prices and offset claims for compensation against the purchase price. This agreement was so closely linked to the employment relationship that it established a direct economic connection pursuant to Section 2 Paragraph 1 No. 4a of the German Employment Act (ArbGG). In another case involving the termination of a contract for the establishment of a silent partnership between an employed personnel consultant and a consulting firm, the Düsseldorf Labor Court also found that a direct economic connection exists if the legal relationship would not have come into being without the employment relationship. Due to this broad understanding of the criterion, almost every corporate law claim of an employee-shareholder can be subsumed under Section 2 Paragraph 1 No. 4a of the ArbGG, such as claims to profit shares or severance payments. If shareholders decide to make an employee a co-shareholder, the employment relationship will always be a conditio sine qua non for the admission of the shareholder.

3. Restrictive recent case law of the Federal Labor Court

In a recent decision, however, the Federal Labor Court (BAG) limited this broad interpretation. An employed sales engineer, who became a limited partner and shareholder of a GmbH & Co. KG (limited partnership & limited liability company) through a joining agreement with the partners after the start of his employment relationship, demanded payment of severance pay for his shares from the company before the labor court following the termination of his employment and his participation. The Federal Labor Court (BAG) found that there was no legal connection between the employment contract and the partnership agreement. There were no mutual references between the agreements, thus precluding a legal connection within the meaning of Section 2 Paragraph 1 No. 4a, 1st Alt. ArbGG (German Labor Court Act). Likewise, the BAG rejected a direct economic connection. Although the plaintiff's admission as a shareholder was contingent upon the employment relationship due to the economic connection, this merely established a "certain" economic connection, but not a "direct" economic connection within the meaning of the law. The work performance and remuneration under the employment contract were not directly dependent on corporate law circumstances such as profit, loss, or severance pay. Therefore, the employment law and corporate law claims were considered separate claims, which precluded any direct economic connection.

V. Conclusion

When an employee who is also a shareholder in the company asserts claims in court, special aspects must be considered. First, the plaintiff's status must be carefully examined. They can only assert employment law claims if their position under corporate law does not give them the opportunity to prevent instructions from being given and they do not act as a representative body of the company. If they qualify as an employee-shareholder, it must be examined in grandfathering proceedings whether they are entitled to special protection against dismissal under corporate law. This requires an examination of the articles of association and, if applicable, the rules of procedure. In disputes that do not concern direct claims arising from the employment relationship, it must be clarified whether the claims are legally related to the employment relationship in order to determine jurisdiction. If the claims cannot be derived directly from the employment relationship, the labor court may still have jurisdiction if there is a direct economic connection with the employment relationship. However, it is not sufficient for the employment relationship to overlap in time with the participation in the company. Rather, a direct economic connection requires that the employment law and corporate law claims arise from a common life situation. Claims arising from employee participation that grant the employee shareholder status can only be asserted before labor courts if the possibility of participation is expressly stipulated in the employment contract.