Service Agreements for GmbH Managing Directors

Service agreements and appointment: two separate relationships

A managing director (Geschäftsführer) of a German GmbH stands in two legally distinct relationships with the company. The appointment (Bestellung) is a corporate act that makes the person an officer with authority to represent the company; it is governed by the Limited Liability Companies Act (GmbHG). The service agreement (Geschäftsführer-Dienstvertrag) is the contract that sets remuneration, benefits, holiday, term and termination. Service agreements are in principle contracts for services under §§ 611 et seq. of the Civil Code (BGB), not employment contracts. The two relationships can end at different times, and much of the drafting work consists in coordinating them.

For foreign parent companies, the distinction is often counter-intuitive. A managing director can be removed from office by shareholder resolution at any time, yet the service agreement may continue for months or years, with full remuneration, unless it is properly drafted. Conversely, a well-drafted agreement allows a clean separation at manageable cost.

Employment versus corporate status

Labour law largely does not apply to managing directors. The Protection Against Dismissal Act excludes members of the body that legally represents a legal entity (§ 14(1) no. 1 KSchG), and the Labour Courts Act provides that such persons are not regarded as employees, so disputes about service agreements generally go to the civil courts (§ 5(1) sentence 3 ArbGG). Managing directors are not represented by works councils and are not covered by collective agreements.

Some protective rules nevertheless apply. The General Equal Treatment Act (AGG) applies to managing directors as regards access to the position and promotion (§ 6(3) AGG), which the courts extend to decisions not to renew a contract. EU law can treat managing directors who work under the direction of the shareholders as workers for certain purposes, which is relevant for maternity protection and for headcounts in collective redundancies. Where a managing director was previously an employee of the company and is promoted, the question whether the old employment contract has been terminated or merely suspended deserves attention: written form under § 623 BGB applies, and a new service agreement in writing generally replaces the previous employment contract.

Social security status of managing directors

Social security law follows its own test. A managing director is in employment subject to social insurance if he or she works under the direction of the shareholders and is integrated into the company's organisation. According to the case law of the Federal Social Court, a managing director who holds at least 50% of the share capital, or who holds a contractual blocking minority covering all company matters, is generally self-employed because he or she can prevent instructions. A minority shareholder-director without such a blocking right, and an external director without any shareholding, is generally employed and subject to contributions, regardless of the title “managing director” or a free hand in practice.

Where the employer reports a managing shareholder of a GmbH to the health insurance fund, the collecting agency must initiate a status determination with the German Pension Insurance (§ 7a(1) sentence 2 SGB IV). The determination binds the other social insurance institutions and creates certainty for both sides. Groups that appoint minority shareholders as directors, for example in management participation programmes, should check the articles of association and any shareholder agreements for blocking rights, because unexpected contribution liabilities are common.

Revocation, termination and coupling clauses

Under § 38(1) GmbHG, the appointment can be revoked at any time by shareholder resolution (§ 46 no. 5 GmbHG), without prejudice to compensation claims under existing contracts. The articles may restrict revocation to good cause, such as gross breach of duty or inability to manage properly (§ 38(2) GmbHG). Under a more recent addition, a managing director may also ask to be temporarily removed from office during maternity protection, parental leave, family care or illness if at least one other director is appointed, with a right to be reappointed (§ 38(3) GmbHG).

The service agreement must be terminated separately. Fixed-term agreements, common for three to five years, can be terminated early only for good cause within two weeks of knowledge of the relevant facts (§ 626 BGB). For agreements of indefinite duration, the courts apply the notice periods of § 622 BGB to external managing directors in many cases. To align the two relationships, agreements often include:

• a coupling clause, under which revocation of the appointment also terminates the service agreement, subject at least to the statutory notice period;
• a garden leave clause allowing the company to release the director with pay after revocation;
• a severance cap, often modelled on two years' total remuneration, for early termination without good cause;
• a clear provision that the company is represented by the shareholders' meeting or, where one exists, the supervisory board in matters relating to the service agreement.

Liability provisions in service agreements

Managing directors must apply the care of a prudent businessman in the company's affairs and are jointly and severally liable for damage caused by breaches of duty (§ 43(1) and (2) GmbHG). They are specifically liable for payments in breach of capital maintenance rules (§ 43(3)), and the claims become time-barred after five years (§ 43(4)).

In a crisis, managing directors must file for insolvency within the statutory deadlines and may not make payments after the onset of illiquidity or over-indebtedness unless they are compatible with the care of a prudent manager (§ 15b InsO). The business judgement rule developed for the stock corporation is applied by analogy, protecting entrepreneurial decisions taken on an adequate information basis in the company's interest.

Service agreements can address liability, but only within limits. Shareholders can waive or limit claims, subject to mandatory rules protecting creditors. Common provisions include an obligation of the company to take out D&O insurance with an appropriate sum insured and run-off cover, rules on legal defence costs, indemnities for claims by third parties where the director acted in good faith, and the procedure for discharge (Entlastung) by the shareholders. A deductible is not mandatory for GmbH directors, unlike for stock corporation board members. Our page on directors' duties in a crisis explains the insolvency-related exposure.

Remuneration, pensions and post-contractual restrictions

Service agreements typically combine a fixed salary with a variable bonus and, in larger companies, long-term incentives. Variable pay should be based on clear targets set by the shareholders, with rules for leavers and for adjustments after transactions. In a crisis, the shareholders may be entitled to reduce remuneration under the principle of good faith. Pension commitments for directors are common in family businesses and are subject to the Occupational Pensions Act only where the director is not a controlling shareholder.

During the term of office, managing directors are subject to a non-compete arising from their duty of loyalty. Post-contractual non-competes are not governed by § 74 HGB, which applies to employees, but are reviewed by the civil courts under § 138 BGB: they must protect a legitimate interest of the company and be reasonable in scope, location and duration, typically not exceeding two years. Compensation is not legally required in all cases but strengthens enforceability. Non-solicitation of customers can be easier to justify than a general non-compete. Where the company pays compensation, it should reserve the right to waive the restriction before the director leaves, with a defined period after which the payment obligation ends.

Checklist for service agreements

• Parties and representation: the company, represented by the shareholders' meeting or a supervisory board, not by a fellow director.
• Term: fixed term with renewal mechanism, or indefinite term with notice periods aligned to § 622 BGB.
• Coupling clause linking revocation of the appointment to termination of the agreement, with a notice period.
• Garden leave and the right to release the director after revocation, with treatment of holiday and bonus.
• Remuneration: fixed salary, variable pay with clear targets, long-term incentives, company car, pension.
• Duties: scope of management responsibility, approval requirements, reporting lines in the group.
• D&O insurance, indemnities and defence costs.
• Confidentiality, return of documents and data, and post-contractual restrictions.
• Choice of German law, jurisdiction of the civil courts or arbitration, and written-form clauses.

Service agreements for directors who are also shareholders should be reviewed together with the shareholder agreement, because leaver provisions for shares often refer to the termination of the service agreement. Inconsistent definitions of good and bad leaver can lead to disputes worth far more than the salary itself.

Practical points for foreign groups

International groups frequently appoint group executives as managing directors of German subsidiaries in addition to their main role. In such cases, it should be clear whether the German service agreement is remunerated, whether the director acts under a secondment or a dual contract, and how the time spent in Germany affects tax and social security.

The managing director is personally responsible for compliance with German law, including tax filings, social security contributions and insolvency filing duties, even where decisions are effectively taken at group level. Instructions from the parent company are binding in a GmbH, but they do not protect the director against liability for breaches of mandatory creditor protection rules. Our article on employment contracts for foreign employers covers the employees below management level, and our corporate governance page explains the GmbH's governance structure.

How TRW & Co helps

We draft and negotiate service agreements for GmbH managing directors for companies and, where there is no conflict, for directors themselves. We advise shareholders on appointments and removals, prepare resolutions and termination notices, and negotiate separation agreements. We assess social security status and initiate status determinations, structure remuneration and pension commitments, and draft post-contractual restrictions. In disputes over removal, termination or liability, we represent clients before the civil courts and in arbitration. For an initial discussion, contact us. This article provides general information and is not legal advice.