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The ability of co-shareholders to review the managing director’s remuneration

The Higher Regional Court (Oberlandesgericht, OLG) in Hamm handed down a landmark ruling, on 9.9.2019, on the question of whether or not and within what limits a managing director who is also the majority shareholder is able to determine his/her own remuneration (case reference: 8 U 7/17). The appropriateness test has to be performed while taking due account of fiduciary duties and multiple functions.

Issue - Exclusion of voting rights on matters of personal interest?

The claimant was a minority shareholder (40%) in a GmbH [German private limited company], which acted as the general partner company for a GmbH & Co. KG [German limited partnership with a limited liability company as a general partner]. The majority shareholder (60%) and managing director of the GmbH was the claimant’s brother. His son was another managing director. Both of them already worked as managing directors in return for payment in other group companies. A dispute erupted when, for the first time, the majority shareholder - even though his brother voted against this - concluded managing director employment contracts with himself and his son that provided for remuneration, in each case, of € 60,000 p.a.

The minority shareholder asserted that his brother was excluded from voting on matters of personal interest and, moreover, that the functions did not justify the respective remuneration, therefore, this constituted a breach of corporate fiduciary duties. However, the OLG took a different view.

OLG ruling - No exclusion of voting rights

GmbH-shareholders are generally excluded from voting if the resolution concerns performing a legal transaction with themselves. It is however generally accepted that this does not include those legal transactions that are based in relationships under company law. According to the OLG, this also includes an employment contract for a managing director. Otherwise, determining the conditions of the managing director function of the majority shareholder would be solely in the hands of the minority shareholder. Therefore, the risk that the majority shareholder could enrich him/herself to the detriment of the minority shareholder should not be eliminated via the exclusion of voting rights but, instead, via the principles of fiduciary duty and equal treatment. These apply particularly with regard to an employment contract with a close relative. Consequently, the majority shareholder was not excluded from voting on the resolution on his own employment contract nor that of his son.

Appropriateness test in accordance with corporate fiduciary duties ...

Fiduciary duty prohibits setting remuneration for a shareholder that would not be granted for an equivalent activity by a third party. In this respect, fairly broad discretionary leeway exists, although the adherence to this will be subject to court review. In doing so, it is possible to draw on appropriate remuneration studies about managing director salaries as well as financial court rulings on the issue of hidden profit distribution. The court implied here that more generous criteria should be adopted under company law than under tax law. Consequently, as the limits under tax law had not been exceeded in the case in question likewise, under company law, there could not have been a breach of fiduciary duty.

... in view of several employment contracts in the group

When assessing the appropriateness, ultimately, you have to take into consideration if the person concerned is working in parallel for other affiliated companies and drawing a salary for this. Nevertheless, in the process, the allocation should not be carried out on a purely pro rata basis using the number of days worked for the respective companies. Instead, it is rather more common to use an appropriate percentage reduction for the part-time activity that does not have to correspond to the time allocation.

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