"Freezing solution" for German Co-determination - Thawed in the future?

1. The Initial Situation: Need-based Co-determination Statute under the One-Third Participation Act and in the SE

German law provides for regulations dealing with co-determination, i.e. mechanisms providing for representation of employees on supervisory boards of German companies. In German, this is referred to as Mitbestimmung, which literally translates as co-determination, but, in pieces of European legislation is often referred to as employee participation.

Pursuant to the corresponding rules, companies that are subject to the German One-Third Participation Act (Drittelbeteiligungsgesetz, DrittelbG) or the German Co-Determination Act (Mitbestimmungsgesetz, MitbestG) due to their legal form (primarily AG, GmbH, KGaA) and provided that the number of employees regularly exceeds 500 or 2,000 (threshold value), must establish a supervisory board, at least one third (DrittelbG) or half (MitbestG) of whose members consists of employee representatives. However, the establishment of the co-determined supervisory board does not take place automatically as soon as the threshold is exceeded. Rather, the management must initiate a status procedure as soon as the requirements of the DrittelbG or the MitbestG described above are met. In this status procedure, the management must announce the now relevant co-determination statute of the company and indicate the provisions according to which the supervisory board will be composed. In addition to the management, the shareholders and the works council may also initiate the status proceedings. Outside and during the status proceedings, the principle of continuity under co-determination law shall apply. Until the conclusion of the status proceedings, the existing ("as-is") co-determination statute of the company remains in force.

In order to secure the existing (actual) participation status, companies which expect and/or plan to reach or exceed the relevant employee thresholds have so far sometimes converted to the legal form of an SE. According to the current legal situation, the applicable participation regime must be negotiated with the employees when the SE is established. If no agreement is reached in this regard, the regime applicable to the company which is to be converted into an SE (e.g. in the course of a change of the legal form or a cross-border merger) applies ("before and after principle" or "freezing solution"). Future changes in the number of employees in the company (or its subsidiaries) will then not result in the co-determination regime changing or having to be changed (see already our Client Alert). Exceptions apply only if there is a so-called structural change; in this case, the co-determination regime must be renegotiated. When exactly such a structural change is given is not regulated by law. In practice, the mere exceeding of the threshold values in the SE is predominantly not regarded as such a structural change.

2. The status quo: shaping co-determination to meet needs through needs-based company and group organization

According to the current legal situation, the DrittelbG also only applies to GmbHs, AGs and KGaAs (as well as to SEs at the time of their establishment) if the company itself employs more than 500 employees. Only in exceptional cases are employees of subsidiaries attributed to the controlling company, namely if the subsidiary is incorporated (“eingegliedert”, a specific term pursuant to German Group law provisions) or the controlling company has concluded a control agreement (in German: Beherrschungsvertrag, often also translated as domination agreement) with it (Sec. 2 (2) DrittelbG). The mere existence of so-called de facto control (faktische Beherrschung) or an (isolated) profit and loss transfer agreement, on the other hand, does not constitute grounds for attributing the employees. A (further) way observed in practice to preserve the co-determination-free status quo was therefore to divide the group into companies each with fewer than 500 employees or, in any case, to ensure that no company exceeds the threshold value on its own and that no circumstances are established which lead to an attribution.

Thus, at least up to now, by taking certain structuring measures, an application of a codetermination regime which is in line with operational requirements and suits business needs can be achieved, as long as less than 2,000 employees are permanently employed in the group structure.

If, on the other hand, the total number of employees in the group exceeds the threshold of 2,000 employees, in deviation from the above, the attribution provisions of the MitbestG shall apply. Pursuant to the MitbestG, the employees employed by group companies or subsidiaries are already attributed to the controlling company if the respective group company or subsidiary is directly or indirectly dependent on the controlling company. The mere existence of a majority shareholding or the majority of voting rights is sufficient for this; the existence of an enterprise agreement (i.e. control agreement or profit and loss pooling agreement) or integration (see above, concept of Eingliederung) is not required for this. The application of the Co-Determination Act on the basis of the attribution of employees of group companies or subsidiaries can nevertheless be ruled out in individual cases in which the controlling shareholder is not the sole shareholder and concludes an agreement by which it renounces control, i.e. a so-called Entherrschungsvertrag (disenfranchisement agreement) with the subsidiary. The conclusion of an Entherrschungsvertrag is not possible in the case of a wholly-owned subsidiary.

3. New World in One-Third Participation: Factual Control in the DrittelbG - and Expansion of the Legal Forms Covered by the DrittelbG?

According to the coalition agreement, the coalition parties intend to in the future transfer the attribution rules of the MitbestG to the DrittelbG. This would mean that in future, a supervisory board composed of one-third employee representatives would already have to be formed at the top of the group if the group has a total of more than 500 employees (without the existence of a control agreement being relevant).

Even if these employee representatives are employees of the company or group - external employee representatives, in particular trade union officials, can only be elected to the supervisory board if it consists of a total of more than 6 persons - this would result in the group of companies covered by co-determination being significantly expanded, namely whenever the group's top management is a company organized in one of the legal forms specified in Section 1 of the DrittelbG, specifically a GmbH, an AG or a KGaA.

This change in the relevant attribution rules alone is unlikely to have any effect on the structure of the GmbH & Co. KG as a parent company, which is widespread among SMEs, because the GmbH & Co. KG is not a legal form covered by the DrittelbG. However, it is clear from the coalition agreement that there are to be further, additional changes in the area of co-determination, and here specifically an "abusive avoidance of co-determination" is to be prevented. This statement in the coalition agreement does not include the explicit announcement that in the future the GmbH & Co. KG (and comparable company forms) will also be included in the group of legal entities covered by the DrittelbG. Nevertheless, companies constituted in this legal form are urgently advised to closely observe further legislative developments. This applies in particular also against the background that in the area of the MitbestG - whose attribution regulations are to be transferred to the DrittelbG - co-determination also takes place in the GmbH & Co. KG, at the level of the general partner GmbH.

4. New World in SE: Freezing Solution - Thawed?

The "abusive avoidance of co-determination" is referred to specifically in the coalition agreement with regard to the freezing solution for SEs - this is apparently such a thorn in the side of the coalition parties that changes to the law are being sought. Whether such a change is possible at all or would be considered inadmissible under European law is disputed. Some argue that the SE is determined by European law, which is why such a regulation would be contrary to European law. At the same time, however, it must be conceded that the underlying EU Directive on Employee Involvement contains an obligation to renegotiate the participation regime in the event of a structural change in accordance with the "before and after" principle. In this context, it is of particular interest that in Austria, a regulation has existed for years according to which a significant increase in the number of employees constitutes a structural change that leads to the requirement to renegotiate the co-determination regime, Section 228 (2) of the Austrian Labor Constitution Act. Against this background, a statutory regulation according to which exceeding the co-determination thresholds constitutes a structural change also appears to be a viable option for Germany.

5. Outlook

It currently remains to be seen whether the instruments used to pursue the objective of eliminating abusive structures will also include further measures which individual coalition parties had set out in their election program (such as, for example, a reduction of the threshold for the application of parity co-determination to 1,000 employees, or similar). With regard to SEs, the question arises as to how a possible entry into force of a statutory provision in the sense outlined above would affect SEs already in existence. The fact that such a provision will claim applicability for SEs to be established in the future is probably beyond question. For SEs already existing at the time of the entry into force of such a provision, on the other hand, the following is likely to apply - without details already being known: Insofar as the SE had already exceeded a corresponding employee threshold prior to the entry into force of the new provision described above, there is much to suggest that it will not be obliged to renegotiate the co-determination regime for reasons of grandfathering.

However, the situation is likely to be different if an SE does not exceed the relevant number of employees until after the regulation has come into force. In these cases, a renegotiation of the co-determination regime is likely to become necessary in the future. And also with regard to groups of companies with more than 500 but fewer than 2,000 employees, it remains to be seen whether there will be an increasing number of changes in the legal form at the top of the group.

It will be interesting to see whether, in addition to the changes to the attribution rules in companies now covered by the DrittelbG and the change in the freezing solution, further measures will be taken to eliminate - allegedly - abusive arrangements. It cannot yet be conclusively assessed whether the legislative changes will also be directed against structures such as foreign corporation & Co. KG (a hybrid legal form of a limited partnership with a nondomestic corporation acting as sole general partner, as has for example been used by Air Berlin).
It is also possible that the entire discussion will lead to a renaissance of the KGaA with its special governance and the different role assigned to the supervisory board in this legal form.

6. Conclusion

Any further concretization of the pronouncements in the coalition agreement on the further development of co-determination is likely to result in considerable reactions in the SME sector and entail various restructuring measures.

We would be happy to provide you with more detailed explanations and a discussion of the possible effects of upcoming legal changes on your company/group.