Update Corporate Co-determination: SE formation, threshold value and status proceeding

When an SE is established, the co-determination statute is not based on the "actual" but on the "target" situation at the time of the company's registration in the commercial register - at least if status proceedings could have been initiated at that time. This was established by the Higher Regional Court of Munich in several judgements dated 26 March 2020 (31 Wx 278/18 to 280/18) for the case of the formation of an SE by means of a change of the legal form. The Court has thus shifted the point in time until which members of the Supervisory Board of an SE can be lawfully appointed. Even though the Federal Court of Justice has not yet confirmed this position, the judgements are likely to have an immediate impact on the practice of structuring the SE with regard to corporate co-determination.

Starting point: threshold figure, status procedure and continuity principle in corporate co-determination

Companies which, due to their legal form (mainly AG, GmbH) and the number of regularly more than 500 or 2,000 employees (threshold figure), are subject to the scope of application of the One-Third Participation Act (Drittelbeteiligungsgesetz, DrittelbG) or the Co-Determination Act (MitbestG), must establish a supervisory board of which at least one third (DrittelbG) or half (MitbestG) of its members consists of employee representatives.

However, the establishment of the co-determined supervisory board does not take place directly and automatically as soon as the threshold figure is exceeded. Rather, the management must initiate a so-called status procedure as soon as the requirements of the DrittelbG or the MitbestG are met. As part of this status procedure, the management must disclose the company's status under co-determination law, which is now relevant, and point out the rules according to which the supervisory board will subsequently be composed. In addition to the management, the shareholders and the works council can also initiate the status proceedings. If employee representatives are elected to the supervisory board without a corresponding status procedure having been carried out beforehand, their election is null and void.

Outside and during the status proceedings, the continuity principle under co-determination law applies. Until the conclusion of the status proceedings, the existing ("actual") co-determination statute of the company remains in force.

SE formation and co-determination statute: Before and after principle and the decision of the BGH of 23 July 2019 on the "modified target state"

The continuity principle under co-determination law is relevant not only with regard to the duties of the executive bodies but also, and especially, when forming an SE.

In practice, an SE is typically formed by (1) a merger involving at least two stock corporations from different EU jurisdictions, (2) a change of the legal form of an AG with at least one EU foreign subsidiary or (3) the merger of a company into a shelf SE. A mandatory element of the formation is the procedure for determining the participation of employees in the supervisory body of the SE. Co-determination is to be determined primarily in an agreement between the management bodies of the companies involved in the formation and the special negotiating body of the employees (SNB) to be established for this purpose. If no agreement can be reached on this, participation is generally determined in accordance with the provisions of the SE Participation Act (SEBG) on the basis of the so-called before and after principle. According to this principle, the regulation on co-determination on the Supervisory Board continues to apply in the SE, which in the case of a change of the legal form of the company existed in the company changing its legal form and in the case of a merger which applied to at least 25% of all employees who were employed in the companies and subsidiaries affected by the formation of the SE (co-determination status).
It has not yet been clarified whether the co-determination status is based on the actual (actual status) or the legally required (target status) status of co-determination for the companies involved in the formation of the SE.

In its decision of 23 July 2019, the Federal Court of Justice (BGH) ruled that the target status is decisive if status proceedings had already been initiated prior to the formation of the SE. In the facts relevant to the decision, the formation of an SE by way of a change of the legal form was resolved by the Annual General Meeting on 2 June 2017 and registered with the Commercial Register on 31 July 2017. Shortly before the constitutive entry on 27 July 2017, a shareholder initiated the status proceedings. At that time, the Supervisory Board of the AG with the change of legal form consisted exclusively of shareholder representatives. In view of the more than 1,250 employees to be allocated to it, the Supervisory Board should possibly have been composed in accordance with the German One-Third Employee Representation Act. The BGH decided that the status proceedings must be continued even after the completion of the SE-formation and that the co-determination status in the SE is thus determined by the target status to be assessed in the status proceedings. It justified this in essence with the purpose of the statutory before and after principle. It is intended to prevent the "escape from co-determination" by establishing an SE; a co-determination statute cannot be laid down on a permanent basis if it is incorrect and its compliance with the applicable co-determination provisions has been put to the test by a status procedure already initiated.

The decisions of the OLG Munich of 26 March 2020: "Target state" in the concrete formation process in the event of dispute or uncertainty about the composition of the supervisory board

In its decision, the BGH did not answer the question of whether the "target" status is also relevant if no status proceedings have been initiated in the company at the time of the formation of the SE. Such situation was the basis for the three decisions of the Higher Regional Court (OLG) of Munich of 26 March 2020: The SE was founded in each case by changing the legal form of an AG and the Supervisory Board in each case consisted only of shareholder representatives, although the AGs each had between 1,851 and more than 2,000 employees group-wide at the time of the founding of the SE. Status proceedings had not yet been initiated at the time of formation and the AGs had each concluded a participation agreement with the SNB under which the Supervisory Board of the SE did not have any co-determination rights and therefore no employee representatives would be members of it. After the respective SE had been entered in the commercial register, one shareholder initiated the status proceedings in each case and asserted in each case that the supervisory body in the SE should also be composed of employee representatives in view of the "before and after" principle, taking into account the statutory co-determination regime applicable to the AG in each case (DrittelbG and MitbestG).

The Munich Higher Regional Court decided that the "target" status of the SE objectively required for the composition of the supervisory body would be decisive if status proceedings could have been initiated at the time of registration of the formation of the SE. This at least presupposes that at that time there was a dispute (e.g. between the subsequent applicant for the status proceedings and the management of the company) or uncertainty about the composition of the supervisory body. If this is the case - for which specific facts must be presented in the status proceedings - the supervisory body of the SE must comprise the corresponding number of employee representatives and a conflicting participation agreement with the SNB under which no (or too few) employee representatives belong to the supervisory body cannot have any legal effect.

The Munich Higher Regional Court (OLG) has in each case allowed the appeal on points of law.

Consequences for practice

It is to be expected that the Federal Court of Justice will make a final decision in each of these status proceedings, insofar as they are brought before the appellate court. The decisions of the Munich Higher Regional Court (OLG) are currently relevant in any case for the formation of an SE in which entrepreneurs are also considering the formation of the SE at least in part in order to "freeze" the current co-determination status. If it is to be expected that the number of employees of the company will exceed the thresholds in the future, so that a dispute or uncertainty about the composition of the supervisory body could then arise and status proceedings could be initiated, it is advisable with regard to the co-determination status to reflect in good time whether the business operations could be restructured legally, organizationally or operationally - and if so, to implement these measures. In addition to the establishment of an SE, the modifications can also include measures, which are directed (1) towards alternative legal forms which are not subject to statutory corporate co-determination or (2) towards operational changes in business operations which result in material thresholds not being exceeded.

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