In a recent case, the Court of Appeal in Berlin (Kammergericht) had to deal with so-called vesting clauses. In its decision as of August 12, 2024 (Decision as of August 12, 2024 – 2 U 94/21), the Court of Appeal ruled that an agreement that grants the shareholders of a German limited liability company (GmbH) the right to exclude a co-shareholder from the company without good cause may be justified if, in the case of a start-up company, it is intended to make the continued existence of a founder's position as a shareholder dependent on his continued active involvement and engagement in the company.

In the following, we would like to explain, what is meant by a vesting clause in general (see I.) and how the Court of Appeal justifies its decision (see II.).

General

In general, a vesting clause is a contractual provision that is intended to prevent founders, members of management, key employees, etc. from leaving the company prematurely, thereby depriving the company of know-how, among other things, and thus ultimately harm the company economically.

Vesting clauses are intended to bind founders, members of management, key employees, etc. to the company, so that in particular the co-founders may rely on each other. This is to be achieved by founders, members of management, key employees, etc. losing their (possibly only virtual) shares in the company, either in whole or in part, if they leave the company prematurely and are therefore no longer actively involved in the company.

Vesting clauses may be structured very individually and play an important role, particulary in the context of financing rounds.

Decision of the Court of Appeal

Facts

The decision of the Court of Appeal was based on the following facts:

The founding shareholders of a GmbH, in which a venture capitalist had also invested, had agreed on a vesting clause in a shareholders' agreement: In the event that one of the founding shareholders terminated his employment with the company prematurely, the other founding shareholders were to be entitled to an option to acquire his shares. One of the founding shareholders subsequently terminated his employment contract (prematurely) as of August 31, 2019, whereupon the other founding shareholders exercised their acquistion options. The founding shareholder who had filed the suit considered the provision to be immoral and therefore void under Section 138 of the German Civil Code (BGB). The Court of Appeal did not follow his opinion.

Reasons

The Court of Appeal based its decision with the rulings of the Federal Court of Justice (BGH). According to these rulings, provisions in company agreements and other contractual provisions that grant the right to exclude a co-shareholder from the company without good cause are generally null and void due to violation of good morals in accordance with Section 138 (1) of the German Civil Code (BGB). However, such a provision may be valid in exceptional cases if it is objectively justified due to special circumstances.

The Court of Appeal has affirmed the existence of an objective justification here and referred to case law in comparable cases: An objective justification may be given if venture capitalists invest in a start-up company and there is a practical need for a time-limited vesting provision. On the one hand, founding shareholders are often dependent on third-party financing, in particular from venture capitalists, to finance their start-up company. On the other hand, they often do not have traditional collateral. In order to secure their investment, venture capitalists therefore need to ensure by other means that the founding shareholders continue to make their expertise available to the company, contribute to the company and lead it to success. 

In order to meet this need, it may be objectively justified to link the shareholder position (at least for a certain period of time) to the shareholder's continued commitment to the company and to exclude shareholders who leave the company in their active role, for example as managing directors or employees, within this contractually defined period from the company and no longer participate in the success of the company. Incidentally, this is also in the interest of all founding shareholders, as it allows them to rely on each other. Furthermore, this is (often) the only way to raise funds for the further development of the company and to resolve disagreements among the shareholders with relative ease.

Consequently, the vesting clause agreed in the present case was not void under Section 138 (1) of the German Civil Code (BGB).

The decision of the Court of Appeal shows that vesting clauses may be effectively agreed under certain conditions. Since vesting clauses may serve the interests of both potential investors and founding shareholders, it may make sense to agree on such provisions at the time of formation.

The avocado’ team will be happy to assist you with any questions you may have regarding formation of German entities, start-ups and venture capital, as well as other corporate law issues.