Start-ups: Court confirms effectiveness of a vesting provision in the shareholders’ agreement

In order to bind founders, shareholders and employees of start-ups to the company in the long term and ensure their long-term commitment, shareholders’ agreements often include vesting provisions. In vesting, company shares are gradually issued to the entitled persons over a defined period of time. Conversely, the entitlement to the shares lapses in the event of a premature departure from the company.

Vesting regulations were contestable due to prohibition of dismissal

Vesting clauses originated in US law, but are now also widespread in Germany. In practice, however, they were often legally contestable. This is because German case law was based on a so-called “prohibition of dismissal”, which attaches strict conditions to the dismissal of shareholders.

However, in a recent reference decision (Hinweisbeschluss) dated August 12, 2024, the Berlin Court of Appeal has now confirmed the validity under corporate law of a so-called “dismissals clause” as part of a vesting provision in a shareholders' agreement.

The decision deals with important questions regarding the withdrawal of a shareholder and the admissibility of call options following a so-called “leaver event”. The underlying facts and the key aspects of the decision are summarized below.

Dispute before the Court of Appeal: founding trio splits up

Together with the two co-founders (defendants 2) and 3)), the plaintiff was an equal founding shareholder of the company and later an equal shareholder of the GmbH, which acted as a holding company and was also a defendant. Between 2012 and 2017, the plaintiff was significantly involved in the development of the software in question. In doing so, he made a significant contribution to the company becoming increasingly interesting for investors from 2017 onwards. On October 12, 2018, an Investment and Shareholders’ Agreement (hereinafter: “Investment Agreement”) was concluded, under which the investors invested a total of EUR 1.373 million in the company in exchange for shares.

Founders decided on three-year vesting period

As part of the Investment Agreement, the founders submitted to a vesting at the level of the company and at the same time undertook to make a corresponding exit provision among themselves at the level of the defendant GmbH within one month of the Investment Agreement’s signing. This was implemented with the conclusion of the Shareholders' Agreement. A total vesting period of three years was agreed, whereby a founder who leaves the company within the first year after the start of the vesting period should lose his entire shares.

Amicable withdrawal failed; plaintiff objected to co-founders’ actions

The plaintiff was released from his duties on November 23, 2018 and has not worked for the company since then. Negotiations regarding an amicable withdrawal failed and the plaintiff’s employment contract with the company was duly terminated with effect from August 31, 2019 in a letter dated July 23, 2019.
On September 6, 2019, the two co-founders exercised the purchase option under the shareholders' agreement to which they were entitled following the termination of the plaintiff's employment relationship with the company by means of notarized declarations of acceptance and paid the purchase price for the shares owed by them to the plaintiff. However, the latter objected to this procedure.

The decision of the Berlin Court of Appeal in detail

Objective justification for the possibility of dismissal

At the heart of the decision was the question of whether a so-called “dismissal clause”, which grants a shareholder, a group of shareholders or the majority of shareholders the right to exclude a co-shareholder from the company without objective reason, can be considered (exceptionally) objectively justified and effective.

The highest courts generally consider dismissal clauses to be null and void pursuant to Art. 138 (1) BGB (German Civil Code) if there is no objective reason. In addition to the various already recognized cases, there is now a further possibility to assume for a dismissal clause to be objectively justified.

In the present case, the objective justification and effectiveness of the vesting rule was affirmed. When venture capitalists invest in a start-up – as was the case here – they are regularly dependent on the founders to fully contribute their expertise to the company. In this phase, which is often decisive for the company’s further development, it may be objectively justified – for a limited period of time – to link the continuation of the founders’ shareholder status to their continued commitment to the company. Conversely, it may be objectively justified to no longer allow founders who – for whatever reason – leave the company during this phase to participate in the continued success of the company.

No ineffectiveness in the case of unreasonable severance pay

The court clarified that a vesting provision is not to be considered objectively unjustified because the agreed severance payment may be unreasonably low. Rather, the agreed severance payment should merely be replaced by an appropriate severance payment.

No violation of the principle of equal treatment

No violation of the principle of equal treatment under company law was established because only the founders and not the other shareholders were subject to such a vesting regulation.
The objective reason for this unequal treatment lies in the different contributions of the founders and the investors to the company’s success. While the investors’ contribution is essentially limited to the financial contribution promised by them, the founders are expected to contribute to the company’s future success primarily through their (continued) personal activities and commitment.

One-year commitment to the company was permissible

It was also not considered unfair if a founder who leaves the company in the first year of the three-year vesting period loses all shares under the vesting rule. This applies not only in the case of a so-called “bad leaver event”, but also if – as in the present case – the founder’s employment contract was terminated with due notice.

Rather, it seems appropriate to make the continuance of a founder as a shareholder dependent on him working for or being contractually associated with the company for at least one (further) year, thereby “earning” his continued status as a shareholder.

Vesting provision and redemption clause were compatible

The vesting rule is also not precluded by the fact that the defendant GmbH’s articles of association stipulate that the redemption of a company share is only possible with the consent of the shareholder concerned or for good cause against payment of a compensation amounting to 100 percent of the share’s market value.

Rather, both regulations can generally coexist, as the founders have submitted to a vesting in relation to the investors within the scope of the financing round, which applies under different conditions and which no longer leads to the complete exclusion of the founder concerned after the end of the first year of the vesting period.

Exclusion withstood an exercise check

Finally, the exclusion of the plaintiff from the defendant GmbH also withstands an exercise check (Ausübungskontrolle), so that it can be assumed that the defendants did not exercise the purchase option to which they were entitled as a result of the termination of the plaintiff's employment relationship with the company in breach of trust (Art. 242 BGB).

The timing in October/November 2018 and, in particular, the close temporal connection between the subsequent approval of the Shareholders’ Agreement by the plaintiff on November 21, 2018 and his release on November 23, 2018 does not justify the assumption that the defendants acted in bad faith. Rather, the founders had already submitted to a practically identical vesting provision in the Investment Agreement of October 12, 2018, which was then merely technically implemented in the Shareholders’ Agreement of November 19, 2018.

Furthermore, the plaintiff de facto accepted his leave of absence – as well as the subsequent ordinary termination – and negotiated the terms of his withdrawal. The fact that the defendant 2), in his capacity as managing director of the company, terminated the employment contract of the plaintiff (who had been released from his duties for months) in July 2019 with effect from August 31, 2019, thereby enabling the plaintiff to be excluded as a shareholder at the level of the defendant 1) before the end of the first year of the vesting period, is not to be regarded as contrary to good faith in this respect.

The purchase option was exercised in due form and time

The notarized declarations of acceptance of the defendants 2) and 3) dated September 6, 2019 resulted in a purchase agreement for the plaintiff’s shares in the defendant GmbH; consequently, the purchase option was exercised in due form and time in accordance with the Shareholders’ Agreement’s provisions.

Consequences for practice: Founders can be bound by vesting regulations

The Berlin Court of Appeal confirms the validity under company law of so-called “dismissal clauses” in the context of vesting regulations in start-ups. This applies in particular in phases in which venture capitalists are invested and, for their part, are dependent on the founders continuing to contribute their full expertise to the company and leading it to the success that everyone hopes for.

The decision has practical significance for start-ups and investors, as it shows that founders can be bound to their continued work for the company through a temporary vesting arrangement. These regulations not only offer protection for investors, but also provide for the company’s stable and long-term development.

If you have any questions about vesting rules, call options or the drafting of investment and shareholders’ agreements, we will be happy to provide you with legal advice at any time.