Venture More Co-Determination?

Two and a half months after the parliamentary election of the German Bundestag, the Social Democrats, the Greens and the Free Democrats signed their coalition agreement titled ‘Venture more progress’ on 7 December 2021. The agreement contains several announcements on company law reform initiatives. Below, I shall present two initiatives which concern the ‘further development’ of employee co-determination on the supervisory boards of German corporations. First, the new government wishes to amend the rules regarding the attribution of a subsidiary’s employees to a parent company for the purposes of determining the applicability of co-determination laws. According to the coalition agreement, the rules set forth under the Mitbestimmungsgesetz (the ‘Co-Determination Act’) should take precedent and should be transposed onto the Drittelbeteiligungsgesetz (the ‘One-Third Participation Act’). Second, the new government wishes to further develop co-determination laws such that so-called ‘European companies’ (Societates Europaeae, SE or SE companies) are no longer able to completely avoid co-determination requirements when growing past certain size thresholds (‘freezing effect’).

1. Co-determination in Corporate Groups

The German co-determination laws apply to companies that fulfil certain criteria related to legal form and size. For the laws to be applicable, the company must be established in a form in which the shareholders are not personally liable for the company’s liabilities, and the company must be of sufficient size. Companies which employ more than 500 people are subject to the One-Third Participation Act — so called because one third of the supervisory board’s members are elected by company employees. If the company employs more than 2,000 people, however, the company becomes subject to the Co-Determination Act, and one half of the supervisory board’s members are elected by the company’s employees. It is important to note that due to their separate legislative histories these two acts are far from harmonized in terms of content and differ from one another in numerous — sometimes quite substantial — ways.

One significant difference relates to the attribution of employees working in subsidiaries to the parent company for the purposes of size calculation. Whereas, under the Co-Determination Act all employees of the parent and subsidiary companies are included in the calculation to determine whether the number of employees meets the 2,000-person threshold, the One-Third Participation Act only includes subsidiary employees in its calculation when a ‘domination agreement’ (Beherrschungsvertrag) exists between the parent company and its subsidiary or in the occurrence of an absorption (Eingliederung) of the subsidiary into the parent company.

While the coalition’s intent to harmonize these rules by amending the One-Third Participation Act to adopt the approach of the Co-Determination Act is understandable in terms of coherence, in practice this change will likely lead to many medium-sized companies which currently do not fall within the applicability of either law being brought into the scope of co-determination — namely, any company which directly employs fewer than 500 employees, but whose group employs between 500 and 1,999 employees when subsidiaries are included in the calculation. For example, the fictional company XYZ, with 400 employees, which owns the subsidiary, ABC, with an additional 400 employees, does not currently fall within the scope of either law, and thus is not required to form a co-determined supervisory board. According to the planned new legal scheme, it would be forced to do so.

The proposed harmonization of group allocation rules in the two Acts will lead to conflicts in medium-sized corporations between management and employee representatives over whether — in the words of the coalition agreement — the parent company exercises ‘real control’ over its subsidiary. Such ‘real control’ will be a prerequisite for attribution and thus a natural point of contention that introduces an associated legal uncertainty within such firms. Additionally, and similar to the current Co-Determination Act, the planned amendment to the One-Third Participation Act will create a perverse incentive for medium-sized companies to relocate jobs abroad. This is because workers employed in foreign companies and in foreign subsidiaries are not included for the purposes of determining the number of company employees under the Acts.

A sensible approach to aligning the Acts should include the following key aspects: (i) to replace the vague and potentially controversial concept of ‘real control’ for determining the attribution of subsidiary employees in size calculations, (ii) to ensure that workers employed abroad are counted for the determination of the relevant number of employees, and (iii) to moderately increase the applicable thresholds of 500 and 2,000 employees (eg to 1,000 and 5,000 employees respectively) in order to avoid an undue extension of co-determination and to limit the requirement of co-determination to genuinely large companies and groups.

2. ‘Freezing’ of co-determination in the SE

Employee co-determination within a European company (SE) is governed by national law, but subject to the requirements of the Council Directive 2001/86/EC of 8 October 2001 supplementing the Statute for a European company with regard to the involvement of employees (the ‘SE Directive’). When a stock corporation is converted into an SE, employee participation is based primarily on an agreement made between a special negotiating body of employees and company management. The agreement shall provide for at least the same level of employee involvement in all aspects as that existing within the company prior to its conversion into an SE. If no participation agreement is concluded, standard rules on employee involvement apply; meaning that all aspects of employee participation that applied to the company before its conversion shall continue to apply to the SE.

If a non-co-determined company is converted into an SE, this means that the agreement may provide that the SE is also free of co-determination (regardless of a subsequent increase of the number of employees). If an agreement is not reached, the standard rules apply, according to which the co-determination-free company remains free of co-determination requirements even after conversion into an SE (regardless of a later increase in the number of employees). The only exception occurs when the company would have already been obligated to form a co-determined supervisory board prior to its conversion into an SE. Thus, if the company's supervisory board unlawfully lacks co-determination, such an unlawful situation cannot be cured or ‘frozen’ by the company’s conversion into an SE.

If the German legislature wants to change this legal framework, it can only try to work towards a change in the corresponding rules in the SE Directive at European level. However, it is highly unlikely that the other EU Member States will be prepared to renegotiate the compromise reached with this directive 20 years ago.

Another possibility to consider is whether the German legislature possesses any leeway to unilaterally create employee co-determination rights beyond what is set forth in the SE Directive. The answer to this question is clearly negative: the SE Directive imposes the before-and-after principle on the Member States. Participation rights that did not exist before the SE was established are not protected by the SE Directive. Part 3 of the Annex to the SE Directive states unequivocally: ‘In the case of an SE established by transformation, if the rules of a Member State relating to employee participation in the administrative or supervisory body applied before registration, all aspects of employee participation shall continue to apply to the SE.’ That means that, if the co-determination rules were not applied before the registration of the SE (or at least should have been applied), the SE is — and remains — free of co-determination. For the SE formed by merger, the SE Directive makes this even clearer by stating: ‘If none of the participating companies was governed by participation rules before registration of the SE, the latter shall not be required to establish provisions for employee participation.’ The German legislature cannot escape these requirements without violating the SE Directive and thus risking an infringement procedure against Germany.

The objective set out in the coalition agreement of preventing ‘abusive circumvention’ of applicable co-determination rights is already enshrined in Article 11 of the SE Directive and has been transposed into German law by a sufficiently precise prohibition of abuse. In this respect, there is no need for the new federal government to take any action.

Caspar Behme is Privatdozent (Associate Professor) at the Ludwig-Maximilian-Universität München.