Employee Rights When Buying Parts of an Insolvent Company in Germany

Employee rights issues arising from M&A transactions in Germany can be difficult to navigate.  Compared to the United States and most other regions, Germany has a high level of employee protection, resulting from a number of statutes which put multiple layers of protection over an employment relationship.  While employee rights issues arising from M&A transactions in Germany may be difficult to oversee, they rarely deter companies from pursuing a transaction; however, employee issues play a major role in most acquisitions and carve out situations, so understanding the nuances of the German employee protection laws can help to ensure a smooth transaction.

High Level of Employee Protection

German statutory law allows for a maximum of seven months notice period, and collective bargaining agreements may even go beyond that and completely exclude all terminations that are not for cause. German insolvency law cuts this strictly down, which can actually lead to a much smoother transition in insolvency situations.  The maximum notice period for an employee of an insolvent company is three months, which allows a speedy reduction in workforce.

Moreover, the salary of employees is secured by the Federal Employment Agency (Bundesagentur für Arbeit) for a period of three months before insolvency is declared by the competent court.  This ensures that employees work throughout the critical final stage of a business.  Under certain circumstances, operational pension entitlements are taken over by a nationwide trust to ensure that employees do not lose them.  As a result, an insolvent business would not bear the burden of such claims.

Shorter Notice Period and Additional Funding

Under German insolvency law, an employee’s options to defend himself or herself against a termination are reduced.  For companies with more than 10 employees, terminations are only allowed if they can be legally justified.  The law explicitly states the reasons that might be used to justify a termination.  In case of a reduction in force, the reason is business related.  The conditions for an employer to prove such business-related reasons in court are very high.  The conditions are much lower, however, in the case of an insolvency, because the burden of proof is transferred partially to the employee and the scope of court review is restricted.

Collective rights are also subject to important modifications.  Most companies in Germany with more than 50 employees have “works councils.”  These bodies represent the workforce and are subject to extensive consultation and negotiation rights.  Under normal conditions, where a works council exists, the close of a company or its parts would require a social plan (among other things).  Such social plans provide for financial compensation for those employees who are terminated.  The severance payments could amount in total to a significant part of the overall value of the company.  It sometimes takes several months until the parties agree on a social plan.  During this time, the company cannot execute any reductions in workforce or take any other measures in connection with the close-down.

In insolvency situations, the fund from which such severances are paid is strictly reduced.  The parameters are as follows:

• The maximum severance is 2.5 months’ salary for the individual employee.
• The overall amount of the severances shall not exceed one-third of the funds available for all creditors of the company.

These parameters not only reduce the financial responsibilities of the company, they allow the negotiations with the works council to take only a few sessions and be closed within days.

Reduction of Consultation Rights of the Works Council

If agreements that provide for benefits, such as annual payments or capital-building payments (vermögenswirksame Leistungen), are in place with the works council, such agreements can be re-negotiated and terminated with a notice period of three months.

Additionally, the German Act on Insolvency (Insolvenzordnung) provides for significant relief with regard to negotiation procedures with works councils, which can often be very time-consuming.  The German Act on Insolvency significantly reduces negotiation procedures by imposing time limits.  The company is in a position to involve the competent courts much earlier in the process and, most of the time, the courts rule in favor of a potential acquirer.  Thus, the agreement of the works council can be replaced by the agreement of the competent court.

During the insolvency procedure, an insolvency administrator manages the company.  Given the legal specifics mentioned above, it is common practice for an insolvency administrator to work closely with a potential acquirer to shape the business or the parts of it that are to be sold.  As soon as the business or its parts transfer to the acquirer, all legal privileges that are connected with the status of the insolvent company are gone.

Tailor-Made Solutions

The major issue in this regard is to care for the risk of a “transfer of undertaking” according to the respective European and German legislation.  Such transfer of undertaking would result in an automatic transfer of the employees who are attributed to this particular part of the company.  Because such transfer cannot be contracted out, it is important that the insolvent company or its part have the necessary structure in place prior to the acquisition.

Foreign acquirers are rarely aware of the significant chances that accompany insolvency of a subsidiary and/or an affiliated company.  If such situation takes place, the management of an acquiring company should receive information in regard to potential legal implications.