Vesting - Berlin Court of Appeal makes important decision for investors

Introduction

We often have investment and shareholder agreements on the table - partly in the drafting, partly in conflicts. Time and again, it turns out that vesting arrangements are commercially central - but legally and fiscally a snake pit, because

1. legally, vesting by redemption may be advantageous because it is subject to less stringent effectiveness control than vesting by call option.

2. from a tax perspective, however, vesting by call option is often preferable because redemption can, for example, unexpectedly trigger gift tax for remaining shareholders.

In an - admittedly no longer very recent - reference decision by the Berlin Court of Appeal dated 12.8.2024 (2 U 94/21), there is very useful practical advice on how a vesting provision in the investment documentation can be structured in a legally stable manner. Precisely because this topic is a perennial issue in the drafting of investment documentation and we recently advised an investor on the leaver of a founder, we have once again taken this decision onto our radar.

Of course, the decision does not cover the entire spectrum of the stable design of a vesting provision, in particular redemption vs. call; tax effects; labor law content control (aggravation of termination). However, the decision provides a very good opportunity to realize that even the most commercially elaborate vesting regulation is of no help if the applicable legal and tax requirements are not clearly defined beforehand.

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Facts of the case

When investing in a start-up, a venture capitalist has a considerable interest in the founders remaining as managing directors for as long as possible. He invests in a specific team rather than in a company. The investor sees the success of the company as closely linked to the founders remaining with the company. The investment documentation therefore regularly combines management with company participation: if the management ends (so-called leaver), the company participation is also lost. The number of “vested” shares increases linearly by 1/48 per month over a period of, for example, 48 months (vesting period). If the management ends during this period, for example through no fault of their own, the founder only loses the unvested shares, but may keep the vested shares. Technically, the loss of shares is usually implemented through a call option under the law of obligations or through a redemption under the articles of association.

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Problem

From a legal perspective, the withdrawal of unvested shares is critical. This is because the founder then loses his shares through no fault of his own. According to supreme court rulings, however, free exclusion rights without an objective reason in the articles of association and shareholders' agreement are null and void due to a breach of morality pursuant to Section 138 (1) BGB. However, a free termination clause or a comparable contractual provision may be valid by way of exception if it is objectively justified due to special circumstances. Reasons recognized in case law include, for example Termination of personal cooperation (BGH - II ZR 237/82), failure of “probationary period” (BGH - II ZR 329/87; II ZR 165/02), cessation of close personal relationship with unilateral financial contribution (BGH - II ZR 194/89), termination of cooperation in employee or manager model (BGH - II ZR 342/03; II ZR 173/04). Until now, it has not been clear in case law whether and, if so, under what conditions the withdrawal of unvested shares is effective.

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Court of Appeal decision

The Berlin Court of Appeal has now ruled that the withdrawal of unvested shares can be objectively justified. The investor is dependent on the long-term commitment of the founder to the company, as his investment decision is based on the success and know-how of the founders. The investor assumes that the founders will continue to be fully involved in the company. For their part, the founders are dependent on the investor, as they cannot raise the necessary funds to develop the company on their own. In addition, the founders cannot offer the investor any security. In a phase that is decisive for the further development of the company, it may be objectively justified - for a limited period of time - to link the continuation of the shareholder position with the commitment to the company and to no longer allow such founders who - for whatever reason - leave the company during this phase to participate in the further success of the company. The Court of Appeal emphasizes that the amount of the severance payment is in no way relevant to the question of the effectiveness of the withdrawal.

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Takeaways

The decision of the Court of Appeal provides more certainty for the drafting of vesting provisions. The interests of the parties involved are central and should be set out in the investment documentation. At the same time, the Court of Appeal gives the impression that the redemption under the articles of association and the call option under the law of obligations are to be treated in the same way in legal terms. This is not correct. This is because in the case of call options, an unreasonably low purchase price regularly leads to overall nullity and the call option lapses (see BGH - II ZR 80/10). In the event of a redemption, the settlement will be adjusted, but not the invalidity of the redemption (see BGH - II ZR 104/92). In practice, the tax effects of the vesting provision are also important. Here, the call option will be advantageous for tax purposes compared to redemption. This is because redemption involves the risk of a taxable increase in the value of the shares of the remaining shareholders.

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