Bad leaver clause

The most important facts in brief:

• Bad leaver clauses are used in particular for management participations.
• Bad leaver clauses regulate the effects on management participation if the manager resigns or is dismissed due to a breach of duty.
• Bad leaver clauses mean that managers do not receive the market value for their shareholding, but a significantly lower value.

What is a bad leaver clause?

A bad leaver clause regulates what happens to the shares of a shareholder or employee in the event of termination. Bad leaver clauses are most important when managers hold shares in their employer. Such forms of Employee participation are particularly common in private equity and venture capital. The bad leaver clause is intended to prevent managers from continuing to hold the shares even if they no longer work for the company.

The background to employee participation is that senior executives and managing directors should pursue the same interests as the owners. For this reason, managers should also participate in value increases and company profits. From the point at which the managers no longer work for the employer, participation in the company's development should cease. Good leaver and bad leaver clauses pursue this goal by regulating what happens to employee participation when the employment contract ends.

A distinction is made between good leaver and bad leaver clauses.

• Good leaver clauseA good-leaver clause regulates the situation if there is no breach of duty by the manager, but the parties part "on good terms". If the termination is due to illness on the part of the manager, for example, there is no reason to punish the manager. Accordingly, good leaver clauses are very positive for managers in most cases.
• Bad leaver clauseBad leaver clauses : Bad leaver clauses regulate the case where the manager has either resigned without cause or the employer terminates the employee due to a breach of duty by the employee. In such a case, the employee participation scheme is settled on significantly less favorable terms for the manager.

What is the content of a bad leaver clause?

The content of a bad leaver clause depends on the specific form of the bad leaver clause. A central component of a bad leaver clause is usually that the shares in the company must be returned at a value below the market value. This is intended to prevent managers from profiting from the fact that they themselves resign without a breach of duty by the employer or are dismissed due to their own breach of duty.

The following structures are possible for the implementation of the bad leaver clause:

• Decay: Insofar as the employee participation is Options the options may expire. Strict requirements apply when structuring the forfeiture of options. In the case of employee options, a forfeiture clause that is too extensive can lead to the forfeiture clause being ineffective. The forfeiture clause must therefore not be so disadvantageous for the employees that the employees are unreasonably disadvantaged.
• Call optionA bad leaver clause can also be structured as a call option. In the case of a call option, the employer has the right to acquire the shares at an agreed price. The prerequisite for the employer's right to exercise the option is usually that the employment or service contract ends due to a breach of duty by the manager or that the manager himself gives notice of termination.
• ReassignmentAnother way of structuring the bad leaver clause is to agree an obligation to retransfer. Such clauses are usually used in articles of association. Accordingly, this form of bad leaver clause is primarily used for managing directors who are shareholders in the company, i.e. who directly hold a stake. It is also possible to make the relevant declarations on retransfer subject to a condition precedent, so that the retransfer takes place automatically once the conditions are met. Instead of retransfer, it is also possible to structure the clause in such a way that the managing director's shares can be redeemed.

When is a "bad leaver situation" present?

A bad leaver situation exists if the manager resigns without a breach of duty by the employer or if the employer terminates the contract due to a breach of duty by the manager. In such cases, the manager has caused the termination themselves and should therefore not benefit from the increase in value of the company. The opposite of a bad leaver situation is a good leaver situation. In a good leaver situation, the employment contract is also terminated. The difference, however, is that the manager is not at fault for the termination. Although managers must also surrender their shares in a good leaver termination, they receive the current market value of the shares in return, meaning that the managers benefit from the increase in value of the shares.

A good leaver situation exists in the following cases:

• Breach of duty by the employerIf the manager terminates the employment contract due to a breach of duty by the employer, this is a good leaver situation. An example of this is if the employer does not pay the salary. In such a case, the manager's termination is understandable. Accordingly, the manager should not be penalized for terminating the employment contract.
• Termination by the employerIf the employer terminates the manager without a breach of duty on the part of the manager, this is also a good leaver situation. If, for example, a division is to be outsourced so that the relevant division managers are also dismissed for operational reasons, this should not be at the expense of the respective managers.
• Occupational disability / death: Even if an employment contract ends due to illness or death, this is a good leaver situation.

When are bad leaver clauses invalid?

Bad leaver clauses are particularly ineffective if the clauses unreasonably disadvantage managers. In particular, this means that the shareholding or options may not be taken away from managers without objective reason. Accordingly, the call options can only be withdrawn or exercised if the executive is in breach of duty or if the executive terminates the contract without cause. If, on the other hand, the bad leaver clause allows the participation to be taken away without cause, the clause is invalid. A bad leaver clause may also be invalid for the following reasons:

• § 138 BGBThe bad leaver clause is invalid if the severance payment is unreasonably low. In such a case, the invalidity may result, for example, from the fact that the severance clause is immoral. A severance payment is immoral, for example, if the severance payment is already so low when the agreement is concluded that the amount of the severance payment is below the value of the shareholding.
• UnclearIf the bad leaver clause is a general terms and conditions clause, which depends on the individual case, high requirements apply to the comprehensibility of the clause. If the clause is incomprehensible, it may be invalid.
• UnbalancedThe clause must also take sufficient account of the interests of managers. If the requirements for exercising the bad leaver clause are too low or the legal consequences are too disadvantageous for the manager, there is a possibility that the clause violates Section 307 (1) and (2) BGB, meaning that the clause is invalid.

The requirements for the effectiveness of bad leaver clauses change regularly as a result of new court rulings. In recent years, the following two rulings have specified the requirements for bad leaver clauses:

• Federal Labor Court, Az:10 AZR 67/24: A clause according to which "vested" share options in the event of a Self-termination expires, puts employees at an unreasonable disadvantage, so that the expiry is invalid.
• Court of Appeal (Berlin), 2 U 15/25The exclusion of a shareholder is subject to very strict conditions and is only possible in exceptional cases. If milder means can be considered, a dismissal that leads to the loss of the company shares is not permitted.