On December 7, 2021, the Social Democrats (SPD), the Greens (BÜNDNIS 90/DIE GRÜNEN) and the Free Democrats (FDP) concluded the coalition agreement for the 20^th legislative period of the German Parliament (2021 until 2025), in which they announced, inter alia, their intention to implement changes to corporate co-determination law to prevent the current practice seeking to avoid the applicability of corporate co-determination rights for employees by changing the company’s legal form into an SE (Societas Europaea).

Background of the Change

The SE is a European legal entity introduced in 2001 by SE Regulation (EC) No. 2157/2001.  There are several ways to establish an SE, each of which requires a cross-border element (e.g., for formation of an SE by merger, (at least) two founding shareholders must be governed by the laws of different EU Member States).

Compared to other EU Member States, the SE is a frequently chosen legal form in Germany.  As of July 2021, approx. 55% of all SEs registered and operating in the EU had their headquarters in Germany.

The provisions dealing with corporate co-determination rights for employees in connection with the establishment of an SE are provided primarily in SE Directive 2001/86/EC, which has been transposed into German law by the German SE Employee Participation Act (Gesetz über die Beteiligung der Arbeitnehmer in einer Europäischen Gesellschaft).  The fallback rules of the SE Directive provide for the so-called “before-and-after principle”, according to which corporate co-determination rules deriving from national law and existing prior to the establishment of an SE shall continue to apply thereafter.

Originally, an SE is not subject to corporate co-determination.  However, when an SE shall be established, a special negotiating body consisting of representatives of the employer side, on the one hand, and representatives of the employee side, on the other hand, must be implemented, which shall reach an agreement on corporate co-determination rights for employees within the SE.  In Germany, such agreement may explicitly procure for the applicability of the fallback rules under the German SE Employee Participation Act (which, in turn, transposes the relevant provisions of the SE Directive).  Alternatively, if the negotiations fail within the stipulated negotiation period (up to a maximum period of one year), the fallback rules will also apply.

In Germany, corporate co-determination for employees generally takes the form of employee representation in the supervisory board of the relevant company (i.e., either one third or half of the supervisory board members will be elected by the employees).  For most companies in Germany, corporate co-determination is governed by the German One-Third Participation Act (Drittelbeteiligungsgesetz) and the German Co-determination Act (Mitbestimmungsgesetz).  The relevant provisions apply only to certain types of companies established under German law and provide for corporate co-determination if headcount thresholds of 500 or 2,000, respectively, are exceeded.

Under the “before-and-after principle”, in case an SE is established prior to reaching these thresholds stipulated under German law, such co-determination status is locked in, i.e., even if the relevant thresholds were exceeded following the formation of the SE, corporate co-determination rights for employees would not apply.  Ultimately, this principle results in the perpetuation of the co-determination rules existing as of the establishment of the SE, which is also known as the “effect of freezing the status quo” (Einfriereffekt).

Thus, by using the “before-and-after principle”, companies are able to avoid the applicability of corporate co-determination in Germany.  Recent surveys show that a substantial number of SEs headquartered in Germany exceed the headcount thresholds of German co-determination laws, but have not implemented supervisory boards with employee representation.

According to the statement contained in the new German government’s coalition agreement, such practice can be seen as circumvention of German corporate co-determination rules and should be prevented in order to strengthen the employees’ participation rights.

German Reform Plans in Light of European Law Considerations

Whether such reform plans of the new German government may be implemented on a national level is strongly dependent on the interrelationship between European and German legislative powers.

Employee involvement in an SE, and therefore corporate co-determination for employees within an SE, is governed primarily by the SE Directive.  When (and after) transposing the SE Directive into German law, the German legislator must adhere to the requirements of the SE Directive and may only deviate to the extent permitted by European law.  However, pursuant to the SE Directive, national law on corporate co-determination (to the extent not just transposing the SE Directive) shall not apply to SEs.

The SE Directive only gives little room to the EU Member States to deviate from the “before-and-after principle”.  This would only be feasible with respect to the establishment of an SE by merger in case the relevant EU Member State opted to the non-applicability of the fallback rules.  However, the German legislator refrained from using such option and it appears doubtful that this option will now be exercised.  In addition, this would only be limited to SE establishments by mergers and could not prevent the applicability of the fallback rules when using other means of SE establishments.

Except for this option to deviate from the from the “before-and-after principle”, the German legislator would not have legal competence to change the “effect of freezing the status quo”.  To implement the new German government’s reform plans, a revision of the SE Directive on a European level would be required.  Thus, the envisaged reform plans could not be realized by the German legislator on its own.

An implementation of such German plans on a European level appears rather unlikely to be achieved in the near future.  Further, even if so, it might well be that SEs already existing as of the date of the implementation of such new law would be exempted (e.g., by grandfathering rights).

Outlook

Given the lack of competence of the German legislator with respect to the applicability of German corporate co-determination rules for SEs, a deviation from the “effect of freezing the status quo” with regard to SEs is not foreseeable in the near future.

As a result, for the time being, companies that are close to exceeding the headcount thresholds under German co-determination laws, will continue to be in a position to avoid the applicability of the German corporate co-determination rules by using the legal form of an SE.  It will need to be seen whether the disclosure of the relevant reform plans in the coalition agreement without having legal powers to implement such changes on national level might even be fostering the practice that is supposed to be prevented.