In a decision dated 10 February 2026 (II ZR 71/24), the German Federal Court of Justice (Bundesgerichtshof – BGH) has provided further legal clarity on the structuring of management equity programs. The decision confirms the validity of market-standard call option mechanisms in private equity structures and offers valuable guidance for contractual drafting.
A. Background
The case concerned was a market-standard management equity program structured through a German limited partnership (Kommanditgesellschaft), through which managers of a private equity-backed company held a pooled equity participation. The claimant – the (then) managing director of the operational group company – had acquired his limited partnership interest at fair market value. The economic incentive was structured as an ‘exit-only’ model with no entitlement to ongoing profit distributions.
Following the claimant’s dismissal, removal from office, termination of his service agreement and release from duties, the co-shareholders exercised a contractually agreed call option. The consideration payable to the claimant as a "bad leaver" was significantly below his original investment amount.
The claimant challenged the clause in court, arguing that it constituted a ‘free removal’ clause (freie Hinauskündigungsklausel) within the meaning of earlier court decisions, classified as "contradictory with public policy" (sittenwidrig) and therefore void. He was initially successful before the Regional Court of Augsburg (Landgericht Augsburg) and the Higher Regional Court of Munich (Oberlandesgericht München).
B. Decision of the Federal Court of Justice
The Second Civil Division of the German Federal Court of Justice set aside the judgment of the Higher Regional Court of Munich on further appeal, refined its ‘manager model’ case law from 2005 in the context of private equity structures, and referred the case back to the Higher Regional Court of Munich for further decision.
The key holdings of the decision are as follows:
- Principle of public policy violation (Sittenwidrigkeit): The court reaffirms its case law that leaver clauses in the form of ‘free removal’ clauses (freie Hinauskündigungsklauseln) remain, in principle, contrary to public policy and are void under § 138 para. 1 German Civil Code (BGB).
- Objective justification in individual cases: Consistent with prior case law, such a clause may nonetheless be valid where the equity participation was granted to the managing director specifically because of his operational role as managing director and the equity participation carries "no relevant independent significance vis-à-vis the position of managing director". A comprehensive assessment of all circumstances of the individual case remains decisive. Notably, the court expressly recognizes that "market-standard and economically sensible arrangements may, in principle, constitute a substantial objective justification" for ‘free removal’ mechanisms.
- Recognition of the ‘exit-only’ model: The court expressly acknowledges the investment model under which managers do not participate in ongoing profits but only in exit proceeds, as a market-standard arrangement in the private equity sector, and accepts it as an objective justification for a leaver clause.
- Separate assessment of leaver clause and severance entitlement: The court confirms the established principle that the appropriateness of the consideration payable upon exercise of a leaver clause is irrelevant to the validity of the clause itself and must be assessed independently. The court does, however, once again fall short of providing specific criteria for a framework to assess the adequacy of such consideration.
- Exercise control as a corrective mechanism: To address opportunistic timing of removal – such as forcing out a manager shortly before a lucrative exit – the court looks to the good faith doctrine under § 242 of the German Civil Code (BGB) as a corrective. In its referral to the Higher Regional Court of Munich, expressly identifies the review the exercise control as a matter to be examined on remand.
C. Conclusion and Practical Implications
The decision represents a strong signal in favor of the permissibility of ‘market-standard’ leaver clauses. The Federal Court of Justice’s receptiveness to the commercial considerations of private equity market participants is to be welcomed and removes existing legal uncertainty in relation to participations acquired at market prices.
For contractual practice, the following is recommended:
- The direct linkage of the manager’s equity participation to his or her operational role should be set out expressly and in detail in the contractual documentation, so as to prevent participation from being regarded as having independent significance as a financial investment.
- When determining the consideration payable upon a leaver event, specific attention should be given to questions of adequacy; fallback provisions should be included to address edge cases.
- When actually exercising the call option under a leaver clause, the chose timing must be carefully evaluated and documented in order to avoid exposure to a challenge on the grounds of bad faith under § 242 of the German Civil Code (BGB).
Developments in this area of case law warrant close attention. In particular, the forthcoming decision of the Munich Higher Regional Court of Munich following the Federal Court of Justice’s referral is likely to carry significant practical implications for the structuring of management equity programs.
