Bad Leaver

What is a bad leaver?

Bad leaver (literally “bad departing person”) is a founder, shareholder or employee who leaves for a reason that the contract attributes to that person. A typical case is summary termination for a serious breach of duty; contracts then speak of a bad leaver event. The stricter consequences of the leaver provision apply to this person, that is, the clause that determines what happens to the shareholding on departure. The person must give up their shares, often including those already earned, at a price well below fair market value. Fair market value is the price an independent buyer would pay. Under virtual programmes, the person loses their entitlements in whole or in part.

For founders, the provision is found in the shareholders' agreement, usually as part of the participation agreement, with the grounds for compulsory redemption additionally in the articles of association; for employees, it is in the terms of the equity participation programme (ESOP). It supplements vesting and is the counterpart to classification as a good leaver. Because the largest part of a founder's wealth often hangs on this category, it is among the carefully negotiated points of every funding round and among the review points of every due diligence.

Typical bad leaver triggers

German participation agreements usually list the triggers exhaustively. Common ones are these:

• Termination for good cause relating to the person: extraordinary termination of the employment contract under Section 626 of the German Civil Code (Bürgerliches Gesetzbuch, BGB) or removal as managing director for good cause that the person has given rise to.
• Serious breach of contract: for example a breach of a non-compete clause, of confidentiality obligations or of material obligations under the shareholders' agreement, often only after an unsuccessful request to remedy the breach.
• Criminal offences to the detriment of the company: breach of trust, fraud or comparable acts against the company.
• Early resignation without good cause: in some contracts, if it occurs within a minimum period, often the first two or three years.

To be distinguished are grounds for compulsory redemption that are not linked to the activity, such as the seizure of a share or the insolvency of a shareholder. The articles of association usually regulate them separately. According to common contractual practice, missing targets is not among the bad leaver cases: poor results can justify a separation but do not establish a personal reproach.

Consequences for the bad leaver: transfer prices

The bad leaver must assign their shares or accept their compulsory redemption. Three tiers are common for the consideration, which are also combined:

• Nominal value: The consideration equals the amount per share fixed in the articles of association, so at EUR 1 per share usually a fraction of the actual value.
• Lower of nominal value and fair market value: protects the acquirers in case the fair market value has fallen below the nominal value.
• Discount on fair market value: for example 50% of fair market value for earned shares, while unearned shares pass at nominal value.

Which tier applies to which shares is the real negotiating question. For unearned shares, nominal value is largely customary in practice. For earned shares, it is contested because the founder has already acquired this part through their work. Many contracts therefore provide for a discount instead of nominal value for earned shares.

Limits of the bad leaver clause: case law and tax law

Expulsion without cause and compensation

Clauses that permit the exclusion of a shareholder without objective reason (Hinauskündigungsklauseln) are regarded by the courts as contrary to public policy in principle and void under Section 138 BGB. With a bad leaver, a reason is present, but the amount of compensation remains open to review. Restrictions on compensation are in principle permissible. They lose their effect if there is a gross disproportion between compensation and fair market value that disadvantages the shareholder unreasonably; if the disproportion arises only later through an increase in value, the compensation may have to be adjusted. A complete exclusion of any compensation is recognised only in narrow exceptional cases. Restrictions that specifically affect only creditors are also invalid, for example those that apply only on seizure or insolvency but not in comparable cases such as exclusion for good cause.

A different standard applies to employees with virtual shares. Their plan terms are standard terms and conditions and are reviewed under Section 307 BGB for whether they unreasonably disadvantage the employees. The Federal Labour Court (Bundesarbeitsgericht) has, since a decision in 2025, generally regarded the forfeiture of already earned virtual shares solely because of the employee's own resignation as invalid. Forfeiture rules that are linked to serious misconduct, such as a justified summary termination, are more defensible. Their reach in respect of earned entitlements has not been conclusively clarified.

Gift tax

Under Section 7(7) of the German Inheritance and Gift Tax Act (Erbschaftsteuer- und Schenkungsteuergesetz, ErbStG), the transfer of a share when a shareholder leaves is deemed a gift to the extent that the tax value of the share exceeds the compensation. In the case of a redemption, the provision captures the increase in value of the remaining shareholders' shares. Bad leaver compensation far below value can therefore trigger gift tax, even though nobody intended to make a gift. The design of the compensation tiers should take this consequence into account from the outset.

The bad leaver event: procedure and questions of proof

Whether a bad leaver event exists is generally asserted by exercising the purchase right or by a redemption resolution. In resolutions on removal or redemption for good cause, the shareholder concerned, according to the prevailing view, has no voting right. If the shareholder disputes the cause, a court or an agreed arbitration tribunal ultimately decides, and until then it is open to whom the shares belong.

Because good cause is difficult to prove, many disputes end in a settlement that in effect treats the departing person like a good leaver. Careful clauses therefore provide for objectively verifiable triggers, a cure period for remediable breaches of duty and a supplementary payment in case the allegation later proves unfounded. Acquirers examine earlier bad leaver cases closely in due diligence, the in-depth review before the purchase. If a redemption or assignment is invalid, a former founder may still hold shares or demand higher compensation.

Worked example: comparing a bad leaver's compensation

A founder holds 10,000 shares with a nominal value of EUR 1 each, which are subject to reverse vesting over 48 months. After 36 months, the employment contract is terminated extraordinarily because of a serious breach of duty. The fair market value is EUR 250 per share.

• Earned: 10,000 × 36/48 = 7,500 shares, unearned: 2,500 shares
• Comparison, good leaver: 7,500 earned shares stay with the founder, value 7,500 × EUR 250 = EUR 1,875,000; for 2,500 shares the founder receives EUR 2,500; together EUR 1,877,500
• Bad leaver with nominal value for all shares: 10,000 × EUR 1 = EUR 10,000
• Bad leaver with a 50% discount on earned shares: 7,500 × EUR 125 = EUR 937,500 plus EUR 2,500 = EUR 940,000
• Difference from the good leaver: EUR 1,867,500 in the first variant, EUR 937,500 in the second variant

In the first variant, the compensation is 0.4% of the fair market value of all shares of EUR 2.5 million. Such a ratio is open to legal challenge. The difference of EUR 2,490,000 is also the amount to which Section 7(7) ErbStG applies, to the extent that the tax value corresponds to fair market value. In the second variant, the founder receives 37.6% of fair market value; here too a difference of EUR 1,560,000 remains, which must be examined for tax purposes.

Distinctions: bad leaver, good leaver, non-compete clause and clawback

• Good leaver: departure without an attributable reason. The person keeps the earned shares, or they are taken over at fair market value.
• Non-compete clause: governs conduct during and after the activity. A breach is often a bad leaver trigger, but the legal consequences are set out in the leaver clause.
• Clawback: the repayment of remuneration already paid. The bad leaver rule, by contrast, concerns the shareholding itself.

Common mistakes

• General clauses as triggers. Wording such as “conduct detrimental to the business” captures almost any wrong decision and is hardly manageable in a dispute.
• No cure period. Without a period to remedy the breach, even a remediable breach of duty leads to loss of the shareholding, which makes the clause open to challenge.
• Nominal value also for earned shares without weighing the risk. The further the compensation is from fair market value, the more likely the clause is not to withstand review.
• Inconsistent compensation rules. If worse terms apply to seizure and insolvency than to comparable exclusion cases, the provision is invalid to that extent.
• No supplementary payment rule. If there is no provision for the case that the allegation falls away, the unwinding remains unresolved.
• Tax consequences overlooked. Compensation far below value can trigger gift tax for the acquirers or remaining shareholders.

Frequently asked questions

What is the difference between a bad leaver and a good leaver?

It depends on whom the contract attributes the departure to. With a bad leaver, it is the person themselves, for example after a justified summary termination; the person gives up their shares well below fair market value, often including the earned ones. A good leaver keeps the earned part or is compensated for it at fair market value.

Does a bad leaver also lose their earned shares?

Often yes, but not without compensation. The shares pass against the nominal value or against an amount with a discount on fair market value. How far this holds depends on the ratio of the compensation to the value.

Is compensation at nominal value permissible?

For unearned shares, it is widespread in practice and rarely challenged. For earned shares, it is legally risky because a gross disproportion between compensation and fair market value can lead to invalidity or adjustment.

Does poor performance make someone a bad leaver?

As a rule, no. Missed targets or a disappointing development at most justify a separation without a personal reproach, which under customary contracts counts as a good leaver case.

Who determines that a bad leaver event exists?

First the entitled parties, by exercising the purchase right or resolving the redemption. If the person concerned disputes the cause, a state court or an agreed arbitration tribunal decides.

What applies if the allegation later proves unfounded?

That depends on the contract. Careful clauses then treat the person retroactively as a good leaver and oblige the acquirers to pay the difference; if there is no provision, lengthy disputes over the unwinding are likely.

The Roemer Capital view

In mandates, we look at bad leaver clauses from two angles. In the funding round, what counts is that the triggers are objectively verifiable and that the compensation tiers are not so far below fair market value that their validity becomes doubtful. A clause that does not hold in a real case protects neither investors nor co-founders.

In a company sale, we list earlier departure cases with date, classification and compensation paid, so that acquirers can quickly trace the legal position of all former shareholders. The drafting and legal assessment of the clauses are handled by the company's law firm, the tax consequences by its tax adviser.