German Labor Court Sets New Standards for Bonus Clauses in Employment Contracts In a recent judgment, the federal labor court set new standards for retention clauses in connection with bonus payments. This judgment will have a significant impact on bonus clauses in employment contracts, particularly in the financial services industry, where bonuses often greatly exceed an individual’s base salary. Background of Repayment and Nonpayment Clauses By way of background, employment contracts that provide for bonus payments often include a retention clause, which provides that the bonus either has to be repaid (repayment clause) or will not be paid at all (nonpayment clause) if the employment relationship ends, or if notice of termination is given, within a certain period from the end of the bonus year, e.g., by March 31 (if the bonus year is the calendar year). The federal labor court has held since 1962 that the enforceability of repayment clauses depends on the amount of the bonus. A repayment clause was unenforceable if the bonus amounted to no more than EUR 100 (formerly DEM 200). If the bonus exceeded EUR 100 but did not reach the employee’s monthly gross remuneration, a repayment clause was unenforceable if it required the employee to remain employed beyond March 31 of the following year. If the bonus amounted to at least the employee’s monthly gross remuneration, a repayment clause could require the employee to remain employed beyond March 31 of the following year (typically until June 30). In principle, retention beyond June 30 of the following year was also possible, although the federal labor court has not yet determined the exact circumstances under which this may be the case. What can be said is that a bonus of twice the employee’s monthly gross remuneration does not suffice to bind the employee beyond June 30 of the following year if the employee has at least two opportunities to give notice of termination before then (which depends on the notice period that applies in the individual case). With respect to nonpayment clauses, the court historically has distinguished between clauses that refer to a date within the bonus year (e.g., December 31) and clauses that refer to a later date. Nonpayment clauses with a reference date within the bonus year had been held enforceable without any further requirements. With regard to later dates, the court had explicitly rejected the view that nonpayment clauses should be subject to the same rules as repayment clauses. The court had held that an obligation to repay the bonus (which the employee may have already spent) would affect the employee’s freedom to choose employment more than would a bonus which the employee would not receive at all. Therefore, the court treated nonpayment clauses more leniently than repayment clauses, and it depended on the circumstances of the individual case whether or not a retention period was excessive. Factors to be taken into account in this context included, for example, the length of the period between the end of the bonus period and the date of payment; the number of opportunities to give notice of termination the employee would have to waive to receive the bonus; the length of the period the employee would be required to remain employed; and the amount of the bonus. On this basis, the court had held enforceable a nonpayment clause that required an employee to remain employed until June 30 of the following year in return for a bonus of only about half the employee’s monthly gross remuneration. In a judgment dated October 24, 2007, published in December 2007, the federal labor court took a completely new approach and distanced itself from former decisions. The court’s starting point is the 2002 contract law reform, which provides that clauses in individual employment contracts must not put the employee at an unreasonable disadvantage. Such unreasonable disadvantage is deemed to exist, for example, where the wording of a clause is not clear and comprehensible. In the new case decided by the court, the wording of the bonus clause was ambiguous as to whether or not the employee should be entitled to a bonus. The court therefore held that the bonus clause was unenforceable to the extent that it explicitly excluded any bonus entitlement. The court also decided whether or not the retention clause in the employment contract was enforceable. The retention clause provided that no bonus would be paid if notice of termination were given prior to April 1 of the year following the bonus year. In connection with a contract that also included a notice period of at least three months to the end of a calendar quarter, this retention clause would have required the employee to remain employed until September 30, irrespective of the bonus amount. The court regarded this as an inappropriate disadvantage for the employee and therefore held that the employee, in principle, was entitled to a bonus. The most unpleasant surprises for employers, however, are included in the dicta of the October 24, 2007 judgment. First, the court stated that it intends to subject nonpayment clauses to the same standards of review as repayment clauses. This would mean that the longstanding distinction between these two types of clauses would become superfluous and that the greater flexibility employers have enjoyed so far for using nonpayment clauses would be gone. The court further indicated that it will establish additional hurdles for larger bonuses. If a bonus amounts to at least 25% of the employee’s total annual remuneration (probably the remuneration in the bonus year), the loss of the bonus due to a retention clause is likely to be inappropriate if the termination is due to reasons beyond the employee’s control, e.g., operational reasons. This is a remarkable turn, as the court very recently, in a judgment on March 28, 2007 concerning a repayment clause, held that the reasons for termination are irrelevant, without any indication that the amount of the bonus might be a factor. The court went one step further and indicated that it may hold retention clauses completely unenforceable if the bonus amounts to at least 25% of the employee’s total annual remuneration. The purpose of such a large bonus to provide additional remuneration could prevail over the purposes of rewarding continued employment and future motivation. If the court were to follow this line of reasoning, the change would be even more significant. So far, the principle has been that the larger the bonus, the longer the employee can be required to remain employed if he or she wishes to receive the bonus. Now, this principle may continue to apply only to small and medium-sized bonuses but no longer to larger bonuses. For the time being, employers must take into account these new uncertainties surrounding their bonus practices. As a first step, they should carefully review the bonus clauses in their employment contracts. Those that include retention clauses most likely will not differentiate in accordance with the amount of the bonus, and presently risk being held unenforceable. Consequently, if employers wish to continue to use retention clauses, new agreements between the employers and the employees in line with the October 24, 2007 judgment may be required. Note that, depending on the individual bonus clause in the employment contract, an employee may be entitled to a bonus without signing a bonus letter, and that such a bonus letter does not help with respect to employees who have already given, or are about to give, notice of termination and will therefore not receive such letter. In the long run, though, there is no alternative to addressing the issue in the employment contract or an addendum thereto. Note further that the October 24, 2007 judgment does not apply to retention clauses in collective bargaining agreements and works agreements.



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German Labor Court Sets New Standards for Bonus Clauses in Employment Contracts Dr. Walter Ahrens \| Partner, Frankfurt In a recent judgment, the federal labor court set new standards for retention clauses in connection with bonus payments. This judgment will have a significant impact on bonus clauses in employment contracts, particularly in the financial services industry, where bonuses often greatly exceed an individual’s base salary. Background of Repayment and Nonpayment Clauses By way of background, employment contracts that provide for bonus payments often include a retention clause, which provides that the bonus either has to be repaid (repayment clause) or will not be paid at all (nonpayment clause) if the employment relationship ends, or if notice of termination is given, within a certain period from the end of the bonus year, e.g., by March 31 (if the bonus year is the calendar year). The federal labor court has held since 1962 that the enforceability of repayment clauses depends on the amount of the bonus. A repayment clause was unenforceable if the bonus amounted to no more than EUR 100 (formerly DEM 200). If the bonus exceeded EUR 100 but did not reach the employee’s monthly gross remuneration, a repayment clause was unenforceable if it required the employee to remain employed beyond March 31 of the following year. If the bonus amounted to at least the employee’s monthly gross remuneration, a repayment clause could require the employee to remain employed beyond March 31 of the following year (typically until June 30). In principle, retention beyond June 30 of the following year was also possible, although the federal labor court has not yet determined the exact circumstances under which this may be the case. With respect to nonpayment clauses, the court historically has distinguished between clauses that refer to a date within the bonus year (e.g., December 31) and clauses that refer to a later date. Nonpayment clauses with a reference date within the bonus year had been held enforceable without any further requirements. With regard to later dates, the court had explicitly rejected the view that nonpayment clauses should be subject to the same rules as repayment clauses. The court had held that an obligation to repay the bonus (which the employee may have already spent) would affect the employee’s freedom to choose employment more than would a bonus which the employee would not receive at all. Therefore, the court treated nonpayment clauses more leniently than repayment clauses, and it depended on the circumstances of the individual case whether or not a retention period was excessive. Factors to be taken into account in this context included, for example, the length of the period between the end of the bonus period and the date of payment; the number of opportunities to give notice of termination the employee would have to waive to receive the bonus; the length of the period the employee would be required to remain employed; and the amount of the bonus. On this basis, the court had held enforceable a nonpayment clause that required an employee to remain employed until June 30 of the following year in return for a bonus of only about half the employee’s monthly gross remuneration. In a judgment dated October 24, 2007, published in December 2007, the federal labor court took a completely new approach and distanced itself from former decisions. The court’s starting point is the 2002 contract law reform, which provides that clauses in individual employment contracts must not put the employee at an unreasonable disadvantage. Such unreasonable disadvantage is deemed to exist, for example, where the wording of a clause is not clear and comprehensible. In the new case decided by the court, the wording of the bonus clause was ambiguous as to whether or not the employee should be entitled to a bonus. The court therefore held that the bonus clause was unenforceable to the extent that it explicitly excluded any bonus entitlement. The court also decided whether or not the retention clause in the employment contract was enforceable. The retention clause provided that no bonus would be paid if notice of termination were given prior to April 1 of the year following the bonus year. In connection with a contract that also included a notice period of at least three months to the end of a calendar quarter, this retention clause would have required the employee to remain employed until September 30, irrespective of the bonus amount. The court regarded this as an inappropriate disadvantage for the employee and therefore held that the employee, in principle, was entitled to a bonus. The most unpleasant surprises for employers, however, are included in the dicta of the October 24, 2007 judgment. First, the court stated that it intends to subject nonpayment clauses to the same standards of review as repayment clauses. This would mean that the longstanding distinction between these two types of clauses would become superfluous and that the greater flexibility employers have enjoyed so far for using nonpayment clauses would be gone. The court further indicated that it will establish additional hurdles for larger bonuses. If a bonus amounts to at least 25% of the employee’s total annual remuneration (probably the remuneration in the bonus year), the loss of the bonus due to a retention clause is likely to be inappropriate if the termination is due to reasons beyond the employee’s control, e.g., operational reasons. This is a remarkable turn, as the court very recently, in a judgment on March 28, 2007 concerning a repayment clause, held that the reasons for termination are irrelevant, without any indication that the amount of the bonus might be a factor. The court went one step further and indicated that it may hold retention clauses completely unenforceable if the bonus amounts to at least 25% of the employee’s total annual remuneration. The purpose of such a large bonus to provide additional remuneration could prevail over the purposes of rewarding continued employment and future motivation. If the court were to follow this line of reasoning, the change would be even more significant. So far, the principle has been that the larger the bonus, the longer the employee can be required to remain employed if he or she wishes to receive the bonus. Now, this principle may continue to apply only to small and medium-sized bonuses but no longer to larger bonuses. For the time being, employers must take into account these new uncertainties surrounding their bonus practices. As a first step, they should carefully review the bonus clauses in their employment contracts. If they include retention clauses, they most likely will not differentiate in accordance with the amount of the bonus and will risk being held unenforceable. Consequently, if employers wish to continue to use retention clauses, new agreements between the employers and the employees in line with the October 24, 2007 judgment may be required. Note that, depending on the individual bonus clause in the employment contract, an employee may be entitled to a bonus without signing a bonus letter, and that such a bonus letter does not help with respect to employees who have already given, or are about to give, notice of termination and will therefore not receive such letter. Also note that the October 24, 2007 judgment does not apply to retention clauses in collective bargaining agreements and works agreements.		Simeon Spencer Condor House 5-10 St Paul's Churchyard London • EC4M 8AL Ph: +44 (0) 20 3201 5520 Fx: +44 (0) 20 3201 5600 simeon.spencer@ morganlewis.com Dr. Walter Ahrens Guiollettstraße 54 60325 Frankfurt am Main Ph: +49 69 714 007 34 Fx: +49 69 714 007 10 wahrens@morganlewis.com François Vergne 68 rue du Faubourg Saint-Honoré 75008 Paris Ph: 33 (0) 1 53 30 43 00 Fx: 33 (0) 1 53 30 43 01 fvergne@morganlewis.com
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