News on remuneration systems at financial institutions

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Bad Leaver regulations

Employers' ideas on incentives repeatedly collide with the case law of the 10th Senate of the Federal Labour Court (Bundesarbeitsgericht – BAG). The decision of 15 November 2023 (10 AZR 288/22)¹ dealt with a clause in a works agreement (Betriebsvereinbarung) according to which employees who leave the company due to termination for cause or resignation are not entitled to a bonus – not even pro rata temporis. In its decision, the BAG dealt with a number of important aspects in connection with bonus payments.

First of all, the BAG clarified that the wording in the employment contract "You will receive a bonus in accordance with the works agreement" can also establish an entitlement under the employment contract, not just an entitlement under the works agreement.

The employer couldn’t rely on the discretion granted in the employment contract. The use of free discretion in granting bonuses would be a deviation from the statutory model of Section 315 para. 1 of the German Civil Code (Bürgerliches Gesetzbuch – BGB), which would constitute an unreasonable disadvantage to the employee under the meaning of Section 307 BGB due to the lack of a corrective full judicial review of the determination of performance and would therefore be invalid.

The reservation of voluntariness in the employment contract did not help the employer either. The clause didn’t differentiate according to the reason for the claim so could be interpreted as including individual agreements. But, as such agreements always take precedence over general terms and conditions, the clause constituted an unreasonable disadvantage.

The BAG is convinced that the reference to the key date regulation in the works agreement is invalid. It’s true that works agreements are not subject to general terms and conditions control in accordance with Section 310 para. 4 sentence 1 BGB. But the parties to the works agreement are bound by the principles of justice and equity when concluding their agreements in accordance with Section 75 paras. 1 and 2 sentence 1 of the Works Council Constitution Act (Betriebsverfassungsgesetz – BetrVG) and are also obliged to uphold the rights of freedom protected by fundamental rights. The legal principles to be observed by the operating parties extend to the applicable legal system that shapes the employment relationship. This also includes Section 611a para 2 BGB, according to which the employer is obliged to pay the agreed remuneration to the extent that the employee has performed the work. The payment of the earned remuneration doesn’t dependent on the fulfilment of other purposes. This legal assessment is also binding on the parties to the agreement.

The key date regulation does not meet these requirements. It deprives the employees of remuneration they’ve already earned through their work and makes it disproportionately difficult to dismiss them. Moreover, there is no evidence that the work is only of value to the employer if it’s performed during the reference period. 

The BAG has already emphasised these findings on the inadmissibility of cut-off date provisions in works agreements in several decisions in 2011. In this respect, it’s astonishing that a 2019 works agreement still contains a cut-off date provision that is obviously ineffective for labour law experts.

 

Bad Leaver regulations under the framework of regulated remuneration

We’ve already reflected on the tension between employment law and regulatory law in an article in the German law journal NZA² in 2015.

The first question we addressed was whether the case law of the 1st and 10th senates of the Federal Labour Court on key date regulations should be applied to deferred compensation components under the Compensation Ordinance for Institutions (Institutsvergütungsordnung – IVV). This question has not yet been answered, despite the frequency of such cases. In March this year, DLA Piper argued a case before the Hessian Higher Labour Court. The case raised a number of issues which have not yet been decided by the highest court:

• What is the measurement or reference period for deferred compensation components? Is it the bonus year or the bonus year plus the deferral period?
• If the latter, what does this mean for the effectiveness of key date regulations?
• If the employment contract refers to the parent company's bonus plan, does a review of the general terms and conditions still apply? Or does only Section 319 of the German Civil Code apply? If so, the provision would only have to be reviewed for obvious inequity.
• How is a provision in the bonus plan to be assessed, according to which an adjustment of the plan regulations is possible to meet the regulatory requirements of the supervisory authority?

All these issues were discussed at the Hessian Higher Labour Court but were not decided. The parties reached a settlement. 

 

Key date regulations and retention bonuses

As shown above, the Federal Labour Court assumes that bad leaver clauses are inadmissible in any case if the special payment is – at least also – remuneration for work performed. But what about retention bonuses?

Retention bonuses are used to retain key employees in the context of restructuring, liquidation, in connection with a change of control or to ensure the completion of major projects. The target group is usually offered a larger sum, often in two instalments, if they stay with the company until the relevant deadlines.

But what happens if these employees leave before then? According to the wording of the clauses, there is no entitlement, not even pro rata temporis. What would the 10th Senate say?

• Retention bonuses are often in the region of three to six months' salary and easily reach the 25% threshold. According to the Federal Labour Court, there’s an indisputable presumption that this is also intended to reward work performance, with the result that key date regulations would be ineffective.
• We’re of the opinion that it can be argued from the special features of the retention bonus that these general principles do not apply here, so that a pure loyalty bonus can be assumed. This would mean that key date regulations would be permissible on the basis of the given circumstances.
• Foreign investors and private equity houses in particular tend to include a performance condition in addition to the cut-off date. The vesting of the retention bonus should depend on the recipient's commitment to the project.
• We regularly advise against including additional performance conditions to avoid the bonus being declared as a performance-related special payment, which would render a key date provision ineffective. The person leaving early would be entitled to the bonus.
• If the key date provision is ineffective and there is no pro-rata provision, depending on the circumstances of the individual case, there may be a claim to the full bonus.
• As is often the case in the financial services sector, there are exceptions. According to Section 5 (7) IVV, retention bonuses are only permitted in exceptional cases and only if the institution can prove that it has a special legitimate interest in doing so.
• According to No. 147 EBA Guidelines, retention bonuses must also include a performance component.³

Financial institutions are faced with a dilemma: if they include a performance component to comply with regulatory requirements, they run the risk that those who leave the company early will successfully sue for the bonus because the cut-off date rule is deemed invalid.

 

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¹ Read more here.
² Löw/Glück, Remuneration at banks in the area of conflict between labor and supervisory law, NZA 2015, p. 137ff.
³ EBA Guideline for sound remuneration policies