German Federal Labour Court Rules on Virtual Share Options and Exit Bonuses

Facts of the Case 

The defendant, an employer, granted the plaintiff, its former employee, virtual options according to its Employee Stock Option Provisions (ESOP). The virtual options were only exercisable in the event of an exit. The exercisability of the virtual options also required the completion of a four-year vesting period. At the end of the employment, vested virtual options were to forfeit immediately if the termination was based on the employee’s resignation or a conduct-based or extraordinary termination by the employer. Otherwise, the virtual options were to forfeit gradually within a period of two years after the end of the employment. After his resignation, the plaintiff asserted the continuation of the virtual options already vested at the time of his departure. An exit was not foreseeable at that time. The Federal Labour Court ruled in favour of the plaintiff. 

Key Reasons for the Decision 

The plaintiff did not lose his already vested virtual options despite his resignation; thus, he remains entitled to participate in future exit proceeds even after his departure. The contrary provisions in the ESOP were deemed invalid. The Federal Labour Court emphasised the remuneration character of virtual options. They constitute earned remuneration that merely is yet to be paid out. The fact that it is unforeseeable at the time of the employee’s departure whether or when a (profitable) exit will occur does not, in the court’s view, obstruct this notion. The Federal Labour Court took a step further: Even the provision that foresaw a gradual forfeiture over a period of two years after the employee’s departure was deemed invalid by the judges. Although it correctly reflects in principle that the employee’s influence on the company’s value decreases over time, the regulation allows — based on the therein regulated vesting period of four years — the virtual options allocated to the employee to forfeit twice as quickly as they were vested. This also unfairly disadvantages the prematurely departing employee. Thus, the plaintiff’s virtual options were not subject to any forfeiture period at all. 

Practical Notes

The Federal Labour Court’s decision concerns the (in practice rather uncommon) case where the exit bonus is promised by the employing entity (and not, as usual, by a (co-)shareholder entity). In the case of “real” virtual options that are not solely linked to an exit, such a two-party constellation is more common. For this two-party constellation, the Federal Labour Court has clarified the following: 

• Virtual options are deemed remuneration, with the consequence that they cannot be easily withdrawn from the employee. The remuneration characteristic is not, according to the decision, lost simply because the employer allows vesting to continue even during periods without a remuneration claim (e.g., during long-term illness or parental leave). 
• Bad-leaver clauses that foresee the loss of vested virtual options upon resignation are invalid; consequently, such virtual options are not subject to any forfeiture period at all. The court seems to consider immediate forfeiture upon termination of the employment to be inadmissible even in other termination scenarios, i.e., regardless of which party terminates the employment or why the employment relationship ends. 
• A “devesting” of already vested virtual options in the period after the employee’s departure is, in principle, permissible. If the employer wishes to make use of this option, it should, however, ensure that this “devesting” — unlike in the decided case — does not occur faster than the vesting itself. 
• Invalid forfeiture regulations have far-reaching consequences because the already vested shares remain fully valid even after departure and can therefore be exercised many years later in the event of an exit. 

The Federal Labour Court did not have to decide on the (in practice frequently occurring) situation where the virtual options are not issued by the employer but by an — often foreign — group company (a three-party constellation). If option granting and the employment relationship are separated in such constellations and the employer is not involved in the option granting, there are still good reasons, in our opinion, that such virtual options are not part of the employment relationship and therefore do not constitute remuneration, thus they do not fall under the Federal Labour Court’s strict requirements regarding remuneration.