Many companies pay their senior executives a bonus on top of their fixed remuneration. This is often based on a combination of personal target achievements and the company's financial position. If the company's results are poor, employers may be inclined to reduce the bonus to zero. But does an employer have the right to scratch the bonus completely or substantially reduce it even if the employee has achieved his or her personal targets? In the wake of the financial and banking crisis, this is an issue which employment courts have frequently had to address in recent years.
If employees are promised a bonus in their employment contracts when certain requirements are fulfilled, they are legally entitled to receive a payment. However, the question is over the amount of the bonus. A provision in an employment contract, according to which a performance bonus is determined by the employer at the end of the year at its due discretion (Section 315(1) of the Civil Code), is permissible, in principle, insofar as mutual interests of the employee and employer are taken into account. However, the employer must observe the contractually agreed provisions - and this is often the difficult part.
Employment contracts often stipulate that a performance bonus is determined on the basis of the financial results of the company and the personal performance of the employee, and not based solely on the profit situation. This gives rise to the question of what happens when the employee achieves his or her personal targets, or even over-performs, but the financial results are negative. If the employment contract (or a works agreement) expressly stipulates that the personal performance of the employee is multiplied by the economic results, then the employer is allowed to completely eliminate the bonus if the financial results are zero. However, if the employment contract contains words such as 'and' or 'as well as', which indicate that the financial situation and personal performance are equal in value, then a poor profit situation cannot necessarily result in no bonus payment.
In two recently published decisions(1) dated March 20 2013, the Federal Labour Court commented on the question of whether an employer is allowed to completely eliminate bonus payments to its employees due to a poor economic situation. In these particular cases, the court confirmed this. However, the decisions must be viewed in light of the specific situation, namely the extreme downturn in the financial situation caused by the banking crisis - losses in the billions and the necessity of state aid in order to survive. The court made an exception due only to this extreme situation, and considered it justified that the performance bonus was set to zero, despite the fact that under the employment contract personal performance was a calculation factor weighted equivalently to financial results. In both cases there were also works agreements which stated that the bonus payment was dependent on the amount in a bonus pot, which was determined each year depending on the company's performance. The bonus pot was empty due to the banking crisis.
The court clearly stated that scratching the bonus completely is permissible only in very few specific situations. Generally, the employer may not completely eliminate the bonus if the financial results are negative in the context of normal fluctuation. This would constitute an unfair shift of the entrepreneurial risk from the employer to the employee.
However, the decisions do indicate a tendency which companies can at least take into consideration during very difficult economic times. If the bonus is eliminated, even though the requirements have not really been fulfilled, there is a risk that employees can assert their bonus entitlements in court, possibly even in instances years in the distant past.
For companies which belong to a group, the question of which financial results are indicative for determining the amount of the bonus may arise:
- the results of the employer itself;
- the parent company; or
- the entire group of companies?
This particularly applies if the results of the company with which the employee has concluded the employment contract are good, or at least average, but the parent company (often a foreign company) or the entire group has suffered a loss. Again, the provisions of the employment contract prevail. As long as the employment contract does not state explicitly that the financial results of another company or the entire group are decisive, it must be assumed that only the financial results of the employer itself must be taken into account.
For companies to be able to react adequately, and avoid (high) bonus payments when the financial results are poor, it should be clearly stipulated in the employment contract that the financial results are the primary requirement for granting the bonus, and that the personal performance-related components serve only as multipliers. Only then is it possible to multiply by zero in the event of negative results. However, if the individual factors (financial results and personal performance) are weighted equally in the employment contract, it is only possible to completely eliminate the bonus payment in very few exceptional cases. Additionally, it is important to indicate clearly from the outset whether it is only the employer's financial results which are decisive, or the results of the parent company or entire group.
For further information on this topic please contact Bjoern Gaul, Bernd Roock, Antje-Kathrin Uhl or Eva Schäfer-Wallberg at CMSHasche Sigle by telephone (+49 711 9764 248), fax (+49 711 9764 96249) or email (email@example.com, firstname.lastname@example.org, email@example.com or firstname.lastname@example.org).
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