General conditions for a revocation clause

A contractually stipulated revocation clause is a widespread tool for keeping salary components flexible. When concluding such a clause, an employer first grants a benefit to an employee for an indefinite period, but reserves the right to prevent renewal of the benefit by exercising their right of revocation.

But what conditions have to be met in order to conclude an enforceable revocation clause?

As a General Term and Condition (AGB in German), a revocation clause in an employment contract is subject to strict legal and judicial scrutiny. It can only be considered a valid part of a contract if the revocation is linked to specific grounds.

The central question regarding the validity of a revocation clause is: What are permissible grounds for revocation?

In examining the validity of a revocation clause, a constantly recurring question is how specifically the grounds for revocation must be designated in the contractual clause.

Regarding this matter, the Federal Labor Court of Germany clarified in a groundbreaking decision as far back as 2005 that the grounds for revocation must at least specify the direction from which a revocation might come, for example, economic grounds or the employee’s performance or conduct. Since then, however, the Federal Labor Court has significantly tightened the conditions for a revocation on economic grounds; not every ground related to economic aspects is considered by the court an objective reason for revocation.

A recent ruling by the Federal Labor Court on January 24, 2017 (1 AZR 774/14) illustrates this point. The judges in Erfurt had to decide once again whether or not the revocation grounds specified in a contract in a specific case rendered the revocation clause invalid.

What was at issue?

The plaintiff had concluded an employment contract with the legal predecessor of the defendant that provided for payment of an earnings-related Christmas bonus. In addition, the parties had concluded the following revocation clause:

»The employer reserves the right to revoke this benefit in the event of an economic emergency.«

The employment contract was subsequently transferred to the defendant, who »revoked the 2012 Christmas bonus due to an economic emergency.« At the time the bonus was revoked, the defendant was facing bankruptcy and could only avoid it by bringing in an investor. The investor made his financial involvement contingent on revocation of the bonus. The plaintiff demanded that the defendant pay the Christmas bonus. In his opinion, the revocation clause was invalid, not least because he held it was unclear which cases constitute an economic emergency serious enough to justify revocation.

After the Labor Court had upheld the case and the State Labor Court had dismissed it, the Federal Labor Court rejected the plaintiff’s claim.

»An economic emergency« on the part of the employer as a sufficient ground for revocation

At the core of the dispute, the Federal Labor Court argued as follows: The ground for revocation specified in the clause was sufficiently transparent. The degree of economic disruption required to justify revocation was put in concrete enough terms. The clause clearly stated that in the event of an economic emergency, the employee should expect having payment of the Christmas bonus revoked. Furthermore, it follows from the wording of the clause that the economic emergency referred to is that of the defendant’s company. Contrary to the plaintiff’s view, the clause does not refer to a general economic emergency, or that of a partner of the defendant, of a business, or of the entire group. Furthermore, the economic emergency was actually happening when the clause was revoked, so that the employer was justified in exercising the clause and thus acted within reasonable bounds. Because the revocation resulted in less than a 5% decrease in total compensation, the upper limit for revocable salary components was also observed.

Consequences of the ruling: What grounds are now sufficient for revocation?

The recent ruling shows that the mere phrase »economic grounds« is no longer sufficient to render a revocation clause valid. A wealth of details is not required, however. An »economic emergency« (affecting the employer) constitutes one sufficiently specific ground for rendering a revocation clause valid. In the past, the Federal Labor Court itself has admittedly provided occasional guidelines for formulating specific economic grounds so as to render a revocation clause valid. But much is still vague.

The bottom line: Use precise wording when formulating economic grounds for revocation!

With its recent decision, the Federal Labor Court has provided somewhat clearer guidelines for what a valid revocation clause should contain. To avoid being deemed invalid, the objective grounds for a revocation must be worded as precisely as possible when an employment contract is drafted. For the employer risks losing flexibility options if revocation clauses are worded too vaguely and are therefore deemed invalid. At the same time, it is neither possible nor necessary for the employment contract to be equipped with a long list of detailed grounds for revocation. The Federal Labor Court has confirmed this by finding the term »economic emergency« to be sufficiently precise.