By Timo Kloster, Firm:kliemt.de

This article explores employers’ duty to set targets for performance-related bonuses, and what can happen when they fail to do so.

Variable compensation via annual target agreements (or unilateral target setting) is enjoying unbroken popularity as a means of motivating employees. At the same time, employers often underestimate the time and effort involved in setting targets, and it is therefore not uncommon for organisations to fail to take the necessary care to do it properly over time, sometimes even to the point of not setting any targets at all.

If, however, objectives are not negotiated or a target is not set, the employees concerned may be entitled to compensation. Even setting the target achievement bonus at ‘zero’ is only possible in certain cases. A recently published ruling of the Paderborn Labour Court shows that this risk can also affect a business acquirer after the transfer of the business.

Missing or delayed determination of targets

Target agreements are usually divided into two parts. Framework provisions such as the amount and due date of the target bonus as well as the procedure for setting targets and determining the achievement of targets are regulated in the employment contract, or company or collective agreement, while the concrete targets themselves are set separately for a certain period of time (usually a year). The setting of objectives can be structured as an agreement on objectives (between employer and employee) or by unilateral target setting (the employer exercising its right of determination).

If the employer does not meet its obligation to negotiate targets or to set unilateral targets, or does so only belatedly, this can result in claims for damages by the employees concerned for loss of bonus payments. In calculating the amount of the bonus, case law generally assumes 100% achievement of targets.

Burden of initiative and documentation

Against this background, the bonus framework agreement should already clearly regulate who has the duty to take the initiative to agree objectives and what concrete duties of cooperation the employee has in this respect. If the employee himself is also responsible for an omitted or delayed determination of objectives, this will at least reduce the amount of any claim for damages.

In case of doubt, the employer must be able to prove that it has set or proposed

appropriate or realistic objectives for the employee in a timely manner. The execution of the process of (attempted) agreement on objectives should therefore be documented in any event. If the acceptance of a target agreement offer then fails for reasons beyond the employer's control, the risk of damages is low.

Is setting a performance bonus to ‘zero’ a viable alternative?

In order to remain flexible with regard to variable remuneration and to be able to react to economic developments, it may also be advisable to leave the determination of bonus requirements and amount to the employer’s discretion (a so-called ‘discretionary bonus’).

Even then, however, the employer is not completely free in deciding on the target bonus, but must remain within the limit of ‘reasonable discretion’ and, if there is a target agreement, adhere to the criteria for exercising discretion stated in it. If it does not do so, the target bonus can be determined by the labour court. By contrast, setting a bonus at ‘zero’ despite the achievement of agreed personal targets is generally unfair, except in extreme cases (e.g. billions lost as a result of the financial crisis).

It may, however, be permissible to make the achievement of certain corporate economic objectives a basic prerequisite for a bonus payment for achieving individual objectives. If the company's objectives are not achieved, the bonus can be set to ‘zero’ without any errors of judgement. If the employer wants to ensure that the payment of goal attainment bonuses is economically viable for the company, this type of two-stage regulation in the framework agreement may be appropriate.

Claims for damages where business transferred?

A recently published ruling of the Paderborn Labour Court (ruling dated 27 March 2019 - 4 Ca 1614/18) shows that the risk arising from failure to set targets after the transfer of a business can also affect a business acquirer. Here, the court awarded an employee a claim for damages against the business acquirer, although the latter had terminated the underlying works agreement on the target agreement after the business was transferred.

This was because the works agreement on the target agreement concerned a matter subject to mandatory works council co-determination with regard to the company wage structure. It therefore had a so-called ‘after-effect’ on the party acquiring the business until it was replaced by another agreement. The party acquiring the business could not unilaterally evade its obligation to set targets by terminating the works agreement. Since the employee had a fixed individual right to payment of a target-related bonus, the acquirer’s declaration that the financial budget for target bonuses would be set to ‘zero’ in the future could not change this.

Recommended action for business acquirers

Since in the case of a transfer of an undertaking the employer's obligation to negotiate or to set targets is in principle transferred to the business acquirer, the acquirer should thoroughly examine rules on target agreements or target setting for existing obligations to act. If the setting of objectives is no longer wanted in the future, the new employer will have to, for better or worse, take the plunge and (if necessary while safeguarding the works council's co-determination rights) reach a new collective or individual agreement.

Conclusion

Agreeing or setting remuneration-related targets can be a useful management tool, but it also entails numerous risks for employers. These risks can be minimised but not completely eliminated by a forward-looking design of the relevant agreement. It is particularly important that the employer is clear about its concrete duties to act and that the fulfilment of these duties is clearly documented. This is especially true for a business acquirer who takes over a set of bonus and target rules in the context of a transfer of business.