Federal Labor Court Ruling of July 3, 2024 – Case No.: 10 AZR 171/23
Employers are not permitted to unilaterally set target agreements for performance-based variable compensation; instead, they must negotiate them with employees. This was clarified by the Federal Labor Court (BAG) in its ruling of July 3, 2024 (Case No.: 10 AZR 171/23). The court declared a contractual clause that allows the employer to unilaterally determine target agreements to be invalid.
A distinction must be made between target specifications and target agreements. The employer may unilaterally determine the target specifications for performance-based compensation. However, the target agreement must be negotiated with the employee, as stated by MTR Legal Rechtsanwälte, a law firm advising on employment law, among other areas.
Target Specifications and Target Agreements
Both target specifications and target agreements aim to provide employees with additional performance-based compensation when they meet certain criteria. While employers may limit themselves to setting target specifications, they often seek discussions with employees to reach a mutually satisfactory target agreement. If the parties fail to reach an agreement, this does not mean that the employer can unilaterally determine the targets.
This principle is reinforced by the decision of the Federal Labor Court. In the case at hand, the plaintiff was employed as a Development Director. In addition to a fixed annual salary of €180,000 gross, his employment contract from February 2020 provided for a variable performance-based bonus. The amount of the bonus was to depend on the achievement of targets agreed upon annually between the employee and the employer. The contract also stipulated that if no agreement could be reached, the employer would unilaterally set the targets at its reasonable discretion.
No Agreement Between the Parties
Disagreements arose between the parties within just a few months. In June 2020, the plaintiff requested the company to begin negotiations on the target agreements. In August, both parties exchanged proposals and counterproposals. However, no agreement was reached. The company argued that the employee’s counterproposal did not aim at achieving specific goals but rather at obtaining additional compensation for regular work performance. Moreover, the company contended that the proposed targets lacked an incentive effect, particularly because the employee insisted that past performance should also be considered. As a result, the company unilaterally set the target specifications, relying on the corresponding clause in the employment contract.
Employee Sues for Damages
The employment relationship was terminated in December 2020 following the employee’s resignation. Since he had not received any bonus payments, he sued for damages, arguing that the company had failed to negotiate the target agreements and was not entitled to set the targets unilaterally.
The Federal Labor Court ruled that the plaintiff was entitled to compensation for lost performance-based variable remuneration amounting to approximately €82,600. The company had breached its obligation to conclude a target agreement with the plaintiff.
BAG: Employer Was Not Allowed to Set Targets Unilaterally
Even though no agreement was reached between the parties, the company was not allowed to unilaterally determine the targets. The relevant contractual provision permitting the company to set targets unilaterally did not withstand judicial review. The court found that the clause placed the employee at an unfair disadvantage.
The court clarified that contractual provisions granting the employer a unilateral right to determine performance conditions are generally permissible. This also applies to unilateral target specifications for achieving variable, performance-based compensation. However, in this case, the clause allowed the employer to override the contractually agreed hierarchy of target agreements and target specifications. Consequently, this provision constituted an unfair disadvantage and was deemed invalid. The employer had, therefore, culpably violated its contractual duty to negotiate and conclude a target agreement.
This ruling highlights the importance of reviewing provisions on variable performance-based compensation in employment contracts.
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