Federal Labour Court ruling overturns expiry of "vested" virtual options in the event of self-termination – accelerated de-vesting also invalid

Judgment of the Federal Labour Court (BAG) of 19 March 2025 – 10 AZR 67/24

The Federal Labour Court has decided – in a departure from its previous case law – that agreements in general terms and conditions according to which virtual options "vested" in favour of the employee expire immediately after termination of the employment relationship due to ordinary self-termination are unreasonably disadvantageous to the employee and are therefore invalid (Section 307 (1) sentence 1, (2) no. 1 BGB). The same applies to a clause that provides that the "vested" virtual options expire twice as fast after the termination of the employment relationship as they arose during the so-called "vesting period". So far, the considerations of the Federal Labour Court are only evident from a detailed press release, the written reasons for the judgment remain to be seen. Nevertheless, there are already signs of a possible need for adaptation for a large number of programmes.

Starting situation

Start-ups in particular are widely using participation programs (VSOP/ESOP) to incentivize and retain employees. In other constellations (e.g. private equity-typical MEP structures), comparable programs are regularly used.

A common core element of such programs is that a beneficiary (based on a virtual option plan) receives a one-time allocation, but these allocated virtual options only become "vestable" ("vesten") over the beneficiary's period of affiliation with the company – "vested" virtual options then entitle the beneficiary to vest in the event of the occurrence of certain events (esp. exit) for the exercise and maintenance of an economic equivalent. Programs designed with such "vesting" then provide for regulations on what happens to the allocated virtual options in the event of the withdrawal of the beneficiary (leaver) before an exercise event occurs – a distinction is usually made between good and bad leaver cases and various legal consequences are attached to them.

The legal consequence of a bad leaver case is usually the forfeiture without replacement of all virtual options allocated to the beneficiary. Good leaver cases often result in already "vested" virtual options being retained and only non-"vested" virtual options expiring without replacement.

A decisive element is therefore how a reason for elimination is categorized. The ordinary termination of the employment relationship by the beneficiary (i.e. without good cause) is often defined as one of the bad leaver cases. Such regulations are typically intended to strengthen the "retention" element, i.e. employee loyalty – especially in the start-up scene, where frequent employer changes ("hopping") are easily possible. It should be mentioned, however, that (regardless of legal requirements) there were already good reasons for a different (more employee-friendly) design even before the BAG ruling discussed here, and some programs already categorize an employee's own resignation as a good leaver case.

If a beneficiary is left with virtual options after leaving the company, it is sometimes envisaged that they will "melt down" again over time, i.e. gradually expire without replacement (so-called "de-vesting"). This is intended to show that the departed beneficiary has less and less influence on the value of the company (e.g. in the event of an exit) and should therefore no longer benefit to the same extent.

Circumstance

The BAG ruling of 19 March 2025 was specifically based on a case in which an employee had resigned with the company after almost two and a half years of service. As part of an employee participation program, the defendant (the company/employer) had allocated virtual options to him, part of which  had already been "vested" during the term of the employment relationship on the basis of a linear four-year "vesting" (with a 12-month cliff). An exercise event required for exercise (such as an exit or IPO) did not yet exist.

The virtual option plan also provided that vesting was suspended for periods in which the employee was released from his obligation to perform work without a salary claim.

The following applied to the treatment of "vested" virtual options in the Leaver case:

1. The ordinary self-termination represented a bad leaver case – with the consequence of the forfeiture of all virtual options (including the "vested") without replacement.
2. In other cases, "vested" virtual options were to expire after exit on the basis of a "de-vesting" mechanism that provided for a linear expiry over a two-year period.

The plaintiff (employee) considered the regulations to be invalid because the "vested" virtual options were part of his remuneration. He had worked out the exercisability of the virtual options by performing the work during the "vesting period". The defendant, on the other hand, referred to the purpose of the virtual options, which was intended in particular to reward loyalty to the company. Thus, only an opportunity to earn, but not wages, had been forfeited.

Key statements of the FOPH

The Federal Labour Court ruled in favour of the claimant.

"Vested" virtual options are an essential component of remuneration:

The relevant regulations were classified as general terms and conditions (GTC) and subjected to a content review. In doing so, the Federal Labour Court initially came to the conclusion that the "vested" virtual options were indeed to be qualified as consideration for work performed (idea of Section 611a (2) of the German Civil Code). The basis of this assessment is, among other things, that "vesting" is paused during unpaid leave, which is an indication of the remuneration character.

Immediate expiry of all virtual options (bad leaver episode) invalid in the event of self-termination

Regulations according to which an immediate expiry of all virtual options occurs in the event of the beneficiary's own resignation unduly disadvantage employees. They make it virtually impossible for them to leave the company without significant financial disadvantages (dismissal impediment). These provisions were therefore invalid. In doing so, the Federal Labour Court expressly deviates from its earlier case law (Federal Labour Court, judgment of 28 May 2008 – 10 AZR 351/07).

Accelerated "de-vesting" ineffective

The court also declared accelerated "de-vesting" invalid in its concrete form. In this context, the Federal Labour Court is fundamentally open to the idea that the decreasing influence of the beneficiary on the value of the company up to the exercise event (which usually only follows with a long time lag) could be reflected by "de-vesting". However, the twice as fast expiry compared to the "vesting" period (i.e. the period of earnings) is inappropriate and the corresponding regulation is invalid.

Effects and design considerations

The Federal Labour Court ruling not only significantly restricts the handling of any bad leaver cases, but also – with regard to "de-vesting" clauses – the handling of good leaver cases. Virtual option programs (and comparable deferred compensation regulations) that contain corresponding clauses must be put to the test and largely require adaptation. In principle, an adjustment of the provisions requires the consent of the employees – although this is often to be expected in view of the positive changes from the employee's point of view.

The exact content of the necessary adjustments will be determined by the written reasons for the decision, which will in particular also make it possible to assess the transferability to other programmes and types of clauses.

Modern participation programs that are based on international VC standards often do not contain clauses that classify an employee's own resignation as a bad leaver case and, in any case, offer greater legal certainty as well as potentially a higher motivating effect for beneficiaries.

However, we see it as problematic that the FOPH has not made a final decision on the possibilities of forfeiture. In particular, it remains unclear whether "vested" virtual options can actually gradually expire after the end of the employment relationship if the "vesting and expiry periods" run synchronously. The classification of the "vested" virtual options as remuneration could argue against this. Although the Federal Labour Court pointed out that the influence of the departing employee on the value of the company decreases over time, every employee who has worked for the company has ultimately shaped it. The Federal Labour Court has also continued to tighten its case law on other remuneration components (e.g. one-off payments) and also moves away from earlier case law in this decision. It is therefore to be feared that virtual options, which are to be regarded as part of the remuneration, may never expire.

Considerations based on up-to-date information

Alternative designs and their effectiveness:

In practice, there are numerous alternative designs that can also promote the "retention" element. At present, it can only be speculated whether these designs will also be subject to narrower limits in the future.

• Longer vesting periods / longer cliff period/smaller and more frequent allotments: A smaller allotment, a slower vesting and a longer cliff period can have a protective effect.
  ►  With the exception of overly long cliff periods, we consider these approaches to be legally unproblematic.
• Non-linear / "back-loaded vesting": Non-linear or "back-loaded vesting" follows the idea that employees only earn the majority of the virtual options allocated to them in the later periods of their affiliation, while only smaller tranches "vest" in the early periods. Particularly research-intensive tech start-ups already apply corresponding vesting rules (e.g. a 4-year vesting period with the logic of 10 % in the first year followed by 20 %, 30 % and 40 %), which motivates employees to stay (even though this may initially complicate the hiring process and salary negotiations).
  ► This and longer vesting periods do not appear to us to be problematic from a legal point of view.
• "Event-based vesting": Part of the virtual options explicitly does not vest on a time basis, but, for example, upon the occurrence of an exit event, provided that the employment relationship continues to exist.
  ►  We do not consider this tranche to be compensation for work performed, since it does not have to be earned over a specific period of time. Therefore, we consider corresponding clauses to be legally effective.
• Target-achievement-based vesting: Instead of or in addition to time-based vesting, vesting can also be made dependent on a certain target achievement (e.g. KPIs).
  ► We continue to believe that agreeing on targets is legally unobjectionable. However, in our experience, target-based agreements in particular require precise drafting in each individual case and can generally be prone to dispute.
• Grey leaver concept: In some cases, programs provide for an intermediate stage, the grey leaver case, in addition to good and bad leaver cases, which only leads to the expiration of a portion of the vested virtual options. Examples may include resignation after two years of employment or resignation per se.
  ►  There is much to suggest that such clauses would also be judged to be legally invalid (at least without additional clauses that promote the balance of interests).
• Right of repurchase by the company: Often, participation programs (at least to the extent that they classify voluntary termination as a good leaver case) provide for a time-limited right of repurchase by the company at market value or similar. This can at least limit the upside of the person who has left.
  ►  We continue to consider these clauses to be effective.
• "De-vesting" in line with the "vesting" period: A "de-vesting" can be designed in such a way that the "vested" virtual options de-vest after leaving the company in line with the original vesting schedule (and not, as in the present case, at double the rate).
  ►  The BAG ruling seems to suggest that this structure would be legally possible. However, the written reasons for the decision remain to be seen.
• "Vesting" independent of work performance: The "vesting" of the virtual options could be completely detached from the compensation, and loyalty to the company could be rewarded with this alone. However, this would mean that the "vesting period" would continue to run in full even in the case of inactive employment relationships (e.g. during maternity and parental leave).
  ►  We consider such a regulation to be effective.

Entire "vesting" regulation infected? It remains to be seen whether the Federal Labour Court has also taken a position on whether the invalidity only partially affects the clauses examined or whether their invalidity renders the entire "vesting" regime invalid. This is relevant for making appropriate adjustments.

Transferability to founder's "vesting" regulations: Founder's "vesting" regulations are subject to legal uncertainty in certain respects (especially with regard to good leaver constellations). It remains to be seen whether, for example, the BAG's assessment of a bad leaver consequence in the event of self-termination will also be included in the assessment of founder "vesting" regulations in the future. In our view, however, this would appear to be misguided, especially against the background of the corporate law nature of such provisions; in particular, the Shareholders' Agreement, in which such provisions would be contained, does not constitute general terms and conditions.

Transferability to MEP constructions typical of private equity: A fundamental transferability of the decision to typical MEP constructions does not appear to be obvious on the basis of current information. In particular, the following aspects (insofar as these are given) would argue against transferability: (i) the MEP company and the operating company or the employer regularly differ, (ii) some programmes are reserved for board members as beneficiaries, so that no regulations regarding employees or employees within the meaning of labour law should apply, (iii) MEP beneficiaries often do not participate in the company's results but in the group's results,  (iv) the bad leaver sequence is usually not set for a forfeiture of allowances without replacement but for a repurchase against a certain remuneration and (v) often MEP beneficiaries have to make their own investment ("skin in the game"), which means that the interests can deviate significantly from the VSOP constellation. At the same time, however, it cannot be ruled out that certain designs are to be assessed in a similar way to a VSOP.

Issuance by another group company: In group situations, it may often be possible to separate the operating company from the company issuing the virtual options, thus decoupling the employment relationship from the virtual option award as much as possible. However, this should only ever be done after careful examination of the possible effects.

With all the above, it should always be borne in mind that even old cases (e.g. after the departure of a beneficiary or the distribution of exit proceeds) require professional handling within the respective limitation period. In this context, forfeiture or waiver clauses can be particularly helpful.

Please feel free to contact us – we will help you to adapt existing programs and to design new programs in a legally compliant and innovative way.