I. Introduction and background

Employee stock option plans with virtual option rights (also known as Employee Stock Option Plans, ESOPs or Virtual Stock Option Plans, VSOPs) are a popular instrument for long-term employee retention and also serve to motivate employees’ commitment and performance. As a rule, employee stock option plans grant participating employees a future payment claim against the company in addition to their fixed monthly remuneration, the amount of which is linked to the company’s success, whereby this is determined by the value or increase in value of the company. In this context, there are often so-called vesting regulations with regard to the accrual (possibly of individual tranches), assertion and expiry of the entitlement to virtual option rights.
In March of this year, the BAG dealt with vesting regulations for virtual option rights in two court rulings that attracted attention beyond the world of employment law and partially abandoned its previous jurisprudence in this regard. In the first decision, the BAG considered two vesting provisions that provided for the expiry of already vested or earned option rights to be unreasonably disadvantageous to the employee and declared them invalid. In the second decision, the BAG clarified that option rights exercised (only) during an existing employment relationship must also be taken into account when calculating the compensation for a post-contractual non-competition clause pursuant to § 74 para. 2 German Commercial Code (HGB).
However, the full reasons for the judgment have not yet been published. Based on the available press releases, the full scope of the change in the jurisprudence can therefore only be assessed provisionally at this point.

II. Invalidity of vesting regulations

The first BAG rulings was based on the following facts: The plaintiff was employed by the defendant. As part of an employee stock option plan, the plaintiff was allocated virtual option rights which, if exercised, led to a payment claim against the defendant. The option rights could be exercised in stages after the expiry of a cliff period (also known as the cliff period) of twelve months within a vesting period of four years. According to the agreed vesting regulations, vested but not yet exercised virtual option rights should expire, among other things, if the employment relationship ends due to the employee’s own resignation. In addition, vested but not yet exercised virtual option rights should expire successively within a period of two years after the end of the employment relationship. In this specific case, the employment relationship ended when the plaintiff resigned. The plaintiff asserted his claim to the option rights that had vested up to this point in time. The defendant rejected the claim with reference to the expiry of the option rights. The labor court and the regional labor court dismissed the claim.
The BAG first determined that the provisions of the employee stock option plan, in particular the vesting provisions in question, were general terms and conditions (AGB) pursuant to § 305 para. 1 sentence 1 German Civil Code (BGB), which are subject to a so-called content review pursuant to § 307 para. 1 BGB. Furthermore, the option rights already vested due to the partial expiry of the vesting period are part of the consideration for the work performed.
The immediate expiry of vested option rights upon termination of the employment relationship puts the employee at an unreasonable disadvantage. In particular, it contradicts the employer’s obligation to pay remuneration set out in § 611 a para. 2 BGB. Furthermore, the clause constitutes a disproportionate impediment to termination, as the employee is de facto required to refrain from terminating the employment relationship in order to avoid a possible loss of assets. For this reason, the corresponding forfeiture clause is invalid in accordance with §§ 307 para. 1 sentence 1, para. 2 no. 1 BGB.
A forfeiture clause according to which vested option rights expire more quickly after termination of the employment relationship than they were acquired is also invalid. It is true that a gradual expiry of option rights takes into account the employee’s diminishing influence on the value of the company. However, the employee is unreasonably disadvantaged if the working time that the employee has spent on the exercisable option rights during the vesting period is not sufficiently taken into account during the expiry period. This constitutes an unreasonable disadvantage for the employee from a standardized perspective.
With this decision, the BAG abandons its earlier decision (BAG, judgment of 28 May 2008 – 10 AZR 351/07), in which it still considered the immediate expiry of vested option rights to be permissible in principle.

III. Consideration of virtual option rights in the case of waiting period compensation

The second BAG decision was based on the following facts. The plaintiff was employed by the defendant. As part of an employee stock option plan, the plaintiff was allocated virtual option rights which, if exercised, lead to a payment claim against the defendant. The option rights are earned in stages within a vesting period through work performed by the plaintiff and can be exercised after the end of the vesting period provided that an trigger event (share deal, asset deal or IPO) has occurred. The plaintiff exercised part of the option rights allocated to him during the existence of his employment relationship in return for payment by the defendant. However, the plaintiff only exercised another part of the option rights allocated to him after his employment relationship with the defendant was terminated by a termination agreement. The employment contract contained a post-contractual non-competition clause. The plaintiff was of the opinion that all payments received for the option rights exercised before and after the termination of the employment relationship should be included in the calculation of the compensation for the post-contractual non-competition clause. The labor court and the regional labor court, on the other hand, argued that only the payments for option rights exercised during the employment relationship should be included in the compensation for non-competition clauses, but not the payments for option rights exercised after the termination of the employment relationship.
The BAG agreed with the opinion of the lower courts and decided that when calculating compensation for a post-contractual non-competition clause in accordance with § 74 et seq. HGB, payments received from virtual option rights are only to be included if the relevant option rights were exercised during the existing employment relationship. On the other hand, payments on virtual option rights that were only exercised after the end of the employment relationship are not to be taken into account when calculating the compensation for non-competition clauses.
This is not entirely convincing. Because the option rights were earned during the vesting period, i.e. during the existing employment relationship through work performed and granted by the employer. They therefore already represent a certain asset – albeit one that is difficult to value – at the end of the employment relationship, even if they have not yet been exercised at that time. The question arises as to why this should not constitute contractual remuneration within the meaning of § 74 HGB. The reasons for the BAG’s judgment can therefore be eagerly awaited.

IV. Outlook and consequences for practice

The two BAG rulings are of great importance in practice. Executives and employees of start-ups in particular are increasingly participating in the company’s success via employee stock option plans and are thus incentivized.
The two court decisions underline the need for careful drafting of the contractual terms of employee stock option plans. Companies should review existing provisions and, if necessary, adapt them to current jurisprudence in order to take appropriate account of employees’ rights and avoid any risks of invalidity or disputes in this regard as far as possible. When agreeing on non-compete clauses, the potential impact of virtual option rights on the amount of compensation for non-competition clauses should also be taken into account.
However, the press releases so far leave some questions unanswered. It is to be feared that these will not be fully resolved even after the reasons for the decision have been published.
It remains unclear, for example, whether the jurisprudence only applies if the option rights are granted directly by a domestic employer itself. In international group structures in which virtual option rights are granted by the holding company – which may be based abroad – and there is no employment relationship between the granting holding company and the employee employed by a subsidiary, it is questionable whether this applies. Foreign law could be applicable to such constellations.
Furthermore, the jurisprudence on the invalidity of expiry clauses does not indicate whether this is also transferable to option rights that have not yet vested.
Insofar as forfeiture clauses take appropriate account of the interests of employees upon departure, they should continue to be permissible and effective. The relationship between vesting and forfeiture will have to be taken into account.
It therefore remains to be seen what arguments the BAG will use to justify its decisions in detail and what specific adjustments will be required in legal practice as a result.