Forfeiture clauses can unreasonably disadvantage the employee and therefore be invalid

The German Federal Labor Court 's decision dated 19 March 2025 was based on the following facts: The employee received "virtual stock options" based on an agreement with their employer. The latter entailed a potential entitlement to a cash payment against the employer, depending on the development of the share price. The prerequisites for the payment entitlement were the expiry of a certain waiting period (vesting period), the fulfillment of certain exercise conditions and the exercise of the options by the employee. The vesting period amounted to a total of four years. During this period, the stock options became exercisable (vested) in stages after a minimum waiting period of one year, provided that the employment relationship still existed at the time of vesting. Vesting was suspended for periods in which the employee was released from the obligation to work without remuneration entitlement. Stock options that had already become exercisable would forfeit if the employment relationship ended due to the employee's own resignation. In any case, they would forfeit successively within a period of two years after termination of the employment relationship. The employee terminated the employment relationship and sought a court decision that the virtual stock options vested during his employment relationship had not forfeited. The employer rejected the claim.

The German Federal Labor Court agreed with the employee and considered the forfeiture clauses to be invalid, as they unreasonably disadvantaged the employee: The immediate forfeiture after termination of the employment relationship was unlawful as it affected vested stock options which, at least in this case, were considered remuneration for work performed. That options were considered remuneration for work performed follows in particular from the provision according to which vesting was suspended for periods of leave of absence without entitlement to remuneration. The provision on the successive forfeiture of stock options was also held to be invalid. It unreasonably disadvantaged the employee if - as in the present case - the stock options forfeit twice as quickly as they were earned.

With this decision, the German Federal Labor Court deviates from its previous case law. In particular, the German Federal Labor Court has abandoned its previous guiding decision 28 May 2008 (case no. 10 AZR 351/07), insofar as it dealt with the immediate forfeiture of vested stock options upon termination of employment. In this (former) decision, the German Federal Labor Court considered forfeiture clauses relating to stock options to be valid even if they covered vested options. At the time, the German Federal Labor Court had rejected the argument of such forfeiture clauses to be unreasonable disadvantageous, as stock options - according to the German Federal Labor Court - had to be seen as special remuneration of a speculative nature which can lose their value at any time. Whether and to what extent the present decision also affects the validity of forfeiture clauses for stock options that have not yet vested remains subject to the assessment of the reasons for the decision.

Consideration of stock options in the calculation of compensation for adhering to post-contractual non-competition obligations

In its decision dated 27 March 2025, the German Federal Labor Court continued its case law on the consideration of stock options in the calculation of "non-compete compensation" (i.e., consideration for adhering to post-contractual non-compete obligations). The court has now addressed the question of how the non-compete compensation should be calculated. The German Federal Labor Court had already ruled in its decision dated 25 August 2022 (case no. 8 AZR 453/21) that stock options must be taken into account when calculating non-compete compensation if they are granted by the employer in return for work performed. 

In the present decision, the employer had also granted (virtual) stock options. Furthermore, the employment contract included a post-contractual non-compete clause and non-compete compensation in return. The employee had exercised stock options before and immediately after the termination of his employment and demanded that all exercised stock options are to be taken into account when calculating non-compete compensation. The employer rejected the claim and argued that only those stock options that were exercised before the end of the employment relationship were to take into account. 
The German Federal Labor Court agreed with the employer. Accordingly, only those stock options that were exercised during the employment relationship are to be taken into account when calculating non-compete compensation. The profit generated from the exercise are part of the "last contractual remuneration received" and must therefore be taken into account at the average of the last three years. This does not apply to stock options that are exercised after the end of the employment relationship.

The decision is consistent if, like the German Federal Labor Court, the consideration of stock options is based on the exercise profit and not the value of the stock options at the time of allocation. However, if the German Federal Labor Court agrees that it is the exercise profit that is relevant, it is up to the employee to specifically influence the amount of non-compete compensation by exercising options during the notice period. It is difficult to reconcile the purpose of compensation for non-competition recognized by the German Federal Labor Court, which is to secure the previous standard of living during the non-competition period, with the acknowledgement of a one-time payment for the non-compete compensation.

Recommendations

The decisions are highly relevant in practice and can lead to considerable additional costs, at least in cases where stock options are granted directly by the employer. For employers who do not grant stock options directly, these decisions once again highlight the importance of drafting the respective contractual relationships properly. If stock options are granted by a third party (usually the group parent company), the legal relationship between the employee and the issuing company should therefore exist separately from the employment relationship with the employer. Furthermore, the employer should neither explicitly nor implicitly enter into an independent obligation to grant the stock options. Under no circumstances should stock options and similar rights be declared as "remuneration" (for work performed). For the same reason, provisions according to which vesting is automatically suspended during periods of leave of absence without entitlement to remuneration should be treated with caution. This also and especially applies to companies where stock options or similar rights are granted exclusively by the group parent company.

Stock options and similar programs should therefore be reviewed in light of this case law. This applies in particular to the clear separation of the employment relationship and the granting relationship of stock options as well as forfeiture clauses and their wording. When calculating the financial impact of a post-contractual non-compete, any stock options granted and the time at which they are exercised should be taken into account. The resulting "(additional) costs" of a non-compete should already be considered when the agreement is concluded. For this reason, it is also advisable to regularly review whether the non-compete still appears economically viable or should be (timely) waived.

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