Revised Legal Interpretation by Germany’s Federal Labour Court – Rethinking virtual participation programs

Virtual participations in the course of judicature

Until now, the prevailing view was that participation programs are a bet on the future: The employee contributes to the success of the company and, in return in the event of an exit - depending on the set-up of the program – shall participate in the proceeds of the sale like a shareholder. In most cases, this is achieved through virtual shares that are granted to the employee as part of the participation program. The advantage for both sides is apparent. The company does not have to spend any liquidity at the time the program is set up, as the due date of the claim is usually not triggered until the occurrence of an exit-event, and the employee has noticeably higher chances of participating in the company's success compared to classic variable remuneration components. At the same time, the shareholders retain full control over the company, as the holders of the virtual shares are not granted any voting rights.

But what happens in case the employee is no longer part of the company and thus no longer contributes to the company's success? Until now, it has been common regulatory practice that the shares already earned (vested) terminate together with the termination of the employment relationship. The possibility of benefiting from the advantages of the participation program was thus regularly linked to the existence of the employment relationship and was directly related to it. This is also not surprising against the background that the investment was intended as a permanent incentivization to make a contribution to the future success of the company. In addition, according to previous judication, the virtual stock options were seen as a speculative profit opportunity and a voluntary additional benefit granted by the employer. If no further contribution is made to the company's success, it is therefore only consequential that the possibility of receiving a return on the previously made contribution is also terminated.

This understanding has fundamentally changed as a result of the Federal Labour Court's decision of 19 March 2025 (10 AZR 67/24) on the termination of virtual shares when the employee leaves the company. In this judgment, the participation program in question did not stand up to a review by the general terms and conditions and the Federal Labour Court moved away from its previous judication for the first time. It no longer sees the virtual shares as a speculative opportunity for profit and a voluntary additional benefit granted by the employer, but as a reward for work performed. An immediate termination of the claim from shares that have already vested in the event of termination of the employment relationship would therefore unreasonably disadvantage the employee. This even applies regardless of whether it is a termination of the employment relationship by the employer or employee.

The Federal Labour Court assessed in its decision the overall character of the participation program and stated that it is comparable to royalties and profit-sharing, i.e. that it has a remuneration character. The vested shares represent a consideration for work performed. An immediate termination of vested shares upon termination of the employment relationship is contrary to the legal concept of Section 611a (2) of the German Civil Code (Bürgerliches Gesetzbuch, “BGB”) and would also create de facto pressure on the employee to remain in the employment relationship to prevent a loss of assets.

Consequence in practice

In practice, this means that claims based on shares that have already vested no longer automatically expire when the employee leaves, but that the employee retains his claim in principle, even if - depending on the structure of the participation program - he should be considered a bad leaver due to the early termination of the employment relationship. The participation program in question also provided for a de-vesting clause that stipulated that the shares expire twice as fast as they were vested in the period after the termination of the employment relationship. The BAG also saw this clause as an unreasonable disadvantage for the employee. Against the background of the justification of the non-termination of vested shares, there is much to be said for that de-vesting clauses should also be reconsidered as a whole.

The Federal Labour Court did not comment on the termination of non-vested shares in the decision. In view of the reasons for the judgment, however, it should still be possible to agree on the termination of non-vested shares upon termination of the employment relationship. The question of the due date of the claim must be assessed independently of this. A due date conditional on the occurrence of an exit event is still possible against the background of the BAG decision, although a more differentiated set-up of the program compared to the previous legal situation is advisable.

Redesign of the programs / Modern employee participation programs (drafting of clauses)

First of all, it should be noted that a blanket termination of shares that have already vested will no longer stand up to a judicial review against the background of the changed legal opinion of the Federal Labour Court. Considering the fact that the allocation of virtual shares is now regarded as remuneration for work performed, one will not be able to avoid awarding the employee this right even after the termination of his employment relationship.

Furthermore, although the Federal Labour Court declared accelerated de-vesting to be invalid, it recognised in the same decision that the employer has a fundamentally legitimate interest in ensuring that the claim for the vested shares expires at the same speed as the vesting period. This is also not contradictory to the legal opinion that the vested shares are remuneration for

work performed, as, after all, remuneration is tied to the future, only possible and thus uncertain event of an exit and hence also differs from the general principle of "wages for work". This also makes sense in light of the fact that the positive influence of the work already performed on a possible exit event decreases over time, namely from the time on when the employee leaves the company, and thus no longer has any influence on the company's success through his or her work performance. As a result, de-vesting clauses urgently need to be put to the test. A termination will continue to be possible through de-vesting if the work performed can no longer have an influence on the exit event, which requires a case-by-case assessment, as this may well depend on the specific industry. At the very least, however, the speed of decay must be synchronous with its earning.

One option to eliminate any future claims with the employee's leaving is to include buyback options for the employer in the contractual agreements. This would offer the employer the opportunity to be freed from future payments, which are usually disproportionately higher in the case of an exit, by paying a sum based on the work performed. It is also conceivable to agree on severance payments – fixed remuneration pro rata for claims that have already been earned – in case of termination of the employment relationship.

In addition to dealing with unvested claims, it is still unclear how the decisions will affect so-called cliff regulations. Cliff regulations usually provide that claims from a participation program only arise after a fixed term, for example 24 months after the employee has joined the participation program. If the employee leaves the company in the future before reaching the vesting cliff, he or she should be granted at least a pro rata claim from the end of his or her accession to the participation program until he or she leaves the company.

The coupling of claims from the participation program to the employee's work performed also makes cross-border arrangements more difficult, in which the share program is typically set up by the foreign parent company, so there is a claim against it, whereas the employment relationship is concluded with the domestic subsidiary. The cost of substantiation for an abstract legal relationship that is supposedly decoupled from the employment relationship is likely to be noticeably higher.

Profit participation rights as an alternative

Recently, the issue of profit participation rights for the purpose of employee participation in the company's success has increasingly come into focus compared to classic participation programs. Profit-sharing rights are obligations sui generis that grant contractual claims against the company and convey typical shareholders’ rights, except for voting rights. A legal definition does not exist in the law, but profit participation rights are mentioned in various places in the law.

The conditions are laid down in a profit-sharing agreement between the company and the respective beneficiary employee and, in the absence of specifications, can be drafted very individually. For example, profit participation rights can be issued at any nominal value, offer the possibility of securitisation in the form of a profit participation certificate and can convey profit participation with or without interest as well as loss participation. In order to represent a real alternative to classic employee participation programs, the terms and conditions of the profit participation rights must be designed in such a way that participation in the increase in the value of the company is realized in the event of an exit. This is typically the case when the company's shareholders sell all of their real shares or all of the company's assets are sold, leaving only the corporate shell in place. The terms and conditions of the profit participation rights must be designed in such a way that, in the event of an exit, a participation takes place as if the employee had a real share in the company.

The advantage is that profit sharing rights securitised as profit participation certificates or profit sharing rights digitised by issuing tokens can also be transferred without further ado, for example in the event that the employee leaves the company. Due to the limited scope of employees entitled to conclude a profit participation agreement, there is usually no obligation to publish a prospectus. As a rule, securities- or basic-information documents are also not to be prepared. In addition, the issuance of profit participation rights is possible quickly and cost-effectively without notarization.

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Our experts have many years of experience in setting up employee participation programs. Simply contact us using the contact details listed on this page. We would be happy to advise you comprehensively on the design of your employee participation program and/or review your existing employee participation program against the background of the changed BAG judicature.