Federal Labour Court overturns forfeiture of vested option rights – what start-ups, investors and companies now need to consider

Background and key statements of the judgment

Virtual stock option plans (“VSOPs”) are a widely used instrument for incentivising employees in the German start-up scene. Their basic structure is relatively simple: the employee is allocated a certain number of virtual options that are usually subject to vesting over several years. This means that they are only earned over a certain period of time and only if the employee continues to work for the company. In the event of a sale or IPO of the company (an “exit”), the employee receives a payment from the company that puts them in the same position as if they had sold a corresponding number of “real” company shares as part of the exit.

Like other types of incentive schemes, VSOP terms and conditions generally contain provisions on complete (“bad leaver”) or partial (“good leaver”, “normal leaver” or “grey leaver”) forfeiture of the virtual options which is linked to the various ways employment relationships end and the circumstances under which this takes place.

In its judgment of 19 March 2025 (case no. 10 AZR 67/24), the reasoning for which was only recently published, the Federal Labour Court (Bundesarbeitsgericht) has now made a far-reaching decision on the legal validity of forfeiture clauses in VSOPs under employment law. The key issue was whether clauses providing for the complete or accelerated forfeiture of already vested virtual options in the event of termination of employment are legally effective.

The Federal Labour Court declared two common VSOP clauses invalid:

1. clauses under which all vested virtual options expire immediately and completely upon termination of the service or employment relationship due to the employee’s own resignation; and
2. clauses under which vested virtual options expire faster after the end of the service or employment relationship due to the passage of time than they were previously accumulated (known as “accelerated forfeiture”).

In the view of the Federal Labour Court, both clauses constitute an unreasonable disadvantage and are therefore invalid (section 307(1), first sentence 1 and section 307(2)(1) of the German Civil Code (Bürgerliches Gesetzbuch – BGB)).

Forfeiture of virtual options due to termination

The Federal Labour Court assumes that the reason for giving notice of termination is irrelevant for the continued existence of the options, as the virtual options represent a “remuneration component” to which no special provisions apply despite their uncertain future value. Remuneration components represent the company’s consideration for the work performed by the employee and can therefore only be withdrawn to a limited extent retrospectively, i.e. after the work has been performed.

The Federal Labour Court initially only explicitly states that at least terminations for which the company is responsible may not lead to option rights that have already vested being forfeited. At first glance, this gives the impression that at least bad leaver clauses, in which the termination of the service or employment relationship is based on a breach of duty by the employee, could still be permissible. However, the court makes it clear in its judgment that it considers all grounds for termination to be irrelevant for the forfeiture of vested options. In the court’s opinion, the only possibility for the expiry of already vested option rights is the passage of a certain amount of time after the end of the contractual relationship – but not the termination itself.

Thus, in the opinion of the Federal Labour Court it does not matter whether the employee is to be regarded as a “good”, “normal”, “grey” or “bad leaver”, as they are entitled to remuneration for the work they have performed regardless of this. As a result, provisions on the automatic and complete forfeiture of vested options in the event of termination are invalid.

The validity of the clauses for old contracts can also not be justified by special protection of legitimate expectations based on the previous case law to the contrary in favour of companies (Federal Labour Court, judgment of 28 May 2008 – 10 AZR 351/07). The permissible content of contractual clauses is always defined by current legal regulations and the accompanying case law, meaning that earlier decisions by the higher courts generally do not give rise to any protection of legitimate expectations.

Forfeiture of virtual options due to the passage of time

In its judgment, the Federal Labour Court also deals with provisions that lead to pro rata forfeiture of virtual option rights after an employee leaves the company. Despite the fact that the Federal Labour Court considers virtual option rights to be compensation for work performed, it accepts the possibility of a pro rata forfeiture of vested options over a certain period following the end of the service or employment relationship. However, appropriate contractual provisions are required for this.

The court does not set specific substantive requirements for the structure of the forfeiture period. However, a uniform linear forfeiture of the options over the entire forfeiture period may be considered. This means, for example, that with a vesting and forfeiture period of four years following a departure event, 1/48 of the vested options would expire each month. Even though the court does not state this explicitly, this type of forfeiture does not appear to constitute an unreasonable disadvantage, since all “earned” options expire equally over time. Such an arrangement for forfeiture should therefore continue to be permitted.

Another option would be to structure the forfeiture phase parallel to the vesting phase. For example, if 10% of the options vest in the first year of the vesting phase, a further 20% in the second year, another 30% in the third year, and the remaining 40% in the fourth year, this would mean that in the first year of the forfeiture phase 10%, in the second year a further 20%, in the third year another 30% and in the last year the remaining 40% of the options would lapse. Under this arrangement, the eligible employee would be better off than under the linear vesting described above.

Effects on practice

Based on the previous case law of the Federal Labour Court on stock options (judgment of 28 May 2008 – 10 AZR 351/07), vested options were also previously regarded as remuneration for work performed by employees. However, due to their uncertain future value, greater flexibility in structuring was allowed. Since this flexibility was generally made use of, there is now often a real need for action. Leaver provisions which lead to vested options being forfeited are particularly critical.

The expiry of virtual options that have not yet vested at the time of termination remains possible. However, even such leaver provisions, which are generally effective, could be ineffective in exceptional cases if they are inextricably linked by contract to an ineffective leaver provision.

However, the scope is limited with regard to agreements already entered into on the granting of virtual options.

Amendment of agreements that have already been concluded or VSOPs that have been implemented

Initially, it is possible to contractually amend the agreements already concluded or the plans regarding the granting of virtual options that are already in progress. However, such an amendment often poses a challenge, as it typically depends on the consent of the employee. This is usually difficult to obtain, especially if the proposed amendment (in this case the replacement of the invalid expiry clause with an effective clause) entails potential disadvantages for the employee. Some schemes contain unilateral amendment clauses that allow the company to make changes to the conditions of the scheme without the consent of the individual scheme participants. However, the effectiveness of such clauses is doubtful if the changes result in disadvantages for the beneficiaries. It may be possible to amend existing contracts amicably, for example in connection with promotions, salary increases, or the granting of additional (virtual) options, i.e. if a specific negotiation situation exists anyway.

Severance agreements

Another option for implementing contractual changes is to enter into clear and transparent individual severance agreements upon termination of the contract. In this context, it is possible to agree on a mutual arrangement for the cancellation or additional cancellation of the options vested up to that point. However, a corresponding financial incentive will also be necessary here, since otherwise the employee would have to forfeit their financially potentially valuable position without compensation.

Design of new VSOPs

New contracts and new VSOPs should take the new court judgment into consideration. Both the continued existence of the options irrespective of any termination and the provisions on the expiry of the options after termination must be taken into account. In particular, failure to comply with the provisions concerning forfeiture after the employment or service relationship has ended may otherwise mean that option rights are not subject to expiry.

Since the Federal Labour Court also does not specify any minimum or maximum vesting periods, these periods can vary. If a faster forfeiture of already vested options after departure is intended, both the vesting and forfeiture phases could therefore be as short as two years each. However, this also means that the eligible employees will earn their options in full more quickly. If this is to be avoided, longer periods can be set so that the vesting phase lasts six years, for example. However, this automatically leads to the forfeiture phase being extended. It is also questionable whether the Federal Labour Court would accept particularly long vesting periods (e.g. ten years) or whether it would again consider this an unreasonable disadvantage and argue that it constitutes an inadmissible restriction on the employee’s ability to give notice.

It may also be possible to link option rights to “performance milestones” or “exit conditions”. In this case, vesting is determined not only (or not at all) by the passage of time, but by achieving certain targets (for example the company reaching break-even point or participation in a successful exit, etc.). These option rights are similar to a bonus awarded in the event that the target is achieved. If the employment relationship ends before the achievement of the target, the option rights expire before they are legally earned.

Cliff provisions

There is no need for action in the case of what are known as “cliff provisions”, provided that these are structured in such a way that option rights only arise and are acquired after a certain period of time (for example, after 12 or 24 months). The usual cliff period up to now has been 12 months. If the employee leaves the company before, they do not acquire any option rights at all. Such provisions should continue to be permissible. In this respect, there is therefore still room for manoeuvre. In future, however, care should be taken to ensure that cliff provisions are structured in such a way that exceeding the cliff is the prerequisite for an entitlement to option rights to arise and not in such a way that not exceeding the cliff results in previously granted option rights being forfeited.

Accordingly, employees could be offered the prospect of being granted VSOPs after two years of service which are subject to a two-year vesting period. This means that an entitlement to VSOPs only arises once employees have been with the company for more than two years. If employees leave the company before having worked there for more than two years, they would not be entitled to any option rights, as VSOPs have not yet been allocated at this point in time.

Effects on other types of incentive schemes

The significance of the Federal Labour Court’s decision is not limited to VSOPs but generally also affects other forms of additional compensation, such as stock options, hurdle shares or equity grants in accordance with section 19a of the German Income Tax Act (Einkommensteuergesetz – EStG). However, the decisive factor is the specific contractual structure. Only if (i) the compensation constitutes remuneration for work performed (and not a reward for loyalty to the company), and (ii) the exemption under section 310(4), first sentence of the German Civil Code, which excludes the application of reviews of general terms and conditions in corporate law contracts, does not apply, can it be assumed that the new case law also applies to other schemes. However, both requirements will regularly be met. It is therefore crucial to carefully examine how contracts structured.

Caution when using English-language terms

The Federal Labour Court’s decision also makes it clear that English terms such as “vested” or “forfeited” do not automatically lead to a lack of transparency and thus to the invalidity of the provision. However, the terms must be sufficiently understandable. It is therefore advisable, at a minimum, to provide a translation or even a definition (e.g. in brackets) for important legal terms in an English-language (virtual) stock option plan governed by German law. However, this is already common practice in many cases.

Conclusion

With its new case law, the Federal Labour Court is making it more difficult for companies to use a tried-and-tested, easy-to-use and widely accepted instrument for incentivising employees. From the perspective of start-ups, this decision is questionable as it ignores the requirements of business practice and the interests of those involved. Typically, not all employees benefit from such schemes, but precisely those employees who are not dependent on these “remuneration components”. In addition, the success of a start-up and therefore also a successful exit event is characterised by a particular degree of uncertainty, meaning that VSOPs are not equivalent to a performance bonus and do not represent a sufficiently reliable remuneration component.

Even if the Federal Labour Court’s change in case law is not convincing as a result, it should nevertheless be taken into account in corporate and consulting practice and forces those involved to carefully review common VSOP structures and similar schemes for employees (e.g. share options). For companies, this means above all that forfeiture clauses due to resignation and short forfeiture periods are not legally sustainable. If you revise your existing schemes now in a legally compliant manner, you will avoid conflicts later on and at the same time ensure the long-term effects of employee participation on retention and motivation. We will be happy to help you design and adapt your VSOP structures and similar schemes to ensure that they are legally compliant. Please feel free to contact us.