Germany: Recent Federal Labor Court Decisions Regarding Employee Stock Option Plans 10 November 2008

Germany: Recent Federal Labor Court Decisions Regarding Employee Stock Option Plans  10 November 2008
Article by Friederike Göbbels

Employee stock option plans have long served as a tool to
strengthen the connection between employer and employees while
allowing the employees to benefit from the company's success.
The employer typically grants stock options directly to the
employees; however, options may also be granted by an affiliated
company (in particular, the parent corporation). Which entity is
ultimately responsible for performing the obligations associated
with the stock options vis-à-vis the employee depends on
which entity granted the options.

2003 Federal Labor Court Decision Serves as Precedent

The Federal Labor Court held in 2003 that stock options do not
constitute a facet of the employment relationship if the parent
corporation rather than the direct employer granted the options. If
the parent company of the employer granted the stock options, then
the employee can make claims arising from those options only
against the parent corporation.

Also in 2003, the Federal Labor Court opined as to what happens
to stock options granted by the parent corporation if the
nongranting employer is involved in a "transfer of
undertaking" (e.g. , the acquisition of a business by way of
an asset deal). Jones Day represented the buyer in that case, not
only with respect to the acquisition itself, but also in the
ensuing litigation concerning the stock options. Specifically, the
German subsidiary of a Finnish corporation had been acquired. An
employee whose employment relationship had transferred to the
acquiring entity subsequently filed an action against his new
employer, arguing that the stock options granted by the Finnish
parent corporation must now be granted by his present employer or,
at the very least, that he should be compensated for the loss of
his options. The plaintiff employee lost his case at the
trial-court level, as well as in the court of appeals and the
Federal Labor Court. Both the court of appeals and the Federal
Labor Court held that the stock options, as granted by the parent
corporation, were separate and distinct from the employment
relationship. Accordingly, the stock options were not subject to
the "transfer of undertaking" rules, which state that all
aspects of an employment relationship are automatically transferred
from the seller (the former employer) to the buyer (the new
employer). Stock options granted by an affiliated company are not
deemed to be an aspect of the employment relationship.

Two 2008 Federal Labor Court Decisions

The Federal Labor Court specifically confirmed this 2003
decision in a January 2008 decision. The court added, however, that
even when an affiliated company grants the stock options, there are
certain circumstances under which an employee may make a claim
against the (nongranting) employer. If the employer and employee
enter into an agreement whereby the employer is involved with the
affiliated company's stock option program, the employer is also
obligated to ensure that the employee's rights are observed. It
may be that the employer's obligations are expressly set forth
in a written agreement; it may also be that the employer's
obligations arise as a result of the employer's actions.
Because the latter was a distinct possibility in the January 2008
case, the Federal Labor Court remanded the matter to the court of
appeals. There was some evidence that the (nongranting) employer,
on several occasions, had discussed the parent corporation's
stock options with the employee during the hiring process and had
described the stock options as an additional aspect of the
employee's compensation. As a result, it was quite possible
that both the parent corporation and the employer had become
responsible for ensuring that the employee could participate in the
stock option program. Whether the court of appeals will reach this
conclusion remains to be seen. One point, however, can already be
made with certainty: Employers need to be cautious about discussing
an affiliated corporation's stock option plan with employees,
during both the hiring process and the employment relationship. If
it is subsequently determined that the (nongranting) employer also
promised the employee that he could participate in the stock option
program, and the terms of the stock option are not satisfied, the
employee may be able to make a claim against the employer that
includes monetary damages.

In the Federal Labor Court's decision of May 28, 2008, there
was no dispute that the employer—without the parent
corporation's involvement—had promised to obtain the
stock options for the employee for a certain price, even though the
options concerned stock in the parent corporation. The dispute
before the court was not whether the employer had agreed to become
involved with the parent corporation's stock option program but
whether this obligation ceased to exist once the employment
relationship ended.

Stock Options as a Financial Risk

Stock option plans often include a clause that requires a
certain connection by the employee to the employer through a
specific date. If this condition is not satisfied— e.g.,
if the employer terminates the employee—the employee may
not exercise the stock options. The Federal Labor Court has
explicitly held that case law concerning benefits, as it has
evolved over the years, particularly in relation to bonus payments,
is not to be applied on its face to stock option plans. This is
because stock options differ fundamentally from conventional
benefits, primarily with respect to the risks involved.

As has become abundantly clear over the last few months, an
employee cannot assume that stock options will retain their value
over time, even when both the employee and the company perform
well. Factors that neither the employee nor the company can
influence may also play a role, e.g., the state of the economy and
interest-rate policies. In extreme cases, as mentioned by the
Federal Labor Court, "the stock options may lose their entire
value within the course of one day." A mere possibility of
financial gain should not be compared to more conventional and less
risky employee benefits, at least from an employment-law
perspective. It is for this reason that the Federal Labor Court has
permitted relatively long vesting periods before an employee may
exercise his stock options. A two-year vesting period for the
initial vesting of stock options is expressly required under
Germany's Stock Corporation Act as long as it concerns purely
the granting of stock options to employees or management.
Conversely, German law does not prescribe a maximum vesting period.
Without taking a formal stance on this issue, the Federal Labor
Court did say, however, that a vesting period of up to five years
is reasonable.

Because of the inherent financial risks associated with stock
options, the Federal Labor Court agreed that an employee's
right to exercise his stock options may lapse once the employment
relationship ends. This is the case not only if the employment
relationship ends during the vesting period, but also if the
vesting period has already expired. The Federal Labor Court added
that it recognizes that this may lead to a financial burden on
employees. Regardless, it is not an unreasonable burden, because
the employee merely lost an opportunity to reap a financial
windfall; he did not take a direct financial hit.

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