Variable Remuneration - Compensation if Targets are Set Too Late

If the target for achieving variable remuneration is set at such a late stage that the incentive function can no longer be fulfilled, the employee is generally entitled to a payment equal to the amount of the bonus if 100 % of the target is achieved.

Cologne Higher Labour Court, 6 February 2024 (Ref.: 4 Sa 390/23)

Compensation: Employer Must Pay the Full Bonus Amount

The parties are in dispute about bonus payment claims due to late setting of targets. The employee's remuneration provided for a fixed and a variable component. The employer adjusted the variable remuneration component in a works agreement at the beginning of 2019 in such a way that the targets for the employee's annual variable remuneration had to be set by 1 March 2019. However, the employer did not set the targets until October 2019.

The Cologne Higher Labour Court ruled that this was too late and awarded the employee a claim for compensation in the amount of the bonus in the event of 100 % target achievement in accordance with Sec. 280 para. 1 and 3, 283, 252 German Civil Code (“BGB”). The employer must inform the employee of the targets for the achievement of variable remuneration at a time within the relevant financial year when it can still fulfil its incentive function. If the target is set at a time when it can no longer fulfil its function, the target is deemed not to have been set at all.

Mutual Target Agreements and Unilateral Target Setting

The employer was obliged to unilaterally set the targets for the employee by 1 March 2019. In contrast to target agreements, such targets are set solely by the employer by way of a unilateral right to determine performance within the meaning of Sec. 315 para. 1 BGB.
According to the case law of the Federal Labour Court, the conclusion of a target agreement becomes impossible within the meaning of Sec. 275 BGB at the latest after the expiry of the target period. The Federal Labour Court has not yet ruled on what applies if the employer is obliged to unilaterally set targets but does not fulfil this obligation within the target period and whether the impossibility of setting targets, which justifies a claim for compensation, can occur before the expiry of the target period.

In line with prevailing case law of the Higher Labour Courts, the Cologne Higher Labour Court sees no difference between the culpable failure to conclude a target agreement and the employer's failure to unilaterally set targets. In both cases, the employer is generally liable for compensation after the expiry of the target period. In the case of unilateral target setting, the only peculiarity is that contributory negligence on the part of the employee is excluded. The Cologne Higher Labour Court has now ruled in relation to a unilateral target setting that it may become impossible to set targets even during the current financial year. It can be assumed that this should also apply in the case of a mutual target agreement.

When is it Too Late to Set the Targets?

The Cologne Higher Labour Court requires that targets can still provide an incentive for the employee, otherwise the targets are deemed not to have been set and the employer must pay the full bonus amount.

The agreement or setting of targets is based on the idea of increasing performance and motivation. To this end, the employee must already be aware of the relevant targets when carrying out their work. If targets are set too late, this incentive function can no longer be fulfilled, as the employee no longer has sufficient time to work effectively towards the fulfilment of the specified targets. If a sufficient increase in the employee's performance and motivation can no longer be achieved in terms of time, then the setting of targets is "pointless".
According to the Cologne Higher Labour Court there is no longer any possibility that the incentive function can still be fulfilled after more than three-quarters of the financial year have elapsed. Others in the literature are of the opinion that the expiry of more than half of the target period is sufficient for targets to no longer be set effectively.

No Other Assessment Regarding to Company-Related Targets

Although the Cologne Higher Labour Court recognises that an employee has less influence on the fulfilment of company-related targets than on personal targets, employees in management positions can certainly influence a company's financial figures. Any other view would also take away the justification for setting company-related targets as the subject of variable remuneration.

The Federal Labour Court also does not necessarily differentiate between personal and company-related targets with regard to the idea of motivation and incentive function.

Amount of the Claim for Compensation

The damages to be compensated include a lost bonus payment as it is a lost profit. In principle, the amount is to be calculated on the basis of 100 % target achievement, unless there are special circumstances that justify a different assumption. The latter could be the case if the employee was unable to achieve the specified targets in previous years.

The Cologne Higher Labour Court rejects a subsequent judicial determination of targets, as the purpose of the target, namely to create a performance incentive, can no longer be achieved retrospectively.

Practical Note

Partly in continuation of previous case law of other labour courts, the Cologne Higher Labour Court has ruled on two issues that have not yet been clarified by the Federal Labour Court yet. Employers shall set targets for variable renumeration of their employees as early as possible and within the agreed period, if applicable, and verifiably document this. If targets are not set or are set too late, the employer is generally obliged to pay compensation in the amount of the full variable remuneration.
The appeal of this case was authorised. It therefore remains to be seen whether the Federal Labour Court will have the opportunity to create clarity on how to deal with too late setting of targets and to eliminate any remaining uncertainties by means of divergent case law of the labour courts.

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