There are many reasons why, in individual cases, the parties to an employment contract wish to part company or one party unilaterally terminates the employment relationship. One possible reason is the avoidance of dismissal proceedings, which entail risks for both parties. Alternatively, the parties may wish to quickly and smoothly settle their differences by dissolving the employment relationship. Another possible reason from the employee’s perspective is that he wishes to take up a new job before the end of his contractual notice period. As in Dutch law, a termination agreement presents a solution here.
A termination agreement is a bilateral agreement to terminate an employment contract, the content of which the parties can largely determine themselves, in accordance with the principle of freedom of contract. This also means that the party who has the legal and contractual rules on their side can decide for themselves on the content of the contract.
Advantages of a termination agreement as opposed to dismissal
The parties to a termination agreement can freely decide the date on which the employment relationship will end, legal or contractual notice periods do not apply and can be extended or reduced. One advantage for the employer is that it avoids the risks of an action against unfair dismissal. These risks arise from the requirements that dismissal must satisfy under employment protection legislation (for more on this, see my article on dismissal legislation in Germany), the Works Constitution Act or other laws that govern special employment protection for employees. Often, the employee receives a settlement as part of a termination agreement, to which he would not have had any legal entitlement in the event of dismissal. However, in proceedings in labour courts, such settlements are regularly awarded. It should be pointed out in this context that, in many cases, senior executives are also subject to the provisions of employment protection legislation and, as such, enjoy protection against unfair dismissal, a fact which improves the employee’s negotiating position in a termination agreement. This is not the case with managing directors, who are excluded from protection under employment protection legislation. However, if a managing director’s employment relationship is terminated, a termination agreement may be wise in order to agree arrangements regarding the remaining term of the contract and mutual financial and other claims.
The biggest drawback is the blocking period that frequently applies for an employee when a termination agreement is concluded. A termination agreement is mutually agreed. The employment agency regards it as the employee’s consent to termination of the employment relationship, meaning that – as is the case if the employee gives notice – a blocking period of at least 12 weeks commences with respect to unemployment benefit. The imposition of a blocking period in the case of a termination agreement can only be avoided in exceptional cases, i.e. if the employer has held out the serious prospect of a compulsory redundancy before the termination agreement is concluded and if the employee receives a settlement in the termination agreement of at least 0.25 to 0.5 month’s salary per year of service and the applicable notice period was observed. Moreover, as a result of the termination agreement, the employee waives any additional legal protection against unfair dismissal to which he is entitled. This includes protection under employment protection legislation, special employment protection for pregnant women or the severely disabled, and protection for members of a Works Council. Furthermore, the Works Council does not have to be consulted about a termination agreement.
Content and form of the termination agreement
A termination agreement must be agreed in writing, i.e. it must be recorded in a written document and both parties must personally sign it. The content can be freely negotiated by the parties. Normally, a termination agreement includes the date of termination of the employment relationship, the salary claims remaining to be paid by the employer (salary, reimbursement of expenses, management bonuses or other bonuses, Christmas bonus, etc.), any payments to be made by the employee to the employer (salary or commission advances, loans, etc.), a list of the items to be returned to the employer by the employee (car, keys, laptop, telephone, documents, etc.), the arrangements regarding outstanding holiday and/or leave of absence, requirements with respect to the reference to be provided by the employer, any settlement payment agreed and a settlement clause. If a settlement payment is agreed, it is important to state in the agreement that the employment relationship is being terminated at the employer’s behest or for operational reasons. This is because settlement payments on account of dissolution initiated by the employer are tax-exempt up to certain maximum amounts set out in Section 3(9) of the Income Tax Act. The portion of the settlement payment in excess of those maximum amounts is, in principle, subject to reduced taxation, provided it satisfies certain requirements of the Income Tax Act.
In general, German employment legislation does not provide for any entitlement on the employee’s part to payment of a settlement. Therefore, there is no fixed rule on the amount of a settlement payment as part of a termination agreement. The often-applied rule of thumb is: 0.5-month salary per year of employment; however, in the case of large international groups, for example, this may be 1.0 month’s salary per year of employment or, in the case of small or financially weak employers, just 0.25-month salary per year of employment. However, the circumstances of each individual case must always be taken into account (age, illness, employee’s performance, strength of the dismissal protection afforded to the employee, how quickly the employee will find a new job, compensation for other disputed financial claims by means of a settlement, etc.) The total package is the key factor.
What distinguishes a termination agreement
The termination agreement is different to a wind-up agreement, in which the employer has already terminated the relationship and the parties agree in the wind-up agreement the winding-up of the employment relationship that has already ended. As such, it is not about the termination, but its consequences. If the employer fails to perform, the employee cannot directly enforce his claims under a termination or wind-up agreement, i.e. cannot directly instruct a bailiff to enforce the claim. To do this, the employee would first have to conduct court proceedings to obtain an enforcement instrument. This is different to a judicial settlement. The ending of an employment relationship following termination by the employer and the bringing of legal action by the employee may also be dealt with by means of a judicial settlement. A judicial settlement is directly enforceable, i.e. if the employer fails to perform, the employee can directly instruct the bailiff to recover/enforce his claim (e.g. to payment of the settlement payment).