Change of direction: The time of "copy & paste" ESOPs at start-ups is over

A recent ruling by the Federal Labour Court (BAG) has led to an acute need for action in the venture capital and start-up sector. Particularly affected is the common practice of incentivising employees through virtual options as part of ESOP programmes (Employee Stock Option Provisions) or VSOP programmes (Virtual Stock Option Plans). The reasons for the judgement that have now been published show that Companies must design new employee participation programmes differently and rethink existing models.

Facts of the case

The plaintiff was employed by the defendant from 1 April 2018 to 31 August 2020. In 2019, the defendant offered the plaintiff the allocation of 23 virtual option rights, which the plaintiff accepted. The employment relationship ended due to termination with notice. At the time of the plaintiff's departure, 31.25% of the plaintiff's option rights were vested (i.e. saved up). The vesting period was 4 years. The exercise of the vested virtual options gives rise to a payment claim against the defendant, provided that a vesting period has previously expired and an exercise event (usually the sale of the company or realisation of profits) has occurred. The dispute essentially concerned two forfeiture mechanisms in the defendant's ESOP programme. One clause regulated the immediate forfeiture of options that were already exercisable (i.e. in the event of an exercise event) if the employment relationship ends due to, among other things, the beneficiary's own termination of employment. According to a further clause, vested options expire in stages within two years (i.e. half as long as the vesting period in favour of the beneficiary) after termination of the employment relationship. In June 2022, the plaintiff asserted the continued existence of his virtual options, which the defendant rejected. The ArbG and LAG dismissed the claim, the BAG now had to decide on the appeal and overturned the judgement of the LAG.

Important aspects of the judgement for the venture capital market

The BAG ruled that a provision in the ESOP, according to which already vested virtual options expire if the employment relationship ends, for example, due to the employee's own termination, does not stand up to a general terms and conditions review, as it unreasonably disadvantages the employee in accordance with Section 307 BGB. Such a provision is void without substitution in accordance with Section 306 BGB.

Vested virtual options and the associated opportunity to participate in the economic success of the company also represent consideration for the work performed during the vesting period. This applies regardless of whether the grant letter or the ESOP itself expressly states that the virtual options are granted as an incentive for the future and not for past performance. The BAG justifies this in particular with an ESOP clause according to which the vesting period is suspended if and as long as the employee is not entitled to remuneration. A subsequent withdrawal of these "vested" rights contradicts the principle of the exchange relationship between work and remuneration (Section 611a BGB).

The ESOP clause, which provides for the immediate forfeiture of vested options due to termination of the employment relationship, also leads to an excessive impediment to the employee's right to terminate the employment contract, which is protected by Article 12 (1) GG. This is because the option holder would then not be allowed to exercise his right of termination before an uncertain exercise event (e.g. sale or IPO) or the maximum period of 15 years contained in the ESOP programme in order to avoid the expiry of his already vested option rights. The employee has already earned this participation opportunity through the work performed.

The other disputed ESOP clause, according to which vested options expire successively after termination of the employment relationship, also unreasonably disadvantages the departing employee in accordance with Section 307 BGB. The successive forfeiture must not be unreasonably disproportionate to the duration of the vesting period spent in the employment relationship. The BAG affirms this here, as the virtual options were cancelled (de-vesting) twice as quickly as they were previously acquired. With this wording, however, the BAG allows the assumption that a clause which provides for a gradual expiry corresponding to the original vesting period could stand up to scrutiny by the courts.

Practical advice

As a result of the BAG's new requirements, the use of previously customary provisions on forfeiture and de-vesting in ESOP programmes is no longer permissible. Existing programmes must now be reviewed as quickly as possible and adapted to the BAG's amended case law. Customised, legally secure solutions are required here. Particular caution is required if virtual options have been reissued after the departure of previous beneficiaries and, taking into account the BAG's case law, may now give rise to multiple claims by different beneficiaries. This applies all the more if an ESOP programme has already been fully exhausted (with re-issued options).

It is also crucial for practice that the BAG has qualified the ESOP clauses as GTC and subjected their effectiveness to a GTC review. The previously common practice of linking the expiry of vested options to the employee's departure is therefore no longer tenable if such clauses are used in the context of GTCs. However, the BAG leaves open whether individually negotiated agreements can continue to provide for stricter forfeiture provisions. However, justifying individual provisions in the context of ESOP programmes, which are usually broadly applicable, is likely to be very challenging to say the least.

A distinction will also have to be made between vested and unvested options. The decision makes it clear that only unvested options may (still) expire without further ado upon termination of the employment relationship. This must also be taken into account in particular in the context of the cap table of start-ups - there is likely to be a need for correction here in many cases.

In addition, greater attention must be paid to appropriate expiry periods in future. With its decision, the BAG has clearly rejected accelerated de-vesting. However, this at least allows the reverse conclusion to be drawn as a presumption that an expiry period corresponding to the vesting period can be provided for options that have already vested. 

Finally, it should be noted that the judgement may also have an impact on beneficiaries who have already left the company. Existing employee participation programmes with ineffective forfeiture clauses harbour the risk that beneficiaries who have already left the company will be able to maintain their claims and will now increasingly approach their former employers with corresponding claims.

(BAG judgement of 19 March 2025 - 10 AZR 67/24)