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Employers’ capital option rights in regards to occupational benefits

Current BAG decisions from 17.01.2023

On January 17, 2023, the German Federal Labor Court (Bundesarbeitsgericht, BAG) dealt with employers’ capital option rights in two rulings when paying out company benefits. Until now, a tried and tested means of limiting risk on the employer side was the choice of a lump-sum payment. From now on, this will be significantly restricted in its application.

Legal classification: substitution power, not a choice obligation

The following clause was agreed on: “The employer reserves the right to pay a one-time lump-sum settlement instead of a current pension.” In both decisions, the BAG assumed that no elective debt pursuant to Section 262 of the German Civil Code (BGB) had been agreed to, but rather a power of substitution. Both pension commitments were subject to general terms and conditions review.

Insufficient capital amount makes capitalization unreasonable

In the first case, the pension commitment was made via a cushion-financed support fund. The amount of the lump-sum payment was to be 10 times the pensioner’s annual pension in accordance with the tax regulations of the support fund. The BAG judged the lump-sum payment in this amount to be not equal in value to the promised pension. The lump-sum payment was therefore unreasonable for the company pensioner within the meaning of Section 308 No. 4 BGB. The company pensioner will now receive a lifelong retirement pension.

Equal value capitalization possible in principle, but additional exercise of equitable discretion

In the second case, a direct insurance was made. It is noteworthy and at the same time positive for employers that the BAG in this case apparently considers the present value pursuant to Section 6a EStG to be a conversion method of equal value from pension to lump-sum benefit. This was unexpected, as the Section 6a EStG present value is determined using 6% actuarial interest and without taking into account any pension trend. It does not reflect – unlike the HGB present value, for example – the actual value of the obligation.

In addition to the equal value, in the opinion of the BAG, the exercise of the lump-sum option by the employer must be in accordance with equitable discretion (Section 315 (1) BGB). To this end, the interests of the employer and the company pensioner are weighed up. In particular, the employer’s interest in limiting its risks and reducing administrative expenses must be weighed. On the other hand, the interest of the company pensioner in lifelong protection must be taken into account. As the lower court (LAG Hamm) had not made any findings on the mutual interests, the BAG referred the legal dispute back to it.

Conclusion: More legal uncertainty when exercising capital options

In the future, the exercise and structuring of capital option rights (right of replacement) will be more difficult. This is due to the requirement of equal value and the balancing of the interests of the employer and the company pensioner. The employer’s interests in capitalization must outweigh the interests of the company pensioner in terms of lifelong provision. This increases the uncertainty as to whether a lump-sum option agreed at the outset can actually be exercised shortly before the benefits fall due.

In addition, it makes little difference whether a lump-sum option is agreed on from the outset or whether the lump-sum payment is to be determined at a later date. In both cases, the interests of both parties must be weighed up using equitable discretion, and in the case of a retrospective determination, additional justification must be provided in accordance with the principles of protection of legitimate expectations and proportionality.

The pending decision of the Higher Labor Court of Hamm is expected to provide initial guidance on the question of whether the employer can replace the pension with a lump-sum payment and how a lump-sum option is to be structured.

We recommend checking pension commitments for unilateral lump-sum options on the part of the employer and, if necessary, adjusting them as best as possible with regard to equal value and equitable discretion. We will be happy to assist you in this regard.

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