Mutual Termination Agreement and Severance Pay:
Your Guide to Consensual Employment Termination

Introduction: Why Mutual Termination Agreements Are Becoming Increasingly Important

In today’s working world, both employers and employees face the challenge of terminating employment relationships flexibly and fairly. While dismissals are often associated with uncertainties and legal risks, mutual termination agreements offer a consensual alternative that can benefit both parties.

A mutual termination agreement (also called a severance agreement) is a civil law agreement between employer and employee that consensually terminates the employment relationship at a specific point in time. Unlike dismissal, which is declared unilaterally, a mutual termination agreement requires the consent of both parties.

The relevance of mutual termination agreements has increased significantly in recent years. Companies use them to implement staff reductions in a socially acceptable manner without having to risk lengthy unfair dismissal proceedings. Employees appreciate the opportunity to negotiate better conditions than with a dismissal and to draw a clear line under the employment relationship.

Legal Foundations of Mutual Termination Agreements

Legal Regulations and Formal Requirements

The mutual termination agreement is not explicitly regulated in the German Civil Code (BGB) but arises from the general principles of contract law. According to Section 623 BGB, a mutual termination agreement that terminates an employment relationship must be concluded in writing. Section 623 BGB states: „The termination of employment relationships by dismissal or dissolution agreement requires written form for their validity; electronic form is excluded.“

A mutual termination agreement is only valid if concluded in writing. This means that both employer and employee must sign the document by hand. An oral agreement, email exchange, or electronic signature is not sufficient – the mutual termination agreement would be invalid and the employment relationship would not be terminated.

The written form serves to protect both parties, creates legal certainty, and prevents hasty decisions.

Freedom of Contract and Its Limits

The principle of freedom of contract generally applies to mutual termination agreements. This means that employers and employees can largely freely design the modalities of termination. They can, for example, agree on the termination date, the amount of severance pay, provisions for release from duties, or confidentiality obligations.

However, this freedom has limits. Agreements that violate mandatory legal provisions or are immoral are invalid. Mutual termination agreements must also not be to the detriment of third parties, such as social insurance carriers.

Special Features for Special Employee Groups

Certain employee groups enjoy special protection that must also be observed in mutual termination agreements. Pregnant women, employees on parental leave, severely disabled persons, and works council members can generally conclude mutual termination agreements, but the special protective provisions should be considered.

For pregnant women and employees on parental leave, the mutual termination agreement should end no earlier than after the expiry of maternity protection or parental leave to avoid social law disadvantages. For severely disabled persons, it should be noted that they may be considered difficult to place by the employment agency.

Severance Pay: Entitlement, Amount, and Negotiation Strategy

No Legal Entitlement to Severance Pay

A widespread misconception is the assumption that employees automatically have a right to severance pay upon termination of their employment relationship. This is generally not the case. Neither employment law nor other laws provide for a general severance pay entitlement.

However, severance pay can arise from various sources: from collective agreements, works agreements, social plans, or indeed from free agreement in a mutual termination agreement. In practice, many employers nevertheless pay severance, as this gives them legal certainty and avoids the risk of unfair dismissal proceedings.

Calculation of Severance Pay Amount

Although there is no legal obligation, certain rules of thumb have become established in practice. The most common calculation basis is the formula „half a month’s gross salary per year of employment.“ This formula is also used in Section 1a of the Protection Against Dismissal Act for certain operational dismissals.

Example calculation:

• Gross monthly salary: €4,000
• Length of employment: 8 years
• Severance pay: €4,000 ÷ 2 × 8 = €16,000

However, this formula is only a guideline. The actual severance pay amount depends on many factors, such as the negotiating position of both parties, the prospects of success of an unfair dismissal claim, the company’s economic situation, and individual circumstances.

Factors Influencing Severance Pay Amount

Strength of the employee’s negotiating position:

• Protection against dismissal (company size, length of employment)
• Weak dismissal grounds by the employer
• Special knowledge or positions
• Non-compete clauses

Employer’s interest in an amicable solution:

• Avoidance of unfair dismissal proceedings
• Time savings
• Reputation and company climate
• Planning security

Economic factors:

• Company’s financial situation
• Costs of alternative dismissal
• Employee’s value to the company

Negotiation Strategy for Employees

Successful negotiation requires thorough preparation. Employees should first realistically assess their negotiating position. The following questions play a role:

• How strong is my protection against dismissal?
• What arguments could my employer have for dismissal?
• How long would unfair dismissal proceedings take?
• What would be the costs and risks for both sides?

Professional advice can help realistically assess one’s own chances and develop an appropriate negotiation strategy.

Advantages and Disadvantages for Employees

Advantages of Mutual Termination Agreements

Planning security and control: Employees know exactly when their employment relationship ends and can plan accordingly. They do not have to fear that a dismissal will be pronounced against which they must defend themselves.

Negotiation opportunities: Unlike with dismissal, employees can help shape the conditions of termination. In addition to severance pay, other aspects can also be negotiated, such as release from duties, references, confidentiality, or non-compete agreements.

Avoiding negative publicity: A mutual termination agreement is often handled more discreetly than a dismissal, which can be image-preserving for both sides.

Flexibility in termination timing: The parties can freely choose the termination date without being bound by notice periods. This can be advantageous for employees who already have a new job in prospect.

Disadvantages and Risks

Suspension period for unemployment benefits: The biggest disadvantage of a mutual termination agreement is the possible suspension period for unemployment benefits of up to twelve weeks. This occurs when the employment agency assumes that the employee has caused their unemployment themselves.

Loss of protection against dismissal: By signing a mutual termination agreement, the employee waives protection against dismissal. Later challenge is only possible under very limited conditions.

Pressure for quick decisions: Employers often set deadlines for decisions about mutual termination agreements. This pressure situation can lead to hasty decisions.

Tax disadvantages: Severance payments are generally subject to income tax, although they can be taxed at a reduced rate under certain conditions.

Impact on Unemployment Benefits

Understanding Suspension Period Regulations

The Federal Employment Agency imposes a suspension period of up to twelve weeks if an employee terminates their employment relationship without good cause or gives cause for dismissal through breach of contract. With a mutual termination agreement, the employment agency generally assumes that the employee has caused their unemployment themselves.

Avoiding the Suspension Period

A suspension period can be avoided if there is good cause for the mutual termination agreement. Good causes are:

Threatened dismissal: If the employer threatens dismissal for conduct or personal reasons that would actually be lawful, there is good cause.

Observance of notice period: The mutual termination agreement should not end at an earlier date than would have been possible with ordinary dismissal.

Reasonable severance pay: The severance pay should be in reasonable proportion to the length of employment (guideline: 0.25 to 0.5 gross monthly salaries per year of employment).

Offsetting of Severance Pay

Severance pay is generally not offset against unemployment benefits. An exception only applies if the mutual termination agreement shortens the ordinary notice period. In this case, the severance pay is proportionally offset against the time by which the employment relationship was shortened.

Design and Negotiation of Mutual Termination Agreements

Essential Contract Components

A comprehensive mutual termination agreement should regulate the following points:

Termination date: Clear determination of when the employment relationship ends. It should be considered whether vacation still needs to be taken or overtime needs to be reduced.

Severance pay: Amount, due date, and tax treatment of severance pay. The regulation of what happens in case of premature departure is also important.

Release from duties: Many mutual termination agreements contain a release from duties for the time until the termination date. It should be clarified whether the release is revocable and how vacation and overtime are handled.

Reference: The type and content of the employment reference should be bindingly determined. Often a reference draft is already attached as an annex.

Confidentiality: Regulations on confidentiality about the contents of the mutual termination agreement and company matters.

Return of documents: Obligation to return company documents, business documents, and work materials.

Negotiation Tactics and Strategies

Preparation is crucial: A thorough analysis of one’s own situation and negotiating position is the key to success. Legal, financial, and personal aspects should be considered.

Demand thinking time: Don’t let yourself be pressured. A reputable employer will grant reasonable thinking time. Use this time for professional advice.

Consider all aspects: The negotiation should not only focus on the severance pay amount. Other aspects such as release from duties, references, or confidentiality can also be valuable.

Show willingness to compromise: Successful negotiations require willingness to compromise from both sides. Consider in advance which points are indispensable for you and where you can make concessions.

Tax Aspects of Severance Pay

Taxation of Severance Pay

Severance payments are generally subject to income tax and are considered taxable employment income. However, they are not treated as ongoing employment income but as other benefits.

One-Fifth Rule

Under certain conditions, the so-called one-fifth rule according to Section 34 EStG can be applied. This rule is intended to mitigate tax progression since the severance pay is paid in one year but economically affects several years.

Requirements for the one-fifth rule:

• The severance pay is compensation for lost income
• The severance pay is received in one calendar year
• The severance pay is higher than the employment income of the calendar year

Calculation: The tax is calculated as if the severance pay were distributed over five years. This can result in considerable tax savings.

Social Insurance

Severance payments are generally free of social insurance contributions since they do not constitute continued wage payment. An exception only applies if the severance pay is to be qualified as hidden wages.

International Aspects and Special Features

Mutual Termination Agreements in International Employment Relationships

Special challenges can arise in employment relationships with international connections. This particularly applies to:

Secondments: Employees seconded abroad by German companies are often still subject to German employment law. When designing mutual termination agreements, however, the provisions of the country of assignment must also be observed.

International professionals: For employees with Blue Cards or other residence permits, residence law consequences may arise. The loss of employment can have effects on residence status.

Cross-border taxation: In cross-border employment relationships, complex tax issues can arise. Double taxation agreements and the provisions of various legal systems must be considered.

Multilingual Contracts

In internationally active companies, mutual termination agreements are often created in multiple languages. It must be noted which language version is decisive in case of dispute. A clause that clearly determines which language version takes precedence is recommended.

Practical Tips for Those Affected

Checklist Before Contract Conclusion

Legal review:

• Have the contract draft reviewed by a specialist lawyer
• Check your protection against dismissal rights
• Assess the prospects of success of an unfair dismissal claim

Financial analysis:

• Calculate the effects on unemployment benefits
• Consider tax aspects
• Plan your financial bridging

Time planning:

• Use reasonable thinking time
• Coordinate the transition to the new employer
• Plan any qualification measures

Avoiding Common Mistakes

Hasty decisions: Don’t let yourself be pressured. A reputable employer will grant reasonable thinking time.

Insufficient advice: The complexity of mutual termination agreements often makes professional advice indispensable.

Lack of documentation: Document all negotiation discussions and carefully preserve all documents.

Neglecting consequences: Consider all effects, not just the immediate financial aspects.

Current Developments in Employment Law

Digitalization and Home Office

The increasing digitalization and spread of home office arrangements also have effects on mutual termination agreements. New questions arise, for example, regarding the return of work materials or the deletion of data on private devices.

European Developments

The European Union is working on a directive on transparent and predictable working conditions. This could also have effects on the design of mutual termination agreements, particularly with regard to information obligations and minimum standards.

Social Change

The transformation of the working world, changed employee expectations, and new forms of cooperation also influence the design of mutual termination agreements. Topics such as work-life balance, sustainability, and social responsibility are gaining importance.

Recommendations for Action

For Employees

1. Inform yourself comprehensively about your rights and possibilities
2. Seek professional advice for complex situations
3. Check alternatives to mutual termination agreements
4. Negotiate not just the severance pay but all aspects
5. Consider the long-term consequences of your decision

For Employers

1. Create transparent processes for negotiating mutual termination agreements
2. Observe equal treatment of all employees
3. Document negotiations carefully
4. Consider employment law special features for different employee groups
5. Plan sufficient time for negotiations

If you find yourself in a situation where your employer offers you a mutual termination agreement or you are considering consensual termination yourself, you should not act hastily. Well-founded advice can help you find the best solution for your individual situation.

Conclusion

Mutual termination agreements are an important instrument for the consensual termination of employment relationships. They offer advantages to both sides but also involve risks. Careful preparation, professional advice, and strategic negotiation are crucial for a satisfactory result.

The complexity of employment law and the individual circumstances of each case make a blanket assessment impossible. Each case requires individual analysis and strategy. Not only the immediate financial aspects should be considered, but also the long-term effects on the professional career and personal situation.

For questions about mutual termination agreements and severance pay, we are happy to be at your disposal. With our many years of experience in advising employees and employers, we can help you find the best solution for your situation.