Bonus Payment Without a Performance Agreement

Variable compensation is an important component of many employment contracts and serves as an incentive for employees to achieve above-average performance. In addition to a fixed salary, companies often offer their employees bonuses, incentives, or other performance-based compensation models. These payments are typically tied to the achievement of specific goals—whether it’s an employee’s individual performance, a team’s success, or the attainment of company-wide metrics.

The key factor here is the nature of the goal-setting process: either the goals are unilaterally set by the employer or they are jointly established in a goal agreement. This distinction not only affects employee motivation but can also have implications under employment law —especially if no goal agreement has been reached.

In this article, we’ll examine the most important aspects of variable compensation, the different types of goals, the difference between goal-setting and a goal agreement, and what happens when goals are unclear or not defined at all.

1. What Is Variable Compensation?

An employment contract sets forth the main obligations of the employment relationship—the work to be performed and the compensation for that work. There are various models for compensating work performance. Compensation can be fixed. This refers to a monthly, fixed income that is independent of individual performance or the company’s success.

1.1 Fixed and Variable Compensation in Employment Contracts

In addition to the fixed salary, the employment contract may include other salary components that depend on the employee’s specific performance. These can include, for example, incentives, special payments, or bonuses that are paid upon meeting certain criteria and depend on the degree to which those criteria are met. These criteria may relate to individual performance, team goals, or the company’s success. In contrast to fixed salary components, these are also referred to as variable compensation.

If variable compensation components are agreed upon, the ratio between variable and fixed compensation components should be balanced. Otherwise, if the proportion of variable compensation is too high, the employer would be shifting the financial risk onto the employee. Furthermore, statutory and collective bargaining minimum wages must not be undercut by an excessively high variable compensation component. The ratio of fixed to variable compensation should be approximately 2/3 to 1/3.

1.2 Variable compensation is often a source of motivation for employees

Variable compensation systems are a common means of motivating employees and specifically steering their performance. By achieving certain targets, employees are encouraged to meet specific company goals or to continuously improve their personal performance.

Performance -based compensation motivates employees to deliver above-average performance. In particular, performance-oriented employees can see a direct link between their efforts and their financial rewards. Furthermore, variable compensation is regularly relevant in severance pay calculations because it ultimately constitutes regular compensation for work performed and must therefore be taken into account in such calculations.

2. How is variable compensation agreed upon?

Variable compensation must be agreed upon between the employee and the employer. There are various ways to do this. Traditionally, such an agreement is already included in the employment contract, which is signed by both parties to the contract.

However, a separate framework agreement can also be established for variable compensation, which governs only the variable compensation. The provisions governing variable compensation should specify the type of compensation sought (e.g., bonus or incentive), how the targets for earning the compensation are set, how these targets are to be evaluated, and the time period to which the agreed- upon targets apply (typically the calendar year).

This is because, in particular, the setting of the goals that the employee is expected to achieve within a specific period and the method of evaluating those goals are central provisions of variable compensation and the question of whether a bonus should be paid—provisions that sometimes lead to problems in practice. However, the more clearly the rights and obligations of the contracting parties are defined and the more precisely the entire process of variable compensation is described, the less legal uncertainty there is regarding the potential payment of the agreed-upon bonuses.

3. What types of targets are there?

For the company to pay out an agreed-upon bonus, predefined targets must be met. These may be targets that an individual employee must achieve. Such individual targets relate solely to the performance of a single employee, such as generating a specific amount of revenue or successfully implementing a project. For a team, however, team-based targets are also possible—targets that the entire team can achieve collectively as a unit, so that the bonus is awarded to the entire team. Examples include improving departmental performance or reducing the error rate in production.

3.1 Distinguishing Between Different Categories of Goals

Another distinguishing feature of goals is whether they are financial or non-financial in nature. Financial goals include, for example, increases in revenue, defined cost savings, or maximizing profit. Non-financial goals may involve, for example, improving quality, increasing customer satisfaction, or boosting the rate of innovation. Particularly with non-financial goals, it is essential to precisely define what goal is to be achieved and whether it is objectively measurable.

The distinction between quantitative and qualitative goals is also important in this context. Quantitative goals have clear and measurable targets (e.g., 15% revenue growth). However, when it comes to qualitative goals—such as improving leadership quality or increasing customer satisfaction—these are usually desirable but significantly more difficult to measure and, in some cases, highly subjective.

Here, too, it is important to ensure that the goals are objectively measurable, because the more clearly the goals are defined, the easier it will be later to assess whether the goal has been achieved and whether a bonus payment is due or not.

3.2 Goals Based on SMART Criteria

A well-formulated goal should meet the SMART criteria: It should be specific, measurable, attractive, realistic, and time-bound. This means:

• Specific: The goal must be clearly defined.
• Measurable: Success should be objectively verifiable.
• Attractive: The goal must be motivating.
• Realistic: The goal must be achievable.
• Time -bound: There must be a clear deadline for achieving the goal.

An example of a goal based on these criteria would be: “Increase revenue by 10% in the next fiscal year,” linked to a specific bonus. This goal is much more precise than a general statement such as “improve sales figures.” The absence

Of such a clear goal definition can lead to problems and misunderstandings among employees—especially when the payment of a bonus depends directly on achieving the goal and fails to materialize due to imprecise goals. As a result, the motivational effect of variable compensation is lost and, in extreme cases, can even backfire.

4. What is the difference between setting a target and agreeing on a target?

When variable compensation is agreed upon, the agreement should also specify how the goals are to be set. A distinction must be made between goal setting and goal agreement. Although both terms are used interchangeably, there are legal and substantive differences.

4.1 Target Setting – Unilateral Setting of Targets by the Employer

Setting a target means that the employer unilaterally determines the requirements the employee must meet to receive a bonus payment. This is particularly common in companies with clearly defined performance criteria or standardized bonus models. In this case, employees have no influence on how the goals are formulated but must adhere to the specified criteria. Since setting goals is a decision made solely by the employer, the goal may, under certain circumstances, be adjusted retroactively, provided nothing else has been agreed upon in the employment contract or the bonus regulations.

However, the employer must adhere to the goals already agreed upon in the employment contract as a framework and must not exceed its authority to issue instructions. The framework established by the employment contract, on the one hand, limits the employer’s discretion and, on the other hand, allows the labor court to review the targets. Since these goals are set without the participation of the When setting performance goals for employees, it is the employer’s responsibility to formulate them in a way that is clear, realistic, and understandable.

Classic examples of performance agreements include increasing revenue by a certain percentage, reducing costs, or meeting specified quality standards.

4.2 Goal Agreement—Goals Negotiated Between Employer and Employee

The term “goal agreement ” itself makes it clear that it must be an agreement. This means that the goal agreement cannot be set unilaterally by the employer. The goal agreement must therefore be developed through a dialogue between the employer and the employee. In particular, the employee’s individual skills, their position, and the company’s overall circumstances must be taken into account.

The goal agreement is not established unilaterally but through a negotiation process that typically takes place during annual performance reviews or goal-setting sessions. Goal agreements have the advantage of increasing employee motivation, as employees identify more strongly with the individually agreed-upon goals because they were actively involved in setting them. Since goal agreements are actively negotiated between employers and employees, they are generally more binding because they are based on mutual consensus.

Examples of goal-setting agreements include developing a new product within a specific timeframe, improving internal communication, or increasing customer satisfaction through specific measures.

The obligation to enter into a goal agreement rests with the employer. If the employer fails to do so or if no goal agreement is reached, the employer may be liable for damages.

4.3 Relevant Difference Between a Target and a Target Agreement

The difference between a target and a target agreement primarily has implications under employment law. The absence of a target can lead the employer to argue that they are not required to pay a bonus because performance is not measurable. If, on the other hand, a target agreement exists, the employee can argue that it was the employer’s responsibility to reach an agreement with them. If such an agreement was not reached, this may result in a bonus still being owed.

5. What happens if no target agreement was reached?

If the employment contract or a corresponding framework agreement provides for the conclusion of a target agreement between the employee and the employer, there is a contractual obligation to enter into such a target agreement. In this case, the employer cannot simply set the targets on its own (which would then constitute a target assignment), make them subject to a voluntary participation clause, or simply fail to enter into such a target agreement. The employer is bound by such a target agreement.

5.1 Goal Agreements Are More Complex Than Goal Setting

Employers should therefore only agree to target agreement clauses if they can ensure that they are able to conduct such a dialogue with their employees employees. If this effort is not feasible, employers should refrain from entering into target agreements, as setting targets unilaterally by the employer involves significantly less effort.

If such a target agreement is nevertheless culpably omitted, this constitutes a breach of an obligation under the employment contract. Since the employer is required to initiate the target agreement or the discussion process regarding it, the failure to enter into a target agreement generally falls on the employer. If the employer cannot demonstrate circumstances showing that it is not responsible for the failure to reach a target agreement, it is generally liable for damages. Liability for the failure to reach a target agreement arises from Section 280(1) of the German Civil Code (BGB) and Section 283(1) of the German Civil Code (BGB).

5.2 Federal Labor Court – Failure to Agree on Performance Targets Gives Rise to a Claim for Damages

The Federal Labor Court (BAG) has already addressed the issue of missing or failed target agreements in several decisions.

If no target agreement was reached, the employee may, upon expiration of the target period—typically the calendar year—demand the maximum bonus as compensation for damages. The basis for this case law is the assumption that, when entering into a target agreement, the employee and employer set realistically achievable targets.

However, once the target period has expired, it is no longer possible to achieve or set targets. With realistic targets, it can therefore be assumed that the employee would have achieved them by the end of the target period, meaning that the employee is entitled to the maximum bonus as compensation even if no target agreement was reached.

5.3 Bonus Payment Without a Target Agreement

The employer’s fault is generally presumed in such cases, although the employer has the opportunity to rebut this presumption ( Federal Labor Court [BAG], Dec. 17, 2020, Case No. 8 AZR 149/20). In this case, however, the BAG also ruled that if the employee fails to request such a discussion or to remind the employer of it, the employee bears a small degree of contributory negligence, meaning that he is entitled to only 90 percent of the maximum bonus as compensation. This follows from the principle of the duty to mitigate damages under § 254 BGB.

It is impermissible for the employer to unilaterally set targets as performance objectives instead of entering into a target agreement. In the BAG’s view, this constitutes an unreasonable disadvantage to the employee under § 307(1), (2) BGB (BAG, July 3, 2024, Case No. 10 AZR 171/23). If the employer were able to unilaterally set a target in lieu of a target agreement—for example, if negotiations on the target agreement fail—this would undermine the contractual obligation to enter into a target agreement. Furthermore, the employer could then always cause the target agreement negotiations to fail in order to subsequently set the target unilaterally.

5.4 Timely Negotiations and Open Communication Regarding the Target Agreement

To avoid claims for damages and disputes, employees and employers should agree on when discussions regarding a target agreement are to take place. If such a clause exists, the discussions should also take place. Employers should ensure that performance agreements are discussed with employees early on— ideally at the start of a new fiscal year—and set forth in writing. This can take place during one-on-one meetings, department meetings, or in the form of an official bonus policy.

To avoid future disputes, companies should also precisely define the rules governing variable compensation in the employment contract, in a framework agreement, or in separate compensation guidelines. Regular communication between managers and employees regarding the status of goal achievement can help prevent uncertainty. Employers should keep employees informed about relevant performance metrics and their impact on bonus payments. Both parties to the employment contract should ensure that goals are realistic.

Employees should not wait until the end of the year to ask about their bonus payment but should clarify early on with their supervisor, the human resources department, or the employer directly what the goals are for the current bonus period. If no goals have been defined by the end of the bonus period, the employee should seek a discussion with the employer. In doing so, they can politely but firmly point out that the goals for the past year are missing and ask what arrangement has been made regarding the bonus payment. In some cases, employers may be accommodating and grant a bonus even without a goal agreement.

6. Conclusion

• Variable compensation and target-based pay: Variable compensation models, such as bonuses or incentives, are often tied to defined targets. These may relate to the employee’s individual performance, team goals, or the company’s success. The targets are established either through a target specification or in the form of a target agreement.
• Distinction Between a Target Set by the Employer and a Mutual Agreement on Targets: A target set by the employer is determined unilaterally by the employer, whereas a mutual agreement on targets is reached through dialogue between the employer and the employee. A binding mutual agreement on targets provides better protection for the employee, as the absence of such an agreement may result in the employee retaining their entitlement to a bonus.
• Consequences of a Lack of a Target Agreement: If a target agreement is provided for in the employment contract but is not actually reached, this can lead to claims for damages. According to case law, in such cases the employee may claim the full bonus as damages, as it is assumed that the employee would have achieved realistically set goals. An exception applies only if the employee bears a small degree of contributory negligence for the failure to reach a goal agreement.
• Missing target agreements cannot be replaced by target specifications: The Federal Labor Court has already ruled that an employer may not unilaterally set a target specification if a target agreement was intended but did not actually come to fruition. The absence of a target agreement is often considered a breach of duty by the employer, which makes the employer liable for damages. Employers are therefore advised to enter into target agreements with their employees early on and in writing.

7. FAQ