JILPT Research Report No.172
The German System of Monetary Settlement in Cases of Dismissal:
Its Legal Framework and Realities

Major Findings

1. In Germany, socially unjustified dismissal is in principle invalidated by the Protection Against Unfair Dismissal Act, based on the legal doctrine of protecting continuance of the employment relationship (the principle of invalid dismissal). Besides this, however, the Protection Against Unfair Dismissal Act also provides for a system enabling the employment relationship to be terminated by means of financial compensation. This is the system of dissolution through court decision (Article 9 and Article 10 of the Act) and Article 1(a) of the Act.

2. Of these, the system of dissolution through court decision only applies when dismissal is socially unjustified and is therefore invalid, but the relationship of trust between the worker and employer has already collapsed on account of said dismissal. In this system, the Labour Court may dissolve the employment relationship and order the employer to pay compensation to the worker (dissolution through court decision), aiming to reconcile the interests of the two parties (rule for exceptional reconciliation of interests).

   Therefore, the party that files a petition for such dissolution through court decision must assert and substantiate the situation that specifically caused the relationship of trust to collapse (grounds for dissolution). This is equally true when the worker files the petition. (However, the Federal Labour Court of Germany interprets the existence of grounds for dissolution more strictly when the employer files the petition.)

   In itself, therefore, this system of dissolution through court decision is rarely used in Germany, partly because it is positioned as an exceptional measure in the Protection Against Unfair Dismissal Act, and also because, for this very reason, strict requirements must be met when requesting dissolution through court decision.

   A framework for calculating amounts of compensation under this system is provided in Article10 of the Protection Against Unfair Dismissal Act. This stipulates that the amount shall be decided at the discretion of the judge, with an upper limit of twelve months’ pay. In theory, it has been pointed out that the worker’s age and years of service are taken into consideration as important elements for the calculation, while in practice, the calculation formula “Years of service x Monthly salary x 0.5” is used as a guide.

3. Incidentally in Germany, there has been a debate on reforming dismissal regulation, designed to broaden the potential for resolving dismissal disputes through monetary compensation since the 1970s. In the 1970s and 1980s, specifically, the debate only concerned methods whereby workers could claim compensation from employers in general cases of dismissal for business reasons, mainly based on the problem awareness that the system of Social Plans (see below) caused inequality. The discussion did not directly tackle the essence of the Protection Against Unfair Dismissal Act as a law protecting continuance, or the principle of invalid dismissal itself.

   From the start of the 2000s, however, two new arguments emerged, in addition to the debate criticizing this inequality of the Social Plan system. One was a call for monetary compensation for dismissed workers to be properly recognized as a legal rule, since the principle of invalid dismissal based on the doctrine of protecting continuance had become estranged from actual practice in processing dismissal disputes (“wide gap between theory and practice”). The other was an attempt to improve cost predictability for employers in cases of dismissal, by introducing measures enabling the termination of an employment contract relationship based on monetary compensation into legislation dismissal.

   At the beginning of the 2000s, unlike the 1970s and 80s, these three debates converged into views that questioned the legitimacy of the very principle of invalid dismissal based on the doctrine of protecting continuance. The most drastic of these was a proposal that the principle of invalid dismissal should be abandoned, and monetary compensation should be positioned as a basic principle of dismissal rules.

   Ultimately, however, the debate on reforming dismissal regulation in this direction did not actually bear fruit in the form of a legal amendment. Nevertheless, the problem awareness of those arguing for reform at the beginning of the 2000s was shared by the German federal government of that time, which led to the introduction of a new Article 1(a) into the amended Protection Against Unfair Dismissal Act.

4. Finally, as a result of this series of debates on reforming dismissal regulation, and in conjunction with the labor market reform in Germany, Article 1(a) was added as a new provision in a 2004 amendment of Protection Against Unfair Dismissal Act. Under Article 4 of the Act, the statute of limitation on dismissals is a maximum of three weeks after receiving notice of dismissal, after which period the dismissal is considered valid. However, the new Article 1(a) gives workers the right to claim a legally prescribed amount of compensation in exchange for waiver of filing an action against dismissal following the lapse of this period. To calculate the amount of this compensation, the formula “Years of service x Monthly salary x 0.5” was to be incorporated as a legal rule.

   Of course, because the structure of this Article 1(a) functions as an incentive for both labor and management to seek resolution through judicial settlement, the reception inside Germany was mostly critical. As a result, it has hardly been used at all in practice.

   Thus, although the system of dissolution through court decision and Article 1(a) of Protection Against Unfair Dismissal Act have been developed in Germany, both are rarely used actually in society. On the other hand, it is also an extremely rare phenomenon for a worker who is dismissed without socially justified reasons to claim invalid dismissal and return to the original workplace, according to the basic principle. Instead, most dismissal disputes in Germany are still processed through judicial settlement even today.

5. In other words, thanks to the existence of the Labour Court system and the attorney insurance system in Germany, the hurdles to filing a lawsuit in itself are not so high in the first place. Moreover, because Article 61(a) of Labour Court Act stipulates that settlement procedures should be carried out within two weeks from filing a petition for restriction of dismissal (out-of-court settlement), most dismissal disputes end in a settlement whereby the employment contract relationship itself is dissolved and the employer pays compensation to the worker. And although the amount of compensation in such cases is not expressly specified by law, a calculation formula―a worker’s “Years of service x Monthly salary x 0.5” ― has already been established in practice. On this basis, the final amount is calculated, taking the individual circumstances of each case into account.

   The fact that court settlements have achieved such a high resolution rate is thought to be because i) the principle of invalid dismissal itself is, for both labor and management, a rule that is not consistent with their actual situations, and ii) the formula for calculating compensation used there is consistent with the indicators of needs for legal protection of dismissed workers shown in the Protection Against Unfair Dismissal Act (years of service and age). On this point, it might be noted that, although the “world of law” and the “world of reality” concerning dismissal in Germany are estranged from each other, the world of law has an element of underpinning the stability of dismissal dispute processing in the world of reality.

6. In addition to the above, there are works councils (workers’ representative bodies) in Germany, and if personnel cuts beyond a certain level – whether due to closure or merger of establishments, company segmentation or other changes affecting establishments – are planned for establishments where at least 21 workers are usually employed, the works council in question acquires co-determination rights for drawing up a “Social Plan” with the employer, in order to compensate for or mitigate the financial disadvantage arising from the dismissals concerned.

   Although the content of these Social Plans is not stipulated in law, they normally specify levels of monetary compensation for dismissed workers. In practice, many Social Plans use a calculation formula whereby “Age x Years of service x Monthly salary” is divided by a fixed coefficient. Because the formulated Social Plans have validity as works agreements and are applied directly to the relevant workers, those workers therefore acquire the right to claim compensation calculated in accordance with the Social Plan from the employer. The characteristic of this Social Plan system is that it enables workers to win financial compensation regardless of whether the dismissal due to change of establishments was valid or not.

   Meanwhile, since the co-determination rights of works councils mentioned above have the nature of consent rights, an arbitration committee makes a judgment on the formulation of a Social Plan in the form of an arbitration ruling, even when no agreement is reached between the employer and the works council. As such, the Social Plan itself is always formulated as long as its conditions are met.

   As stated above, however, the system of Social Plans is premised upon the existence of a works council. Given that the establishment rate of works councils is in a year-on-year decreasing trend (albeit gradual) in Germany today, cases of Social Plans being formulated are also thought to be in a declining trend accordingly.