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Remuneration in tokens

#lawvolution

Oct 2018

For the blockchain generation, virtual stock option plans are old-fashioned and token-based remuneration systems are no longer a vision of the future.

Even though there are no specific regulations for tokens yet, they do not exist in a legal vacuum. If companies want to implement token-based remuneration in Germany and avoid disputes, they will have to determine the framework for this type of compensation on the basis of current legislation.

Appeal of tokens

A token is a virtually created object to which the general public attributes a value, or at least those involved in its creation and transfer. Tokens can act as a means of payment, allow access to a service or product, or even “embody” rights. Tokens are often created as part of an ICO and sold to investors for corporate financing.

Tokens are extremely appealing: The marginal cost of issuing a token is practically zero. Similar to stocks, they also offer the opportunity for an immense increase in value when the company goes public with the tokens as part of an ICO, and thus creates a market of supply and demand. However, this is not guaranteed. A token can potentially remain worthless, for example if the ICO fails or the tokens are never assigned a function.

Transparency

The remuneration agreement should be structured transparently, specifying that the performance of a token is unpredictable and could devalue to zero. If the transfer of tokens is tied to a condition such as the success of the ICO, it must be clear that this condition may not be met and that in this case (e.g. the failure of the ICO) the company will not transfer any tokens or compensate. 

“Truck ban″

Furthermore, the “truck ban” (§ 107 of the German Industrial Code or Gewerbeordnung/GewO) must be observed in Germany: The employer must pay the employee in euros for work performed and, in principle, should not evade this obligation by substituting with payment in kind. Remuneration in tokens only is therefore not possible in an employment relationship, since tokens – in the absence of state recognition – are viewed not as money, but rather as payment in kind.

In any event, the part of the salary that cannot be seized must therefore be paid to employees in euros. In Germany, according to § 1 of the Minimum Wage Act (Mindestlohngesetz/MiLoG), the minimum wage of currently 8.84 euros per hour must also be paid in money to ensure that each employee has a certain monetary base in a state-recognised currency.

Maximum share of tokens

If the remuneration is paid in tokens as compensation for work performed, it must, according to § 107 of the GewO, correspond to the interests of the employee or to the “nature of the employment relationship.”

The volatility of tokens must be taken into account in this context: In Germany, the Regional Labour Court in Düsseldorf ruled that an agreement under which more than 50% of the remuneration is in (potentially worthless) stock options, is not in accordance with the employee’s interest and is therefore invalid (judgment of 30 October 2008 – 5 Sat 977/08). In line with Federal Labour Court case law on the revocability of remuneration, it is therefore recommended that the share of tokens for employees should not exceed 25% - 30% of the total remuneration, provided that the tokens are granted in return for work performed.

However, it is still not clear whether this case law can be applied to tokens. There are practical problems in the implementation: the value of the tokens at the time of their transfer to the employee is often not yet known when the remuneration agreement is concluded. It is also unclear whether remuneration in tokens is in line with the specific "nature of the employment,” if the employer is at the same time the issuer of the tokens.

To this extent, companies are now faced with the decision on whether to minimise the token share of employees’ performance-related remuneration or to accept the risk that the right to remuneration is not met by granting tokens and that employees could demand an increase to the remuneration customary for their work.

Flexibility for employers

In Germany, if tokens are issued not as compensation for work performed, but in addition to remuneration, for example as a reward for loyalty to the company (as a type of gratuity), § 107 of the GewO does not apply. This is also the case if tokens are given to the employee by a third party (e.g. a company founded for financing purposes that issues tokens), without this being set out in the employment contract. 

It is also conceivable that § 107 of the GewO is not applicable to those tokens which, based on their programming, only allow employees to use a network provided by the employer. This opens up an organisation’s scope for employee retention through token participation programmes.

Direct transfer of tokens or option arrangement

For the transfer of tokens, the specific contract design has numerous variants: It is possible, for example, by agreement to transfer a certain number of tokens to the employee at a specified time. It is also conceivable to convert a fixed sum or a fixed salary share into tokens by a target date. Finally, it is possible and popular to agree to an option under which employees are granted the right to the future transfer of tokens.

Which option makes sense for the company and the employee must be assessed on a case-by-case basis and depends above all on (wage) tax and social security considerations. For employees, the risk of “dry incomes”, i.e. a tax situation without a corresponding influx of money, should be minimised. Otherwise, the participation programme is not attractive. 

Employee retention through acceleration clause

If the purpose of the transfer of tokens or the granting of an option right to this effect is not the remuneration of work performed but, for example, rewarding loyalty to the company, the entitlement to the transfer of tokens or the option and/or exercise right may be made dependent on the (unterminated) existence of the employment relationship on a target date. 

Because the value of tokens is very volatile and the earnings for the employee concerned are uncertain, there are no excessively stringent requirements for the effectiveness of such a target date or acceleration clause. If the remuneration in tokens is for work performed, target dates or acceleration clauses are not permitted.

Blocking period and waiting time

The company must ensure that employees do not immediately resell any tokens they receive. Otherwise, early fluctuations in prices may threaten the success of the ICO. In addition, the goal of employee retention and the reward of loyalty to the company might not be achieved. The company can counteract this either with a technical disposal restriction (comparable to the limit on transferability of registered shares) or a legally agreed prohibition of disposal, if necessary coupled with a contractual penalty.

If initially only an option to transfer the tokens is agreed, the exercise of the option right may also be made dependent on the fulfilment of a waiting period, flanked by the exclusion of the transferability of the option right.

Co-determination of the works council

When introducing token-based remuneration systems in Germany, the right of co-determination by the works council (§ 87 para. 1 No. 10 of the Works Constitution Act or Betriebsverfassungsgesetz/BetrVG) must be observed. If there is a works council, the allocation of the token remuneration to employees must be set out in a company agreement. 

The question of the number of tokens to be issued to employees is not subject to the co-determination right. A co-determination right would also be excluded, for example, if the tokens were not transferred by the employer but by another group company and the employer had no influence on the distribution of the tokens.

Specific features for freelancers

If external employees, such as ICO advisors, work on the basis of a freelance service contract, employment law protection regulations in Germany such as § 107 of the GewO and § 1 of the MiLoG do not apply. In principle, these employees can be fully paid in tokens. Nevertheless, it is also important to ensure that the economic risks associated with an ICO and remuneration in tokens are identified transparently in the relevant agreement.

However, full remuneration in tokens is not possible if freelancers are actually dependent employees, i.e. falsely self-employed. In this case, the employment protection regulations apply, even if these employees are referred to in the contract as external freelance consultants or such like.

Conclusion: Tokens as attractive employee remuneration

Remuneration in tokens is possible under German employment law and, from a commercial point of view, opens up a way to let employees participate in the company’s success. The scope for flexibility depends essentially on whether the tokens are issued for work performed or in addition to the usual remuneration, for example, for loyalty to the company. 

Authors

Nina Hartmann
Dr. Nina Hartmann
Partner
Munich
Timo Kloster
Timo Kloster