When an employee is dismissed and disagrees with the employer on the termination of the contract, there is often talk of severance pay. The employee looks for compensation regarding the loss of a job and the negative economic consequences it entails.

Untangling the legal reality

Employment contracts are terminated if an employee is dismissed, if the contract is limited in term or if a suspension agreement is signed. Employees are not entitled by law to receive severance.

Nevertheless, agreements on severance pay are often concluded. When an employee contests the legality of a termination or a fixed term contract, nearly 80% of all proceedings that are brought to a labor court result in an agreement for a settlement. It turns out that the employer is generally not capable of providing proper justification for dismissing the employee.

In other instances the employer is concerned about the risks of a court case. For good reason, too. The employer runs a huge risk in the process. If the labor court decides in favor of the employee and determines that the dismissal is unlawful, the employer loses the case. The employer is then required to pay the employee’s back salary. He must pay for the time since the termination became effective. The employee is not required to work off the time. The employer runs the risk of having to pay an employee for work that the employee did not perform.

Severance pay: How much?

There are no laws governing the scope of severance pay. Often the judges base their ruling on the following calculation: one half of the gross monthly salary for every year worked at the company. However, this is only a rule of thumb.

A much more decisive point is whether or not one party can build up pressure and the economic situation can be leveraged. Employers whose company does not generate high profit margins are normally not capable of offering high severance payments. However, when the company is doing well in economic terms, the amount of severance pay can be higher. Another factor is whether the employee already has a new job at a different company.

Taxes and social insurance

Severance is free of social security contributions, which is a great economic advantage for employees. On average, employees receive approximately 21% more (net) than they would have with their regular wage/salary pay.

Although the payment is still taxable, there is a considerable tax benefit for employees thanks to the one-fifth method according to the income tax law in Germany.

Social selection/social plan

Social plans are agreed when companies with works councils need to make changes to operations and announce mass layoffs. These plans include severance payments. In this case, employees are entitled to receive severance. For more information, refer to the article written by RA Rainer Polzin in AA 1/2004, p. 7 et seqq.. [available in German only].

However, many employees are often not aware that careful negotiations can potentially mean that the employer will agree to a higher severance, despite the social plan.

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