Termination Agreement Explained: Key Clauses and Legal Implications

A termination agreement is an agreement between an employer and an employee to end the employment relationship by mutual consent. It is therefore an alternative to dismissal. However, this seemingly simple solution can conceal financial risks of which you should be aware. Employees can avoid a number of mistakes when concluding a termination agreement, from avoiding a waiting period for unemployment benefits to securing a fair severance payment and improving their tax situation. In our article, we highlight the most important advantages and disadvantages of termination agreements, including aspects of social security and tax law, and explain these topics in detail using a sample agreement. We also provide practical tips on how to protect your interests when concluding a termination agreement.

The key points at a glance:

• Mutual termination: This type of agreement allows the employment relationship to be terminated by mutual consent. A severance payment is often included in the agreement.
• Advantages and disadvantages for employees: Employees waive important rights by signing a termination agreement. However, employers are often willing to pay a higher severance payment in return. Employees should carefully consider the advantages and disadvantages of a termination agreement on a case-by-case basis. We recommend comparing it with our sample termination agreement (see below). If you have been employed for a long time and receive a high salary, you should discuss the draft termination agreement with a solicitor.
• Social security and tax aspects: Terminating an employment contract can result in a waiting period for unemployment benefits. However, this can often be avoided through careful wording. You should also consider the tax implications at an early stage and incorporate them into the contract.

What is a termination agreement?

A termination agreement is a voluntary agreement between an employee and their employer that ends the employment relationship. ‘Voluntary’ means that your employer cannot force you to sign one. If you do not agree to it, your employment contract remains in force. A termination agreement is also referred to as a termination contract.

Distinction between a termination agreement and a dismissal

If you do not sign, your employer will have no choice but to dismiss you. This is often not possible. It may also involve risks, costs, deadlines and other disadvantages for the employer. In addition, for a dismissal to be effective, the employer usually needs a reason that would stand up in a labour court, and they would have to consult the works council. None of this applies to a termination agreement. The most important advantage of a termination agreement over dismissal for the employer is that:

• No notice period: Once a termination agreement has been reached, the statutory notice periods do not apply. The employment relationship can be terminated with short notice — theoretically, even on the same day — or with an agreed notice period.
• No protection against dismissal: Employers do not have to observe any statutory protection requirements. Social criteria such as length of service, age, having children, or special protection against dismissal (e.g. in the event of pregnancy or severe disability) are not taken into account.
• There is no right of co-determination for the works council: Unlike dismissal, the works council or staff council is not involved in the termination agreement. Social aspects or alternative employment options do not need to be considered.

A termination agreement could lead to a high willingness to pay

A termination agreement is much simpler and quicker for the employer than a dismissal. This is why they are usually willing to pay for it.

Of course, this is also because the situation is completely different for the employee. Apart from the amount of severance pay, termination is usually better for the employee. This is because a termination agreement can result in the loss of important rights (see above regarding the notice period, protection against dismissal and the involvement of the works council) as well as a waiting period for unemployment benefits, which can have serious financial implications.

In certain cases, however, a termination agreement is the only way for an employer to ‘get rid’ of an employee, for example if ordinary termination is not possible due to parental leave or length of service. – would not be possible. Employers will be willing to pay significantly more to conclude a termination agreement in these cases and in others.

Therefore, the ‘fair’ severance payment should be significantly higher in a termination agreement than in a dismissal. Unfortunately, employers often try to agree a significantly lower severance payment in a termination agreement. It is therefore extremely important to compare the amount of the severance payment in the agreement with market rates.

Distinction from a settlement agreement

A termination agreement differs from a settlement agreement. A settlement agreement is concluded by the parties after notice of termination has been given, in order to settle the contractual relationship, but does not terminate the employment relationship. While a settlement agreement regulates how the termination will be carried out, a termination agreement only initially terminates the employment relationship. It usually contains the same provisions as a settlement agreement.

The advantages and disadvantages of a termination agreement

It is difficult to make a general statement about the pros and cons of a termination agreement. If negotiated well, a termination agreement can offer significant financial advantages, but this depends on individual circumstances. Of course, the amount of the severance payment is important, but many other factors also play a role. For example, you need to consider whether you are comparing the termination agreement with dismissal or continued employment, whether you already have a new job lined up and what your tax situation is. We have listed the most important advantages and disadvantages of a termination agreement below:

Advantages of a Termination Agreement

• ‘Fair’ severance pay: You may not be directly entitled to severance pay in the event of termination. Or you may be. Either way, without adequate severance pay that is ‘fair’ in light of the specific circumstances of your case, you should not sign a termination agreement. Since employers often try to offer far too little in a termination agreement, you should not let yourself be pressured into accepting it.
• Flexibility: If you have received a new job offer, a termination agreement can allow you to bypass notice periods and start your new job immediately.
• Short-term exit: If the employment relationship has become unbearable, a termination agreement can offer a quick solution.
• Influence the terms: You can influence the terms on which you end the employment relationship. This gives you flexibility in individual cases.
• Reference letter: If your employer is interested in a termination agreement, they will also agree to provide you with a positive reference. However, this is no longer an issue for many people nowadays, as formal reference letters have lost their significance in many industries.

Disadvantages of a Termination Agreement

• Protection against dismissal: If you sign a termination agreement, you will no longer be able to invoke the provisions on protection against dismissal. This usually means that you cannot file a claim for unfair dismissal.
• Special protection against dismissal: A termination agreement also circumvents the provisions on special protection against dismissal for pregnant women, severely disabled persons, works council members, and persons on parental leave.
• Consultation with the works council: If there is a works council, it must normally be consulted before any dismissal. This does not apply to termination agreements, however.
• Waiting period for unemployment benefits: A termination agreement often results in the employment agency imposing a waiting period. During this period, you will not receive Unemployment Benefit I, and the waiting period can last up to twelve weeks, which can result in significant financial disadvantage.
• Company pension: The termination agreement may also mean that you will not receive any additional pension from the company pension scheme.
• Higher tax rate due to severance pay: If you negotiate a high severance payment as part of the termination agreement, your gross annual income will increase. This can lead to a higher tax rate. However, this effect can be mitigated to some extent by smart structuring of the payment terms.
• Loss of employee participation programmes: This only affects employees who receive shares, VSOPs, ESOPs or LTIPs as additional forms of remuneration. Special care must therefore be taken in the termination agreement for these employees to ensure that they do not lose remuneration components they have already earned (e.g. by including ‘good/bad leaver‘ provisions in the agreement).
• Loss of company cars and other fringe benefits: This issue is very similar to that of employee participation programmes. Clear provisions are also required here, e.g. regarding how long a company car may continue to be used for.

The advantages and disadvantages of a termination agreement can vary significantly depending on your individual situation. These depend on the specifics of your case and can be very complex. If your severance payment involves large sums of money — for example, if you have been with the company for a long time — you should seek advice from an employment law expert (such as a lawyer or trade union representative), who can assess the pros and cons of a severance agreement in your specific case.

Tips and advice for concluding a termination agreement

If an employee wishes to sign a termination agreement, the following aspects must be considered:

1. The content of a termination agreement that is necessary and useful.

Carefully read through the draft termination agreement and ensure that it is complete. As well as being legally correct, an employee-friendly severance agreement should secure optimal conditions for the employee’s future career and financial situation, for example by avoiding a waiting period for unemployment benefits and circumventing ‘tax traps’.

The required provisions of an employee-friendly termination agreement:

The following elements should always be included in an employee-friendly termination agreement. See our termination agreement template (sample) and checklist below for more information.

• General: Termination of the employment relationship ‘at the initiative of the employer’. This wording is often included in the preamble of the agreement to avoid a waiting period for unemployment benefits due to the termination agreement. It is usually supplemented by ‘to avoid termination by the employer for urgent operational reasons’ (see above for the advantages and disadvantages of a termination agreement).
• Termination date: The date on which the employment relationship is to end must be specified. To avoid waiting periods, the standard notice period should be observed.
• Payment and amount of severance pay: The contract should specify the amount of a reasonable severance payment. In termination agreements, a severance payment is almost always made (see above); the amount should be clearly stated and ‘unconditional’. The payment date should also be specified. However, this can be left at the employee’s discretion, primarily for tax reasons. The tax optimisation of payment dates should be discussed with a tax advisor before signing.
• Variable remuneration elements: Where applicable, provisions should be made for the full payment of bonuses, royalties, premiums, shares/options, etc. (pro rata if applicable).
• Holiday: The contract often specifies how many holiday days you are entitled to. If your employer grants you leave in lieu of holiday entitlement, you should consider whether this is worthwhile.
• Compensation for overtime: If you have overtime credits on your working time account, this is an important issue to include in the contract.

Sensible terms and conditions in an employee-friendly termination agreement.

The following provisions are also recommended to include in a termination agreement for employees:

• Leave of Absence: Many agreements stipulate that employees are released from their duties until their termination date. However, exemptions can also be revocable, i.e. the employer can ‘call back’ the employee. It is better if the exemption is irrevocable.
• Turbo/sprinter clause: In the case of longer notice periods, this clause allows the employee to leave their employment early, often in exchange for an additional severance payment instead of salary.
• Issuing of references: The termination agreement often includes a provision regarding references. A typical clause is: ‘The employer undertakes to issue the employee with a favourable reference.’ However, this is not clear enough as it could also mean a ‘merely satisfactory’ reference. Therefore, it is essential to ensure that the termination agreement contains a specific provision to avoid any ambiguity in the reference. Either the finished reference should be attached to the termination agreement, or wording such as ‘The employer undertakes to issue the employee with a qualified and favourable reference with the grade “very good”‘ should be used.
• Compensation clause (with exceptions for outstanding claims): It is common to include a confirmation that no further claims exist, except for those explicitly mentioned (e.g. severance pay, references, salary, bonuses and holiday entitlement).
• Other: The contract usually contains provisions regarding non-competition, confidentiality, and the return of company property and work equipment. From the employee’s point of view, such clauses are generally dispensable.

Our employee-friendly draft termination agreement is available for comparison.

2. An Agreement on a fair severance payment

If you are offered a severance payment, examine the amount carefully. Whether a severance payment is considered ‘fair’ depends on the specific circumstances of your case. In principle, the amount depends on length of service and salary. In some cases, an amount equivalent to between one and one-and-a-half months’ salary per year of service is agreed, but sometimes even more is agreed. It is especially advisable to seek legal and tax advice when negotiating the amount of the severance payment in the case of longer periods of employment, in order to avoid costly mistakes. You can use our free severance payment calculator to carry out an initial assessment of the range of severance payments.

3. Enough time to consider the contract

You should always ask for time to consider a termination agreement before signing it – never sign immediately. If you are in any doubt, seek advice.

If you are asked to attend a meeting where you are expected to sign a termination agreement without being given time to consider it, this could be considered a surprise move. Depending on the specific circumstances of the individual case, a severance agreement concluded under such pressure may be invalid.¹

The draft contract will often come from the employer. We therefore recommend that all employees at least briefly consult an employment law expert to determine whether the severance payment amount is reasonable and whether the contract contains any legal issues.

4. Consider how you can optimise your tax situation.

Your severance payment is subject to income tax, and to the solidarity surcharge and church tax if applicable. What you ultimately receive after taxes should be your main consideration. Therefore, you should consider the tax consequences when negotiating your severance package. There are a number of things you can do to reduce your tax liability. You will find numerous tax tips in our article on the taxation of severance payments. Our gross-net severance payment calculator provides an initial assessment of the tax consequences of your ‘severance package’.

5. What about unemployment benefits despite a termination agreement?

When concluding many termination agreements, a key question for our partner lawyers is: Are employees entitled to unemployment benefits despite the agreement? This is a legitimate question, given that a termination agreement often results in a waiting period. As a consequence, you will not receive unemployment benefits for up to twelve weeks. Such a waiting period usually occurs when the agency assumes that you have ‘voluntarily’ ended your employment contract through the termination agreement.

However, this does not have to be problematic: many people willingly accept a possible waiting period for unemployment benefits, for instance if they have a new job lined up and will not be unemployed or if they are financially secure. If a severance payment is also made, some people consider this sufficient compensation for the financial gap caused by the waiting period.

Other employees considering a termination agreement should definitely contact a solicitor or the employment agency in advance to clarify any possible consequences for their entitlement to benefits. Without prior consultation, a waiting period of up to 12 weeks may be imposed. This means that you will have no income for almost three months!

However, skilful contract wording and a comprehensible justification, such as operational circumstances, can often avoid the waiting period, enabling you to receive unemployment benefits ‘from the outset’ despite the termination agreement. Therefore, legal advice or prior consultation with the Employment Agency is strongly recommended.

Checklist for termination agreements with employees

If your employer presents you with a draft termination agreement, you should review it thoroughly. The following checklist provides guidance on the necessary (and advisable) content from the employee’s perspective.

Topic	Contents
Preamble	• Termination of employment ‘at the employer’s instigation’ (to avoid a waiting period for unemployment benefits due to a termination agreement).
Termination of employment	• Is the termination date entered correctly and in full? • Has the regular notice period been observed to avoid blocking periods? • Has the notice period specified in the employment contract been taken into account?
Work performance and remuneration	• Is remuneration regulated until the end of the contract? • Is the employee’s obligation to perform until the end of the contract specified? • Is the amount of the severance payment and the payment terms clearly defined? • Are other payment entitlements (such as bonuses, royalties, premiums, shares/options, etc.) regulated? • Have all mutual claims been settled?
Leave of absence and holidays	• Is the period of leave specified? • Is continued payment of remuneration during leave included? • Have holiday and leisure time compensation entitlements been taken into account? • Does it refer to avoiding blocking periods?
Turbo clause	• Is the possibility of early termination regulated? • Is the deadline for exercising the clause specified? • Is there no deduction from severance pay despite early termination? • Do the exemption regulations remain valid in the event of early termination?
Confidentiality (Optional)	• Is confidentiality regarding internal information permanently agreed? • Is the confidentiality of the contract content regulated by both parties?
Returning work equipment and data (Optional)	• Is the return of all materials, data carriers and documents regulated? • Is there an obligation to return unsolicited items?
Reference (Optional)	• Is entitlement to a favourable reference included? • Are interim and final references clearly regulated in terms of timing? • Is there a provision for further certificates to be sent after the end of the contract?
Information on social security law	• Does it contain information about possible suspension or rest periods for ALG? • Are employees obliged to obtain information independently? • Does it contain information about the obligation to report to the Employment Agency at an early stage?

Sample termination agreement: template available for download as a PDF

A termination agreement enables employers and employees to end an employment relationship by mutual consent, without having to comply with statutory notice periods or provide reasons for termination. To ensure that no important points are overlooked, it is essential to use a legally compliant template. In this article, we provide a free PDF download of a termination agreement template and explain what to bear in mind when using it. This will help ensure that the mutual separation proceeds smoothly and in accordance with the law:

Frequently asked questions (FAQs)