Doris-Maria Schuster and Christian Mathias of Gleiss Lutz discuss post-contractual non-compete restrictions affecting employers in Germany.
"Given the importance of the legally effective incorporation of post-contractual non-compete restrictions in contracts with key employees of a company, the related risks should not be underestimated."
In order to prevent employees from disclosing valuable know-how, customer contacts or other sensitive information to competitors after their employment relationship has terminated and they have left the company, many employers agree on post-contractual non-compete clauses in the employment agreements. Such post-contractual restrictions of competition are particularly frequent in the case of management board members, managing directors and other senior and key employees. Different from the US or other European countries, such post-contractual non-compete clauses are, however, subject to strict requirements in Germany as regards form and content. If these requirements are not met, this may result in the post-contractual restriction of competition being invalid. Therefore it is particularly important for company groups acting on an international level to be aware of those restrictions in order to avoid any pitfalls. Given the importance of the legally effective incorporation of post-contractual non-compete restrictions in contracts with key employees of a company, the related risks should not be underestimated. Invalid or non-binding clauses may undermine corporate efforts to protect valuable know-how, customer contacts or other sensitive information from being transferred to competitors.
Requirements as regards form and content
Post-contractual non-compete clauses generally prohibit employees from working for competitors after the end of the employment relationship with their previous employer for the contractually agreed term. They restrict the employee’s professional advancement and possibly limit prospective earning opportunities during the respective term. Therefore German statutory regulations and case law require employers to comply with a number of strict requirements as regards both the form and content of post-contractual non-compete clauses. Section 74 of the German Commercial Code (HGB) outlines the general formal requirements for such clauses. The post-contractual non-compete clause must be always agreed upon between the employer and employee in writing. The employer must be duly represented by the competent bodies or representatives and is under an obligation to serve the employee with a signed original of the agreement.
With regard to the content of post-contractual non-compete clauses, German statutory law requires that the respective clauses be drafted carefully: on the one hand, the non-compete clause must reflect legitimate business interests of the employer, and on the other hand such clause must protect the employee from being unreasonably hindered in his or her professional advancement. If both criteria are duly met by the respective non-compete clause, such clause is regarded to be valid and fully binding on both parties. Preventing valuable know-how, customer contacts or other sensitive information from being transferred to competitors by the outgoing employee is generally deemed to be a legitimate business interest of an employer. However, there must be an overlap between the respective employee’s previous position or the activities he or she performed for the employer and the subject matter or activities included in the post-contractual non-compete clause. Thus, the exact legitimate scope of any prohibited activities being subject to a post-contractual non-compete clause depends on the previous position of the employee in question. Where executive employees are concerned, the legitimate scope reflecting the employer’s business interests is broader and may be more company-focused, rather than relating to a specific kind of work.
The question of whether a specific clause unreasonably hinders an employee’s professional advancement is assessed at the end of the employment relationship based on the scope of the clause as regards its territorial application, the applicable duration of the non-compete restriction and the amount of compensation agreed upon. While there are no generally binding standards regarding the legitimate territorial application of post-contractual non-compete clauses, the term of any such agreement is limited to a period of up to two consecutive years. In addition, section 74, paragraph 2 HGB requires compensation equivalent to at least 50 per cent of the employee’s most recent remuneration to be paid during the agreed term. Section 74b, paragraph 2 HGB provides in the case of additional variable forms of remuneration, that the precise amount of additional compensation to be paid shall be calculated on the basis of the employee’s average contractual variable remuneration during the last three years. In addition to the most recent regular monthly salary, the total compensation must therefore also take into account any forms of additional variable remuneration such as bonus payments, gratuities or awards for particularly long periods of service.
Consequences of invalid or non-binding post-contractual non-compete clauses
Any non-compliance with the described requirements as regards the form and content of post-contractual non-compete clauses will result in the respective clause being either invalid in whole or non-binding (in part). Neither the employer nor the employee can derive any contractual rights from an invalid non-compete clause. A non-compete clause is generally regarded to be invalid if no compensation has been agreed upon at all or if the agreement was concluded during an apprenticeship or with employees who are minors.
In most cases the threshold of the clause being invalid will not be reached, thus rendering a non-compete clause that does not fully meet the statutory requirements non-binding on the employee. In this case the employee will be entitled to choose whether to abide by the agreement and refrain from engaging in competing activities in order to receive the compensation or otherwise to commence competing activities without being entitled to compensation. The contractual agreement of an insufficient amount of compensation or the commitment to pay compensation only subject to a condition will render post-contractual non-compete clauses non-binding for the employee. If the legally acceptable maximum term of two years is exceeded, the agreement will be binding on both the employer and the employee for the two-year term only; thereafter the employee will be entitled to choose whether or not to continue to abide by the post-contractual restriction of competition.
Conditions for a waiver or suspension of post-contractual non-compete clauses
Under German law the mutual obligations under a post-contractual non-compete clause may be revoked unilaterally by the employer or by the employee or by mutual agreement of the parties. Under section 75a HGB the employer is entitled to unilaterally waive any rights under a non-compete clause by means of a written declaration regarding the employee in the event that the employment relationship has not yet ended with legal effect. As soon as the employee receives such waiver, he is no longer obliged to refrain from engaging in competing activities. However, the employer is still under the contractual obligation for a period of 12 months from receipt of such declaration to pay the relevant compensation.
Both the employer and the employee also have a right to withdraw from the post-contractual non-compete clause unilaterally under certain conditions. Such right to withdrawal is available if either the employer or the employee is legally entitled to terminate the employment relationship for cause with immediate effect. In the absence of an accepted cause for an extraordinary termination with immediate effect, the unilateral withdrawal from a non-compete clause would be ineffective. Revoking a post-contractual non-compete clause by means of a mutual agreement such as a termination agreement or a court settlement is deemed to be permitted before or even following the end of the employment relationship. Although the scope of the common catch-all settlement clauses is regularly interpreted quite extensively by German labour courts, it is advisable to include explicit wording providing for the annulment of any rights and obligations under a post-contractual non-compete clause.
Differences in non-compete restrictions for managing directors and for board members
Unlike the aforementioned requirements, which are to be met for post-contractual non-compete restrictions concluded with regular employees, the statutory regulations of sections 74 et seq HGB are not applicable to managing directors or to members of the management board. However, comparable requirements must be met, which are generally based on the described statutory regulations originally relating to ordinary employees. Once again, this refers to the balancing of the employer’s legitimate business interests on the one hand and preventing unreasonable obstructions to the managing director’s professional advancement. However, the threshold for a post-contractual non-compete clause being invalid is set by unethical conduct and is therefore more difficult to exceed.
Furthermore, the payment of 50 per cent of the recent most regular total compensation is not required by statutory law for managing directors, but is merely recommended in cases of a comprehensive list of prohibited competing activities. Therefore it is possible, unlike in the case of a comparable agreement concluded with an ordinary employee, to agree with legal effect compensation that does not take into account the variable remuneration but only the fixed salary.
In contrast to the statutory regulations of sections 74a HGB, which are applicable to ordinary employees and which allow for a post-contractual non-compete clause to be effective in part if some requirements are not met, the most significant difference is that such reduction of an unfair contractual term to its legally permitted core would not apply in the case of managing directors and board members. Therefore it is important to include wording to the desired effect in a non-compete clause concluded with such person in order to prevent the agreement from being rendered invalid in whole, for instance, by way of a too extensive territorial scope or other minor clauses not observing the aforementioned balance.
Finally, consequences also arise with regard to the wording of post-contractual non-compete clauses. For instance, section 74c HGB allows under certain conditions for other earnings of the employee to be offset against the compensation during the term of the clause. While said provision statutorily applies only to all clauses concluded with regular employees, such offset must be explicitly agreed upon with managing directors or with board members.