Post-contractual non-competition clauses and compensation for waiting periods

Prohibition of working for a competitor

Most employment contracts contain a provision on the prohibition of competition. In an ongoing employment relationship, this prohibition already applies to the employee because of his duty of loyalty under sec. 241 para. 2 of the German Civil Code (Bürgerliches Gesetzbuch – "BGB"). Thus, the employee cannot work for the employer and work for a competitor of the company in his "free time".

A post-contractual non-competition clause has to be expressly agreed – in writing –  between the parties to the employment contract. The employer may prohibit the employee in the employment contract by agreement to work for a competing company after termination of his employment. In this regard, there is a wide range of requirements and restrictions that must be observed when drafting the contract and later when enforcing the non-competition clause.

Regimes of Sections 74 et seq. Commercial Code

The legal basis for the post-contractual non-competition prohibition are sections 74-75 et seq. of the Commercial Code (Handelsgesetzbuch – "HGB"). To apply these norms in the employment relationship reference to sec. 110 Trade, Commerce and Industry Regulation Act (Gewerbeordnung – "GewO") needs to be made, which states that the regulations on the post-contractual non-competition prohibition for commercial assistants shall also apply to employees. Due to the strict regime of sections 74 et seq. Commercial Code the content of the post-contractual non-competition prohibition may be arranged so that the legitimate business interests of the employer (referred to as the "principal" in the act) are protected. "Legitimate business interests of the employer" is thereby an undefined legal term that may be fully reviewed by courts. The act merely stipulates that the non-competition clause may not, in terms of place, time or subject matter, constitute an unreasonable impediment to the employee's advancement (sec. 74a para. 1 Commercial Code). The time limit is a maximum of two years (sec. 74a para. 1 sentence 3 Commercial Code). In addition, it is mandatory to pay the employee a so-called "waiting allowance". The employer has to pay this waiting allowance to the employee as financial compensation for the fact that the employee is not free to choose in which company he wishes to continue his employment after termination of his employment relationship. In principle, this compensation payment must be set at a minimum of 50% of the previous contractual benefit last received by the employee for each year of the prohibition (sec. 74 para. 2 Commercial Code).

Drafting in the employment contract 

Based on numerous decided cases complex guidelines have developed over the years for the content of the post-contractual non-competition clause and the question of the justified business interests of the employer. In principle, a balance must be struck between the employee's interest in his professional development with the freedom of occupation protected by Article 12 of the Basic Law on the one hand, and the employer's interest in not having to pass on know-how and expertise, which the employee has naturally acquired as a result of his work, to a competitor without protection, on the other. The fundamental rights are therefore restricted by the employer's legitimate business interest.

In this balancing of interests, it should be noted that the contractual provision also has to contain a spatial/geographical limitation in addition to the maximum duration of two years. The employer may only extend the non-competition clause to the area which corresponds approximately to the geographical area of activity of its company. With regard to the factual scope, it depends on a legitimate business interest of the employer, which can be, for example, the protection of business and trade secrets. The situation becomes particularly critical if, for example, the company in question employs highly specialized experts and is active worldwide. Where should the line be drawn in this case? Is the employee ultimately forced to look for a completely new field of activity? Must the employer accept having to let the employee move to a competitor? But also in the case of  general management activities of an employee, for example, the question arises as to how a limitation can be imposed. There is a lot of potential for dispute hidden here. In each individual case a court examines whether the form of the post-contractual non-competition clause meets the strict standards. Against this backdrop, the legally secure drafting of a post-contractual non-competition clause in an employment contract is a legal challenge and must be tailored in each individual case to the situation of the employer and, under certain circumstances, the Group, as well as to the employee's activity and position. 

Calculation of the waiting period compensation

In the subsequent enforcement of the post-contractual non-competition prohibition after termination of the employment relationship, in addition to the question of the scope of the non-competition clause, a dispute may also arise as to how to calculate the waiting compensation to be paid. This question was also subject of the aforementioned Federal Labour Court decision dated 25 August 2022. The plaintiff was an employee in a management position who had agreed a post-contractual non-competition prohibition in his employment contract. After termination of the employment relationship, the question arose as to whether the stock options, which he had been promised by the parent company of his employer, were also to be taken into account when calculating the compensation for non-competition. His claim was dismissed in all three instances.

As can be seen from sections 74 et seq. Commercial Code, the employer must continue to pay at least 50% of the employee's most recent contractual benefits for the duration of the non-competition clause. The act fails to provide an explanation of what counts as part of the contractual benefits and, in sec. 74b Commercial Code, only mentions the commission or "other changing payments" in a rather unspecific manner about the payment and calculation of the compensation. It is undisputed that the basic salary to be paid needs to be taken into account. In principle, variable compensation components are also included, as are non-cash benefits from the granting of a company car or a railcard, but also stock options, insofar as they constitute compensation for work performed. The term "contractual benefit" is therefore to be understood in a very broad sense. 

Parent company stock options as contractual benefits?

The Federal Labour Court has pointed out a limit in its recently decided case. According to the Federal Labour Court, the "value" of the stock options of the parent company of the group, of which the defendant employer was one of the subsidiaries, should not be decisive for the calculation of the waiting allowance. In justification, the Federal Labour Court stated that the stock options were not granted by the employer itself, but by the legally independent parent company. The Federal Labour Court reiterated that the term "contractual benefits" only includes those benefits which result from the exchange character of the employment contract and which the employer owes to the employee as remuneration for work performed. Since the plaintiff had not entered into the respective agreements on the granting of the stock options ("Global Restricted Stock Unit Award Agreements") with his employer, but with the parent company, the consideration of the stock options in the calculation of the waiting allowance required at least that the employer had expressly or impliedly assumed a (co-)obligation. However, the Federal Labour Court did not see any such obligation or any reference at all to the American parent company; it denied any obligation on the part of the employer. Even under the aspect that a group-wide non-competition clause was to apply in the case decided, the Federal Labour Court did not come to a different assessment. This broad territorial scope possibly led to a limitation of the non-competition clause to the permissible territorial scope, but not to the fact that the plaintiff, insofar as he also had to abstain from competition, in particular in the business area of the parent company, could demand a waiting allowance taking into account the stock options. For the calculation of the waiting allowance, therefore, only what is part of the contract with the employer and leads to the employer's own obligation remains to be taken into account. Benefits resulting from obligations of third parties are therefore precisely not "contractual benefits of the employer".

Consequences for practice

From the quoted decision dated 25 August 2022, the importance of the precautionary practice is once again apparent. This applies in the specific case with regard to the agreement on participation in the stock option program and equally to the careful drafting of the post-contractual non-competition clause in general. Because a court carefully examines the circumstances of the individual case and weighs up the interests of both parties, there is nevertheless always a risk that a post-contractual non-competition agreement may not be enforceable or may even be void.

Tip

In each individual case, the employer should carefully examine whether the employee, with his know-how and experience, is really worth the compensation to be paid over two years to keep him away from the competition. Alternatively, the employer could consider agreeing to a longer notice period. With a six- or twelve-month notice period at the end of the year, the employee can also be kept away from the competition for a not insignificant period of time. This does not necessarily make the employer financially worse off. Legally, this alternative entails fewer legal risks than the error-prone post-contractual non-competition prohibition.