Possibilities of contractual and post-contractual non-compete agreements
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The US Federal Trade Commission (FTC) recently called for a ban on post-contractual non-competes ("NC"). The background to this was that, as part of the Biden administration's political agenda, the FTC was instructed to investigate the effects of and possible changes to post-contractual NC in employment relationships. As a result, the FTC proposed new legislation to prohibit the conclusion of new NC and the enforcement of existing NC for employees and contractors altogether. Against this background, this article will take a closer look at the legal options for contractual and post-contractual NC that exist in Germany.
Significance of post-contractual NC in Germany
According to the FTC's report, it is estimated that one in five workers in the US has a post-contractual non-compete arrangement. FTC estimates that ending this practice would increase wages by nearly $300 billion and create new career opportunities for about 30 million Americans. However, these figures are not transferable to Germany. On the one hand, NC have been agreed extremely frequently in the US in recent years and are not limited to special know-how carriers or key employees. In this respect, the case of a security service employee who received the minimum wage, but had to pay a contractual penalty of $100,000 if he was employed by another security company, caused a stir. Secondly, there is no legal provision in the US for the payment of waiting compensation, which explains the extent of the predicted wage increases resulting from the ban.
NC have gained importance in Germany in recent years, particularly against the backdrop of the shift towards a candidate market. Companies no longer compete only for customers, but also for qualified employees. Employees are increasingly free to choose between many offers. This increases the risk of know-how carriers and key employees migrating to competitors. The consequences of such a migration can at least be addressed by concluding a post-contractual NC.
Legal situation in Germany
In Germany, post-contractual NC that prohibit employees from switching directly to a competing company are in principle effective and enforceable in court, but are subject to clear legal requirements.
NC during the term of employment
Contrary to the wording – which may suggest a separate agreement – employees are subject to a comprehensive statutory NC during the existence of their employment relationship even without an express individual or collective agreement, Secs. 60, 61 German Commercial Code (Handelsgesetzbuch "HGB") (Federal Labour Court (BAG) dated 30 May 2018 - 10 AZR 780/16, NZA 2018, 1425). Accordingly, employees are prohibited from working independently or for third parties in the business area of their employer for the duration of the employment relationship.
Indeed, Sec. 60 German Commercial Code expressly applies only to commercial employees. However, according to established case law (Federal Labour Court dated 17 October 2012 - 10 AZR 809/11, NZA 2013, 207 with further references), Secs. 60, 61 German Commercial Code also apply accordingly to all other groups of employees. This concretises the general legal concept of the duty of loyalty of all employees, which is also expressed in Sec. 241 para. 2 German Civil Code (Bürgerliches Gesetzbuch "BGB").
Thus, the statutory NC applies equally to all employees, regardless of whether they are employed full-time or part-time, in secondary or marginal employment, or in training.
Secs. 60, 61 German Commercial Code do not apply to bodies of corporations, commercial agents and freelancers.
- For members of the management board of a stock corporation a NC results from Sec. 88 Stock Corporation Act (Aktiengesetz "AktG").
- There is no such provision for managing directors of a limited liability company (GmbH). However, the Federal Labour Court (dated 12 June 1989 - II ZR 334/87) applies Sec. 61 German Commercial Code and Sec. 88 para. 2 Stock Corporation Act accordingly to managing directors of a limited liability company.
- For other service providers, a NC during the term of the contract mostly follows from the general duty to safeguard interests pursuant to Sec. 241 para. 2 German Civil Code.
After terminating the employment relationship, employees are with regard to freedom of occupation in principle no longer subject to any restriction of competition. However, the employer and the employee may agree on a post-contractual NC that restricts the employee's professional activities for the period after the termination of the employment relationship.
Pursuant to Sec. 110 Industrial Code (Gewerbeordnung "GewO"), the regulations on post-contractual NC in Secs. 74 et seq. German Commercial Code apply to all employees – including executive employees and authorised signatories.
A prerequisite for the effective agreement of a post-contractual non-compete is compliance with the provisions of Secs. 74 et seq. German Commercial Code.
Accordingly, the employer must provide the employee with a written document on the agreed provisions and pay a waiting allowance in the amount of at least half of the last contractual remuneration received for each year of the post-contractual non-compete (see our article on the calculation of the waiting allowance).
Furthermore, it is a prerequisite that the employer has a legitimate interest in protection by a post-contractual NC and that the employee's professional advancement is not unreasonably impaired.
In addition, the post-contractual NC may only be agreed for a maximum of two years.
Consequences of a NC violating the provisions of Secs. 74 et seq. German Commercial Code
A violation of the provisions of Secs. 74 et seq. German Commercial Code does not automatically lead to the invalidity of the post-contractual NC; it may in part be non-binding or reduced in order to preserve its validity.
- The violation of the written form leads to the nullity of the NC (Sec. 125 para. 1 German Civil Code). Neither party is bound by a non-written post-contractual NC. If, on the other hand, only the written document is not handed over to the employee, the NC is not void, but merely non-binding.
- If no waiting allowance is agreed, the post-contractual NC is void; if it is merely too low, it is only non-binding.
- If the employer has a legitimate interest in only part of the NC or if parts of the NC unreasonably impair the employee's professional advancement, the NC shall be reduced to the extent permitted by law. The employee remains obliged to comply with the NC to this extent. However, the employee does not have to comply with the excess part. For his part, the employer remains fully obligated to pay the agreed waiting allowance.
- If a post-contractual non-compete is agreed for longer than two years, it is binding for both parties for the first two years. From this point on, i.e. from the third year, it is non-binding.
As far as a post-contractual NC is non-binding, the employee has the right to choose in this respect: he can adhere to the (incorrect) NC against payment of the agreed waiting allowance or he can free himself from it. The employee must exercise his right to choose at the beginning and for the entire duration of the prohibition period (Federal Labour Court dated 22 March 2017 - 10 AZR 448/15, NZA 2017, 846). There is no express declaration required by the employee to exercise the right to choose; his actual conduct is decisive. However, in order to create legal clarity, employers may request employees to exercise the option in accordance with Sec. 264 para. 2 sentence 1 German Civil Code.
Employers, on the other hand, do not have the right to choose; they are bound by non-binding NC without restriction if the employee chooses accordingly.
Is the post-contractual non-competition clause also subject to general terms and conditions review?
Pursuant to Sec. 307 para. 3 sentence 1 German Civil Code, a review of the content of contractually agreed post-contractual NC can only be considered insofar as the contractual agreement deviates from Secs. 74 et seq. German Commercial Code or supplements them. A post-contractual NC – regardless of whether it is concluded separately or within the employment contract – is deemed to be a mutual contract within the meaning of Sec. 320 German Civil Code (Federal Labour Court dated 31 January 2018 - 10 AZR 392/17); the regulations it contains on mutual obligations as well as the relationship between performance and consideration (amount of the waiting allowance) are thus main performance obligations and consequently not subject to review. Nevertheless, the transparency requirement must be observed, Sec. 307 para. 3 sentence 2 German Civil Code. This means that general terms and conditions are subject to review, with the exception of a review of content pursuant to Secs. 308 - 309 of the German Civil Code.
For employers who use post-contractual NC in the sense of pre-formulated clauses, it is therefore particularly important to observe the prohibition of surprising clauses under Sec. 305c para. 1 of the German Civil Code and the transparency requirement under Sec. 307 para. 1 sentence 2 of the German Civil Code.
- NC are indeed quite common and not surprising per se. Nevertheless, they must not be "hidden" in the text of the contract and should therefore be identified in a separate paragraph with a suitable heading.
- A post-contractual NC complies with the transparency requirement if its scope is sufficiently specified in terms of time, place and content. For this purpose, the NC must delimit the period and the area of application as well as define the type of company with whom the employer is in competition (competing company and competing activity).
In the event of a violation of Sec. 305c para. 1 German Civil Code or Sec. 307 para. 1 sentence 2 German Civil Code, a reduction that preserves the validity of the agreement is also ruled out, and the post-contractual NC would be invalid.
No application of Secs. 74 et seq. German Commercial Code
According to the case law of the Federal Court of Justice (BGH) (dated 26 March 1984 - II ZR 229/83), Secs. 74 et seq. German Commercial Code do not apply either directly or accordingly to members of executive bodies of corporations. As justification, the Federal Court of Justice states that executive bodies represent the company to a far greater extent than employees and that this would give rise to a much greater risk that the company would suffer damage as a result of competitive activity.
However, it is questionable whether this almost 40-year-old case law can be upheld against the background of the case law of the ECJ, which, for example, subsumed an external managing director of a limited liability company under the term of "employee". Also according to the case law of the Federal Labour Court (dated 17 September 2014 - 10 AZB 43/14), managing directors of a limited liability company can be in an employment relationship and thus be employees. Although neither the cited ECJ nor the cited Federal Labour Court decision have a direct impact on the applicability of Secs. 74 et seq. German Commercial Code to executive bodies, however the tendency can be derived that at least external managing directors of a limited liability company have recently been regarded by case law as being increasingly worthy of protection. It can therefore not be completely ruled out that this could lead to a change in the case law on the applicability of Secs. 74 et seq. German Commercial Code.
The validity of a post-contractual NC has to be assessed for executive bodies – at least according to the current state of case law – only by the standard of Sec. 138 para. 1 of the German Civil Code. However, the values of Secs. 74 et seq. of the German Commercial Code must be taken into account within this framework.
In concrete terms, this means:
- There is no obligation for the written form.
- A legitimate interest of the company in the NC is also required in the case of executive bodies.
- The NC must be reasonable to the executive body in terms of time and content.
If a post-contractual NC with an executive body complies with the provisions of Secs. 74 et seq. German Commercial Code, it is generally regarded as being in the interests of the company. In case of deviations to the disadvantage of the executive body, a case-by-case examination must be carried out.
Consequences of invalidity
According to the case law of the Federal Court of Justice (29 October 1990 - II ZR 241/89), a reduction of an overly broad NC – in contrast to the case of employees – is only possible in the sense of a reduction to the permissible degree of time. In all other cases, the post-contractual NC is void as a whole. Otherwise, the purpose pursued with Sec. 138 German Civil Code to assign the risk of immorality and nullity to the beneficiary (here: the company) would be missed. The nullity of the NC pursuant to Sec. 138 German Civil Code means that neither party can derive any rights from the agreement: The company has no claim to withholding from competition, and the executive body, on the other hand, has no claim to payment of any agreed compensation for waiting.
If applicable, reduction in accordance with the law in the case of reference to Secs. 74 et seq. German Commercial Code
In the literature (cf. Bauer/Diller, Wettbewerbsverbote, § 24 marginal no. 1070b), it is argued that a valid reduction of the post-contractual NC should be permissible in any case if the contract contains a reference to Secs. 74 et seq. German Commercial Code (e.g.: "Secs. 74 et seq. German Commercial Code apply in addition"). In this respect, it can be argued that it is not acceptable that one cannot agree with a member of an executive body on something that is legally required in the case of employees. This is particularly the case since the Federal Court of Justice emphasizes that, in the case of members of an executive body, the protection of the company takes precedence over the social protection of the member of the executive body in case of doubt. However, this question has not been decided by the Federal Court of Justice (BGH). In any case, companies are advised to first of all provide for the deviations from Secs. 74 et seq. German Commercial Code in the contract with the member of the executive body and to refer to these provisions in addition. In any case, this reference cannot be harmful if the company proceeds accordingly.
Relevant assessment date
The relevant time for assessing the effectiveness of a post-contractual NC is the time of the legal termination of the contractual relationship.
The agreement of post-contractual NC with employees or executive bodies can be a suitable instrument for safeguarding the legitimate interests of companies. However, due to the strict provisions of Secs. 74 et seq. German Commercial Code that apply to employees, employers are required to carefully review and formulate the agreement. Otherwise, the NC may become null and void or at least non-binding. Since it is generally not possible to reduce a post-contractual NC that is too broad in the case of executive bodies - apart from exceeding the time limit - errors on the part of the company can have far-reaching consequences.