NEWSLETTER Labor and Employment Client Service Group GERMAN LABOR LAW & HR 1/2012 From Bryan Cave, Hamburg 11 June 2012 Post contractual non-compete agreements with employees Problems to enforce foreign non-compete provisions in Germany When employees change employer, post contractual non-compete clauses can be a reasonable means in order to protect a previous employer s company secrets. As a consequence of globalization employees are more often providing their services in multiple countries. This applies, for example, to employees from the sales department of international companies. This is one reason why post contractual non-compete clauses with a cross-border or even with a worldwide scope of application can be found on a regular basis. The enforcement, however, of cross-border non-compete provisions triggers specific problems under German law. I. Initial situation under German law 1. General requirements of post contractual non-compete agreements under German law In general, pursuant to sec. 74 et seq German Commercial Code (HGB) it is permissible to enter into a post contractual non-compete agreement with employees. However, whether a non-compete agreement is legally effective always depends on the individual case at hand. Under German law such agreements must comply with certain very strict framework conditions in order to be valid and binding: Written form (sec. 74 para. 1 HGB). With regard to the temporal, geographical and factual scope a post contractual noncompete agreement must be justified by a legitimate interest of the employer. 1
The simple desire to prohibit an employee from competing with the employer for a certain period after the end of the employment contract as such is not regarded as a legitimate interest under German law. This requires, in particular, a concrete relationship between the services provided by the employee on the one hand side and the scope of the non-compete agreement on the other hand side. Moreover, there must be a specific risk that the utilization of know-how gained by the employee during the employment relationship with the employer can cause economic danger for the employer. A legitimate interest is recognized, for example, where the post contractual non-compete agreement serves to protect company secrets, the clientele or the employer s relationship with its suppliers. A restricted period of up to two years is permissible (sec. 74 a para. 1 HGB). With regard to the geographical scope an appropriate limitation according to the services historically rendered by the employee has to be made. The pure fact that the employer and/or the group the employer belongs to is present in several countries or even worldwide, is not of itself sufficient to justify a corresponding geographical scope of a post contractual non-compete agreement. With regard to the factual scope, a close link between the former professional activities of the employee on the one hand side and the field of application of the non-compete restriction on the other hand side is required. This becomes apparent if an employee only renders services with regard to a certain part of his employer s diverse business. Under these circumstances there is no legitimate interest to agree upon a non-compete provision covering the whole scope of the employer s business. Attention should be paid to the fact that post contractual non-compete agreements are only valid and enforceable if the clause also contains an obligation by the employer to pay compensation for the duration of the restrictive covenant. The compensation must amount to at least 50% of the last contractual remuneration and benefits (sec. 74 para. 2 HGB). When calculating the compensation, not only the fixed salary but also bonus payments, company cars and further elements of the employee s remuneration have to be taken into account. Keeping the aforementioned principles in mind and based on the individual case at hand it has to be determined which temporal, geographical and factual scope of the post contractual noncompete agreement might be justified. Post contractual non-compete agreements have to be tailor-made to each single case. There is no one size fits all solution. 2
2. Legal consequences of incorrect post contractual non-compete clauses Post contractual non-compete agreements which do not fulfill the legal requirements under German law can be either non-binding for the employee or null and void. This depends on the kind of breach of statutory law. a. Post contractual non-compete agreements being null and void Post contractual non-compete agreements which have not been entered into in writing are null and void and therefore not enforceable. A post contractual non-compete agreement which does not contain a clause providing compensation to the employee during the term of the restriction, also makes the whole agreement null and void so that the agreement has to be regarded as non existent. b. Post contractual non-compete agreements being non-binding for employees In the event a post contractual non-compete agreement is not null and void but non-binding for the employee this leads to the result that the employer is not able to base a claim on the agreement. In addition, the employee can choose either to compete with his former employer without being entitled to a compensation payment or he can adhere to the non-compete clause and claim compensation as set out in the agreement. In the following cases a post contractual non-compete agreement has to be regarded as nonbinding for employees: The clause contains an obligation to pay compensation, but the amount of the compensation is too low. The employer does not have a legitimate interest for being protected by a post contractual non-compete agreement (e.g. the non-compete agreement is solely targeted to keep the employee from terminating his job with the employer). The non-compete agreement is targeted to limit the professional advancement of the employee in an unreasonable manner (e.g. the combination of the temporal, geographical and factual scope of the post contractual non-compete agreement leads to an unjustified impact on the employee s career development). Due to the fact that multiple terms related to abstract legal concepts (which need to be specified or interpreted on a case-by-case basis, e.g. the principle of proportionality) come into play it is always complicated to provide a clear evaluation, if and to what extent any particular post contractual non-compete agreement will be legally valid and enforceable in German courts. Consequently, even for the most tightly-drafted non-compete agreements, there will remain a residual element of risk when it comes to enforcement. 3
For the drafting of post contractual non-compete agreements the strict rules regarding the temporal, geographical and factual scope have to be kept in mind. Otherwise the employer runs the risk that the non-compete agreement will not be enforceable against the employee. II. Problems related to cross-border non-compete provisions in Germany 1. Legitimate business interest of the employer According to German law extending the scope of post contractual non-compete agreements beyond the borders of the Federal Republic of Germany requires a corresponding legitimate interest of the employer. The sole fact that the employer operates in several countries is not sufficient in this regard. The job of the employee and accordingly the experiences gained by the employee in this context must show a relation to the countries the restrictive covenant shall apply for. For example for a sales manager who (i) has never worked in the U.S. market and (ii) has no sensitive business related information of his employer regarding the U.S. market, a restrictive covenant with a worldwide scope respectively one which applies in the U.S. will not be regarded as justified under German law. Whether a post contractual non-compete agreement which is governed by German law will be enforceable outside of Germany depends on the applicable law at the place where it shall be enforced. In particular for post contractual non-compete clauses that shall apply in several countries the geographical scope has to be examined very closely and thoroughly in each single case. It has to be examined whether a legitimate interest of the employer for such extensive scope can be proved. 2. Enforcement of post contractual non-compete agreements in Germany In contrast to the legal situation in Germany, other jurisdictions sometimes allow post contractual non-compete agreements that do not contain an obligation of the employer to pay compensation. This applies, in particular, to parts of the U.S. and the United Kingdom. For this reason in particular, the use of post contractual non-compete agreements is widely spread in employment contracts from these legislations. It is not unusual for an employer situated outside Germany, who has entered into a post contractual non-compete agreement with an employee, to become aware that the former employee competes with it in Germany. As a matter of course, the employer will want to enforce the post contractual non-compete agreement with regard to the employee in Germany. However, employers are regularly facing problems in this situation. This is even if the employment agreement provides that it is governed by the law of a different country and/or would be enforceable in that country. 4
In several cases dealing with the enforcement of post contractual non-compete agreements in Germany which were not governed by German law, the German courts have clearly stated that if such restrictive covenants do not provide for a compensation payment during the term at all, they will not be enforceable in Germany. The reason for such ruling is that German courts have examined the conformability of the restrictive covenant with the fundamental principles of German law (ordre public) and in case a restrictive covenant does not comply with the ordre public it will not be enforceable in Germany. Even if a post contractual non-compete agreement governed by a foreign legal system is definitely legally effective under this legal system it might end up having no bite in Germany. III. Possible Solutions There is a growing legitimate interest of employers in preventing former employees from competing with them after the employee leaves the business not only in one country but in several countries. However, the current legal situation in Germany with regard to restrictive covenants raises the question of how to approach this matter effectively. Whether a post contractual non-compete clause is valid has to be determined in view of the national legal system applying to the individual employment relationship. However, in order to find out whether a post contractual non-compete agreement is also enforceable in other countries this is not sufficient. A possible approach might be to enter into a separate restrictive covenant agreement for each country each based on the local legal system. This, however, would constitute an administrative headache and extraordinary expenditure. Another approach might be to examine, as a first step, which countries are the most relevant countries where the employer has a legitimate interest to be protected by a restrictive covenant. As a next step a post contractual non-compete clause covering the most relevant countries can be drafted that complies with all the laws coming into play. This approach, however, would lead to a clause that will be very employee-friendly, because it would contain a combination of the most employee-friendly elements from all relevant legal systems. In the end, this might be the prize employers would have to pay in such cases. With regard to German law, yet another approach might make sense. As an alternative to a post contractual non-compete agreement employers might consider to agree upon longer notice periods with key employees. Though the employer would have to pay the full salary during the whole notice period this might be an interesting approach, because under German law during the notice period the employee must not compete with his employer. Unlike post contractual non-compete agreements the covenant not to compete during the notice period does not require an explicit agreement, because it is regarded 5
as an implied secondary obligation under the existing employment contract. An explicit definition of the temporal, geographical and factual scope is therefore not required. In case the employee is be sent on garden leave at least during a part of the notice period, the employer would be able to remove the employee from the operational business. During the notice period and the garden leave time it would be the employer s task to approach clients of the employee in order to build up new, and to strengthen existing personal relationships with these clients before the employee is able to contact such clients as a new employee of a competitor. Employers doing business internationally should be aware that post contractual non-compete clauses with multi-national geographical scope often turn out not to have the penetrating power their wording within the respective employment contract seems to suggest, in case a dispute with an employee not adhering to the non-compete clause arises. For the drafting of post contractual non-compete agreements with multi-national geographical scope it is important not only to keep in mind the legal system applying to the specific employment relationship but also the legal systems of all countries the non-compete agreement shall apply to. Firm News: Bryan Cave LLP opens second German office in Frankfurt am Main We are happy to announce that Bryan Cave has opened its second German office in Frankfurt am Main at the beginning of 2012. After successfully building up the Hamburg office this step is part of Bryan Cave s strategy to grow significantly in Germany. The new office in Frankfurt starts with the Partners Dr. Tobias Fenck and Dr. Veit Denzer. Dr. Denzer and Dr. Fenck are mainly advising clients in the area of Private Equity and Mezzanine Fonds as well as banks in the area of M&A, corporate law and finance. The two German offices are fully integrated among each other as well as with the worldwide offices of Bryan Cave. The German offices cover a wide spectrum including labor and employment law, intellectual property, commercial law, competition law, technology as well as litigation. Dr. Michael Leue, Managing-Partner of Bryan Cave in Germany: This increase of our German team will enable Bryan Cave even more to support national as well as international clients of any size. The significant experience of our new partners, especially in the Private Equity area, enlarges our already existing capacities and creates a strong basis for our future growth far beyond the financial sector. 6
Should you have any questions concerning this newsletter or other matters, please contact us at the following addresses: Bryan Cave LLP Dr. Steffen Görres, Attorney, Specialized attorney for Labor Law Hanseatic Trade Center Am Sandtorkai 77 20457 Hamburg Tel.: +49 (0)40 3033 16 0 on the Internet at http://www.bryancave.com as well as per E-Mail Steffen.Goerres@bryancave.com This newsletter is published for the clients and friends of Bryan Cave LLP. To stop this newsletter or all future commercial e-mail from Bryan Cave LLP, please reply to: hamburg@bryancave.com and either specify which newsletter you would like to stop receiving or leave the message blank to stop all future commercial e-mail from Bryan Cave LLP. Information contained herein is not to be considered as legal advice. Under the ethics rules of certain bar associations, this newsletter may be construed as an advertisement or solicitation. Bryan Cave's Briefings are available online at www.bryancave.com. 7