Introduction

Concluding non-compete agreements or including non-compete clauses and other restrictive covenants in employment contracts has been common practice in Hungary since its change of government regime and conversion to a market economy. The previous Labour Code of 1992 contained only a general clause and no detailed provisions on such agreements, so the applicable legal principles were developed mostly by the courts and through legal practice.

The Labour Code 1992 provided only that after the termination of an employment contract, employees could remain subject to non-compete agreements or restrictive covenants for a three-year period on conclusion of an agreement containing appropriate compensation, and that such agreements were governed by civil law.

The present Labour Code of 2012 sets out important rules on non-compete agreements, mostly by incorporating the principles developed by court practice. The present code is similar to the previous one in that it provides only fundamental (albeit more detailed) provisions, thereby giving parties significant contractual freedom. These agreements are now regulated by the Labour Code, where they are referred to as "other agreements related to employment relationships". Most practitioners believe that this regulation method strengthens the employment law characteristics of non-compete agreements.

This update outlines common issues that occur in practice, which should be carefully considered before concluding non-compete agreements. Failure to do so may cause problems for parties and their legal counsel in the event of a legal dispute.

Statutory compensation

Under Hungarian law, a non-compete agreement is valid only if appropriate compensation is paid to the employee in exchange. This can be deduced from the constitutional freedom of profession principle, which means that everyone has the right to choose his or her profession. This fundamental right may be limited temporarily (for a maximum period of two years under the Labour Code 2012) if it is necessary to protect the employer's economic interests, but only in exchange for appropriate compensation.

As the appropriateness of compensation often raises disputes, relevant court practice is well developed. All court decisions addressing this question stress that the appropriateness of compensation can be established only after careful consideration of all circumstances, such as:

  • the geographical scope of the restriction;
  • the scope of the restricted activities; and
  • the nature of the employee's profession.

Before the Labour Code 2012 entered into force, the general market standard compensation was approximately 50% of the base salary payable for the non-compete period.

An important change introduced by the Labour Code 2012 is the prescribed legal minimum compensation amount; compensation may not be less than one-third of the base salary that would be due for the non-compete period. Compensation below this limit will result in invalidity of the non-compete agreement. This applies to non-compete agreements concluded after the Labour Code 2012's entry into force.

Enforceability

Another common problem with non-compete agreements relates to their enforceability.

For example, if an employee leaves a company and starts working for a competitor (by violating the non-compete agreement), few options would exist for the original employer to enforce the non-compete obligation and impede the employee's new employment. While parties can establish financial penalties for violation of a non-compete clause, such penalties can lack effect. Typical penalties include repayment of the compensation received and payment of a contractual penalty or damages.

In the case of a damages claim, employers must be able to quantify and prove the exact damages suffered as a result of the violation of the non-compete agreements (ie, the employee's employment by a competitor), which is often difficult. Contractual penalties therefore remain a safe and popular option, but the courts may reduce them if they are too high. If contractual penalties are too low, an employee or competitor may be willing to pay them to relieve the employee from the non-compete obligation.

Ultimately, efficient methods that ease the enforceability of such agreements and better protect employers' interests are yet to be established in practice.

Cancellation right

Parties often conclude post termination non-compete agreements on commencement of an employment contract or include non-compete clauses in the contract. If post termination non-compete obligations become effective only on termination of the employment contract, the parties' intentions and interests and the nature of their relationship would likely be different to when the employment contract was concluded.

The question remains as to whether such non-compete agreements or clauses can be terminated unilaterally by either party if the party does not want to maintain them following termination of the employment contract. If so, it must also be assessed when termination can take place.

The legal practice surrounding this question is constantly evolving. Following a conservative approach, such agreements can be cancelled unilaterally only if it is stipulated in the agreement. Court practice is quite clear that, even in such cases, the unilateral cancellation (typically and particularly by the employer) must occur before termination of the employment contract (ie, before the employee has commenced fulfilment of the non-compete clause). Thereafter, unilateral termination may take place only if it is expressly provided for in the agreement.

In a recent decision, the first-instance court declared that an employer may be entitled to cancel a post-termination non-compete agreement unilaterally before termination of the employment contract, even when no contractual clause allowing it to do so exists. A unilateral termination (ie, cancellation) by an employer may be acceptable, particularly if there was a long time between conclusion of the agreement and termination of the employment contract. Many practitioners questioned this decision, which the court derived from the contractual freedom principle. The case is yet to be heard by the Supreme Court. It will be interesting to see whether the Supreme Court shares the views of the first-instance court, which could lead towards a more employer-friendly approach.

Regardless of the Supreme Court's views on this matter, it is always advisable to avoid legal disputes and set out the rules of cancellation in the agreement itself.

Comment

To avoid the pitfalls described above, it is recommended that employers seek legal advice and have their generally applied templates reviewed by legal counsel before concluding non-compete agreements.

For further information on this topic please contact Dániel Gera at Schoenherr Hungary by telephone (+36 1 8700 700) or email (d.gera@schoenherr.eu). The Schoenherr website can be accessed at www.schoenherr.eu.

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