Decision of the German Federal Labour Court dated 7th July 2015 (file number: 10 AZR260/14)

In principle the mere equity participation in other companies does not constitute anti-competitive activity within the meaning of Paragraph 74 (1) of the German Commercial Code (Handelsgesetzbuch, ‘HGB’). However, a different assessment is needed when, in connection with an equity stake, an activity ‘is carried out’. In accordance with this, an activity ‘is carried out’ if the capital is granted to set up a competing company or allows the exercise of decisive influence on the competing companies.

Background:

The claimant sought compensation for the duration of his post-contractual non-compete covenant. The parties had entered into a formally effective post-contractual non-compete agreement, which prohibited participation in a competitor company by the claimant. The defendant had terminated the employment relationship without notice, as it accused the claimant of having promoted the creation of a competing firm, since the claimant had supported the person who subsequently became CEO with an interest-free loan in the amount of EUR 75,000 for the purposes of establishing the competitor company.

The claimant claimed that he was entitled to the compensation since he had complied with the post-contractual non-competition clause, even though he had granted the loan to the person who subsequently became CEO of the competing company during the term of the employment relationship and has not demanded repayment during the term of the post-contractual non-compete agreement. The claimant claimed that he was only involved in the foundation phase of the competing company as an investor and was neither a shareholder of the rival company nor (currently) entitled to interest on the loan which he had granted.

The labour court dismissed the claim. The higher labour court also rejected the claimant’s appeal.

Decision:

The German Federal Labour Court (Bundesarbeitsgericht, ‘BAG‘) rejected the claimant’s appeal as being unfounded. According to the BAG, the claimant was not entitled to payment of compensation. The claimant breached the post-contractual non-competition clause by not demanding repayment of the loan from the rival company. For this reason, the defendant was not obliged to pay the agreed compensation. The BAG states that the claimant’s claim for compensation did not fail according to Paragraph 75 (3) of the HGB because the defendant had effectively terminated the claimant’s employment relationship due to breach of contract by the claimant for an important reason, as this regulation was void for unconstitutionality. The gap left by the unconstitutionality of Paragraph 75 (3) of the HGB was closed by the application of Paragraph 75 (1) of the HGB by analogy. According to the latter provision, when a breach of contract has been caused by one party, the other party could declare the invalidity of the non-competition agreement by means of a unilateral written declaration within one month after termination.

In the present case, the defendant had not declared that it no longer considered itself bound by the non-competition agreement within one month after the termination of contract.

The effective non-competition agreement between the parties covers the provision of the start-up loan to the competitor company. By way of interpretation, the BAG concluded that continuing with the interest-free start-up loan after termination of the employment relationship constituted a prohibited interest in a competing company within the meaning of the non-competition agreement. The agreed non-competition clause was not non-binding within the meaning of the first sentence of Paragraph 74a of the HGB as it was intended to protect legitimate business interests of the defendant. According to Paragraph 74a (1) of the HGB a non-competition clause is non-binding insofar as it does not serve to protect a legitimate business interest of the employer. Accepted business interests are for example (i) the protection of trade secrets or (ii) preventing the former employee from breaking into customer or supplier structures by taking advantage of special knowledge or personal contacts acquired during the employment relationship. A mere interest in restricting competition is not sufficient. In individual cases the employer could also have a legitimate business interest that the former employee does not hold a significant share in a rival company and so indirectly enters into competition with the employer.

However, a mere shareholding in another company is basically not an activity within the meaning of Paragraph 74 (1) of the HGB. Therefore, for example, a stake through the purchase of shares of a rival company traded at the stock exchange, which allows no specific influence on that company, cannot be the subject of a prohibition on competition pursuant to Paragraph 74 of the HGB.

However, it is a different matter if an activity is ‘carried out’ in connection with the equity investment. Examples of this would include when the capital is granted to set up a competing company or allows the impact of a decisive influence on the competing company. In the present case, continuing to provide a loan granted which is necessary for the continuation of the competing company is of considerable economic importance. This behavior is aimed and targeted to support a competitor. Accordingly, the defendant in the present case has a legitimate business interest that the claimant should not hold an economic interest in a competing company during the term of the non-competition prohibition, i.e. by the claimant providing an interest-free start-up loan and not demanding its repayment.

Because of the breach of the agreed non-competition clause, caused by continuing to provide the loan to the start-up company, the claimant’s claim for compensation fell away. By infringing a non-competition agreement an employee loses his entitlement to compensation for the obligation not to compete. According to the first sentence of Paragraph 326 (1) of the German Civil Code (Bürgerliches Gesetzbuch, ‘BGB’) the claimant’s claim for compensation is void.

Consequences:

The BAG has clarified that legitimate business interests may even exist when former employees are involved to a significant economic extent in a rival company, without them being actively involved in the day to day operations of the company. Moreover with its decision the court has approved the common practice of extending the scope of post-contractual non-compete agreements to prohibit certain financial activities. The BAG makes it clear that it is necessary for such an extension of the non-competition agreement to be justified by legitimate business interests. Further, the court states clearly that it is not possible to effectively prohibit employees from having an interest of any kind in a competing company. Investments to an extent which does not allow the investor to have any material influence on the rival company cannot be covered by a binding non-competition prohibition.

Furthermore, the BAG has explicitly clarified that in the event of infringement of the post contractual non-compete covenant, there is no obligation on the company to pay the compensation.