For as long as an employment relationship lasts, an employee must not compete against his or her employer. This means – even where there is no express clause in the employment contract – that the employee must respect the business interests of the employer and may not make use of business opportunities for his or her own benefit.
Under German law, a restrictive covenant intended to prevent employees from competing with their employers after their employment has ended can be enforced only if it meets certain legal requirements set out in Section 74 et seq of the Commercial Code.
Post-contractual restrictive covenants must be in writing, and the employee must receive a signed copy of the contract containing the restraints. Moreover, the restrictive covenant is binding only if it serves the company's legitimate business interests and does not hinder the employee's career in a disproportionate way. If restrictive covenants are for periods exceeding two years after the termination of employment, they are binding only for the initial two-year period and are thereafter non-binding.
In particular, the restrictive covenant clause must contain a commitment by the employer to pay compensation for the duration of the non-competition period, which must be no less than one half of the last annual salary of the employee for each year of restraint according to Section 74(2) of the Commercial Code.
A restrictive covenant that provides for no compensation for the employee's abstention is invalid and is thus unenforceable for either of the contracting parties. If compensation for the non-competition period is provided for, but is not in line with the requirements of statutory law, the restrictive covenant is non-binding for the employee only. In this case, the employee may choose whether to comply with the restrictive covenant. If the employee chooses to comply and abstains from competing with his or her former employer, he or she can demand the contractually agreed compensation. In this case, the amount of the compensation is, in principle, limited to the amount agreed on in the contract, even if the statutory compensation would have been higher.
However, this applies only if the contractual compensation is specified in terms of amount. If no specific figure is provided for in the contract, the employee may demand the full amount of compensation provided for by law. The Federal Labour Court made it clear in a recent decision(1) that a restrictive covenant is non-binding for the employee when the amount of the compensation is left to the discretion of the employer without a minimum amount as defined in Section 74(2).
In this case, the employment contract included a post-contractual restrictive covenant that obligated the employee not to work for a competitor for a period of two years after the termination of his employment. At the same time, the employer undertook "to pay the employee for the duration of the restrictive covenant compensation left to the employer's discretion". After the employer had terminated the employment relationship for operational reasons, the employee stated that he would comply with the contractual restrictive covenant and expected a confirmation of the amount of the monthly compensation that the employer would pay. According to the understanding of the employee, the compensation had to be at least the amount provided for by law. The employer held the view that the restrictive covenant was indefinite and thus invalid. In any case, he felt that it was non-binding for him.
The court allowed the employee's claim to payment of compensation to the amount provided for by law. The restrictive covenant in the employment contract was valid. According to the court, the fact that the amount of the compensation was left to the discretion of the employer did not mean that no compensation was promised. However, the restrictive covenant was non-binding for the claimant because it did not make clear that compensation to at least the amount required by law (half of the last annual salary for each year of restraint) would be achieved.
In explicitly stating that he intended to comply with the restrictive covenant, the employee had exercised his option. This caused the entitlement to compensation for his abstention to arise.
Compensation in statutory amount in absence of a different agreement
In the absence of deviating indications, the amount of the compensation had to be determined as appeared just and fair. In this context – according to the court – the decision as set out in Section 74(2), according to which compensation must be equal to at least half of the most recent contractual remuneration received by the employee, must be heeded. The minimum amount set out is considered reasonable, as a rule, for the reconciliation of the interests of the parties. This minimum amount of compensation would have to be maintained. In the court's opinion, a lower compensation would not be considered.
Entitlement of contractually agreed compensation in event of too low compensation
In addition, the court upheld its earlier rulings that compensation for the duration of a restrictive covenant that is below the amount prescribed in Section 74(2) is not to be increased to the minimum amount provided for by law. The employee was protected because he knew what compensation he was entitled to if he exercised his option in favour of compliance with the restrictive covenant that was non-binding – this lead to an entitlement to the contractually agreed compensation.
This decision shows again that restrictive covenants should be carefully drafted by employers. It is particularly important to agree on compensation that is in line with statutory law. Errors in drafting contracts have significant consequences and can lead to unpleasant surprises.
In light of the strict requirements for a restrictive covenant that is binding for the employee and thus enforceable from the employer's perspective, it should also be subjected to critical analysis in each individual case as to whether such a restriction of the employee is necessary. Once a (non-binding) restrictive covenant has been agreed on, it may not be possible for the employer simply to cancel it unilaterally. In the worst case, such a restrictive covenant can even lead to a situation in which the employer must pay compensation for a certain period, but the employee is not obliged to comply with the covenant not to compete.
For further information on this topic please contact Björn Otto, Patricia Jares, Bjoern Gaul or Bernd Roock at CMS Hasche Sigle by telephone (+49 221 7716 195), fax (+49 221 7716 252) or email (firstname.lastname@example.org, email@example.com, firstname.lastname@example.org or email@example.com). The CMS Hasche Sigle website can be accessed at www.cms-hs.com.