In review: employment law for executives in Finland

The Executive Remuneration Review, 10th Edition

Employment law

i General

The Finnish Employment Contracts Act (ECA)¹² is applicable to most employment relationships in Finland. Managing directors of limited liability companies are, however, excluded from the scope of the ECA. The terms of assignment for managing directors are determined by the service contract between a director and a company. In addition, the Finnish Companies Act¹³ regulates the managing directors' position as an organ of a company. In practice, most of the agreed terms of assignment of managing directors do not, however, differ to a large extent from those of other executive directors.

The ECA provides for a loyalty obligation for employees, according to which employees must avoid everything that conflicts with actions reasonably required of an employee, considering the employee's position. In addition, the ECA explicitly prohibits competing activities. During the term of employment, an employee must not work for other employers or engage in activities that would apparently cause harm to the employer as a competing activity contrary to fair employment practices. The nature of the work and the position of the employee are taken into account in this assessment. In the event of a breach of a non-competition obligation, the employer may claim damages from the employee for any losses caused by the breach. Furthermore, an employer may be liable to pay damages jointly with a new employee if the employer knew upon recruitment that the new employee was precluded from working on the basis of a non-competition covenant.

ii Post-contractual non-competition and non-solicitation obligations

The ECA sets limits to non-competition undertakings applicable after expiry of employment. Under the ECA, a non-competition undertaking may limit an employee's right after the end of an employment relationship to conclude an employment contract with an employer engaged in operations competing with his or her previous employer, and also to be otherwise engaged in competing operations, either directly or indirectly.¹⁴ A non-competition obligation should always be supported by particularly weighty reasons in order to be valid.¹⁵ In practice, a non-competition clause is typically included in management level contracts.

When assessing the particular weight of the reason for a non-competition clause, one of the criteria taken into account is the nature of an employer's operations and the need for the protection of trade secrets.¹⁶ Special training given to an employee by his or her employer and the employee's status and duties must also be taken into account.

The prohibited activities may be restricted to cover only a certain geographical area or certain parts of the employer's business. It is also possible to limit the restriction to cover activities with specified competitors, or to cover specific products or services of the employer.¹⁷

A non-competition clause may, under the current ECA, restrict an employee's right to conclude a new employment contract or to be engaged in the trade concerned for a maximum of six months.¹⁸ If the employee receives reasonable compensation for the restrictions imposed by a non-competition clause, the maximum duration of the restriction is one year. Based on established practice, the level of reasonable compensation in such cases is set at a minimum of 50 per cent of the normal salary for the full duration of the restricted period. The compensation is typically paid either as a lump sum or in monthly instalments after the end of employment.

In cases of a breach of the non-competition covenant, an employee may be liable to pay either damages for loss, or alternatively the agreed contractual penalty. The level of such penalty may not exceed the amount of salary received by the employee for the six months preceding the end of the employment relationship.

According to the ECA, a non-compete clause that does not comply with the above is void. If the duration of the restriction or the amount of contractual penalty exceeds the maximum amount provided by law, the restriction does not apply for the part by which it exceeds the limits set by the ECA.

The restrictions related to the duration of a non-competition undertaking and the maximum contractual penalty do not, however, apply to employees who, in view of their duties and status, are deemed to run an enterprise or an independent part thereof, or to have an independent status comparable to such managers. Even if the restrictions on the duration of the non-competition undertaking and the level of contractual penalty provided for in the ECA are not applied to the aforementioned managers, terms unreasonably restricting competition are prohibited under the Finnish Contracts Act.¹⁹ Therefore, a contract under which a person, in order to prevent or restrict competition, has undertaken not to engage in a certain activity or not to conclude an employment contract with another person engaging in such activity, may not bind a party who has made such a promise to the extent that it unreasonably restricts his or her freedom. In practice, the non-competition undertakings applicable to managers rarely exceed 12 months in duration; the amount of contractual penalty is also usually within the range set in the ECA. Managing directors of large companies form an exception to this rule.

The term of a non-competition undertaking applicable after employment is calculated as of expiry of the notice period. Therefore, a release from duties during a notice period does not, unless otherwise agreed, affect the duration of the non-competition undertaking. A non-compete clause is not, however, applicable if the employment relationship has been terminated for reasons deriving from the employer, for example, in the case of collective redundancies.

Amendments to the legislation regarding post-contractual non-competition undertakings have been considered and prepared for years. The government finally issued a legislative proposal in November 2020, which is now being considered by Parliament. The amended act is expected to enter into force as of the beginning of 2022.

Based on the proposal, the obligation of the employer to pay compensation for the duration of the restricted period would be extended to apply to all post-contractual non-competition undertakings irrespective of their duration. The level of compensation would be 40 per cent of the employee's salary for any restricted period lasting no more than six months, whereas the compensation would be at least 60 per cent of the salary in case of a non-competition undertakings longer than six months. The compensation would be paid on the customary paydays of the employee during the restricted period, unless otherwise agreed with the employee at the time of resignation.

The maximum duration of the restricted period would remain at 12 months and in cases of a breach of the non-competition covenant, an employee could still be liable to pay either damages for loss, or alternatively the agreed contractual penalty. The level of such penalty would remain at an amount corresponding to the employee's salary for six months. In addition, non-competition undertakings of employees who, in view of their duties and status, are deemed to run an enterprise or an independent part thereof, or to have an independent status comparable to such managers would remain to be exempt from such limitation in time as well as the restriction of the maximum contractual penalty.

The suggested amendments would also introduce a right for the employer to renounce the non-competition agreement. This would allow the employer to serve notice of termination of the non-competition undertaking during the employment relationship in case of, for example, a change of the circumstances of the employer, by observing a notice period corresponding to one-third of the agreed restricted period, but not less than two months. However, no unilateral right of serving notice of the non-competition undertaking would exist in case of a resignation served by the employee.

Based on the proposal, the new regulation would also apply to non-competition agreements concluded before the entry into force of the amendments after a transitional period of one year.

The objective of the amendment is to steer employers to consider whether and to what extent the use of restrictive post-contractual covenants are necessary, and in this way to reduce the use of post-contractual restrictions and to increase the flexibility of the labour market. Finnish law does not recognise the concept of non-solicitation and no provisions regarding restrictions related to non-solicitation are expected to be included in the aforementioned new regulations either. Based on legal practice, however, a non-solicitation clause restricting the solicitation of clients or employees of a former employer has been considered to correspond to a non-competition undertaking. Therefore, a non-solicitation obligation can only be enforced when particularly weighty reasons related to the operations of the employer are at hand and the restrictions regarding its application correspond to those set for non-competition covenants.

In the case of a transaction, non-competition covenants applicable in the employment relationship remain in force as such. However, the presence of the particularly weighty reasons referred to above is determined on a case-by-case basis (see footnote 16). Based on recent legal practice, courts tend to interpret non-competition obligations restrictively, or even conclude that the weighty reasons needed for a non-competition obligation to be possible do not exist. A non-competition obligation should therefore always be drafted carefully to suit the particular case in question.

In situations where an employee is also a shareholder, or where a former shareholder continues to be employed by a company after the sale of his or her shares, the shareholder agreement or transactional documentation may impose a non-competition undertaking exceeding the limits in duration and the maximum contractual penalty set by the ECA. The assessment of the fairness of the restrictions relating to the separate non-competition undertakings in shareholder or transactional agreements must then be made on a case-by-case basis, based on the general prohibitions of unfair terms of contract and restricting competition.

iii Termination of service relationship

Managing directors of Finnish companies are not covered by the restrictions related to the termination of employment of employees. All other employed executives are covered by applicable employment legislation and the provisions on termination of employment relationships.

An employment relationship can be terminated based on an agreement or based on a notice from either party. Employment legislation in general does not regulate termination of an employment relationship with an agreement. Owing to the mandatory nature of provisions in the ECA, a company cannot, however, freely agree with an employee on all issues related to termination of employment.²⁰ Instead, general standards of reasonableness will limit the contents of such an agreement regarding both managing directors and employees. A typical clause of such an agreement is a release of claims against the employer.

For an employer to be able to terminate an employment contract legally, valid and weighty grounds for termination are required, which may be either organisational or related to an employee. When assessing whether sufficient grounds for termination exist, the situation is always evaluated as a whole, taking all relevant factors into account.

Organisational grounds relate to the economy, production or organisational change of the employer company. Employment can be terminated if work available has diminished materially and permanently. Valid organisational grounds are not considered to exist in a situation where an employee can be offered other duties that are suitable for his or her training and skills, or where an employee can reasonably be trained in new duties.²¹ The ECA also lists other situations where valid organisational grounds are not deemed to exist.²²

Regarding termination grounds related to an employee, the grounds for termination must be weighty and proper. The concept is not defined in the ECA; rather, the ECA includes a list of reasons that do not fulfil this requirement. Employees who have neglected their duties or have breached their terms of employment may normally not be given notice before they have been specifically warned and have thus been given a chance to change their conduct.²³ The warning should specifically refer to the possible termination of the employment relationship if similar problems continue.

Constructive termination or voluntary termination for good reason as concepts are not defined in the ECA, but the issue is recognised.²⁴ Cases of voluntary termination for good reason are, once an employee has shown it probable that a good reason for terminating the employment relationship exists, treated as cases of unfair dismissal. The number of cases where voluntary termination for good cause is claimed to exist has been on the rise during recent years. Likewise, the number of cases relating to harassment and unfair treatment of employees in general has risen.

Severance payments to employees are not mandatory under Finnish law. Often, an employer will pay voluntary severance in addition to salary for the notice period. The amount of severance varies greatly depending on the position of the employee and the type of business in which the employer operates, and also depending on the general economic and organisational situation of the company.

Change of control as such is not a ground for terminating employment contracts. In a transfer of business, however, employees are entitled to terminate employment relationships applying a specific, shorter notice period.²⁵ The transfer of employment to a new owner in connection with a corporate transaction will not give rise to a severance payment if an employee terminates the employment relationship, and no custom regarding payment of such severance exists.

All companies that employ at least 20 employees in Finland²⁶ on a regular basis must follow a specific negotiation process before decisions to terminate employees' contracts are taken based on economic or organisational reasons.²⁷ There is no limit regarding application of the process based on the number of employees who would be given notice of termination, and this process must thus also be followed when the organisational reason relates to just one employee in a senior executive position. The process does not relate to termination of employment, which is made based on agreement between the employer and the employee.