This article sets out some of the considerations for employers when considering the use of a preliminary agreement to a post-termination non compete clause with employees.
Post-termination non-compete clauses are undoubtedly a perennial issue in employment law advice. Many companies understandably wish to protect themselves against competition from employees who have left the company. However, this protection has its price: compensation paid to the former employee during the waiting period.
However, employers naturally only want to undertake to pay compensation if the employee concerned can actually become ‘dangerous’ after leaving the company. The crux of the matter is that it is not always possible to reliably predict the extent to which an employee will come into contact with competition-relevant information when the employment contract is concluded and whether it is therefore worth agreeing on a post-contractual non-competition clause. Under certain circumstances, this uncertainty can be countered by concluding a ‘pre-contract’.
The fine line between a permissible pre-contract and inadmissible ‘conditional’ non-competes
‘We would like to decide whether or not the post-contractual non-competition clause should take effect when the employee actually leaves.’ Many companies approach us with this kind of wishful thinking. However, the danger of unenforceability always hovers over these kinds of conditional clauses. If the validity of a post-termination non-compete clause depends solely on the employer's will and the employer can decide whether to invoke it (and pay compensation) or not (no compensation), this is an invalid condition. These types of conditional non-compete obligations will not be binding; the employee has the right to choose whether to comply with the non-compete obligation and claim compensation for not competing with their former employer, or whether to undertake activities in competition with their former employer instead. So far, so problematic...
Nevertheless, in order to maintain a certain degree of flexibility in ‘using’ a post-contractual non-compete clause, employers can choose to conclude a preliminary agreement on the subsequent agreement of a post-termination non-compete clause.
Preliminary agreement to a post-termination non-compete
The case law considers the conclusion of preliminary agreements by which an employee undertakes, at the employer's request, to agree on a non-competition clause with particular drafting for the period after termination of the employment relationship to be permissible in principle. But caution: depending upon the circumstances and the concrete terms, such a preliminary agreement can be an unfair obstacle to the employee’s progress under s 74a (1) of the German Commercial Code (HGB).
In this case, the preliminary agreement will not be binding, meaning the employer has no enforceable claim against the employee to impose a post-termination prohibition of competition. But the restriction goes further: the employer must treat the employee as if a non-binding post-termination non-compete was agreed upon. This means the employee can choose whether he or she adheres to the (promised) non-competition clause and demands compensation for doing so, or takes up a competing activity.
Particular importance is attached to the appropriate time limit for the employer's option right when drawing up a preliminary agreement. The German Federal Labour Court (BAG) recently decided (BAG v. 19.12.2018 - 10 AZR 130/18) that an employer can only ask for the employee’s agreement to a post-termination non-compete until one of the contracting parties has given notice of termination of the employment relationship. The same is likely to apply in the event that a termination agreement is concluded. The claim for conclusion of a post-termination non-compete arising from the preliminary agreement must therefore be limited in time, otherwise there is a danger it will not be binding.
The employer’s legitimate interest
Even if the time limits are respected, the binding nature of the pre-contract is far from certain. Rather, case law requires that the employer have a legitimate interest in concluding a preliminary contract. A legitimate interest could exist, for example, if the future professional development of the employee, the further development of the employer's competitive interests worthy of protection or its financial resilience are not sufficiently predictable when the employment contract is concluded and the conclusion of a definitive post-termination non-compete is not (yet) possible.
In the case of a start-up company whose future position on the market is difficult to foresee, this requirement is likely to be met frequently. The same applies to the hiring of an employee who is initially to be employed in a less competitively sensitive position but who, depending on his or her development, could soon be promoted to a strategically important position.
On the other hand, it may be more difficult to demonstrate the employer is justified in wanting to conclude a preliminary contract if it is already apparent at the time of hiring that the employee will come into contact with competition-relevant information right from the start of his or her activity.
Ultimately, this means that the mutual interests in each individual case must be weighed up and the binding nature of the preliminary agreement decided.
Degree of specificity of content required
Finally, the question arises as to how specifically the content of the post-termination non-compete obligation to be agreed in the future must be specified in the preliminary agreement. At first glance, it may be tempting for the employer to leave as much leeway as possible with regard to the content and to make only vague specifications in the preliminary agreement. But this can backfire, as only the written form of the preliminary contract is (just as the non-compete clause itself) is legally enforceable. The written form will only be deemed to have been complied with if the information in it on the content of the prohibition to be agreed in the future is sufficiently concrete and complete that in the event of a dispute, the content of the agreement to be concluded can be determined (cf. Regional Labour Court LAG Rheinland-Pfalz v. 16.2.2017 - 5 Sa 425/16). Therefore, if the preliminary agreement does not contain at a minimum, concrete information on the essential elements of the restriction to be included, it is null and void.
In order to draft an effective, binding preliminary agreement on the future agreement of a post-termination non-compete, there are some hurdles to overcome. The use of preliminary agreement is therefore by no means a panacea. Correctly implemented, however, it can offer companies an excellent compromise between flexibility and planning security.