Forced to pay compensation for non-compete undertakings? Possible risks and side effects of “severability clauses”

Companies involved in sales and distribution or research often agree post-contractual non-compete covenants with their employees. However, section 74(2) German Commercial Code states that such an undertaking is null and void unless the company promises to pay compensation (equivalent to at least 50% of the pay last received) for a period during which an employee agrees not to enter into competition with their ex-employer. If an ineffective post-contractual non-compete covenant is agreed, under the current case law there is a risk that the employee will enter into competition with the company after leaving; yet the possibility of the employer being exposed to payment obligations is ruled out since no compensation for a non-compete undertaking was promised. At the end of March, the Federal Labour Court is to look at whether there are any exceptions to this rule – and whether employers can be obliged to pay compensation that they never promised (case no.: 10 AZR 448/15).

The employer against whom legal action was brought agreed a non-compete covenant lasting two years with an employee working as an industrial clerk; the employee was supposed to pay a contractual penalty of €10,000 for each event of breach. However, there was no duty to pay compensation for the period during which she agreed not to engage in competition with her employer. After leaving the firm the woman demanded payment of compensation equivalent to 50% of the pay last received by her. Although the post-contractual non-compete clause agreed in the employment contract was initially ineffective under section 74(2) German Commercial Code because no compensation had been agreed, the contract also contained a “severability clause” stating that if a term was ineffective, the arrangement the parties would have agreed in this situation should apply. Thus the employee argues that the parties would have definitely agreed on an effective non-compete covenant and therefore on compensation for the period of non-competition at the minimum statutory level of 50% of her most recently earned pay.

The labour court and Hamm Regional Labour Court (case no.: 10 Sa 67/15) both allowed the claim. They pointed out that it was correct that the agreed post-contractual non-compete covenant was initially ineffective due to the lack of an agreement on compensation for non-competition. However, they said that, due to the severability clause, the arrangement the parties would have made if they had been aware that the provision was ineffective should apply. Moreover, whether such a severability clause with the effect of a legal fiction was effective in an employment contract (which is quite rightly denied by well-known voices in the legal literature) was not to be decided here, since the employer that was applying the clause could not claim that it was ineffective anyway. They said that each individual case had to be examined to discover whether the parties had definitely intended to agree an effective post-contractual non-compete clause. They added that notably the contractual penalty agreed would indicate that this intention existed. Consequently, the severability clause led to a post-contractual non-compete period of two years and compensation equivalent to 50% of the pay most recently earned being deemed to have been agreed.

The upcoming decision of the Federal Labour Court entails great risks for companies. On the one hand, companies often agree a post-contractual non-compete clause without compensation even though they know that it is void, hoping that the employee will nevertheless keep to it. Hamm Regional Labour Court emphatically regards such clauses as not being worthy of protection.

Besides this, many employers – especially in international corporations and company groups – also use post-contractual non-compete clauses unconsciously. What comes to mind are, for example, situations where the German employment contract does not contain any post-contractual non-compete clause, but the rules on commission applying worldwide in the sales division, which reflect foreign practices, provide for a post-contractual non-compete clause without compensation. Thus up to now many companies were able to uncritically adopt this clause (since the company wanted the rule to apply uniformly on a worldwide basis, for example). But if the Federal Labour Court confirms the case law of the Regional Labour Court, there is a danger that these companies will be obliged to pay compensation that they never agreed and never intended.

For this reason, companies should review their employment contracts, and especially any other agreements with their employees, to see whether a post-contractual non-compete clause without compensation has been agreed. Cases in which a severability clause was also agreed in the employment contract at the same time (which is normal practice) are particularly risky. If the Federal Labour Court confirms the case law of Hamm Regional Labour Court, post-contractual non-compete clauses with employees should be amended by mutual agreement. If the non-compete clause is not desired in specific situations, the easiest way to avoid paying unintended compensation is to unilaterally waive the non-compete requirement in good time (section 75a Commercial Code).