Validity of restrictive post-employment non-compete covenants

Lexology, June 14, 2019

There are many ways how employers may protect themselves and their legitimate business interests against employees leaving the company. Some of them include non-compete, non-dealing or non-solicitation clauses either in respect of existing or prospective employer’s clients or employees. As an indirect restriction employers may exercise incentive arrangements (e.g. garden leave).

Restrictive post-employment non-compete covenants may especially come under spotlight when it comes to company’s key employees with in-depth knowledge of certain confidential information such as business plans and trade secrets or with direct access to privileged information such as the customers databases, pricing policies, intellectual property, etc.

General impression is that Croatian employers are not particularly worried about protecting company’s business against former employees leaving the company. The most frequently exercised restrictive non-compete covenant is post-employment contractual prohibition of competition which is regulated in the Employment Law.

Contrary to the statutory prohibition of competition which applies during the time of employment, an employer and an employee may stipulate that, for a certain time after the termination of the employment contract, an employee must not enter into employment with another person who is competing on the market with an employer, and that an employee must not conclude business transactions that constitute competition with an employer, neither for her/his own account nor for the account of another.

Such contract must not be concluded for a period longer than two years after the date of the termination of employment and is not binding on the employee if the aim of the contract is not to protect the legitimate business interests of the employer or if, taking into account the area, time and aim of the prohibition and in relation to the legitimate business interests of the employer, the contract disproportionately limits the work and promotion of the employee.

In practice a post-employment non-compete clause is commonly included in the employment contract. It is also possible to agree on such a restriction in a form of a separate agreement which in order to be enforceable must be concluded in writing. Because a restrictive non-compete covenant is valid only if agreed by consensus reached between the employer and the employee, consequently it shall be deemed invalid if unilaterally imposed by the employer. A typical example of invalid non-compete clause would be where an employer includes a non-compete clause in the decision on termination of employment.

Employers should especially be cautious not to contract non-compete clauses that the court may find invalid. Under the Employment Law, a non-compete contract shall be considered null and void if it is concluded by a minor employee or by an employee who, at the time the contract is concluded, is receiving a wage amounting less than the average wage in the Republic of Croatia.

Even though Croatia does not recognise the doctrine of precedents in that the court rulings may not be considered a direct source of law, in practice when it comes to employment disputes the court practice shall have decisive effect, in particular in a part relating to interpretation of particular provisions of the Employment Law. A consequence may be that even a non-compete clause is at first glance contracted in accordance with the law, depending on particular circumstances of the case, the court may find it invalid.

For example, by agreeing the statutory provided maximum non-compete term of two years in respect of a former “ordinary” employee (employee other than “key personnel”) and extending the application of a post-employment prohibition of competition to the entire Croatian territory and for the entire range of services a former employee has been qualified for, employers put themselves in risk of losing the court case if they decide to enforce such a clause against the former employee.

This statement is upheld in the court dispute instigated by former employer against former employee who was employed for a position of a salesman and who was subject to post-employment prohibition of competition that was agreed for the maximum period of two years and extended for the entire territory of Croatia. In this case, the Croatian Supreme Court has ruled the clause to be null and void arguing that considering the quality of the employee’s working position (ordinary salesman without been entrusted with the duties of the key employee) such restrictive covenant disproportionately limits the work and professional advancement of the employee and as such may not be deemed to protect legitimate interests of the employer.

Furthermore, the contractual prohibition of competition shall be binding on an employee only if the employer has undertaken a contractual obligation to pay compensation to the employee for the duration of the prohibition, amounting to at least half of the average wage paid to the employee in the period of three months prior to the termination of the employment contract. The employer may be exempt from the obligation to pay the employee compensation during the time of contractual prohibition of competition only if in case of a breach of a non-compete clause, the parties have agreed the contractual penalty as a single sanction. In that case a consequence on the employer’s side would be that it shall have a limited right in enforcing its claim towards employee in that it shall not be entitled to compensation of damages occurred as a result of the employee’s breach of a non-compete clause, should these be greater than the amount of the agreed contractual penalty but only the payment of the amount of contractual penalty.

Where the employee breaches the agreed post-employment prohibition of competition and engages in activities that are violating employer’s rights, depending on the content and the scope of the restrictive arrangement, the employer may claim: (i) imposing an injunction against the employee for ceasing the competitive activities; (ii) compensation of damages in case of violation of the clause in which case it needs to prove actual accrued damages; (iii) contractual penalty, if any but the court has a right to modify it in which case the existence of a penalty clause only, prevents the employer from enforcing the non-compete clause by any means other than the penalty.

This shows us that already at the occasion of entering into employment relationships with employees but also on a later stage when amending the existing employment agreements, employers should pay particular attention to content and scope of application of the restrictive non-compete covenant which shall be drawn up in such a manner to meet the needs of the particular situation (e.g. the scope of limitations, the length and the territory subject to application of a restrictive covenant shall be agreed dependant on the employee’s position within the company and the importance of her/his tasks and duties she/he was entrusted with).

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