08. Restrictive Covenants

Definition and Types of Restrictive Covenants

During an employment relationship, the employee is not allowed to work for any competitor pursuant to statutory law. However, after the expiration of the notice period, the employee is no longer bound by the statutory non-compete. Therefore, it may become necessary to agree upon a post-contractual restrictive covenant with the employee.

Under German law, the freedom to include restrictive covenants in an employment agreement is limited by statutory law. According to statutory law, a post-contractual restrictive covenant is only binding if:

• the agreement is in writing (wet ink signatures) and the employee received an originally signed copy;
• the employer has a justified commercial interest in the content of the restrictive covenant;
• the justified interests of the employee are not unlawfully restricted;
• the covenant does not exceed a period of two years; and
• the employer pays a compensation for the duration of the post-contractual restrictive covenant in the amount of at least 50 % of the prior overall earnings of the employee.

If the justified scope of the post-contractual restrictive covenant is exceeded, the employee may choose whether to adhere to the legitimate part of the restrictive covenant and to be compensated or whether to ignore the restrictive covenant overall, without being compensated. Therefore, the content of restrictive covenants must be drafted very carefully.

The employer may waive the post-contractual restrictive covenant. However, the obligation to pay the necessary compensation continuous for a period of twelve months, although the employee is no longer bound by the restrictions. Only in case of a termination for cause with immediate effect, the employer will be entitled to withdraw from the restrictive covenant. Therefore, if the employer no longer has an interest in the post-contractual restrictive covenant, he should waive those rights and obligations as soon as possible.

Especially with respect to the obligation of compensation payment in the amount of 50% of the last overall remuneration, the post-contractual non-compete is expensive in Germany and should therefore only be used with respect to key employees.

Types of Restrictive Covenants

a. Non-compete clauses

Non-compete clauses can be divided into clauses, which regulate any activity of a former employee for competing companies (company-related), and clauses, which regulate the kind of activities of a former employee (activity-related).

b. Non-solicitation of customers

Such clauses regulate that a former employee is hindered to actively pitch to and contact former customers of the employer in order to transfer the business from the former employer to him/her or a company the employee works for. Customer-related non-solicit clauses will be considered a non-compete under German law, and are therefore subject to the compensation requirement set out above.

c. Non-solicitation of employees

Such clauses regulate that a former employee is hindered to actively solicit other employees of the former employer to terminate their employment and to start working with him/her or a company the employee works for. It should be noted that these covenants (also called non-poaching covenants) do not require non-compete compensation and are therefore, far more common in Germany than actual non-compete or non-solicitation agreements with respect to customers.

Enforcement of Restrictive Covenants – Process and Remedies

If the restrictive covenant is agreed upon lawfully, it can be enforced by the labour courts. There is a possibility of obtaining injunctive relief, whereby the employee can be forced to stop any competing activities. Furthermore, the employer is not obligated to pay any compensation during the time of violation of the restrictive covenant.

The employee has to compensate the employer for any damages, which result from the violation of the restrictive covenant. However, in most cases, it will be difficult for the employer to demonstrate and prove the amount of the damages.

The parties also have the opportunity to agree upon a contractual penalty for each case of violation of the restrictive covenant. This has the advantage that the damages incurred by the employer do not need to be demonstrated, as the amount of the contractual penalty is realised upon any violation.

Use and Limitations of Garden Leave

The employee has a right to work for the employer and therefore cannot be released unilaterally by the employer without a justified reason (criminal acts of the employee, concerns of the employer regarding the protection of its business and trade secrets or any competing acts of the employee). In practice, employees are nevertheless often released from their duty to work after a termination notice until the end of the applicable notice period. During such release, the contractual remuneration of the employee needs to be paid. The employer is, however, entitled to offset any outstanding vacation against the release. Generally, during the time of release the employee may not perform any competing activities as the employment relationship is still ongoing, and the statutory non-compete still applies. However, in case of an irrevocable release, the employer should explicitly state that the non-compete shall continue to exist. In theory, employees can challenge garden leave through an interim injunction, but in practice this rarely occurs.