Questions and answers on non-competition agreements
The Employment Contracts Act and the Seafarers’ Employment Contracts Act understand a non-competition agreement as an agreement between an employer and an employee that restricts the employee’s right to:
enter into an employment contract with another employer engaged in a competing operation, concerning work that commences after the employment relationship ends, or
engage in competing operations on a self-employed basis.
A non-competition agreement governs a period during which the employee is required to refrain from competing with the former employer. The new Act refers to this period as the restraint period.
An employer and an employee may make a non-competition agreement either at the beginning of, or during their employment relationship.
A non-competition agreement does not prevent an employee from transferring to the service of another employer or becoming self-employed if the operation does not compete with the former employer.
A non-competition agreement governs the period after employment ends. The prohibition of competing activity by an employee during employment is based on the Employment Contracts Act or the Seafarers’ Employment Contracts Act.
The conditions for making a non-competition agreement are laid down in the Employment Contracts Act and the Seafarers’ Employment Contracts Act.
The conclusion of a non-competition agreement requires a particularly compelling reason related to the employer’s operations or to the employment relationship. The assessment of a particularly compelling reason must consider:
the nature of the employer’s operations,
a need for protection arising from preservation of the employer’s business secrets,
the employer’s need for protection arising from special training provided to the employee,
the position and duties of the employee, and
other similar facts.
Each non-competition agreement must accordingly be preceded by an overall assessment of the individual case that considers the employee, the duties and the industry concerned, and their specific features. The mere desire of the employer to restrict competition is not an acceptable reason for making the agreement, and instead the employer must have a particularly compelling reason for using a non-competition agreement.
An employer may typically have a real need for a non-competition agreement if the employee’s duties are related to product R&D, and if the employer has knowledge and expertise that are not widely available to competitors.
The amendments to the law are due to take effect on 1 January 2022. Employees will have to be compensated for all non-competition agreements after the new law enters into force. Liability for compensation currently only arises when a non-competition agreement lasts for longer than six months.
The new law also lays down the amount of compensation that must be paid, the time of payment, and the employer’s right to terminate a non-competition agreement and the period of notice to be observed in such cases.
The employer must pay compensation to the employee for a non-competition obligation. This compensation is either 40 or 60 per cent of the employee’s normal salary for the entire duration of the obligation.
The employer must pay 40 per cent of the employee’s salary for a restraint period lasting for no longer than six months.
The employer must pay 60 per cent of salary for a restraint period that lasts for longer than six months.
The employer must pay the compensation within the restraint period specified in the non-competition agreement after the employment ends.
The compensation must be paid within the restraint period in accordance with the salary payment practice that applied during the employment. The employer and the employee may also agree some other compensation payment practice after the employment ends.
The new law entitles an employer to terminate a non-competition agreement during the employment relationship.
The period of notice under the law is at least one third of the restraint period imposed by the non-competition agreement, and must always be at least two months.
The employer may nevertheless no longer unilaterally terminate a non-competition agreement after the employee has terminated the employment, i.e. submitted notice of termination to the employer.
The employer has no duty to pay compensation if the employment ended for reasons attributable to the employer, such as redundancy. A non-competition agreement no longer binds the employee in such cases.
A non-competition agreement will generally be permitted to stipulate a non-competition agreement lasting for no longer than one year, as at present. The maximum duration of one year nevertheless does not apply to employees in a senior position.
Yes, the compensation is a consequence of making a non-competition agreement.
The new regulation will only govern old non-competition agreement made before the new law took effect after a transition period, i.e. as of 1 January 2023. The transition provisions allow an employer to terminate an old non-competition agreement without notice during the transition period. There is no need to terminate the agreement before the employee resigns.
The new regulations will also govern a non-competition agreement that was made before they entered into force. The new law will nevertheless only begin to govern such an agreement after a one-year transition period, i.e. as of 1 January 2023.
The employer may terminate an old non-competition agreement without notice during this transition period, thereby avoiding the obligation to pay compensation under the new law.
The new regulations will not govern an old non-competition agreement if the employer has already:
paid reasonable compensation under current legislation for a non-competition agreement lasting longer than six months, or
begun paying this in instalments before the new regulations take effect.