A Managing Director may not enter into competition with the company with which he is employed for the duration of his activity. A non-compete clause also exists without an express agreement since the corporate fiduciary duty demands entrepreneurial austereness regarding the business of the company during the Managing Director’s tenure. In order to provide clarity for both sides, the employment contract should determine in detail the activities of the Managing Director still permissible.
Interests
In practice, post contractual non-compete clauses for Managing Directors play a far more significant role. Especially (startup) companies, to whom technology, development, expertise and specialist knowledge or contacts of the Managing Directors are crucial for their success on the market, should sufficiently protect themselves against competitive activities of their former Managing Directors. This is offset by the Managing Director’s interest in continuing to pursue economic activities – a freedom which is protected by Art. 12 of the German (Federal) Constitution.
Contractual Arrangements
Each company would be well advised to determine internally which activity restrictions shall apply after the Managing Director leaves the company. Then, the outcome should be clarified in a dialogue with the Managing Director. This procedure applies regardless of whether the Managing Director is involved in the company as a shareholder. If there is no agreement of a post contractual non-compete clause, and if in doubt, the former Managing Director has the freedom of economic activity after termination of service.
A legally permissible stipulation, however, must not completely remove the Managing Director’s ability to compete. Instead, it should create a balance between the interests of the company and the Managing Director. The clause should be included either in the contract of employment of the respective Managing Director or, in case the Managing Director is also involved as a shareholder in the company, in a shareholder agreement. A provision in the Articles of Association is not recommended since any alterations (in a limited liability company – GmbH) would have to be notarised; furthermore, the Articles of Association must be submitted to the Commercial Register so that any alteration would be made public.
In the case of a breach of the post contractual non-competition agreement, the company is entitled to injunctive relief and damages against the former Managing Director. It is also feasible to agree on a contractual penalty in case of infringement.
Design and Limitations
According to jurisdiction, a post contractual non-compete clause must be limited to a necessary level so as not to curtail the Managing Director’s economic freedom of action. In particular, the company must be able to demonstrate a legitimate interest, e.g. protection of customer and business relationships. In addition, a post contractual non-compete clause must be limited in terms of relevant business, geographical area and duration:
- Subject matter: The non-compete clause may, in general, not exceed the statutory corporate purpose and the commercial activity of the company.
- Geographical Area: The non-compete clause must be limited to the geographical area in which the company operates in a relevant way, or for which specific plans are made in order to expand business operations.
- Duration: Since a perpetual post contractual non-compete clause is invalid, a fixed time period is mandatory. The standard is one to two years.
In particular: Waiting Allowances
Of crucial importance for the balance of interests is a waiting allowance, i.e. a reasonable remuneration for the period of the non-competition obligation. Without such a waiting allowance, a post contractual non-competition clause is not necessarily inadmissible, but the agreement of a waiting allowance may protect any arrangement significantly impeding the Managing Director’s career advancement from ineffectiveness.
Custom Design
Time and again, jurisdiction declares agreements restricting competition to be invalid. It highly depends on the specific case which design is ultimately allowed. Thus, an objectively moderate restriction for a highly specialised Managing Director may de facto entail a fully-comprehensive ban on the pursuance of economic activities. A pure customer protection clause is subject to less stringent requirements than a comprehensive restriction for the Managing Director.
Conclusion
Due to the central position of Managing Directors in (start-up) companies, post-contractual non-compete clauses have a high practical relevance. Companies should therefore consider the design of a post contractual non-compete clause for Managing Directors carefully, and have the desired scope and concrete form legally verified.