Legal Updates

Legal updates covering current topics.

Legal Updates / 13.11.2020

New rules concerning non-compete obligation in employment contracts

Under the Employment Contracts Act, the employer and the employee may agree on a non-compete obligation only in limited circumstances. However, in practice the criteria have been vague and non-compete obligations have been more commonly used than what was intended. The reform of the Employment Contracts Act aims to change this situation and force employers to carefully consider when to include non-compete obligation in an employment contract.

 Including a non-compete obligation in the employment contract

Attitudes towards non-compete obligations vary. In other Nordic countries, non-compete obligations are in principle allowed, but the employer must compensate the employee for the harm caused by it. In California, on the other hand, non-compete provisions are systematically prohibited whereas in Belgium the validity of a non-compete provision is connected to the salary level of the employee.

In Finland, the validity of a non-compete provision is not tied to any single factor but a non-compete provision has been deemed permissible if the employer can show that it has a “special reason”  that necessitates the inclusion of a non-compete provision in the employment contract.  Whether such a “special reason” exists depends on the outcome of an overall assessment of the situation at hand.  The reform of the Employment Contracts Act will not bring any changes in this respect.

In practice, the concept of a “special reasons” has remained very vague. It has generally been accepted that a non-compete obligation can, in principle, be agreed with employees working in managerial positions but especially in smaller companies, there should not be more than a handful of such employees. Further, work within research and development has also generally been regarded to constitute a sufficient “special reason” for binding an employee to a non-compete obligation since  the employee,  in this case, may have access to sensitive information such as the employer’s future business plans.

It is particularly difficult to assess whether a “special reason” exists for employees working in sales. From the employer’s point of view there may be number of reasons necessitating the use of a non-compete obligation. It is in the interest of the employer to stop a salesperson from going to a competitor and persuade his/her clients to follow. However, this is not a “special reason” required under law. A non-compete obligation is permissible only if the customer relations within the relevant industry are very personal. In the absence of personal connections there may also be a sufficient “special reason” to include a non-compete obligation in an employment contract if the salesperson’s information on the employer’s pricing and future projects can be considered a significant competitive advantage.

Compensating the employee for a non-compete obligation

Despite the conditions imposed for the use of a non-compete obligation the employers have, in practice, tied their employees to non-compete obligations rather carelessly. Under current law employees have been entitled to reasonable compensation for the non-compete obligation, but only if the non-compete obligation has lasted for more than six months. Shorter non-compete obligations have not required any compensation and therefore the use of non-compete provisions has not really involved any risk for the employer. Even if the non-compete provision was ultimately invalid, the employer had not paid anything for the possibility that it may have led to the employee hesitating to move to a competitor.

The reform of the Employment Contracts Act changes the above described situation dramatically. In the future, an employee tied to a non-compete obligation must always be separately compensated for the period during which the non-compete provision is in force. If the non-compete obligation lasts for a period not exceeding six months, the employee will be entitled to a compensation equalling to 40% of the employee’s normal monthly salary for each month the restriction is in force. For non-compete obligations in force for a period exceeding six months, the compensation to be paid amounts to 60% of the employee’s normal monthly salary. An employee cannot effectively agree on a lower compensation than that defined in Employment Contracts Act. Any agreement on a lower compensation will invalidate the non-compete provision

The above requirement to compensate an employee for a non-compete obligation he/she is bound to also applies to existing non-compete provisions. However, the reform of the Employment Contracts Act is planned to take effect from the start of 2022 there will be a grace period of one year before old contracts are affected giving employers time to renegotiate or terminate existing arrangements. So now is the time to review the current contracts and to determine which kind of non-compete provisions are worth keeping.

Releasing the employee from a non-compete obligation

Currently, an employer can, at any time, unilaterally release an employee from a non-compete obligation. However, if the employee is entitled to a separate compensation for the duration of the non-compete obligation, the employer’s right to waive the non-compete obligation and to be released from such a payment obligation must be specifically stated in the employment contract.

Once the reform of the Employment Contracts Act enters into force, the employer will have an obligation to in advance notify the employee of the termination of the non-compete provision. The applicable notice period is equal to a third of the duration of the restrictive period, but it is always at least two months. This means that a longer notice period applies only in respect of such non-compete obligations that are in force for more than six months after the relevant employment relationship has ended. However, once the employee has notified his/her resignation, the employer can no longer unilaterally release the employee from the non-compete obligation. The employer can, of course, refrain from invoking the non-compete obligation, but the employee is nevertheless entitled to compensation for the non-compete obligation.

Sanctions for breach of a non-compete obligation

An employee who violates the non-compete obligation is liable to compensate the employer for the damage caused. However, proving that the employer has suffered loss due to competing activity is in most cases so challenging that in practice a non-compete provision does not really function unless it is tied to a contractual penalty.

Under the Employment Contracts Act, the contractual penalty may not exceed the employee’s six-month salary. Since the maximum amount does not apply with employees working in managerial positions the contractual penalty may be significantly higher for these employees.

The employer may try to stop the employee from breaching a non-compete obligation by seeking a temporary injunction. This means that a court may prohibit the employee from continuing the competing activity under the threat of a fine. The use of temporary injunctions for the above purpose has in legal practise been approved by the Courts of Appeal but has not yet been subject to a preliminary ruling issued by the Supreme Court. Therefore this is a matter that is still partly open to interpretation and has also not been addresses or clarified in connection with the discussed reform of the Employment Contracts Act. Until told otherwise by the Supreme Court the possibility of resorting to temporary injunctions remains.

Author:

Jouni Kautto
Specialist Partner
Tuurna