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02 October 2019
Regulation of non-compete agreements
Appropriateness of compensation
Form of compensation
Payment of compensation – during or after employment?
Can you impose a non-compete clause without paying compensation?
Companies often use non-compete agreements to prevent highly skilled employees from using their know-how in favour of competitors following their termination. As employers face increasing labour shortages (especially in Central and Eastern Europe), non-compete agreements are likely to increase in popularity. The Supreme Court recently addressed various questions relating to the compensation paid to employees for post-termination non-compete agreements. This article examines this topic in light of the Supreme Court's recent guidelines and a recent decision which led to debate among practitioners.
In Hungary, post-termination non-compete agreements are regulated by the Labour Code. However, the Labour Code sets out only basic rules (including the maximum term of an undertaking and the minimum compensation to be paid by employers). Therefore, the content of a non-compete agreement is largely up to the relevant parties to decide.
As the Labour Code provides only general rules, the question has arisen as to whether parties are limited in what they can agree. Court practice over the past two decades has played a significant role in shaping the non-compete agreement framework and establishing certain limits. Still, it is sometimes unclear to what extent general conclusions can be drawn. As such, the Supreme Court recently made two attempts to unify this court practice.
First, at the beginning of 2019, the Supreme Court published a summary of the court practice regarding non-compete clauses and study agreements. In its summary, the court drew conclusions from past cases and established guidelines for the adjudication of future cases. Second, in one of its recent decisions, the court found that a non-compete clause which had been imposed without compensation was invalid.
As a matter of principle, post-termination non-compete clauses are valid and enforceable only if appropriate compensation is paid to the employee. The previous Labour Code 1992 provided no regulations as to compensation, but rather left it up to the relevant parties to determine.
Previously, the general market standard compensation for a non-compete clause was approximately 50% of the employee's base salary that would have been due for the same period. However, in practice, parties would agree an amount based on the circumstances of the case, which could be higher or lower than 50%.
Court practice has always stressed that the appropriateness of compensation must be considered on the basis of several circumstances, such as:
In general, court practice accepted that 50% of an employee's base salary was a general benchmark and usually considered such compensation to be appropriate.
Now, the Labour Code (in force since 2012) sets out the minimum compensation to be paid to employees – namely, one-third (33%) of the employee's base salary for the non-compete period.
This new statutory minimum for compensation has resulted in another important change. Under the previous regime, if compensation was disproportionately low, the employee could sue to establish the (partial) invalidity of the non-compete agreement or claim additional compensation. Under the current regime, if compensation is below the legal minimum, the agreement is legally invalid and cannot be enforced.
The Labour Code is silent on the nature and form of compensation. Although uncommon, situations may arise in which the parties agree compensation that is provided in kind, as was the case in a lower level court case. In that case, the employer bore the costs of the employee's training and prohibited them from working for a competitor for a certain period. After the employee's termination, the employer argued that the training costs were in fact the consideration for the non-compete undertaking.
According to the Supreme Court's guidelines, the function of compensation is to cover an employee's living costs during the non-compete period, when the employee is not free to perform work. Therefore, compensation must be financial, and in-kind compensation – especially if paid before the non-compete period – is invalid.
Parties have great freedom to establish the payment terms of compensation, although it is typically paid on the termination of employment (either in instalments or as a one-off lump sum).
In principle, compensation may also be paid during the term of employment. In such cases, compensation for the non-compete agreement must be paid in addition to the employee's salary as a separate item.
Parties often make the mistake of including non-compete compensation in an employees' salary. This may result in the invalidity of the non-compete agreement, as it is generally unacceptable to include such compensation in an employee's salary.
Court practice confirms that the amount and legal basis of an employee's monthly salary and compensation must be separate in terms of payroll; otherwise, the employee may successfully argue that only the monthly salary was paid. To avoid this outcome, if compensation is paid during the employment period, the employee's payslip must clearly indicate the amount and legal basis of the paid sums.
In practice, parties may fail to agree compensation or specifically agree that no compensation will be paid. According to the Supreme Court guidelines, if the parties to a non-compete agreement fail to agree compensation, the agreement is not effected and the non-compete undertaking cannot be enforced.
In a recent case heard by several courts, the parties had specifically agreed that no compensation would be paid for the non-compete agreement. It was then debated whether a non-compete agreement may be concluded in such a way if the employee is employed in an executive position. According to the Labour Code, executive employees may be employed under more flexible terms and they and their employer may contractually deviate from the statutory rules of the Labour Code – even to their detriment. In the case at hand, the employer argued that it was possible to impose a non-compete obligation without paying compensation, as this would constitute a permitted deviation from the statutory laws. The Supreme Court rejected this argument and concluded that compensation is a necessary element of any non-compete agreement and that parties therefore cannot deviate from the rules in this regard.
Although parties have great freedom to establish the terms of their non-compete agreements, several aspects of such agreements are regulated – albeit only by court practice. It is therefore always recommended that parties seek legal advice to avoid the pitfalls which may result in the invalidity or unenforceability of a non-compete clause.
For further information on this topic please contact Dániel Gera or Dorottya Gindl at Schoenherr Hungary by telephone (+36 1 8700 700) or email (email@example.com or firstname.lastname@example.org). The Schoenherr website can be accessed at www.schoenherr.eu.
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