By: Caroline Greco, Rontavian Mack, Sabridass Ponnou, Charlotte Robin, University of Montpellier, Centre du Droit de l'Entreprise, Program of Master 2 "Droit du Commerce International"
Overview
Even though post-term non-compete clauses are usual, they keep raising legal issues in the European Union (EU) in particular within distribution (I), company (II) and professional (III) law.
I. Post-term non-compete clauses in distribution law
In distribution contracts, the validity of post-term non-compete clauses is subject to harmonized conditions throughout the EU (A). However, national concerns may arise (B).
A. Consistency with EU regulation
Article 101 paragraph 1 of the Treaty on the Functioning of the European Union (TFEU) prohibits agreements with the purpose to restrict competition within the internal market. Post-term non-compete clauses prevent access to the market for former network distributors. Consequently, post-term non-compete clauses should be prohibited in distribution contracts.
However, article 101 paragraph 3 of the TFEU defines the conditions under which article 101 paragraph 1 of the TFEU is not applicable.
Thus, post-term non-compete clauses are considered valid according to certain conditions that are presented in the EU Regulation of April 20, 2010. Article 5.3 of this Regulation provides for the application of article 101 paragraph 3 of the TFEU to categories of vertical agreements. They mainly concern franchise agreements. In this instance, the conditions of validity for post-term non-compete clauses are the following:
- Firstly, the clauses must relate to goods or services;- Secondly, they must be limited to the premises and territory from which the distributor has operated during the contract period;- Thirdly, their duration must be limited to a period of one year after termination of the agreement;- Fourthly, they must necessarily be implemented to protect the know-how transferred by the supplier to the distributor.
When the conditions of the EU Regulation are not fulfilled, the post-term non-compete clause could be held invalid. However, the Guidelines on Vertical Restraints allow some individual exceptions based on specific circumstances. Post-term non-compete clauses will be reviewed on a case-by-case basis to determine whether they constitute a restriction of competition.
B. Consistency with national regulations
The EU provisions of the April 20, 2010 Regulation have been restated in national legislations, notably in France by the law of August 6, 2015 as codified by article L341-2 of the French commercial Code, and in Germany in the Handelsgesetzbuch (HGB), which is the German commercial Code.
Different national legislations may have specificities in their application of EU law. In Germany, for instance, there has been a concern regarding the geographic limitation of post-term non-compete clauses. In this regard, an innovative condition to the provision has been granted: it must be geographically limited to a group of customers or a specific area. In this context, a judgment of the Federal Court of Justice of Germany (BGH) ruled on a provision contained in an agency agreement which obliged the commercial agent to refrain from engaging "prospect customers of the company or only to attempt to do" for a time period of two years after the termination of the agency agreement. According to the German judges, this clause was not valid because the concept of "customer prospection" was too vague.
II. Post-term non-compete clauses in company law
In company law, the validity of post-term non-compete clauses is subject to different conditions throughout EU countries relating in particular to proportionality tests (A) and restrictions to re-establishment (B).
A. Proportionality tests
In France, when a company is created, its bylaws may validly contain a post-term non-compete clause prohibiting a former shareholder from competing with the company. The French Court of cassation regularly held that post-term non-compete clauses must contain geographical and temporal limits, which are proportionate to the legitimate interests to be protected. After the publication of the company's bylaws, the introduction of a post-term non-compete clause is more difficult. Indeed, article 1836 of the French civil Code considers that an increase of commitment cannot be imposed upon a shareholder without his consent. Thus, the French Court of cassation ruled that such a clause would have to be decided unanimously.
Furthermore, according to article 1171 of the French civil Code, granted by an ordinance of February 10, 2016 that modified French contract law and the French civil Code, clauses leading to a significant imbalance between the rights and obligations of parties are deemed as not written. Therefore, if a shareholder considers that the post-term non-compete clause causes significant imbalance, he might be able to challenge the provision and even the agreement in its entirety. Consequently, a few questions may arise from this notion:
- Firstly, one could wonder about the applicability of the significant imbalance between shareholders when one of them is bound by a much more important post-term non-compete clause;- Secondly, one could wonder whether shareholders' agreements should be considered as adhesion contracts. Indeed, it must also be noted that in order to fall under article 1171, the contract in question must be an adhesion contract, i.e. a contract that is not proper to negotiation. In practice, it is frequent to see shareholders' agreements including an appendix with a model, which would consequently impede negotiation. Therefore, some legal practitioners consider that it is necessary to review the way to enter into shareholders' agreements;- Thirdly, questions may arise regarding the lack of negotiation in shareholders' agreements. It might be advised to examine the pros and cons of being qualified as an adhesion contract versus negotiating. While the absence of negotiation used to be seen as timesaving, it might now constitute a legal risk for companies governed by a shareholders' agreement.
B. Restrictions to re-establishment
In Italy, article 2557 of the civil Code applies to post-term non-compete clauses with reference to the sale of commercial companies. The transferor is prohibited for a five-year time period to affect the transferee by quickly establishing a new company that would produce the same goods as the company transferred.
The Italian Court of cassation declared illicit the behavior of the transferor who sold his business assets that produced fruits and acquired minority shares in a family business that was located nearby the transferred company. One can wonder if such prohibition of competition would apply in the case of a sale of shares of companies. Case law tends to answer negatively, on the basis that the company and the transferor are two distinct persons.
III. Post-term non-compete clauses in professional law
In professional law, post-term non-compete clauses are subject to restrictions relating to clients' freedom of choice (A) and professionals' freedom to practice (B).
A. Clients' freedom of choice
Some professional rules protect clients' freedom of choice. Indeed, there shall be no de jure or de facto incentive for the client to choose one professional over another. The French Court of cassation has cancelled a clause, which stated that a notary transferring his company would have to payout to the transferee the legal fees that he would receive from his former clients through his new activity, for a ten-year time period. The Court ruled that such a provision altered too much clients' freedom of choice. De facto, this clause was indirectly inducing the former clients to choose the transferee.
In any case, it is recommended, in contracts aiming at guaranteeing the transfer of clientele, to refer to levels of revenue rather than to mention clients' names. We may also recommend drafting a provision that is narrower than non-compete clauses such as provisions forbidding active prospection of clientele after the termination of the contract.
B. Professionals' freedom to practice
A non-compete obligation can also be reached by "garden leave" clauses. According to them, the person subject to the provision is asked to leave work, and stay at home during the time of his/her notice period. This person is exempted from work but remains paid as the employment contract remains during this period.
This is a strategy used in order to keep the person under the company's control and to prevent him/her from working for competitors directly after the termination of the contract.
"Garden leave" clauses appear as a risky provision as, de facto, they may restrict the freedom of professionals to practice.
Conclusion:
Considering the various rules applicable to post-term non-compete clauses and how risky they can be, professionals often adopt similar, yet different provisions.
A final alternative to the non-compete clause is the "non-solicitation" clause, which is sometimes found in service agreements. Such clauses bind the clients instead of binding the employee; the clients commit to refrain from
soliciting and recruiting the employee whose competition is feared.
The French Court of cassation stated that the "non-solicitation" clause might be interpreted as a non-compete obligation as it may affect the employee's freedom of work.
Consequently, this provision could bring innovation to the contract, but might actually lead to the same effects as the non-compete clause.
Region:
European Union
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France
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Germany
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Italy
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