The retroactive and complete withdrawal of a non-competition compensation in the event of a violation against a post-contractual non-compete obligation may be effectively agreed with a managing director of a GmbH (German limited liability company).
German Federal Court of Justice (BGH), decision of 23 April 2024, II ZR 99/22
During the term of their service contract, managing directors of a GmbH are subject to a statutory non-compete obligation requiring them to always keep in mind the best interest of the company and thus banning them from taking advantage of business opportunities for themselves or for third parties. The non-compete obligation ends upon their leaving the position. This (statutory) non-compete obligation will not survive the directors’ term of office. Managing directors are also subject to a contractual non-compete obligation for the duration of their service under their contract.
A post-contractual non-compete obligation may, however, also be agreed with a managing director for an appropriate period after the end of their service term. While sections 74 et seq of the German Commercial Code (Handelsgesetzbuch, HGB) provide for a mandatory non-competition compensation for employees, it is the prevailing opinion in legal literature and practice that these sections apply neither directly nor mutatis mutandis to managing directors. At least part of legal literature argues that the requirement of a non-competition compensation could, however, be derived from section 138 of the German Civil Code (Bürgerliches Gesetzbuch, BGB) in connection with Art. 2 of the Basic Law for the Federal Republic of Germany (Grundgesetz, GG) (moral law check). According to (consistent) rulings of the BGH, it is not mandatory to promise any non-competition compensation to the managing director at all for the duration of the non-compete obligation. The effectiveness of a non-compete obligation is not contingent on any compensation. If the decision is taken to pay a compensation regardless of the above, the amount of such compensation will therefore be at the discretion of the parties.
In the case ruled upon by the BGH, a former managing director of a GmbH requested to be paid a non-competition compensation. The managing director was removed from office at the end of May 2012. According to his service agreement, he was subject to a two-year post-contractual non-compete obligation banning him from working for a competitor. The service agreement stipulated monthly payments for the duration of the non-compete obligation as a compensation. This compensation was, however, going to be forfeited retroactively (ex tunc) should the managing director breach the non-compete obligation.
The managing director started working for a competitor in mid-June of 2013. The GmbH therefore took the stance that it had not been obliged to pay any non-competition compensation from the start due to the violation of the non-compete obligation. The former managing director, on the other hand, believed that the contractual agreement regarding the complete and retroactive withdrawal of his right to compensation was invalid and that the ban particularly violated the principle of proportionality.
The BGH ruled in favour of the GmbH confirming the effectiveness of the contractual agreement. It argued that non-compete obligations were only valid if they did not go beyond the scope necessary in terms of place, subject-matter and time.
The BGH stated that the retroactive withdrawal of the non-competition compensation agreed in the employment contract was not an unfair burden on the managing director. The reasoning behind this was that it was, in fact, not mandatory to promise and pay a non-competition compensation to the GmbH’s managing director who did submit to a post-contractual non-compete obligation. The BGH is of the opinion that if a compensation is agreed despite this fact, the parties are free to negotiate any amount. It reasoned that, consequently, the GmbH and the managing director may effectively agree that the right to compensation in its entirety was forfeited retroactively should a managing director breach the non-compete obligation.
The Court also disagreed with the managing director's view that the non-competition compensation constituted a what is known as income replacement benefit which could not be forfeited retroactively as the managing director was even contractually allowed to unilaterally waive the non-compete obligation.
This decision is consistent with past rulings of the Senate according to which a GmbH is not obliged to promise its managing director a non-competition compensation in exchange for the agreement of a non-compete obligation. The possibility of a (complete) loss of the compensation following a breach of the obligation lies within the scope granted to the GmbH by judicial decisions.
Such retroactive withdrawal is, however, most likely invalid when it comes to employees. The non-compete obligation of an employee is, in fact, not freely negotiable (unlike the obligation of managing directors). Pursuant to section 74 (2) of the German Commercial Code (Handelsgesetzbuch, HGB), the employee's non-competition compensation is the designated consideration for the employee assuming and complying with the obligation. The non-compete obligation of an employee is only valid if a compensation has been agreed for its duration, the amount being at least half of the last remuneration contractually received by the employee and it is paid at the end of each month pursuant to section 74b (1) HGB. When it comes to the fixed payments granted, payments depend on the last monthly salary before leaving the company. Pursuant to section 74b (2) HGB, one-off payments and variable remuneration are based on the average of the last three years broken down to monthly payments.
In practice, this ruling opens another option for drawing up and negotiating managing director service agreements.
Dr Barbara Mayer
Dr Christian Osbahr
This post also appears in the Haufe Wirtschaftsrechtsnewsletter.
