Changes to non-compete agreements in 2022
Katja Halonen, Attorney-at-Law, Trained on the Bench, M.Sc. (Econ.)
On 12 November 2020, the Government submitted a proposal to Parliament to amend Chapter 3, Section 5 of the Employment Contracts Act concerning non-compete agreements. The amendment is scheduled to enter into force on 1 January 2022. The purpose of the legislative change is to promote the mobility of workers and cut back the widespread use of non-compete agreements that slow down economic growth. What will change in practice?
Currently, the Employment Contracts Act permits the use of non-compete clauses for very compelling reasons. If the agreed non-compete period does not exceed six months, the employer is not obligated to pay the employee compensation for the period of non-competition. After the proposed bill is passed, all non-compete agreements and non-compete clauses of employment contracts are subject to compensation without exception.
In the proposed bill, the amount of compensation is tied to the duration of the non-competition period. The employer is obligated to pay the employee 40 per cent of the employee's normal salary for the period of non-competition if the duration of the non-competition period does not exceed six months.
If the non-competition period is more than six months, the compensation is 60 per cent of the employee's normal salary. Compensation must be paid at standard salary period intervals unless the employer and the employee agree otherwise after the termination of the employment contract.
The proposal also gives employers the option to terminate the non-compete agreement with a notice period of at least one-third of the non-competition period but no less than two months. If the duration of the non-compete agreement is nine months, the employer must provide a notice period of at least three months.
However, the right to terminate the agreement no longer exists after the employee has terminated the employment contract. In this case, at the end of the employment contract, the employer is obligated to pay the employee compensation for the period of non-competition.
What remains unchanged?
As before, signing a non-compete agreement requires a very compelling reason related to the employer’s operations or the employment relationship. A non-compete agreement is not binding on an employee whose employment has ended for reasons attributable to the employer, such as on economic or production-related grounds.
As the sanction for violating a non-compete agreement, the employer and employee may agree to pay a contractual penalty instead of damages, the amount of which may not exceed the salary of the month preceding the termination of the employee's employment.
The maximum duration of non-compete agreements remains at 12 months. As before, the duration of a non-compete agreement or the amount of contractual penalty is not limited for employees who work in a managerial position or an independent position equivalent to a managerial position.
The bill proposes the adoption of transitional provisions for non-compete agreements that have been signed before the amended law’s entry into force. Non-compete agreements signed before 1 January 2022 will be subject to current legislation until one year after the amendment’s entry into force.
After this date, i.e. 1 January 2023, the amended law will apply also to non-compete agreements signed before 1 January 2022. However, an exception to the application of the amended law are situations where the duration of the non-compete agreement has been agreed to be more than six months and the employer has paid or began to pay the employee a reasonable compensation for the period of non-competition under the current legislation. In such situations, the current legislation will continue to apply one year after the entry into force of the amendment.
Under the transitional provisions, employers also have the right to terminate non-compete agreements signed before the entry into force of the amendment on 1 January 2022 for one year after this time without the need for a notice period. In other words, employers have until the end of 2022 to terminate unnecessary non-compete agreements in order to avoid paying potential non-competition compensation in the following years.
The employment contract was signed in 2020. The employer and employees have agreed on a non-compete clause of six months. The employee resigns and the employment relationship ends on 31 May 2022. The non-competition period extends from 1 June 2022 until 1 January 2022. The employer is not obligated to pay the employee compensation for the non-competition period as the non-compete clause was signed before 1 January 2022.
The employment contract was signed in 2020. The employer and employees have agreed on a non-compete clause of six months. The employee resigns and the employment relationship ends on 30 September 2022. The non-competition period extends from 1 October 2022 until 1 April 2023. The employer is obligated to pay the employee 40 per cent of the normal salary for the period 1 January 2023 to 1 April 2023. The employer is not obligated to pay compensation for the non-competition period before 1 January 2023.
The employment contract was signed in 2020. The employer and employees have agreed on a non-competition period of 12 months. The employee resigns and the employment relationship ends on 30 June 2022. The non-competition period extends from 1 July 2022 until 1 July 2023. The employer has paid the employee reasonable compensation since the start of the non-competition period. The employer continues to pay the same reasonable compensation from 1 January 2023, and the amount of compensation is not adjusted to 60 per cent of the employee's normal salary despite the fact that the transitional period ends on 31 December 2022. The employee receives the same reasonable compensation from the employer until 1 July 2023.
What can be expected in the future?
The employer's obligation to pay compensation for all non-compete agreements will hopefully curb the use of unjustified and unnecessary non-compete agreements in the future. At times, non-compete agreements even appear to be part of the standard terms of employment, and employees’ real possibilities of influencing their content have been poor.
Narrowing the scope of non-compete clauses in employment contracts as a result of the obligation to pay compensation may lead to a wider use of different types of non-disclosure and non-solicitation clauses, such as prohibiting an employee from soliciting the employer’s customers to a new employer on pain of a significant contractual penalty. In the future, employees should pay more attention to the terms of the employment contract and, if necessary, consult with a lawyer on the content and meaning of the terms.
Employers may also consider offering employees a nominal stake in the company, which may allow non-compete clauses to be transferred to a much more legally strict partnership agreement. The terms of such offers and partnership agreements should be carefully reviewed with a lawyer.
The author, Katja Halonen, is an Attorney-at-Law, Trained on the Bench & M.Sc. (Econ.) from Teperi & Co Attorneys-at-Law.