Bill aims to amend rules on non-competition clauses

In February 1999, the Danish Ministry of Labour tabled a bill aimed at restricting the use of non-competition clauses in contracts of employment, on the grounds that they inhibit labour market mobility. The proposal seeks to specify the right to compensation where clauses are applied. The hope is that the changes will result in a reduction in the use of these clauses so that they cover only those employees for whom they were originally intended - ie specially entrusted salaried employees. Trade unions have criticised the bill for (among other things) not being extensive enough, while employers claim that it is too wide in application.

In February 1999, the Danish Ministry of Labour (Arbejsministeriet) tabled a bill aimed at amending § 18 of the Salaried Employees Act (Funktionærloven) so as to restrict the use of "non-competition clauses" and "non-solicitation clauses" in contracts of employment.

Non-competition clauses and non-solicitation clauses

A "non-competition clause" (DK9710137N) is an agreement entered into between a salaried employee and an employer to the effect that the employee cannot take up employment with a company which competes with the employer, or set up or be financially involved in such a company him- or herself. Such agreements may be entered into only by salaried employees who hold special positions of trust.

A "non-solicitation clause" is an agreement entered into between a salaried employee and an employer to the effect that, for a certain period of time, the employee cannot take up employment with, or otherwise work for, the employer's business connections. Case law has established that such an agreement is not a non-competition clause, which means that it is not only specially entrusted salaried employees who may enter into such an agreement.

The current situation

The existing rules on anti-competitive agreements between companies and employees are laid down in two provisions in § 36 and § 38 of the Contracts Act (Aftaleloven) and in § 18 of the Salaried Employees Act. One of the provisions of the Contracts Act (§ 36) stipulates that an agreement may be amended or completely set aside if it would be unreasonable or contrary to honest and fair conduct to enforce the agreement. This rule applies in general to all anti-competitive agreements - for example, agreements between two self-employed partners. Under the second of the provisions of the Contracts Act (§ 38), an anti-competitive agreement is not binding if it goes further than that which is required as protection from competition, or if it restricts, in any unreasonable way, the party who is bound by the clause from carrying on business activities or an occupation.

Furthermore, in pursuance of the Contracts Act, a special rule applies to employees, which provides that the anti-competitive agreement cannot be enforced by the employer if the employee is given notice or is dismissed without the employee having given a due cause for this, or if the employee leaves his or her position and the employer's failure to meet its obligations has given the employee a valid reason for this.

Under the new bill, these provisions in the Contracts Act are to continue to apply. The amendment to the provisions on anti-competitive agreements is to be introduced through an amendment to the Salaried Employees Act.

Under the current provisions of the Salaried Employees Act, a non-competition clause may be entered into only by a salaried employee who holds a special position of trust, or who enters into an agreement with his or her employer on the right of use of an invention made by the employee. The legislation provides that the non-competition obligation applies for a year from the date on which the employee leaves his or her position. If the clause is to apply for a longer term, the employee must receive or must have received a payment - which has been agreed in writing - for the restriction of his or her right to carry on business activities or an occupation.

As mentioned above, in addition to non-competition clauses, there are non-solicitation clauses. These clauses typically stipulate that, after salaried employees leave their positions, they must not serve their former employer's customers etc. Such clause thus do not mean that employees are not allowed to carry on competing business activities, as long as this concerns new customers. A non-solicitation clause gives the former employer a period in which it may maintain and (re)build up the relationship which the employee had with the customer.

Reasons for the bill

The bill amending the Salaried Employees Act was tabled by the Minister of Labour, Ove Hygum, on 3 February 1999. The Ministry of Labour states that the bill is a reaction to the increased use of non-competition clauses and non-solicitation clauses, which inhibits labour market mobility. As a result of ever-increasing specialisation and technical development, companies are becoming more interested in securing their technical edge and invested resources. At the same time, competition between companies is becoming sharper, and there is consequently a greater temptation for companies to try to hold on to well-qualified employees. Both these considerations can be handled by imposing a non-competition clause on the employees. Technological development also means easy access to exchange of information internally in companies which, together with the introduction of modern management principles which are based on flat organisational structures and involvement of employees at all levels, has had the effect that today a larger proportion of salaried employees must be regarded as holding special positions of trust within the meaning of the Salaried Employees Act.

However, the Ministry's opinion is that the rules on non-competition clauses suffer from the weakness that it may be difficult for the individual employee to evaluate the legality of the clauses. Furthermore, a court ruling will most often be made only after the expiry of the agreement, at which point it will be meaningless if the employee wins the case, as only in exceptional cases will there be a basis for the employer to be held liable to pay damages for having imposed too wide a non-competition clause. This has the effect that former employees do not bring legal action with a claim for clauses to be set aside, even though they may feel that, in order to be given a job, they have accepted a non-competition clause, the consequences of which were not clear to them.

The Ministry of Labour states that these developments and the unclear wording of the rules give reason to assume that an increasing number of salaried employees have non-competition clauses imposed on them, including clauses which could be set aside under the terms of the Contracts Act because they have a wide wording and have been applied without further consideration about whether the clause could be limited to a specific area, specific products etc. This assumption is supported by studies conducted by trade unions. The debate indicates that non-competition clauses are an increasing problem, not only for salary earners, but also for companies which cannot recruit qualified labour. This trend limits labour market mobility and is therefore also, to a great extent, damaging to the companies themselves. On this basis, the Ministry of Labour believes that there is a need to restrict the use of non-competition clauses.

Regarding non-solicitation clauses, the Ministry of Labour proposes that compensation should be paid if the clause runs for a term of more than one year - such a clause being, in effect, a non-competition clause. The compensation should be on the same scale as for non-competition clauses - 50% of the employee's salary - but would be reduced to 25% if the employee finds other suitable work.

This view is shared by lawyer Stig German Mathiasen, the chair of the Association of Danish Lawyers and Trainee Lawyers (Foreningen af Advokater og Advokatfuldmægtige, FAAF) in the Association of Danish Lawyers and Economists (Danmarks Jurist- og Økonomiforbund, DJØF), who states that within these organisations' field nearly 40% of all lawyers and trainee lawyers are today subject to an anti-competitive agreement. Two years ago, the percentage was around 33%.

Danish Salespersons (Danske Sælgere), a trade union representing sales staff, is one of the organisations which feel that the bill does not go far enough. In a survey among its 26,000 members, the organisation has found that the level of non-solicitation clauses has more than doubled from 1998 to 1999, and that, in the same period, the use of combined non-solicitation and non-competition clauses has increased by 40%. The explanation for the increased use of non-solicitation clauses given by head of department Bent Hansen is that companies, aware that there will be a restriction of non-competition clauses, have therefore been advised by their lawyers and staff managers to switch to non-solicitation clauses, as the new bill does not contain uniform rules for non-competition clauses and non-solicitation clauses. This may, it is claimed, risk putting the employees in an even worse position than before.

The new rules

Certain parts of the Salaried Employees Act's existing provisions in this area would be kept, under the bill's proposals. This means that in the future there would be the same right as today to enter into agreements which stipulate, for example, that the employee is not allowed to carry on his or her own business or take up employment with another company. It would, moreover, be in the same cases as now that a non-competition clause would come into play, ie where the employee has given notice to quit without due notice to the employer and where the employer has given notice of dismissal of the employee or has summarily dismissed the employee because the employee has given a reasonable cause for this, including notice of dismissal due to sickness. However, in line with the Contracts Act, non-competition clauses cannot be enforced in connection with notice of dismissal of the employee due to the affairs of the company - for example, for financial reasons.

The Ministry of Labour proposes the removal of the provision in the Salaried Employees Act which provides that a non-competition clause may be enforced only if a reasonable remuneration is paid for the period in which the obligation is to apply. Instead, it is proposed that in the future compensation should be paid for all non-competition clauses, irrespective of their term. This means that there would be compensation for the restriction of the right to carry on business activities or an occupation which such a clause entails, and which also applies during employment because the salaried employee is limited in his or her job application possibilities. It is proposed that compensation be fixed at a minimum of 50% of the salary on the date on which the employee leaves his or her position. The payment would not result in a reduction in unemployment benefits, which would mean that a very large proportion of salary earners would be able to maintain their current income, if they have unemployment insurance.

The compensation - depending on whether the obligation applies for more than three months - would fall into two parts. The compensation for the first three months would be a minimum compensation to which salaried employee would always be entitled and which would be paid out as a lump sum when the employee leaves his or her position. The rest of the compensation would be paid monthly. This part of the compensation would lapse if the employer waives the clause, or if the employee finds other suitable work. The compensation is to be paid after the employee has left his or her position. This means that, unlike under the Act's existing provisions, it would no longer be possible to pay the compensation as a supplement to the salary during the employment. The reason for this is first and foremost that the compensation is to alleviate the financial problems which occur during the term of the clause (ie, after employment has ended). If it is paid out during the employment, it would, if anything, make these problems worse. In addition, a new proposal is that the employer could choose to terminate a non-competition clause at one month's notice. If the employer terminates the agreement and is consequently released from the obligation to pay compensation, the employee should have time to adjust to the situation that he or she is now no longer restricted in his choice of occupation. Therefore, as a general rule, the employer should, as a minimum, pay compensation of 50% of the salary for the first three months.

Summary of the amendments

The following is a brief summary of the bill's provisions (and the differences with present provisions).

Non-competition clauses

• A non-competition clause applies only if compensation is paid for the period during which the clause applies.

• The agreement must be in writing.

• The compensation must be paid after the termination of the employment and not, as is currently the case, as a supplement during the employment.

• The compensation must be at least 50% of salary.

• The employer has a right to terminate the clause at one month's notice - however, the salaried employee is entitled to compensation for at least three months.

Non-solicitation clauses.

• Compensation must be paid if the clause runs for a term of more than one year.

• Compensation is paid in accordance with the same rules which apply to non-competition clauses.

Comments on the Bill

The Danish Employers' Confederation (Dansk Arbejdsgiverforening, DA) is not satisfied with the bill, which will mean extra costs for companies which want to bind their employees. Chief consultantAnne Kathrine Schøn thinks that the bill is inflexible and will affect all companies, irrespective of whether they have narrow or wide non-competition clauses. According to her, the problem is that a small company with few employees will be proportionately harder hit by having to pay a salary to an employee who has left his or her position. DA finds it unfair that companies which use narrow non-competition clauses have to pay half the employee's salary for at least three months, and predicts that there will be a reluctance to use clauses, even where companies have a legitimate need. The employers' organisation would have preferred that there had been some discussion of what could be done in the event of abuse of the clauses. DA is of the opinion that a board or a tribunal would be appropriate, as such a body would also be able to hear complaints far more quickly than the courts.

Some companies disagree with DA's objections to a restriction on non-competition clauses. For example,Jørgen Elbæk, director of RTX Telecom A/S, believes that DA's view is incorrect and that the use of non-competition clauses throws suspicion on the employees and that it sends out the wrong signal if employers' first action towards new employees is to bind them: "We would never have been able to create the growth market in Northern Jutland if employees were not able to break out and start up on their own". The firm of consulting engineers, Rambøll A/S is also of the opinion that clauses are not the right way to attract and retain employees, which owes more to finding the right job with the right possibilities for development.

Stig German Mathiasen, the chair of FAAF, thinks that the proposed tightening of non-competition clauses is not extensive enough, and fears that non-solicitation clauses will become even more widespread in the future. He believes that non-solicitation clauses are often so wide that they are at least as restrictive as non-competition clauses. For example, large law offices have such large client portfolios that it may be very difficult for lawyers to find a job if they are cut off from serving clients or from being employed by them. Mr Mathiasen thinks that the bill could be improved if non-solicitation clauses were equated with non-competition clauses, so that they were valid only if the employee gives notice to quit or is to blame for the notice of dismissal.

The Organisation of Managerial and Executive Staff (Ledernes Hovedorganisation, LH) is pleased that there will finally be a loosening of what it calls the "serfdom" of managers and other entrusted employees. Niels Sørensen of LH states that, in the first half of 1997, 65% of LH members' contracts of employment contained a non-competition clause and that in 1999 the figure is even higher. However, LH believes that the bill has to be amended if the wish for increased mobility is to be achieved. LH shares the opinion of FAAF that the rules on non-competition clauses should apply to non-solicitation clauses. It would still be cost-free for companies to use non-solicitation clauses, and therefore the desired mobility could fail to materialise as a result of the increased use of non-solicitation clauses instead of non-competition clauses. Therefore, LH hopes that, during the reading of the bill, the intention to ensure increased mobility is met by equating the rules on non-competition clauses and non-solicitation clauses.

Comments

The Ministry of Labour's arguments that non-competition clauses inhibit labour market mobility are important and of current interest. This should be seen in the light of the fact that, during recent collective bargaining, both public and private employers have sought greater flexibility on the labour market in order to be able to secure competitiveness.

The problem with this attempt to get rid of restrictions of labour market mobility is that non-solicitation clauses may have a wide scope and may have the same effect as non-competition clauses. Therefore, the bill may, in a worst-case scenario, have only a limited effect and create irritation among the parties. The proposal to equate non-solicitation clauses with non-competition clauses could solve this problem.

However, this creates another problem, in that it constitutes a move away from a voluntary regulation of work through an agreement between the parties to regulating the labour market through legislation. Instead of finding a solution to the problem through legislation, an independent body or board could be set up to settle disputes in connection with the use of such clauses in contracts of employment. The ruling of the board would then be respected by the parties and form the legal basis for any hearing by the courts.

If the sceptics are right, the bill will, in its present form, only have a limited effect. (Kristian Nielsen, FAOS)