Of-counsel Annika Jaanson and associate Maarja Kärson write that in their recent work they have come across several cases where companies wish to claim against previous management board members due to their competitive activities. For this reason they give a brief overview of what restrictions affect the competitive activities of a management board member and the most practical ways to manage restrictions in order to avoid disputes.
Written agreement
Although the Commercial Code does lay down certain restrictions on the competitive activities of management board members, entrepreneurs may wish to protect their business interests even more strongly by setting additional restrictions. These must certainly be set out in a written agreement with management board members. This should take account of the area of activity, competitive situation and other aspects of the specific company.
Restrictions laid down by law
The Commercial Code prohibits a management board member during their term of office from being any of the following in the area of activity of the company: a sole proprietor, a partner of a general partnership, a general partner of a limited partnership or a member of a directing body of a company (except if this company belongs to the same group). However, the restrictions are not absolute – these activities are permitted with prior consent of the shareholders or the supervisory board. Agreements that are somewhat milder than those laid down by law may be included in the contract of a management board member that is approved by the shareholders or the supervisory board, if a supervisory board exists.
Reasoning for restrictions
Restrictions on the activities of a management board member must be reasoned (and reasonable) and in line with the activities of the specific company. The purpose of restricting the competitive activities of a management board member is to protect the business interests of the entrepreneur, so that the content and extent of restrictions should correspond to this purpose. In general these restrictions should concern only activities in the area of activity of the company in order to be justified as protecting the business interests of the company.
Term of validity of restrictions
By law, a prohibition on competition of a management board member is valid only during their term of office. If it is in the interest of the company that the prohibition on competition should remain valid after the end of the term of office, an agreement to that effect should be concluded with the management board member by setting the term of validity of the restrictions. It is practical to conclude the agreement at the beginning of the term of office to avoid problems that might arise in reaching a future agreement. However, it should be kept in mind that the term of validity of any prohibition on competition must be reasonable by taking into account the area of activity of the company and the actual extent of the restriction.
Compensation for restriction
Compensation is not paid to a management board member for restrictions on competition valid during the term of office as such restrictions are typical to the position. Nor does the law lay down any obligation to pay compensation for restrictions on competition that exceed the term of office. However, one must consider that such restrictions may infringe the constitutional right of a person to choose an area of activity and a place of work. This could mean that in case of dispute the court may form the opinion that the restrictions are valid only on payment of fair compensation. Today, there is no clear court practice in this matter; therefore, just to be on the safe side and in order to avoid disputes, agreement on compensation should be seriously considered. Without reasonable and fair compensation, agreed restrictions may turn out to be void. The obligation to pay compensation for restrictions valid after the term of office cannot be excluded even when the work of a management board member is not compensated in other respects, because their freedom of activity continues to be restricted in that case.
Liability
Violating a prohibition on competition may result in a management board member being liable to the company. If a management board member violates a prohibition on competition even during their term of office, the company may demand that the management board member end the prohibited activity. Moreover, the company may also claim payment of the income thus gained, in addition to compensation for damages in excess of claimed income. The company may also file a claim if a management board member causes damage during and after their term of office when the restriction on competition is valid.
In general, violation of the prohibition on competition is proven by the mere fact that the consent of the shareholders (or of the supervisory board, if one exists) was not granted for competition. Since proving the existence and amount of damages caused by competitive activities may be extremely difficult, it would be wise to agree on a contractual penalty in case a violation of the obligation occurs, because this would spare the company from having to prove details of damage caused.
Conclusion
Legal restrictions on competition may be insufficient from the entrepreneur’s point of view for protecting their own interests. Specifying these restrictions and supplementing them, if necessary, in a contract concluded with a management board member ensures clarity for both parties and helps to avoid time-consuming disputes. Therefore, it is always wise to conclude a specific agreement with a management board member on what activities are included in their prohibition on competition, how long the term of validity of the prohibition is and whether the company should pay compensation. It is also important to agree on a contractual penalty in order to avoid difficulty in proving damage caused and the scope of damages.
Prohibition on competition by management board members
Of-counsel Annika Jaanson and associate Maarja Kärson write that in their recent work they have come across several cases where companies wish to claim against previous management board members due to their competitive activities. For this reason they give a brief overview of what restrictions affect the competitive activities of a management board member and the most practical ways to manage restrictions in order to avoid disputes.
Written agreement
Although the Commercial Code does lay down certain restrictions on the competitive activities of management board members, entrepreneurs may wish to protect their business interests even more strongly by setting additional restrictions. These must certainly be set out in a written agreement with management board members. This should take account of the area of activity, competitive situation and other aspects of the specific company.
Restrictions laid down by law
The Commercial Code prohibits a management board member during their term of office from being any of the following in the area of activity of the company: a sole proprietor, a partner of a general partnership, a general partner of a limited partnership or a member of a directing body of a company (except if this company belongs to the same group). However, the restrictions are not absolute – these activities are permitted with prior consent of the shareholders or the supervisory board. Agreements that are somewhat milder than those laid down by law may be included in the contract of a management board member that is approved by the shareholders or the supervisory board, if a supervisory board exists.
Reasoning for restrictions
Restrictions on the activities of a management board member must be reasoned (and reasonable) and in line with the activities of the specific company. The purpose of restricting the competitive activities of a management board member is to protect the business interests of the entrepreneur, so that the content and extent of restrictions should correspond to this purpose. In general these restrictions should concern only activities in the area of activity of the company in order to be justified as protecting the business interests of the company.
Term of validity of restrictions
By law, a prohibition on competition of a management board member is valid only during their term of office. If it is in the interest of the company that the prohibition on competition should remain valid after the end of the term of office, an agreement to that effect should be concluded with the management board member by setting the term of validity of the restrictions. It is practical to conclude the agreement at the beginning of the term of office to avoid problems that might arise in reaching a future agreement. However, it should be kept in mind that the term of validity of any prohibition on competition must be reasonable by taking into account the area of activity of the company and the actual extent of the restriction.
Compensation for restriction
Compensation is not paid to a management board member for restrictions on competition valid during the term of office as such restrictions are typical to the position. Nor does the law lay down any obligation to pay compensation for restrictions on competition that exceed the term of office. However, one must consider that such restrictions may infringe the constitutional right of a person to choose an area of activity and a place of work. This could mean that in case of dispute the court may form the opinion that the restrictions are valid only on payment of fair compensation. Today, there is no clear court practice in this matter; therefore, just to be on the safe side and in order to avoid disputes, agreement on compensation should be seriously considered. Without reasonable and fair compensation, agreed restrictions may turn out to be void. The obligation to pay compensation for restrictions valid after the term of office cannot be excluded even when the work of a management board member is not compensated in other respects, because their freedom of activity continues to be restricted in that case.
Liability
Violating a prohibition on competition may result in a management board member being liable to the company. If a management board member violates a prohibition on competition even during their term of office, the company may demand that the management board member end the prohibited activity. Moreover, the company may also claim payment of the income thus gained, in addition to compensation for damages in excess of claimed income. The company may also file a claim if a management board member causes damage during and after their term of office when the restriction on competition is valid.
In general, violation of the prohibition on competition is proven by the mere fact that the consent of the shareholders (or of the supervisory board, if one exists) was not granted for competition. Since proving the existence and amount of damages caused by competitive activities may be extremely difficult, it would be wise to agree on a contractual penalty in case a violation of the obligation occurs, because this would spare the company from having to prove details of damage caused.
Conclusion
Legal restrictions on competition may be insufficient from the entrepreneur’s point of view for protecting their own interests. Specifying these restrictions and supplementing them, if necessary, in a contract concluded with a management board member ensures clarity for both parties and helps to avoid time-consuming disputes. Therefore, it is always wise to conclude a specific agreement with a management board member on what activities are included in their prohibition on competition, how long the term of validity of the prohibition is and whether the company should pay compensation. It is also important to agree on a contractual penalty in order to avoid difficulty in proving damage caused and the scope of damages.