Taking counsel: Employee's prohibition on competition

  • 2007-07-18
  • by Annika Vait [Teder, Glikman & Partnerid]
The situation on the Estonian labor market has compelled employers to mull over ways to restrict employees' departure. They are signing an increasing number of agreements with employees that prohibit the latter from working for competitors. At the same time, Estonia's legislative system has not yet responded to the changes in the labor market, and the weak regulatory environment has caused practical problems.
Currently there is only one provision on an employee's prohibition on competition in the Estonian Employment Contracts Act, pursuant to which a worker is required not to compete with the employer, including not working for a competitor without the employer's permission. Otherwise, an employer and employees are also free to sign an agreement according to which a prohibition on competition will remain in force after the expiry or termination of the employment contract.

Any such agreement after termination of employment contract is valid only if it contains provisions on payment of compensation or other benefit to the employee for compliance with the prohibition. To be sure, there is no legal regulation or grounds for calculation of compensation. Pursuant to the draft employment contract act examined by Estonia's parliament, the monthly compensation for prohibition on competition could not be less than 60 percent of the employee's average salary. Although today this draft law has been withdrawn from Parliament, it still serves as a rough guide to gauge the magnitude of fair compensation.
Taking into consideration the purpose of a prohibition on competition, it is neither economically wise nor legally sound to sign agreements of prohibition on competition with all employees. The law does not provide answers to the question as to which cases and what extent such a prohibition is justified.

Professional literature provides a principle that the employer must have justified business interests in respect of the certain employee and that the prohibition on competition must be reasonably limited. The estimation of justified business interest should be based on the nature of the employee's work. As for the requirement of reasonable limitation, the employee must have a clear understanding of the scope of the prohibition, as well as duration and territorial limits.
As a rule, substantial limitation is acceptable in cases where the agreement provides limitation in the sphere of the employer's activities. In Estonia, this principle is above all based on compliance with the requirement to determine competitive activities and competitors. As for duration, there are no problems within the validity of the employment contract, but the regulator has not provided any rules for duration of the prohibition after expiry or termination of the employment contract.

If the agreement of prohibition on competition is breached employee liability may be disciplinary, proprietary or punitive. As a rule, proprietary liability is the employer's obligation to pay the employer contractual penalty and/or compensate damages caused to the employee. A precondition for claiming contractual penalty is the existence of a written agreement of the penalty clause and breach of the prohibition on competition clause by the employee. The employer is not required to prove cause of damage or the amount of damage. Agreement on contractual penalty simplifies materially compensation of damages caused to the employer.
For protection of the employee's business interests we suggest an extremely individual approach when entering into agreements of prohibition on competition. When stipulating the prohibition clause we suggest that employers estimate, in respect to which employees they have such business interest, whether it is reasonable to sign an agreement of prohibition on competition. Only those employees should be chosen with whom it would be economically wise, due to business interest, to sign the agreements of prohibition on competition.

Also, formulation and wording of the prohibition clause should be based on reasonable limitation of the prohibition, inter alia the clause should explicitly stipulate what is considered to be competing activities and who is considered to be the employer's competitors. In respect to an employee's liability in cases of a breach of the prohibition clause, we suggest signing of agreements on contractual penalty. 

Annika Vait is lawyer at Teder, Glikman & Partnerid, a member firm of the Baltic Legal Solutions, a pan-Baltic integrated network of law firms, including Kronbergs & Cukste in Latvia and Jurevicius, Balciunas & Bartkus in Lithuania, dedicated to providing a quality 'one-stop shop' approach to clients' needs in the Baltics.