Pacta sunt servanda principle and judgement of the Constitutional Court on non-competition clause

In today's article we bring you a summary of the judgment of the Constitutional Court of May this year concerning the contractual nature of the non-competition clause in connection with the pacta sunt servanda principle.

Circumstances preceding the dispute

The case concerned a dispute between a former employee and her former employer. For the duration of the employment, the parties agreed on a valid non-competition clause, which provided the former employee with a monthly income of CZK 35.000 upon termination of the employment, on condition that she would not perform job, that is the same as a job for a former employer or that is of a competitive nature to him. For breach of this obligation, the parties agreed on a contractual penalty of CZK 420.000 corresponding to twelve times above mentioned monthly monetary compensation for compliance with the agreed non-competition clause.

The former employer insisted on a contractual penalty and default interest against the former employee at the Brno Municipal Court, because the former employee violated the negotiated non-competition clause by being employed by a competing trading company performing a competitive nature against the former employer's business. It was clearly established in the proceedings that the defendant was in breach of its obligation to refrain from competition, even though its new employment lasted only four days.

Judgements of the General Courts

The Municipal Court ordered the defendant to pay the former employer CZK 35.000 with interest for late payment and the costs of the proceedings in the amount of CZK 114.032 while the court, in its decision, took into account in particular the short period of employment with competitors and the inability to pass on all relevant information and knowledge to competitors in such a short time.

However, the Brno Regional Court commented on the appeal of both parties to the dispute that the contractual penalty agreed in the event of a breach of the non-competition clause cannot be moderated, as it was not negotiated in contradiction with good morals and was not disproportionate. If the defendant refrained from abstaining from activities, she would have been entitled to a pecuniary compensation for a period of twelve months in aggregate corresponding to the amount of the contractual penalty agreed. The Court of Appeal therefore ordered the defendant to pay CZK 385.000 with the default interest and the costs of the proceedings of both courts in the amount of CZK 227.741,55.

The defendant appealed against the decision of the Court of Appeal to the Supreme Court, which changed the judgment of the Court of Appeal in all its appeals, and resulted in the former employer's action being dismissed in its entirety. Although the Supreme Court agreed with the appellate court's view that the fine was not disproportionate, it also stated that the exercise of the prosecutor’s right in the present case is contrary to good manners, in particular because of the very short duration of the new employment relationship. Consequently, the appellate court ordered the former employer, to pay the defendant costs of the proceedings in the aggregate amount of CZK 234.860. The former employer filed a constitutional complaint against the decision of the court of appeal.

Judgement of the Constitutional Court

In its decision, the Constitutional Court primarily dealt with a contractual penalty negotiated in a non-competition clause, both with regard to its adequacy and in relation to Article 26 of the Charter of Fundamental Rights and Freedoms, which, inter alia, guarantees freedom to conduct a business. The Constitutional Court has stated that this provision is intended to protect business from harmful interference not only by public authorities but also by individuals, and thus imposes an obligation on the general courts to protect the interests of employers even in cases where they are affected by an infringement contractual obligation in a way that even potentially favours competitors.

The purpose and purpose of the non-competition clause is to prevent the employer from escaping information to a competing entrepreneur through employees who, during their employment with the employer, have become familiar with information that is of a commercially confidential nature or are competitive in competition. It is therefore irrelevant whether or not the employee actually uses such information for the benefit of the new employer. Thus, a contractual penalty for a breach of an obligation agreed in a non-competition clause constitutes not only a penalty for breach of a contractual obligation, but also a flat-rate compensation of its kind for leaking sensitive business information. Thus, in the present case, only the fact that the contractual obligation of an employee from a non-competition clause was infringed, irrespective of the length of her new employment relationship or whether the transfer of the protected information actually took place, was essential for entitlement to a contractual penalty.

Given the contractual nature of the non-competition clause, it is also necessary to interpret the relevant provision of the Labour Code in accordance with the constitutional principle of pacta sunt servanda, which is based on the rule of law and is the basis of private law as one of the highest legal principles. This principle expresses the very conceptual character of contracts, namely the fact that the contract is binding and as such is to be respected by the parties. Thus, if the parties' mutual rights and obligations agreed in the non-competition clause are balanced and do not violate good manners, there is no reason for the court to moderate the contractual penalty. In the case under consideration, the Constitutional Court did not find a breach of the equality of the parties to the contractual relationship, as the contractual penalty claimed corresponded to the total performance that the defendant would have received from the prosecutor if it had acted in accordance with the non-competition clause. On the contrary, the decision of the court of appeal has disrupted the parties' balance without substantiating sufficient arguments.

If the conclusion reached by the Court of Appeal on only a negligible breach of the contractual obligation arising from the non-competition clause was accepted, its applicability would be highly questionable in practice, and employers could not be sure that its future breach by the employee would not be found in the litigation negligible, and consequently, a negotiation of a non-competition clause would be entirely meaningless for the employer. Moreover, the boundary between acceptable negligible contractual obligations on the one hand and unacceptable non-negligible infringements on the other is by nature unclear, unpredictable and opens the door to potential arbitrariness, which is unacceptable in terms of legal certainty.

In conclusion, the Constitutional Court also dealt with the issue of the correctness of the moderation of the contractual penalty by the court of appeal, using good morals as the ultimate corrective of the autonomy of the will of the parties to the contractual relationship. The task of the courts in their decision-making practice, especially in disputes based on the law of obligations, is to find the purpose of the contractual relationship and its optimal benefit, i.e. to find out what the parties have pursued through the relationship, what has been achieved and whether the result achieved can be considered fair. However, in the opinion of the Constitutional Court, the court of appeal did not respect this assumption, as the former employee violated her obligation under the non-competition clause, because the former employer did not succeed with a claim for payment of a contractual penalty, and moreover as a result he was obliged to pay the former employee the costs of the proceedings in the amount of CZK 234.860. However, this result, favourable only to the party that has demonstrably violated its contractual obligation, cannot be considered fair. On the contrary, the Constitutional Court found the original setting agreed in the competition clause to be equilibrium and not immoral, and for this reason the moderation of the agreed contractual penalty was unjustified by the court of appeal.

Conclusion

We can say that the above-mentioned process just confirmed the functionality of competition clauses, thus providing employers with the necessary security in the field of know-how protection and fair competition protection. Although it is clear from the circumstances of the dispute that a former employee violated her duty, which was arranged properly and in accordance with good morals, both the Municipal Court in Brno and the Supreme Court have dealt with the idea of moderating of the contractual penalty of a former employee or even forgiving it, referring to the assessment of a "seriousness”, resp. “negligence” of the violation of the contractual obligation. Thus, they practically ignored the essence of the matter, which is the unequivocal violation of the proper commitment that the former employee committed. The Constitutional Court therefore turned its attention back to the constitutionally guaranteed freedom to conduct a business and interpreted its purpose. The Constitutional Court stressed that the protection of business activity is not only a matter of the intervention of public authorities, but also of the interventions of individuals who can endanger it in the same way. Therefore, the Constitutional Court expressed its will to protect the employers in this respect against all interventions that may only potentially threaten them. In order to qualify an employer for compensation, it is not necessary to deal with the extent of the breach by the former employee, sufficient is the fact that the breach occurred. Directly to the functioning of the competition clauses, the Constitutional Court stated that if the general courts were to be allowed to decide on the "seriousness" of these violations, the applicability of clauses in practice would be endangered and their negotiation to the employer would be completely meaningless. Indeed, the relatively guaranteed certainty of protection of know-how would be lost, which is not possible while a non-competition clause is the only available instrument of this protection.