IS A FIXED AMOUNT OF DAMAGES VALID IN EMPLOYEE NON-COMPETE CLAUSES IN HUNGARY?

09 December 2020

In its recent decision, the Curia dealt with questions, which may affect many employer in Hungary. Whether the non-compete clause of an employment contract, obliging the employee to pay a fixed amount damages in case of breach of the non-competition agreement, is valid? We analyse the decision in our short article.

1. Facts

There was an employment relationship between the plaintiff („Employer”) and the defendant („Employee”) from 1^st September 2012. Afterwards, in 25^th July 2014, the parties concluded a new employment contract („Employment Contract”), under which the Employee continued to work as an executive employee in a position of franchise director at the Employer for the base wage of HUF 150.000.

According to the non-competition agreement in the section 3.8. of the Employment Contract, the Employee shall not engage in any conduct in Hungary for two years following the termination of the employment relationship by which he might infringe or jeopardize the lawtful economic interests of the Employer.

According to the Employment Contract, employment relationship or other employment related relationships with  a legal entity, which has the same activity as the Employer or establishing an own undertaking or cooperating in the undertakings of his relatives, which have similar activity as the Employer mean, in particular, the violation of the above obligation.

Furthermore, the Employment Contract laid down that in case of engaging in an activity contrary to the aim of the agreement by the Employee, the Employee shall pay damages of HUF 15Million on the basis of the Section 6:531 of Civil Code[1] (hereinafter: general damages).

The parties terminated the employment relationship on 25th August 2014 by mutual consent. Pursuant to the agreement of the parties, they have no further claims, demands deriving from the employment relationship against each other.

2. Legal dispute between the parties

Half year after the conclusion of the mutual agreement, the Employer started a litigation and requested the defendant to pay HUF 4.500.000 and its interests primarily on the legal title of damages, or alternatively on the legal title of penalty.

According to the Employer, the Employee breached the non-competition agreement as the Employee took part in the establishing of a company, which is regarded as a competing undertaking with the Employer, within the two-year term of the non-competition agreement, moreover he is still the stakeholder of that company.

In its statement of defence, the Employee argued substantially that the company established and owned by him was not a competitor of the Employer and he also claimed that the amount of the wage stipulated in the Employment Contract was invalid, consequently the non-competition agreement was also invalid. Furthermore, the Employee also alleged that the non-competition agreement was contrary to good morals because its aim was to obstruct him, therefore it was null and void.

The Employee also brought a counterclaim, in which he requested to be established  that the non-competition agreement is null and invalid. .

3. The first and second instance court decisions

The first instance court („First Instance Court”) rejected the claim of the Employer and the counterclaim of the Employee.

The First Instance Court declared that the parties negotiated about the future of the non-competition agreement during the termination of the employment relationship, but an agreement was not concluded in connection with this matter. The First Instance Court considered that the Employer waived his claims concerning the non-competition agreement by terminating the employment relationship by mutual consent and by waiving his claims deriving from the employment relationship, consequently he could not pursue a claim against the Employee on the basis of that.

Despite the above, the First Instance Court assessed also the lawfulness of the non-competition agreement. According to its standpoint, the agreement laid down obligations for the Employee, which had wide territorial and material scope. . Moreover, the stipulated consideration for the non-compete obligation, which was 1/3 part of the monthly base wage (HUF 50.000), was disproportionate to the general damages of HUF 15.000.000 laid down in case of breach of the agreement by the Employee.

Furthermore, according to the First Instance Court, the Employer did not prove that he had paid the agreed consideration , which also confirmed that the parties settled all matters at the termination of the employment relationship and they did not intend to pursue any further claim against each other.

The Second Instance Court upheld the decision of the First Instance Court, explaining that at the time of the termination by mutual agreement, the parties settled all claims deriving from the employment relationship and they did not maintain any further claims . Consequently, together with the employment relationship  the parties also considered the non-competition agreement stipulated in the Employment Contract as terminated.

Furthermore, the Second Instance Court also established that the non-competition agreement was invalid, because it prohibited too widely the Employee from working and the Employee received disproportionate payment for that.

4. Decision of the Curia

The Curia maintained the final decision in force, but it amended the justification of the decision.

According to the Curia, the lower courts wrongly considered that the Employer had waived his claims in relation to  the non-competition agreement by the mutual termination agreement. As pursuant to the Labour Code[2], agreements which waive or restrict the rights of a person cannot be broadly construed, and based on the judicial practice, a waiver can only be established if the entitled person made an unambiguous declaration or if the waiver derived undoubtedly from the circumstances.[3]

The Employer did not make a statement about the termination of the non-competition agreement, therefore it was not excluded that the Employer may pursue claims on the basis of the non-competition agreement.

Nevertheless, the Curia established that the provision of the Employment Contract, under which the parties stipulated a fixed amount of damages (HUF 15.000.000) in case of any breach of the contract, was invalid.

The Curia explained that undertaking to pay damages can only be stipulated validly in case of occurrence of a damage, as the occurred damage is the legal ground of the damages. General damages can only be paid  when the amount of proven damages cannot be calculated precisely.

Based on the above, the provision of the Employment Contract, under which the Employee shall pay a fixed amount of general damages in case of any violation of the contract without proving the occurrence of the damage, is unlawful and therefore invalid.

The Curia also considered the alternative claim of the Employer, according to which he was entitled to the „general damages” stipulated in the non-competition agreement on the legal title of penalty, unfounded, as according to the Civil Code[4], penalty can only be set forth in writing, which did not happen in the present case. „General damages” was stipulated in the Labour Contract, which could not be reassessed as penalty by the courts.

5. Assessment of the decision

In the present case the courts should answer the question whether the waiver made in the mutual termination agreement shall be interpreted as covering claims arising from the non-competition agreement. The lower courts and the Curia had different standpoints. The Curia finally concluded that the waiver could not be interpreted broadly, and it could not be interpreted in the way that the parties did not maintain the non-competition agreement.

Ultimately, the Curia had to decide, whether the „general damages” stipulated in the non-competition agreement, which was in fact a penalty, shall be assessed on the basis of its name or its content. According to the Curia, the “general damages” cannot be reassessed as penalty later, and undertaking to pay general damages can be stipulated only in the case of occurrence of damage.

The present case highlights that a poorly drafted employment contract can cause serious damages to the employer. In the present case, the Employer defined the consideration for the non-competition obligation and the „general damages” for the breach of the agreement incorrectly, and as a consequence, he could not pursue his claim against his former Employee, which otherwise seemed legitimate,.