The end of contractual penalties clauses in employment contracts or yet another discrepancy in jurisprudence?
This article comments on the recent judgement rendered by the Higher Labour and Social Court, Ref. No. Pdp 767/2016, in which the court ruled that, where an employee violates a non-compete clause, an employer’s only recourse is to submit a compensation claim under the Employment Relationship Act (ERA). This denies the employer of the possibility of agreeing a contractual penalty for violation of a non-compete clause, since this would mean that it is not required to prove the existence and amount of damages.
This judgement is striking especially (i) since the court departed from the position of the Slovenian Supreme Court and (ii) since the arguments put forward by the court run contrary to the (current) interpretation of the legal theory. The Supreme Court has on numerous occasions decided that, where a non-compete clause has been violated, the employer and employee are free to agree on a contractual penalty and/or compensation. Legal commentators of the new Employment Relationship Act (ERA-1) have even advised employers to conclude contractual penalty clauses because damages (e.g. loss of profit) are practically impossible to prove in court.
We cannot agree with the court’s new line of argument as the ERA (as well as the ERA-1) does not prescribe any particular sanctions in the event of a breach of a non-compete clause. Parties are thus free to agree on any sanction, even more so since the non-compete clause actually regulates the relationship post-employment; e.g. when the employee is no longer a weaker party but an active player on the market inflicting damages on the employer by violating non-compete rules.
If this judgement indicates a tack in case law, all contractual penalty clauses in current employment contracts could be declared void where challenged before the courts. This means that in case of a breach of a non-compete clause employers will be faced with a myriad of complex tasks, as they would need to prove all elements of a tort (wrongful act on the part of the employee, damages, cause and liability). Consequently, the deterrent effect of such a clause would practically be negated, as employees would realise that it would be next to impossible for employers to claim damages. Going forward, we predict that the courts would declare as void all other contractual penalty clauses in the event of a breach by an employee (e.g. for breach of non-compete undertakings, trade secrets, etc.).
Time will tell whether the case in question will really change jurisprudence. Until then we suggest that employers substantiate their claims employing both legal grounds; contractual penalty (if agreed) as well as on a claim for damages.
