The restraint of trade and confidentiality obligations for a member of the management board after their term of office

A member of the management board of a private limited company or a public limited company has a central role in the management of the company as prescribed by law. In performing their duties, a management board member frequently encounters sensitive and valuable information, which makes them significantly more capable of harming the company’s interests compared to an ordinary employee — both during their term of office and after it ends.

Under Estonian law, members of the management board are obligated to maintain confidentiality and adhere to a restraint of trade clause to protect the company from potential harm. In addition to these statutory requirements, companies may enter into additional agreements with the members of the management board to specify or extend these obligations.

At the same time, a balance must be struck between the interests of the company and the rights of the management board member. Excessive restrictions may be unacceptable to the member of the management board, especially if they apply after their term of office ends. Therefore, when imposing additional obligations, the company must comply with the law and court practice. Otherwise, the agreements may be invalid or unenforceable.

The following highlights key aspects to consider when entering into an agreement on the duty to maintain confidentiality, also known as the obligation to keep secrets, or a restraint of trade clause agreement with a member of the management board after their term of office ends.

 

Post-contractual restraint of trade clause for a member of the management board

 

Subsection 1 of section 185 and subsection 1 of section 312 of the Commercial Code provide restrictions on a member of the management board engaging in business activities in the same field as the company or being associated with a competitor. If a company wishes to ensure that a management board member cannot compete with the company even after their term of office, it is advisable to enter into a separate restraint of trade clause agreement.

Case law has confirmed that a post-contractual restraint of trade clause for a member of the management board is a permissible agreement. It constitutes an independent long-term contract governed by the general provisions of the Law of Obligations Act and the Act on the General Part of the Civil Code. Such an agreement can either be part of the management board member's contract or entered into as a separate agreement.

Unlike employees, a member of the management board typically operates within the scope of their economic and professional activities. Therefore, they are not considered the weaker party in relation to the company, as is the case with individuals working under employment contracts. This allows for greater application of the principle of contractual freedom when entering into restraint of trade clause agreements with management board members. Additionally, the risk of the agreement being declared invalid is lower if it is properly drafted.

 

Terms of a post-contractual restraint of trade clause

 

When establishing a post-contractual restraint of trade clause, it is essential to comply with the law and the principle of good faith to avoid its invalidity. The purpose of the restriction is to protect the company’s economic interests, which could be harmed by the member of the management board using information obtained during their term of office. To achieve this, four key aspects must be considered:

 

1. Limitation of activities

The restraint of trade clause must exclude activities by the member of the management board that directly harm the company’s interests. For example, it may prohibit the member of the management board from:

• serving on the managing bodies of a competitor;
• being a shareholder or a general partner in a competitor;
• providing competition as a sole proprietor.

 

What the restriction should not include:

• Disproportionate or unreasonable restrictions: the restrictions must not prevent the member of the management board from using their general skills and knowledge in activities that do not compete with the company.
• • Example: if a management bard member worked for a technology company specializing in software development for the banking sector, it would be unreasonable to prohibit them from working in the IT field after the contract ends, such as developing e-commerce platforms or acting as an IT trainer. These activities do not harm the company’s interests.
• Overly broad prohibitions: For instance, a restriction that prohibits a member of the management board from working in a generally similar field may be too vague and deemed invalid. However, a more broadly worded restriction may not always be invalid. In cases where the member of the management board, due to their specialized knowledge, clearly understands which activities constitute competition with the company, a more general restriction may still be enforceable.

 

2. Defining the territorial scope

The restriction must be tied to a specific and justified territory. If the company operates only in Estonia, it would not be reasonable to prohibit the member of the management board from operating in another country where it does not pose a threat to the company's interests.

 

3. Duration of Validity

The restraint of trade clause must have a reasonable duration. In case law, a restriction lasting up to one year after the termination of a management board member's contract has generally been considered appropriate.

 

4. Payment of indemnity

Although the law does not require the payment of indemnity to a member of the management board for compliance with a post-contractual restraint of trade clause, it is generally advisable to include the payment in the agreement. This obligation arises from the principle of good faith. An extensive post-contractual restraint of trade clause typically makes it more difficult for the member of the management board to earn income within the same field. According to the principle of good faith, such a restriction should be compensated by the company through the payment of indemnity. However, it is not excluded that, due to the specific relationship between the member of the management board and the company or due to a minimally restrictive restraint of trade clause, payment of indemnity may not be necessary.

The amount of indemnity depends on the scope and intensity of the restriction. If the restriction nearly entirely prevents the member of the management board from operating within their field, the indemnity should be comparable to the remuneration paid to the member under the agreement. Paying an unreasonably low indemnity or unjustifiably failing to pay indemnity may result in the invalidity of the agreement.

 

Duty to maintain confidentiality

 

Under section 625 of the Law of Obligations Act and sections 186 and 313 of the Commercial Code, a member of the management board of a private limited company or a public limited company has a statutory duty to maintain confidentiality. This obligation automatically continues after the conclusion of the contractual relationship between the parties to the extent necessary to protect the legitimate interests of the company.

To more effectively protect the company’s interests and avoid potential disputes, it is advisable to enter into an additional confidentiality agreement with the member of the management board. Such an agreement can govern the rights and obligations of the parties both during their contractual relationship and after it. An additional agreement helps clarify the expectations of the parties and enables quicker and more effective action in the event of a breach.

 

Terms of the contractual duty to maintain confidentiality

 

The duty to maintain confidentiality of a member of the management board primarily involves protecting the company’s production and business secrets. A confidentiality agreement should define as precisely as possible what information qualifies as production and business secrets.

According to the Restriction of Unfair Competition and Protection of Business Secrets Act, a business secret is information:

• that is not generally known or readily accessible to individuals who typically deal with such information;
• that has commercial value due to its confidentiality;
• for which the person with lawful control has taken necessary measures to maintain its confidentiality.

Business secrets may include, for example, the company’s business plans, clientele, contractual partners, contract terms, pricing, business strategies, and other similar information. It also encompasses the business secrets of another person that the company is obligated to keep confidential.

Production secrets may include, for example, descriptions of production processes, production volumes, substance compositions, and manufacturing methods.

 

Scope of restrictions:

• The duty to maintain confidentiality must not be so broad that it entirely restricts the member of the management board from working in the same field of activity.
• Agreements that require confidentiality in situations where the law mandates disclosure of information are prohibited.

 

Duration of the obligation:

According to the law, the duty to maintain confidentiality remains in effect as long as it is necessary to protect the legitimate interests of the company. This requires a case-by-case assessment of whether the company still needs to safeguard the confidential information. However, a confidentiality agreement may specify a defined period during which the obligation applies after the termination of the relationship between the parties.

 

Contractual Penalties

 

In the event of a breach of the restraint of trade clause or the duty to maintain confidentiality, the agreement may include a provision for the payment of a contractual penalty. The purpose of such a clause is to motivate the former member of the management board to comply with the agreement, as a breach could result in significant financial consequences.

The amount of the contractual penalty must be reasonable and proportionate. When determining it, the following factors should be considered:

• the indemnity paid in connection with the restraint of trade clause;
• the potential damage caused to the company by the breach;
• the complexity of proving the damage;
• the restrictiveness of the agreement for the member of the management board;
• any other relevant circumstances.

If the contractual penalty is unreasonably high, it may be reduced to a reasonable amount. If the penalty clause also qualifies as a standard term, an unreasonably large penalty is deemed void. According to case law, a contractual penalty equivalent to six months' remuneration of a member of the management board has been considered reasonable.

 

What else to keep in mind?

 

The terms of agreements on the restraint of trade clause and the duty to maintain confidentiality, applicable after the termination of the relationship with a member of the management board, should always be thoroughly negotiated. When both parties can actively influence the content of the agreement, it helps avoid situations where the agreements qualify as standard terms. Agreements classified as standard terms carry a higher risk of being deemed unreasonable and, therefore, invalid.

Duty to maintain confidentiality agreement and restraint of trade agreement significantly simplify the protection of a company’s rights in cases of breaches, whether through out-of-court resolution or by filing an action with a court. If you want to effectively safeguard your company’s confidential information, prevent unfair competition, or ensure that you are not unfairly exploited in a contractual relationship, contact law firm Lepmets & Nõges. Our team will stand up for your rights and ensure that your interests are fully protected.