The non-competition clause in a shareholders' agreement

Introduction

In public limited companies (SA/AG), the shareholder’s only obligation is to pay up the subscribed capital (art. 680 CO).

Unlike the law governing limited liability companies (Sàrl/GmbH), the law governing public limited companies does not provide for the possibility of subjecting shareholders to a prohibition on competing with the company. The law only lays down a prohibition on competition for members of the board of directors or management (cf. art. 717 CO) and for employees of the stock corporation (cf. art. 321a para. 3 or art. 340 CO). Shareholders who do not serve as directors and who are not employees of the company, are therefore not subject to any prohibition of competition.

However, these shareholders may voluntarily agree to a non-competition clause as part of a shareholders’ agreement.

The purpose of this paper is to outline the non-competition clause in a shareholders’ agreement, and to highlight important points.

The purpose of the non-competition clause

Generally speaking, a non-competition clause is used to prohibit the parties to a shareholders’ agreement from competing with the public limited company.

The inclusion of a non-competition clause in a shareholders’ agreement can be particularly useful when there is a profit-sharing plan for employees in place, as well as in certain situations involving business transfers.

In addition, legal prohibitions on competition (art. 717 CO or art. 340 ff CO) can be made more specific or even reinforced.

Duration, application and limits of the prohibition on competition

A prohibition of competition applies in full to shareholders during their participation in a shareholders’ agreement, and may, if contractually agreed, continue to apply even after a shareholder has left the company. This has the effect of restricting the economic freedom of the shareholder subject to the non-competition clause. Art. 27 para. 2 of the Swiss Civil Code does, however, impose restrictions, in that the clause must be limited in material, geographical and temporal terms.

It should be noted that the limits imposed by law and jurisprudence on non-competition clauses in employment contracts and the conditions set out in articles 340 ff CO are not applicable to determining the validity of a prohibition on competition in a shareholders’ agreement (TF 4C.5/2003 ruling of March 11, 2003, recital 2.1.2).

One of the reasons for this is that in an employment contract, only the employee (and not the employer) is subject to the prohibition on competition, whereas in a shareholders’ agreement, all shareholders are subject to it equally. Consequently, the application of the non-competition clause can potentially be more far-reaching under a shareholders’ agreement than under an employment contract.

As far as the material limit is concerned, it is important to specify the branch of activity to which the prohibition of competition relates. A prohibition on competition that also covers activities or holdings outside the scope of the company’s purpose would be problematic. As a general rule, it would be better to base the prohibition on the company’s actual purpose, rather than on its statutory purpose, which is generally very broad.

As far as the geographical limit is concerned, it is necessary that the geographical scope of the prohibition of competition be defined as precisely as possible and that it be limited in space (e.g. within a radius of 50 km around the company or within the territory of the canton of Aargau, TF 4C.5/2003 of March 11, 2003, recital 2.1.2).

Finally, with regard to the time limit, a prohibition of competition must also be limited in time (e.g. to two years after the sale of the shares).

In principle, these different limits are assessed together, and can be applied in different ways depending on the circumstances.

For example, a materially broad or geographically extensive prohibition of competition may be admissible if it is only valid for a short period. Conversely, a long-term prohibition of competition may be valid if it is limited to a narrow material area. Non-competition clauses which prevent the entire economic activity of a contracting party for a long period of time are considered excessive. In such cases, the judge may reduce the scope of the non-competition clause by analogous application of art. 163 para. 3 CO.

Lastly, the non-competition clause may be accompanied by a contractual penalty in the event of a breach of the non-competition clause.

Conclusion

In the final analysis, including a non-competition clause in shareholders’ agreements enables the parties to a shareholders’ agreement to refrain from competing with the corporation, and may prove useful in certain situations. To be valid, however, the non-competition clause must be limited in material, geographical and temporal terms. The authors advise customers to consult a lawyer when drafting such a clause.