The CEO is not an employee of the company, and the Employment Contracts Act does not apply to the CEO. The CEO of a limited liability company is a corporate organ in the same way as the board of directors and the general meeting. Therefore, the CEO is not in employment relationship with the company. The CEO's position and duties are primarily regulated by the Companies Act, the Limited Partnerships Act and the Co-operatives Act. The liability of the CEO is similar to that of the company's board of directors.
It is always advisable to enter into a written agreement with the CEO (a CEO agreement) which defines the terms of the employment relationship. This type of executive agreement should be made as early as possible to avoid a situation without an agreement and to ensure that the agreement is in force between the parties as soon as the employment relationship begins. The drafting and terms of a CEO agreement should be carefully considered when preparing it, as a well and comprehensively drafted agreement is important for the company, and investing effort in its drafting phase may lead to savings later on.
Key points of the CEO agreement
The careful drafting of an executive service agreement is extremely important for both the executive and the company. An executive service agreement defines the rights and obligations of the executive and the company. An executive service agreement is not an employment contract, and therefore, employment legislation does not apply to it, but rather general legal rules and principles concerning contracts. However, an executive service agreement can refer to employment law provisions. For example, holiday entitlements can be agreed to accrue according to the Annual Leave Act, or that pension benefits are paid in accordance with the Employees Pensions Act (TyEL). However, references to the Employment Contracts Act do not make the agreement entered into with the executive an employment contract under the Employment Contracts Act.
The CEO agreement can be indefinite or fixed-term. The company and the CEO can freely agree on the duration of the employment relationship. If the CEO becomes unemployed, it is possible for them to receive earnings-related unemployment benefit, provided they have been a member of an unemployment fund.
Salary, bonuses and incentive schemes
The CEO's service agreement should carefully define how the CEO is remunerated, so that their actions are directed in the right direction, i.e. towards the company's strategic objectives. The CEO's total remuneration typically consists of a monthly salary and various fringe benefits and/or incentive schemes, as well as a possible individual pension package. Remuneration may also include share ownership or options.
The agreement should preferably cover salary or remuneration, potential options, separate compensation, pension benefits, bonuses, and other potential benefits, as well as liability insurance. Key aspects related to remuneration also include agreeing on working hours, holidays, holiday pay, and the entitlement to sick pay. The grounds for reviewing the salary or remuneration should also be documented in the agreement.
An incentive scheme should also be agreed separately, if one is to be used. The company must decide whether it wants immediate financial returns for the owners or if it will operate more with a long-term perspective, in which case the financial return will be realised by the owners as an increase in the company's value. Additional remuneration or various bonuses, directly based on the company's profit, have been considered the most effective incentives.
Reporting obligations and limitations of authority
In addition, it is always advisable to agree on the chief executive officer's reporting obligation to the company's board of directors, as well as any limitations on authority. However, for a limitation to have a practical effect, the liability for damages as a consequence of exceeding authority should also be agreed upon.
Confidentiality obligation and non-compete clause
The CEO agreement should, at a minimum, stipulate a confidentiality obligation and a non-compete clause. The purpose of these obligations is to protect information that the CEO gains about the company during their employment. When agreeing to these obligations, it is sensible to precisely define the scope of competitive activity, the information to be kept confidential, and when the confidentiality obligation commences. It should always be agreed that the confidentiality obligation continues indefinitely after the employment relationship ends, at least concerning trade secrets, and that the non-compete clause is valid for a pre-agreed period after the termination of the CEO agreement.
In addition, compensation for damages arising from a breach of these obligations must be agreed upon. Normally, liability for damages requires that damage has actually occurred and that there is a causal link between the action and the damage that has occurred. Proving these conditions may be difficult. For this reason, the company should use a penalty clause in the CEO agreement, in which case it is sufficient to prove only the breach of contract.
On the acceptability of a non-compete clause
In a CEO agreement, a non-compete clause can be agreed upon more freely than in, for example, employment contracts, meaning that the mandatory provisions of the Employment Contracts Act do not apply here. There is no specific legislation in Finnish law concerning non-compete clauses for CEOs. The legal provisions applicable in this context are primarily Sections 36 and 38 of the Contracts Act, which allow for the modification of unreasonable contract terms. A non-compete obligation in a CEO agreement may be subject to modification, for example, when the CEO is placed in an unreasonable situation due to the non-compete obligation and is unable to pursue their profession or trade.
On the one hand, the unreasonableness of the managing director's non-compete obligation can be avoided by limiting the non-compete clause to either a very narrow geographical area or only to a specific business activity. Certain companies for which one cannot work, or for example, the company's current clients or principals, can also be used as restrictive conditions. The key aspect in this assessment is that the managing director is left with a real opportunity to practise their trade or profession.
Secondly, the unreasonableness of a non-compete obligation in a CEO's contract can also be limited by the company paying the CEO specific, reasonable compensation for agreeing to the non-compete obligation. This is a practice that is accepted in case law and is commonly used, even though it is not specifically mentioned in the Contracts Act. For example, the company can pay the CEO monthly compensation for as long as the non-compete obligation is in force. If this compensation is reasonable in proportion to the obligation/non-compete, the non-compete will remain valid for a longer period than if this compensation were not paid.
As stated above, it is always advisable to agree on a fixed contractual penalty for a breach of the non-compete clause. Since the Employment Contracts Act does not apply to managing directors, there is no obstacle to agreeing on a contractual penalty that is larger than, for example, six months” salary prior to the termination of the contract. However, it is important to note again that a contractual penalty that is so-called ”excessive" could be moderated if the company has not actually suffered any damage due to the managing director's competitive activity.
On the acceptability of the duty of confidentiality
Similarly to employment contracts, confidentiality obligations both during and after the term of the agreement can be stipulated in CEO agreements. Unlike employment contracts, a broader confidentiality obligation can also be agreed upon with a CEO. Therefore, there is generally no obstacle to extending the confidentiality obligation to information that does not meet the definition of a trade secret. However, a confidentiality clause that excessively restricts freedom of expression may be assessed as a non-compete clause.
Establishing the damage caused by a breach of confidentiality is particularly challenging. It is therefore worthwhile to reinforce the obligation of professional secrecy with a contractual penalty, even if the breach of a non-compete obligation is already subject to an agreed contractual penalty.
Many CEO agreements specifically define the obligation to pay a contractual penalty for breaches of both non-competition and confidentiality obligations. However, this does not always mean that the company can claim both contractual penalties in the event of a breach of contract if the CEO breaches the confidentiality obligation and the non-competition clause with one and the same action. Naturally, breaches of the confidentiality obligation and the non-competition clause can involve completely different actions, even if the breaches occur temporally close to each other.
How to act when the CEO breaches a confidentiality obligation or a non-compete clause?
If a non-compete clause or confidentiality obligation in a CEO’s employment contract is breached, then in addition to contractual penalties and/or damages, the company can demand that the infringing activity cease through injunctive relief. In any event, it is important that the breach is responded to immediately upon the company becoming aware of it, so that the company is not deemed to have accepted the conduct that contravenes the agreement, and so that the undesirable activity is brought to an end as quickly as possible.
Procedures on termination of the agreement
When the interests of the CEO and the company diverge at times, it is advisable to agree in advance on the compensation the CEO will receive in different situations and what the procedures will be upon termination of the contract. The CEO's contractual relationship is often terminated without prior notice.
A CEO agreement should specify termination, notice periods, the effects of termination, and the obligation to work during the notice period. In principle, the CEO is not entitled to a salary during the notice period, but an agreement can be made to this effect. For example, the CEO could be paid their salary for the notice period, in which case they would continue to work during that time. Another option is a severance payment, where the CEO leaves the company immediately.
However, it is recommended to agree on the termination with immediate effect, without a notice period, as this allows the contract to be terminated immediately if a loss of trust has possibly occurred. When agreeing on the termination of the contract, it is also possible to agree on a potential severance payment, if one is intended to be paid in the termination situation. In a management contract, it is advisable to clarify precisely and in detail when a severance payment will be made and when it will not. From the company's perspective, it is appropriate to agree that a severance payment is made only when the contract is terminated by the company or when the CEO terminates the contract due to a reason attributable to the company. It is also appropriate to agree that the severance payment is not made if the CEO materially breaches the terms of the CEO contract. It is advisable to define at least the breach of the non-compete clause and the confidentiality obligation as material breaches of contract.
Dispute resolution mechanisms
Despite the fact that considerable effort has been put into creating the CEO's employment contract and that the contract has been made as comprehensive as possible, disputes unfortunately arise. For this reason, it is important to prepare for such disputes at the contract negotiation stage by including a clause on dispute resolution in the contract. It is often most appropriate to use an arbitration clause, which stipulates that disputes will be resolved through arbitration.
Arbitration is considered expensive, but the confidentiality, flexibility, speed, and immediate enforceability and finality of the award speak in favour of its use. The arbitral award is final, meaning there is no possibility of appeal. Furthermore, as stated above, the advantages of arbitration include that it is conducted behind closed doors between the parties, thus avoiding potential negative publicity associated with public court proceedings.
This article was written by
Jari Sotka
Lawyer, MBA
Tel. 040 544 0610
Amos Attorneys at Law Oy
The author has worked as a lawyer and advocate for more than 25 years, focusing throughout his career on preventing and solving legal problems for small and medium-sized enterprises.