In the Serbian market, contractual penalties are often included in employment contracts since this is concrete and efficient protection for the employer in case of a breach of certain contractual obligations by employees. On a general note, a contractual penalty is a fixed monetary receivable that can be claimed in case of a breach of contractual obligations by one party, without having to prove the actual amount in damages. However, in the area of labor law, there is still uncertainty when it comes to the validity of such clauses and their enforceability in case of disputes.
Namely, an employment contract is primarily a contractual relationship that is subject to the principle of freedom of contract, implying that a contractual penalty may be applied based on the parties’ mutual consent. On the other hand, there is the principle of protection of employees as the weaker party, which in Serbian labor law is expressed in the provision which mandates that employment contracts must not introduce less favorable work conditions than those guaranteed by the law.
A contractual penalty as such is not regulated by Serbian labor legislation. Hence, it can be argued that it would not be valid since it deviates from the legal norms by imposing additional obligations (i.e., sanctions) on employees. On the flip side, it could be argued that these do not constitute less favorable work conditions but rather just specific sanctions for a breach of obligations arising from employment.
A contractual penalty is most commonly stipulated as a sanction for a breach of the following obligations arising from employment: non-compete clauses (i.e., the obligation not to engage in activities which are competitive to the business of the employer) – both during employment and after its cessation; protection of confidential information (confidentiality); and non-solicitation clauses. It is typically expressed as an obligation to pay an amount equivalent to a certain number of base salaries (i.e., six base gross salaries).
These are all potentially very sensitive issues for employers, especially in industries where knowledge and information are key for a company’s competitiveness in the market (e.g., IT). Since these are industries characterized by dynamic competition, employees often switch jobs in search of better conditions, which additionally increases the risk of violations as well as potential damages for the employer. Therefore, it can be legitimately argued whether employers’ interests can be adequately protected without contractual penalties, especially keeping in mind that violations often occur after termination of employment or after the employee has decided to quit, which renders disciplinary sanctions inapplicable. Consequently, the only remaining legal recourse for the employer is compensation of damages, which is notoriously difficult to prove, and thus employers are facing the prospect of long litigation with an uncertain outcome.
A connected but still separate issue is the legal treatment of non-solicitation clauses (i.e., the covenant that precludes employees from soliciting other employees, associates, or clients of the employer for a certain period of time after termination of employment), which is a standard clause in some jurisdictions. As pointed out, non-compliance with this clause is often sanctioned by a contractual penalty.
As with contractual penalties, Serbian labor law does not regulate such a provision, leaving the same opposing interpretations.
The existing case law is not sufficient to resolve the aforementioned dilemmas since disputes concerning these issues are apparently very rare. This could be due to the efficiency of contractual penalties as a deterrent against violations or just reluctance by both parties to engage in disputes with uncertain outcomes.
To be sure, there is an argument found in the elaboration of a verdict that asserts that a contractual penalty is a covenant inherent to contractual law and not suited for labor relations. However, the case in question did not directly relate to the validity of contractual penalties and the reasoning could have been different if this was specifically the subject of dispute. Consequently, it cannot be said with certainty that judicial practice does not allow contractual penalties in labor law.
Until the above uncertainties and competing interpretations are resolved, our recommendation for employers is to stipulate contractual penalties as a sanction for violations that can cause significant damage to the company. Regardless of the uncertainty when it comes to its legal validity, there is no doubt that contractual penalties are a significant deterrent against violations and abuses by employees. It is also important to emphasize in employment contracts that the contractual penalty supersedes the contract itself and that it remains valid even after the termination of employment.
By Damjan Despotovic, Partner, DNVG