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Can a contract with a management board member provide for penalties?

Given the nature of their function, management board members take key business decisions. They have access to confidential information, including trade secrets whose disclosure or misuse could expose the company to a loss.

The risk connected with management board members’ adoption of an erroneous business decision is most often limited through implementation of appropriate mechanisms in the company’s articles of association or management board bylaws. Some restrictions, such as the need to obtain the consent of the shareholders’ meeting to sell the company’s enterprise, or the ban on pursuing competing activity without the company’s consent, are expressly provided for by law. Requiring joint representation may also serve as a brake preventing management board members from taking rash decisions for the company.

A company sometimes will decide to introduce contractual provisions to secure the company’s potential claims against members of its management board. The solution most often encountered in practice is security in the form of a contractual penalty. But the possibility and scope of application of contractual penalties depends on the type of legal relationship in place between the company and the management board member.

Contractual penalty in the case of an employment contract

Current law leaves no doubt that management board members can be hired under an employment contract. If the parties choose an employment contract as the basis for hiring a management board member, this carries all the related consequences, also including the limited ability to secure claims the company may have against the management board member.

Provisions of labour law practically exclude the possibility of imposing security for the employer’s potential claims against the employee for improper performance of employment duties. The Supreme Court of Poland takes the position that the Labour Code (Art. 114–127) almost exhaustively regulates the grounds and rules for liability for material injury caused to the employer by the employee, and does not provide in this respect for security for employment claims. It is recognised that security for claims by the company against an employee is contrary to principles of labour law and thus impermissible.

The cases handed down by the Supreme Court have thus consistently denied the possibility of reserving a contractual penalty in an employment contract in the event of non-performance or improper performance of employment duties.

Security for claims for non-performance or improper performance by a management board member of an obligation to the company after the end of the employment relationship falls into a separate category. In practice, this primarily has to do with situations connected with the management board member’s violation of the duty to refrain from competitive activity after termination of employment, as well as the duty to maintain the confidentiality of the company’s affairs. In this respect, the rulings from the courts uniformly allow for inclusion of a contractual penalty in case the employee violates these obligations.

But when concluding a non-competition agreement for the period following the end of the employment relationship, the parties should take care that the contractual penalty provided in the event of the former employee’s breach of a non-competition agreement not be inflated. The contractual penalty which the employer is entitled to enforce against the former employee for infringing a ban on competition should not be grossly higher than the compensation payable to the management board member for refraining from competitive activity. Including a grossly overstated contractual penalty in the non-competition agreement, followed by a demand for payment of such an inflated amount, may give rise to a dispute between the company and the management board member and lead to a demand by the employee to reduce the penalty under Art. 484 §2 of the Civil Code in connection with Art. 300 of the Labour Code.

It is essential to note in this respect that pursuing damages exceeding the amount of the contractual penalty is permissible only when the parties have provided for this possibility.

Contractual penalty in a managerial contract

However, the restrictions on securing claims do not apply to a situation where the management board member has a managerial contract with the company. A managerial contract is a civil contract, not an employment contract, and thus is subject to the general regulations on contractual obligations. Therefore, when concluding a managerial contract, the parties may arrange the legal relations between them within their discretion, in accordance with the principle of freedom of contract. This also applies to the possibility of providing for a contractual penalty.

The validity of a contractual penalty provided for in a managerial contract is evaluated under general rules: in terms of compliance with regulations of law, the nature of the legal relationship, and principles of social policy (Civil Code Art. 3531).

The possibility of providing for a contractual penalty in a managerial contract does not raise doubts. Significantly, reserving a contractual penalty for breach of a management board member’s obligations should be recognised as admissible both during the term of the managerial contract and after the contract term ends. Such solutions are also commonly applied in practice.

Although a managerial contract offers greater freedom and flexibility in defining the rights and obligations of the parties, including the use of contractual penalties, it should be borne in mind that if the stated penalty is grossly inflated, the management board member will be entitled to seek a reduction of the penalty.

Agnieszka Godusławska