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August 29, 2023

Costa Rica: Non-Compete Covenants in Costa Rica

Gloriana Lara Ramos

Costa Rica has been known to attract foreign investment through multinational companies in the manufacturing, knowledge intensive services, life sciences and tourism infrastructure sectors, over the past forty years due to favorable incentives and benefits provided by the Free Zone Regime. The Costa Rica Investment Promotion Agency (CINDE), a private non-profit agency in charge of attracting direct foreign investment to the country, has helped guide over 400 high-tech companies in establishing operations in the country, alongside the Ministry of Foreign Trade (COMEX).

Due to high competition within the different sectors, companies have implemented the practice of subscribing non-compete contractual clauses or covenants with employees, to prevent them to work for competitor companies after the employment relationship ends. Non-compete covenants are those contractual agreements by which an employee undertakes, for a specific period after the termination of the employment relationship, not to perform work for other companies that carry out similar commercial or productive activities as those carried out by the organization for which they previously worked.

Constitutionality of Non-Compete Covenants

However, concerns over the legality and enforceability of such covenants in Costa Rica frequently arise, as the Political Constitution states that employment is an unrelinquishable constitutional right of individuals, and that the State must prevent conditions that in any way undermine the freedom of work and guarantee the right to free choice of work.

The Labor Code does not expressly regulate non-compete agreements, however, it establishes the employee’s confidentiality obligation towards the employer, which is limited to the duration of the employment relationship. Nonetheless, the Undisclosed Information Law dictates that any person who, due to their work, employment, position, profession or business relationship, has access to undisclosed information and whose confidentiality has been expressly warned, must refrain from using or disclosing it without the consent of the owner, even when the employment or business relationship has ceased.

Likewise, it specifies that in the contracts through which specialized technical knowledge, technical assistance, basic engineering or technologies are transmitted, confidentiality clauses may be established to protect the undisclosed information that meet the conditions referred to in the first paragraph of article 2 of said law, which are: a) that it is secret, not generally known or easily accessible to people in circles where this type of information is used; b) that it is legally under the control of a person who has taken reasonable and proportionate measures to keep it secret; and c) has a commercial value due to its secret nature. The undisclosed information refers to the nature, characteristics or purposes of the products and the production methods or processes.

It is important to note that the Labor Code was approved in 1943 and has since suffered minor reforms until 2017 in which the procedural reform came into force, which changed many aspects of the procedures of the labor legislation. However, it still hasn´t endured the necessary reforms to include the modern forms of employment and contracting required by current labor relationships and new forms of service provision and conditions, which are already occurring in practice. 

Supreme Court Case Law on Non-Compete Covenants

The case law of the Second Chamber of the Supreme Court of Justice of Costa Rica has developed the figure of non-compete covenants in labor relationships, as well as the conditions that they must comply with to make such agreements permissible and enforceable. The Second Chamber has indicated that non-compete agreements are not against the law, because they seek to prevent a socially reprehensible and illegal conduct such as unfair competition, using knowledge or information acquired during the labor relationship. Therefore, businesses may protect themselves from such activity through such covenants with their workers after the employment relationship has ended

The right of the employer to convene such agreements must include, to be considered valid, a proper economic compensation to the employee, as well as being established for a reasonable period, as it cannot be perpetrated indefinitely. The foregoing, because companies cannot expect that an individual refrains from working, whether as an employee or independently, for a company in the same line of business than the former employer, without compensation. Such obligation would lack the essential element of cause that must be present in all contracts, along with consent and object, which would make the contract null, as per the Civil Code of Costa Rica.

The same vote of the Second Chamber considered the term of two years for the non-compete agreement rational, and instead, vote number 00977-2016 of September 14th, 2016, considered a restriction of four years excessive. Regarding the compensation amount, vote number 00089 – 2003 indicated that 50% of the salary was fair, and in the contrary, vote number 00977-2016 considered a compensation of 30% of the salary disproportionate, being that the discussed agreement prohibited the worker from carrying out similar activities in all the Latin American region.

Similar to the case law of the Second Chamber of the Supreme Court of Justice, the Ministry of Labor has referred  to these types of agreements, stating that for their validity they must include the following elements:

  • They must establish an adequate economic retribution for such concept
  • Establishing them for an indefinite term makes them unfeasible and null
  • The quantification of the compensation is determined by the parties in either the employment contract or the non-compete covenant or clause
  • That the company has an effective industrial or commercial interest that justifies the need of the agreement due to a possible damage caused to the company for carrying out the activity that is being prohibited
  • That the agreement cannot be unilaterally terminated by the employee, even if they reject the agreed financial compensation
  • That the effects of the agreement are mandatory for the duration of the agreement

Concluding Thoughts: Elements Required for Non-Compete Clauses

Based on the preceding, it is concluded that non-compete covenants in Costa Rica are not only valid, but they are aimed at protecting the employer from possible damages caused by unfair competition through the use of knowledge or confidential information acquired during the labor relationship. However, the legitimacy of such agreements depends on the conditions established since the beginning of the relationship, which must include a proportionate compensation to the employee and a reasonable term.

If these elements are not present in the agreement, the obligation becomes null, and the employee would not be forced to comply with the clauses and could even be entitled to the payment of damages due to the imposed restrictions. It is also advisable that, when establishing a non-compete agreement, the employer expressly reserves its right not to enforce the clause or covenant after the employment relationship finalizes for any reason, to avoid entering a discussion of a mandatory payment. 

    Gloriana Lara Ramos

    Associate, Labor Department Aguilar Castillo Lov San José, Costa Rica