Restrictive covenants: employment

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Restrictive covenants: employment

Restrictive covenants prevent employees, directors or consultants setting up in competition, taking staff, poaching clients or exploiting trade secrets.  We ensure your restrictive covenants and non-compete provisions are up to-date and enforceable.

We preserve your business’ value. That value can comprise business relationships, trained employees, or know-how. One particular expertise the protection of hi-tech business’ intellectual property.

Restrictive covenants: employment

Restrictive covenants prevent ex-employees soliciting customers, clients, suppliers and other employees for a defined period after termination. Thus restrictive covenants protect an employer’s confidential information, trade secrets, customer connections, goodwill and workforce.

Usually restrictive covenants define mechanisms for:

  • Protection: of the employer’s legitimate interests, e.g.:
    • Trade connections, customers, prospective customers, their workforce;
  • Extent: for how long and over which geographical areas.

Restrictive covenants versus garden leave

Restrictive covenants and garden leave clauses differ. A:

  • Restrictive covenant is determined when the employee signs the contract,
    • If a restrictive covenant is valid when agreed, the employer is entitled to have it enforced.
  • Garden leave clause is determined when the employee leaves,
    • and so offers greater flexibility.

Restrictive covenants don’t add costs.  Garden leave costs the employee’s salary during the gardening period. Garden leave clauses may be attractive if the employees’ remuneration mainly comprises a discretionary bonus.

There is no basis to set-off the period covered by a restrictive covenant against a period of garden leave. Nevertheless a ‘garden leave’ clause may affect the restrictive covenant’s validity. If the garden leave is a long period, courts may decline to grant additional protection.

In practice, the time spent on garden leave often reduces the time for which the restrictive covenant applies.

Enforceable restrictions

First we identify the individuals’ status, who the employer wishes restrict. The allowable restrictions depend on the person’s status in the organisation:

Employees

The law recognises that the obligations employers place on employees depends on their seniority and job function. These obligations are defined in the employment documentation.

Directors

The director’s service agreement enables employers to impose more stringent enforceable restrictions on directors than the employment documentation. These restrictions take into account directors superior knowledge of the business and their fiduciary duties.

Shareholders

The law views a shareholder’s relationship with the company as strictly commercial. Hence the law assumes that shareholders understand their obligations when signing the shareholder’s agreement.  A shareholder’s agreement can contain more restrictive covenants than the employment documentation.

Shareholders might take the company’s know how and apply it to engagements or investments in competing businesses. Shareholders are not employees and do not have the protection of employment rights.  Accordingly, restrictive covenants attaching to the holding of shares in a private company will generally be easier to enforce than those set out in an employment agreement.

Shareholders who are also employees or directors create additional complications. The benefit to including restrictions in the shareholders’ agreement is, for an employee or director, the value of shares may well be of greater than the work of the employment contract and therefore restrictions attaching to shares may be more of a deterrent.

Often we include shorter restrictions in the employment agreement and longer more restrictive restrictions in the shareholders’ agreement.

Consultants

The employment law protections which benefit employees and directors do not apply to consultants.  Thus companies gain a wider range of possibilities.

Problems can arise with transactions where there has been use of consultants. For example: if the transaction involves the sale of intellectual property any buyer will ensure the seller owns the intellectual property.

The solution is a tight consultancy agreement that make it very difficult to wriggle out of post termination restrictions.  As a matter of course, creators of intellectual property must assign all rights to the end user.

5 restrictive covenant categories

Typically, businesses use the following types of covenant, which all seek to prevent the ex-employee doing something.

Covenant TypeSeeks to prevent
ConfidentialityUsing or disclosing, the ex-employer’s trade secrets, confidential information & IP
Non-competeJoining, or operating, a business competing with the ex-employer’s
Non-dealingDealing with, or acting for, the ex-employer’s customers or suppliers
Non-solicitation/enticementSoliciting the ex-employer’s customers or suppliers
Non-poachingPoaching other members of the ex-employer’s workforce

 

Businesses often expand the scope of the restrictive covenant by including the following within the clauses:

Prospective customers

Employers can enforce clauses preventing ex-employees dealing with their actual customers. What’s trickier is a clause preventing the ex-employee dealing with companies with whom the employer has only had previous “negotiations” .

It is difficult to determine whether communication with a prospective customer amounted to ‘negotiations’. ‘Negotiations’ means more than an introductory meeting, more than a customer expressing interest in the employer’s services. ‘Negotiations’ means a contract is a real possibility, and both parties discuss the contract’s terms.

Confidential information and trade secrets

Employers wish to prevent former employees exploiting confidential business information and trade secrets. However, the business must identify what information is protected by restrictive covenants, and what isn’t.

Personal skill and restrictive covenants

This is difficult because an ex-employee is entitled to exploit their personal skill, training, qualifications and general knowledge for their or a future employers’ benefit. However, specific items of information may indisputably belong to the ex-employer, for example:

  • Customer lists;
  • Business plans;
  • Delivery routes;
  • Price lists;
  • Costings; and
  • Supplier details.

Maintain effective restrictive covenants

Employers should update restrictive covenants whenever an employee, director or consultant changes role. Usually that person gains access to new IP, e.g. suppliers, customers or know-how.

Risk with existing covenants

Many clients discover too late that their restrictive covenants are inappropriate for their current business. It is then difficult for employers to add new restrictive covenants to existing employment contracts and directors’ service agreements.

Corporate transaction can create problems.  Often the pre-sale restrictions are not appropriate for the post-sale business. The post-sale business is different, or employees have new roles.

For example, consider a media business. The business has probably moved into digital media, and perhaps expanded abroad. It no longer fears its competitors when it started, but faces a new set of competitors with different capabilities.

Update restrictive covenants

Follow the correct process, and employers can update restrictive covenants. Employers can change employment terms and modify restrictive covenants, if they take care. Employees who unreasonably refuses to enter into a revised covenant risk a fair dismissal.  Employers could claim ‘some other substantial reason’ defence to unfair dismissal.

Defending employers

Some clients are employers who are considering dismissing an employee or director who refuses to sign new post-termination provisions.  How we proceed depends on the terms of the revised clauses.

Employment Tribunals usually consider if the:

  • Refusal to sign the contract with the restrictive covenant justifies dismissal;
  • Employer had a genuine belief that dismissal for that reason was justified;
  • Threat to the business was justified,
    • Directors are more likely to be a threat than a junior employee,
  • Necessity to dismiss was fair.

Restrictive covenants enforcement

The starting point for any contractual post-termination restriction is whether it is void. It can be void because it is a restraint of trade and contrary to public policy.

Employers must show the restrictions:

  • Protect legitimate business interests;  and
  • Extend no further than is necessary to protect those interests.

Often we enforce these restrictions in the courts.

Drafting restrictive covenants

Our skill is not to draft the restriction too widely. We carefully define the restrictions’:

  • Duration;
  • Geographical scope; and
  • The restricted activity.

Impact of duration on enforceability

As a general rule restrictions for more than 6-12 months are:

  • Difficult to justify;
  • Likely to be considered unreasonable.

If so, the restriction will be void and unenforceable. The courts regard restrictions of 6-12 months as restrictive for employees. The exceptions are very senior employees. Often the restriction’s duration is in line with the employees notice period, which usually reflects their seniority.

Tailoring restrictive covenants

We define appropriate durations and restrictions that depend on the employee’s role and their seniority. Then the restrictions pass the reasonableness test.  Blanket clauses across all employees are less likely to be enforceable.

Cautionary point

Reasonableness depends on when the restrictive covenant was signed, not when the employee leaves.  The teaboy who works his way up to director, whose first and only employment contract was appropriate for a director, probably won’t have an enforceable contract. Thus restrictive covenants should be regularly reviewed and updated, especially after promotions.

A settlement agreement can include fresh restrictive covenants when an employee leaves.

What can be done by businesses faced with breach

Clients often suspect a breach of a restrictive covenant.  We quickly stem any damage. If an employee, director or consultant ignores the restrictions, which turn out to be enforceable, there are serious repercussions. To enforce the restrictions the business can:

  • Obtaining an interim injunctionprecluding the infringer from engaging in the restricted activity;
  • Seek damagesfrom the employee for breach of the restrictions;
  • Sue the new employer:for inducing the employee to breach their contract.

In any case, the infringer potentially faces significant legal costs.  The new employer could offer the employee an indemnity against damages and costs. The indemnity might secure their employment. However, such an indemnity does not always happen.  Nor can legal costs be under-estimated.

Injunctions and undertakings agreed at Court to prevent breach of restrictive covenants

Sometimes the breach can only be stopped via litigation.  The most common process is an  injunction to prevent the employee from taking certain actions.  Another process is via the court to require undertakings to be given.  Court agreed undertakings are more likely to be taken seriously than informal undertakings agreed between the parties.  We often find that rather than face an injunction hearing the offending party will agree to undertakings to refrain from breaching the restrictive covenant.

The success of any court action will depend upon the facts and the employment documentation the employer has to rely upon.

Review of the evidence if considering court action

We can review the facts and the evidence and tell you what choices you have.  We will assess the strength of the evidence and narrow down the avenues worth pursuing.

Restrictive covenants track record

Some recent instructions include:

Restricted former employee starting competing business

Enforced restrictive covenants for firm of financial advisers, with a household name, against former employee. The employee had founded a competing business.

Restricted competitors recruiting developers

Bolstered restrictive covenants for fast growing software company. Thanks to the company’s reputation, competitors coveted their developers.

Prevented customers’ poaching employees

Drafted bespoke restrictive covenant for a service provider client to prevent customers poaching employees.  We inserted a bespoke clause into client-facing employee’s employment agreements. This was not a common non-compete clause to restrict ex-employees working or dealing with competitors.

The benefit of our service is that we draw on our extensive employment law knowledge and experience. The law relating to enforcement of restrictive covenants against employees and directors is fast changing.  We work you to ensure that you have the best possible protections in place and when needed those restrictive covenants are enforceable.