Home | Restrictive covenants: How far can you go?

Restrictive covenants: How far can you go?

27 February 2008

What can an employer do when a key employee leaves them for a competitor? How do restrictive covenants work and what are the common problems for employers seeking to enforce them?

How do you protect your business against a leaving employee?

Employers have long sought to restrict the activities of their ex-employees by putting covenants that will apply after termination into employment contracts. However, the enforcement of such restrictive covenants is notoriously problematic. In this article we remind readers of the basic principles that need to be considered when drafting restrictive covenants. For the reasons outlined below, an employer will need to provide the fullest explanation of the factual background to assist the draftsperson in crafting the most protective covenants standing the best chance of enforcement.

Why is this area so difficult for employers?

If a leaving employee ignores their contractual post-termination restraints it is down to the employer to take action to secure compliance. This is usually achieved by applying to the Court for an injunction to force the ex-employee to abide by the terms of their employment contract. Courts have a wide discretion as to whether to grant an injunction and each case will turn on its own specific facts. It is therefore difficult to predict with certainty in any given case whether a Court will enforce the covenants. Traditionally the UK Courts have taken a very strict approach to post-termination covenants and an employer can incur significant legal costs seeking enforcement with no guarantee of success.

When do employers need to worry about restrictive covenants?

Restrictive covenants will usually be included in the employment contract entered into at the start of employment. At the outset of an employment relationship (like any other relationship!) no one really likes to dwell too much on what might happen if that relationship comes to an end. However, getting the drafting right at the outset is vital, an employer only gets one bite at the cherry. The Courts apply strict rules of construction to covenants and a will not re-write a covenant to make it enforceable. All too often an employer only turns their attention to restrictive covenants once an employee has handed in their notice and announced their intention to join a competitor – at this point it can be too late.

The principles that a Court will apply to determine whether to enforce a restrictive covenant in effect require the employer to get out their crystal ball before entering into the employment contract. They need to anticipate how their business and the employee’s role within it might evolve in the future to make sure that the covenants provide the maximum protection that is likely to be needed in the worst case scenario.

How will a Court decide whether to enforce a restrictive covenant?

When a Court is considering whether to enforce a restrictive covenant or not the starting point is that any provision which attempts to restrict an individual’s freedom to earn a living is void for public policy reasons. The Courts consider that any attempt to restrain economic activity is wrong in principle. However, if the Court considers that the restrictive covenant:

• protects a legitimate business interest of the employer; and
• goes no further than is reasonably necessary to protect that interest.

they will consider enforcement. The drafting of the restrictive covenant is therefore crucial because if it goes further than a court considers is reasonably necessary for the protection of the employer’s legitimate business interests it will be void.

What is a legitimate interest?

The Courts have recognised the following legitimate interests of employers:

• trade secrets and confidential information;
• connections with customers and suppliers;
• in certain circumstances, connections with prospective clients; and
• stability of the workforce.

It is possible that this list may be expanded in the future. If the employer can not identify one of these legitimate interests that it is seeking to protect the covenant will fail.

What is reasonable protection?

This is not an exact science but a matter of the overall impression of the Court. Factors that will be considered, depending upon the covenant under consideration, include:

• the length of the restriction;
• the scope of the restriction;
• the nature of the business and the employee’s role within it; and
• whether the covenant is usual in the relevant sector.

As regards the length of the restrictive covenants, the absolute ceiling for employment contracts is almost always 12 months. However, an employer should ask itself how much protection it actually needs and not how long it can get away with. The shorter the duration of the covenant the easier it will be to argue that it is reasonable. A duration of nine, six or even three months should be considered. A court may also take into account whether the employee was paid anything for agreeing to the covenant and whether the employee received legal advice on the covenant before signing up to it.

What are the different types of restrictive covenants?

There are various types of restrictive covenants that commonly appear in employment contracts:

• non-poaching of customers or suppliers of the employer (note that this can be very hard to enforce because it is difficult to gather evidence of the ex-employee approaching customers);
• non-dealing with customers or suppliers of the employer;
• non-poaching of employees; and
• non-compete (the harshest of all the different covenants because it actually prevents the employee from working for a competitor for a specified period). The current trend is for the Courts to be more willing to enforce these types of covenants than they used to be. However, this may change again in the future.

An employer may use some or all of these covenants in the employment contract, but the appropriate types of covenant to be used will always depend upon the circumstances.

How will the Courts interpret restrictive covenants?

The Courts apply what are known as the rules of construction when interpreting restrictive covenants to assess if they are reasonable . The main rules are:

• covenants must be clear and certain;
• words used will be given their ordinary meanings and extravagant interpretations will be ignored;
  reasonableness will be judged at the time the contract was entered into taking account of the reasonable expectations of the parties at that time; and
• the Courts will not re-write a covenant to make it reasonable but may sever certain words as long as what remains does not change the character of the provision (also known as “blue pencilling”).

Are there any other circumstances in which a Court will not enforce a restrictive covenant?

Yes, an employer will not be able to enforce a restrictive covenant if it has breached the terms of the employee’s contract first. For example, if the employee has claimed constructive dismissal based on a breach by the employer of the implied term of trust and confidence. Ex-employees often try to argue that they are no longer bound by their restrictive covenants because their ex-employer has breached the contract in some minor way and employers should be very careful to make sure that they follow their obligations under the contract to the letter.

Are there any alternatives to restrictive covenant?

If an ex-employee’s contract of employment does not contain express restrictive covenants the employer will only be able to rely on the implied term of confidentiality for protection. This has limited scope and would not protect an employer to the extent they might hope - it will only bind the ex-employee in respect of the use of information that amounts to a trade secret.

Alternatively, if the employment contract contains a well drafted garden leave clause the employer might use this to effectively isolate the employee from customers, current information and other employees for the duration of their notice period. The downside of such a clause is that the employer must carry on providing salary and benefits and, if the employee has already left in breach of contract the employer is in the same position as regards applying to the Court for enforcement of the garden leave clause. However, unlike in restrictive covenant cases, a Court can be more flexible and might consider granting a garden leave injunction for a different period to that specified in the contract. The issue of the interrelationship between any garden leave clause and the restrictive covenants should also be considered, in particular whether any period spent on garden leave should be set off against the period of any post termination restriction? It is unlikely that a court would enforce a restrictive covenant had an employee already spent a considerable amount of time on garden leave.

Can an employer only include restrictive covenants in the initial employment contract?

There is nothing to stop an employer and an employee from entering into a separate agreement containing restrictive covenants either at the start of employment, during employment or even when employment has ended, in a compromise agreement.

An employer would be well advised to keep the situation of post termination restraints under review for its key personnel, particularly where they are long-serving and their role may have varied over the years. There is however the practical problem of securing the employee’s agreement to new restrictive covenants during employment as new contractual provisions can not be forced onto the individual without their agreement. The employer may therefore find that they have to combine asking the employee to agree to new restrictive covenants with an offer of a payment or enhanced benefits. In any event, it should be remembered that for an agreement to be binding consideration must be given in return for the employee’s promise to be bound by new covenants.

Should an employer include standard restrictive covenants in the contracts of all its employees?

An employer can not seek to restrict competition simply for the sake of it. It should always ask itself what damage, if any, an employee could do if they left and joined a competitor? Would the employer wish to spend the money on enforcing the covenant against this particular employee in the Courts? In most cases junior employees will not have access to confidential information or trade secrets and neither will they be responsible for crucial customer or supplier relationships. In such cases there is little point in including elaborate restrictive covenants in their contracts. If the employer can not ever envisage enforcing a particular covenant against an employee there is little point in including it in the employment contract simply as a “deterrent”.

It is also unwise to rely on “standard form” covenants. To stand the best chance of being enforceable covenants should be tailored for each individual taking into account the factual background such as the demands of their role and the operation of the business.

However, employers should be careful to ensure consistency of treatment for employees carrying out the same type of role. If one person has restrictive covenants in their contract but another does not this could undermine any argument by the employer that it is reasonable to seek enforcement. This issue can be particularly problematic where another business has been bought and is being integrated into the buyer’s organisation and legal advice should always be taken.

Drafting tips

Consider carefully the role that the employee will have in the business and the protection that is likely to be needed should they leave to join a competitor. How are the business and the role likely to evolve? Make sure that this is communicated to whoever is drafting the contract.

• Ensure consistency of treatment across the business for employees carrying out the same type of role.
• Do not restrict the employee for any longer than necessary. If they are only going to have access to confidential information that has a limited shelf life before it is in the public domain the duration of the covenants should reflect this.
• If the employing company is involved with different types of businesses make sure the employee is only restricted as regards the part of the business with which they were personally involved.
• The employer must avoid drafting the covenants too widely. It should focus solely on prohibiting the activities with which the ex-employee was involved on behalf of the ex-employer.
• If including a non-compete covenant in the contract, consider the appropriate territory for the restriction: the employee should not be prevented from working everywhere but only in the markets where the company does business and with which he was involved.

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