An Employer’s Guide to Restrictive Covenants
Let’s begin with what restrictive covenants actually are: simply put, they are clauses in employee contracts that are designed to restrict ex-employees from specific actions that could be seen as detrimental to the well-being of a business or its competitive advantage. For example, an employee who leaves to set up a company of their own, could be prevented from attempting to poach clients from their existing employer. Let’s set that out in a little more detail:
What do restrictive covenants do?
Usually, there will be a number of restrictions that restrict the employee from:
- working for a competitor or setting up a rival business
- contacting clients directly
- dealing with clients who contact the employee personally
- poaching staff
- interfering with the company’s relationship with its suppliers
Given that definition, making use of restrictive covenants might seem like a no-brainer. BUT (you knew there would be one), life and the law are rarely that straightforward, and the truth is that restrictive covenants can be tricky to enforce.
Interestingly, in our experience, clients can have quite contrasting views on this subject. Some feel particularly strongly that employees should not be allowed to work for a competitor for as long a period as possible; others believe that restrictions on future employment are unrealistic and impossible to enforce.
What is the starting point for enforcing a restrictive covenant?
In principle, any element of a contract that aims to restrict an employee’s activities after termination is technically considered as being ‘in restraint of trade and contrary to public policy’, or in plain English, an unfair burden on the employee because it could hinder their search for new employment. However, courts recognise that employers who have invested in their staff and shared their most confidential information with them, can legitimately seek to be protected from former employees using the investment or knowledge against them. Freedom of trade should prevail, so restrictive covenants will only be enforced if its aim is to protect a legitimate aim and is no more than is necessary.
This is a contractual matter. The courts are not ask to consider the actions of a former employee or its impact on the employer’s business, they are asked to consider if the clause as drafted represented the right balance between the protection of the freedom of trade and the protection of the employer’s legitimate business interests.
So how are restrictions enforced?
Mostly through injunctions. An employer will seek a court order preventing their ex-employee from breaching the restrictive covenants.
The court will then apply the test summarised above – asking very specifically if there is a genuine legitimate business interest to protect; that the employer is not in any way in breach of contract, and if the restriction is reasonable in relation to both parties’ interests, and the public interest. What this means in practice is that each case turns on its facts and what was granted by the courts in one case may not be granted in your particular circumstances.
What is ‘the blue pencil’ doctrine?
This is a legal phrase, which means the judge can only use the delete key. The court has no power to amend or rewrite a restriction to make it enforceable. For each clause, if it passes the test outlined above, an injunction will be granted; if the drafting of the clause makes it too wide, no protection will be given to the employer seeking the injunction.
Is it always possible for an employer to seek to enforce the restrictive covenants?
Before embarking on enforcement of a restrictive covenant, one crucial point to bear in mind is that the employer themselves must be squeaky clean when it comes to their side of the bargain; you won’t be permitted to enforce restrictive covenants if you have already breached the contract of employment. For example, the contract of employment may have been breached by dismissal without notice or by non-payment of sums provided for in the contract.
There are also less obvious breaches, such as the payment of a sum in lieu of notice which is not provided for in the contract. This just shows how critical it is to make sure your employment contracts are all water tight and fit for purpose for your particular organisation and staff, right from the start.
How do I prove that I need to protect a ‘legitimate interest’?
You need to be able to show that each restriction is necessary to protect the business from harm: the seniority of the employee, their access to confidential information and their relationship with customers or clients will all be taken into account.
Is there a standard, basic restrictive clause that could be incorporated into a contract?
The basic structure of these types of clauses is relatively standard but their content must be adapted to your own business. There isn’t an easy one-size-fits-all restriction because that would have to be overly broad in scope, and would therefore be unenforceable. For example, a nationwide non-compete may be appropriate for an online UK business, whilst one would expect the non-compete for a dentist to be limited to a few postcodes.
What is the “minimum necessary”?
What constitutes the minimum necessary for protection is decided on a case-by-case basis. If the length of time restricted by the clause is considered to be unreasonably long and/or the protected territory in which an ex-employee is not permitted to operate, too large, then the enforcement is likely to fall at the first fence. As is so often the case, the discretion of the court is everything; if the restriction is wider than necessary or too long, the restrictive covenant will simply fail.
What if the employment contract was signed years ago?
This is a really important point: the court must consider the restriction at the time the contract was entered into. What this means in practice, is that unless a new set of restrictions is signed by the employee when he is promoted, the analysis is done on the position the employee held when he signed his very first contract. If the post room boy becomes the MD after a long career without signing a new contract, then the judge will decide whether his employer merits protection against the post room boy and not against the MD. It is therefore crucial to ask employees to sign a new contract or an addendum to the original contract with new restrictive covenants each time they are promoted.
Does the nature of the contract itself make a difference?
Yes, the contract itself can make or break the power of a restriction because the origin of the restriction also plays a central role. Restrictions arising from a contract for the sale of a company or an agreement entered into with a departing employee will have more weight than restrictions contained in a standard employment contract. An employee who has agreed to restrictions during a sale or termination will have difficulty in obtaining judicial protection because he will have agreed to the restrictions with full knowledge of the facts, and in the situation where a settlement agreement is being entered into, with the advice of his solicitor. Restrictions contained in a standard employment contract have less weight because it is accepted that the bargaining power of a new or newly promoted employee is very low.
So as an employer, should I use restrictive covenants or not?
The million dollar (in some cases, literally) question. In a nutshell we do believe it wise to include restrictive covenants in an employment contract where appropriate.
First of all, enforceability isn’t everything; not every employee consults employment lawyers: it often happens that employees abide by restrictive covenants simply because they are in their contract of employment and automatically turn down jobs from competitors for that reason.
When employees take legal advice on the restrictions, unless the restrictions are non-existent or very poorly drafted, lawyers asked to advise on the enforceability of the restrictions rarely take a definite position because litigation is uncertain and costly and consequently, your ex-employee’s lawyer is likely to be cautious when telling him what he can and cannot do.
If you are an employer seeking to enforce restrictions, we advise that you instruct your lawyers to write letters before action to the ex-employee and their new employer. Alternatively, you may yourself receive a letter from your new employee’s former employer asking you to rescind the offer of employment or to move the employee to a different department.
Very often these situations lead to a new set of restrictions or some undertaking, whereby for example, the employee can work for the competition but must not approach certain clients for a set period – a compromise is reached between the parties
These clauses are extremely technical and ‘borrowing’ them from a friend’s contract or from the internet is a dangerous option. If you decide you need restrictive covenants it’s wise to have them drafted by lawyers. The more time and resource you invest in drafting these clauses, the stronger your position will be when you need them.
To sum up, here are our key Employease tips for this area:
8 ways to deal with restrictive covenants
- Get assistance from specialists;
- Decide which positions should have restrictive covenants;
- Identify the threat to your business on a role by role basis;
- Identify your clients and the buying cycles;
- Review the covenants at each promotion or role change;
- Ensure that you obtain freshly signed covenants when promoting;
- Seek advice from specialists when sending or receiving a letter before action; and
- Be prepared to compromise.
For more specific information or to discuss your requirements please call either Amanda Galashan or Julie Calleux at Employease on 0333 939 8741, or email us at email@example.com. This note does not constitute legal advice on any particular situation you may have.
© Employease: The Employment Practice Ltd 2017
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