Restrictive covenants in employment contracts

This guide is based on UK law. It was last updated in July 2006.

What are restrictive covenants?

Every business has information that it considers both integral and invaluable to its success. Restricting the use of this information by employees after their term of employment may be vital to the protection of your market position. An ex-employee who has been privy to your client details and trade secrets may be an attractive asset to a competitor seeking to encroach upon your market.

An employer may seek to protect the use of this information through the inclusion of a restrictive covenant in the contracts of employment of senior or key staff at the commencement of the employment relationship.

A restrictive covenant is usually a clause in a contract which prohibits an employee from competing with his ex-employer after the employee has parted company with the business, or prevents the ex-employee from soliciting customers of the business by using knowledge of those customers gained during his prior employment.

The starting point for any such post-termination restriction is that it is void on the grounds of illegality. However, if the ex-employer can convince a court that the covenant is:

• designed to protect his legitimate business interests; and
• that it extends no further than is reasonably necessary to protect those interests

then it will be upheld and enforced.

It follows that an employer generally is not entitled to protect himself against competition from his ex-employees. So where a non-compete clause is enforced it is to protect a legitimate business interest – for example, client connection or confidential information – and not simply to stifle or prevent competition.

Types of restrictive covenants

The standard types of restrictions which can be used by employers are:

• restrictions on the former employee working for a competitor – commonly known as area covenants;
• non-solicitation covenants – which prevent poaching clients/customers of the former employer;
• non-dealing covenants – which prevent a former employee from dealing with former clients/customers, regardless of which party approached the other;
• non-solicitation of staff covenants – which usually are restricted to those employees the former employee had material dealings with in a defined period prior to the termination of his employment

For a restriction to be reasonably necessary it must not be drafted too widely. It will be for the employer, in the event of a clause being challenged, to show that the clause is justified and sufficiently narrow. To meet these criteria an employer must be mindful of certain factors:

• The breadth of the geographical area of any restriction and length of time of the post termination restriction must be justified. It is unlikely that a wide geographical area will be justified and, as a general rule, a restriction for more than six months will be difficult to justify.
• Regard will also be had to the type of interest being protected, for instance, information such as trade secrets may be granted a wider area of protection than information regarding customer information, given that its potential use across markets is wider.
• An employer may also be required to evidence any connection between the employee and any information that is being protected.

The extent of clauses, therefore, must be relative to the employee's position within the business. As more senior employees will be in contact with more sensitive information, restrictions placed upon them may be justified as being more onerous. Overall, a one-size fits-all policy on restrictive covenant clauses risks the clause becoming unenforceable.

It is advisable to draft each clause separately. That way, should any single clause fail for reasonableness or necessity, it may be severed from the contract by the court without affecting any of the remaining clauses. Restrictive covenants may also require periodic review in order to maintain their enforceability.

Garden leave

Garden leave is also commonly used in conjunction with restrictive covenants. The inclusion of a garden leave clause in a contract of employment allows an employer to require the employee to spend all or part of the notice of termination period at home whilst continuing to receive his usual salary and benefits.

The benefit of a garden leave clause is that it creates a time period in which the employee cannot take-up other employment and is no longer privy to the company's confidential information. Garden leave must also be created expressly by a clause in a contract and is also subject to a test of reasonableness with regard to its duration.

Remedies for breach of restrictive covenants

If an employer has reason to believe that an employee has breached the post-termination restriction, the most common remedy sought is an injunction (or interdict in Scotland). An application will generally be made for an interlocutory injunction pending full trial – i.e. the court will be asked to stop the employee in his tracks and hear the full evidence at a later date.

Whether or not an interlocutory injunction will be granted will depend upon whether the court is satisfied that there is a serious question to be tried – that is, that the claim is not frivolous or vexatious and the so-called 'balance of convenience' lies in favour of granting or refusing the interlocutory injunction. The court will consider:

• whether damages would be a sufficient remedy at trial – this will not be the case where damages are unquantifiable and/or where the employee is unlikely to have the means to pay them;
• whether more harm will be done by granting or refusing an interim injunction;
• where factors appear to be evenly balanced, the court will favour preserving the status quo;
• any delay in making the application or acquiescence on the part of the employer; and
• the conduct and dealings of the parties.

Where an employer claims damages for breach of a restrictive covenant in an employment contract, the employer will need to show some loss resulting from the breach. This will normally be loss of profits on contracts or opportunities diverted by the employee. Often it is hard to prove that such contracts or opportunities would have definitely been placed with the employer had it not been for the employee's breach. In such cases, the courts will evaluate damages based on the chance the employer has been deprived of. Assessing damages in this area is often difficult. However, the courts will not allow this difficulty to free a wrongdoer from paying damages for his breach.

Contact: Jonathan Coley jonathan.coley@pinsentmasons.com (Birmingham, 0121 200 1050) or Ben Doherty ben.doherty@pinsentmasons.com (Glasgow, 0141 249 5420)