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 employment has ended may be vital to the protection of your business or customer contacts. An ex-employee who has knowledge of your technology, strategic information or customers or clients may be an attractive asset to a competitor seeking to encroach upon your market.
There are certain terms which are implied into employees' contracts which may provide a certain level of protection for employers whilst the employee's employment continues.
However, an employer may seek to protect the use of this information both during employment and after the employment ends through the use of what are known as restrictive covenants. Many employers include these clauses in the contracts of employment of senior or highly skilled staff at the commencement of the employment relationship. Having such clauses set out in the contract from the outset may help to deter employees from joining competitors and may warn off potential new employers.
A restrictive covenant is typically a clause in a contract which prohibits an employee from competing with his ex-employer for a certain period after the employee has left the business, or prevents the ex-employee from soliciting or dealing with 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 that it is a restraint of trade and contrary to public policy. It follows that an employer is generally not entitled to protect himself against competition from his ex-employees. 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.
A non-compete clause may be enforced to protect a legitimate business interest – for example, client connections, confidential information or a stable workforce – and not simply to stifle or prevent competition.
Types of restrictive covenants
The standard types of restrictions which can be used by employers are:
- non-competition covenants - restrictions on the former employee working in similar employment for a competitor;
- non-solicitation covenants – which prevent poaching of clients/customers/suppliers of the former employer;
- non-dealing covenants – which prevent a former employee from dealing with former clients/customers/suppliers, regardless of which party approached the other;
- non-poaching covenants – which prevent an employee poaching former colleagues.
For a restrictive covenant to be enforced 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 the 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 6-12 months will be difficult to justify.
- The breadth of the activities that the employer is trying to restrict.
- The type of interest being protected, for instance, information such as trade secrets may be granted wider protection than 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.
Restrictive covenants may also require periodic review in order to maintain their enforceability as the reasonableness of the covenant is judged at the time it was entered into.
The court may have regard to what is standard practice in the employer's industry with regard to such covenants and the above factors.
Garden leave is also commonly used in conjunction with restrictive covenants for maximum effect. 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 period at home whilst continuing to receive his usual salary and benefits.
The benefit of a garden leave clause is that it prevents the employee from taking up other employment with a competitor whilst enabling the employee's successor to establish himself and develop relationships with the employee's customers and contacts. Whilst on garden leave the employee is also no longer privy to the company's confidential information and what information they do have will become out of date.
In order to be able to place an employee on garden leave the employer will need to have an express clause in their contract. Any such clause is subject to a test of reasonableness in relation to its duration. The period of garden leave should not be unduly long as the longer the period, the less likely it is that it would be enforceable in full.
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 injunction and request that the employee "deliver up" or destroy confidential information. This means that the court will be asked to stop the employee in his tracks and will hear the full evidence at a later date in another trial.
Where an employer claims a financial remedy or 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.
Where the employee has been induced by the employer's competitor into breaching restrictive covenants, the employer might choose to sue that employer (particularly as the competitor company is likely to have greater financial resources from which to pay any award of damages made).
Team moves between competing businesses have become a hot issue as businesses try to poach teams of employees from profitable parts of their competitors' businesses. Restrictive covenants will usually feature heavily in team move litigation if they are included in departing employees' employment contracts.
Once an employer becomes aware that there may be a raid on its employees, it is important to act quickly to determine the best strategy to protect its position. Recent case law has demonstrated an increased willingness by the courts to uphold post termination restrictions in favour of employers.
For employers looking to recruit teams, careful planning and execution will be necessary to avoid the pitfalls. If not properly handled a team recruitment drive will be found to be an unlawful poaching exercise.
Legal action in this area can involve a substantial amount of time and money so it is important for employers to understand their commercial objectives from the outset. Employers should consider what they want to achieve and the commercial implications of taking a particular stance in relation to publicity, client relationships, management time and cost. Evidence gathering in the form of emails, telephone recording print logs and the identification of weak links will be key. Credible evidence of wrongdoing will create a position of strength from which to negotiate an advantageous statement.
Overall, a clear strategy and a game plan are essential. Seek legal advice immediately.
- Jonathan Coley
- Edward Goodwyn