We are often instructed by Companies seeking to enforce post-termination restrictions against an ex-employee who poses a threat to their business. We have put together this guide on the essential considerations when drafting and seeking to enforce restrictive covenants.
What is a restrictive covenant?
A restrictive covenant is a clause that is put in employment contracts purposely to ensure that the activities of employees are restricted after they exit the employment relationship for a limited time, to protect the employer’s legitimate business interests.
Restrictive covenants should be drafted as narrowly as possible to protect the legitimate business interests of the employer, otherwise, they will be void on public policy grounds and for restraint of trade.
What are the different types of restrictive covenants?
The types of restrictive covenant include:
- non-competition covenants– this prevents the former employee working in similar employment for a competitor company or business
- non-solicitation covenants–this prevents the poaching of customers, clients and suppliers of the former employer
- non-dealing covenants– this prevents a former employee from dealing with clients, customers and suppliers who still work for the former employer regardless of which party it was that approached the other
- non-poaching covenants– which prevent an employee poaching former colleagues
Why impose restrictions?
It is not surprising employers wish to impose restrictions on the use of information and to stop the exploitation of business relationships by ex-employees. Every business has confidential information, knowledge and contacts that are integral to its overall success. Businesses have ownership of goodwill, client identities, requirements, pricing, suppliers and knowledge of the workforce and future business strategy. These things can all be included in the definition of “legitimate business interests” and employers will want to protect them and prevent others from using or damaging them.
In a time of economic uncertainty ensuring that ex-employees’ behaviour post -service is restricted is important, which is why many businesses implement post-termination restrictive covenants in their employment contracts.
Who should have such restrictions imposed upon them?
As an employer, you should be careful that the same restrictive covenants are not simply implemented in all employment contracts and applied across the board. This approach will make them more difficult to enforce, as employers must justify in each individual case what the business interest is that they seek to protect, and why the covenant is no wider than necessary to protect that interest. Different business interests and levels of protection usually apply to different employees within a single business.
For example, restrictive covenants for senior management and members of staff should be drafted differently because more senior staff are more likely to have more client contact and influence, and more knowledge of business strategy and trade secrets. Likewise, some staff such as sales staff might have contact with customers over a broad geographical area but a broad geographical restriction may not be appropriate for other members of staff based in one location who do not deal regularly with customers.
Do you need to explain the purpose of the restrictive covenant?
A preamble to explain the purpose of the covenant is not necessary but may aid the employer in protecting its legitimate business interests, as a court may decide that it is clearer what interests the employer seeks to protect. Preambles should be carefully thought over, as if the employer considers there are other business interests at the time of the contract which is not listed in the preamble, this could affect the authority of the covenant in question and potentially result in it not being upheld.
How long should a covenant be?
An employer needs to find a balance between ensuring that the covenants are long enough to protect their legitimate business interests, but at the same time ensure they are not too long that they risk being deemed unenforceable. Restrictive covenants in employment contracts are usually between 6-12 months. However, there are no set time-limits, and a court would consider enforceability on a case by case basis, balancing the length of the restriction together with various other factors such as seniority, nature of the work, the renewal periods for client contracts, and more. Anything longer than 12 months tends only to be enforced in exceptional circumstances. When advising you, we would consider all circumstances of your business and the role of the employee in question.
What do you mean by Consideration?
As an employer, you must provide consideration, i.e. something in return for the benefit of being protected by the restrictive covenant. This is usually satisfied by the employee being entitled to a salary and benefits.
What if I want to update a covenant?
If you give an employee a new contract during the employment, for example, because of promotion, and it contains new restrictive covenants (it is always a good idea to review the covenants when the role changes), there should usually be some additional consideration provided at that point. This can either be financial consideration such as a pay increase or benefit. Alternatively, if the new contract is signed as a deed, that will amount to consideration. If no consideration is given for new covenants, arguably those restrictions are not enforceable against you, so it is important to take advice when implementing covenants and varying/replacing contracts, to ensure that you will be able to rely on the covenants in future.
What is the ‘blue pencil test’?
As already mentioned the courts are reluctant to introduce new wording or limitations. However, they can remove void provisions from the covenants, leaving the remaining provisions intact and enforceable, but only if removing the unenforceable wording does not change the nature of the employment contract. This is the ‘blue pencil test’.
What is Garden Leave?
A garden leave clause is not a restrictive covenant. It is a contractual clause which aims to prevent your employees from immediately working for a competitor. A garden leaves clause means that the employer has the option to continue to employ and pay the employee during a given period, without requiring them to work and preventing them from having access to customers, colleagues, information, and the premises. Whilst (on paper at least) still working for their current employer, the employee continues to be bound by their employment contract and the employee duty of good faith. Where there is a garden leave clause and restrictive covenants, it is likely that time spent on garden leave would count towards the period to which the restrictive covenants apply. Garden leave clauses can be easier to enforce than restrictive covenants so should be considered inappropriate cases.
What happens if the employer breaches the employment contract?
As an employer, it is more difficult for you to rely on the employee’s post-termination restrictive covenant if you have breached the contract yourself. For example, you must implement payment in lieu of notice clause in the contract if you wish to terminate the contract immediately without cause, otherwise, you may not be able to rely on the covenants.
When is a covenant enforceable?
This fundamentally depends on the circumstances in every case. However, for general guidance, there are key factors the courts have considered in various cases to determine whether a particular covenant is likely to be enforceable against an employee, including the following:
- Does the covenant seek to protect a legitimate business interest and is it clear about what interests it seeks to protect?
- Is it reasonable taking into account the parties’ interests and the public interest?
- Is it any wider than necessary?
- How senior was the employee and what access and influence over customers did they have, or what knowledge did they have of the employer’s affairs?
- What shelf-life did any restricted information have?
- Are the lengths of customer contracts/ timings of customer renewal dates relevant to the length of the restrictions?
- Is the geographical area reasonable taking into account the area of the employee’s activities and the nature of the area?
- How specialised is the business? Is a very wide geographical restriction reasonable given the limited number of businesses worldwide that carry out that business?
- How long would it reasonably take for a replacement employee to settle and establish relationships with customers etc. for themselves?
- What was the typical frequency of contact with customers/the exclusivity of those relationships?
When should legal action be taken?
Employers should seek legal advice promptly if they think a covenant has been breached which is damaging their business interests, or if they think an employee is breaching the terms of their garden leave. They should investigate and gather as much evidence as they can, and if appropriate, take steps to protect their information and business relationships.
What remedies are available?
Before resorting to court proceedings, it is common for employers to write and seek undertakings from the former employee. An undertaking is a legally binding promise to do or not to do something, such as not to work for a competitor, or not to set up a competing business, or agreeing to abide by the restrictive covenants in the contract. We can assist you with a letter requesting undertakings.
If the employee does not provide the undertakings and cannot otherwise come to an agreement with the employee, the next step may be to issue court proceedings for breach of contract.
There are various remedies that can be sought from the court by the employer:
An injunction is a court order in which the court orders a party to do or not to do something, An injunction is discretionary, meaning the court will only usually only grant one where a financial remedy such as damages is not adequate, for example where the individual is using confidential information or poaching employees for their own new business, and the employer needs to put a stop to that quickly before further damage is done to the business. Where an injunction is needed, typically it is needed urgently, so the former employer would probably seek an interim injunction, to begin with.
An interim injunction is an emergency injunction that an employer can seek from the court at short notice before the matter gets to a full trial. The employer will have to persuade the court that there is a serious issue and that the individual will do damage to their legitimate business interests if they are not prevented promptly from breaching the covenant(s). A court will often assess the merits stringently and will require persuasive evidence at the interim stage even though it is not a full trial, because by the time the case reaches trial the restricted time periods may have expired in any event. An interim injunction might, for instance, order an individual to stop working for a competitor or order them to comply with their restrictive covenants.
Employers should be confident there has been a breach, and that they have evidence of the breach, before going ahead with court proceedings, because they will be required to give a cross-undertaking to the employee upon any interim injunction being granted. The effect of the cross-undertaking means that if when the trial comes around the court decides that the interim injunction should not have been granted, the employer will be liable to pay damages to the employee for losses suffered as a result of the injunction.
In addition to enforcing post-termination restrictive covenants, injunctions can be used to enforce garden leave clauses and breaches relating to confidential information. There are also springboard injunctions, which aim to prevent commercial gain as a result of being in possession of the employer’s confidential information.
An employer can seek damages, i.e. payment of money, in addition to an injunction if the loss is attributable to the breach of covenant. Alternatively, they might only seek only damages if for example, all the possible damage has already been done/the restricted period has expired and an injunction would be ineffective.
- Account of profits
Sometimes it can be difficult to attribute the loss as a result of the breach of a restrictive covenant. This alternative remedy is a recovery of the profits the individual or their new competing business may have made as a result of the breach of covenant. It is exercised on the discretion of the court.
- Suing competitors
As an employer, you can sue your employee’s new employer if the new employer has induced or attempts to induce the employee to breach the covenant. The former employer may prefer to sue the new employer as they will probably have greater resources than the employee. If you have a prospective new employer, they will probably ask to see a copy of your restrictive covenants for that reason.
If you need advice on your restrictions contact us at [email protected] or call our Sheffield office on 0114 303 2300 or London office on 020 329 0280 for a free confidential conversation.