An overview on Restrictive Covenants

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Restrictive covenants are included in employment contracts to restrict a former employee's future commercial activities as a means of allowing the employer to protect its business after that employee has left.
Restrictive covenants

They are primarily used with senior executives or employees with access to confidential information, or those who have key relationships with clients or customers, suppliers or other employees. They may be used in tandem with garden leave provisions, which seek to restrict the activities of an employee due to depart by keeping them “out of the business” and away from key contacts during their notice period.

The English courts traditionally view such restrictions as being “in restraint of trade” and, for public policy reasons, will not enforce them unless certain conditions are met. In order to be enforceable, the employer must be able to show that the covenant in question goes no further than is reasonably necessary to protect a legitimate interest of the employer’s business. The courts will look to strike a balance between the employer’s interests, and allowing the employee the freedom to work where he chooses and to take advantage of his own professional skills and knowledge. Covenants included in a contract only to deter an employee from leaving are most unlikely to be enforceable.

What business interests can I protect?

Over the years the courts have identified only a small number of legitimate interests which can be protected by restrictive covenants. These are: · client or customer connections, including those with prospective clients or customers in some circumstances. Non-dealing and non-solicitation covenants are most often used here although in some cases a restriction on competition may also be appropriate;

  • confidential information and trade secrets. These may include customer lists, price lists, costings, financial details and terms and conditions of contracts with key suppliers. Non-compete restrictions are usually the most effective method of protecting confidential information although other restrictions may also be relevant; and
  • the stability of the workforce, particularly in a highly competitive business. Clearly covenants preventing the employment and “poaching” of other employees are crucial here.

Identification of the relevant protectable interest is critical. The recent case of Beckett Investment Management Group –v- Hall is helpful to employers on this issue. The restriction concerned was a 12- month non-dealing covenant, which identified the relevant clients with whom dealing was prohibited as clients of “the Company”, the employees’ employer. However, the employer was, in fact, only the holding company in the group: the trading business was carried out by individual subsidiaries. The High Court refused to grant an injunction enforcing the restrictive covenant, on the basis that the employing holding company had no business interest to protect. However, the Court of Appeal held that this interpretation was too narrow. It found that the only sensible construction was for the covenant to cover the business of the subsidiary company. The contrary construction would have meant that effectively the company and the two employees involved had, at the time they entered into the contract, agreed to a pointless provision whereas in fact all parties were familiar with the background to and aim of the clause. Employers should, nonetheless, ideally extend the scope of restrictions to subsidiary companies to be absolutely sure they are protected.

How long can non-dealing restrictions last?

A non-dealing restriction is wider in scope than a non-solicitation restriction. It prevents the employee from having any dealings with specified customers/clients or suppliers of the employer and means that the ex- employee cannot deal with the relevant contact even if they are approached by the contact concerned. As this is potentially very restrictive, it needs to be drafted:

  • to cover only those contacts with whom the employee dealt or for whom he had responsibility;
  • to be limited to particular contacts dealt with during a particular period prior to the termination of employment;
  • to last for a reasonable duration after employment has ended; and
  • if appropriate, to be limited to contacts in defined areas of the business.

Will non-competition covenants be enforced by the courts?

A non-compete restriction requires the employee not to work for a competing business. To be enforceable, it must be limited to:

  • the particular business activities that compete with the employer’s business and which the employee carries out;
  • the relevant geographical area; and
  • a reasonable period of time.

The duration of the restriction should be calculated with reference to how long it is necessary for the business to be protected. The effect of this type of restriction is potentially drastic, as it could prevent an employee from earning a living. The court must therefore be satisfied that it is a reasonable means of protecting a legitimate interest before it will be upheld. The legitimate interest concerned is usually the protection of the employer’s confidential information.

By Jahed Morad

 

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