Will your restrictive covenants stand up in court? We examine some recent cases and give practical guidance to maximise the chances that your restrictions will be enforceable.
Will your restrictive covenants stand up in court? Recent months have seen a flurry of cases on restrictive covenants. The good news for employers is that the courts are apparently more willing to enforce non-compete and non-dealing covenants, but the cases also serve as a salutary reminder that restrictive covenants must be carefully drafted or they will not be upheld by the courts. This article reviews the recent cases and gives some practical guidance on what you can do to maximise the chance that your restrictions will be enforceable. Restrictive covenants - a reminder of the basics 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. 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 Olswang 2007 www.olswang.com 1
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 exemployee 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. In contrast, a non-solicitation restriction has potentially less impact than a non-dealing restriction. A nonsolicitation restriction prevents the employee only from actively trying to obtain business from contacts and so if the contact approaches the ex-employee voluntarily, the ex-employee is permitted to deal with them. However, the drafting considerations set out above are still relevant. It is generally appropriate for non-dealing restrictions to be of shorter duration than non-solicitation restrictions. However, in the Beckett case (see above) the Court of Appeal expressly stated that the fact there was a 12-month non-solicitation clause did not necessarily mean that the 12-month non-dealing restriction that ran at the same time was unenforceable. The High Court judge had held that a non-dealing restriction of three months' duration would be more than enough for the employer to seek to re-establish contact with the departing employee's contacts and that a 12-month period was arbitrary and excessive. The Court of Appeal overturned this. They held that any restriction period is necessarily arbitrary and emphasised that it is appropriate for the employer to put in place a restriction that takes account of the following factors: the seniority and importance of the employees. In this case, the two departing employees were of enormous importance to the employer's business at the location concerned; the fact that the non-dealing clause potentially interfered with the clients' choice as to whom to instruct was not fatal; evidence of business patterns; Olswang 2007 www.olswang.com 2
the logistics of replacing the employee. In this case, to have any prospect of retaining their clients, the employer would have to recruit, organise and train suitable replacements; and evidence of an industry standard. In this case, there was uncontradicted evidence of an industry standard of 12 months. Accordingly, the Court of Appeal was happy to uphold the 12-month non-dealing restriction but did say that a period in excess of 12 months would not have been reasonable in respect of either employee. 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. Recent cases have shown a trend for the courts to uphold non-compete restrictions of fairly long duration, if the interest being protected is confidential information. For example, in the recent case of Thomas v- Farr plc the Court of Appeal upheld a 12-month non-compete clause in the contract of a managing director of an insurance broker providing insurance services to housing associations. The managing director maintained that any information which he had was either too general to be capable of supporting a claim of confidentiality, or was part of his general skill and knowledge, or was in the public domain. In a decision that is helpful to employers, the Court of Appeal stated that: an employer just needs to show that the nature of the employee's employment was such that the employee would be exposed to trade secrets or other information of equivalent confidentiality; the fact that it is difficult to distinguish between information which remains confidential after the end of the employment and information which is not (for example, information within the employee's skill and knowledge) is not fatal to the enforceability of the non-compete covenant; and in practice, the fact that the distinction may be hard to draw may support the reasonableness of a non-compete clause rather than stand against it. In circumstances where there may be serious difficulties in identifying precisely what is or what is not confidential information, a non-compete clause may be the most satisfactory form of restraint. Furthermore, the Court of Appeal could see no reason why the 12-month duration was unreasonable. The fact that the employee's evidence was that most relevant insurance policies were for periods longer than 12 months and that therefore a 12-month ban bore no connection with the clients' insurance cycle, did not persuade the Court of Appeal not to enforce the clause. The employee also sought to argue that the non-solicitation and confidentiality clauses in his contract provided adequate protection for the employer. The employee pointed out that the relevant market was Olswang 2007 www.olswang.com 3
not one in which customers were transient or difficult to identify and the placement of insurance on behalf of housing associations was done by a publicly-regulated tendering process which required a substantial degree of openness. However, the Court of Appeal dismissed this ground for three reasons: despite information being in the public domain (and therefore not confidential) the nature of the employer's business and the employee's role in it was such that he would know a good deal of information of a sensitive nature which was not in the public domain, both at a strategic level and at an operational level; the problem of policing a non-solicitation covenant arises from the difficulty of differentiating between confidential and non-confidential information; and much of the solicitation of clients was likely to be done by staff working for the employee, rather than the employee himself. In such circumstances, the Court of Appeal's view was that the practical problems of trying to police a nonsolicitation clause are self-evident. The decision in Thomas v- Farr plc has already been followed. In Intercall Conferencing Services Limited v- Steer, the High Court granted a temporary injunction preventing an employee working for certain named competitors for a period of six months plus the one month the employee had already spent on garden leave. Practical advice Recent decisions indicate that the courts are more ready to enforce lengthy blanket noncompetition restrictions for senior staff than they were a few years ago. Senior executives who face a non-compete restriction in a proposed employment contract may therefore be more likely to attempt to negotiate it away entirely or to seek to reduce the period of restriction. Employers may consider including non-competition restrictions in employment contracts when previously they did not. The recent cases emphasise the need to draft restrictive covenants extremely carefully and to ensure that they are tailored to the particular business and the employee's precise role within the organisation. Particular care needs to be taken when the organisation has a group structure with different trading companies to ensure that the restrictions cover the relevant protectable interest and reflect the employee's working practices. Additional attention is required if there is a group re-organisation or a take-over/merger but employers should bear in mind that it can be tricky to introduce new restrictive covenants effectively after a TUPE transfer. Employers should ensure that their restrictions are regularly reviewed. It is all too frequently the case that an employee may have worked their way up through the ranks and either have no restrictions at all or restrictions that are inadequate given their new management responsibilities. Restrictions should also be re-visited if the company substantially changes its business or starts operating in different fields or geographical locations. The process for seeking to introduce new or revised covenants for existing employees needs to be carefully managed. Revisions will generally only be enforceable if there is valuable consideration for them, for example if they are introduced as a condition of receiving a salary increase. Employers need to consider whether, ultimately, they will be prepared to dismiss any employee Olswang 2007 www.olswang.com 4
who does not sign up to the new contracts. Although such dismissals may potentially be fair, where the restrictions sought are unreasonable or where there is a failure to adhere to a proper procedure it may render them unfair and thus expensive. Be aware that an employer may have to resort to potentially expensive litigation to enforce covenants. In the cases we report above the employers had to pursue their cases as far as the Court of Appeal before they obtained the commercial result they wanted. Olswang 2007 www.olswang.com 5
Key contacts Catherine Taylor +44 (0)20 7067 3500 catherine.taylor@olswang.com Daniel Aherne +44 (0)20 7067 3547 daniel.aherne@olswang.com Sarah Keeble +44 (0)20 7067 3655 sarah.keeble@olswang.com Julia Palca +44 (0)20 7067 3505 julia.palca@olswang.com Gary Henderson +44 (0)20 7067 7320 gary.henderson@olswang.com Michael Deeks +44 (0)20 7067 3411 michael.deeks@olswang.com Martin Scott +44 (0)20 7067 3381 martin.scott@olswang.com Melanie Adams Associate +44 (0)20 7067 3484 melanie.adams@olswang.com Rebecca Barnett Associate +44 (0)20 7067 3429 rebecca.barnett@olswang.com Olswang 2007 www.olswang.com 6
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