2020-06-04
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Guide to restrictive covenants (non compete clause)

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Posted by Susan Hopcraft on 28 May 2020

Susan Hopcraft - Professional Negligence Lawyer
Susan Hopcraft Partner

Restrictive covenants in employment and consultancy contracts.

Consultancy and employment contracts often contain clauses restricting an individual’s working activity when they leave a business.

These clauses, ‘post termination restrictive covenants’, typically restrict the ex-staff member’s ability to work in competing businesses, to deal with clients, to try to win business from them, or to poach other staff members.

Employee Restrictive Covenants the future image

The employer who has invested in building its own goodwill and customer base, developing its own processes and strategies, as well as training the staff member, will want to enforce that restrictive covenant to protect its interests.  They will also want to rely on the duty of confidentiality that staff owe, a duty that continues after they leave.

Staff, on the other hand, expect freedom to work elsewhere and will want to deal with their business contacts without restriction.  They will want to earn a living from their own skills, knowledge and hard earned experience.

Are restrictive covenants enforceable?

The starting point is that these post termination restrictions are void on grounds of public policy because they are in restraint of trade and prevent an individual’s ability to earn a living.

However, they can be enforced if the clause is no wider than strictly necessary to protect a business’s legitimate business interests.

The court has to balance freedom of trade, allowing people to work, with freedom of contract where the staff member has agreed not to do certain things that would damage their former employer.  The Court will also consider what is in the public interest more generally since, in some contexts such as financial advisers, it might not be considered appropriate for members of the public to be deprived of the services of their trusted professional adviser because of a covenant.

The business perspective

If you are a business wanting to enforce restrictive covenants you will need to demonstrate:

  • That the contract between you and the person is signed. If you cannot locate a signed version of the employment or consultancy agreement with the express restriction in, you are unlikely to be able to enforce a covenant even if you think it was agreed at the time.
  • That you have something in return for imposing the restrictions, perhaps a pay rise at the time they were introduced. This ‘good consideration’ is needed.
  • That you have a legitimate business interest to protect, such as a client base that you have built over many years of continuous investment in marketing and client service. Or a loyal, trained staff who you want to retain for the good of your business.  Or confidential processes that you developed to give your business a competitive advantage.  You can’t stop people moving job or competing with their own skill, experience and knowledge, but you can stop them taking your own data and using your client lists.
  • That the restriction is as narrow as possible to be reasonable. If customers are defined to those with whom the member of staff had direct contact in the 12 months prior to departure, or fall within a small geographic area and the covenant is limited to that, then that would be narrow.  If it is limited in time to 3 or 6 months that is, for many employees, reasonably narrow.  For a very senior sales director or key person who has intimate knowledge of the customer base, a longer period of protection to enable your business to build solid client relationships with a new employee may be justifiable but generally to stop someone working in their chosen role for more than 12 months would be unreasonably wide.

If a covenant has several parts it is possible for the part that is too wide to be deleted, making what would be an unenforceable clause narrow enough to apply.  This has become more usual in recent years so that employers may be better advised to choose only one narrow part of any covenant and, if that can be read in isolation and still make sense without re-writing the whole clause, it may be enforced on its own.  That could be a better outcome for the employer than trying to enforce a wide set of covenants unamended  and ending up with none being enforced.

For an injunction to be granted you also need to show that the damage to your business cannot be repaired by financial compensation alone.  If, for example, your business will lose many £000,000 in lost profit and the individual may not be capable of repaying that themselves, then an injunction to stop that loss is a better remedy.

The individual’s perspective

If you are an individual needing to defend a claim for breach of restrictive covenant, these are the items that you need to undermine. 

  • Did you expressly agree to the restrictions in return for a pay rise or some other good consideration, or were they pushed on you or just slipped in without your knowledge or agreement?
  • Did you bring clients to the business when you started work there and just want to continue those relationships? Do your clients still want to deal with you personally rather than your ex-employer?
  • Were the covenants unreasonably wide at the time they were entered into? Did they prevent you from working and earning a living for a period that extended well beyond the time when the business ought to be capable of replacing you?  Were they unduly long for someone of your seniority at the time?

These issues are always a matter of fact in each case, but it is for the employer to make their case with compelling evidence if they want to restrain an individual’s freedom.

Employees and consultants also owe general duties to keep their employer’s confidential information confidential.  In most restrictive covenant cases the duty of confidentiality is also important since often the breach centres on an alleged misuse of confidential data, such as client lists and contact information.

Consultants are thought to be capable of negotiating their service agreement rather than having standard employee terms imposed.  In practice that may not be the reality though as so many sectors rely on consultants for their workforce.  The courts are likely to be less inclined to draw a line through a consultant’s covenant than an employee’s, but it is still very much a matter of fact in each case.

Types of covenant

Covenants can be in any form but the main types are these:

Non compete:  this tries to prevent a staff member from working for a competitor for a period.  These are more difficult than non-solicit or non-deal to enforce because they have the effect of preventing someone from taking a job in their chosen career for a period.  The advantage to the employer is that they can ensure a high level of protection and they do not have to, for example, obtain evidence of solicitation which can be difficult.   Only if these are relatively short in time, area and application can these be enforced.  Also, if a non-solicit covenant could have been used instead then a Court is less likely to enforce a more onerous non-compete restriction.

Non solicitation of clients/customers: this stops an ex staff member from approaching customers (or employees) to entice them away.  Clearly if large numbers of customers move to follow the staff member this can be very damaging, but if they opt themselves to move without any encouragement then that is the legitimate action of a free market economy.  Often the client relationship sits with the individual adviser rather than the employee, but his can be highly contentious in cases where the adviser’s support from his employer (and the costs associated with that back office service) is allowing the individual to provide that advice.  Courts do allow non-solicitation covenants although difficulties arise in proving that a customer moved directly as a result of the approach and encouragement of the former member of staff.  

Non deal: this tries to prevent dealings with clients/customers and is a more onerous covenant.  Someone can move jobs but if they are prevented from dealing with a client base that they have personally built up over their entire career then the effect of a non-deal covenant could be to leave an ex-employee without an ability to earn a living.  In some sectors these covenants are more contentious than others.

Non poaching of staff: these allow employers to maintain a stable workforce, which is considered to be a legitimate business interest.  As with all covenants these can be enforced if reasonably narrow, taking into consideration the factual background.

Remedies for breaches of confidentiality and covenant

When an ex-member of staff uses your trade secrets, or client list, or poaches your valued employees, what can you do?  There are two main remedies: an injunction and damages.

Injunctions are court orders that stop someone from doing certain things, working for a competitor, using your data, calling your clients.  Or they can require certain things to be done such as delivery up of your documents and data.

Injunctions can only be obtained if there is real urgency and if financial compensation afterwards is not going to be adequate to make good the damage.  One of the practical considerations is whether an individual has the ability to pay the damages that might be awarded.  Usually they will not and therefore stopping the damage in the first place is the best course of action, which means obtaining an injunction.

If you think you might need an injunction you have to act fast; delaying by even a few weeks could mean the injunction is not granted because the high degree of urgency is not demonstrated.

Injunctions are not imposed lightly.  The court considers the evidence very carefully to support an application before imposing one.  They are Penal Orders, which means that if you do not comply with any part of the injunction you are liable to be in contempt of court and imprisoned for up to 6 months.

Damages to compensate loss is the other option, although this is usually sought alongside an injunction.  The types of loss that can be recovered are the lost profits that would have been earned from the client connection.  Often claims for damages are pleaded on lost revenue over several years, but the courts will award lost profits, a fraction of the revenue, and usually over only a few years because the client relationship was never guaranteed to continue indefinitely.

Breach and loss

It is for the former employer to show that the covenant is enforceable.  If that can be established, they also have to evidence breach by the ex-employee and show that loss was caused by that breach to succeed in recovering damages.

If a financial adviser has left and then contacted all of their clients to tell them of their move to a new business, inviting all clients to contact them, that would be solicitation.  A former employer ideally needs to have a letter from the ex-employee to a client to evidence that solicitation. 

But, if the client did not react to that letter and simply continued to invest as usual, then that solicitation will not have caused the former employer any loss and is of no consequence.

If the client does decide they prefer to use their trusted adviser and moves all investments to the new business, then it may be that loss has resulted.  However, if that client was so keen on the individual adviser and had no real connection to that individual’s former employer, and was going to move with that adviser at all costs and without any solicitation being needed, then it cannot be said that the breach of covenant has caused loss.  The loss of revenue to the ex-employer was going to happen in the natural course anyway.

Evidence and proof of loss can therefore be difficult to come by.

The new employer angle – incitement

New employers are often joined into legal action on covenants and even served with injunctions, since they are the beneficiary of the unlawful conduct.  The new employer needs to be cautious when there might be restrictions on the new staff member they are taking on.

Contracts can require an employee to inform their new employer about any restrictive covenants that (apparently) bind them.  Whilst that may or may not always happen, if a new employer knowingly entices a new staff member to breach a covenant by poaching clients or former colleagues, then they can be dragged into a dispute, accused of having committed the tort of ‘incitement to breach a contract’.

If an injunction is obtained against an individual that can also be served on a new employer. If that Penal Order is breached, and the employer played any part in that breach, then the employer can also be found in contempt of court.  Again, injunctions are powerful remedies, not to be taken lightly by anyone affected.

Conspiracy and team moves

An area that can become very heated is when a group of staff leave, together.  Individuals who leave, particularly the star salesman or the best financial adviser, can be painful, but when a whole team leaves, it can cause even greater damage.

Employers who lose whole teams are more likely to inspect restrictive covenants more closely because they have more to gain by launching legal action.

There are additional factors to consider though, since teams can be accused of having conspired prior to departure to damage the interests of their former employer.  That is rarely the sole intent although it may be a collateral result when people move together to a new employer or set up in business for themselves.

Whilst employed an employee owes a duty of loyalty.  They can make preparations to change jobs and even to compete in the future but cannot actually trade in competition with their employer.  Contacts sometimes contain more onerous provisions which the court have upheld on occasions.  Some senior employees owe higher duties as fiduciaries, meaning they are even required to tell their employer if they hear of other employees trying to leave.

When teams move former employers often investigate closely to find unlawful behaviour by employees prior to departure.  It is not unknown for careful investigations into what phone calls were made between leavers pre-departure, what emails were exchanged, what activity took place on social media and even what documents were printed off by staff pre-departure.  All of this can be used to put together a picture of a team scheming against their current employer, breaching the general duty of employee loyalty.  Or, for more senior staff and directors, breaches of their fiduciary duties to their employer.

The most effective remedy in this type of situation is for the existing employer to obtain an injunction to prevent unlawful activity, a springboard injunction.  Strong evidence is needed but businesses that discover a risk of substantial financial damage from disloyal staff can act fast.

Summary

Many contracts include restrictive covenants.  They often discourage leavers from doing certain things but, just because they are in black and white in a contract, that does not mean they are valid and enforceable.  If they are unfair to an individual who needs to work to earn a living they need to be scrutinised.  It is best to take legal advice early if you need to know what you can and can’t do once you leave your position, since that advice could enable you to navigate a safer path once you leave.

Employers sometimes put very broad restrictions in contracts, even for junior staff.  They might consider that this increases the level of protection they have but, when covenants are included as a matter of course, without thought and as wide as can be, this might only result in a watering down of protection because those provisions are void.  Ongoing assessment of covenants by employers is vital to ensure they are no wider than necessary.

About the author

Susan is a disputes and professional negligence lawyer, mainly in the financial services sector.

Susan Hopcraft

Susan is a disputes and professional negligence lawyer, mainly in the financial services sector.

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