Nick Hawkins writes for Employment Law Journal on demystifying employment contracts
In an article for Employment Law Journal, Nick Hawkins, Senior Associate looks at the different types of restrictive covenant and how to ensure they are enforceable. Read the full article below:
Demystifying employment contracts: Key considerations for drafting effective post-termination restrictions
In the third part of our series, Nick Hawkins looks at different types of restrictive covenant and how to ensure they are enforceable.
Post-termination restrictions are an important element of many employment contracts, offering much-needed protection against departing employees causing damage to the business. Former employees can use their knowledge of technology, strategic information and client contacts to benefit a new employer unless provisions are included in the contract to prevent this. In addition, the growth of social networking sites, such as LinkedIn, means keeping control of client information is becoming increasingly tricky and in-house lawyers need to give proper consideration to what steps they can take to protect the business effectively.
Without effective restraints in the contract, the employer will have no protection as courts will not imply any restrictions (save in very limited circumstances with respect to confidentiality). Because of the potential value to a business of having suitable protections in place and individuals’ desire not to be constrained when they move, the enforceability of restrictions is often fiercely fought over between the parties.
The courts’ approach
As a rule, the UK courts will not prevent an individual from earning a living, which they view as being in restraint of trade and contrary to public policy. However, as an exception, the courts will enforce post-termination restrictions if the employer can show that:
- it has a legitimate interest to protect; and
- the protection sought is no more than is reasonable, and no longer or wider than necessary, to protect the legitimate interests identified.
This is often a difficult line to walk for employers who want to push the breadth of a restriction to its limits.
Legitimate business interest
Preventing competition is not in itself a legitimate interest capable of protection. Over the years, the courts have identified various categories of legitimate business interests that can be protected, which generally fall into the following categories:
- trade or customer connections;
- trade secrets or confidential information; and
- the stability of the workforce.
The courts also make a distinction between:
- experience and skills which the employee has acquired during their employment, over which the employer cannot claim possession; and
- information and knowledge which is the employer’s property and which the employee had access to during employment.
Only the latter will amount to a legitimate interest which the employer can seek to protect.
One difficulty for employers is that the courts will consider the reasonableness of the restriction as at the date the employee entered into it, which will usually be when they started employment. So, for example, if a contract imposes broad restrictions (suitable for a senior employee) on a junior employee, the fact that the individual has become more
senior by the time they leave will not make the restrictions enforceable. This can be a damaging oversight, so an employer should include restrictions that are appropriate to the employee’s current role and status and update them when it promotes the individual. At this point, the employer must also provide fresh consideration such as a promotion, pay rise or a one-off payment, to ensure the provisions are enforceable.
In judging the reasonableness of any restrictions, the courts will consider:
- the nature of the employee’s work and status;
- how widely any prohibited classes of customers, employees etc are defined;
- how long the restraint lasts after the employment terminates;
- industry standards – particularly in the financial services and insurance sectors;
- the geographical area in which the interests are protected; and
- the activities from which the employee is debarred.
These considerations often differ according to the type of restriction which an employer is seeking to impose.
Employers must take care not to subject an employee who was engaged in one sector of an industry to a covenant excluding them from participation across the whole of that industry and effectively barring them from earning a living. It is overwhelmingly likely that such a restriction will be deemed unreasonable and therefore unenforceable.
Length of restrictions
Employers should think carefully about time limits in the context of their business. As you might expect, the shorter the restricted period, the more reasonable it is likely to be.
However, it is not quite as simple as dismissing (say) a 12-month restriction as being unenforceable and such restrictions have been upheld in some situations, although usually only against senior individuals. Periods longer than this will only be upheld in exceptional circumstances and it is worth noting that restrictions contained in things like share plans will be treated differently.
Types of restriction
These are some specific types of covenant which employers and their advisers may wish to include in employees’ contracts.
Non-dealing and non-solicitation covenants
These restraints seek to prevent former employees from either soliciting or dealing with the employer’s clients or customers. The advantage of a non-dealing clause is that it is not relevant who approaches who. This avoids the need to prove the individual approached or otherwise solicited the customer, which is usually difficult to show in practice. However, it does broaden the prohibition, affecting the rights not only of the employee but of third parties, so a court is more likely to be cautious about enforcing it.
It is important to limit the scope of the covenant to those clients who the employee has had contact with, otherwise the restriction is unlikely to be enforceable.
Non-solicitation of other employees
This is to prevent ‘poaching’. It should, for example, be limited to colleagues with whom the former employee had dealings or to senior personnel, and to poaching for the purposes of a competing business.
These are often the most attractive covenants to employers. However, the courts are very reluctant to uphold non-competition covenants as they are unwilling to prevent an individual from earning a living. The view seems to be that if a business is already protected by other covenants (such as non-dealing and non-solicitation covenants) then having the addition of a non-competition clause is draconian. That is not to say they will never be enforced, but the purpose must be to protect one of the legitimate interests set out above and it must not be possible to protect that interest in a less onerous way. These types of restrictions tend to be for a shorter period than other types of restriction.
All employees are subject to a general duty of fidelity and confidentiality during and, to a limited extent, after employment. Post termination, this implied duty only applies to information that is strictly confidential and in the nature of a trade secret. Most employers include express confidentially provisions in their contracts to widen the scope of information which is protected to include matters such as marketing strategies, pricing information, customer lists and technical data.
While garden leave is not a post-termination restriction, it is a restriction nonetheless and it is often helpful to include such a clause in an employment contract. When an employee has either resigned or has been given notice, a garden leave clause enables the employer to prevent the employee from coming into work or contacting clients and staff. The aim is to protect the company by keeping the employee out of the marketplace long enough for any information they have to be rendered obsolete, or to give the employee’s successor time to establish themselves, particularly with customers, so as to protect goodwill.
Social media use
The use of social media as a business tool creates additional issues to consider when protecting the employer’s business. In particular, LinkedIn enables the employee to build up a database of the employer’s customers which they then have access to via their personal account, even after the employment terminates – this is potentially troublesome for business. Quite how the use of social media can be restricted post-termination is an evolving area of law which the courts have only considered in a small number of cases. However, we can expect to see further developments in the coming years.
How to enforce restrictions
An employer seeking to enforce restrictive covenants can apply for an interim injunction to stop the employee breaching the contract. Alternatively, it may seek damages from the employee. Inducing a breach of contract can in itself give rise to a claim, so a former employer may be able to sue the individual’s new employer if the employee has breached a restriction.
If an employer engages employees in the UK with contracts that are governed by foreign law, it needs to ensure that the restrictions are valid under both English law and the chosen law of the agreement. The English courts will not enforce clauses that are ‘manifestly’ incompatible with English law.
- Tailor all covenants to the particular business and to the particular employee. The courts are unlikely to enforce generic covenants as readily.
- Use clear drafting as the courts will not rewrite covenants. They will, however, in certain circumstances ‘blue pencil’ unreasonable parts to delete them.
- If an employee is promoted, review and, if necessary, update restrictions to reflect the level of seniority. Remember that covenants are assessed as at the time they are entered into.
- If asking an employee to enter into new restrictions, ensure there is some form of consideration.
- Remember that any fundamental breach by the employer (such as termination without giving proper notice or by making a payment in lieu of notice which is not permitted by the contract) will mean the individual is no longer bound by the terms of the contract, including confidentiality and post-termination restrictions.
- Consider whether to include specific provisions in contracts to restrict the use of social media information and contacts after termination of employment.
- Although restrictive covenants are also sometimes included in other documentation such as shareholder agreements and business purchase agreements, bear in mind that the courts enforce these differently from those in employment contracts. It is often easier to enforce restrictions which have been agreed on a commercial basis where both parties have equal bargaining power.
- When seeking to enforce covenants, be aware of all the options and consider tactics and strategy carefully. Early action can make all the difference and can save management time and legal costs.
Nick's article was first published in the June issue of Employment Law Journal.(www.lawjournals.co.uk - subscription required).
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