Opinion

'Legitimate and reasonable' basis for restrictive covenants

30th October 2019

'Legitimate and reasonable' basis for restrictive covenants

Restrictive covenants are found in contracts of employment and seek to prevent solicitation of customers, clients, suppliers and employees, or prevent competition generally, for a defined period of time after termination of the employment relationship. 

The purpose of a restrictive covenant is to protect an employers’ confidential information, customer connections, the stability of the workforce and goodwill. 

In the light of the recent long running case of Tillman v Egon Zehnder Ltd [2019] UKSC 32, Carole Maddock, a member of the specialist Dispute Resolution and Litigation team at Higgs & Sons, looks at the different types of restrictive covenant and what they mean to both employer and employee

“Restrictive covenants can also be found in contracts for the sale of businesses,” said Carole, “although the approach of the Courts following a business sale is different. This article does not specifically cover restrictive covenants following business sales. 

“An employer will want to impose a post-termination restriction upon senior employees to try to protect the business from an employee taking advantage of confidential information, customer and client details and other strategic information which they could then use in their new employment. 

“It is important to note that the position is that any term which restricts an employee’s activities after termination is void as being in restraint of trade. This is because such restraint is considered contrary to public policy. For such clauses of trade to be enforceable an employer has to show that it has a legitimate interest which it is appropriate to protect and that the protection sought is no more than is reasonable in the interests of the parties and the public interest. 

“It is also important to note that in employment contracts post termination restrictions are less likely to be considered reasonable because of the inequality of bargaining positions between the employer and employee.  However, a covenant will often provide a considerable deterrent to employees in post termination activities.”

What is a legitimate interest?

An employer would have a legitimate interest in protecting its trade connections, that is, goodwill, trade secrets and confidential information and the stability of the workforce. Restrictions protecting these interests are likely to be enforceable if reasonable. 

A non-solicitation or non-dealing covenant will protect an employer’s relationship with its customers, clients and other trade connections and a non-solicitation and non-dealing covenant is more likely to be enforceable than a non-compete covenant. There are circumstances where a non-compete covenant may be appropriate, but such a restriction is more difficult to enforce.

Trade secrets and confidential information must be clearly defined if they are to be enforced. The information must truly amount to a trade or be confidential in nature. The gathering of evidence to prove breaches can be difficult to obtain.   

The stability of the workforce is generally protected by a clause such as a non-poaching or non-employment restrictive covenant. 

The list of legitimate interests is not fixed, however the above categories are those established to date in case law. 

What is reasonable protection?

Restrictions should be no wider than is reasonably necessary to protect the interest.  This means that the employer should limit the restricted activities but also should limit the period and geographical extent of the restriction if appropriate. This is a balancing exercise between the interest of the employer’s business and the individual’s right of freedom of movement and to earn a living. 

Relevant factors include the employee’s seniority and status and whether or not they were involved in the negotiating of the wording of the covenants in the first place. Also, the level of contact that they may have with the employer’s customers. Generally, the more senior an employee, the easier it is for an employer to enforce post termination restrictions.

It is important to consider that covenants should in fact be tailored to the specific employee as generic ones often fail the reasonableness test and it is for the enforcer i.e. employer to demonstrate that a particular covenant is reasonable.

It should also be borne in mind that when assessing reasonableness that it is the employee’s job title and seniority at the time of entering into the contract which is relevant, and not whether or not that employee has had subsequent promotions.  In circumstances where one or part of a restriction is considered to be unenforceable the Court will look to sever that restriction from others contained within a contract if it is possible to do so without changing the general meaning (see Severance below). 

TYPES OF RESTRICTION

Non-solicitation

Whilst solicitation usually refers to an ex employee’s positive act on contacting a customer it is possible for solicitation to occur even where a customer contacts the ex-employee first.  If an employer wants to prohibit any contact with customers then the more appropriate clause would be a non-dealing covenant. 

There is generally no implied restriction on soliciting a former employer’s customers, an important factor is the employee’s personal influence over those customers and therefore a covenant should often be restricted to customers with whom the employee had contact during a specified period before termination. 

Non-poaching and non-employment clauses

These clauses are generally considered to be enforceable due to the employer’s interest in protecting the stability of its workforce, particularly in respect of more senior employees. It is important to consider how long after termination the outgoing employee’s influence over other employees will continue and the scope and class of employees over whom such influence will exist. 

Non-competition covenants

These are more difficult to enforce because of the employee’s right to earn a living. However, in circumstances where it is not possible to give sufficient protection for the employer’s proprietary interest in any other manner then such a clause may be considered to be enforceable. This is also likely to be in circumstances where the individual’s influence over customers is considered to be great. There should be exclusion for minor shareholdings in any non-competition restriction otherwise the clause may be considered to be unreasonably wide. This is the sort of clause that allows an employee to hold up to a 5% interest in a competing business.

Geographical restrictions

These are perhaps less important than in previous times due to the reliance that businesses now have on electronic communications i.e. most businesses are much less reliant on physical presence in the marketplace. A geographical restriction is therefore more likely to be appropriate in circumstances where a business does rely on local trade and goodwill. In such circumstances a defined radius from a former employer’s premises may be appropriate however this should not be so wide as to force the employee out of work. 

Duration

In considering the duration of a restrictive covenant an important factor is the employee’s seniority but also to consider how long it will be before competitive activities by the individual represent less of a material threat to the employer’s interest. Therefore factors such as how long will it take the departing employee’s replacement to settle in, the shelf-life of confidential information and the frequency of contact with customers or clients are important considerations. 

Employer’s breach

In circumstances where an employer is in repudiatory breach of a contract, the general rule is that the employee is then free from the terms of the agreement, including any post termination restrictions. 

Severance

The recent long running case of Tillman v Egon Zehnder Ltd [2019] UKSC 32 has clarified the position to be adopted when a restrictive covenant is too wide on the basis reading of the clause.  The Supreme Court stated in Tillman that words within a restriction could and should be severed from the rest of the covenant if they can be removed without generating any major change in the overall effect of the covenant.

 

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