How to ensure the restrictive covenants in your employees’ contracts are effective.

Overview

In an employment contract, restrictive covenants are clauses which restrict the post-employment activities of the employee for a limited period after the employment relationship ends.

As an employer, from an administrative point of view, it may be tempting to apply the same blanket restrictive covenants to your whole workforce. But if you do this, you risk those covenants being void and unenforceable if and when they come to be challenged.

As a general rule, post-termination restrictive covenants are void and unenforceable on public policy grounds. This public policy ensures the economic freedom of individuals to earn money, start a new business, move jobs etc. The courts will always adhere to this doctrine. Restrictive covenants will only be enforceable if they protect a legitimate business interest and are drafted in a manner that is designed to go no further than is reasonably necessary to protect that legitimate business interest.

Types of post-termination restrictive covenants

Non-Compete clause: This aims to prevent your employee from working for a competitor in a competing capacity, or seeking to set up a competing business.

Non-Solicitation clause: This imposes a duty on the employee not to approach your customers or prospective customers with a view to doing business with them.

Non-Dealing clause: This also targets preventing an employee from doing business with your customers or potential customers, but in a situation when the customer approaches without encouragement from the employee.

Non-Poaching clause: This aims to prevent an employee from trying to take your staff with them to their new employment or business.

Non-Disclosure of Confidential Information: This prevents an employee from using confidential information, which the employee has obtained whilst in employment, for the benefit of a competitor.

Reasonable Protection

A covenant which is wider than is reasonably necessary to protect a legitimate business interest is at risk of being unenforceable. You also need to ensure that it is not so narrowly drafted that it no longer protects your interests.

It is crucial that this question is considered before a contract is entered into because the courts consider the reasonableness of a covenant at the time it is entered into, not at the time of enforcement.

This is the case even if the covenant may be reasonable at the date of enforcement, following later events. For example, take a scenario where an employee starts at a junior level with an initial contract of employment containing excessively onerous covenants, unreasonable for her junior role.

But then over the years, the employee receives a series of promotions resulting in her being in a more business-sensitive role at the point her employment ends. No updates to her initial contract of employment were ever made, but now the restrictive covenants in it look more reasonable given the employee’s increased responsibility in the business. In this situation, the covenants in the contract of employment will still be void because they were unenforceable at the date of the signing of the contract, due to them being too widely drafted.

Circumstances for each covenant

Whether a restrictive covenant is reasonably protecting a legitimate business interest will always depend on the individual circumstances in each case. Factors affecting reasonableness include scope, duration, geographical location (if appropriate), the nature of the employer’s business, the nature of the employee’s role and whether the covenant is usual in the sector. Restrictive covenants are a complex area of law and for advice on any particular restrictive covenant and its enforceability, legal advice should be sought.

By way of example as to how circumstances dictate effectiveness, if the legitimate business interest to be protected is confidential information, the court will look at how long the information remains confidential before it becomes obsolete or enters the public domain. If the period of time tends to be longer, it will be more reasonable to seek a covenant with a longer period of restriction so that the information is protected. Similarly, if contact between a business and its clients is infrequent or if clients are locked into contracts for a minimum period, this may justify a longer restricted period, because it is only at the end of the period that the business is likely to suffer damage as a result of solicitation.

Multiple sets of covenants

Where different sets of covenants are contained in different documents which apply to an individual, a court may take the approach that only the least restrictive set of covenants is enforceable.

Enforcing Restrictive Covenants

Where an employee’s employment is terminated, and the covenants provide valuable protection, take particular care to act in accordance with the terms of the contract, as restrictive covenants may be unenforceable if the employer breaches the employment contract.

It is always best to seek legal guidance regarding covenants prior to taking legal action to enforce them. Losing a case can be costly since the losing party generally pays between 60 to 80% of the winning party’s costs and injunctions are expensive and time-intensive to pursue.

In addition, if you have incorporated a standard set of covenants in your employment contracts and they are held to be unenforceable against one employee, this may create an unhelpful precedent in relation to other employees who seek to challenge the covenants. Such a precedent will reduce any deterrent value that the covenants may otherwise have had.

On the other hand, a successful claim against a former employee who has breached covenants will send a clear deterrent message to say future departing employees who may be inclined to carry on activities in breach of their restrictions.

Updating Your Covenants – Practical Tips

  1. Tailoring at the outset: At the time that a new employment contract is entered into, ensure that restrictive covenants are correctly drafted and tailored appropriately to the employee's and the business' circumstances.
  2. Individual employee focus: Consider what risk the employee in question actually presents to the business and what aspects of the business legitimately require protection at the time the restrictions are drafted. If an employee holds a junior position without access to business sensitive information or key clients, imposing a restriction to cover every eventuality will not be fair and reasonable. The key question is what is reasonably necessary for each individual employee.
  3. No blanket covenants: Do not use standard form covenants. One template set of covenants applied to all employees risks unenforceability for some.
  4. Multiple sets of covenants: Avoid using more than one set of covenants because if challenged, a court may potentially enforce only the least restrictive set.
  5. New roles, review contracts: If you promote employees or change their roles, review their existing contract to determine whether the existing covenants are valid. A simple statement to indicate that the terms and conditions remain the same cannot make an invalid covenant valid. Seek express acceptance of any new restrictive covenants by asking the employee to sign a new contract of employment when taking on a new role.
  6. Pay increases, new covenants: Use changes to employment contracts as an opportunity to update the restrictive covenants. Employees may be more amenable to agreeing covenants when offered a pay rise or promotion. (This will also provide clear consideration for the covenants.)