In a recent judgment, the High Court upheld a covenant that restricted a solicitor from joining a competitor for 12 months following the termination of her employment. This decision reinforces the importance of carefully drafting restrictive covenants in employment contracts to ensure the scope of any restrictions go no further than is reasonably necessary to protect an employer's legitimate business interests.
Post-termination restrictions in employment contracts are designed to protect the employer against competitive activities by former employees. A non-compete clause is typically a restriction that seeks to prevent a departing employee from starting work with a competitor during the term of the restriction. Any post-termination restrictions on an ex-employee's activities that go further than reasonably necessary to protect a "legitimate business interest" will be void for being in restraint of trade and unenforceable.(1)
The courts have developed a four-stage test to determine whether a post-termination restrictive covenant, such as a non-compete clause, is enforceable:
- Firstly, the court must decide what the covenant means when properly construed.
- Secondly, the court must decide whether the former employer has shown that they have a legitimate business interest that requires protection in relation to the employee's employment.
- Thirdly, the covenant must be shown to be no wider than is reasonably necessary for the protection of those interests.
- Finally, the court must use its discretion to decide whether the injunctive relief sought should, in all the circumstances, be granted.
Saira Ali was employed by LBD, a law firm in North West England primarily specialising in employment law work for National Health Service (NHS) clients. Ali was a senior director and almost exclusively worked on employment matters for NHS entities. Ali entered into a shareholders' agreement and a separate service agreement with LBD, under which she was subject to post-termination restrictions. These included:
- a service agreement – Ali was prohibited for 12 months following the termination of her employment from undertaking any work in competition with the parts of LBD's business in which she had been materially involved in the 12 months preceding the termination date. The covenant did not prohibit her from being engaged in a business where her duties would relate solely to a geographical area where the business was not in competition with LBD's business. Ali accepted a salary increase in return for entering into the service agreement; and
- a shareholder agreement – in return for a 3% shareholding, Ali was prohibited for 12 months following the date she ceased to be a shareholder from being involved in a business that competed with any part of LBD's business that operated in the preceding 12 months.
Ali resigned after eight years with LBD to join a national law firm.
LBD applied for injunctive relief to enforce both the 12-month non-compete restriction in the service agreement and the wider restriction in the shareholders agreement.
The High Court found that the 12-month non-compete restriction in the service agreement was enforceable and granted an injunction. However, the High Court held that the restriction in the shareholder agreement was too wide and could not be enforced.
Service agreement restriction
The High Court held that the restriction in the service agreement only prevented Ali from being involved with businesses competing with the areas of LBD's business in which she materially worked during her last 12 months of employment (ie, the NHS work), and in the territory LBD worked (primarily North West England).
LBD had "legitimate business interests that very clearly required protection", such as client contacts, charge out rates, the content of training materials and the status of ongoing matters. This was reinforced in evidence disclosed in the proceedings from a business plan prepared by Ali for the new employer (deemed "revelatory of her plans" by the High Court), which stated that she "anticipate[d] transitioning clients and revenue". The amount of potentially "transitioned" revenue would have totalled approximately a third of LBD's revenue.
The High Court concluded that the restriction was no wider than reasonably necessary to protect LBD's legitimate business interests because it was limited to the parts of LBD's business with which Ali was materially involved for a reasonable defined period prior to the termination of her employment.
Shareholder agreement restriction
In contrast, the High Court decided that this restriction was not enforceable. While there was a legitimate business interest to protect, the clause restricted Ali from being involved with a business in England and Wales that competed with any part of LBD's business, regardless of whether she had been materially involved in that area.
This case concerned two non-compete clauses at the upper end of the duration that might typically be considered reasonable by the courts in the employment context. While these cases depend heavily on the circumstances (and in this case the specialist work involved and the geographic scope were relevant to the findings), this decision provides a useful reminder of the factors a court will take into account when scrutinising non-compete restrictions on departing employees. Even where there is an obvious legitimate business interest to protect, a non-compete will not be enforced if it is wider than is reasonably necessary to protect the interest in question. Employers should therefore ensure that any post-termination restrictions are drafted carefully so they are:
- no wider in scope than is necessary to protect the employer's interests (eg, in relation to the business of the employer and the employee's role, geographic scope and duration);
- tailored to the role of the employee in question at the outset of the employment relationship; and
- reviewed regularly and kept up to date (particularly when individuals are promoted or change roles).
The government is consulting(2) on measures to reform the use of post-termination non-compete clauses in employment contracts. Whilst we await the government's response, you can read our thoughts on the latest position here.(3)
For further information on this topic please contact Amy Earnshaw at Lewis Silkin by telephone (+44 20 7074 8000) or email ([email protected]). The Lewis Silkin website can be accessed at www.lewissilkin.com.
(1) Further information is available here.
(2) Further information is available here.
(3) Further information is available here.