Each month during 2017 we will look at a specific term of the employment contract, consider how it works, why it is needed, common issues which arise in practice and offer some drafting tips. Our second article considers restrictive covenants.
Restrictive covenants are also referred to as post-termination restrictions because they are intended to bind individuals after the end of their employment with the employer. Restrictive covenants can be the most difficult terms of the employment contract to draft because, unlike other terms of the employment contract, there are special rules which govern their enforceability.
In this article we explore the enforceability of such provisions and provide some guidance on key drafting considerations.
Restrictive covenants are commonly used in employment contracts to prohibit ex-employees from competing with their previous employer by working for a competitor, soliciting or dealing with their clients or poaching their remaining staff.
It will be appropriate to include restrictive covenants in an employment contract where it is anticipated that the employee will:
- have access to confidential information and trade secrets;
- work closely with clients or manage client accounts;
- provide a personal service to clients; or
- be a commercial risk to the organisation should they work for a competitor.
The way in which restrictive covenants are enforced is by applying to court for an injunction. An injunction is a remedy which is at the discretion of the court. This method of enforcement can be very expensive for an employer.
As a matter of public policy, restrictive covenants are considered a restraint of trade by the courts and are therefore presumed to be unenforceable unless they go no further than reasonably necessary to protect an organisation's legitimate business interests.
Protectable business interests include:
- preserving client connections,
- protecting trade secrets/confidential information,
- preserving goodwill,
- retaining key employees; and
- maintaining a stable workforce.
Employers should therefore think very carefully about the content of such covenants and it is advisable that these should be closely tailored to the employee in question and the role that they are carrying out at the time of entering into the restrictive covenant.
A court will not re-write a restrictive covenant to make it enforceable; if it considers that the drafting of the covenant is unreasonable it will decline to grant the employer an injunction restraining the ex-employee.
Restrictive covenants in the employment context are heavily scrutinised by the courts due to the unequal bargaining position between the employee and the employer. In particular, the courts will consider the reasonableness of the covenant by considering:-
- the length of the covenant and whether this is unreasonably long;
- the geographic scope of the covenant and whether this is too wide; and
- whether the competitors, clients, and employees covered by the covenant are reasonable.
Factors affecting enforceability
Whilst every case turns on its own facts, it would be very unusual for a period of restraint of longer than 12 months to be enforced by a court. In addition, covenants that go beyond the geographical scope of the employer's existing business are likely to be viewed as unreasonable. Furthermore, if the covenant seeks to prevent the employee from working in a substantially different role with a competitor or purports to cover those clients/employees with whom the employee had no contact whilst working for the employer it is likely that this will be viewed as unenforceable.
Important considerations when drafting restrictive covenants include:
- Ensuring that there are separate covenants for non-competition, non-dealing, non-solicitation of customers and non-poaching of employees. A clause stating that each covenant is separate and severable may be helpful in case any one of the covenants is not enforceable.
- The covenant must be reasonable at the time that it is entered into by the employee. Accordingly, it is advisable to tailor covenants for individual employees and to update these as individuals are promoted or move roles. A catch-all set of covenants contained in a Company Handbook will be more difficult to enforce. While covenants are commonly contained in employment contracts they may also be included in a separate document.
- If entering into new restrictive covenants after the start of employment then fresh consideration (i.e tangible value, usually money) will generally need to be provided by the employer. This might be linked to a pay rise, promotion or enhancement of benefits.
- Careful consideration of the duration of the covenants is recommended. A non-compete covenant should be no longer than is reasonably necessary for the role in question. Employers should consider the likely shelf-life of the confidential information to which an employee is likely to be privy.
- While not absolutely required, setting off the duration of any covenant against any period of Garden Leave that the employee may have been placed on under the contract could assist with evidencing that the covenant is reasonable in terms of duration.
- It is important to ensure that non-dealing, non-solicitation, and non-poaching covenants are restricted to those clients and colleagues that the employee actually had significant dealings with during a period prior to the termination of their employment (for example, employees above a certain grade). This is important to limit the scope of the restriction and aid its enforceability.
It is always sensible for express restrictive covenants to be entered into where there are legitimate business interests to be protected, but employers need to ask themselves honestly: from what do we need protection and for how long? What is the worst case scenario in terms of this person leaving in a few years' time and working for a competitor? It is unlikely to be appropriate to include restrictive covenants in the contract of a very junior employee as they will be able to do very little damage to the business if they leave and equally, employers should ensure the scope and duration is able to be justified in the context of the business in question.
It is essential to ensure that restrictive covenants are drafted carefully, taking into account the specific circumstances and factual background of each case as there are no second chances; a covenant held to be unreasonable in either scope, duration or extent will be unenforceable and not worth the paper it is written on.