As well as buying the tangible assets of a business, a prudent buyer will want to make sure that the intangible assets of the business, such as market position and stability of the workforce, are also sufficiently protected.
When a key employee remains in a business post-purchase, the buyer will want to protect the business against the employee launching elsewhere and selling competitive products, or offering competitive services to the market.
Protection can be sought by the use of restrictive covenants in the key employee's contract of employment and in the business sale documents, particularly if the key employee is also one of the sellers of the business.
Employment contracts or sale agreement - where should the restrictive covenants be contained?
- A restrictive covenant given by the seller in a sale agreement will seek to protect a buyer against a seller selling a business and then starting a new rival business immediately after the sale completes. Such covenants will include non-solicitation of customers and employees, and non-compete clauses.
- All restrictive covenants are presumed void for restraining trade, but it can be easier to rebut this presumption in sale contracts than in an employment situation. In order to rely on such covenants, the buyer will need to demonstrate that they have a legitimate business interest to protect and that the covenant goes no further than is reasonably necessary to protect that business interest.
- It is generally easier to enforce covenants which have a longer duration and cover a broader geographical area than in an employment context, in recognition of the fact that this is an even-handed business arrangement rather than an employment contract.
- Such covenants run for a period from the date of completion of the sale. This period may come to an end long before the key employee's employment comes to an end.
You should use a post-termination restrictive covenant in a new employment contract for key employees:
- If you are seeking to prevent a departing employee from competing with your business, or want to preserve confidential information, trade secrets and key client relationships;
- If you want to protect the stability of the workforce (for example to prevent the departing employee from encouraging others in your business to join them in moving;
- If you want to protect trade connections (for example, with suppliers)
Employment covenants run for a period starting on the day on which the employee's employment comes to an end, which means that they would potentially be more valuable to the buyer if the plan is for the key employee to remain in the business beyond the term of the restrictions in the sale agreement.
But remember that:
- You can only prevent an employee from using or damaging something which legitimately belongs to the business that you have bought; and
- Restrictive covenants should be kept under review. If an employee's contract of employment is amended, or the employee is promoted, the restrictive covenants may need to be revised.
Scope of covenant
When considering the scope of a restrictive covenant, you should consider:
- The duration of the restriction (no more than 12 months following termination of employment). You should consider for how long it is reasonable to keep an employee out of work in order to protect client relationships and/or confidential information. Do not assume that the longer the restraint remains, the stronger it is. If the restriction is regarded as too long, it will be unenforceable, and the Courts will not insert a shorter period;
- The markets and region that you want covered. Think about what you want to prevent the employee from doing and ensure that it is appropriate for your business; and
- The specialist knowledge that you wish to protect. Think about the employee in question, what specialist knowledge do they have? Consider the employee's role and tailor the restriction to the role.