What are restrictive covenants?

To recap, a restrictive covenant is a clause in an employment contract that restricts an employee from undertaking certain competitive actions such as working for a competitor, poaching fellow employees, or soliciting clients, for a specific period of time from the end of their employment.

Why are restrictive covenants important?

Every business possesses sensitive information such as marketing insights, customer contacts and/or business knowhow.  It is not uncommon for competitors to seek to gain an advantage over a business by poaching a senior employee who has access to such sensitive information or for an existing employee to look to set up in competition with their employer using such information. The ability of a business to restrict their current and former employees from using such sensitive information against them is integral to their continuing success. Typically this is done through the use of restrictive covenants.

How do restrictive covenants work?

The standard approach taken by courts is that contractual terms that restrict an employee's activities after termination are considered void on the grounds that they are a restraint of trade and contrary to public policy. However, an employer can prevent an employee from unjustly appropriating a legitimate business interest of the employer for their own purposes, even where the employee may have contributed to the business interest.

For a restrictive covenant to be enforceable it must be demonstrated that:

  • The restrictions are designed to protect an asset, advantage or other business interest;
  • The restrictions are no greater (in time and geographical scope) than is reasonably necessary for the protection of the identified business interests; and
  • Having regard to the interests of the parties and the public interest, it is reasonable to enforce the covenant.

Historically, the courts have demonstrated a reluctance to impose any restrictions upon the restraint of trade. If the enforceability of a restrictive covenant is challenged, it is up to the employer to demonstrate that the interest being protected is legitimate and the restrictions imposed upon the ex-employee are proportionate. In order to illustrate how this can be achieved by employers, we look below at three recent cases where the courts have upheld the use of restrictive covenants.

Recent cases

In Coppage and another v Safetynet Security Ltd [2013] the Court of Appeal considered the enforceability of a non-solicitation clause which sought to prevent a director of the Company from approaching anyone who was a customer of the Company at any point during his employment for a period of six months after the cessation of his employment.

In his appeal, Mr Coppage argued that as there was no restriction as to how recently he had dealt with the customers, the non-solicitation clause was unreasonable and therefore unenforceable. He argued that the clause should, for example, have been limited to those persons who became customers of the Company during the last 12 months of his employment with them.

The Court of Appeal unanimously dismissed the appeal placing great emphasis on the fact that it was a non-soliciting rather than non-competition clause, despite being far-reaching in terms of its scope, and that the duration of the restrictive covenant was "only" six months and that this "must be a powerful factor in assessing the overall reasonableness of the clause.” .........

In JM Finn & Co Ltd v Holliday [2013] the High Court considered whether to grant an injunction to enforce a contractual garden leave clause for the duration of a stockbroker's notice period. The effect of the injunction was to force the stockbroker, who had found employment with a new firm, to remain on garden leave for the duration of his 12 month notice period.

The High Court accepted that the employer would need a reasonable period in which to re-establish client relationships in the absence of the employee, and allowing the employee access to the clients in the short term could damage the employer’s prospects of doing so. The injunction was a reasonable way of protecting the employer's legitimate interest in retaining its clients, as it would take the firm's investment managers a long time to forge new client relationships. In this case, the High Court found that 12 months was a reasonable period of time for a stockbroking firm to establish itself with its clients. The Court also factored in the fact that Mr Holliday would not suffer any financial loss as he would continue to be paid his full salary and benefits and there was no suggestion that he would lose his new job as a result of the enforcement of the garden leave clause. .........

In East England Schools CIC (trading as 4myschools) v Palmer and another [2013] the High Court considered the reasonableness of non-solicitation and non-dealing covenants in a recruitment consultant’s employment contract which prevented her from soliciting or dealing with candidates or clients with whom she had dealt in the 12 months prior to the termination of her employment, for a period of six months after termination.

The Court accepted the employee’s arguments that there was little loyalty owed by the clients to any particular consultant or to any particular agency and the information about the candidates was publically available. However, the Court also recognised that there was value in being a candidate or client’s first point of contact and that the relationship between a consultant and manager can be a decisive factor.

The Court held that the restrictive covenants were enforceable as the employer had a legitimate interest to protect, despite the fact that recruitment information was widely available on social media. The fact that these relationships were known to be fragile made it necessary and legitimate for the employer to seek to protect them.

Comment

Cases involving restrictive covenants are highly context-specific. The merits of each restrictive covenant are determined by the facts surrounding its conception and enforcement and what may be considered to be reasonable restrictions in one case may not be held as reasonable in another. However, any examples of restrictions that courts have found to be reasonable are always useful as guidance on what factors will affect the enforceability of restrictive covenants.

In all of the above three cases the courts found that the restrictive covenants were proportionate to the business interest to be protected. Employers using restrictive covenants should consider whether the protections sought are proportionate to the interest to be protected and whether they can produce credible evidence of this at the time of drafting the restrictive covenant clauses in employees’ contracts, especially those being recruited to senior positions within the organisation.