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Legislation update: Restrictive covenants

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Georgina Folkes, specialist employment solicitor from Withy King Solicitors, considers the tricky area of post employment restrictive covenants aimed at protecting the former employer’s business, in light of a recent decision of the Court of Appeal to uphold the enforceability of a 12 month restrictive covenant in a senior insurance broker’s contract of employment.


Employers often incorporate post-termination obligations into their employees’ contracts of employment, which have the effect of prohibiting the employee from doing certain things which may harm the employer’s business after he or she leaves the company. These obligations are called restrictive covenants. They are designed to protect the employer’s business and are particularly common in the contracts of employment of sales staff who have access to and intimate knowledge of an employer’s customer base.
Restrictive covenants are notoriously difficult to enforce because the Courts’ starting position is that all contractual restraints on an ex-employee’s freedom to work where he or she pleases are void as being in restraint of trade and contrary to public policy unless they can be shown to be reasonable.

The Court of Appeal considered the enforceability of restrictive covenants in the case of Thomas v Farr (2007) in which a senior insurance broker was prevented from working for a competitor’s business for a period of 12 months under the terms of his contract of employment. In this case, the Court of Appeal determined that the restrictive covenants were enforceable, giving rise to some helpful guidance to employers on ensuring that the restrictive covenants in the employees’ contracts of employment are enforceable.

In the case of Thomas v Farr (2007), Mr Thomas was the managing director of Farr plc (Farr), an insurance broker specializing in the social housing market. Following a restructuring exercise, Mr Thomas resigned and accepted a job with a competitor of Farr in breach of his contract of employment which prohibited him from competing with them for 12 months after the termination of his employment. Mr Thomas sought a declaration from the Court that the non compete clause was unreasonable and therefore void so that he could join the competitor without fear of being sued.
Crucially, the scope of the clause only prohibited Mr Thomas from operating as an insurance broker in the social housing sector in England and Wales and not in all other sectors of the insurance industry.

Farr argued that the non compete clause was necessary to safeguard itself against the risk that on taking up employment with a competitor, Mr Thomas would misuse confidential information to Farr’s detriment and to the competitor’s advantage. The specific information which Farr sought to protect was budgetary data, pricing structures and business plans which was specific to the social housing sector.

The Court of Appeal held that the non compete clause was a reasonable limitation. In giving its judgment, the Court of Appeal held that the highly confidential information that Farr sought to protect was precisely the type of information which in a highly competitive area of the insurance industry is likely to fall within the category which can be properly protected by an express covenant in the contract of employment.

The Court of Appeal found that the confidentiality clause and the non-solicitation of customers clauses contained in Mr Thomas’s contract of employment alone did not offer adequate protection for Farr in protecting its legitimate interests of protecting its confidential information because of the difficulty of policing the covenants. The Court also stated that the 12 month restriction was a conservative estimate of the time for which its confidential information would retain its currency and therefore the 12 month period was not unreasonable.

Advice

A restrictive covenant may be reasonable and therefore enforceable if it gives adequate protection but no more than adequate to the legitimate interests of the employer. Legitimate interests fall broadly into the following categories:
1. trade secrets (chemical formulae, manufacturing processes, designs etc,
2. trade connections (customers, suppliers); and
3. the stability of the employer’s workforce.

On the face of it, the Thomas v Farr decision comes down firmly on the side of employers who are seeking to protect themselves against departing employees taking confidential information to competitors which will not be protected by a non solicitation clause.

However, the Courts ruling in favour of Farr was largely due to the fact that the clause was tightly defined, in that it only extended protection in the specialist area that Mr Thomas worked, rather than the whole insurance industry. Consequently, employers wishing to be able to enforce restrictive covenants should remember the ‘less is more’ approach and resist temptation to include wide restraints as these are likely to be unenforceable.

However this fairly simple statement disguises the complex considerations involved in defining what is “reasonable” and what is a “legitimate business interest” in any given circumstance. For example, a covenant which prevents an employee from working for a competitor for a period of twelve months anywhere within the United Kingdom may be enforceable against a national sales director but would not be appropriate for, say, a vet who only deals with people in the immediate locality.

Similarly, a ten mile geographical restriction might be appropriate for a hairdresser working in a rural area, whereas the same restriction placed on a hairdresser working in an urban location might well be unreasonable. Professional advice is therefore a pre-requisite to ensuring that your restrictive covenants are enforceable.

Garden leave

Garden leave is also commonly used in conjunction with restrictive covenants. The inclusion of a garden leave clause in a contract of employment allows an employer to require the employee to spend all or part of the notice of termination period at home whilst continuing to receive his usual salary and benefits.

The benefit of a garden leave clause is that it creates a time period in which the employee cannot take-up other employment, is no longer privy to the company’s confidential information and is much more likley to be enforceable than a restrictive covenant which takes effect after the end of the contract of employment. Garden leave must also be created expressly by a clause in a contract and is also subject to a test of reasonableness with regard to its duration.

For further information on this topic, please contact Georgina Folkes by email at: [email protected] or telephone her: 01793 536526.


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