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Annie Hayes



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Restrictive covenants: worth the paper they’re written on?


Contract being signed
I’ve heard it said that contracts preventing employees from competing or taking customers are not worth the paper they are written on. That is a myth, which is exploded every day in the Courts; in this feature Paul Lambdin, employment partner at Stevens & Bolton looks at a recent ‘Any Answers’ posting on restrictive covenants by member Linda Parrott.

The question: ”We’ve experienced scenarios where senior ex-employees have broken their restrictive covenants, for example poached a fellow employee, or taken our pricing, client details or other confidential information to their next employer who’s our competitor. Or someone who’s on three months notice refuses to work it out and leaves after one month. It just seems there’s very little useful action that an employer can take in these instances. Yes, we can spend money with our legal eagles and take the person to court.

But if no “loss” can be proven (e.g. the amount of revenue lost if we lose a client as a result – very difficult to prove, as well as the downside of getting a client involved) – then all the employer gets is a huge legal bill. Withholding a good reference is a small compensation in our industry where references are seldom taken up anyway. Apart from a slight deterrent and tons of paperwork – what are these covenants worth?

In order to enforce a contract against a former employee who is competing, using confidential information or seeking to take customers with them, an employer needs to do three things: show how they have a “legitimate” business interest to protect, have a well drafted contract and be sure the commercial interests at stake warrants the investment of substantial time and money.

The courts regard, for example, confidential business information, the influence an employee has over customers – i.e. “trade connection” – and a stable workforce as “legitimate” business interests. It would not be legitimate, however, simply to seek to prevent an employee joining a competitor if there was no evidence of a risk that the employee would abuse their special knowledge.

It is not possible in a short article to analyse all the issues arising in drafting restrictive covenants. Employers must always take professional advice. However, the most important point is that any clauses seeking to prevent an employee abusing their knowledge of a business or influence over its customers should be targeted at particular business needs. “Off the shelf” or “boiler plate” clauses are risky.

Clauses preventing solicitation or dealing with customers are, for example, regularly enforced by the courts. Some employees seem to think that because they have built up a relationship with customers, they are “theirs”. Unless there are exceptional circumstances, however, the courts say that trade connection belongs to the employer. The employee has been paid by the employer and has used the employer’s reputation, resources and product to build up trade connection. This sort of clause is particularly effective against sales staff and other “customer-facing” employees.

It is also possible to prevent former employees from soliciting remaining employees. However, the contract should limit this to senior or key employees.

A clause simply preventing competition after termination is more difficult to enforce because it is a very severe restriction on an employee’s ability to earn a living. However, they can work if, for example, it can be shown that it will be impossible to police a clause preventing the solicitation of customers or the mis-use of confidential information.

The length and geographical scope of these clauses depends on each particular business. While it is often said that these should be restricted to six months, it may be possible to enforce periods of longer than a year, if, for example, customers’ contracts are renewable annually or longer. Geographically, scope depends on where the employer does business. In some rare cases, even a world-wide restriction may be justified.

Clauses protecting confidential information can also be problematic. The law says that only information that is “highly confidential” is capable of being protected after termination of employment.

There is, however, some scope for defining highly confidential information in writing. Care is needed though because a very wide-ranging definition of confidential information can backfire. In a recent case the Court struck down the clause because it included every imaginable piece of company information.

Although some similar rules apply in the case of “gardening leave” clauses, this is probably the best means of protecting a business from competition. A continuing contract is easier to enforce than post termination restrictions. However, in the absence of an express clause, the courts will not usually enforce gardening leave.

The employee should receive all of their benefits during a garden leave period. For example, if there is a discretionary bonus, a failure to make provision for paying this could undermine the clause’s effectiveness.

As I suggested at the beginning, there is the overriding commercial issue for employers to consider. Even though there may be a sufficient business interest and the contract may be perfectly drafted, an employer has to decide whether the damage the former employee may do is so serious that it warrants them investing considerable sums of money and effort in seeking a court order.

On the other hand, well-drafted contracts can be used in negotiations and the threat of potential proceedings will sometimes be sufficient to protect the employer.

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Annie Hayes


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