17/03/22

Restrictive Covenants in Employment Contracts

Recent case highlights the importance of carefully considering restrictive covenants in Employment Contracts and Directors Service agreements.

Post termination Restrictive Covenants are clauses which are often contained within employment contracts and directors service agreements with the aim to protect business interests when an employee or director exits. An enforceable covenant prevents employees and directors from taking clients and colleagues with them when they depart. The main categories of covenants are non-solicitation (or employees and clients/ customers), non-compete (not working for a competitor within a certain areas), non-dealing (with former clients/ customers) and confidentiality (protecting information). Well drafted and considered covenants are often restricted in time, scope and geography. For example, a non-solicitation covenant that lasts for 6 months and only applies to clients that the employee has had material dealings with in, say, the last 12 months of their employment. Some non-compete covenants look to stop employees or directors from working for a competitor within a certain radius of their place of work. Non-compete covenants are often more difficult to enforce and justify where there are other enforceable protections in place to protect legitimate business interests (such as information and clients/ customers)

If a covenant is drafted too widely, a court will find that the restriction is not reasonable, and it will be unenforceable as it will be considered a restraint of trade. It is crucial that covenants are carefully considered when drafted. A covenant must be reasonable in its scope in order to protect legitimate business interests.

The High Court recently found in favour of a law firm, Law By Design (LBD), when a former director, Ms Ali, resigned and sought to join a direct competitor (Weightmans). This case considered post termination restrictive covenants in a Directors Service Agreement.

The majority of LBD’s work was with NHS Clients in the North West and Herts Valley CCG.

Ms Ali’s Service agreement with LBD contained non-competition restrictive covenants which restricted her from working for a competitor, in areas of business that she was involved with when working for LBD, for 12 months following her termination date.

The specific clause reads as follows:

“19 Post Termination Restrictions

19.1 In order to protect the Confidential Information and business connections of the Company to which she has access as a result of the Appointment, the Employee covenants with the Company that she shall not:

(a) for 12 months after Termination solicit or endeavour to entice away from [LBD] the business or custom of a Restricted Customer with a view to providing goods or services to that Restricted Customer in competition with any Restricted Business;

….

(d) for 12 months after Termination, be involved in any Capacity with any business concern which is (or intends to be) in competition with any Restricted Business;

(e) for 12 months after Termination be involved with the provision of services to (or otherwise have any business dealings with) any Restricted Customer in the course of any business concern which is in competition with any Restricted Business…

19.2 None of the restrictions in clause 19.1 shall prevent the Employee from:

(a) holding an investment by way of shares or other securities of not more than 5% of the total issued share capital of any company, whether or not it is listed or dealt in on a recognised stock exchange.

(b) being engaged or concerned in any business concern insofar as the Employee’s duties or work shall relate solely to geographical areas where the business concern is not in competition with any Restricted Business; or

(c) being engaged or concerned in any business concern, provided that the Employee’s duties or work shall relate solely to services or activities of a kind with which the Employee was not concerned to a material extent in the 12 months before Termination.”

Restricted business was defined as: “those parts of the Company with which the Employee was involved to a material extent in the 12 months before Termination”

Ms Ali argued that this restriction was unenforceable in that it was:

  • Drawn too widely; and
  • Too long in duration.

Ms Ali provided a 7 page ‘business plan’ to Weightmans in which she stated that she would transfer £250k worth of client work from LBD when she moved.

Ms Ali said that her work was:

  • ‘self generated and were based upon the relationships she has built up predominately whilst at LBD’’ and were
  • ‘personal to her, her own and as something she was entitled to transport’ to Weightmans.

The High Court disagreed.

The Judge found in LBD’s favour and upheld their claim to restrain Ms Ali’s breach of covenant by joining Weightmans, who were a direct competitor.

The High Court found that the covenant was enforceable on the basis that it was no wider than reasonably necessary to protect LBD’s legitimate business interests, specifically it’s confidential information (the specific examples referred to by the Judge: client contacts, charge out rates, status of ongoing matters, content of LBD training materials).

The restriction still enabled Ms Ali to join any business, anywhere in England and Wales, that did not compete for the same clients in a restricted area. This was deemed to be no wider than necessary to protect LBD’s business.

The Judgement provides an excellent summary of how the courts assess the enforceability of covenants in employment contracts and service agreements. The Judge went through each of the following steps (amongst others) when considering whether to grant injunctive relief (set out in the case of TFS Derivatives Ltd v Morgan [2005]):

1.         The meaning of the provision upon its proper construction

What does the covenant mean when it is properly construed?

Is there any ambiguity?

What is prohibited, and what are the limitations of the principal restriction?

2.         Demonstration that legitimate interests require protection

This will require an assessment of a number of factors:

  • What was the working environment? Open plan?
  • How is confidential information shared?
  • The size of the business
  • The nature of the business
  • The nature and number of clients
  • The nature and length of Client relationships

3.         Covenant no wider than is necessary for the protection of legitimate business interests

Is the covenant adequately limited to the parts of the business that the employee is engaged with to a material extent?

How long does it take to find a replacement? This will be dependent on the size and nature of the business concerned.

What is the ‘shelf life’ of the confidential information and the employee’s ability to remember it?

4.         Discretion

In injunctive proceedings, the court has the discretion to consider all the circumstances (which includes the parties conduct etc), having regard to amongst other things, the reasonableness at the time of the trial. The exercise of discretion can include deciding to decline to enforce an enforceable post termination restriction.

The full judgement can be accessed here: https://www.bailii.org/ew/cases/EWHC/QB/2022/426.html

If you have any questions regarding covenants in:

  • Employment Contracts
  • Directors Service Agreements
  • Shareholder Agreements

please contact our Employment team using the form below.

Kitsons Solicitors - Rory Wakeling

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    17/03/22

    About the author

    Kitsons Solicitors - Rory Wakeling

    Rory WakelingAssociate

    Rory is an Associate Solicitor in our Employment team

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