2 September 2013

Restrictive Covenants in Employment Contracts: Protecting your Business

All organisations have information they consider integral to their success. Restricting the use of this information by former employees is vital to protect the business. A former employee with knowledge of strategic information, client data, pricing and technology is an appealing prospect to a competitor organisation. This information can be protected both during and after employment ends through the inclusion of restrictive covenants in employment contracts. Express restraints may deter employees joining competitors and warn off potential new employers.

Typical restrictive covenants in an employment contract include:

• Non-Competition: to prevent the employee from working in a similar role for a competitor;
• Non-Solicitation: to prevent the employee from poaching clients/customers/suppliers;
• Non- Dealing: to prevent the employee from dealing with clients/customers/suppliers (regardless of which party approached the other);
• Non-Poaching: to prevent the employee from poaching former colleagues.

Garden leave is often used in conjunction with or as an alternative to restrictive covenants as it prevents the employee from taking up their new position with a competitor for a specified period, during which time the employee is no longer privy to any current confidential information and their successor can establish a relationship with clients/customers/suppliers. Like restrictive covenants, garden leave must be expressly agreed in the employment contract and its duration is subject to a reasonableness test.

1. What interests can be protected?

An employer cannot have a blanket protection from competition from a former employee. To be enforceable the restriction must not be drafted too widely: the burden is always on the employer to demonstrate that the restriction is justified. The law in England and Wales permits an employer to impose reasonable and necessary restrictions to protect its business interests. Express post-termination restrictions are enforceable if the employer can convince the Court of the following:

• That the covenants are designed to protect legitimate business interests; and
• Extend no further than is reasonably necessary to protect those interests.

The Court’s approach is that one size does not fit all. When assessing what is reasonable, the length of the restriction, the geographical spread, the type of interest being protected and overall scope of the restriction needs to be considered as against the employee’s seniority and role within the business. As a general rule, a restriction for more than 6 – 12 months will be difficult to justify.

Restrictive covenants should be periodically reviewed in order to maintain their enforceability, especially when an employee is promoted as the covenant is judged at the time it was entered into.

A useful reminder of the principle that the reasonableness of a post-termination restriction must be judged at the time it was entered into is the decision of Patsystems Holdings Ltd v Neilly [2012]. Mr Neilly commenced employment with Patsystems in June 2000 as an account manager on a salary of £35,000. At that time his employment contract contained a one month notice period and a 12 month non-competition clause. In 2005 he was promoted to Director of Global Accounts: his salary increased to £80,000 and his notice period was extended to 3 months. He was sent a letter confirming the changes which he signed and returned, which provided:

I agree to the variation of my terms with Patsystems, which are stated in this letter and I acknowledge and agree that all other terms and conditions outlined in my original documentation remain unchanged.

Mr Neilly resigned in April 2012 to join a competitor business giving 3 months notice. Patsystems regarded his new employment as a breach of the non-competition restriction in his employment contract and sought an injunction to prevent him from working for the competitor.

The Court refused to grant the injunction on the basis that the non-competition clause was not enforceable as it was not reasonable at the time it was entered into in 2000 given Mr Neilly’s status and responsibilities at that time. The Court stated that the only way the restriction could have been enforceable would have been in the following circumstances:

• Explicitly securing Mr Neilly’s acceptance of the restriction; or
• If Mr Neilly had signed a new employment contract

The Court did not accept that the general acknowledgement Mr Neilly signed in 2005 satisfied either criteria and found that he had not entered into new restrictions.

The Patsystems case highlights the importance of reviewing restrictive covenants when employees are promoted; ensuring that any changes are brought to the attention of the employee; and obtaining an employee’s express agreement to any updated restrictions.

In another recent case a little hope was offered to employers where an employee does not sign a new employment contract. In the case of FW Famsworth Ltd v Lacy [2012] the Court found that an employee was bound by post-termination clauses in a new employment contract issued to him upon promotion, even though he had not signed it.

In addition to the restrictions, the new contract gave the defendant, Mr Lacy, private medical insurance (PMI). When he received the updated employment contract he made no objection to the restrictions and filed it away, unsigned. A year or so later he made a claim on his PMI.

The Court found that Mr Lacy had accepted the new employment contract when he had applied for PMI, a benefit that was only available to him under the new contract. As a result he was also bound by the post-termination restrictions. The key point to remember in this case if Mr Lacy had not applied for the PMI benefit the Court would not have found him bound by the new contract. As a matter of policy employers should ensure they receive signed copies of contracts when recruiting and following any promotion which necessitates a change to the terms of employment and restrictive covenants.

2. Recruitment: Practical Considerations

2.1 As companies seek to recruit the best talent to give the business a competitive edge, consideration should be given to post termination restrictions contained within a prospective employee’s contract of employment.

2.1.1 Always ask prospective employees about their existing restrictions at interview so that you can consider their enforceability and how to manage the risk. Consider whether the restrictions are drafted too widely to protect the previous employer’s legitimate business interests.

2.1.2 Enquire whether there has been a breach of contract committed by the previous employer (i.e. has there been a constructive dismissal or a payment in lieu of notice made without the contractual right to do so) as the restrictions may fall away.

2.1.3 If the restrictions are potentially enforceable, consider whether they will impact on the prospective employee’s ability to undertake the role required in your business. Can they provide assurances to their former employer that they will comply with their restrictions, or does the restriction mean they need to be placed in an alternative role and/or branch/office until the restriction period expires?

2.1.4 If the former employer takes action, the prospective employee should obtain their own legal advice. If you keep close to any discussions between them and the previous employer this will help to manage the risk that your business will be joined into any proceedings for inducing a breach of contract.

2.1.5 Where there is a non-dealing restriction, establish whether any leverage can be exercised by the clients/customers/suppliers contacting the former employer directly to confirm their wish to continue a relationship with the prospective employee. Take care not to involve the prospective employee in any such approaches if the restrictions also prohibit direct or indirect solicitation of clients/customers/suppliers.

2.1.6 Ask the new employee for a copy of the restrictive covenants for their previous employment to be kept on their personnel file. Monitor the new employee to ensure that any potential breaches are detected early.

2.1.7 Once the best candidate has been secured, the necessary protection tools must then be built into the employment contract. Companies should ensure that those individuals with operational and technical knowledge are consulted about the length and breadth of the restrictions required, and that all incoming employees sign their contracts of employment in order to protect the business as fully as possible. The restrictive covenants should be reviewed when an employee is promoted and any changes should be expressly agreed in a new employment contract.

2.1.8 Where there is an international element, at the outset of the contractual relationship an employer should carefully consider the most appropriate governing law and jurisdiction to enforce restrictive covenants in order to protect the business. In the case of OJSC TNK-BP Holding and another v Igor Lazurenko [2012] an injunction restraining a former employee from disclosing confidential information was discharged as the relevant contract of employment contained a confidentiality clause and dispute resolution clause nominating the governing law as Russian and the jurisdiction as the Russian Court. The injunction of the nature granted by English Court was not available under Russian law, and it was discharged with the claim against the former employee dismissed.

3. Dealing with Exiting Employees: Practical Considerations

In the current economic climate it is crucial for businesses to protect valuable assets such as confidential information, senior skilled employees, clients, customers and suppliers. Team moves are relatively commonplace at the moment as competing businesses try to poach profitable teams of employees from each other. There has been an increasing trend to enforce restrictive covenants by way of an injunction against exiting employees to compel them to cease their activities and/or for the delivery up/destruction of confidential information.

As soon as an employer becomes aware that an employee, or team of employees, intends to leave it should act quickly to protect its position.

3.1 Carry out a risk assessment to determine your strategy:
3.1.1 What are the restrictive covenants in the employment contract?
3.1.2 Are the restrictions enforceable?
3.1.3 What is the employee’s level of seniority and what data and/or contacts do they have access to?
3.1.4 When and where is their new role?
3.1.5 What is the potential impact of a breach of covenant on your business?

3.2 Employees may not recall the exact wording or extent of their restrictive covenants. To avoid any doubt:
3.2.1 Immediately set up a meeting with the employee to discuss the covenants. If possible, seek to agree what the employee can and cannot do from that point. For example, whether they are no longer allowed to attend marketing events or have access to customer data;
3.2.2 Notify your IT and HR teams of the employee’s departure; the restrictive covenants which apply and the agreement that you have reached with the employee during the restriction period;
3.2.3 Most businesses have internal email and internet policies which provide that an employee’s mail and internet usage may be monitored. Ask your IT department to monitor outgoing emails to the employee’s private email accounts; the new employer; emails with large amounts of data attached; whether the employee is notifying clients they are moving to a new company or printing large quantities of documents from their personal folders and/or company database;
3.2.4 Consider limiting access to certain accounts and/or databases;
3.2.5 Arrange for key files to be moved to another member of staff;
3.2.6 Consider whether to invoke any contractual garden leave provisions for all or part of the employee’s notice period.

3.3 The activities of the exiting employee should be monitored prior to their departure until the end of their restrictive covenant period. Speak to clients/customers/suppliers to see whether they have received mail shots from the employee, or their new employer, and check social media sites such as LinkedIn, Twitter or Facebook to see who the employee has contacted.

4. Remedies for Breach of Restrictive Covenant

4.1 Prior to the departure of the exiting employee

All too often employers act hastily when they discover a breach of a restrictive covenant before the employee has left the business and dismiss them with immediate effect. Not only does this potentially expose the business to an unfair dismissal claim, if the business commits a repudiatory breach of an employee’s contract it cannot enforce the terms of any restrictive covenants. This leaves the business in the vulnerable position where the employee leaves on bad terms and may use the opportunity to exact revenge.

Where there has been a breach of restrictive covenant, speed is of the essence in order to limit any damage to the business. Preparation is essential. If a breach is suspected:

4.1.1 Investigate:
Establish whether the employee’s conduct constitutes a breach of the restrictive covenant. It is vital to properly collate the evidence for the purpose of any court proceedings and at the outset identify the materials believed to have been taken, copied or transferred. Care needs to be taken when making applications to the Court to ensure they are made at the right time and address all of the relevant issues. Failure to do so can result in wasted legal costs.

In the recent case of White Digital Media Ltd –v- Weaver and Anor [2013] the Court refused to grant an injunction against an employee as, amongst other things, the Claimant had failed to provide sufficient evidence of the alleged breach of restrictive covenant. In the case of Phaestos Ltd and Anor v Ho [2012] the employer alleged that the defendant had unlawfully copied, retained and misused its documents and was operating in direct competition. They applied to Court and were granted an Order which required the defendant to disclose disc images of his computers and electronic storage devices. Phaestos made a further application for an Order for an independent computer expert search for evidence and to produce a report. The Court rejected the further application as premature and an unjustified fishing expedition. Phaestos had to wait until the conclusion of the initial disclosure process and then make a new application if it was not satisfied with the information disclosed by the defendant.

4.1.2 Consider the Options:
Litigation is not necessarily the most suitable or cost effective option. Consider whether the risk to your business is significant enough to justify court proceedings, or whether there are alternative options which may provide adequate protection. For example:
• garden leave;
• obtaining signed undertakings from the employee that they will return data/documents/possessions and desist from their competing activities;
• agree further restrictive covenants;
• dismiss the employee with the assistance of the HR team to ensure that restrictive covenants that may be enforceable are not rendered void because of a hasty process.

4.2 During the Restriction Period

Follow the same steps outlined at (4.1) above. As the employee has already left the company, speed is even more so of the essence as an employer can no longer immediately control their actions. As before, investigate the breach; collate evidence; and consider the options. Obtain early legal advice as any delay may undermine an application to Court for injunctive relief.

4.3 Legal Remedies

There are a variety of interim injunctions and remedies available which can, in certain circumstances, be obtained within a matter of days to limit the potential damage to a business when an employee breaches their restrictive covenants. These include:

4.3.1 Springboard Injunctions: an urgent, without notice application to prevent an unfair competitive advantage gained as a result of breach of restrictive covenant;
4.3.2 Order for Delivery Up: for the return of documents, confidential information, company property and/or other data wrongfully taken;
4.3.3 Search Orders: permitting the search of premises (residential or business) under strict supervision to seek evidence and/or materials obtained in breach of restrictive covenant;
4.3.4 Freezing Orders: freeze the assets of the former employee to prevent them from disposing of their assets beyond the reach of the employer thereby making them unattractive to sue for damages;
4.3.5 Order for Damages: either for an account of profits obtained as a result of breach of covenant (which can be time consuming and complex to calculate) or general damages. In Safetynet Security Ltd –v- Coppage and Anor [2012] the court awarded the Claimant £50,000 in general damages as a result of the Defendant’s breach of covenant in poaching five clients.

An injunction is a discretionary remedy and an expensive process. The party applying for an injunction assumes significant costs risks if the Court is willing to grant the Order sought. Key to dealing with potential breach of restrictive covenant is to seek early legal advice and assess the most appropriate and cost effective options. A clear strategy is essential. There are always a number of factors to consider, especially where there is an international element.

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About the Author
Elizabeth Beatty, Partner
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