Restrictive covenants a guide for SME business owners and HR professionals

Transcription

1 Restrictive covenants a guide for SME business owners and HR professionals A restrictive covenant is an explicit constraint placed on an employee which comes into effect on termination of their employment with you. Playing an important role in protecting your commercial interests, at Linder Myers, our employment experts have created a guide to arm business owners with the knowledge they need to ensure that their restrictive covenants are enforceable. 1

2 Introduction In an increasingly competitive business world, information is power. It is difficult, if not impossible, however, to run a successful business without employees becoming privy to confidential information about your strategy, key stakeholders and other business assets. But what happens to this sensitive information once a member of staff leaves your employ? Unfortunately, it is not unusual for ex-employees to seek to use their knowledge of your business to further their own means. Whether they are looking to set up on their own or join a competitor, their acquired insight into your confidential business operations can help them to gain an unfair competitive edge. Restrictive covenants play an important role in protecting your commercial interests from this threat. Easier to police than confidential information clauses, in employment law, a restrictive covenant is an explicit constraint placed on an employee which comes into effect on termination of their employment with you. Primarily used with senior employees, and those with access to sensitive business information, restrictive covenants usually form part of the employment contract (or Director s Service Agreement) and need to be signed by employees to be valid.

3 Types of restrictive covenant Ex-employees who agree to restrictive covenants are legally prevented from engaging in specific activities that could adversely impact your legitimate business interests, for a set period of time. The main categories of restrictive covenants are: Confidentiality covenants which prevent exemployees from using or disclosing trade secrets and other confidential information (such as price lists, contract information etc.). Non-competition covenants which place restrictions on former employees from working in similar employment for a direct competitor Non-solicitation covenants which prevent exemployees from soliciting your suppliers and existing customers (and in some cases even potential customers with whom the ex-employee has engaged in defined negotiations with) Non-dealing covenants which prevent ex-employees from dealing with your existing customers and suppliers, even where the customer/supplier approaches the former employee rather than the other way round 3

4 Geographical area covenants which prevent exemployees from working for, or running a business which directly competes with yours within a defined geographical area Non-enticement covenants which prevent exemployees from poaching your existing employees Quite often restrictive covenants are inserted into contracts of employment purely as a deterrent. However, when correctly drafted, courts are increasingly likely to enforce restrictive covenants, making them a compelling tool that can be used to protect the interests of your business.

5 When should you introduce restrictive covenants? While ideally, restrictive covenants should be introduced on commencement of employment, they can be implemented at a later stage. Introducing restrictive covenants retrospectively however, can prove problematic. The introduction of a new covenant amounts to a change of the employment contract. As such, it needs to be supported by real consideration and must be agreed to by the employee. Understandably, employees are often unwilling to accept any additional restrictions placed on them, and you may need to negotiate additional benefits to secure their acceptance of any changes to their terms. Where an employee refuses to accept the introduction of restrictive covenants, you may be within your rights to dismiss them. This is however, a complex process which is fraught with difficulties and legal advice is recommended. It may be possible to introduce restrictive covenants as part of a severance or redundancy package. In such situations restrictive covenants may be included as a specific term in a Settlement Agreement. 5

6 Restrictive covenants require specific consideration under the Transfer of Undertakings (Protection of Employment) Regulations 2006 (TUPE). Where employees transferring to a new company are already bound by restrictive covenants, these restrictions will remain. However, unless the nature of the new employer s business is exactly the same in scope and size as the business the employee is transferring from, and there is no change to the employee s role, then the restrictions may no longer be deemed reasonable. Updating restrictive covenants following a TUPE transfer can also be problematic. Where restrictive covenants are required, these will need to be managed and drafted very carefully to mitigate the risk of legal challenges. Once introduced, it is important to continue to review any restrictive covenants on a regular basis. Where an employee has been promoted, or their duties have changed, an automatic review should take place to ensure any restrictions are still valid. Where a change is required, it is necessary to seek fresh agreement from the employee.

7 In 2012, the danger of not using restrictive covenants correctly was highlighted by the High Court. In this case, an employee s original employment contract had a 12- month non-compete clause. On promotion he was sent a letter confirming the changes to his terms of employment, namely an increase in his notice period to three months. On resignation, his employer challenged his decision to work for a competitor stating that he would be in breach of his contract should he do so. The employer sought an injunction, but this was rejected by the court. Instead, the court found that the 12-month non-compete clause could not be justified in the case of an employee with the status and responsibilities that he had originally entered into when he began working for the company. The court, however, did uphold the ex-employee s counterclaim for unfair dismissal. The decision highlights the importance of not only ensuring restrictive covenants are drafted correctly in the first place, but that they are also reviewed at regular intervals. 7

8 Are restrictive covenants enforceable? Many people incorrectly assume that post-termination restrictive covenants are unlikely to be upheld by the courts. However, if they can be shown to protect a legitimate business interest, and have been drafted as narrowly as possible to protect this interest, they can be enforced by law. In general, legitimate business interests are seen by the courts as being trade secrets and confidential information, customer connections, and the stability of the workforce. The key is whether the restriction is deemed to be reasonable in the protection of a legitimate interest. What counts as reasonable however, depends on the nature of your business. Matters that the court will look at when considering whether a restrictive covenant is reasonable include: The breadth of the activity that the employer is trying to restrict The breadth of the geographical area of any restriction and the level of damage that could be done to your business should the ex-employee continue to operate in this area

9 The length of time of the restriction (which must be of a duration no longer than is needed to protect the legitimate business interest). Typically, the court will only impose restrictions of up to six twelve months. Restrictions that last for over 12 months, however, are unusual unless there are exceptional circumstances The role and seniority of the ex-employee and the extent of the restriction compared to the employee s role within the business. Blanket covenants for all employees are unlikely to be upheld The nature of the industry within which the business operates and what is standard practice within this industry. While designed primarily to protect employers, restrictive covenants can t be used to deny a former employee the right to make a living in his/her chosen industry or profession, nor can they be used to quash the competition. 9

10 There is, therefore, no one-size-fits-all policy when it comes to restrictive covenants. In any dispute, the courts will usually look to strike a balance between the interests of the employer and the ex-employee. Furthermore, it is important to note that if, as an employer you are in fundamental breach of the employment contract yourself, for example by wrongfully terminating an employment contract, any restrictions contained within the contract will be automatically void.

11 How can you enforce a breach in a restrictive covenant? When a member of staff leaves and is in breach of a restrictive covenant, employers are perfectly within their rights to pursue the ex-employee for this breach. However, evidence will be required before a claim can be pursued. Evidence can include unusual client file activity, computer records, correspondence, security access logs and word of mouth. Enforcement of restrictive covenants takes place through the civil courts. The Courts can and regularly do make injunction orders preventing employees from acting in breach of restrictive covenants as well as ordering employees to pay compensation and costs as a result of their activities in breach of such covenants. While the process can be fraught with difficulties, the best way to ensure that ex-employees are held accountable for failing to adhere to restrictive covenants is to ensure that any agreements are correctly drafted in the first place. In addition, it is vital that as an employer, you can demonstrate that where a breach does occur, you have acted, and continue to act, reasonably at all times. 11

12 In addition, where you believe your ex-employee s new employer has induced them to break any agreed covenants, and they were aware of the restrictions placed on the employee, you may be within your rights to sue the new employer. A successful restrictive covenant claim against an exemployee can also send a clear message to other employees in regard to your commitment to protecting your interests in this way. However, in many circumstances employers are put off by the potential costs of litigation. It is often the case that to obtain a positive result, employers need to pursue their case to the High Court, which for many can be commercially unviable. It is however possible to secure policy pursuit cover to reduce your exposure to costs should you wish to ensure that any breaches to restrictive covenant agreements are challenged.

13 In conclusion Restrictive covenants can be an extremely powerful means by which you can protect your business against the threat of departing employees. However, they can be difficult to enforce. It is vital, therefore, that any restrictions are carefully drafted by an employment solicitor, that they are correctly implemented, and that they are reviewed (and if necessary updated) regularly. Should an employee breach a restrictive covenant, or indeed challenge the legality of a restriction placed upon them, it is up to you to convince the court that the restriction was reasonable to protect a legitimate business interest and that it was sufficiently narrow in order to be enforced. If you would like to find out more about introducing restrictive covenants into your contracts of employment, or if you would like a review of any existing clauses to ensure they are fit for purpose, contact Alan Lewis on or by at alan.lewis@lindermyers.co.uk. 13

14 Further reading FAQs for settlement agreements Restrictive covenants policy cover How to protect your business from Employment Claims Employment Law Facts & Figures 2014 Employ-Line from Linder Myers

15 About Linder Myers Linder Myers Solicitors provides a range of high quality legal services to both individuals and business clients. With an unwavering commitment to meeting your legal needs, our team of specialists will ensure that you have the best possible experience throughout the legal process. Linder Myers specialises in the following areas of law: Corporate & Commercial Commercial Litigation Commercial Property Costs Management Court of Protection Disputed Wills and Probate Employment Family Medical Negligence Occupational Disease Personal Injury Residential Conveyancing Trusts and Estates enquiries@lindermyers.co.uk