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What are restrictive covenants and how do they work?
17th Mar 2021
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What are restrictive covenants and how do they work? - Linkilaw Solicitors
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Restrictive covenants are commonly found in employment contracts and can be a source of significant issues upon the termination of an employment contract. These are clauses specifically designed to prohibit an ex-employee from taking advantage of the ex-employer’s client-base, employees and/or general business information.

Restrictive covenants can be used to restrict the former employee from contacting the company’s clients or its employees or setting up a competing business within a specific geographical distance from his/her former employer’s office.

Enforceability of restrictive covenants 

Employers should be aware of the fact that mere incorporation of restrictive covenants into employment contracts, does not necessarily mean they are legally binding and enforceable. This is the case even in circumstances where the employee has provided their express agreement to the terms of the contract. The Courts recognise that there is a degree of inequality in bargaining power between the employer and the employee, thereby adopting a much stricter approach when considering the enforceability of such covenants in an employment context.

The Court undertakes a balancing exercise between the legitimate interest of the business and the employer’s freedom of movement, taking into consideration the doctrine of restraint of trade.

Under this doctrine, a contractual term that restricts employee’s activities after termination would be void, unless the employer can show that:

  • The clause protects its legitimate business interest;
  • It is no more than reasonably necessary to protect that legitimate business interest.

Legitimate interest: what can the employer protect? 

When considering what amounts to a legitimate business interest, the Court generally allows the following categories to be protected:

(a) trade connections,

(b) trade secrets and other confidential information,

(c) the stability of the workforce.

This list is not exhaustive and as per Dawnay Day & Co Ltd v de Braconier d’Alphen and others [1998] ICR 1068, other business interests are also capable of being protected. Each case will differ on its own facts, and employers are generally advised to seek legal advice to determine what can and cannot be protected under the above categories.

No more than necessary? 

In addition, if the employer is successful in establishing that there is a legitimate interest to be protected, it should not impose restrictions on ex-employee’s activities that are wider than reasonably necessary. This includes geographical and any time restrictions, which are discussed in more detail below. Failure to demonstrate this, will result in the restrictive covenant being treated as void by the Court.

Restrictive covenants - Team

Types of restrictive covenants 

There are different types of covenants both employers and employees should be aware of.

(A) Non-competition clauses

These clauses impose a restriction on the former employee by forbidding him/her from working for a competitor for a stated period of time. These clauses can be particularly substantial for people who specialise in a niche business sector.

(B) Non-solicitation clauses

These clauses restrict a former employee from contacting/soliciting customers, clients or contacts of the former employer.

(C) Non-dealing clauses

These clauses are a more extreme version of the non-solicitation clause, in that it outright restricts the former employee from doing business with customers, clients or contacts of the former employer.

(D) Non-poaching clauses

These clauses do not allow a former employee to “poach” other employees of the former company during a stated period of time.

Time restrictions and geographical restrictions 

When reading restrictive covenants in a contract, it is common that they are bound by two varying elements, the one of time and geographical area. It is these two elements that the Court closely considers in determining whether a restrictive covenant is no more than reasonably necessary to protect that legitimate business interest.

Overview of the prospective reform   

As of the time of writing this article, the Government is looking to introduce laws relating to non-compete clauses in Employment contracts. A consultation has been released in December 2020, suggesting 2 proposals:

  1. The introduction of an obligation on the employer to compensate the employee after termination, during the time when he/she is bound by the non-compete clause; or
  2. The outright ban of non-compete clauses;

These proposals are seen by the Government as a way of increasing competition in the market, in pursuit of recovery after the impact of COVID-19. It should be noted, however, that the first option would, in practice, lead to a drastic reduction in the number of non-compete clauses added to contracts, especially if the compensation comes close to a full salary.

Updating Restrictive Covenants 

It is common for employees to be promoted or transferred to other internal positions throughout their career at the company. As a result, they may have greater exposure to confidential business and client information over time. Employers thus need to take careful steps to regularly review and update restrictive covenants to protect their business and ensure covenants reflect the seniority of the individual.

 

Concluding Thoughts 

When deciding whether to insert a restrictive covenant or to challenge one, you must carry out a balancing test in the assessment of the clause’s enforceability. Multiple factors should be considered, including but not limited to, the employee’s position, access to confidential information, and industry considerations. The aim of the employer is to achieve a suitable balance of these restrictions in terms of timeframe and geographical radius, in light of their reasonableness in protecting the business’s legitimate interests.

On the other hand, a former employee must decide whether the clauses are disproportionate, hence unenforceable, or whether to wait through the timeframe before carrying out his intended activities. 

At Linkilaw Solicitors, we offer our expertise in the area of employment law and advise you accordingly on any issue relating to restrictive covenants. Our services include the drafting of employment agreements, revision of current versions and advice on the next steps in setting up your business, which may be restricted by such covenants. 

If you require further assistance on Employment law matters, you can speak to one of our legal specialists by booking a free consultation here 

Our legal commentary is not intended to be a comprehensive review of all developments in the law and practice. Please seek legal advice before applying it to specific issues or transactions. 

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