Departing employees are often well-placed to take advantage of confidential information, strategic plans, customer and client details or other information about their employer’s business, after the termination of their employment.
They may attempt to use this information for the benefit of their new employer, or in order to set up a rival business. This can seriously harm the former employer’s business.
Although employees must observe certain terms that are implied into every contract of employment these are of a limited nature and do not generally extend to the period after termination of the contract (except in relation to trade secrets). Express restrictions, on the other hand:
- Can be specifically designed to reflect the parties’ circumstances.
- If properly drafted and reasonable, can limit the employee’s conduct and prevent them from damaging the former employer’s business.
- Might deter employees from joining competitors.
- Might deter potential new employers, who face the risk that the restrictions will be enforced by the courts, and may themselves be vulnerable to certain tort claims, such as inducing a breach of contract, or unlawful means conspiracy.
The court applies the following key principles in assessing and enforcing post-termination restrictive covenants:
Reasonableness. Post-termination restraints are enforceable if they are reasonable, having regard to the interests of the parties and the public interest. The question of reasonableness has to be considered at the point when the covenant was entered into, not in the light of subsequent events.
Legitimate interest. To be enforceable, a restrictive covenant must be designed to protect a legitimate proprietary interest of the employer for which the restraint is reasonably necessary. Legitimate interests include an employer’s trade connections with customers or suppliers, confidential information and maintaining the stability of the workforce.
Special treatment for employment covenants. Restrictive covenants in employment contracts are generally viewed more strictly than those in commercial contracts, such as those between a seller and a buyer. They are usually less likely to be regarded as reasonable, because of the inequality of bargaining positions between employer and employee.
Preventing competition must not be an end in itself. Restrictive covenants having the sole aim of preventing competition are never upheld by the court. A non-competition restriction must be designed to protect the employer’s confidential information, trade secrets or customer connections, and prevent the employee from obtaining an unfair advantage by exploiting these for their own, or another employer’s, benefit. Non-solicitation clauses are therefore looked on much more favourably than pure non-competition clauses.
Restrictions must be no wider than necessary. For any covenant in restraint of trade to be treated as reasonable in the interests of the parties, “it must afford no more than adequate protection to the benefit of the party in whose favour it is imposed.” This will involve limiting not only the restricted activities themselves, but also the period and (if appropriate) the geographical extent of the restriction. Failure to do so may result in the covenant being treated as void for having too wide a scope. In effect, the test of reasonableness requires a balancing exercise to be carried out between the interests of the employer’s business (such as goodwill, confidential information, trade secrets and trade connections) and the individual’s right to freedom of movement and to earn a living.
Burden on the employer to demonstrate validity of covenants
The burden of proving that a particular restrictive covenant is reasonable falls on the party trying to enforce it.
In employment cases, the employer will therefore need to be able to show why a particular covenant provides adequate protection, but does not go further than is necessary to protect its legitimate interest.
Legitimate interest: what can an employer protect?
An employer cannot impose a covenant simply because it does not want an ex-employee to compete with it. However, it can seek to prevent the individual from using or damaging something that legitimately belongs to it.
To determine what rights may require protection, the employer must look at the nature of its business and the employee’s position in the business
In broad terms, the rights that a court will allow to be protected fall into the following categories:
- Trade connections (with customers, clients or suppliers) and, more generally, goodwill.
- Trade secrets and other confidential information.
- Stability of the workforce.
Defining the legitimate interest expressly
Restrictive covenant clauses often contain introductory wording setting out the interests that the employer is seeking to protect (effectively, the reasons the employer needs the protection of the covenants).
Where this approach is adopted the wording needs careful drafting, as the covenants will be interpreted in line with the interests it sets out, and the employer will not be entitled to rely on an additional interest at a later stage
Connections with customers, clients and suppliers
An employer is entitled to protect its relationships with its customers, clients and other trade connections (for example, suppliers).
The courts have recognised that employees may build up close relationships with such people, and gain their trust. They may then seek to take advantage of these relationships in a subsequent role, even though the trade connections belong to the employer.
In some cases, the customer, client or supplier may want to continue dealing with their familiar contact, and so will follow them without any encouragement or solicitation by the employee.
This type of legitimate interest can be protected by means of a non-solicitation or non-dealing covenant, or in some cases by means of a non-compete covenant.
An employer must be careful to distinguish its own customer connections from the personal connections of the employee. This is a distinction that is not always easily applied.
Where the employer provides a significant expenses budget to enable relationships to be developed it is more likely that it will be able to show a proprietary interest in those that result.
Trade secrets and confidential information
An employer can legitimately use restrictive covenants to protect its confidential information from being used for the benefit of a competitor. However, the employer must be able to demonstrate that the information is genuinely confidential information, or amounts to a trade secret.
In particular, an employer should distinguish between
- confidential information that may be regarded as the employer’s property (which can be protected) and
- skills, experience and know-how that an employee has acquired during the course of employment. The courts will not prevent an employee from using this kind of information, even though it may be useful to a competitor.
Stability of the workforce
An employer has a legitimate interest in maintaining a stable, trained workforce, and that this may warrant protection through restrictive covenants.
Where a departing employee encourages others to join them in moving to a competitor (often known as a team move), this can exacerbate the damage done to the employer.
Employers can attempt to protect the stability of their workforce by using non-poaching and non-employment restrictive covenants
Non-solicitation covenants
Solicitation in this context usually refers to an ex-employee’s positive act of contacting a customer or client of the former employer or making an initial approach, with a view to obtaining their business. (i.e. to “tempt, lure, persuade [or] inveigle”).
It is generally regarded as acceptable for an employee to inform clients and customers that they are leaving, and even to mention a contact address. However, there is a fine line between acceptable communication and unlawful solicitation.
At the very least, solicitation seems to require an invitation to transact business, and an intent to do so, whether express or implied.
Non-competition covenants
A non-competition (or “non-compete”) restriction, which prevents an employee joining a rival employer for a defined period after termination, has traditionally been harder to enforce than a non-solicitation restriction and is viewed as “the most powerful weapon in an employer’s armoury”.
These are only viable where other forms of protection, such as confidentiality restrictions and non-solicitation restrictive covenants, cannot always be effective in safeguarding a former employer’s legitimate interests.
A non-competition restriction is likely to be enforced in certain circumstances:
- where it may not be possible to give the legitimate proprietary interest (for example, a manufacturing process or confidential trade secret) sufficient protection through the implied and express confidentiality terms. For example where it is inevitable that the employee will use such information in any future employment. In this type of case a restriction against carrying out the activity is more realistic and easier to police.
- The individual’s influence over customers or suppliers may be so great that the only effective protection is to ensure they are not engaged in a competing business in any way.
Non-dealing covenants
A restriction on the solicitation of customers can be extended to cover not only enticement or interference (where active steps are taken by the departing individual), but also the provision of services (where no active steps are required: the customer could approach the individual). This is known as a non-dealing covenant.
This type of covenant has clear advantages because it avoids the practical difficulty of proving that the individual made an approach. However, it does significantly broaden the prohibition, not only to affect the rights of the employee in question but also those of third parties, so a court is more likely to be cautious about upholding it.
Enforcement may be more likely where the employer can establish a substantial personal connection between the employee and the relevant customers, and where the business environment is such that overt solicitation is not necessary for the employer to be exposed to significant loss of business (e.g. where the employee’s personal qualities are such that clients will gravitate towards them).
The courts have also indicated that a non-dealing clause, when used in conjunction with a non-solicitation clause, can be justified in circumstances where it might be difficult to define and police non-solicitation clauses, and to prove that solicitation has occurred.
A non-dealing covenant will not be enforceable if it prevents any contact with the relevant business contacts. The restriction must be focused on contact that would affect the employer’s business.
Duration of restrictive covenants
With the exception of restraints on using or disclosing confidential information, any post-termination restrictive covenants that restrain a former employee’s freedom to trade must be for a limited time.
When deciding the appropriate period, it is necessary to consider how long it will be before competitive activities by the individual represent less than a material threat to the employer’s legitimate interest. This will vary from case to case and should be carefully considered each time restrictive covenants are drafted. Relevant factors may include:
- The length of time it is likely to take for the departing employee’s replacement to settle in and cement relationships with the employer’s customers and clients.
- The “shelf life” of the employer’s confidential information (for example, how long it is likely to be before the manufacturing process or product range changes so much that the individual’s knowledge becomes obsolete).
- The frequency of contact with clients and the longevity of customer connections. For example, in the insurance broking industry most clients will have annual policies and so many clients will only speak to their broker in the period leading up to their renewal date. This may help the employer justify a duration of 12 months. Conversely where clients are more transient, or contracts shorter, it will be harder to justify lengthy restrictions.
- The turnover of staff, the length of employees’ notice periods and the state of the recruitment market. Where turnover is high and employees often leave on short notice, it may be harder to justify long non-poaching restrictions, as the employer will not be able to demonstrate a stable workforce. Conversely, where the business is highly specialised and there is a shortage of staff with the right skills or experience, then a longer non-poaching restriction would be justifiable.
- Any geographical restrictions that apply. Generally speaking, if there is a wide geographical restraint, it will be harder to justify a covenant of longer duration.
- The “industry standard” for the particular sector. This is not likely to be determinative, but the court may take it into account. However, the duration will still need to be justified in its own context.
- As with all considerations of reasonableness, the overarching consideration is whether the duration of the covenant is no longer than necessary to protect the particular legitimate interest of the employer.