Restrictive Covenants

Shirley Blair, Associate in the Employment & Incentives Team at A&L Goodbody discusses Restrictive Covenants. Shirley details when you need to use them and what you need to think about when drafting them.

Transcript

In this video, we are looking at restrictive covenants, when to use them, and what you need to think about when you're drafting them. I'm also going to look at two recent cases from the courts, including a decision from the Supreme Court, which is a highly significant case around the area of enforceability of covenants.

First, let's look at a scenario to put this all into context. Nikki is one of your managers. She came into work as normal on Monday but handed in her notice. She said that she was just planning a break for a while before thinking about a change in career. You've since found out that she's going to a competitor business and rumour has it that she's trying to persuade her assistant to go with her.

How much you can do to protect the company will depend on whether you have effective post-termination restrictions in Nikki's employment contract. Most employers have information or business contacts that are fundamental to its success. A prudent employer will ensure that its contracts of employment contain appropriate clauses that protect its business in the event that key employees with access to confidential information, IP, key business contacts leave the company. These are usually collectively referred to as restrictive covenants or post-termination restrictions.

Implied Terms

There are some terms that are implied into employees' contracts, which will give some protection whilst the employment is on-going. So, for example, there is an implied duty of confidentiality, which includes the duty not to disclose to third parties or misuse for their own purposes their employer's confidential information on trade secrets.

This implied duty only survives after the employment has ended in respect of trade secrets. Ordinary confidential information is not protected on an implied basis, and as such, an employee would be free to use and abuse the employer's confidential information unless he or she has been properly restricted from doing so, usually in their contract of employment.

Types of Non-Solicitation Clauses

Drafting those post-termination restrictions can be challenging and should be given a lot of consideration. The law says that the protection contained within them must go no further than is absolutely necessary to protect the legitimate business interests of the company.

The usual types of restrictions relied upon by employers are non-compete clauses. These are intended to prevent the former employee from doing similar work for a competitor.

Non-solicitation clauses, these seek to stop the former employee poaching a former client or customer and sometimes supplier. In this instance, it covers only where the former employee makes the first approach.

Non-dealing clauses are intended to protect the customer relationship regardless of who makes the approach to the other.

There's another category of non-solicitation clauses, this time for employees. And they seek to prevent the poaching of former colleagues.

The clauses should be tailored specifically to the individual that is signing up to them. And they should be regularly reviewed and refreshed to ensure that they continue to offer the needed protection.

Duration of Restrictions

Given that the employee may change their role during the lifetime of their employment, careful consideration should be given to the duration of the restriction. The court will need to be satisfied that this period can be objectively justified by reference to the interest being protected and not just a figure plucked out of the air.

As a very rough rule of thumb, restrictions for a 12-month period should only be reserved for those at the top of the company or with very specialist, highly confidential information or connections.

Geographical Coverage

The geographical area that it covers should be considered. A worldwide covenant is unlikely to be upheld unless the employer can show that it operates on the worldwide stage and the employee was engaged in worldwide business too.

The nature of the business being protected should be considered. It shouldn't go beyond that area in which the employee was engaged or had good knowledge about.

As the restrictions are so closely tied to the individual's role within the business and access to information or contacts, it's imperative that they are regularly reviewed to make sure that they remain enforceable. The reasonableness of a covenant is judged at the time it was entered into. So, if an employee was then promoted several times, it may have lost its relevance or reasonableness over time.

Case Law

There have been two recent cases that are worthy of note, and the first is the case of Tenon FM and Cawley. This is a case that was decided in July 2018. And there are a number of salutary lessons that came out of it.

First, do not underestimate the difficulty of persuading a judge to enforce restrictive covenants in a contract that has not been signed by the employee. In that case, the court could not be persuaded that the former employee had signed the contract containing the restrictions when they couldn't find a copy. The former employee said, "You can't find it because I didn't sign it, and I didn't sign it because I didn't agree to the restrictions".

It's not impossible, however, to enforce covenants in an unsigned contract of employment. There's a case from 2012, which is a case of FM Farnsworth and Lacy that says that the employer may be able to rely on covenants in an unsigned contract if it can show that the employee has acted in some way that unequivocally shows that they had considered themselves to be bound by the contract.

Clearly, however, it is much better to have the restrictions in a contract that has been signed by the employee to avoid this argument arising at all.

The second point that came out of the Tenon case was that if you're introducing new or updated restrictions after the employment has commenced, make sure that appropriate consideration has been given to the new restrictions.

The second case I want to look at is the recent and highly significant Supreme Court decision that was handed down in July 2019. The case is Tillman v Egon Zehnder Ltd. In this case, the Supreme Court was asked to reconsider about 100 years' worth of law to make it more fit for purpose.

The facts of the case are this. Egon Zehnder are a global specialist executive search and recruitment business. They recruited Ms Tillman in 2004. She was very highly regarded, started in a senior role, and was very well-recompensed. She had £120,000 salary and £100,000 bonus.

She was very successful in her job and progressed through the ranks. By 2012, she was Joint Global Head of Financial Services and was a shareholder in the Swiss Holding Company. Not surprisingly, her contract retained restrictive covenants. One of these was a non-compete in which she promised that for six months after the end of her employment, she would not directly or indirectly engage or be concerned or interested in any business carried on in competition with any of the businesses of the company or any group company.

Ms Tillman left Egon Zehnder on the 30th of January 2017. She told them she was joining competitor on the 1st of May 2017. So, the six-month non-compete was still running. She argued that the non-compete was void in restraint of trade. She said that the words "interested in any business" meant that you couldn't even have a minor shareholding interest in a company, and that therefore, the covenant was too broad.

The case went to the High Court and then the Court of Appeal. And the Court of Appeal said that Ms Tillman's argument was right.  Egon Zehnder argued that, "If that was correct, the court should just strike out the offending words". And that's called the “blue pencil test."  And let the rest of the covenants still stand". But the Court of Appeal refused.

The Supreme Court agreed that the wording made the covenant too broad. It then considered whether the words could be severed. The previous case law in this area had suggested that it should not be, as it might render the contract very different in meaning to that entered into.

That said, there were conflicting Court of Appeal decisions in this area, which is why we were all so interested to see what the highest court would make of it. Well, the Supreme Court made new law. It allowed the words "interested in" to be severed from the covenant and for the remainder of the covenant to stand.

New Law

Following this case, the court has said that the three criteria will have to be applied before severance is considered. And these are:

1. First, that the offending provision can be removed without adding to or modifying the remaining words. That's the old blue pencil test.
   
   
2. Second, that the remaining parts continue to be supported by adequate consideration.
   
   
3. And thirdly, that the removal of the unenforceable parts will not mean any major change in the overall effect of the restrictive covenant in the contract.

This is not, however, a charter for us all to become sloppy with our covenant drafting or updating. The burden still remains on the employer to prove its legitimate business interest and that the covenant is reasonable.

Post-termination restrictions is a fascinating area of law, not least because it usually involves protection of the company's crown jewels in speedy high court cases. When these sorts of issues arise, it is not uncommon for each side to find themselves in court at the injunction stage within a matter of days, either defending the drafting of a covenant or challenging it.

And it makes a lot of sense to invest some time in making sure that the right protections are in place at the outset of the employment and are regularly reviewed and updated before issues arise, and that flurry of litigation gets underway.