Protecting your business – How restrictive covenants can help
Protecting your business – How restrictive covenants can help
In recent months we have seen an increase in businesses looking to actively enforce restrictive covenants in contracts of employment and ex-employees who want advice on whether their personal restrictive covenants are enforceable.
The current economic climate is proving to be a challenge for businesses. Unfortunately, many businesses are having to consider redundancies and restructuring to cope with the costs of the Coronavirus pandemic and the down turn in work they have experienced as a result. Many employees are therefore looking for work elsewhere and turning to competitors to find it. Restrictive covenants have become even more vital for businesses to protect their remaining client base and ongoing contracts.
Key issues around restrictive covenants
This article looks at the key issues around restrictive covenants, what they are, how businesses can make sure they offer adequate protection, how to introduce new restrictive covenants if a business doesn’t currently have them and what to do if an employee acts in breach.
The nature of restrictive covenants
Restrictive covenants can be controversial. A restrictive covenant essentially restricts the action an employee can take when they leave their employment.
There are lots of different types of restrictive covenants. The most common types are:
- non-solicit – restrictions which prevent ex-employees from proactively contacting certain suppliers/customers/clients;
- non-deal – restrictions which prevent ex-employees from doing any work for certain suppliers/customers/clients;
- non-poach – restrictions which prevent ex-employees from convincing ex-colleagues to go and work with them at a new employer; and
- non-compete – restrictions which prevent ex-employees from working in a particular industry or for companies in competition with their ex-employer.
Normally restrictive covenants kick in once someone leaves employment. However, we also see restrictions which apply during employment. Particularly if people work part time or have very senior roles. For example; not holding share above a minimum level and not working elsewhere or with other companies without the express consent of their employer.
What makes a restrictive covenant enforceable?
The key to a successful restrictive covenant is that it is drafted to be enforceable. The starting point with restrictive covenants is that they are “void as a restraint of trade and contrary to public policy”. I.e. they limit someone’s actions and therefore can prevent them from making a living.
However, a lot of case law has built up around restrictive covenants and if an ex-employer can demonstrate that the covenant meets the following criteria it will usually be upheld and enforced.
To be enforceable a restrictive covenant must:
- be designed to protect the specific businesses legitimate business interests; and
- go no further than is necessary to protect those interests.
To meet these requirements there are several factors to consider:
- The restriction should not be too wide geographically.
- The restriction should not last for too long; i.e. only as long as it should reasonably take the employer to shore up their client base or protect their confidential information.
- The activities that the restriction cover should be as narrow as possible; i.e. restricted to the role the person carries out or activities they were involved in.
- The people it covers should be as specific as possible; i.e. restricted to the clients/customers/suppliers that the employee worked with a certain period before they left.
- The interest that the business wants to protect should be specifically set out; i.e. a customer data base, trade secrets or confidential information of a particular kind.
How these factors are applied will depend on the industry the business operates in and the role that the employee does.
As a more senior employee will have greater access to confidential information and trade secrets and can arguably do more damage to a business if they left to work for a competitor, it is likely that stronger restrictions would be enforceable against them compared to a more junior role. The courts will also look at the other terms of the contract too. For example, if someone only has a 1 month or statutory minimum notice period, this suggests that they can be quite easily replaced by their employer and the employer does not feel they need much notice to replace them. Restrictions of 6-12 months could therefore be seen as excessive in comparison.
Generally speaking, the courts will not normally enforce restrictions that last for more than 12 months and there need to be strong reasons for 12 month restrictions too. A 6 month restriction is much more likely to be seen as reasonable.
Whilst it can be tempting to have a stock set of restrictive covenants for all employees, to have the best chance of enforcing them they should be viewed each time a new contract is issued and tailored to that specific role.
What to do if you don’t currently have restrictive covenants in your contracts of employment
Businesses without restrictive covenants in their contracts should consider whether it would benefit the business to introduce them. For some businesses, only key senior or director roles may pose a risk to the business in which case there is no need to introduce them for all staff members.
Service industries generally suffer the most when restrictive covenants are not in place -– i.e. those who work with a repeat client and customer base whom they don’t want to lose.
A restrictive covenant will only be enforceable if consideration is given when they are introduced though. Otherwise the requirements for a legally binding contract won’t be met. This is often missed when restrictions are updated during employment and could mean they are not enforceable when the person leaves. Consideration could be in the form of a bonus, a pay rise, an extra day’s holiday or another benefit offered to the employee; provided it is tied specifically to the changes to their contract of employment.
We would always recommend that employees are asked to sign the updated contract, including the restrictive covenants, as proof that they have agreed to them. This can be particularly important if the employee later tries to challenge their existence or their enforceability.
It can also be possible to introduce restrictive covenants at the end of employment if someone leaves under a Settlement Agreement. However, this all depends on the negotiating position of both parties and the nature of any dispute so should never be relied upon as a way of protecting legitimate business interests.
When should you review the restrictive covenants in your contracts of employment?
Businesses should regularly review their restrictive covenants to check they remain fit for purpose.
In particular, businesses should review and update restrictive covenants every time someone is offered a promotion or changes roles.
Restrictive covenants are judged as at the date they are entered into. If an employee signs a contract as a junior admin assistant the reasonableness of the restrictions will be judged against that role. Even if that junior admin assistant later becomes the CEO of the company, the restrictions will still be looked at in the context of the role the person was in when they accepted the restrictions. If they were unreasonable for that role it is likely they won’t be enforceable, even if they would be enforceable compared to the new role the person is now in.
It is therefore vital that if someone is offered a promotion or changes their role that their restrictions are reviewed and if necessary updated to reflect the new role.
Restrictions may also need updating if the nature of the business changes or there are other changes which mean the restrictions are no longer as relevant as they once were. If restrictions are being updated in circumstances where someone isn’t being offered a promotion then the normal rules on consideration referred to above will apply and an additional payment may need to be made.
What can you do if an ex-employee acts in breach of their covenants?
The options available for an employer if an ex-employee acts in breach of their restrictive covenants will depend on what they have done, whether the restrictions were enforceable and whether the business has suffered any loss or damage as a result.
The first step will always be to review the restrictions and seek advice on their enforceability.
The second step will depend upon the outcome of that review and the how immediate the risk the breach poses to the business. The options are likely to include:
- Consider whether an injunction is required for serious breaches causing substantial loss
- Write to the employee highlighting the breach and requesting undertakings that they will cease acting in breach
- Consider any other formal legal action for breach of the restrictions against either the ex-employee, or their new employer, depending on the circumstances
At the same time, businesses should also do as much as possible internally to protect the confidential information or business that the breach could affect. I.e. contact the clients who may be affected directly and check any contact details are up to date.
If you have any questions or queries about the restrictive covenants in your contracts please don’t hesitate to contact any member of the Employment team who would be happy to help.