Restrictive covenants – just another case on not asking for too much from your employees

November 2013

Reading time (1-10 minutes): 3 minutes

Sophistication level (1 (idiot) – 10 (expert)): 5

Entertainment value (1 (turgid) – 10 (side-splitting)): 5

Background:

As an employer you don’t like training an employee up, giving him access to customers and confidential information, letting him develop relationships with other staff, and paying him a nice salary, only to see him leave you to set up a competing business, take some of your staff with him, solicit your customers using your customer lists and use your confidential information to help him compete with you.  So you put restrictive covenants in his employment contract saying he can’t do any of this for a few years after he leaves. Seems fair enough?

Recent case:

A recent case helps to remind us that it is not as simple as this. The law says that restrictive covenants for employees must be drafted to balance the legitimate interests of the employer with the legitimate interests of the employee in being able to work to earn a living.

In this case a publishing company employee had covenants saying he couldn’t recruit senior staff, deal with customers or use confidential information. He left the employer, took various information with him (although he said he relied on information he obtained from other sources), hired two former colleagues and set up a directly competing business targeting the same African business market. The employer tried to get an injunction to stop him because he was in breach of his restrictive covenants. He clearly was. But the court said these covenants were too unreasonable to be enforceable AT ALL, because as worded they would stop him doing what he was able to do, which really had to involve working for a rival business in some capacity.

Musings:

Without restrictive covenants, there’s nothing in law to stop an employee going off and joining a competing business. The only thing the employer can try to rely on is the law relating to misuse of confidential information, which is pretty much the same whether or not it is written as a covenant in an employment contract.

If a court thinks a restrictive covenant goes too far it has to strike it out completely – it cannot enforce it on a watered down basis. I have occasionally advised employee clients (and share sale clients) not to try to negotiate a watering down of restrictive covenants they have been asked to sign because there is a very good chance that as worded they will never be enforceable!

A carefully worded clause will separate different covenants so that if for example the non-compete covenant is held to be unreasonable it can be struck out but the other covenants can remain standing on their own and still be enforceable.  Some time ago I once for a laugh took this principle to an extreme and drafted a really really long restrictive covenant clause in a share sale agreement which covered a whole lot of different variations of the same covenant and was worded in such a way that if a court thought one was unreasonable it could strike it out but then would have to go on to consider the next variation. So for example, the length of the non-compete restriction started at 4 years, and reduced in 3 month periods down to 3 months. It worked ok but just looked very silly and I haven’t done it again. Not sure why it shouldn’t have become standard practice though…

It’s worth bearing in mind that the courts will look at whether the restrictive covenants were reasonable as at the date of the employment contract – and not as the date of termination. Employers should review the appropriateness of restrictive covenants where an employee is promoted to a more responsible role (where they may deal with more customers or have greater exposure to the company’s confidential information) and consider trying to get the employee to enter into new covenants.

Many employers don’t realise until it’s too late that young Johnny whom they recruited as a trainee many years ago and is now a key senior employee and could cause an awful lot of damage if he leaves for a competitor, has never signed any restrictive covenants at all!

Note that the enforceability of covenants against an employee is looked at differently from that of those against someone who is selling their business. The latter is effectively being paid for the goodwill value of the business which justifies somewhat more restrictive restrictive covenants, although these too need to be drafted carefully to be reasonable in the circumstances.

Advice:

• You need to be careful how you draft your restrictive covenants!
• You need to carry out a regular review of the restrictive covenants in your key employees’ contracts.