Restrictive covenants

This article is about restrictive covenants, an area that trips up more employers than perhaps any other.

Restrictive covenants are post-termination restrictions in employment contracts that stop an employee doing something after termination. That explains the “restrictive” part. “Covenant” simply means “promise”.

Beware the hard worker who looks like he might be plotting something

These are terms you might find into a contract to prevent an employee from giving a competitor an unfair advantage by:

  • Allowing their new employer to use confidential information learned during employment with you (confidentiality clause)
  • Poaching your customers or employees (non-poach clause); and where the above is not enough
  • Working for a competitor (non-compete clause)

The general rule is that any individual is free to secure any job they want and use skills developed earlier in their career to progress in it. But while it is acceptable to use your training and industry knowledge to advance your career, few employers would want an employee to use client lists or commercially-sensitive pricing information in their new job.

And although your business’s relationship with its customers has to be nurtured by individuals, the customer relationship should remain with you not the employee.

That’s where restrictive covenants come in.

The law doesn’t help you here; if you want to restrict your employees in some way after employment, you must write the clauses into your contracts of employment. Employment solicitors have a body of caselaw knowledge that they use to create watertight clauses.

Because restraint of trade is generally thought to be a bad thing (hence the competition commission and anti-trust lawsuits), the default position with these clauses is that they are void.

To repeat, post-termination restrictive covenants, which you see in the employment contracts of most employees at a senior level or at any level where there is a personal relationship with customers or suppliers, are, by default, void.

So, if you fall out with an ex-employee over this issue, you start from a position of having to win over a judge, who will only side with you if your clauses go no further than necessary to protect your legitimate business interests.

That means that in the context of their particular job role, in the context of the employee dealing with their particular customers in that particular industry and those particular pricing structures in that particular geographical area (you get the picture) your clauses must ask for no more than you actually need in order to stop the new employer benefiting from your information or customer relationship.

Often, the answer is “Sorry, you bit off too much” and the penalty is hard, swift and costly -the whole clause is void.

To take a routine example, a London hairdresser has a very personal relationship with a salon’s customers. His restrictive covenants prevent him from asking his regulars to move with him to his new salon.

If the restrictive covenant simply says the stylist “must not poach our customers”, that would be seeking to prevent the stylist who is moving from London to Kent from cutting the hair of that one lady who for some reason travels every month from Kent for a haircut – the unintended consequence is a sledgehammer cracking a nut. The clause is void. Or, in a two-salon town, if it tried to prevent him from joining the salon down the road for a period of one year (a common timescale for covenants), again that would be overkill, because people get several haircuts in a year and there are several opportunities to cement the client relationship in that time. Again, the clause would be void. The employee could join the competitor straight away.

Or, take a company that has been in your family for generations. Your chief scientist is the only person outside the family who knows your secret process for making a fuel that prevents engine-knock. Companies around the globe have no idea what your secret ingredient or mixing method is. Once the cat is out of the bag, your business would collapse. You could patent the process but this protection only lasts for twenty years. You figure you can protect the business with family secrecy for many more generations. In this scenario, only a restrictive covenant not to work for rival manufacturers anywhere in the world would stop them from reproducing and selling your product. The employee would not realistically be able to work for a rival without steering its research towards the secret ingredient or mixing method that could improve their product. Now, if your restrictive covenant also tries to stop her applying her skills to the food industry, or working in a petrol station, that element of overkill would be fatal to your clause and she could ignore the clause.

 

A more mundane example is, like one of our clients, a buyer of fridges for the wholesale market who knows exactly what deals their employer has struck with its suppliers. He couldn’t work for a rival without using that knowledge to low-ball his former employers in the market-place. You’d want to prevent him joining a competitor and using that negotiated pricing information against you. But draft your restrictive covenants carefully, because if it says “you may not work for a fridge vendor for 2 years”, that applies to the retail market, which you’re not part of, and that clause would be void.

All this has been well-known for many years and employers are very often finding that their clauses go too far in some small respect and are consequently worthless. So it surprises us to see how many employers just type a new employee’s name into their terms and conditions template without stopping to give careful thought to tailoring the restrictive covenants. Sometimes, HR doesn’t even diarise to make sure the contracts are signed and returned.

In a one case, a company designed very bespoke software. When its sales manager left and joined a competitor they sought to enforce his contract, which had a 12 month non-competition restrictive covenant stopping him from selling “any products with which you were involved whilst employed by us in the last 12 months”.

What they meant was not “don’t sell our software with a competitor” but “don’t sell software in this industry – feel free to sell software in other sectors, or point-of-sale software in this industry – just stay away from competing with our program”.

The employee’s lawyers noticed that the wording “products with which you were involved” could only mean the employer’s own-brand software. He tried saying that he was free to use his knowledge about the program (that he by now knew inside-out) to the benefit of his new employer.

In a surprising decision, the court read that restrictive covenant clause as if it said “products with which you were involved or similar products”, thus stopping him from joining his competitor.

The employer won narrowly. But not before spending, no doubt, upwards of £15,000 on a trip to the Court. These are not cases that are heard in the employment law tribunal.

We will never know whether the lawyer who drafted that restrictive covenant got into trouble.

Another common mistake made by those drafting this type of clause is to say that it covers all customers, regardless of whether or not the employee has ever had any contact with them. If the business’s turnover is £1m and the employee only deals with customers who contribute 10% of that then the covenant is about ten times too wide.

Another mistake is to have a “one clause fits all” approach – this simply won’t work because although a clause might be appropriate for a senior manager who has been promoted to that role, it would almost certainly have been too wide before their promotion; if it was too wide earlier in their career then it stays unenforceable for them after that.

One message from these cases is not to feel you can rely 100% on restrictive covenants.

But there are other, non-legal, strategies that can protect your business, including keeping your employees happy in their jobs so they are less likely to leave and less likely to want to twist the knife when they do.

Also, if you address their training needs generously you can avoid them becoming so specialised that their employment options steer them towards your competitors. You can let key staff buy into your business with shareholdings so that they have a stake in its success after their departure.

As with so many areas of business, there is much to be said for the carrot and stick approach.

For employees thinking of leaving and working for someone else, the message is to get specialist advice on the terms of the contract, because to the trained eye, a restrictive covenant is often far from watertight.