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Restrictive Covenants and Non Compete Clauses

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Restrictive Covenants and Non Compete Clauses

Restrictive covenants and non compete clauses (or post-termination restrictions; whatever you call them) are clauses within a contract of employment or settlement agreement which restrict a departing employee’s ability to trade freely. These restrictions are subject to strict limits and can only be enforced where reasonable.

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Employment contracts

It is the right of an individual to trade in any lawful way they choose but employers may wish their employees to enter into post-termination restrictions upon starting their employment so that the legitimate business interests of the employer will be protected.

Individuals are free to enter into contractual restraints should they so wish and for high level employees if an employer cannot lawfully restrain his behaviour once their employment ends this could be a cause for mistrust, lack of promotion or training opportunities and therefore such clauses can be very useful.

The law therefore strikes a balance to be struck between two competing principles: on the one hand the desire to stop unnecessary restraints of trade; and on the other hand allowing parties the freedom to enter into restrictions should they so wish.

Restraints are currently presumed to be unenforceable until they are proven by a former employer to be reasonable. Should a valid restraint of trade clause exist is it very possible for a company to take legal action to stop former employees from breaching promises to restrain their activities.

The Courts will ask three questions:

  1.  Can the company demonstrate that the restraint protects a legitimate interest?
  2.  Is the restraint reasonable in the circumstances?
  3.  Can the former employee demonstrate that the restraint is contrary to the public interest?

 Types of restraint clauses

There are broadly five types of restrictive covenant:

  • Non-compete: which seek to prevent an ex- employee from directly  competing or working for a competitor, usually within a specific geographical area and for a set period following termination;
  • Non-solicitation: which seek to prevent  an ex-employee seeking orders for goods and services, for a set period following termination;
  • Non-dealing: which seek to prevent an ex-employee from entering into working relationships with former customers for a set period following termination;
  • Non-poaching of employees: which seek to prevent an ex-employee from recruiting former colleagues for a set period following termination;
  • Restrictions on the use of confidential information: which seek to prohibit the use of any confidential information and trade secrets.

It is not possible for a company merely to attempt to restrain competition; a company has to show that it has a genuine interest to protect.

Three interests that the courts have been willing to protect are:

  1. Trade secrets and confidential information
  2.  Trade connections
  3.  Maintaining the stability of the workforce.

Reasonableness of the restriction

The contractual clause in question must be no more than adequate to protect the business interest.

The reasonableness of the duration or scope of any restraint is tied to the nature of the interest in question.

For example, the secret formula for Coca Cola can be restricted worldwide!

Severance

A Court is not permitted to uphold a covenant in restraint of trade by reducing its duration.  However English courts do have the power of “severance”.  For example, if a contract contains covenants with varying types of restrictions i.e. non-solicitation and non-dealing, the court has the power to uphold part of the clause, for example, the non-solicitation restriction but not allow the non-dealing part of the clause.

Enforcement & Breach of covenants

An action for the breach of restrictive covenants must would normally be brought through the civil courts and not the employment tribunal.

An employer seeking to enforce restrictive covenants may take steps to obtain an interim injunction. Alternatively, or if it is not successful in obtaining an injunction, it may seek damages from the employee for breach of the covenants.

When the courts are determining whether to award damages the following points will be given consideration:

  1. Whether the covenant was enforceable.
  2. If so, whether the employee had breached the covenant.
  3. If so, whether the breach had caused the employer loss.
  4. If so how that loss should be assessed.

Suing a competitor that has induced employees to breach their contracts

Inducing a breach of contract can in itself give rise to a claim in tort.  Therefore, where a former employee is induced by the employer’s competitor to breach restrictive covenants, the employer might choose to sue that competitor.

Covenants not binding if employment is terminated wrongly

An important point to remember and one that comes up a great deal in practice is if an employment contract is terminated wrongly the post termination restrictions would no longer take effect. So if an employee is summarily dismissed and not paid notice pay then if this was found to be unfair the covenants would be unenforceable. Equally, if the employer fundamentally breaches the employee’s contract of employment and this leads to a constructive unfair dismissal then this would also mean that the covenants are not enforceable.

Consideration

Adequate “consideration” must be given for restrictive covenants to be valid. This means that in order for the employee to validly restrict themselves they must be offered something in return. On starting employment the consideration would generally be the new position, however, if an employer is seeking to make fresh restrictions in a new contract during the employment of an employee then there must be some consideration provided for this, normally a one off sum of money payable net of income tax and national insurance contributions.

Confidential information

See also our page on confidential information.

 

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