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Restrictive Covenants - should you bother and are your restrictive covenants fit for purpose?
As we make tentative steps out of the recession, there is greater movement in the labour market and it is becoming increasingly important for businesses to ensure that their trade connections, trade secrets and other confidential information are adequately protected. Ensuring that (i) relevant employees are subject to appropriate restrictive covenants; and (ii) restrictive covenants are used effectively are two ways in which to protect these valuable assets.
This article looks at the value in having restrictive covenants and looks at some considerations which come into play when introducing restrictive covenants.
Is it worth having restrictive covenants?
Employers often question whether it is worth bothering with restrictive covenants - even if you have gone to the effort of drafting reasonable restrictive covenants which are appropriate for the individual concerned, in practice they are often just too difficult and expensive to enforce.
Restrictive covenants are generally enforced through an injunction. It is true that an application for an injunction can be very expensive given the speed of the application and the level of evidence required. In many instances the potential for damage to the business is far outweighed by the expense. However, in practice restrictive covenants have a lot more going for them than just providing a route to an injunction.
Restrictive covenants encourage good behaviour from former employees. The mere presence of a restrictive covenant may make former employees think twice about going to work for a competitor, solicit clients etc. In addition, it may deter potential employers from hiring the individual or they may well take precautions to ensure the individual is not working in a way which breaches the restrictive covenants and it may mean there is a delay in the employee commencing work for them in a meaningful way.
The threat of an injunction can be quite powerful and the possibility that the employer could seek such a remedy is a good deterrent. If an employer suspects an employee is acting in breach of his covenants and threatens an injunction this can cause considerable inconvenience for the employee and the new employer in having to respond to such threat and taking legal advice on the matter. A breach of a restrictive covenant is essentially a breach of contract, so the new employer may be particularly concerned about being liable for inducing the employee to breach their contract with a former employer.
Being able to threaten to seek an injunction may be enough to illicit undertakings (either to the court or just in written correspondence between the parties) from former employees and new employers in relation to certain actions they will and will not do, which can provide the required protection whilst enabling the parties to avoid an expensive injunction application.
Introducing or reviewing restrictive covenants
The basic principle is that restrictive covenants which seek to restrict an employee’s activities following termination of employment are void as a restraint of trade unless it can be shown that:
- the employer has a legitimate proprietary interest which is appropriate to protect; and
- the restriction goes no further than reasonably necessary in order to protect that interest, having regard to the interests of the parties and public interest.
In principle employers can seek to protect the following as legitimate proprietary interests:
- trade secrets and other confidential information;
- trade connections, suppliers, clients;
- skills of workforce.
What does this mean in practice for tech businesses?
When thinking about introducing restrictive covenants or reviewing current ones, the starting point is to consider what proprietary interest you are looking to protect. Having a clear idea of this will make the rest of the analysis easier in terms of deciding (i) what type of restriction would be appropriate; and (ii) the scope of the restriction to try to ensure it goes “no further than reasonably necessary”.
The interest you are trying to protect may be different for different functions and seniorities of employee, for instance a CFO may not have any relationships with clients or customers therefore a restriction on soliciting clients may not be appropriate for that individual. However, the CFO is likely to have access to highly confidential information about the business generally and so a non-compete may be appropriate.
In determining the length of the restrictions, if you are aiming to protect confidential information you should consider how long such information will be ‘current’ for. Where you are seeking to protect relationships with customers or suppliers you should consider how long it would take a new recruit to build up the same sort of relationship with customers and suppliers.
We have set out below some specific issues which should be considered in relation to different forms of restrictions.
Courts will not generally enforce a restriction which is simply to prevent competition. However, sometimes a restriction on competition is the only way of protecting confidential information. As this is the most onerous form of restriction this ought to be the most carefully drafted.
One main issue is how to define the business with which the employee cannot compete. Restrictions are often entered into when an individual first joins a company but you will only come to rely on them a number of years down the line when the business may look very different to when they were entered into. Given the rapid growth of tech businesses, an employee’s role can often change significantly too, therefore covenants should be reviewed regularly and careful drafting is needed to prevent the definition of ‘business’ going quickly out of date.
For internet businesses and other tech companies with a global presence, where the employee could be based anywhere in the world, employers should consider which territories it conducts business in respect of as well as where their employees and customers/clients are located.
An added complexity is whether a business seeks to protect confidential information in relation to prospective business; this may be where an employee has been heavily involved in developing a new product which is yet to come to market or in plans to extend business to new geographical areas.
A careful balance needs to be struck when drafting in respect of geographical scope and prospective business as making restrictions too broad could render them completely unenforceable.
Non-solicitation of / non-deal with clients
When looking to protect relationships with clients or customers, restrictions on solicitation and dealing with clients are often used.
When determining the scope of such restrictions you need to consider to which clients it will extend. In a small business it may be that one employee has contact with and influence over all clients of the business, so such a wide restriction may be appropriate. However, this may not be appropriate where the employee has dealings with only a limited number of clients of the business. Again, with growing businesses this may be something which changes fairly quickly, therefore careful drafting is needed to avoid the definition becoming too broad in a changing business.
An employee may have been developing relationships with potential clients prior to his termination. You should consider whether relationships with potential clients should also be protected, although this is potentially extremely broad therefore drafting with care is needed here in order to strike a balance between the need for protection of the employer and casting the net too widely.
Non-solicitation of / non-employ employees
The interest in maintaining a stable, trained workforce is something that can in principle be protected. Whilst one person leaving may be something a business can deal with, a number of individuals leaving in quick succession may be problematic in terms of leaving a gap in skills and knowledge. Restrictions on soliciting and employing/ engaging employees and other personnel of the business are often used to seek to protect this interest. Such restrictions may also be used to protect confidential information and customer connections too.
With these restrictions, you need to consider which employees they would apply to and this is likely to depend on the purpose of the restriction. Applying this to all employees may be too broad to be enforceable as poaching very junior employees is unlikely to be damaging to the business’ legitimate interests. Where the concern is protecting confidential information, you would look at including employees who are privy to material confidential information. Where the concern is stability of the workforce, you would look at including employees who have influence over other employees and/ or whose departure would otherwise be a significant detriment to the business.
It may be that actually the relationships you are more concerned with protecting are those with your suppliers rather than your customers or clients. For instance the priority for an online TV or film streaming service may be to seek to protect the relationships with the companies who provide that content rather than relationships with customers; there may be no relationship between individual customers and employees to protect if there are thousands of customers who buy the products or services through a website. Such businesses should therefore think about restrictions designed to protect these interests.
In our view, restrictive covenants are worth having, even if you do not plan on seeking an injunction to enforce them. Getting the right balance in the covenants can be more complex for tech businesses than for more traditional businesses so careful drafting is needed.
If you are thinking about introducing restrictive covenants, you’re concerned your current restrictions are not fit for purpose or if you would like advice on how to use your restrictive covenants to best effect - feel free to contact a member of our Employment Team who would be delighted to help you.
For further information, please contact Amy Douthwaite - Employment associate