Could your business benefit from the use of effective restrictive covenants (post-termination restrictions)? If you have any specific questions or would like more information about restrictive covenants in employment contracts, contact our specialist employment solicitors.
- Why include restrictive covenants in an employment contract?
- What are the different types of restrictive covenant in employment law?
- Who can restrictive covenants apply to?
- Are restrictive covenants in employment contracts legally binding?
- How enforceable are restrictive covenants in employment contracts?
- What if a former employee breaches a restrictive covenant?
- What duties and obligations do employees have towards your business, after they leave employment?
- What can you do if employees breach their post termination obligations?
- Do restrictive covenants apply on a TUPE transfer?
- Restrictive covenants in the case of redundancy and other dismissals
- PILONs and restrictive covenants
- Is the situation different when an employee resigns?
- What future changes might be made to restrictive covenants?
Why include restrictive covenants in an employment contract?
Restrictive covenants can restrict the activity of employees once they leave a business and help protect your legitimate business interests, if done in the correct way. However, the default position is that the implied terms employees must abide by during their employment do not usually survive termination of employment. Explicit contractual terms that restrict employee activities after termination are void for being in restraint of trade, unless you can demonstrate:
- legitimate proprietary interest, which it is appropriate to protect; and
- b) the protection you seek is no more than is reasonable, considering the interests of the parties and the public.
By including specific restrictions from the outset in a written employment contract, it makes clear to both parties what is restricted, how long the restrictions last and in the exact circumstances they apply. If drafted precisely and in accordance with employment law, this can help to protect your business from a former employee using confidential information, strategic plans, business contacts or other sensitive information in a damaging way once the employee has left your employment.
Restrictive covenants might also prevent employees from joining competitors and prevent competitor employers from hiring restrained employees. This is due to the risk of the courts enforcing post-termination restrictions against both the new employer and the former employee.
Getting post-termination restrictions right could make a huge difference for the future profitability and security of your business. Our employment experts recommend you seek professional advice when initially drafting and updating your contracts of employment.
What are the different types of restrictive covenant in employment law?
There are various types of restrictive covenant designed to protect businesses once employees leave. All types of restrictive covenant should be limited by a reasonable timescale post-termination and geographically. To give a restrictive covenant the best chance of enforceability, the restriction should only include the interest that needs to be protected and the specific geographical area where the employee carried out activities for you. The size, nature and density of the population in the geographical area concerned also needs to be considered. Worldwide restrictions are possible if you can prove that this is required to protect a legitimate business interest.
Here are the main types of restriction that could be drafted in your employment contracts:
Non-solicitation clauses – These prevent a former employee from actively contacting your customers or clients. This might include an employee making an initial approach to persuade a contact of yours to change their dealings with your business. However, the employee does not always have to be the one to make the first move, as it depends on the facts surrounding the contact. If an employee has a significant personal influence over a customer and has had recent dealings with them, a non-solicitation clause for a reasonable time relating to those customers would be appropriate, and likely enforceable. Recent dealings usually relate to the past 12 months. However, this depends on the employee’s seniority, role, loyalty of clients in the market, time it might take for a future employee of the business to gain the same influence over that customer and what competitors’ non-solicitation clauses look like.
It is also possible for a business to protect the general customer base and goodwill if an employee knows of a confidential customer (provided the restriction is limited to the likely time that the customer will remain secret and limited to the time there would be any attachment of goodwill to that individual).
It is possible, although more difficult, to enforce a non-solicitation post-termination restriction relating to potential customers, if they can be clearly defined. There would, however, need to be proof that in the role and industry, winning work from a customer was a lengthy, difficult and expensive process. A potential customer would need to have had previous ‘dealings’ with you, even if these had not led to the close of any actual business at the time of the employee’s departure. Simply ordering samples of a product which were not subsequently ordered was not ruled to be sufficient to amount to ‘dealings’ to fall under the head of a ‘potential customer’ in a non-solicitation restrictive covenant.
- Non-poaching and non-employment covenants – These types of post-termination restriction are to prevent a former employee poaching or employing other members of your staff when they leave. This helps to protect the stability of your workforce. Both types of restrictive covenant are possible to enforce, if correctly drafted, however non-poaching clauses tend to be easier to enforce than non-employment covenants, which limit a third-party employee from seeking work elsewhere and so can be more problematic for employers to justify. Generally, these clauses should be limited to restricting more senior employees, but if you are a small business with very few key employees, it may be reasonable for you to restrict a former employee from poaching any staff members. The period over which an employee will have influence over their former colleagues will be limited, and so any non-poaching or non-employment clause must also be limited by that same period, to be deemed reasonable.
- Non-dealing clauses – This type of clause restricts a former employee from providing services or goods you provide to your customers, without any active steps being taken. These clauses are more difficult to enforce than a non-solicitation clause, as the decision making of third parties are being restricted, as well as the former employee. The reasonableness of a non-dealing clause will be interpreted according to what the parties intended when they initially agreed on the restriction, not necessarily the reality later. To boost the chances of your non-dealing clause being enforceable, you should expressly state in the clause that particular contacts where dealings with the former employee could cause a significant loss. If there is a clear personal connection with customers and an environment where solicitation isn’t required for you to suffer significant loss, a non-dealing clause is far more likely to be viewed as reasonable and enforceable. Non-dealing clauses are often included as well as non-solicitation clauses, to avoid you having to prove that a former employee made an approach.
- Non-compete clauses – This type of clause prevents an employee from joining a competitor or from setting up their own business in competition immediately after leaving your business. Generally, there is a carve-out of this type of clause for holding minor shareholdings (typically up to 5 per cent) held by the employee in a competing business, so that the clause is not unreasonably wide. Non-compete clauses tend to be more difficult than non-solicitation clauses to enforce. They can sometimes be enforceable where there is specific confidential information (such as a manufacturing process) which cannot be protected by confidentiality provisions in an employee’s contract. This might be where an employee is bound to use the specific information once they left an employer to join a competitor business. Alternatively, if an employee’s influence is so great the only effective protection for you is if the employee does not work for any competitor at all, for a certain period, these clauses are more likely to be enforceable. An example of this might be where a more senior employee bypasses a non-solicitation clause by getting a less senior employee at their new competitor employer to contact and deal with customers, with the more senior employee working in the background and feeding information and strategy. There is more of a trend for these types of clauses being enforced if the clauses are sufficiently precise, so the importance of getting the correct wording incorporated in the employee’s contract is critical. Our experienced employment lawyers can help with this.
Who can restrictive covenants apply to?
Most case law focuses on the employer/employee relationship, but restrictive covenants can apply to other types of employment relationship.
|Employment relationship||Can restrictive covenants be applied?|
|Casual workers||It would not normally be appropriate to impose conventional post-termination restrictive covenants on a casual worker (for example in a zero hour contract). This is because there is usually no continuity of employment and no mutuality of obligation, so workers can work for others even during their contract.|
Attempting to include post-termination restrictions in a worker’s contract can lead to confusion about the employment status of the worker. Imposing numerous post-termination restrictions on an individual suggests a level of control over the activities of the worker that is more akin to an employment relationship than that of an employer and casual worker. It is likely to be unreasonable to restrict a casual worker, as they tend to be more junior with fewer responsibilities or influence over business contacts, and so no legitimate business interest is being protected by restricting these individuals.
The employer is instead trying to both deny the worker the protection of employment rights, but also treat them as an employee when it comes to restricting their activities, which is unlikely to find favour with the courts.
|Partners and LLP members||While the same rules apply to partners in respect of restrictive covenants, it is widely accepted that the bargaining power between partners is generally more equal than between employer and employee. Even in the absence of express restrictive covenants, a partner can be subject to implied restriction.|
Most significantly, a partner who retires from a partnership, while free to set up in competition and to act for clients of a previous firm who approach the partner directly, is prevented from canvassing or soliciting such customers for as long as they remain clients of that firm.
As well as the restrictions you might see in an employment contract, a partnership agreement can impose restrictions to prevent team moves. This means that for a specified period following departure, a partner cannot join a firm to which another partner or senior employee from the original firm has recently transferred. Such provisions have not yet been tested in the courts.
Non-competition restrictions which prevent a partner from working for a competitor within a defined geographical area are generally upheld if the geographical extent of the covenant is held to be reasonable, even if the restraint is for a significant period.
|Consultants||A consultant may build up close relationships with the client’s customers, suppliers and employees of a business they carry out work for. They may also acquire valuable confidential information which they could use to their advantage in appointments with other clients. While it is very rare to impose a non-competition covenant on a consultant (as it might suggest an employer/employee relationship), other types of restrictive covenants are common and advisable. Provided that the usual rules relating to restrictive covenants are met, restrictive covenants could be binding against self-employed consultants, but there is less case law on this. If a service company is used, the restrictive covenants will only bind the service company unless the consultant is also a party to the agreement or enters the restrictions separately using another document.|
Are restrictive covenants in employment contracts legally binding?
Restrictive covenants can be legally binding if they are not void for restraint of trade. This means that they must be reasonable regarding the interests of all parties at the time the restriction was entered into and the restriction must protect a legitimate business interest which it is appropriate to protect (such as business contacts).
Restrictive covenants in an employment context have stricter rules and are less likely to be enforceable than, for example, restrictive covenants on the sale of a business, where bargaining powers are more equal as between the parties. For a general guide in a wider commercial context, see our advice on Restrictive Covenants in Business Agreements.
While non-compete clauses are possible, they must be carefully drafted, as a restrictive covenant only designed to restrict competition will not be enforceable. In order to be enforceable, a restrictive covenant must be necessary to protect an employer’s confidential information, trade secrets or contacts and to prevent a former employee using these for their own or a competitor’s unfair advantage against you. Restrictions must be no wider than required to protect legitimate business interest, otherwise they will be viewed as too wide and unenforceable due to restraint of trade.
Access legal support from just £125 per hour
If you need advice on restrictive covenants in employment law, our employer solicitors can help.
How enforceable are restrictive covenants in employment contracts?
Provided that the restrictions comply with the above and are properly incorporated into an employee’s employment contract (or signed by the employee in writing and incorporated into the employee’s contract, or are signed at the end of the employee’s employment in a settlement agreement with additional consideration provided) restrictive covenants are enforceable. Albeit that enforcing them in the courts can be an expensive and time-consuming process. Restrictive covenants will not be enforceable if they are not clearly drafted or are not reasonable at the time the parties entered into the covenants.
If a restrictive covenant is not enforceable because it’s too wide or unreasonable, the court will not sever parts of the clause or rewrite the clause to make it reasonable and so enforceable. The Court can only treat separate promises as severable, and so can delete one clause and apply others, but cannot delete part of a clause to give it the effect the employer would like at the time of enforcement. The Court must bear in mind that the contract stays the type that was entered into by the parties in the first place and that there is sufficient consideration for the promises made.
Courts can very rarely adopt a purposive approach where restrictive covenants are defective. For example, because poor drafting has led to a vague covenant or a covenant which does not match the type which was clearly agreed between the parties at the time the contract was formed. This discretion is severely limited and so it is critical to get the correct legal advice from the outset and ensure that restrictive covenants are sufficiently precise and specific to the employee an employer is attempting to restrain, and that the clauses are properly incorporated into the employee’s contract. If you would like assistance with this, our employment law solicitors can help.
What if a former employee breaches a restrictive covenant?
Provided that the restrictive covenant is valid and enforceable, if an employee is in breach of a restrictive covenant, there are several enforcement options available:
|Apply for an interim injunction||If there is a serious issue to be tried, damages would not be a sufficient remedy and if on the ‘balance of convenience’ granting the injunction would not prejudice the employee more than the employer in all circumstances, then an interim injunction may be granted. Damages are unlikely to be sufficient if damage is likely in the future but has not yet taken place and cannot be accurately quantified. Generally, this is the end of the matter as it will never get to a full hearing before the expiry of the restrictive covenants, but the courts can assess the merits of the cause of action not just ask if there is a serious issue to be tried. |
The type of interim injunction applied for would likely be a prohibitive injunction to prevent the employee from committing a breach. A final injunction may also be required and granted after a full trial.
|Seek damages from the employee||Where financial compensation is sufficient, an injunction would not be granted. The court would assess whether a restrictive covenant is enforceable, has been breached, whether this had caused the employer loss and then how the loss should be assessed. An account of profits is possible in breach of restrictive covenants cases, but is usually only available where there has been a breach of fiduciary duties or the duty of confidentiality. It is possible, although less likely, to claim ‘negotiating damages’ (also named Wrotham Park damages) if an employer cannot prove actual loss, by claiming a sum equivalent to what the employee would have paid the employer, before breaching the post termination restriction, to release the employee from its obligations.|
|Undertakings||The former employee can offer undertakings to observe the contractual restrictions pending a speedy trial (as a contested interim injunction application is not required). This option saves both parties time and money and gives employers short-term protection from breach of the covenant (even if it is not likely to be enforceable). In many cases the matter settles before the trial. |
An undertaking can be through solicitors in writing or to the court: the former will only have contractual effect, whereas the latter will mean a court order and any breach could be a contempt of court.
|Declaration||The court can, but rarely does, make a binding declaration in respect of post-termination restrictions. Even more infrequently, an employee can apply for a declaration that their post-termination restrictions are unreasonable or otherwise unenforceable.|
|Act against a third party||A former employer could act against a third party which has benefited from the former employee’s breach of a restrictive covenant. Such a third party might be a) a new employer of the former employee if they have induced or conspired in the breach; b) a recipient of the former employer’s confidential information; and/or c) any funders or associates of the former employee’s new business (where the former employee has set up their own business). This can be a better option for a former employer, as a new employer may have deeper pockets than a former employee and it puts further pressure on a former employee not to continue a breach. |
A claim for inducing a breach of contract can be brought against a third party, if the former employer can prove that the third party knowingly and intentionally induced or procured the breach without reasonable justification, and that as a result the former employer suffered financial loss.
A former employer could also look at bringing an action for the tort of conspiracy, if it can prove that two or more persons, which might be a former employee and their new employer, are working together by unlawful means and intending to cause loss to the former employer.
What duties and obligations do employees have towards your business, after they leave employment?
Aside from those obligations which are stated in an employee’s contract of employment which continue after the end of the employee’s employment, most fall away on termination. Most contracts will entitle an employer to the return of their confidential information and company property, including passwords and logins.
- Fiduciary duties - Having said the above, directors have fiduciary duties and must act in their employer’s best interests (as opposed to their own) by statute. Other more senior employees may also owe duties of fidelity without being a director of their employer, obliging those employees to report their own wrongdoing and that of other employees, which would include having knowledge of a team or an individual move to a competitor. Even if an employee does not owe fiduciary duties, contracts of employment may contain clauses obliging the employee to notify their employer immediately if they receive an approach or offer of employment. In that case, an employer may be able to argue that an employee has committed a repudiatory breach of their employment contract, but this may not be a reasonable argument. Where an employee is less senior and does not owe fiduciary duties, it is unlikely that having a confidential plan to set up alone and in lawful competition with their employer in the future would be something they would be required to disclose, as per a High Court decision on this matter in 2017.
- Confidential information: aside from any express post-termination restrictions stated in an employee’s contract of employment or settlement agreement, there is an implied term into every contract of employment relating to confidential information. This term means that an employee shall not during or after their employment disclose to third parties confidential information and trade secrets learned during and as a result of their employment with an employer. Neither must they use that confidential information for their own benefit.
Employers are much better protected by express terms protecting confidential information, as they are clearer on the specific information which might be included under the head of ‘confidential information’ and have been agreed in advance between the parties. You should regularly review confidentiality clauses and what they cover: as a business develops, there may be more information that you would like to keep confidential. If there is more information that you would like to keep confidential, but the employee is about to leave the business, you may be able to offer the employee a settlement agreement containing enhanced confidentiality protections and a further sum of money (consideration) for this. If you would like further guidance on protecting your business’s confidential information on the exit of an employee, please contact us.
What can you do if employees breach their post termination obligations?
If you can prove that an employee has breached their disclosure obligations, you could be entitled to terminate the employment contract without a notice period or any payment in lieu of notice (PILON) with loss of any bonus, commission or benefits from any incentive plan, where an employee is still employed. Many bonus schemes also reward loyalty as a separate (and generally higher) percentage, as well as good performance. Bonus payments are often paid at the employer’s discretion, and they can defer payment and order that the company is reimbursed by a certain percentage if an employee leaves within a certain period after a loyalty bonus is paid. You can also state that if an employee is no longer in employment by a set payment date, or is under notice by that date, that they are not entitled to be paid for that bonus period.
If an employee is not still employed, you could claim damages for loss suffered or for profit made because of the former employee’s breach. Alternatively, you could apply for an injunction to prevent the former employee from working for or dealing with a new employer, or apply to search a former employee’s premises for evidence (although this may not be viewed as a reasonable response by the courts in most circumstances for a breach of disclosure obligations).
Do restrictive covenants apply on a TUPE transfer?
Under the Transfer of Undertakings (Protection of Employment) Regulations 2006 (TUPE), the automatic transfer principle means that employees being transferred retain their terms and conditions of employment and the transferee business inherits those terms, including any restrictive covenants. A transferee may try to harmonise terms and alter restrictive covenants. If you are looking to alter restrictive covenants of employees, whether in a TUPE context or otherwise, contact us for individual and specific advice.
Restrictive covenants in the case of redundancy and other dismissals
So long as a restrictive covenant is reasonable and enforceable as per the above, a restrictive covenant will usually run from the employee’s last date of employment (unless the employee has been on garden leave and there is a clause in their contract stating that restrictive covenants will be reduced by any period spent on garden leave). It does not matter what the reason for dismissal is or indeed whether the dismissal is unfair, if the restrictive covenants are enforceable, they will apply.
Where there has been a breach of an employment contract, such as in the case of wrongful dismissal (for example, if a contract was not ended correctly by giving due notice under the employment contract) or in the case of a constructive unfair dismissal, the entirety of the employment contract will no longer bind an employee, including any restrictive covenants contained in the employment contract. Whether this applies to confidentiality clauses as well as restrictive covenants is doubtful, but a final decision has never been made on this by the Employment Tribunal.
PILONs and restrictive covenants
If an employment contract states that an employer can terminate the contract by paying in lieu of an employee’s notice (PILON) period, terminating employment without a notice period and making a payment in respect of this is legitimate and not in breach of contract. Post-termination restrictions in the employee’s contract remain in full force and effect, unless there is another repudiatory breach of the employment contract by the employer.
You may have to pay all contractual benefits, not just basic salary, which may mean a higher cost to you than paying compensation for wrongful dismissal. The extra cost may be worth it so that the restrictive covenants remain in place.
Is the situation different when an employee resigns?
Apart from in the case of resignation because of constructive unfair dismissal, after an employee resigns any restrictive covenants which are enforceable under the usual rules will continue to bind an employee after they leave their employment.
What future changes might be made to restrictive covenants?
Following on from a more general government consultation in February 2016 on restrictive covenants, on 4 December 2020 there was a more specific government consultation on the reform of non-compete clauses in employment contracts, which closed at the end of February 2021. Particularly following the economic impact of the Covid-19 pandemic, the government is looking at restricting the use of non-compete clauses to maximise opportunities for those who may find themselves out of work. This could mean setting statutory limits on the restrictions or banning them altogether and could be extended to other restrictive covenants, because of the feedback from the consultation.