If reasonable and drafted precisely, restrictive covenants (sometimes known as post termination restrictions) can be used to limit damage caused to your business by employees leaving and joining a competitor, setting up a competing business, poaching key employees or using your confidential information or business contacts.
There are different types of restriction which might be helpful in a variety of circumstances when an employee leaves. Our employment solicitors can help with specific advice, but below is some general information about restrictive covenants in employment law.
- 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?
Why include restrictive covenants in an employment contract?
The default position is that most implied terms applicable during employment do not usually survive post termination of employment. Explicit contractual terms that restrict employee activities after termination are void for being in restraint of trade, unless you can demonstrate:
- a legitimate proprietary interest, which it is appropriate to protect; and
- the protection you seek is no more than is reasonable, considering the interests of the parties and the public.
By including specific restrictions in a written employment contract, it makes clear to both parties what activities are restricted, how long the restrictions last and in which exact circumstances they apply. If drafted precisely and in accordance with the necessary requirements, this can help protect your business in a variety of ways. This can include preventing a former employee using confidential information including strategic plans, business contacts or other sensitive information in a damaging way once the employee has left your business.
Restrictive covenants might also prevent employees from joining competitors and restrict competitor employers from hiring restrained employees, as courts can enforce post-termination restrictions against the new employer and the former employee in some circumstances.
Getting post-termination restrictions right could make a huge difference for the future profitability and security of your business. Our employment solicitors 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?
The main types of restriction are:
- Non-solicitation clauses – these clauses seek to 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 to your detriment. However, the employee does not always have to make contact first, it depends on the facts. 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 may be appropriate, and would likely be 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 say.
You can also protect the general customer base and goodwill if an employee knows of a confidential customer (provided the restriction is limited to the time that customer will likely remain secret and the time there would be goodwill attached to that individual).
It is possible, although more difficult, to enforce a non-solicitation 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 an expensive process. A potential customer would need to have had previous ‘dealings’ with you, even if these had not led to any actual business by the employee’s departure. For instance, ordering samples of a product which were not ordered is insufficient to amount to ‘dealings’ with a ‘potential customer’.
- Non-poaching and non-employment covenants –these provisions prevent a former employee poaching or employing members of your staff when they leave in order to protect the stability of your workforce. Both types of restrictive covenant are potentially enforceable, if deemed to be correctly drafted and reasonable. Non-poaching clauses are generally easier to enforce than non-employment covenants, which limit third-party employees from seeking work elsewhere, so can be more difficult to justify. Generally, these clauses are limited to restricting the poaching or employment of senior staff, 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 or employing any staff members. The period over which an employee will have influence over their former colleagues will be limited, and so the restriction can only last for that same period, in order to be deemed reasonable.
- Non-dealing clauses – these provisions restrict a former employee from providing services or goods you provide to your customers, even if the relevant individual has taken no active steps. These clauses are more difficult to enforce than a non-solicitation clause, as the decision making of third parties is being restricted, as well as the former employee. The reasonableness of a non-dealing clause will depend on what the parties intended when they agreed the restriction, not the reality at alater junture. Enforceability is more likely if, you expressly state the particular contacts where not only solicitation, but dealings with the former employee could cause a significant loss and if a non-dealing clause is enforceable you will not be required to prove that the former employee took action to secure that customer.
- Non-compete clauses – these are considered the most onerous type of restriction as they seek to prevent an employee from joining a competitor or setting up their own business in competition shortly after leaving your business. Non-compete clauses tend to be more difficult than non-solicitation clauses to enforce. If there is specific form of confidential information (such as a manufacturing process) which cannot be protected by confidentiality provisions and other restrictions in an employee’s contract and an employee is bound to use that information if they joined a competitor, this type of clause is more likely to be enforceable. Similarly, if an employee’s influence is so great that the only effective protection is if the employee does not work for any competitor, for a certain period, these clauses are more likely to be enforceable. For example, if a senior employee bypasses a non-solicitation clause by getting a less senior employee at their new competitor employer to contact and deal with customers, and works in the background feeding information and strategy, this could be potentially very damaging to your business. These types of clauses can be enforced if they are sufficiently precise, reasonable and justifiable so the importance of getting the correct wording incorporated in the employee’s contract is critical. Also, it would usually be advisable for there to be 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 considered unreasonably wide. Our experienced employment lawyers can help with this.
Who can restrictive covenants apply to?
|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 hours contract). There is usually no continuity of employment and no mutuality of obligation, so workers can work for others even during their contract in such arrangements.|
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 also 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.
|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 an employer and an employee. Even in the absence of express restrictive covenants, a partner can be subject to implied restrictions.|
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 as an intermediary in such an arrangement, 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 being in 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 that apply following the sale of a business or in other commercial agreements, where the parties’ bargaining powers are more equal. A general guide in a wider commercial context can be found here Restrictive Covenants in Business Agreements.
While non-compete clauses can potentially be valid, they must, in particular, be carefully considered and drafted. A restrictive covenant only designed to restrict competition in itself will not be enforceable. The restriction must also 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 interests, otherwise they will be too wide and unenforceable due to being in restraint of trade.
Given that restrictions would be assessed against the interests of the parties at the time the provisions were entered into, it is advisable to review and update restrictive covenants wherever an employee is promoted or their role changes substantially. Our employment solicitors can advise you further on this.
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How enforceable are restrictive covenants in employment contracts?
To give a restrictive covenant the best chance of enforceability, the restriction should only include the interest that needs to be protected, should be limited to a reasonable period post-termination and to the specific geographical area where the employee carried out activities for you. The size, nature and density of the population of the geographical area is relevant too. Worldwide restrictions are possible if this is required and justifiable to protect a legitimate business interest.
The restrictions will need to be properly incorporated into an employee’s employment contract (or in a settlement or other agreement with additional consideration provided as may be necessary). Enforcing restrictions in the courts can be an expensive and time-consuming process and so to maximise the chance of them being enforceable you will want to ensure they are clearly drafted and reasonable when the parties entered into them.
If a restrictive covenant is not enforceable because it’s too wide or unreasonable, the Court can only treat separate provisions 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 have intended at the time of enforcement.
Courts rarely enforce restrictive covenants where poor drafting has led to a vague covenant or a covenant which does not match the type clearly agreed between the parties when the contract was formed. This discretion is severely limited and so getting the correct legal advice from the outset is valuable. If you would like assistance with this, our employment law solicitors can help.
What if a former employee breaches a restrictive covenant?
The options available when seeking to enforce restrictive covenants include the following:-
|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 in such circumstances and particularly if damage is likely in the future but has not yet taken place and cannot be accurately quantified. An interim injunction is intended to be a temporary remedy pending a full trial taking place.|
The type of interim injunction applied for would likely be a prohibitive injunction to prevent the employee from committing a further breach. A final injunction may then also be required and granted after a full trial.
|Seek damages from the employee||Where financial compensation is considered to be 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 a breach of 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 agreed through solicitors in writing or to the court: the former will only have contractual effect, whereas the latter will result in a court order and any breach could be amount to 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 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 conspiracy, if it can prove that two or more persons, typically, 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 obligations stated in an employee’s contract as continuing after the end of their employment, most implied terms end on termination apart from those outlined below.
- Fiduciary duties - directors have fiduciary duties and must act in their employer’s best interests as determined by statute. Senior employees may also owe duties of fidelity without being a statutory director, obliging them to, amongst other things, report their own wrongdoing and that of other employees, including having knowledge of a team or an individual moving to a competitor. Where an employee is less senior and does not owe fiduciary duties, it is unlikely that such duties would be applicable.
- Confidential information: aside from express post-termination restrictions stated in an employee’s contract or settlement agreement, there is a term implied into every contract of employment relating to confidential information. An employee shall not during 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. However, only the most confidential type of information amounting to ‘trade secrets’ such as secret processes can be protected post-employment by the implied duty of confidentiality.
Employers are, therefore, much better protected by express terms including in relation to protecting confidential information, as the specific information intended as being ‘confidential information’ can be made much clearer, having been expressly agreed in advance between the parties. Regularly reviewing confidentiality clauses and what they cover is helpful: as a business develops, there may be more information you would like to keep confidential.
It is also advisable for a provision to be included within employment contracts entitling an employer to the return of their confidential information and company property, including passwords and login details.
Separately, contracts of employment may also contain clauses obliging employees to notify you immediately if they receive an approach or offer of employment.
If you do not have sufficient protection by way of existing contractual provisions, but an employee is about to leave the business, you may be able to offer the employee a settlement agreement containing enhanced confidentiality protections and/or other restrictions in exchange for a further sum of money if necessary (known as consideration).
What can you do if employees breach their post termination obligations?
If you can prove that an employee has breached their contractual obligations, subject to the wording of relevant contractual provisions, you could be entitled to terminate the employment contract without a notice period or any payment in lieu of notice (PILON) without any bonus, commission or other benefits. Many bonus schemes 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 it can be possible to defer payment or order reimbursement if an employee leaves within a certain period after a loyalty bonus is paid. If an employee is no longer in employment by a set payment date, or is under notice by that date, they may not be entitled to be paid for that bonus period, depending on the wording of your bonus scheme.
If an employee is not still employed, as mentioned above, you could claim damages for loss suffered or for profit made because of the former employee’s breach. Alternatively, or in addition to such a claim, you could apply for an injunction to prevent the former employee from working for a new employer, or apply to search a former employee’s premises for evidence in certain circumstances (although this may not be viewed as a reasonable response by the courts 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. The transferee business (the buyer) inherits those terms, including restrictive covenants and may try to harmonise terms. However, issues can often arise in such scenarios as the covenants will have usually been tailored to the business of the transferor (the seller) and may well not extend to the interests the buyer wishes to protect. We would therefore recommend that specialist advice is taken as to the likely scope of restrictive covenants following a TUPE transfer to ensure that a buyer’s interests are protected as far as possible.
Restrictive covenants in the case of redundancy and other dismissals
A restrictive covenant will usually run from the employee’s last date of employment (unless 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 the employee’s dismissal is or whether the dismissal is unfair.If the restrictive covenants are otherwise enforceable, they will apply in the usual way.
Where there has been a breach of an employment contract by the employer, such as in the case of wrongful dismissal (for example, if correct notice was not given as required under the contract) or in a constructive unfair dismissal case where an employee resigns in response to a breach, terms intended to survive post termination, including restrictive covenants, cannot be enforced. Whether this applies to confidentiality clauses, is doubtful.
PILONs and restrictive covenants
An employment contract may allow for an employer to make payment in lieu of an employee’s notice (PILON) period, rather than the employee serving out their notice period. Such a provision should state whether the PILON should just represent the employee’s basic pay or should also include the value of other benefits. In that case, making a PILON is legitimate and not in breach of contract. Therefore, any post-termination restrictions in the employee’s contract would remain in full force and effect, unless there was another repudiatory breach of the employment contract by the employer.
If there is no such clause, you may have to seek written agreement to making a PILON from an employee. This would, however, likely result in all contractual benefits, not just basic salary, being payable, which would mean a higher cost to you. However, this would help ensure. That the restrictive covenants remained in place (subject to there being no further breaches on the part of the employer).
Is the situation different when an employee resigns?
Apart from in the case of an employee resigning in response to a repudiatory breach of contract by an employer, 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.
Whilst the default position is that restricting an employee’s right to work once they have left your employment is unlawful, there are ways of protecting your business’ legitimate business interests in proportionate ways, with carefully drafted and reasonably limited restrictive covenants which can be enforceable against former employees and those who try to employ them. Precision in the drafting of these clauses can make the difference between them being binding or not and so seeking professional advice to draft or review these clauses is a strongly recommended investment, to give your business the best chance of being able to rely on the protections provided by valid, enforceable post termination restrictions.