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Restrictive covenants – restraints of trade or reasonable protection?

Posted on 3rd June 2015 in The Lodders Blog

VIDEO: Nick Rowe, Lodders Head of Employment, explains restrictive covenants and how they can protect your business

We are often surprised by client reactions to issues arising out of contractual restrictions upon post-employment conduct.  Often we hear strident views expressed such as “well, restrictive covenants aren’t enforceable are they?”  Well, the opposite is true.

Despite the fact that there are available tactical steps to try to avoid, dilute or negate the impact of restrictive covenants, the reality is that if the provisions are well focused and drafted tightly, they are a very useful tool in preventing conduct which might otherwise be competitive and ultimately damaging to a business.

Every business has information that it considers invaluable to its success.  Often that information has taken years to acquire and collate.  Restricting the use of this information by employees (or shareholders) during and/or after their involvement with the business has ended (amicably or otherwise) is often crucial to the interests of that business.  A former-employee and/or shareholder who has knowledge of a business’s technology, strategic and financial information or clients may be an attractive proposition to a competitor seeking to advance its commercial interests and in so doing, damage the enterprise in question.  Often, the conduct of individuals seeking to join a competitor has its origins whilst that individual still holds shares and/or is still employed in the business that he or she is considering leaving.  In our experience, there is often a great deal of activity in anticipation of the termination of the relationship and a good deal of work undertaken in preparation for the intended competition.  This activity can be in breach of both actual and implied contractual terms and can, without very careful thought, present a very interesting and illuminating body of evidence of a pre-meditated intention to breach of contract.

A business and/or its shareholders can attempt to protect the use of confidential information both during the relationship with its employees and/or shareholders and after that relationship ends.  Amongst other things, this is commonly achieved by the use of restrictive covenants.  Many businesses include these provisions in the contracts of employment of senior or highly skilled staff and/or shareholders agreements at the commencement of the relationship.  In our experience, there is often, in well-drafted provisions, also a contractual obligation placed upon the departing employee and/or shareholder to show any future employer these restrictions.  If anything else, the inclusion of restrictive covenants and clauses of this kind can help to deter employees/shareholders from joining competitors.  In turn, it may warn off potential new employers.

In addition, employers and companies can also rely upon the often overlooked Copyright and Rights in Databases Regulations 1997 to provide additional protection.

A restrictive covenant is commonly used as a provision to try to prevent an employee and/or shareholder from competing for a certain period of time after that person has terminated his or relationship (whatever that may be) with the business.  They may also seek to prevent the former-employee and/or shareholder in question from damaging the business in question by soliciting business from its customers.  A well-drafted provision can prevent this conduct whether it takes place directly or indirectly (i.e. as a consequence of somebody else within the competing business using the information provided by the former-employee).

Are restrictive covenants actually effective?

 The starting point for any such post-termination restriction is that it is void on the grounds that it is a restraint of trade.  However, if the former-employer can enforce such restrictions only in the event that:

  • They were designed to protect its legitimate business interests; and
  • The restrictive covenant extends no further than is reasonably necessary to protect those interests.

For a restrictive covenant to be enforceable it must not be drafted too widely.  It must be reasonable.  It will be for the party seeking to enforce the restriction to show that the clause is justified, sufficiently narrow and clearly drafted.  A party must be mindful of certain key factors when endeavouring to do so.

The breadth of the geographical area of any restriction and the length of time of the post-termination restriction must be justified and reasonable.  As a general rule, a restriction upon an employee for more than 12 months can be justified if it is elsewhere sufficiently limited in its scope. In our experience, courts are more likely to enforce longer periods for former-shareholders.

The scope of the activities that the employer is trying to restrict

Regard will also be had to the type of interest being protected.  For instance, information such as trade secrets may be granted wider protection than customer information, given that its potential use across markets is wider.

The extent of clauses must be relative to the employee’s position within the business.  As more senior employees will be in contact with more sensitive information, restrictions placed upon them may be justified as being more onerous.

The outcome of these issues is very much determined upon the individual facts of each circumstance.  Courts will assess each individual case on the facts.  That is why careful consideration should be given to the drafting of each individual contract; with the provisions tailored in particular to the individual circumstances.

Remedies for breach of restrictive covenants

If a business or fellow shareholders have reason to believe that an individual has breached the post-termination restriction, there are a range of remedies.  These include:

  • Injunctive relief – preventing the employee from acting in a certain way as well as imposing certain obligations to provide certain information about the offending conduct.
  • Loss – where a party claims a financial remedy or damages for breach of a restrictive covenant in an employment contract and/or a shareholders agreement, the party seeking the remedy will need to show in detail the loss resulting from the breach. This will normally be loss of profits resulting from the breach of contract.
  • Inducement – where the individual in question has been induced by the competitor into breaching restrictive covenants, the damaged party might choose to sue that competitor for inducement to breach.

Conclusion

Legal action in this area can involve a substantial investment (in terms of time and money).  In our experience, it is crucial for companies and shareholders (when seeking to enforce) and individuals (when seeking to resist) to understand their commercial objectives from the outset.  Often the stakes are very high with cross indemnities in costs being required where injunctive relief is sought.  Litigation of this kind should not be embarked upon lightly and advice sought as early as possible.

Head of Employment at Lodders, Nick Rowe has vast experience when acting for employees and employers in respect of drafting restrictive covenants and acting for clients in respect of disputes that arise out of restrictive covenants and the Copyright and Rights in Databases Regulations 1997.  Nick and his team do so from our offices in Cheltenham and Stratford upon Avon.

For more advice, please contact Nick Rowe on 01242 229096 or drop him an email.

Nick Rowe, Lodders Solicitors

Nick Rowe, Lodders Solicitors

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