Time to review your restrictive covenants?
Restrictive covenants – express terms in the contract of employment which restrict employees’ activities after they leave employment – can be vital in protecting your business. But careful drafting is essential.
To be enforceable a covenant must be designed to protect a legitimate business interest (such as goodwill, trade secrets or confidential information) and must be no wider than reasonably necessary to protect that interest (so will usually be limited by reference to restricted activities, duration and geographical extent).
However, getting the basic wording correct is also critical, as highlighted in two recent cases.
In January 2017 Ms Tillman resigned with notice from Egon Zehnder to go and work for a competitor. Her contract required her for six months from the termination date not to “directly or indirectly engage or be concerned or interested in any business carried on in competition with any of the businesses of the Company or any Group Company.”
Egon Zehnder issued proceedings, alleging that by working for a competitor Ms Tillman would be in breach of her non-compete clause. She argued that the covenant was void as it was wider than reasonably required for the protection of legitimate business interests. In particular, she claimed that a restriction on being ‘interested in’ a competing business was too wide as it could prevent her from having a minor shareholding in a competitor.
The Court of Appeal agreed. The non-compete restriction was impermissibly wide and, as a result, the entire restrictive covenant clause was void.
In practice: If a covenant contains similarly wide wording (‘interested in’ or ‘concerned with’), good practice is to include a carve-out expressly allowing the employee to hold a minority shareholding in other companies, whether competitors or not.
In April 2017 Mr McDougall resigned with notice from Informa UK Limited. He later disclosed that he was to be assumed as a partner (but not employed by the partnership) in a newly formed partnership whose business competed with Informa’s.
His employment contract contained wide non-compete and non-solicitation restrictions that would apply after termination: “The Employee agrees that for a period of six months following employment with the Company they will not – whether on their own behalf or in conjunction with or on behalf of any person, company, business entity or other organisation and whether as an employee, director, principal, agent, consultant or in any other capacity directly or indirectly……be employed by any direct competitor, or any subsidiary of a direct competitor.”
There was a dispute as to whether the covenant was wide enough to include working as a partner in a competitive business. Informa argued that it was because ‘employed’ had to be read in the general sense of ‘engaged’. Mr. McDougall believed that it was not as the meaning of ‘employed’ is clear and does not include working as a partner.
The Court of Session decided that there was a strong argument that the restrictive covenants had not been breached as Mr McDougall was working as a partner and not as an employee. The application to grant an interim interdict was refused.
In practice: A restrictive covenant can be drafted so that it protects a business against competitive activity for a period after termination regardless of the individual’s employment status (i.e. whether they are an employee, partner or sole trader).
General drafting tips
- Both cases are good reminders of the need for clear drafting. In the first case the drafting was too wide; in the second it did not go far enough. Think carefully about precisely what types of competitive activity should be restricted post-termination.
- Individual restrictive covenants should be separate obligations so that, in the event that one is found to be unreasonable and so void, it can be severed while preserving the enforceability of the remaining restrictions.
- A one size fits all policy risks covenants being unenforceable. Tailor restrictive covenants for each individual employee, considering what the business wishes to protect itself against in each case.
- A covenant’s reasonableness will be determined as at the date the contract was entered into, not at the time of termination. Accordingly, restrictive covenants should be reviewed periodically to ensure they remain relevant and enforceable.
If you have any queries on drafting or reviewing covenants, please get in touch with your usual Brodies’ contact. Workbox users can also access more information at the pages on Employee Restrictions.