Restrictive Covenants: the Need to Know Basics
Whether in times of economic uncertainty or recovery, the need for effective restraints on employees after they have ceased active service with their employer is particularly strong. Employees may have knowledge of technology, strategic information about the employer’s business or customer contacts that they may try to use for the benefit of their new employer or business.
Employees must observe certain restrictions that are implied into a contract of employment, however, these are of a limited nature and do not generally extend to the period after termination of the contract, whereas express restrictions can. Further advantages of having express restrictions applying either during or after active service are:
- They can be specifically designed to reflect the parties’ circumstances.
- They might deter employees from joining competitors.
- They might warn off potential new employers, who face the risk that the restrictions will be enforced by the courts.
- At the very least, they will provide a basis for negotiation.
What is a restrictive covenant and when will it be enforceable?
- A business can use restrictive covenants to protect its interests by restricting an employee’s activities for a period of time after their employment has ended.
- A restrictive covenant will only be enforceable if it protects a legitimate business interest, otherwise it will be regarded as an unlawful restraint of trade. The only recognised business interests are:
- trade connections (including the relationship between the business’s customers and its workforce); and
- trade secrets and confidential information.
- If the business has a legitimate business interest to protect, the restriction will be enforceable, provided it is no wider than is necessary to protect that interest. The covenant must be limited in terms of the restrictive activities themselves, and also apply:
- for a limited time; and
- within a limited geographical area (if appropriate).
Ensure restrictive covenants are drafted carefully
Restrictive covenants must be drafted carefully so that they:
- Accurately reflect each employee’s role.
- Reflect the circumstances of the business.
- Go no further than is necessary.
The business should regularly review contracts that include restrictive covenants and check whether they need to be updated (for example, if the employee’s role has changed).
Non-solicitation restrictive covenants
- A business can include a covenant in an employee’s contract preventing them for soliciting customers after they have left the business. This type of covenant will be particularly useful if the employee has a strong relationship with certain customers.
- Generally, the covenant should be restricted to customers that the employee had contact with during a specified period before they left. There are a number of factors the business should consider when trying to establish the length of this period, including:
- the amount of time it would take for the employee’s successor to gain influence over the business contacts;
- the employee’s seniority within the business;
- the extent of the employee’s role in securing new business;
- the loyalty (or otherwise) of customers in the particular market; and
the length of similar restrictions in the employment contracts of competitors.
A restrictive covenant that attempts to extend the restriction to potential customers will be harder to enforce. However, it may be possible to protect an interest in genuine prospective customers if they are accurately defined.
A restrictive covenant preventing a former employee from poaching your existing employees is likely to be enforceable, as the stability of the business’s workforce is a legitimate business interest. However, the covenant should usually be limited to those employees at the same level as the former employee and those more senior to them. Any clause that attempts to prohibit the poaching of employees will need to consider:
- How long the former employee’s influence over the other employees will last.
- The roles of the employees over whom the influence exists.
Non-dealing restrictive covenants
- A restriction on the solicitation of customers can be extended to cover not only enticement or interference (where active steps are taken by the former employee), but also the provision of services where no active steps are required (for example, where the customer approaches the former employee). This is known as a non-dealing covenant.
- This type of covenant has a clear advantage as it avoids the need to prove that the former employee made an approach, which is usually difficult to show. However, it does broaden the prohibition and consequently may make it more difficult to enforce.
- The enforceability of a non-dealing covenant will depend on the interest the business is trying to protect (for example, enforcement may be more likely if the business can establish a substantial personal connection between the former employee and the business’s customers).
Non-competition restrictive covenants
- Employees are prohibited from disclosing confidential information amounting to a trade secret (for example, a manufacturing process) after they leave your business. A business can also include express confidentiality provisions in their employment contract to protect the information. Therefore, additional restrictive covenants may be regarded as unnecessary, and non-competition restrictions in particular can be hard to enforce.
- However, there are circumstances in which a non-competition restriction is likely to be enforced. For example, where the former employee’s influence over customers or suppliers is so great that the only effective protection is to ensure they are not engaged in a competing business in any way.