When Senior Executives are asked about their contractual restrictive covenants, their response is usually either, “yes, I have some, but they aren’t enforceable are they?” or “well I am stuck for the next year and I can’t work”. These polar opposite responses no doubt stem from the fact that enforceability of restrictive covenants will turn on the specific facts of the executive’s employment, and terms of the covenants. One size does not fit all.
While restrictive covenants must not be ignored, neither should they be seen to be automatically enforceable. Many employers include widely drafted covenants, that if challenged would likely be found to be unenforceable. They are included purely as a deterrent, as employers anticipate that generally employees would not even think to challenge them.
The legal position is not clear cut. Numerous factors must be considered when assessing whether restrictive covenants are enforceable and whether they should be complied with.
The starting position is that restrictive covenants will be void as a restraint of trade and contrary to public policy, unless the party seeking to enforce them can demonstrate that:
a. The restriction protects a legitimate business interest;
b. It goes no further than is reasonably necessary to protect that legitimate interest;
c. It is reasonable in the interests of the parties; and
d. It is reasonable in the interests of the public.
Importantly, “reasonableness” should be considered at the time the covenant was entered into not at the point of enforcement. In short, the restrictions must go no further than is reasonably necessary – they should not be widely drafted.
Legitimate business interest
It is for the employer to prove that the restrictive covenants are reasonably necessary for the protection of its ‘legitimate business interests’. The employer will need to identify some advantage or asset inherent (the legitimate interest) in its business belonging to the employer, which would give the employee an unfair advantage in their next venture if they were to appropriate it for their own purpose.
The three most common forms of ‘legitimate business interest’ relied upon, and recognised by the Courts, are:
a. Client connections,
b. Trade secrets or confidential information; and
c. The stability of the workforce.
The Court’s approach to determining enforceability of restrictive covenants turns on the factual matrix of each case. However, there are general principles that apply when considering enforceability. The key areas include:
a. The seniority of the restricted individual;
b. The individual’s access to confidential information, and its shelf life;
c. The geographic scope of the restriction;
d. The individual’s contact with and influence over clients and employees.
This list is in no way exhaustive; it is a notoriously fact sensitive area of law.
Consideration
A critical component of enforceability is whether any consideration has passed for the covenants. This means that an employer must give something meaningful to the employee in return for the imposition of the restrictions. This is usually not an issue if the covenants are contained from the outset in an employer contract that was signed before the employment commenced, but if the covenants are agreed at a later date, consideration may be more difficult to identify unless the agreement was signed as a deed. Consideration could be in the form of a pay rise, enhanced benefit, or a change in hours or other contractual term that is beneficial to the employee. If valuable consideration does not pass the covenants may not be enforceable (unless contained in a deed).
Narrow drafting
Covenants range from flat out non-competes, applying anywhere in the world, to non-solicitation of certain employees and clients in specific geographical areas. Not only must a covenant be no wider than is necessary to protect the employer’s legitimate business interests, but it must also be framed in terms that are sufficiently clear to enable the employee to understand what is restricted.
For instance, if the executive works for a large global firm with thousands of clients, a covenant that prevents them from dealing with all clients of the company is likely to be unenforceable, due to it not being sufficiently certain; it is unlikely that the executive would know all of the clients.
Commonly, employers do not draft covenants tailored to the executive’s actual role. This leaves the covenants open to challenge. What may be reasonable to protect legitimate business interests in respect of a client facing executive, may not be reasonable in respect of a similar level executive who is not client facing.
Challenging a restriction
If an executive believes their restrictive covenants are too wide, what options are available to them?
In the first instance, they can attempt to negotiate a reduction in the ambit of the covenants with their employer. If this is not forthcoming, they have several options, they could:
a. Choose to comply with the covenants.
b. Partially comply with the covenants.
c. Act in breach of the covenants.
d. Seek a declaration from the Court as to their enforceability.
Commonly, a hybrid option may be to reduce the scope of the covenants, whereby the executive complies with the covenants for part of the restricted period and then quietly goes about their business at a point at which the employer’s attention has moved elsewhere.
If an executive acts in breach of covenants, they are at risk of legal action, which could range from a High Court injunction restraining them from further breach or a breach of contract claim for damages for the financial loss caused by the breach, possibly an account of profits, and costs (among other remedies). An account of profits can frequently be entirely disproportionate to the executive’s earnings, as the profit sits with the new employer not the executive. While the costs can be high for the executive, legal action to enforce covenants is not only expensive for the employer, but a drain on management time. Many employers shy away from bringing such legal disputes into the public arena as it can be bad for public relations and demotivating for existing staff. It can also be inferred that the departing executive was critical to the business making the employer appear potentially vulnerable. In addition, as cases turn on their specific factual matrix, often the outcome of any litigation is far from certain.
Conclusion
In summary, executives should not be held hostage by their restrictive covenants; just because they are included in a contract does not make them enforceable. Executives are well advised to seek legal advice on the likely enforceability of their covenants if they are concerned to avoid a potential dispute with their employer.
If you are a senior executive or founder considering a strategic move, with questions arising from this alert, or for specific legal advice on particular circumstances, please contact Senior Consultant Elizabeth McEneny or Partner Emma Bartlett who specialise in contentious and non-contentious employment and partnership issues, including director’s duties and shareholder issues.
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