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Restrictive Covenants – What’s happened in 2019

08 November 2019 #Other

There have been some cases in 2019 which have offered employers guidance on restrictive covenants and demonstrated how important it is for employers to review such restrictions carefully.

Restrictive covenants in employment contracts usually try to prevent an employee acting in a certain way after they have left employment.  The most common are those preventing the employee from working in a competing business (“non-compete”) or soliciting clients and/or staff (“non-solicitation”). 

As, restrictive covenants are a restraint of trade, they tend to be viewed as contrary to public policy. But there are good reasons why businesses would want them as they can offer them necessary protection against, for example, departing employees stealing their business connections and staff, and using confidential information to assist a competing business.  To be enforceable they must protect a legitimate business interest and they must be proportionate. Restrictive covenants in employment contracts are generally viewed more restrictively than in other types of contracts, particularly given the parties often unequal bargaining power in negotiating employment terms.

Tillman v Egon Zehnder

In the recent case of Tillman v Egon Zehnder, the Supreme Court was asked to determine the reasonableness of a non-compete restriction. The Supreme Court had to specifically determine whether is was reasonable to prevent an ex-employee from holding a minor shareholding in a competing business.

The Claimant’s contract prohibited her from having “any interest in, any shares or other securities in any company whose business is carried on in competition with any business of the Company”. The contract also said that she could not be “directly or indirectly engaged or be concerned or interested in any business carried on in competition with the business.”  The Claimant argued that the restrictions were unreasonably wide for the protection of a legitimate business interest and therefore should be void. She argued the clauses prevented her from holding even a minority shareholding in a competing business.

The High Court upheld the non-compete restriction. They did not think it was unreasonably wide as they didn’t think it prevented her from holding a minor shareholding in a competitor for investment purposes. The case went to the Court of Appeal. The Court of Appeal held the words used in the restriction were impermissibly wide. Specifically, “engaged or be concerned or interested in”.  The Court of Appeal refused to remove key words from the clause (which would have the effect of leaving a narrower clause in force) and, instead, ruled the whole clause void.  The case then went to the Supreme Court. The Supreme Court agreed that the words did not allow shareholding but felt that the words ‘interested in’ could be removed from the clause, leaving the rest of the clause intact and enforceable.   

Tilman v Egon Zehnder is seen as strengthening the enforceability of restrictive covenants and therefore a win for employers. However, employers should note that the courts have made it clear that they will not save an employer who has drafted disproportionately wide covenants. Nor will the courts insert words into contracts. It is not their job. Whilst the court intervened in this case, employers shouldn’t rely on the court helping them. The key for enforceability is that they need to be drafted carefully.

Affinity Workforce Solutions Ltd v McCann 

This was a High Court case, handed down in October, which dealt with restrictive covenants following Tillman V Egon Zehnder.

The employer in this case, Affinity Workforce, was a recruitment company. In May 2019 an employee was dismissed for gross misconduct. She challenged this and took up employment with a competitor business. Four further employees decided to leave and join the dismissed employee at the competitor business. Affinity Workforce argued that the employees were bound by their restrictive covenants and could not contact clients with whom they had dealt during their employment.  It requested undertakings confirming they would not contact those clients. This was generally agreed and lists of prohibited clients were exchanged to reach agreement. Negotiations on this continued until September 2019 and a list of prohibited clients was agreed. Affinity Workforce then decided to stop negotiations. The employer argued that the departing employees were restricted from joining a competitor business full stop. Affinity Workforce applied for an interim injunction to prevent the five former employees working for the competitor business. 

The High Court was satisfied that those relationships and the information gained during their previous employment was capable of being protected by a suitable restrictive covenant. This was reinforced as prohibited clients for each employee could be clearly distinguished. The High Court had to balance the interests of both parties in determining whether the broader non-compete covenant could be enforced. The High Court was satisfied that the employer could protect its interests by the employee’s undertakings and that it would be unreasonable to, therefore, grant the broader non-compete covenant.

This case highlights that the Courts will only enforce restrictive covenants when they are necessary to protect a legitimate business interest.  If one restriction sufficiently provides the protection required, it will be unlikely that any broader restriction will be enforceable. 

Pricewaterhousecoopers LLP v Carmichael 

This case involved a restrictive covenant preventing a Partner, and member of PWC (whose membership was governed by a members’ agreement) from joining a competitor business within six months of retiring. The issue of whether a company was a competitor would be determined by the “reasonable opinion of the management board”.   

The High Court had to determine whether the restrictive covenant was capable of being enforced. The High Court held that the company was entitled to protect its business interests with the non-compete clause and that the length of time was reasonable. However, the Partner argued that the wording of “reasonable opinion of the management board” was too wide to be enforceable. The High Court held that the wording was necessary so that members could use the dispute resolution procedure in the members’ agreement. The Partner argued that enforcing the restrictive covenant would be extreme, but the court rejected this argument highlighting that he had been paid “a substantial sum” whilst on garden leave at a time when he was aware that PWC would be seeking to enforce the restrictive covenants. The injunction was granted.

It is common for organisations to use wording similar to that used here when making decisions on whether an organisation will be a competitor and this case will, therefore, be welcomed by employers.

Smith & Frater Ltd v Frater

This case, a Scottish Sherriff Appeal case, looked at the financial remedies available to an employer when seeking to enforce restrictive covenants.

In this case the employee had set up a competitor business whilst still employed. He was dismissed. He sought to recruit his former colleagues and tried to entice them by offering increases to their salary. Those employees informed the employer that they would take up the offer unless their salaries were matched by it. The employer matched the salary and brought proceedings against the departing employee.

At first instance the Sheriff Court held that the employer had acted in breach of his restrictive covenant by poaching staff and that the breach caused the employer loss (i.e. the increased salaries). The Sheriff Court held that the employer’s actions in increasing the salaries were necessary to limit the damage to its business and that it was reasonable for the employer to recover reasonable expenses incurred in mitigating its loss.

The employee appealed. The Sheriff Appeal Court determined that the financial loss, had the departing employees left, would have been between £350,000.00 - £400,000.00. This was not disputed. The steps the employer took to retain its staff were reasonable. Those steps were linked to the employee’s actions and passed the causation test (i.e. did the employee’s breach contribute to the employer’s loss). The Sheriff Appeal Court, therefore, dismissed the appeal.

Although this is a Scottish case and not binding on the English courts, the legal test behind the decision is the same as that used in the English courts. This case highlights that when restrictive covenants are valid an employer can recoup their losses from the employee. The losses will need to be reasonable and directly linked to the departing employees breach of restrictive covenant.

As technology advances and with the introduction of social media it is now more important than ever to have restrictive covenants in place so that employers can protect their business interests but, as these cases show, employers have to be extremely careful with their drafting.

For more information on restrictive covenants, get in touch with our Employment department.

Disclaimer
This information is for guidance purposes only and should not be regarded as a substitute for taking professional and legal advice. Please refer to the full General Notices on our website.

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