Restrictive Covenants in Employment Contracts Apr 28, 2014Views: 1221
The law provides protection to employers against competitive activities of employees and ex-employees by the use of confidentiality clauses and restrictive covenants in employment contracts.
Confidentiality During Employment
During employment, an employee is under a number of implied obligations to their employer, including an implied duty of confidentiality and implied duties of trust and confidence and good faith. The former means that the employee is under an obligation not to disclose to unauthorised third parties their employer’s confidential information and trade secrets obtained during the course of employment.
However, in cases where employees have access to confidential information, it is always advisable to insert an express confidentiality/non-disclosure clause into the employee’s contract of employment which makes it clear that they must not reveal such information during employment. Such a clause can usefully define the information that the employer classes as confidential. Employers are able to discipline employees for disclosing confidential information during employment and the case will be strengthened where there is an express clause that has been breached.
Confidentiality After Employment
When an employee leaves employment, they are generally free to use the skills, training and knowledge gained during their employment. However, employers are entitled to protect their information which can properly be classed as a trade secret or information which, while not properly described as a trade secret, is in all the circumstances of such a highly confidential nature as to require the same protection as a trade secret. Unfortunately, there is no generally accepted definition of what information amounts to a trade secret. Essentially, it is likely to constitute information which, if disclosed to a competitor, would be liable to cause significant damage to the employer’s business. Each case will turn on its own facts but it may include: secret manufacturing processes, chemical formulae, designs or special methods of construction, customer lists and confidential price lists. In determining whether information is a trade secret, the court will have regard to the nature of the employment, the nature of the information, whether the employer impressed on the employee the confidentiality of the information and whether the relevant information can easily be isolated from other information which the ex-employee was free to use or disclose.
Employers who wish to protect themselves should ensure that employees are subject to an express post-termination confidentiality/non-disclosure clause preventing disclosure of trade secrets and highly confidential information when employment ends. It is always better to have an express clause than to rely on an implied duty.
Enforcing Confidentiality Clauses
It is normally easier to enforce a restrictive covenant than to enforce an express or implied obligation of confidentiality post-termination of employment. Restrictive covenants give certainty whereas the line between information which is confidential and information which is not is hard to draw. However, if there are no express post-termination restrictive covenants, they cannot be implied and the employer will then have to rely on express/implied obligations of confidentiality.
The courts may enforce confidentiality clauses by the use of injunctions and search orders/orders for delivery up.
Springboard injunction: an injunction may be obtained as a means of protecting the employer against the competitive activities of ex-employees who have wrongfully used confidential information, for example, a customer list obtained during employment. It is used to prevent the ex-employee from taking an unfair advantage of the springboard they have gained by the misuse of the confidential information. Essentially, the ex-employee is not allowed to use information in confidence as a springboard for activities detrimental to the owner of that information. If an injunction is granted, it should not normally extend beyond the period for which the unfair advantage may reasonably be expected to continue.
Search order/delivery-up order: a search order is used in cases where the employer believes that confidential documents or documents containing trade secrets have been taken and the employee will destroy those documents if they become aware of legal proceedings. A delivery-up order orders delivery up of documents or other property belonging to the employer.
Account of profits: the employer could alternatively try to seek an account of profits for breach of confidence i.e. all profits the employee has made due to the breach. There is no requirement to mitigate.
Damages for breach of contract: an employer is entitled to sue an employee who has acted in breach of contract for any direct and actual losses incurred as a result of the breach of confidentiality complained of.
One of the most effective means of protecting a business from competition is to ensure that employees are bound by enforceable post-termination restrictive covenants. Restrictive covenants in the context of employment contracts are covenants placing restrictions on an employee’s activities once employment has ended. They need to be express: they cannot be implied. Such clauses will only be upheld against the employee to the extent that they are reasonably required for the protection of the employer’s legitimate business interests. A restrictive covenant will not be enforced if its sole purpose is to prevent the employee from competing with their ex-employer or from using the skills, experience and knowledge acquired during their employment. For the covenant to be enforceable, it is essential that three conditions are fulfilled:
- It protects a legitimate business interest – an employer has a legitimate interest in (a) its trade secrets and confidential information, (b) its trade/customer connections or goodwill, and (c) protecting the stability of its workforce. There is no requirement to identify the legitimate interest in the covenant itself but where the covenant does identify the legitimate interest, the employer is stuck with having to rely on that interest and cannot rely on a different on a different one.
- It is drafted no wider in scope than is reasonably necessary for the protection of that business interest.
- It is not otherwise contrary to the public interest.
However, it may be possible for an employer to insist on an employee accepting a restrictive covenant when it comes under a competitive threat and then to fairly dismiss the employee on SOSR (some other substantial reason) grounds if they refuse. It will depend on whether the employer acted reasonably or unreasonably in treating that reason as sufficient to dismiss the employee.
Types of Restrictive Covenant
There are four main types of restrictive covenant:
- Working for a competitor, or carrying on a competing business on the employee’s own behalf (non-compete covenants).
- The soliciting of the employer’s clients or customers (non-solicitation covenants).
- Dealing with the employer’s clients or customers (non-dealing covenants).
- The soliciting of the employer’s other employees (non-enticement covenants).
Restrictive covenants may place restrictions on:
- Area: covenants of this kind restrict an employee from competing in a geographical area where the employer has legitimate business interests.
- Scope: restrictive covenants of this nature must be carefully defined with regard to the business interests of the employer which they seek to protect. So, for example, an employer will not be allowed to enforce a restrictive covenant attempting to prevent a business activity which is wider than the activities the employer’s business would normally be involved in.
- Time: restrictive covenants must be reasonable in relation to the length of time for which they restrict competition. A clause not limited in time is likely to be unenforceable.
Non-solicitation covenants: this type of covenant prevents an employee from soliciting, canvassing or accepting any work from the former employer’s existing customers or clients for a period of time (usually six months). Such a covenant will be enforceable if it is necessary to prevent the employee from using their personal influence over their former employer’s customers or clients, and the knowledge of their requirements, which they acquired during the course of their employment, to entice them away from their former employer. The covenant should preferably only include those customers or clients with whom the employee actually had personal dealings (or specific knowledge of) in a defined time period prior to the termination of their employment (usually 12 months). The key factors here are therefore: duration, definition of the client/customer/supplier and prohibited business activity.
Non-dealing covenants: covenants of this nature prohibit employees from having any dealings with their former employer’s customers or clients for a period of time (usually six months). It prevents ex-employees from responding to customers and clients who approach them unsolicited, as well as restraining ex-employees from dealing with the customers and clients who they approach. Again, the covenant should only include those customers or clients with whom the employee actually had personal dealings (or specific knowledge of) in a defined time period prior to the termination of their employment (usually 12 months). The key factors here are again: duration, definition of the client/customer/supplier and prohibited business activity. A non-dealing covenant is more onerous than a non-solicitation covenant (as it prohibits dealings even if the client approached the ex-employee) and hence is harder to justify – but easier to enforce because they are easier to prove on the facts.
Non-enticement covenants: this type of covenant prevents the ex-employee from enticing away their former employer’s other employees for a period of time (usually six months). However, it should not cover all employees. Such a covenant should specifically refer to the seniority or knowledge and experience of particular employees and ensure that employees who join after termination of the employee’s employment are not covered. The key factors here are therefore: duration, definition of the staff and prohibited business activity.
Breach of Contract and Restrictive Covenants
If an employer dismisses an employee wrongfully (in breach of contract), or otherwise commits a repudiatory breach of contract, normally he will be prevented from enforcing any restrictive covenants in the ex-employee’s contract of employment. To partly deal with this, employers should consider inserting a clause entitling them to terminate the contract by making a payment in lieu of notice where the contract also contains restrictive covenants. However, be aware that a PILON (pay in lieu of notice) clause in the contract will generally make this payment taxable as earnings. If an employee is dismissed for gross misconduct but the misconduct was not gross, this will not only be an unfair dismissal but also a wrongful dismissal, again enabling the employee to get out of the restrictive covenants. Employers therefore need to be particularly careful when dismissing employees for their competitive activities during employment. An employee can generally make a claim for unfair dismissal if they have been employed for two years or more where their employment commenced on or after 6 April 2012, or one year or more where their employment commenced on or before 5 April 2012. The same principle would apply where the employee resigns alleging constructive dismissal on the basis of fundamental breach of contract/breach of the employer’s duty of trust and confidence: some employees may purport to do this to avoid having to be bound by their post-termination restrictive covenants.
Enforcement and Remedies
Injunction: an interlocutory or interim prohibitory injunction may be used as a temporary order restraining the employee from acting in contravention of their contract of employment, pending the full trial of the action. In this case, the employer would have to provide evidence to support the allegation that the employee is or is about to act in breach of their post-termination covenants. It is only in exceptional circumstances that an ex parte injunction (i.e. without notice to the other side) will be granted. Normally, an injunction is sought on notice to the other side. There is generally no need for the employer to prove damage/loss (except in exceptional cases). The court will decide whether, as a matter of discretion, an injunction should be granted. For example, they will look at the amount of time left to run on the covenant, any delay in enforcement (and the reasons for it), the likely utility of an injunction and whether the employer could be adequately compensated by readily calculated damages or an account of profits.
Damages: the employer is entitled to sue an employee who has acted in breach of contract for any direct losses incurred as a result of the breach complained of. The financial loss to the employer’s business must be quantifiable. Since it is often difficult to prove that a victim of unlawful competition has suffered financial loss, damages calculated on the traditional compensatory basis may be nominal.
Account of profits: the employer could alternatively try to seek an account of profits for breach of confidentiality or fiduciary duty i.e. all profits the employee has made due to the breach. There is no requirement to mitigate.
Claims against the new employer: an employer whose ex-employee has disclosed or is threatening to disclose confidential information to a competitor, or who has entered or is threatening to enter the employment of that competitor in breach of a restrictive covenant, may be able to bring a claim against the competitor himself, even though the competitor was not a party to the original contract.
Please note that proceedings in relation to the enforcement or breach of restrictive covenants must be brought in the County or High Court and not in the Employment Tribunal. This is because most disputes in relation to the enforcement or breach of such covenants fall outside the jurisdiction of the Employment Tribunal.
Restrictive covenants and garden leave
An employer may restrict or deny an employee who has resigned and is working out their notice period access to confidential information and/or customers, suppliers and clients by placing the employee on ‘garden leave’. A garden leave clause has the effect of requiring an employee to serve their period of notice at home. During the period of garden leave, the employee would be entitled to their full salary and benefits, while at the same time they must not work for anyone else and they continue to owe obligations of good faith and confidentiality. The aim of the employer in imposing garden leave is to maintain the employee’s fidelity whilst at the same time ensuring the employee does not maintain his contacts with the employer’s customers, suppliers, clients and confidential information. For garden leave to be enforced, there must be an express clause included in the employee’s contract of employment. Otherwise, putting an employee on garden leave could be in repudiatory breach of the right to work – and may invalidate any restrictive covenants.
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