Key Considerations on the Application & Enforcement of Restrictive Covenants

 

 

 

 

 

 

 

 

 

 

 

1.RESTRICTIVE COVENANTS - THE LEGAL STARTING POINT

 

Restrictive covenants are a form of Restraint of Trade, and the default position of the courts in respect of such restraints are that they are unenforceable. 

 

Nordenfelt v Maxim Nordenfelt Guns and Ammunition Co Ltd 1894 AC 535:

“All interference with individual liberty of action in trading, and all restraints of trade of themselves, if there is nothing more, are contrary to public policy, and therefore void. That is the general rule”

 

As the starting point therefore, clients and lawyers should assume that any restrictive covenant will be deemed unenforceable unless…

 

“But there are exceptions: restraint of trade and interference with individual liberty of action may be justified by the special circumstances of a particular case. It is sufficient justification, and indeed it is the only justification, if the restriction is reasonable – reasonable, that is, in reference to the interests of the parties concerned and reasonable in reference to the interests to the interests of the public, so framed and so guarded as to afford adequate protection to the party in whose favour it is imposed, while at the same time it is in no way injurious to the public”

 

Despite the 120 years of case law since Nordenfelt, its principles remain central to the enforceability or otherwise of restrictive covenants.

 

2. THREE KEY CONSIDERATIONS

 

Whether drafting or seeking to enforce/defend injunctions in respect of restrictive covenants in an employment context, the key factors to consider are:

  1. What are the legitimate interests that the employer is seeking to protect?

  2. Is the restraint sought to be imposed reasonable, as in no wider or more onerous than reasonably necessary to protect that legitimate interest?

  3. Enforcement

 

 

2.1 LEGITIMATE INTERESTS

 

A restrictive covenant cannot be created or enforced solely for the purpose of preventing competition from a former employee, because ‘competition’ or the absence of competition is not a legitimate interest owned by an employer. As stated in Herbert Morris Ltd v Saxelby [1916 1 AC 688 a restrictive covenant cannot be imposed or upheld simply because the employee ‘would, by reason of his employment or training, obtain the skill and knowledge necessary to equip him as a possible competitor in the trade’.

 

Instead, ‘the employer’s claim for protection must be based upon the identification of some advantage or asset inherent in the business which can properly be regarded as, in a general sense, his property and which it would be unjust to allow the employee to appropriate for his own purposes, even though he, the employee is entitled, may have contributed to its creation.’

 

Examples of interests that have been considered legitimate and protectable are:

  • The stability of the employer’s workforce (which will then support covenants that prevent the solicitation of employees)

  • Client & customer connections (which can then support non-compete clauses)

  • Employer’s reputation (as part of its goodwill)

  • Suppliers’ trade connection (although typically only if there are a limited number supplying the product/service such that the connection is a valuable asset of the employer)

  • Pool of workers on an agency’s books

  • Confidential information (including trade secrets)

 

When drafting, employers should ideally set out and identify the particular legitimate interest that the relevant restrictive covenants are seeking to protect. This can often be covered in a preamble to the covenant.

 

However, note that if this interest is so identified, it will not be open to the employer to argue that the restrictive covenant should be used as protection for a different legitimate interest that was not identified – Office Angels Ltd v Rainer-Thomas [1991] IRLR 214.

 

2.2 REASONABLENESS OF THE RESTRAINT

 

When considering the reasonableness of the restraint, the courts will look at three central factors:

  • What is the nature of the restraint sought to be imposed?

  • How wide/broad is that restraint?

  • How long does it last?

Because the approach of the courts is to uphold covenants only if they are no more onerous than reasonably necessary, consideration will also be given as to whether a less onerous covenant could have achieved the necessary protection. If so, the covenant will not be upheld - Office Angels Ltd v Rainer-Thomas  [1991] IRLR 214.

 

Further, when assessing the reasonableness of the clause, it is its reasonableness at the time the contract was entered into (and not when the matter is actually before the court, that will be considered – Pat Systems Holdings Ltd v Neilly [2012] EWHC 2609 ).

 

As such employers should be careful to update restrictive covenants through the course of employment to ensure they remain relevant to the particular role undertaken by the employee.

This can lead to tricky situations because the imposition of such a new term cannot be done unilaterally, but must be done by agreement. If the employee agrees to the new term, there must be some form of consideration for it, and continued employment will not be sufficient consideration unless the employee would in fact have been dismissed if they did not accept the terms – Reuse Collections Ltd v Sendall [2015] IRLR 226.

 

Interestingly, a refusal to sign new terms and conditions including restrictive covenants, have been held to be a potentially fair reason for dismissal - Willow Oak Development Ltd v Silverwood [2006] EWCA Civ 660.

 

If new covenants are introduced only in handbooks and common policies, this can result in problems if there is no evidence of specific agreement by the employee concerned.

It is also relevant to TUPE situations because whilst the rights of an employee are transferred on a TUPE transfer, this will not have the effect of rewriting a restrictive covenant to make it relevant to the new employment situation. So, for instance, a clause that restricted an employee from working for competitors of a transferor, was not automatically updated to apply to competitors of the transferee - Morris Angel & So Ltd v Hollande [1993] IRLR 169.

 

i) Nature of the Restraint - what type of covenant is appropriate?

 

As stated in Office Angel the court will consider whether the interest sought to be protected, could have been so protected with a narrower less onerous clause.

 

Furthermore, the nature of the restraint needs to be tailored to be relevant to the legitimate interest sought to be protected.

 

For instance, if the legitimate interest to be protected is client or customer connections, then a non-solicitation clause may be appropriate, whereas a geographical restriction on setting up a competing business may not be appropriate if the customers and clients are not also located in that region.

 

Alternatively, if it is trade secrets that the employer wishes to protect, then a non-compete clause may in fact be the only realistic method of protection from that risk.

 

As with all contractual clauses, the courts will look at the wording of the contract and interpret them according to the ordinary meaning that such a clause would convey to a reasonable person with the background knowledge available to the parties. - Investors Compensation Scheme Ltd v West Bromwich Building Society [1998] 1 WLR 896 at 912.

 

Once the court is clear on the true meaning of the clause, regard should also be had to the purpose of object of the restraint being sought so as to give a purposive meaning to the clause  (Clarke v Newlan [1991] 1 All ER 397). The court’s aim should be to try to construe a legal rather than an unlawful interpretation to the clause, as well as considering the factual matrix in existence at the time the contract was entered into.

 

Whilst a clause should be drafted clearly, the courts will not strike down a clause as too wide merely because on a strict reading of the clause as this is ‘an argument from merely theoretical or fanciful possibilities’ Coppage v Safety Net Security [2013] EWCA Civ 1176.

Severance can be an option although employers should not seek to place reliance on ‘saving’ provisions such as clauses to the effect ‘if held to be unenforceable, but would be enforceable if the ambit or duration of them were reduced, may be reduced accordingly’ since these are dismissed as attempts to oust the jurisdiction of the court - Living Design (Home Improvements) Ltd v Davidson [1994] IRLR 69.

 

Severance (otherwise known as blue-pencilling) can be done if clear meaning of the remaining clause can be achieved without addition or alteration of the meaning of words - Attwood v Lamont [1920] 3 KB 571.

 

In Sadler v Imperial Life Assurance Co of Canada in relation to severance it was stated that

i) the court should be able to strike out offending parts of a covenant without adding or amending the words

ii) there should be sufficient consideration for the remaining covenant

iii) the severance should not change the character of the clause and contract

The court will not rewrite the covenant to make it reasonable and enforceable or infer implicit restrictions within the covenants that are not explicitly stated - JA Mont UK Ltd v Mills [1993] IRLR 172.

 

ii) How Wide/Broad is the Restraint?

 

Restrictive covenants will often seek to restrict post termination activity in certain areas. In order to be valid, any such clause must relate to a legitimate interest that also has a geographic element to it.

 

Again, a preamble setting out that the company acts or proposes to act in certain geographic regions will be helpful (though this should be updated as and when needed) to retain relevance.

 

Restrictive covenants should be no wider geographically, than reasonably necessary, however, this means a covenant can have worldwide application if this is relevant and necessary to protect the interest. For instant trade secrets in a financial industry context may require worldwide protection for a limited period.

 

However, employers should consider whether a more targeted clause will be sufficient and preferable e.g. a non-solicitation clause.

 

If geography is relevant to the business e.g. a hair salon, restaurant, or barbershop, the covenant should nevertheless be no wider than necessary in respect of the particular clientele of the business e.g. it should be 5 miles only if this is where customers largely are located, and even then it should only be relied on in circumstances where a mere non-solicitation clause would not be sufficient.

 

In Merlin Financial Consultants Ltd v Cooper [2014] IRLR 610 it was held that a UK wide restraint was reasonable even where the clients were largely based in London since in the modern age with electronic communication, the financial markets form a single geographic market.

 

The width of the restraint can also be found in the wording of the clause, for instance a prohibition on an employee from working for or setting up a ‘similar’ business will also be considered too wide - Scully v Lee [1998] IRLR 259 since it effectively extends the ambit of the protection sought beyond the extent reasonably necessary.

 

Employers are advised to limit the operation of the clause by reference to the particular target of the covenant e.g. clients with whom the employee had material dealings in the 6 months before termination.

 

iii) How long does it last?

 

Covenants should be no longer than reasonably necessary in the circumstances. However, there is no precise formula for determining what is a reasonable length of time - Stenhouse Australia Ltd v Phillips [1974] AC 391.

 

A covenant related, for instance, to trade secrets of the kind that will never ultimately be made public, could reasonably be unlimited in length, although the courts still caution against this - Printers and Finishers Ltd v Holloway (no 2) [1965] 1 WLR 1.

 

A longer covenant for a senior employee may be more reasonable than one for lower level employees Beckett Investment Management Group Limited and others v Hall and others [2007] IRLR 793.

 

However, clauses that run beyond the 12 month mark will inevitably be subjected to particular scrutiny especially if not also accompanied by other narrowing restrictions.

 

2.3 ENFORCEMENT

 

Restrictive Covenants are typically addressed by means of injunctions, since damages will often not be an adequate remedy, particularly because often it will be difficult or impossible to assess what damage is done by the breach of covenants.

 

Employers should be mindful that where there has been a repudiatory breach by either party, that is then accepted by the other party, this will render the covenant unenforceable, since both parties are treated as discharged from future performance - General Billposting Co Ltd v Atkinson [1909] AC 118; Photo Production Ltd v Securicor Transportation Ltd [1980] AC 827.

This is potentially highly relevant where it is the employee that has committed a repudiatory breach ie gross misconduct. If there is no express term within the contract or contractual procedure entitling the employer to dismiss summarily for gross misconduct, then any such dismissal will be treated as an express acceptance of a repudiatory breach by an employer. In those circumstances, the parties will again be treated as discharged from future performance of the contract including restrictive covenants.

 

The employer avoids this unfortunate outcome by ensuring its contract expressly provide for the action it can take in response to gross misconduct or other breaches.

 

The normal American Cyanimid rules and principles apply equally to restraint of trade injunctions.

 

In particular, the competing interests of the company and its legitimate interests must be balanced against the right of the employee to work.

 

An employer should not delay unduly before seeking an injunction -  Wincanton Ltd v Cranny [2000] IRLR 716.

 

By reason of the typically short duration of restrictive covenants, the courts will generally grant speedy trials so that an interim injunction does not become in effect a final injunction.

Ex parte and without notice injunctions are highly risky because the courts are particularly concerned about the impact of such injunctions on employees capacity to work - CEF Holdings Ltd v Mundey [2012] IRLR EWHC 1524.

 

When considering the granting of injunctions, it is important to show that there has either been a breach or there is a risk of breach of covenant. This can often involve analysis of the nature of actions already taken and showing how they relate to terms of the covenant.

 

For instance, in Wessex Dairies Ltd v Smith [1935] 2 KB 80 a milkman informed the customers on his route that he was leaving his job and would be available to do business with them in the future, this was held to amount to ‘solicitation’.

 

In Taylor Stuart & Co v Croft (Timothy) (1998) 696 IRLB 15 the employee wrote to clients on headed notepaper (of his new firm) that he had left the partnership and he would be establishing his own practice and could be contacted there. It was held that the invitation to contact amounted to solicitation.

 

General advertisements will probably not be considered solicitation, although query whether with the more targeted options available through social media advertising the courts will be more willing to find that such advertising amounts to inducement.

 

Springboard Injunctions are granted in the increasingly common scenario where employees appropriate confidential customer lists or confidential information in order to facilitate the setting up of a rival business - Roger Bullivant Ltd v Ellis [1987] ICR 464.

 

The springboard injunction approach can also be used against companies seeking to engage in mass poaching of teams of employees - UBS Wealth Management UK Ltd v Vestra Wealth LLP [2008] IRLR 965.

 

Springboard injunctions in fact are relevant to the issue of competition because the purpose of granting a springboard injunction is to restrain the unfair competitive advantage that the employee will otherwise gain by being allowed to benefit from his or her breach of covenant.

Depending on the potential impact of the breach of covenant, a springboard injunction can be sought that lasts longer than the original duration of the restrictive covenant itself. As stated in QBE Management Services UK Ltd v Dymoke [2012] IRLR 458 the question to be considered as far as duration is concerned is how long it would have taken the employee to achieve the state and advantage it achieved, but without the benefit of the breach of covenant.

 

Employers should also consider seeking an account of profits.

 

3. RECENT CASES

 

3.1 Covenants upheld

Employer able to vary restrictive covenant

  • Decorus Ltd v Penfold [2016] EWHC 1421 (QB) (20 June 2016)

The employer was awarded damages of almost £30,000 and injunctive relief against the Defendant employee who was accused of poaching the Claimant's clients after he left their employment and set up on his own contrary to the restrictive covenant in his employment contract. The court found that the conduct of the employee amounted to a breach of his duty of confidence. The information which he used included contact details and information from purchase logs and was acquired during his employment. The covenants had been varied during the employee’s employment. The effect of the earlier case of Reuse Collections Ltd v Sendall, had been to call into question an employer’s ability to vary restrictive covenants without consideration. In Decorus restrictive covenants had been varied in the course of the employment by less stringent covenants. The variation was part of a process, one element of which had been the increase of the employee’s  salary. The Judge was satisfied that when taken together an appraisal, pay rise and continued employment amounted to valid consideration for the new contract.

 

Clauses in commercial agreements enforceable, e.g. Franchise or Share Purchase Agreements.

  • Rush Hair Ltd. v. Hayley Gibson-Forbes & S.J. Forbes Ltd. [2016] EWHC 2589 (QB) (21 October 2016)

The Evening Standard headline was “Top hairdresser ordered to shut rival salon after court battle”. The court had to consider how restrictive covenants in a share purchase agreement should be construed, including the circumstances in which the court will pierce the corporate veil where the alleged breaches are carried out by a company controlled by the seller. Ms. Gibson-Forbes was an award winning hairdresser and through her 2 companies (“Hair Windsor and Hair Madenhead”) was a franchisee of Rush Hair Ltd. On 9 March 2015, in Ms Gibson-Forbes (as Seller) and Rush (as Buyer) entered into a Share Purchase Agreement whereby Rush agreed to buy all the shares in Hair Windsor and Hair Maidenhead Under the Share Purchase Agreement, Ms. Gibson-Forbes was restricted from competing within a 2 mile radius for a period of 2 years and from employing 3 employees. The High Court upheld the restrictive covenants. The decision provides a useful summary of the relevant case law relating to restrictive covenants, in particular the circumstances on which the courts will prevent a party from circumventing the effect of these provisions through the use of a company controlled by the party.

 

3.2 Covenants unenforceable

 

Consideration may be relevant to reasonableness

  • Re-Use Collections Ltd. v. Sendell and another [2015] IRLR 226 The High Court suggested in obiter remarks in this case that the adequacy of consideration is a factor relevant to the reasonableness of the restrictive covenant. The restrictive covenants in this case were not upheld. The employer sought to enforce a number of restrictions, including a 6 month non-solicitation and non-dealing clause and a 12 month non-competition clause against their former employee who had left to work for a competing business owned and operated by his children. For over 30 years the employee had had no written contract of employment, although he did have a written statement of particulars. in 2012 he was provided with a written contract containing restrictions which he later signed in 2013. The employer argued that there was consideration as the restrictions were introduced as part of a package of  benefits, including a pay rise. The employer also claimed that consideration could be found in the employee’s continued employment in the months after the contract of employment was introduced. The Court found that the benefits were already enjoyed by the employee and rejected the notion that continued employment could amount to consideration.

 

Effect of giving an undertaking to observe a restrictive covenant on enforceability and the effect of the employer losing a customer contract

  • Capgemini India Private Ltd and another v Krishnan and others [2014] EWHC 1092 (QB), The High Court refused an employer’s application for an interim injunction there the employees had previously given an undertaking to observe a restrictive coventant but then argued that it was unenforceable. The employees’ contracts had contained a restrictive covenant prohibiting them from dealing, for a period of six months after the end of their employment, with an existing customer of the employer with which they had either business dealings or whose confidential or commercially sensitive information they had access to, in the last six months of their employment.

  • When the employer lost their contract with a client to a competitor, the employees resigned and went to work for the competitor on the client contract. The employer wrote to the employees stating that they were in breach of their restrictive covenants and seeking undertakings that they would abide by those covenants. After taking legal advice the employees gave undertakings but subsequently withdrew them. The employer applied for an interim injunction in the High Court but the High Court refused the application.

  • The High Court held that the real issue was whether, having regard to the facts including the fact of the undertakings, Capgemini had established that it was necessary and just to protect its rights by issue of an interim injunction. It was arguable that the employees, as a result of their training and experience on the contract with the client, had acquired commercially sensitive information, although it was not clear that any such information had been acquired or wrongly used. However, the employer had lost that contract and even if the employees were held to their undertakings, there was no chance of the contract being recovered. In the circumstances, "an interim injunction would serve no real or useful purpose and would be a disproportionate response to the apparent though limited breach of the clause" (paragraph 82). The High Court considered that the loss asserted by Capgemini if the interim injunction was not granted was "vague and tenuous". The restrictive covenant was also due to expire shortly in any event.

 

 

 

Non-inducement and Social media - injunction to prevent Facebook advertising unlawful restraint of trade.

  • Sean Hanna Ltd v Barber [2015] EWHC 3113 (QB)

The court granted an interim injunction against a hairdresser in relation to a clause that he should not compete for 6 months within a ½ mile area but refused to enforce a 6 month non- inducement covenant. The Claimant has set up his own business after leaving his former employer. He traded through his mobile phone and through social media. He had advertised his new business on his Facebook page and his Facebook friends included a substantial number of former clients, some of whom followed him to his new salon. The employee admitted that he was in breach of the geographical restriction but denied he had induced customers. He claimed that he was doing no more than advertising the continuation of his trade from the new salon. The court found that if the employee chose to operate outside the prohibited area it would be unduly restrictive to prevent him from advertising this on Facebook. Facebook was available to a large number of people, not just his former employer’s clients.

 

 

A Thriller injunction case: injunction refused

  • Legends Live v Harrison  

This case concerned an injunction to prevent a Michael Jackson impersonator leaving one tribute show to join a rival tribute show. Michael Jackson impersonator. The employment contract provided that the employee would not “...compete on any other look/soundalike shows in Blackpool for a period of 12 months from the final date of their current contract”. In January 2016, the employee had entered into a contract with a competing tribute show for the summer 2016 season. The employer threatened legal proceedings when it became aware of the new contract. Crucially, however, LL did not seek injunctive relief until June 2016, shortly before the summer season was due to start. The claim went to full trial and the employee raised the delay between his employer’s knowledge of his new contract with the competitor and the commencement of legal proceedings. The court held that the delay had been unacceptable and that to grant the injunction at this late stage would cause injust disruption to C's summer production.

 

 

17 year old clause for trainee unenforceable years later

  • Bartholomews Agri Food Ltd. v. Michael Andrew Thornton [2016] EWHC 648 (QB) (23 March 2016)

The court considered a clause in the 1997 contract of employment of an agronomist who had joined his employer as a trainee. The clause restricted the employee for a period of 6 months post-termination from engaging with, working or supplying goods or services which competed with the employer to the employer’s customers, trade competitors within the company’s trading area (West and East Sussex, Kent, Hampshire, Wiltshire and Dorset), or on his own account. Unusually the clause provided that “In this unlikely event, the employee's full benefits will be paid during this period." The High Court found the clause unreaonable on various grounds. Following  Pat Systems v Neilly [2012] IRLR 979, the court ruled that a covenant which was unenforceable when it was first imposed, remains unenforceable regardless of whether the employee is later promoted to a role where it could be regarded as reasonable.

 

When the employee had joined as a trainee he had no experience or customer base; therefore a non-compete clause which prevented him from working with any of the employer's existing customer base for six-months was manifestly inappropriate and in restraint of trade. The covenant was unenforceable.The Court also found that the terms of the covenant were drafted too widely to be reasonable.  

 

The clause sought to prevent the employee from dealing with any customer regardless of whether he had had any prior dealings with them. However, the employee worked with customers who represented only 2% of the company's overall turnover. It would be manifestly unfair to prevent him from working with customers representing the other 98% of the employer's existing customer base.The Court was not also persuaded by an unusual term of the clause which provided that the employer would continue to pay the employee in full during the six-month period. The Court found, following JA Mont (UK) Ltd v Mills [1993] IRLR 1782 in the context of a severance agreement, it would be contrary to public policy to allow an employer to 'purchase' a restraint of trade.

 

3.3 Others

 

Salary level not a factor in determining reasonableness

  • Norbrook Laboratories (GB) Ltd. v. Adair and another [2008] EWHC 978 (QB).

The employees sought to argue that a 1 year non-competition clause was unreasonable given her modest salary level of £25,000 a year. The High Court disagreed and said there was no reason to giver her salary level any particular significance when deciding the reaaonableness of the restrictions.

 

 

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