Restrictive covenants are legal provisions used to protect information that is integral to business operations. These provisions can restrict the ability of the leavers of a business from establishing or joining a competing organisation within a specified time period or within a stated geographic region. Since these clauses restrict an employee or shareholder’s activities after leaving a business they are scrutinised carefully when disputed.
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Additionally, these restrictions may also prevent the former employee from soliciting or approaching customers of the business by using relationships or knowledge gained during their previous employment. As well as employment agreements similar restrictions may be drafted in shareholder agreements.
Importantly, restrictive covenants are not provided for in terms of common law or statute: accordingly, for an employer to have any form of protection, the required restrictions must be clearly set out in a written contract with the employee. Furthermore, the employer must be able to show that the employee has expressly agreed to be bound by the terms of that contract, which would usually be evidenced by a signed document. Without a binding contract, an employer has very limited rights to restrict what an employee can do post-employment. As such, getting an appropriate contract drawn up is key and the starting point to being able to protect the business.
Whether or not a restrictive covenant is enforceable will depend upon whether it protects a legitimate business interest and is reasonable in the circumstances to restrict competition.
Legitimate Business Interest
A business may use restrictive covenants to protect its interests by restricting an employee’s activities for a period of time after their employment has ended. This will only be enforceable if it protects a legitimate business interest, otherwise it will be regarded as an unlawful restraint of trade. The only justifiable business interests are:
If the business has legitimate business interests to protect, the restriction will be enforceable against the former employer or shareholder.
Once the employer has established that a legitimate business interest is being protected, it must then demonstrate that the clause is no wider than is necessary to protect the interest. The reasonableness of the restriction will be determined by reference to the circumstances of the parties at the time the covenant was entered into. Additionally, within this reasonableness evaluation, the court will assess the relative strengths of the bargaining positions between the parties.
The factors which will influence the reasonableness of a clause are:
The standard types of restrictions that can be used by businesses are:
These involve restrictions on the former employee working in any capacity for a competitor. Given the stringent restrictions it places on an exiting employee, it is difficult to have this type of restriction upheld by the courts. These restrictions have commonly been justified in order to protect confidential information, however, they may also be used to protect trade connections where the individual has influence over customers or suppliers.
The enforcement of such clauses is assessed depending on the position of the employee they are being enforced against. For example in one case, a 12 month non-compete clause in the case of managing director, who had an intimate knowledge of how the business ran, was upheld.
These restrictions prevent soliciting clients/customers/suppliers of the former employer for business. This provision may be justified where an employee holds substantial influence over customers. It requires a specific purpose and intention to obtain trade from customers and must involve the employee initiating contact with the customer for that sole purpose so as to act in competition with the former employer.
This covenant prevents a former employee from dealing with former clients/customers/suppliers for a given period of time. This restriction may be applied regardless of which party approached the other and does not require the enticement or interference on the part of the exiting employee.
The chances of their successful application of such a clause is more likely where the employer can demonstrate a substantial personal connection between the employee and the relevant customers.
The restriction must prohibit contact which would specifically affect the employer’s business adversely. If the employee is departing to undertake an entirely different type of work then the non-dealing restriction should not limit contact to customers.
These prevent an employee poaching and recruiting former colleagues. It is essential that these extend no further than is reasonably necessary to achieve its aims. Consideration will be given to how long it will be before the employee no longer has influence over other employees and the level of seniority of the exiting employee.
If an employer has a reason to believe that an employee has breached such a restriction, the common course of action is to seek an interdict (injunction in England and Wales) before a court. If the application is successful, the court will compel the employee to stop whatever action is requested pending a wider hearing in which more evidence is presented and a more permanent outcome determined.
The court will consider all previously discussed principles and its applicability to the facts of the restriction. Some of the factors which will affect the exercise of the court’s discretion are:
The court will need to be satisfied that the employee concerned had access to trade secrets and confidential information or trade connections which warrant this protection.
Additionally, if a previous employee has breached the terms of a restrictive covenant, an employer could also consider claiming damages or lost profits where that breach has caused the business a loss.
Interestingly, as well as the employer being able to raise these types of claim against the departed employee, it is also competent to bring actions against that employee’s new employer. This may provide for a greater certainty of financial recovery where the employee’s departure has caused a significant loss of business.
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