Clarifying the law on restrictive covenants: what employees need to know?

Most senior employment contracts and service agreements will contain post restrictive covenants, the purpose of which is to protect the company’s business interests.

The more senior the employee, the more they will represent a threat to the legitimate business interests of the employer when they leave.

There are several types of restrictive covenants, common forms of which include:

Non-compete: The employee is restricted from working for a competitor or setting up in competition.

Non-solicitation: The employee must not approach or attempt to attract business from the employer’s existing clients.

Non-dealing: The employee must not deal with the employer’s existing clients.

Non-poaching: The employee must not hire or entice away from the employer any of the employer’s (usually) senior staff.

The problem with restrictive covenants is that they represent a restraint of trade, i.e. they prevent an individual from being able to earn a living. Therefore, a restrictive covenant will only be enforceable if it can be justified as being reasonable to protect the legitimate business interests of the employer.

The scope of a restrictive covenant must be proportionate to level of risk posed. The length and geographic extent of the restrictions must be considered. For example, a 12-month non-compete might be unenforceable for a junior employee but enforceable for a senior executive. Similarly, a restriction applying to the world is unlikely to be enforceable if the employer only actually does business and has customers in London.

How the courts view restrictive covenants

Where the enforceability of a restrictive covenant is challenged, it is up to the courts to determine whether the restriction is reasonable or not.

Over the years the courts have adopted an employer-friendly approach to interpretation of such restrictions.

In the decision of the Supreme Court out today on the case of Tillman v Egon Zehnder, the Court had to consider whether an otherwise unenforceable covenant could be saved by the deletion of certain words.

The employee’s contract included a restrictive covenant which stated that, for six months post-termination, she must not “directly or indirectly engage or be concerned or interested in any business carried on in competition with any of the businesses of the Company or any Group Company…”.

The issue with the restriction was that the words ‘be concerned or interested in’ would include the employee owning any shares (no matter how few) in a competing company. It was held that this wording constituted a restraint of trade which was unreasonable because, amongst other reasons, it went further than the restrictions which applied to the employee during the term of her employment (which allowed her to own up to 5% of shares in any company). The parties accepted that any post-termination restriction which went further than a restriction which applied during the term of employment would be unreasonable and void.

The employer argued that the wording “concerned or interested in” was not intended to apply to shareholdings but was instead simply intended to prevent the employee from working for or with a competitor in any capacity, and that the clause should be construed in that way.

Ultimately, the Supreme Court held that by deleting the words “or interested”, the scope of the clause was limited to its stated intended meaning, i.e. to prevent the employee from working for a competitor. As such, the clause was held to be enforceable, with the deletion of those words.

In giving his judgment, Lord Wilson applied an updated test for whether severance/deletion can be used to save a badly drafted restrictive covenant. In order for such severance/deletion to work, two criteria must be satisfied:

  1. the relevant words must be capable of being removed without having to add to or modify the remaining wording; and
  2. the removal of the words must not generate any major change in the overall effect of all the post-termination restrictions.

The courts can therefore save otherwise unenforceable restrictive covenants, where the unenforceability is caused by poor or ambiguous drafting.

The decision also reinforces the idea that each element of the restrictive covenant should be separated out to allow for severance/deletion if needed i.e. if one restriction is too broad, it can be deleted without wiping out the remaining restrictions. However, if all restrictions are grouped together, it becomes much more difficult to use severance/deletion.

The judgment also suggests that, contrary to the general principle that the loser always pays in terms of costs, the employer may have to bear the cost consequences of having relied on the Court to save a poorly drafted restrictive covenant.

What can employees learn from the decision?

When negotiating employment contracts, especially at a senior level, it is a common tactic to agree to restrictive covenants which seem excessive in the assumption that they will ultimately be unenforceable in any event. However, employees ought to be wary of this tactic, as the Tillman case shows, the courts may be willing to help employers render restrictive covenants enforceable where drafting allows for severance/deletion.

If you are thinking of changing employment, either as an individual or as part of a team move, we can help advise as to the extent and enforceability of your restrictive covenants and to plan your exit strategy accordingly. Please contact David Greenhalgh of the Joelson employment team on +44 (0)20 7580 5721.

This article is for reference purposes only. It does not constitute legal advice and should not be relied upon as such. Specific legal advice about your specific circumstances should always be sought separately before taking or deciding not to take any action.