Managing restrictive covenants

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Managing restrictive covenants

So what happens when someone jumps ship to a competitor and has a restrictive covenant in their contract of employment? How does a manager manage restrictive covenants?

In May the Department for Business Innovation and Skills – now the Department for Business Energy and Industrial Strategy (BEIS) – opened an 8-week call for evidence regarding ‘no-compete’ clauses in restrictive covenants. The concern voiced to BEIS by business is that such clauses could impede innovation by stopping people from moving easily from one employer to another. A second concern is that these covenants stop innovation because people are barred from setting up their own business through fear of breaching such agreements. The suggestion is that no-complete restrictive covenants stifle innovation in the UK and should be prevented or severely modified by statute.

What are restrictive covenants?

Where an employer wants to protect their business, they insert a clause into an employee’s contract preventing them from being involved in certain activities or taking certain actions once they leave. The employee ‘covenants’ or agrees to be bound by certain restrictions. These clauses, once agreed to by the employee, endure for a period after the employee leaves the firm. Given certain conditions, they are binding and enforceable.

There are four elements that can be included. Each is independent of the others. They are:

  • ‘No-compete’, preventing an ex-employee from immediately going to work for a direct competitor;
  • ‘No-solicitation’, preventing an ex-employee from enticing away a customer;
  • ‘No-dealing’, preventing an ex-employee from interacting with customers of the firm they left; and
  • ‘No-poach’, preventing an ex-employee from encouraging their former colleagues to leave and join them.

The clauses specify time-periods and geographical areas over which the restrictions apply. 

Enforcing restrictive covenants

The restrictive covenant clauses in an employment contact act as warning for both the departing employee and new employer. However, to enforce the restrictive covenant clauses, the original employer has to be prepared to resort to court action.

Typically the aggrieved employer first puts both the new employer and the departed employee on notice that the departed employee is likely to breach the covenant and the new employer is likely to be party to that breach. Often the aggrieved employer will wish to hear from the new employer about what they intend to do in order to avoid a breach.

And if these tactics fail to get any assurances, the aggrieved employer can seek a court injunction. Taken to the limit, the aggrieved employer could sue for loss of revenue – assuming of course that they could prove such loss.

Taking out an injunction to legally enforce a restrictive covenant could cost the aggrieved employer in the order of £20K. This means that the loss of business likely to be experienced by the aggrieved employer needs to be significant to justify the cost and effort of petitioning a court.

Injunctions will only be granted, and the clauses enforced, if they protect a legitimate business interest and if the timescale and geographical area are reasonable. If the clauses are deemed to be unreasonable, or insufficiently specific to the departing employee’s former role, they will not be upheld. The scope of the covenant must be adequate to protect, but go no further.

Determining that adequacy is tricky and it’s typically where restrictive covenants fail – the employer often demands too broad a restriction.

Impact on business

The Government aims to see if the clauses are stifling start-ups and young firms by stopping them from attracting the best talent. Larger businesses, on the other hand, see these clauses as the only way they can protect their legitimate business interest from arguably significant financial loss.

Most managers would agree that it’s important for business to have a legitimate means of protecting themselves, whilst allowing employees the ability to move on when the time is right. But it’s getting the balance right that’s the issue for BEIS.

The employee should be aware of the restrictions they have in their contract, and the fact that they agreed to them. Many employees don’t really understand what they are signing when they join a firm. Some don’t even read their contract when they sign it, and just trust that the firm is being reasonable. It can come as a shock to realise that they might be blocked from accepting their dream job.

When an employee intends accepting an offer from a new firm, it is up to them to tell their prospective new employer about the restrictions they’ve agreed to.

Managing restrictive covenants

It is then up to the new employer to determine how they can move forward such that they, and the employee, don’t break any legitimate covenants that are in place. By talking this through with the firm that the employee is leaving and with the new employer, a solution can often be found. Sometimes, it takes an assurance from the new employer that the work, or client base, is significantly different to placate the aggrieved employer. In such circumstances both employee and new employer can argue that there will be no breach. Sometimes, new employers can place employees in other areas of the business until the covenanted period expires. In this case, the breach is avoided.

We shall have to wait some months to learn the outcome of the BEIS consultation. Meanwhile, having to take court action to implement a restrictive covenant is not a positive use of time or money. It’s always much better for all parties to find a way forward that protects the legitimate business of the ex-employer whilst allowing the ex-employee to move on.

Getting help

If you need help with managing a prospective employee’s restrictive covenants, or if someone is leaving you and you’d like help in gaining assurances that no breach will occur, call us.

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