Restrictive convenants in a directors' service contract
This guide is based on UK law.
Purpose
The directors, as the most senior employees of a company, are
likely to have strong relationships with the company’s key
customers, intimate knowledge of the company’s most confidential
information and, quite possibly, significant sway over the
company’s employees, many of whom they will probably have
recruited. Given this, it is prudent for a company to protect
itself against the risk of future competitive activity from a
departing director. The mechanism for doing so is restrictive
covenants.
There is an anecdotal view in some sectors that covenants are
“not worth the paper they are written on”. While it is true that
justifying the need and scope of covenants can be difficult,
costing the company significant amounts in management time and
legal fees, the UK courts do have a track record of enforcing
appropriate and properly drafted restrictions.
Starting position of UK courts (restraint of trade
doctrine)
A UK court will only enforce a particular covenant if:
- it is satisfied, on reviewing the evidence, that the covenant
is necessary to protect the company’s legitimate business interests
(historically, client connections, confidential information and
workforce stability);
- the particular covenant is drafted so as to provide the minimum
necessary protection to those interests.
This reflects the need to protect and uphold the principle of
free trade.
Ensuring enforceability
The key to enforceability is making sure that any covenant can
be seen to have been tailored to the particular business of the
company and the role that the employee will be carrying out. A long
non-solicitation of customers covenant may be appropriate where a
company has a limited number of important clients with whom it has
developed a close relationship over time and from whom it receives
instructions on a fairly infrequent basis – for example, once a
year; it will be less easy to justify where a company has a
significant number of more “arm’s length” customers who buy its
products/services very frequently. Similarly, a 12-month
non-solicitation restriction may be right for a sales director who
has very close relationships with key customers and in-depth
knowledge of their requirements but “wrong” for a junior employee
or a finance director who has no direct dealings with
customers.
As a rule of thumb, courts will be reluctant to enforce
employment covenants for more than a 12-month period. Six-month
covenants will be easier to enforce, particularly in the case of
non-compete restrictions (see below).
In cases where the departure of a director could be a real
competitive threat to the business, detailed instructions should be
given to a specialist employment lawyer so that covenants can be
properly tailored and drafted.
Types of covenant
Non-compete covenants
These have often been viewed as unreasonable, extreme and,
therefore, as difficult to enforce. A court will ask why sufficient
protection to the business could not be provided by less stringent
clauses (e.g. non-solicitation, non-dealing and non-poaching
covenants or an express confidentiality provision) and will
question the company’s right to preclude an individual from joining
a competitor.
It may, however, be possible to justify a non-compete provision
where:
- the company has a very local clientele that may be expected to
follow a departing employee; thus, a hairdresser or estate agent
may be justified in preventing someone from leaving and setting up
in opposition in the same street;
- the company can prove that significant technical or other
business-critical information that is not necessarily
client-specific and, therefore, not necessarily safeguarded by
non-solicitation/dealing covenants could not be adequately
protected through an express confidentiality provision.
A 2007 decision by the Court of Appeal has confirmed that
appropriately drafted non-compete restrictions will be enforceable.
In the case of Thomas v Farr plc, the Court upheld a
12-month non-compete restriction for a managing director on the
grounds that the employer had demonstrated that it had a legitimate
business interest in protecting commercially sensitive information.
Since this information was not client-specific, it could not have
been adequately protected by a non-solicitation or dealing covenant
or by a pure confidentiality provision. The fact that it would be
difficult for both employee and employer to draw the line between
information that remained confidential post-termination and
information that did not, only strengthened the argument for a
non-competition clause.
As stated above, the length of the restriction will be key. So,
too, will its geographical scope: if a director has been primarily
responsible for and had knowledge of a company’s business in the
south east, a clause preventing them from competing anywhere in the
UK is likely to be held to be too wide and, therefore,
unenforceable.
Non-solicitation covenants
The easiest type of covenant to enforce is usually that
precluding an ex-director from soliciting his former employer’s
clients for a period following termination. Provided the length of
the period is reasonable, and the covenant only covers the previous
employer’s line of business and those clients with whom the
director has had individual dealings or of whom he has individual
knowledge, a well drafted non-solicitation of clients clause should
be enforceable.
Non-dealing covenants
A non-dealing covenant not only precludes active solicitation of
the former employer’s clients but also acceptance of work from the
former employer’s clients – even when it is they who make the
initial contact. Nonetheless, non-dealing restrictions can be
enforceable. This is particularly true if the policing of a
non-solicitation clause is likely to prove difficult.
Where non-solicitation and non-dealing restrictions are part of
the same contract, they should be contained in severable
sub-clauses. This way, the employer will still be able to call on
the non-solicitation clause if the non-dealing restriction is found
to be too wide and, therefore, unenforceable.
In sectors where an employer may need to go through a lengthy
tendering process for a contract or where the company invests
heavily in building up contacts with potential clients, the company
may wish to protect those potential leads as well as existing ones.
The scope of non-solicitation and non-dealing covenants may thus
extend beyond established customers.
Non-poaching covenants
The position on clauses to prevent a departing director
recruiting former colleagues was in doubt for some years. Several
cases have now made clear that, in the right circumstances, a UK
court will enforce a non-poaching restriction.
The keys to enforceability are to ensure that the covenant:
- is drafted only to cover those who may be expected to have
particular knowledge of/influence with clients or knowledge of a
company’s confidential information;
- is of reasonable duration.
Where a company is particularly concerned about the risk of
poaching by a departing director it should consider further
provisions. It could, for example:
- expressly specify that information about employees’ salaries
and remuneration is confidential;
- place directors and other senior employees under a contractual
obligation to notify the company if a colleague or former colleague
seeks to solicit them.
Non-interference with suppliers covenants
These covenants can be useful where a company is very reliant on
relationships with certain key suppliers. They should be drafted to
preclude interference with those relationships (and to make clear
that they do not apply to the suppliers of general utilities).
Covenants and garden leave
Most companies will wish to protect themselves from competitive
activity by a departing director not just through restrictive
covenants but also through a “garden leave” clause. On “garden
leave”, an individual remains employed but is not given any duties.
They serve out all or some of their notice at home, tending, the
popular fiction is, to their garden. Provided the clause is
properly drafted, the individual will remain under a contractual
and fiduciary obligation not to compete in any way with the company
for the duration of the garden leave. Further restrictions will
prohibit contact with customers or clients and deny access to
offices etc. The company therefore gets a breathing space – time to
shore up customer contacts etc. before the individual’s
departure.
The relationship between garden leave clauses and restrictive
covenants has been a topic of debate. Should a company that wishes
to rely on a restrictive covenant give credit for any period of
garden leave? The leading case on the issue makes clear that this
will not always be necessary. In practice, however, covenants are
generally now drafted to apply for a particular period less any
period of garden leave served.
Other related clauses
Well-drafted service agreements will contain various other
provisions to make restrictive covenants more effective. They
should, for example:
- allow the company to enforce restrictions on behalf of other
group companies;
- oblige a director to make any prospective new employer aware of
the terms of the restrictive covenants that apply to them. (New
employers who ignore the terms can be sued for inducing a breach of
contract);
- make clear that the director should not have any other business
interests during the period of employment;
- include an express confidentiality clause. Where particular
categories of sensitive information exist, these should ideally be
specified within the clause and, also, treated as confidential
within the company.
Enforcement
The detail of how restrictive covenants may be enforced through
an injunction or action for damages is beyond the scope of this
text. The key point for a company that believes that an employee
may have acted in breach of a covenant is to act quickly.
Injunctions can prevent ex-employees and their new employers from
taking certain steps but they are emergency measures; courts will
be reluctant to grant them if they feel the company has been late
in seeking relief.
