Enforceability — overviewIntroducing covenants

To be enforceable, a restrictive covenant has to be incorporated into a contract between the employer and employee, which may be the contract of employment, or a separate collateral contract. It is possible to introduce covenants at any stage, either before, during or on termination of the employment relationship.

Before the start of employment

This is the most straightforward time to introduce covenants.

Covenants must be suitable and reasonable, judged by reference to the employer’s business and the job of the individual employee. The employer should therefore identify the specific role the employee is to undertake and tailor covenants to that role and to its business as a whole, rather than eg reusing covenants from an old, unrelated contract.

During employment

Once employment has started, introducing covenants is less simple: the inclusion of a new covenant amounts to a variation of contract which requires consent from the employee, and must be supported by good consideration.

Consent may sometimes be implied, eg where an employer asks an employee to accept a covenant in return for a pay rise, and the employee carries on working accepting the higher wage. However where employees object to new covenants or reserve their positions consent is unlikely to be implied. In most cases securing express consent will be the better option.

Consideration for the inclusion of new covenants can be in the form of a pay rise, a one off payment, or other valuable benefit.

On termination

Covenants are often introduced as part of an agreed severance package, particularly where none existed before, or those that did were defective. Consent and good consideration will again be required: but both will usually be present in the context of an agreed severance package.

Any severance agreement which includes the employee agreeing to covenants should attribute a separate sum as consideration for the adoption of the covenants to avoid tax difficulties: there is no tax relief on such sums (whereas compensation for loss of employment is tax free to £30,000).

Business transfers

Particular problems arise in the context of business transfers that fall within the protection of the Transfer of Undertakings (Protection of Employment) Regulations 2006.

For instance, consider the case of a transferee company B taking on an employee from transferor company A, who is subject to non-solicitation and non-dealing covenants. The employee resigns shortly after the transfer, and seeks to deal with A's customers. B wishes to enforce the covenants, but they are phrased in such a way as to prevent the employee soliciting/dealing with the customers of transferor (company A). In such a case it is permissible to read the covenants as though B had always been the owner of the part of A’s business that was transferred: B will then be able to enforce the covenants and prevent the employee from soliciting or dealing with A’s clients.

On a transfer, it is not permissible to change the contractual terms of the transferred employees by reason of the transfer. This means an employer will be unable to introduce new restrictive covenants as a result of a transfer: for covenants introduced to be valid, there must be clear reason for doing so unrelated to the transfer.

Restraint of trade

Any restraint of trade is unlawful unless it falls within one of a number of lawful exceptions.

A restraint of trade by agreement in an employment situation will be contrary to public policy, and therefore unlawful, unless:

• the person seeking to enforce the restraint has a legitimate business interest to protect

• the restraint is reasonable in the public interest

• the restraint is reasonable as between the parties

Legitimate business interest

An employer will not be able to enforce a covenant merely to prevent former employees competing against it: rather, it must show that it has some more defined business interest, that amounts to property of the business, which it is therefore entitled to protect. Such legitimate business interests principally include:

• trade secrets and/or confidential information: prevention of misuse of information that is properly categorised as a trade secret or confidential information is sufficient to amount to a legitimate business interest. By contrast, information which is merely general skill and knowledge acquired by an employee will not be capable of protection even with an express covenant

• trade connections, customers and suppliers: relationships with existing customers and suppliers, and in some cases with potential customers and suppliers

• the skills of the employer’s workforce: the combined skills of a trained and stable workforce have been held to be a legitimate business interest, which may therefore be protected by a suitable non-poaching covenant

Restraints against the public interest

Even if an employer is able to establish that it has a legitimate business interest to protect it will only be able to enforce a restrictive covenant if the restraint is reasonable in the public interest.

The public interest rarely arises in cases relating to employment covenants.

An example of where the public interest issue was determinative concerned restrictive covenants against the inventor of a new ventilator for use in hospitals: it was held that where a restraint of trade would restrict the development of inventions or processes which would benefit the public in a field such as medical science, any contractual restraint on further invention would only be permitted in exceptional cases.

Appropriateness of scope of restraint

Even if an employer is able to establish that it has a legitimate business interest to protect it will only be able to enforce a restrictive covenant if the restraint is reasonable as between the parties.

This does not mean the covenant must give equal benefit to employer and employee: rather, it means the employer must show the covenant is no wider than is necessary to protect the legitimate interest in question.

The reasonableness of the covenant will be assessed as at the date the covenant was agreed.

Assessing reasonableness between the parties will usually include consideration of:

• the nature of the restraint

• the geographical ambit of the protection

• the duration of the covenant

Nature of restraint

The nature of the restraint imposed must be examined to see whether it is a reasonable means of protecting the legitimate interest in question.

Express words in the contract that identify the legitimate interest are relevant: an employer will not be able to contradict such words and argue the true interest to be protected was otherwise.

Where the legitimate interest is customer connection, a blanket geographical non-compete covenant is likely to be more than the minimum necessary to protect customer relationships, and hence unenforceable: usually that interest could have been adequately protected by non-solicitation and/or non-dealing covenants.

Similarly, where the legitimate interest is in a trained and stable workforce, this is usually adequately protected by a non-poaching clause, making a blanket non-compete clause once again overly wide, and hence unenforceable.

Blanket non-compete clauses usually only succeed where the interest to be protected involves trade secrets and/or confidential information. They may occasionally succeed where used to protect customer connection, but only where it can be shown that it would be impossible or impracticable to police a less draconian restriction. The court will scrutinise claims to this effect closely, as alleged difficulty in policing a non-dealing covenant may in fact indicate lack of a sufficient customer-connection to amount a legitimate business interest.

Geographical ambit

Non-solicitation, non-dealing and non-poaching clauses may not need a geographical limitation, as the ambit of restriction on the employee’s activities is likely to be suitably limited by proper definitions of the customers, suppliers and employees covered by such clauses.

Other types of covenant, such as non-compete clauses and those designed to protect confidential information, may require a geographical limitation to render them enforceable.

Where no area is specified, covenants will probably be treated as of worldwide application, which is rarely enforceable. The area specified must be reasonable in the circumstances:

• the duration of the clause may be important: generally the longer the duration, the less likely a wide area will be justified

• where the interest to be protected is customer connection, the area specified must have a functional connection with the actual location of the employer’s customers

• the activities of the employee in the course of his employment are important: even where the area specified coincides with the location of the employer’s customers as a whole, if the employee only dealt with customers in one smaller part of that area, then the covenant is likely to be too wide

• in general, wider areas will be more supportable in rural locations than areas of dense population, because the number of potential competitors covered by the restriction will be much lower

Duration

In determining a reasonable duration over which a covenant will be effective, the proper question is how long the employer is entitled to protect his legitimate business interest, rather than how long the departing employee would enjoy a competitive edge over others.

The true impact of a restrictive covenant is likely to be greater than the duration of the restriction might suggest: eg an employee subject to a six month non-solicitation clause will take rather longer than six months to get back to a position in which he can truly compete with his former employer. The court is likely to consider the reasonableness of the overall period of the clause's effect, rather than just that of the stated period of restriction.

When protecting trade connections with suppliers or customers, a reasonable period of restriction might be how long it would take a replacement employee to establish sufficient connections with those suppliers or customers.

When protecting confidential information, the reasonable period is likely to correspond to the shelf life of that information.

The period of notice in the employment contract may also be a relevant factor.

Customer clauses

Certain specific considerations apply with restrictive covenants that seek to protect an employer’s customer connection by way of non-solicitation and/or non-dealing clauses:

• the customer connection protected must be identified with precision: usually, customers should be defined by reference to the employer’s business and the employee’s activities during the course of employment. Clauses should not prevent contact with customers with whom the departing employee has had no previous involvement

• the effect of the covenant must be restricted to those who were customers of the employer during a defined (and not overly lengthy) period before the termination of the employee’s employment

• where it is difficult to identify the customers with whom the employee has been involved:

• • an alternative form of covenant may be more appropriate

  • alternatively, this difficulty may indicate there is no legitimate business interest to protect

• it may be difficult to draft an enforceable customer connection covenant where the relevant customers tend to use a variety of suppliers in addition to the employer for the type of business the employer undertakes

Effect of repudiatory breach

Termination of a contract of employment following a repudiatory breach by the employer, such as a wrongful or constructive dismissal, will render the employer unable to enforce any restrictive covenants in that contract.

Some contracts state that the restrictive covenants they contain will apply ‘howsoever the contract is terminated’ or ‘following termination, whether lawful or unlawful’. The inclusion of such wording:

• will not succeed in rendering the covenants enforceable where the contract was terminated by the employer's repudiatory breach; but equally

• will not prevent the covenants from being enforceable where the employer terminated the contract lawfully

Construction

The construction of restrictive covenants essentially follows the same rules of construction used with other types of contractual term:

• timing: the reasonableness of a clause will be judged as at the point in time it was agreed by the parties

• clarity and precision: restrictive covenants are construed in the context that restraint of trade is generally unlawful, meaning clarity and precision are particularly important. If a covenant is vague, it may well be unenforceable: eg lack of clarity as to which customers are covered by a non-dealing clause, or failure to define the geographical area properly

• purposive approach: restrictive covenants will generally be interpreted in the context of the whole contract. This may sometimes assist the employer: eg where a clause did not define the type of goods an employee was prevented from selling, the court held the restriction applied only to the type of goods he had sold during employment. However, in another case, concerning a covenant restraining involvement in any business of a type undertaken by the employer, the failure to limit its application to businesses in competition with his employer proved fatal

• contra proferentem: where a clause remains ambiguous even after other construction rules have been applied, the clause should be construed against the party from whom it originated, if that would enable that ambiguity to be resolved. The originator will almost always be the employer

• re-writing and severance: Courts are not entitled to re-write clauses to render them enforceable. Severance of offending words may sometimes be permissible (see below)

Severance

Courts have the power to sever unreasonable parts from what would otherwise be an enforceable covenant: separating the bad from the good. This is commonly referred to as ‘blue-pencilling’. For severance to be permissible:

• the covenant must contain a number of independent restraints

• once the unenforceable independent restraints have been removed, those that remain must be coherent and enforceable without the need to add to or change their wording

• there must be adequate consideration for the parts which remain

Severance is not restricted to removing minor or trivial wording: eg where a non-solicitation covenant is reasonable but a non-dealing one is not, it may be possible to blue-pencil out the non-dealing element.