This checklist explains what restrictive covenants are, when they are likely to be enforceable and how they can be used in employment contracts to protect your business’ interests.
What is a restrictive covenant and when will it be enforceable?
You can use restrictive covenants to protect your business’ interests by restricting an employee’s activities for a period of time after their employment has ended.
A restrictive covenant will only be enforceable if it protects a legitimate business interest, otherwise it will be regarded as an unlawful restraint of trade. The only recognised business interests are:
- trade connections (including the relationship between your customers and your workforce); and
- trade secrets and confidential information.
If you have a legitimate business interest to protect, the restriction will be enforceable, provided it is no wider than is necessary to protect that interest. The covenant must be limited in terms of the restrictive activities themselves, and also apply:
- for a limited time; and
- within a limited geographical area (if appropriate).
Ensure restrictive covenants are drafted carefully
Restrictive covenants must be drafted carefully so that they:
- Accurately reflect each employee’s role.
- Reflect the circumstances of your business.
- Go no further than is necessary.
You should regularly review contracts that include restrictive covenants and check whether they need to be updated (for example, if the employee’s role has changed).
Non-solicitation restrictive covenants
You can include a covenant in an employee’s contract preventing them for soliciting customers after they have left your business. This type of covenant will be particularly useful if your employee has a strong relationship with certain customers.
Generally, the covenant should be restricted to customers that your employee had contact with during a specified period before they left. There are a number of factors you should consider when trying to establish the length of this period, including:
- the amount of time it would take for your employee’s successor to gain influence over the business contacts;
- your employee’s seniority within your business;
- the extent of your employee’s role within the new business;
- the loyalty (or otherwise) of customers in your particular market; and
- the length of similar restrictions in the employment contracts of your competitors.
A restrictive covenant that attempts to extend the restriction to potential customers will be harder to enforce. However, it may be possible to protect an interest in genuine prospective customers if they are accurately defined.
A restrictive covenant preventing a former employee from poaching your existing employees is likely to be enforceable, as the stability of your workforce is a legitimate business interest. However, the covenant should usually be limited to those employees at the same level as the former employee and those more senior to them. Any clause that attempts to prohibit the poaching of employees will need to consider:
- How long the former employee’s influence over your other employees will last.
- The roles of the employees over whom the influence exists.
Non-dealing restrictive covenants
A restriction on the solicitation of customers can be extended to cover not only enticement or interference (where active steps are taken by your former employee), but also the provision of services where no active steps are required (for example, where the customer approaches your former employee). This is known as a non-dealing covenant.
This type of covenant has a clear advantage as it avoids the need to prove that the former employee made an approach, which is usually difficult to show. However, it does broaden the prohibition and consequently may make it more difficult to enforce.
The enforceability of a non-dealing covenant will depend on the interest your business is trying to protect (for example, enforcement may be more likely if you can establish a substantial personal connection between your former employee and your customers).
Non-competition restrictive covenants
Employees are prohibited from disclosing confidential information amounting to a trade secret (for example, a manufacturing process) after they leave your business. Your business can also include express confidentiality provisions in their employment contract to protect the information. Therefore, additional restrictive covenants may be regarded as unnecessary.
However, there are circumstances in which a non-competition restriction is likely to be enforced. For example, where your former employee’s influence over customers or suppliers is so great that the only effective protection is to ensure they are not engaged in a competing business in any way.
If you have any queries about the content of this checklist, please contact Gary Lee.