Last reviewed 25 October 2017
Bob Patchett takes a highly critical look at the use and effectiveness of restrictive covenants.
If you have never encountered a restrictive covenant and come across the concept for the first time, you may think what a good idea it is. But think again. They certainly are used, and to good effect, but in rather limited circumstances, so be fully aware of what they are and what they can and cannot achieve. Then think honestly about whether one could be useful in your particular circumstance and, if so, take care how you construct it.
On the surface, a restrictive covenant constrains an employee from leaving you and setting up a business in competition with you or from joining a business competitor. However, should an employee who has a restrictive covenant in his or her contract leave you for one of these reasons, and you decide to go to law to enforce the terms of the covenant, the court must balance three concepts as they appear in your case — your right to safeguard your business, the employee’s right to earn a living at his or her trade, and the public interest. The balance largely is between the right of the employer and the employee; you are allowed to do just enough to protect your business interests without restricting excessively the ability of the departing employee to get a suitable job or start a business.
Someone leaving your employment could of course damage your business in several ways. The person could take your secrets to a new employer, and indeed, consciously or unconsciously, this might make him or her attractive to that employer. Your product design programme, marketing plans, pricing structure, agreements you have with customers or suppliers, all might be of value to a competitor. A departing salesperson could entice your customers to the new employer, especially if he or she had a strong relationship with them. Understandable concerns, certainly. But a restrictive covenant may not be the best way to protect yourself because it is rather a heavy hammer to crush what might be a relatively small nut and, as described later, it may fail in the detail. Better perhaps to put into the employment contracts of any employee who handles confidential information words to the effect that he or she will, during his or her employment, come into contact with confidential information such as — and here you should give examples — which must not be revealed to anyone outside the organisation without the permission of a senior director either during his or her employment or for a reasonable time afterwards. This sort of arrangement is far more commonly used, does not sound untrusting or threatening, and should be emphasised to employees who leave you. It appears to work well.
A restrictive covenant usually begins like this but is stronger and more precise. You need to take great care to specify the areas of confidentiality that you are trying to protect, though make clear that it is not an exhaustive list. The constraint on the employee must not be permanent, but only for as long as is reasonably necessary. The time limit on the covenant requires realistic thought. Judges usually consider that six months is long enough, though in exceptional circumstances have stretched that to one year. A reasonable length of time is a subjective measure so, accepting that judges have to make a personal judgment, do the same yourself or ask an independent person to give an opinion. In so doing, recognise that the damage the departing employee can do will diminish with time, and if the new employer does want the information the new person has, it will probably be acquired in the first month. Consider also that key staff, the ones who handle critical information, usually are on long periods of notice, say 6 or 12 months. During that time you could ban them from certain areas or restrict the information they handle, or send them home on garden leave so that you continue to pay them but they are isolated from company information. In the latter case, however, you must state clearly in the employment contract that you have the right to put the employee onto garden leave during the notice period.
The restrictive covenant should also contain a geographic limitation. A departing employee starting a business such as yours in New Zealand is unlikely to be a real threat. In the next road would be a greater problem. Therefore state a reasonable area within which the covenant is enforceable — within a quarter mile for a hairdresser in a town, two miles in a rural area, the UK for a sales director, three small counties for a sales representative.
Thus, you need to think realistically about three areas of restriction. First the confidential information, second the geographic area and third the time limit. If an employee breaches a restrictive covenant, you will need to go to law to seek an injunction and will need a lawyer to do this on your behalf. The lawyer probably will seek an interlocutory injunction, which, if the judge considers your application to have merit, will temporarily stop the employee from acting against you until a full trial can be held. Before going down this path, however, ask for an idea of your counsel’s and the court’s fees. These will be considerable, so consider whether the employee could do harm to that value.
So, how necessary is a restrictive covenant for an employee you have decided to recruit? Apply the “who cares?” test. What harm could be done if the person were to leave for a competitor or start a competitive business?
If the damage is likely to be insignificant, then forget restrictive covenants because they can cause ill will by suggesting that you do not trust the employee. Put in the above general confidentiality clause and leave it at that. If the departure of the employee could have a significant though not drastic effect on your business, then by all means draft a restrictive covenant. State clearly in separate subclauses the sensitive information that the employee will be in contact with, describe what he or she must not do with it, limit the geographic area, put a time limit on the restriction of no more than six months, and make clear that the subclauses are severable from each other such that, if one fails the test of reasonableness, the rest remain intact. But if the employee on departure could do considerable damage to your business, seek legal advice. Explain to a specialist lawyer the nature of your business and its vulnerabilities and have him or her customise a restrictive covenant for that particular contract of employment. Do emphasise to the employee that this is nothing personal. You have no doubt whatsoever about his or her integrity, but need to safeguard the organisation in every possible way.
And how effective are restrictive covenants? Pretty good if drafted by a specialist employment solicitor. But these people charge high fees, and enforcement of a covenant can be traumatically expensive if a full injunction is sought. Their greatest effectiveness probably is as a deterrent.
Perhaps you could dissuade key staff from leaving by paying and treating them well, and giving them interesting, long-term work. Problem solved. Money saved.