Monday, 19 September 2011

Are restrictive covenants in employment contracts actually protecting employers from confidential information leaks?

Employers typically devote most of their efforts to come up with new, effectual programmes enabling these to engage and retain their employees and attract talented people from the exogenous environment. It can thus occur that some individuals might decide at some point to leave their organization lured by the apparently most attractive opportunities offered by other organizations.
Under such circumstances, employers are habitually everything but ecstatic. The loss of experienced, knowledgeable professionals, especially of those who have gained a relevant degree of expertise in their professional domain over the years, is in fact highly likely to make a considerable negative impact on an organization. Yet, depending on the activities performed by individuals, their knowledge and use of business-related confidential information, once these have left the organization, usually represent a serious reason for employers concern.

The risk associated with these occurrences is invariably potentially remarkable, but whether the individuals leaving the organization should work, for instance, in the sales department such occurrences might produce even more hampering and detrimental effects by reason of these employees having full access to the customers’ database and an in-depth knowledge of the business sales strategy.
Employee knowledge of the organization’s technology, strategy and working procedures may indeed invariably cause high degrees of concern for businesses experiencing unexpected departures of their key staff. These individuals might in fact effectively help both the direct and indirect employer’s competitors to expand and strengthen their presence in the market.
In order for organizations to reduce and mitigate the effects produced by such undesirable occurrences these can include in their contracts of employment specific covenants aiming at regulating the post termination behaviour and activity of their former employees. The ultimate aim is of preventing individuals who leave a business from setting and running a company or joining an existing business availing themselves of the information gathered during their previous working relationship, to the detriment of the former employer. In some instances, covenants can indeed help employers to buy time to lessen the effects usually produced by such circumstances. Things, nonetheless, are not as straightforward as they can apparently seem to be.
The first aspect which needs to be considered is that restrictions to individual trading activities are not protected by public law so that it is up to employers to do whatever they can to protect their legitimate business interest (Holt and Bazen, 2008). As held by the Judge Macnaghten (Nordenfeldt v Nordenfeldt Guns and Ammunition Company, 1894), any interference in and limitation to individual liberty of trade per se is contrary to public policy and as such void. What employers can essentially do is hence including in the contracts of employment signed with the individuals filling key roles in their organization some clauses aiming at protecting their interest. These caveats, notwithstanding, must respond to the requisite of reasonableness in all the circumstances.

Employers need to be extremely careful when formulating their contracts of employment, whether these should include clauses later deemed unreasonable by the Courts, these will be considered void and as such unproductive of any effect. Yet, it will be up to the covenantee to persuade the Court that these caveats are reasonable both in the parties and public interest (Tucker, 2008). The Courts habitually enforce a restrictive covenant only whether the employer is able to provide evidence of the circumstance that this actually protects a business interest (as a trade secret or some confidential information), it is formulated to attain this objective and extends no further than reasonably necessary to achieve this aim (Herbert Morris Ltd. v Saxelby, 1916). In order to avert formulating covenants later deemed void by the Courts on grounds of legality employers should hence, first and foremost, clearly identify which is the real interest they actually aim at protecting. These will be thus able to formulate a clause focusing on that interest, to the extent which is reasonably necessary to protect this (Tyler and Mecrate-Butcher, 2011).

Types of restrictive covenants
Employers habitually introduce in their contracts of employment one of the following main types of covenants:

1.    Non-compete covenant – aims at preventing individuals who have left their employers directly competing or working with the former employer’s competitors. Usually such a clause identifies a specific non-competition temporal limit (for instance, six months from termination) and a geographical area delimitation (for example, within fifty miles of the former employer’s premises, headquarters or previous workplace). With particular reference to this aspect, Holt and Bazen (2008) stress that covenants increasingly tend to refer to the “employer’s market(s)”;

2.    Non-dealing/non-solicitation covenant – whose objective is to prevent individuals from working with the previous employer’s customers and suppliers by sending or accepting orders for goods and services, more often than not for a predetermined post-termination period of time;

3.    Non-poaching – this clause is aimed at averting that individuals who have left an organization may persuade former colleagues to come and work for their new employer, also in this case for any given period of time subsequent to termination;

4.    Non-use of confidential information – this clause is introduced to prevent employees unveiling or using any confidential information (such as technology, strategy, etc.) gained during their previous working relationship.
The employer’s outlook
Employers are particularly and comprehensibly sensitive to the loss of key employees and to the risk associated with this type of circumstances. When trying to protect their business, firms should strive to clearly identify and focus on the main interest they want to protect and act in a way which may be objectively considered reasonably necessary to attain that objective. The expression “reasonably necessary” more specifically relates to the duration, scope, nature and effects of the limitation (Andela and Pitt, 2008). The risk would otherwise be emptying and voiding the content of the clause and achieving in practice no objective at all.

In Thomas v Farr plc and Hanover Park Commercial Ltd (2007), for instance, the managing director had accepted an employment offer from his former employer’s main competitor and sustained that the covenants included in his contract represented an unreasonable limitation of trade and that these were as such unenforceable (Skeaping, 2010). The employer was able to show the Court that the MD had actually access to confidential, strategic information enabling this to quickly design and develop an effective strategy for the new employer, which could have seriously hampered the activity of his business. The High Court and the Court of Appeal respectively held and upheld that the restrictive covenant included in his contract (non-competition clause for twelve months following termination) was reasonable (Skeaping, 2010). Things would have arguably gone differently whether the non-competition clause would have been wider and not limited to the specific sector in which the former employee was actually operating.
As a general rule, a limitation concerning the solicitation of trade with the customers of the previous employer with whom the employee was regularly in contact is more likely to be enforceable than a wider restriction concerning all of the customers of the previous employers, including those with whom the employee had actually never been in contact (Roydens, 2009).
The employee’s outlook
Individuals who have gained a relevant degree of expertise and experience in an industry sector will find it virtually impossible and inappropriate having to change industry and putting aside the expertise these have gained over the years. Yet, this would clearly have a remarkable impact on their capability to find a new job and on the worthiness of the income these would be able to earn. It is thus very unlikely that judges may enforce covenants preventing any form of competition with the former employer or clauses vaguely formulated (Roydens, 2009).
Regardless of their reasonableness, limitations are due to be considered unenforceable in all of those cases in which an employer concludes the employment relationship wrongfully, for instance failing to give the required notice or to respect statutory disciplinary procedures. By contrast, the fact an individual receives a payment in lieu of notice does not prevent the enforceability of the covenant. Things may work differently when an individual leaves the organization after having reached an agreement with his/her employer, but also in this case to be enforceable the covenant needs to be reasonable in every circumstance (Roydens, 2009).

Garden leave
Garden leave is a clause enabling employers to require the individuals who have decided to leave the organization to spend all or part of their notice period at home. Since during this period the contract of employment is still effective, employees continue to regularly receive their full pay and contractual benefits (Net Lawmen, 2011). In order to maximise the effects of the contractual limitations this clause is usually associated with restrictive covenants (Tyler and Mecrate-Butcher, 2011).
The combination of garden leave and restrictive covenants may enable employers to attain several remarkably significant objectives. Preventing the employee to have access to the organizational premises enables the business to keep this unaware of the foreseen change of strategy and of the other types of plans the business might decide to make. Yet, during this period the employee will not be in a position to start working for any other employers, whereas the current employer can appoint his/her substitute and give this the time to establish in the new position (Tyler and Mecrate-Butcher, 2011). Last but not really least, the enforcement of the garden leave clause also prevents individuals from resigning and claiming constructive dismissal during the period of its valid (Net Lawman, 2011).
As warned by Tyler and Mecrate-Butcher (2011), nonetheless, the garden leave clause needs to be clearly and specifically mentioned in a contract of employment. During its preparation it must be remembered that also this clause needs to be reasonableness-proof, in particular with reference to its duration.

The Courts are lately adopting a different approach to restrictive covenants, mostly focused on the identification of the clause purpose, rather than on its literal interpretation (Andela and Pitt, 2008). In Beckett Investment Management Group Ltd & Ors v Hall & Ors (2007), for instance, to make its decision the Court of Appeal had regard to the business realities. The Court also considered the clients of the employer subsidiaries, albeit these had not been mentioned in the clause. This new trend clearly emerges also from TFS Derivatives Ltd v Morgan (2004) where the Judge held that the first thing to look at when considering a restrictive covenant is what it means when it is properly interpreted.

Courts will obviously never re-write a limitation clause that they consider inappropriate or unenforceable, but a Court may “sever” part of the clause in order to make it appropriate and as such enforceable. This is actually what occurred in the case TFS Derivatives Ltd v Morgan (2004). In the contract of employment the original formulation contained the expression: “any business which is either competitive with or similar to”; the High Court held that removing the words “or similar to” would have created an enforceable covenant (Andela and Pitt, 2008) so that it considered the covenant enforceable to this extent.
As suggested by Tucker (2008), notwithstanding, “the doctrine of severance may ride to the rescue of covenant that is defective in one or more respects except that with respect to time.” A limitation unreasonably set in twelve months will not be severed to the, for example, reasonable period of six months by the Court. In such a case the clause would be hence considered void and unenforceable.
Employers should thus avert being over-reliant on severability when drawing up a contract of employment. In general, this is deemed acceptable when the clause is composed of a combination of several covenants. This is indeed the only case in which the partial enforcement of the overall clause is possible in that it will not require neither to be re-written nor to be altered in any way to be, albeit partially, enforced (Tucker, 2008). The exercise, nonetheless, may prove to be exceedingly risky and particularly difficult to perform in practice.
As a general rule, the Courts consider void a contractual term aiming at restricting an individual trading activity after termination unless an employer can provide evidence that this has a legitimate business interest to protect and that this protection is reasonable having regard to the parties and the public interest (Net Lawman, 2011).
The enforceability of restrictive covenants sorely depends upon the circumstances so that this definitely represents a case in which the one size does not fit all. Each clause must be differently considered according to the business needs. The Courts habitually permit employers to protect two specific rights:

-      Trade connections (with suppliers or customers) or more broadly goodwill;

-      Trade secrets and other confidential information (Net Lawman, 2011).
In general, there are some specific points which employers should carefully consider when assessing reasonableness, amongst these extra care should be taken with:

-      The level of seniority of the employee concerned

Employers can impose more onerous limitations to senior employees; otherwise it may prove to be sorely hard to show that limitations go no further than necessary;

-      The position covered by the individual

The reference is here to the role covered by the employee in the new organization, in order to find out whether any link actually exists between the previous and the current role;

-      The nature and extension of the business

This is extremely important to determine the reasonableness of the geographical limitation included in the clause;

-      The duration set for the covenant

Excluding the case of garden leave and eventually considering the length of its duration, individuals will have no source of income during the enforceability of the limitation (Holt and Bazen, 2008);

-      The real contacts, relationships and level of involvement

It is in fact pointless to prevent an individual getting in contact with suppliers or customers with whom he has never been in contact during his working relationship with the covenantee.
For employers it is definitely most appropriate to draw up contracts containing a few, well-identified, reasonable and as such defendable limitations, rather than a list of draconian restraints which would even make no point to enforce.

Before recruiting an experienced, high calibre individual, especially a sales professional, employers should care to ask and know what types of clauses, that is to say limitations, are contained in his/her current contract of employment. Yet, since the individual is willing to leave his/her previous employer this may do it again; employers are hence strongly advised to include a restrictive covenant clause in the contract they are going to agree with the new hire whether his/her position justifies this.

In the event the former employer should judge that by joining a different organization and covering a particular role within this the former employee has breached the restrictive covenant clause included in his previous contract, the first think the former employer will do is to seek an injunction. Usually, but not necessarily, the first stage is represented by the application for an interlocutory injunction. With this application the former employer asks the Court to immediately suspend the new employment relationship until the case is discussed (Lynder Myers, 2011).

The Court grants the injunction whether it is satisfied that the application is actually representative of a serious issue, that is, whether the Court judges that the claim is neither vexatious nor frivolous. To this extent the Court takes heed, amongst the other elements, of whether damages would be a sufficient solution in case of trial and whether it may prove to be more detrimental granting the injunction, rather than refusing it.
Employers, provided that they can produce evidences of that, may also claim to have suffered some losses for the employee breach of the limitation clause, usually loss of profits and of trade opportunities. To determine whether and to what extent these losses can be associated with the employee breach of the covenant, the Court evaluates the damage based on the opportunities the business has actually lost. Despite this is everything but a straightforward process, this circumstance has never represented a good reason for the Court to exonerate individuals (who this has deemed to have breached the restrictive covenant) to pay damages to their former employer (Lynder Myers, 2011).

Inasmuch as the injunction and eventually the court case represent a serious problem for employers, things do not go any better for employees who, especially in the event these have actually breached the contract, will have to face the trial and the expenses associated with this.

As suggested by Roydens (2009), “restrictive covenants are a bit of a game”, the winners are likely to be the ones who better know the rule. It could also be added that in order for employers to enhance their chances to win these should be careful when writing the limitations. Well-identified, defensible, well-described and narrowed objectives are most likely to be considered reasonable and then enforceable by the Courts.
Longo, R., (2011), Are restrictive covenants in employment contracts actually protecting employers from confidential information leaks?, HR Professionals, [online].