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Protecting your Business – Post-Termination Restrictive Covenants in Employment Contracts and Contractors’ Contracts for Services

It is very important to protect and to safeguard the assets of a business. One important step in achieving that objective is to ensure that employees and contractors engaged by a business are suitably contracted to protect the business they are serving.

Appropriate post-termination restrictive covenants (PRCs) should be considered for all employment contracts and contracts for services.

In the case of employees and contractors PRCs commonly prevent solicitation of the employer’s clients, suppliers, and other employees and sometimes prohibit competition for a set period of time following the employee’s termination. Additionally, they should prohibit the departing employee from divulging confidential information about the employer/contractor and its clients.

In the case of contractors engaged by a business, given that copyright created by a contractor engaged to provide services does not automatically vest in the business the contractor is engaged to provide services to, it is important to include an assignment of intellectual property created by the contractor for the business’s behalf, together with a waiver of moral rights, in favour of the business concerned.

Fundamentally, for a PRC to be enforceable, it must protect the legitimate business interests of the employer and extend no further than is reasonably necessary to protect such interests. Legitimate interests include, but are not limited to, trade connections with clients or suppliers, confidential information and maintaining the stability of the workforce. In that respect, the PRC has to be reasonable.

Of course, the reasonableness of a restrictive covenant cannot be measured without paying heed to the nature of the employment or engagement. Factors s such as the type of the business, the job role, the geographical area of the restriction, the time frame of the restriction, and the legitimate business interest that the employer or contractor is trying to protect must be taken into consideration. For example, a 6 month non-compete clause may be suitable for the CEO of a public listed company but would be inappropriate for the line-manager of a regional limited company.

In assessing the reasonableness of restrictive covenants, an employer’s interests must be balanced with the employee’s interests, such as the employee’s fundamental right to earn a living. It is worth bearing in mind that if the employer is in breach of the employment contract then the employee will not be bound by the contract’s terms. Even a technical contractual breach may invalidate PRCs.

Sanctions for breaching a PRC can be serious. The Court may grant an interim injunction to prohibit an employee from engaging in the restricted activity. Additionally, an employer may be able to seek damages from the offending employee for breach of contract and recover its legal costs incurred. Clearly, the consequences of breach can be both financially and reputationally difficult for an offending employee. It will certainly not be the clean start an offending employee had hoped for.

Furthermore, if an employee has been induced by a competing business to breach a PRC, the former employer may be able to take action against the employee’s new employer based on the tort of inducing a breach of contract.

The Court of Appeal examined this situation recently, and, specifically, the notion of breach in Allen t/a David Allen Chartered Accountants v Pollock and Anr [2020] EWCA Civ 258. The Court of Appeal considered the liability of an employer which had hired an employee from a rival accounting firm, in breach of the employee’s post termination restrictive covenants.  This case concerned the potential liability of the employee’s new employer in tort.

The new employer had received legal advice that the post termination restrictive covenants were “probably” unenforceable. This legal advice transpired to be incorrect. This is a case where the provision of incorrect legal advice to a client actually helped the client – so that can happen!

The Court of Appeal ruled that for a person to be liable in tort for inducing a breach of the employment contract, the contract must be binding and enforceable. Furthermore, the person must have actual knowledge that the act performed would breach the contract. As Lord Justice Lewison succinctly put it: “You must actually realize that the act you are procuring will have the effect of breaching the contract in question”.

The ruling also established that the onus is on the claimant (the previous employer) to prove that the new employer has actual knowledge of the breach. Therefore, the new employer was not liable in tort for breach of contract in this case because he had received advice that the PRCs were not enforceable. The employer was entitled to rely on legal advice received, despite it being incorrect.

So the new employer escaped culpability in this case, but the ability to bring proceedings against the future employer of an ex-employee remains an option if the facts fit.

Regarding contractors, an ever more common feature in businesses seeking greater people flexibility, it is important to ensure that a business protects itself through contract to ensure it is protected in the same way as with its employees.

Posted By Michael Hatchwell & Annabel Riekie

18 January 2021

Michael Hatchwell & Annabel Riekie
Partner and Head of Corporate & Commercial; Trainee Solicitor, Corporate & Commercial