As the ongoing saga of Ilion versus Landis heightened followingoyers, and company interests remain paramount, restrictive convenants have become a requirement rather than an option. Ilion's managing director, Allan Mack's memo about staff contact with ex-colleagues - as revealed in PC Dealer (25 February) - employers need to consider how to protect company interests against defection and possible competition fom employees.
Even a brief period of under resourcing or rivalry can be damaging in a fast-moving market. So it comes as no surprise that restrictive covenants, which take effect after employment, are a favoured choice for employers. Equally, as restraints are inserted in employment contracts, those recruiting will need to review whether such protection is enforceable.
Obligations during employment
During the course of employment, an employee must follow lawful and reasonable instructions from an employer. There is an ongoing obligation of confidentiality, so if an employee discloses confidential information without authorisation then, depending on the nature of the information and the result, it is likely to constitute gross misconduct justifying summary dismissal.
Likewise, there is the duty of 'mutual trust and confidence' between employer and employee. Neither must take a step which is so fundamental as to undermine the employment contract. Unsurprisingly, this includes an obligation for the employee not to compete with the employer's business.
Setting up rival operations or assisting those doing so would be a breach of contract, again likely to justify summary dismissal.
Inevitably, however, summary dismissal may prove inadequate. Firing the wrongdoer will remove the employee from the business, but once their notice period (if any) has ended, it may not prevent them from continuing to harm the employer once they are on the outside. Increasingly, sophisticated contractual provisions are incorporated into employment contracts to address this issue.
First principles on termination
After employment has ended, an employee is under a continuing duty of confidentiality, but no more than that. Even this duty is limited to a narrow interpretation of protecting 'trade secrets'. Short of a top-secret industrial formula, it may be very difficult to show that sensitive know-how beyond the employee's skills set falls within that narrow definition.
Moreover, an ex-employee is immediately free to compete. For these reasons, well drafted restraints are necessary to protect the ex-employer.
The basic proposition is that covenants taking effect after termination of employment are unenforceable, being contrary to public policy in restraining trade. The exception is where covenants go no further than is necessary to protect the employer's legitimate business interests. In recent years, courts have taken a restrictive view about the scope of protection which is necessary to meet that aim.
What is a legitimate interest?
To demonstrate a covenant's validity, the employer must show the protection was necessary. It cannot blindly include anything and everything. Instead, the focus must be for a legitimate interest.
Legitimate interests include customer connections, goodwill and confidential information in the nature of trade secrets. More recently, the courts held that retaining a stable workforce can, in appropriate cases, constitute a legitimate business interest.
One such example is the Alliance Paper Group versus Prestwich case, where the courts upheld a non-poaching clause which restrained a former managing director from enticing an employee engaged in a senior capacity.
A non-poaching covenant, therefore, needs individual tailoring, limited to those colleagues who, if they defected, would damage the business interest. Thus, an IT project manager could be restrained from taking senior executives with him, but not those responsible merely for data inputting.
If the employer shows a legitimate interest deserving protection, the courts will consider whether the extent of the restraint is reasonable.
The courts can put a 'blue pencil' through offending clauses so they make sense, but they will not rewrite the contract. For that reason, the more narrowly drawn the restraints the more likely they will be enforced.
First to be looked at by the court is the restraint's geographic reach.
An IT consulting company would be entitled to protect its client contacts from the influence of a local office manager. However, it would only be entitled to protect customers local to that particular office. It would usually be unreasonable to bar all customers in the UK.
The courts will also look at how long a clause will last. Nowadays, longer than 12 to 18 months is unusual and open to challenge.
For this reason, employers are more commonly adding a 'garden leave' clause - keeping employees at home while retaining them under contractual obligation, with a reduced period of post-termination restraints.
This is a more expensive option, since those concerned still have to be paid a wage, but it cuts out the risk that a post-termination restraint will be challenged and the employee is set loose in the market early. Without that express power in the contract, placing an employee on garden leave is likely to be a constructive dismissal.
Of course, the employer must be careful not to fall into the trap of finding that a person on garden leave has not contacted any customers when at home, so that restraints do not bite.
Another issue is an employee's actual knowledge. The employee cannot be restrained from competing with the former employer simply because he has the job skills in his head. The employer must show that the departing employee was privy to some particularly sensitive information. For example, if the manager leaving was closely involved in a new software product which was about to be launched.
In such an instance, the courts are likely to prevent competition with that product or using the knowledge of the marketing plan to undercut the former employer's launch. Thus, it is always worth making commercial sensitivity plain to the employee.
What is the effect of wrongful termination?
After some debate as to whether restrictive covenants could be prevented by drafting in such phrases as 'howsoever termination is caused', the courts have come down firmly against such a whitewash provision.
Instead, the courts declared that if an employer wrongfully terminates the contract in breach, then the restraints will be unenforceable. This can place an employer in a predicament if he knows that an employee is proposing to depart. The employee will be working notice, but may be engaged in sensitive areas.
On the other hand, the employer cannot simply relocate the employee concerned - either because of operational needs or from a legal perspective - because of the risk of a constructive dismissal claim. For example, there is no point removing a marketing executive to simple administrative tasks.
In addition, the courts have frowned upon employers creating some form of set-off against their costs. In other words, employers' attempts to argue that if the restraints of trade fall away, the employee should lose some collateral benefit, for example commission owed, are unlikely to succeed. The courts have declared that even if the restraints of trade fall away, the separate right of payment to an employee remains effective.
If a valid restraint is breached, the employer has two possible remedies.
Either to claim damages for lost business or, if the employer can show damages would be an inadequate remedy, seek an injunction to preserve the status quo until the parties' rights have been determined at trial.
The injunction will restrain the employee and possibly his new employers from acts such as soliciting business or poaching former colleagues.
The principle behind applying for an injunction is that the employer establishes a good, arguable claim. It is enough to show there is a serious question to be tried, but the granting or refusal of an injunction is a matter for the court's discretion on 'the balance of convenience'.
In many ways, the tactical advantage lies with the employer. It is often easier for an employer to show that convenience rests in preserving existing and future business - for example preventing an employee from poaching colleagues when a project is nearing completion. Also, unless the former employee is supported by a third party, the cost of resisting an injunction may be prohibitive.
Against that, it is often difficult to produce sufficient evidence that the former employee is breaching the restraint. This is simply because the wrong-doer's acts are known only to him or her. Also, employers are reluctant to demonstrate to the market that they are concerned by a person's actions.
If only for the purposes of gathering evidence, therefore, exit interviews can prove a valuable tool in gaining indications from employees as to their intentions. If they are foolish enough to make false representations as to their destination to reduce the contractual notice period, they are exposing themselves to a further claim.
Aside from the costs of gaining an injunction, such a step should not be taken lightly. First, it will always be on the back of litigation.
While many injunctions decide the dispute, if needs be, proceedings will remain on foot all the way to trial.
Also, the court normally orders the person granted an injunction to give what is known as a 'cross undertaking as to damages'.
Broadly speaking, this forces the employer to make good any losses suffered by the employee if the trial decides the injunction should not have been granted. Such losses may appear speculative but they could be high - for example where a startup business is proposing to sell to former customers with an appropriate profit margin.
If the ex-employee is prevented from doing this, it is easy to envisage an escalating risk of loss.
Not unnaturally, the fear a challenge can make employers averse to hiring specialists who come with specific knowledge and their contacts. Accordingly, a prospective employer may wish to qualify the employment as conditional.
The prospective employer will thus legitimately be able to release the employee, rather than have a restrained executive sitting idly on the payroll.
There is no doubt that while it opens up possible legal pitfalls, the use of effectively drafted restrictive covenants can be a powerful weapon in the armoury of a former employer, going beyond the limited common law obligation of confidentiality. The acute skills shortages and greater mobility within the IT sector mean that the use of such devices is increasingly attractive.
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