Are your restrictive covenants worth the paper they are written on?

Year Published: 2012

A recent decision of the High Court in Patsystems v Neilly has called into question the validity and timing of restrictive covenants, which should serve as a warning to all employers who have already entered into or are considering entering into these arrangements with their employees.

The employee started working in June 2000 in the position of account manager. On his appointment he signed a post termination non-compete covenant, which made it clear that he was not permitted to work for a competitor for 12 months following his termination.

During his employment he was promoted on a number of occasions and finally in 2005 he was promoted to the position of Director of Global Account Management. He agreed to the variations in the terms of his contract consisting of an increased salary, notice period and pension plus he signed an agreement acknowledging that all the terms and conditions outlined in his contract from 2000 remained unchanged, including – so the employer thought – the original restriction on joining a competitor.

In April 2012 the employee handed in his resignation and confirmed that he had taken a role with a competitor. He was informed by his employer that if he started to work for them within 12 months of his contract ending they would regard this as a breach of his non-compete covenant. Due to his refusal to reject the job offer he was dismissed with immediate effect on the basis that his intention to start working for the competitor was a fundamental breach of his contract.

The employee started working for the competitor and the employer brought proceedings in an attempt to secure an injunction to enforce the non-compete clause in his contract. The employee counter claimed that his summary dismissal was wrongful.

The main issue that the High Court had to determine was the date on which the reasonableness of the non-compete clause should have been assessed.

It was argued that the imposition of the non-compete clause at the start of the employee’s employment in 2000 was disproportionate to the role he was hired to undertake at the time. However, the employer felt it could be enforced because when he was promoted in 2005 he agreed to the original terms he had been provided with.

The High Court decided that the non-compete clause could only be regarded as being entered into in 2000 when he was first presented with the terms of his contract. In 2000 it was void due to its unreasonable and disproportionate nature and therefore could not be relied upon in 2012. As a result the employee was found to have been wrongfully dismissed and the employer could not prevent the employee from joining the competitor.

The law

The time for establishing the reasonableness of a restrictive covenant is at the time the contract is entered into. An unreasonable or unenforceable covenant cannot be salvaged at a later stage simply by saying that the employee on promotion is bound by his earlier terms and conditions of employment. If it is void from the start, it is void at the end of employment.

The acknowledgement of his existing terms and conditions in 2005 was unsatisfactory as a means to reissue the restriction.

The High Court felt that if the employer had wanted to rely on this covenant then it needed to have been reissued expressly to the employee. This could have happened by issuing a new contract and not just saying that the old terms remained in force. The employer should also have explicitly drawn his attention to this specific restriction and been able to demonstrate that when he was promoted, the importance of the restrictions was made clear to him.

The High Court also felt that the clause went further than was necessary to protect the legitimate business interests of the employer and advised that the clause should only have restricted the employee for 6 months rather than 12 months.

How does this affect employers?

This case reminds employers that employment contracts must be fit for purpose and should be carefully tailored to the particular role and business requirements.

Employers must carefully review the restrictions imposed at the time the contract was made and carefully consider:

  1. Whether these were reasonable in all the circumstances at the time the contract was made.
  2. Whether they remain sufficient to protect the legitimate business interests of the employer at the time of the review.
  3. Whether the covenants could be held by a Court to be too far reaching to be enforceable – making them unenforceable.
  4. Whether any changes have occurred in the course of employment which would require reissue or reconsideration of the restrictions already in place.
  5. Whether any contracts need to be reissued or renegotiated.
  6. How often regular reviews of contracts and restrictive covenants are undertaken.

Employers should carry out a thorough review of their employment contracts at least every three years, to take into account not only the issues highlighted above, but all contract clauses, to ensure that they continue to be relevant to the current employment.

Whenever circumstances change with an employee including promotion, demotion or change of job role, the restrictions contained within the contract must be considered in light of the change, and amended to ensure they are consistent with the employee’s role. The employee must then be issued with a new contract of employment, having their attention specifically drawn to the restrictions.

This is especially important in the current financial climate, where competing businesses more than ever need to protect their legitimate business interests.

For further information on restrictive covenants, please contact our Employment team.

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