Restrictive covenants: commercial v employment contracts
Restrictive covenants are a common feature of commercial agreements (e.g. distribution agreements, shareholders’ agreements, franchise agreements and acquisition agreements) and senior level employment contracts and directors’ service agreements.
Restrictive covenants are generally used to prevent a departing party from competing with a business (e.g. their previous employer or company of which they were a shareholder) by soliciting or dealing with their clients/suppliers or by poaching staff.
Restrictive covenants can also be used to prevent a party to an agreement from competing throughout the duration of that contract e.g. in the case of a joint venture or to prevent a departing employee from joining a competitor for a set period of time (known in the employment context as a “non-compete”).
In this article, we briefly consider the differences between restrictive covenants in employment contracts and commercial contracts and suggest some helpful tips for maximising the chance of them being enforceable.
Commercial v employment comparison
Restrictive covenants are potentially void as an unlawful restraint of trade unless they go “no further than is necessary” to protect a party’s legitimate business interests (e.g. trade connections, trade secrets and confidential information).
However, the enforceability of the duration and scope of a restrictive covenant in an employment and commercial context does differ. Key differences are set out below:
| Commercial | Employment | |
| Court’s view | Court generally takes the view that the parties are the best judges of reasonableness because there is greater freedom of contract and restrictive covenants can facilitate trade (by facilitating a deal/trade) | Viewed more stringently. Courts are more likely to question reasonableness because of the unequal bargaining position between an employee and an employer |
| Duration | Common to see a duration of 2/3 years. It is unlikely that a covenant will be unenforceable purely because of its duration. In fact, a 25-year worldwide non-compete, was held to be valid by the courts in a share sale scenario | Assessed on a case-by-case basis. For non-solicitation clauses, it is unusual for a period of restraint of longer than 12 months to be enforced. For non-compete clauses, this period is typically 6 months. Note that, following a consultation, the Government proposes to cap non-competes in employment contracts to three months (see here for more details) |
| Geographic scope | Scope can vary from a few miles to worldwide depending on the circumstances (the latter may be appropriate for global internet businesses) | Likely to be unenforceable if the geographic area is unreasonably wide |
| Restricted activities commonly included in an agreement | • Non-solicitation of employees and contractors • Non-employment of employees • Non-solicitation of customers • Non-dealing • Non-solicitation of suppliers • Non-compete • Non-association • Non-disparagement • Non-circumvention |
• Non-solicitation of clients/customers • Non-solicitation of employees • Non-solicitation of suppliers • Non-employ • Non-compete • Non-dealing Note that the restricted activities will typically vary depending on the seniority of the employee |
Tips for maximising enforceability
Whilst the enforceability of a covenant will always depend on the specific facts, when seeking to maximise the enforceability of restrictive covenants, it is helpful to consider the following with your legal advisors:
- Narrow scope. Consider the legitimate business interests requiring protection and, ideally, only include the minimum level of restriction that is needed to protect them.
- Include separate covenants to increase the possibility of severability (and therefore improve the chances of enforceability).
- Ensure that the activities restricted are specific to the risk that the business is protecting against. For example, does a non-solicitation/dealing clause need to extend to junior staff?
- The parties’ bargaining powers, since the more unequal the bargaining power, the less likely that a restrictive covenant will be enforceable.
- The duration of the restriction. Essentially, the longer the term, the greater the chances are that the court will find the restraint unreasonable and therefore unenforceable.
- The geographic scope in the circumstances. Consider the size, nature and population density of the area in question. Is the restriction so wide that it could be unreasonable? Typically, the restriction would extend only to territories in which the business operates or directs its activities.
- The amount of consideration. In a commercial contract, the greater the consideration, the more likely that the covenants will be enforceable.
Of course, a business may choose to have lengthier and broader restrictive covenants than are reasonable but these would be of deterrent value only since they are highly unlikely to be deemed enforceable.
Comment
For parties on either side of a corporate transaction, it is common for the restrictive covenants contained in an acquisition agreement to be much longer and broader than those in the employment context on the basis that the parties have more equal bargaining power. However, it is important that each covenant is considered on its facts, since equality of bargaining power is not necessarily a given, nor does it forgive all sins.
For employers, restrictive covenants continue to be a complex area. Departing senior level employees are often well-placed to take advantage of the business’ confidential information, strategic plans, customer/client lists or other sensitive information. Ex-employees may try to use this information for the benefit of a new employer or a competing business, and their actions can seriously harm the former employer’s business. It is therefore vital to seek specialist employment advice when entering into restrictive covenants in order to maximise their enforceability and to protect the business when the employment relationship ends. It is also important to keep existing restrictive covenants under review. As circumstances change, such as the employee’s role expanding through promotion, or the employer growing through acquisitions, even a restriction that was enforceable at the time it was entered into may become outdated and thus unenforceable.
How we can help
Our Corporate & Commercial and Employment teams can provide expert advice on the drafting of restrictive covenants in either context to help protect your business and its assets. Get in touch if you need any help, we would be delighted to assist.
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