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Restrictive Covenants: Non-Compete Clauses And Enforceability

During employment, it is an implied term of the contract that the employee must not compete with their employer. This forms part of the implied duty of fidelity (i.e. that the employee will serve their employer with good faith, loyalty, and with regard to the employer’s interests). Nevertheless, this implied duty does not extend to the period post termination of employment. Accordingly, should an employer wish to prevent the employee from working for a competitor/limit the extent to which the employee can work for a competitor for a period post termination, then an express non-compete clause will need to be included as a restrictive covenant within the contract of employment. Nevertheless, the drafting of non-compete clauses is always problematic, as when they are drafted too widely or in a manner that goes beyond just protecting the employers legitimate business interests, then they run the risk of constituting a restraint of trade and of thereby being unenforceable.

Non-Compete Clauses

Non-compete clauses are extremely common, especially in the contracts of senior employees, as employers have concerns about protecting their legitimate business interests when key employees leave and may potentially join a competitor. For example, the employee may have worked in a position with the employer where they have built up extensive contacts with the company’s client’s, suppliers, and staff, and may possess sensitive information as regards intellectual property, trade secrets, and other key information about the employers business. The extent of this may be such, that the employee may be able to exploit this very quickly post termination to the employers detriment, and to the advantage of a competitor. Given this, the employer may believe it to be essential that they contractually prohibit the employee from taking up employment with a competitor for a period of time post termination of employment (usually 3-12 months), in order to protect their legitimate business interests.

Nevertheless, any contractual term which seeks to restrict an individuals freedom to earn a living, work within their own occupation, and utilise their own skills, knowledge, and talent, is normally void and unenforcebale on the basis that it constitutes a restraint of trade. Given this, non-compete clauses are only valid and enforceable where an employer can show that a legitimate business interest needs to be protected. Furthermore, the extent of any such clause can only be such, that the restrictions it places upon the employee (e.g. geographical area, activities, duration, etc) are no wider than are necessary to protect the legitimate business interests in question. That is, should the restrictions created by the non-compete clause go beyond protecting those interests, then it will render the clause void and unenforceable.

TFS Derivatives Ltd v Morgan (2004): The 3 Stage Reasonableness Test

In the case of TFS Derivatives Ltd v Morgan (2004), a 3 stage test for determining the reasonableness of non-compete clauses was set out as follows:-

  • Determine what the covenant means. Where there is some uncertainty and the covenant  can be construed in more than one way, of which some constitute a restrain of trade, but others are lawful, then the Court should adopt the most appropriate lawful interpretation on the basis that there should be an assumption that it was the intent of the parties to enter into a legitimate contract. This holds so long as the covenant does not breach the public interest, as their is a need to strike a balance between the wider public need to maintain a competitive environment, and the interests of the parties themselves.
  • Does the employer have a legitimate business interest that needs protecting?
  • Is the non-compete clause no wider than is necessary to protect the employers legitimate business interest?

Tillman v Egon Zehnder Ltd (2017) EWCA Civ 1054: Non-Compete Clause Drafted Too Widely

The need to ensure that non-compete clauses are not drafted too widely, and to ensure that the restrictions imposed are no greater than are required to protect the legitimate business interests of the employer was highlighted again back in October 2017, by the Court of Appeal ruling in the case of Tillman v Egon Zehnder Ltd (2017) EWCA Civ 1054. In that case, the Court held that the non-compete clause was too wide on the basis that the words “interested in” would include the holding of minor shareholding in a competitors company. This took the scope and ambit of the clause beyond what was required to protect the employers legitimate business interests, and rendered the clause void and unenforceable.

Settlement Agreements And Non-Compete Clauses

When advising an employee who has been offered a Settlement Agreement, the adviser should determine whether there are any non-compete clauses contained in any restrictive covenants that the employee will remain bound by post termination of employment. If there are, then the adviser should seek to negotiate the inclusion of an additional clause in to the Settlement Agreement, under which the employer agrees to waive the non-compete clause (assuming no such clause had been included in the first place), especially if the non-compete clause would obstruct the employee in terms of securing alternative employment. Where it is evident that the non-compete clause has been drafted too widely (and thereby constitutes a restraint of trade) or is in any other way invalid, and is thereby void and unenforceable, then that should be pointed out to the employer during negotiations in support of the contention that the employer should agree to an additional clause being added to the settlement agreement, within which the employer agrees to waive the non-compete clause. Whilst the non-compete clause may very well be unenforceable anyway, the fact that the employer has agreed to waive it will provide the employee with peace of mind and avoid an expensive and stressful court case later on at which the parties argue the point.

Posted in General Employment Law, Non-Compete Clauses, Restrictive Covenants, Settlement Agreements and tagged , , , .