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Making covenants bite. Courts give answers to burning questions on restrictive covenants!

Making covenants bite. Courts give answers to burning questions on restrictive covenants!

There have been a few recent cases on restrictive covenants that have answered some interesting questions.

How do we judge an old covenant’s enforceability when the employee has been promoted since?

This question was answered in the case of Pat Systems v Graeme Neilly.

Mr Neilly started employment with Pat Systems in June 2000 in a junior role. He had a 12 months non-compete clause in his contract which, in broad terms, restricted him from owning or working for a business which competed with a part of Pat Systems’  business with which he had been engaged or involved in the 12 month period prior to his termination.

Mr Neilly was successful at his role and quickly rose up the ranks. In July 2005, as part of a promotion to “Director - Global Account Management” he was sent a letter confirming the new terms. He signed an endorsement to the letter in the following terms (our underlining):

I agree to the variation of my terms with Pat Systems, which are stated in this letter and I acknowledge and agree that all other terms and conditions outlined in my original documentation remain unchanged.”

In April 2012, when Mr Neilly handed in his notice, he was a member of Pat Systems’ executive committee (although not a statutory director). He had direct client responsibility for a small number of customers designated as “global”.

Mr Neilly joined a competitor business and the issue arose as to whether the non-compete restrictive covenant that he had agreed to as a junior employee was enforceable.

Pat Systems conceded that the imposition of a 12 month non-compete clause could not be justified in the case of an employee with the status and responsibilities enjoyed by Mr Neilly when he was first engaged by Pat Systems in 2000.

However, Pat Systems argued that the covenant should have been treated as entered into in July 2005 when the contract was varied, at which point Mr Neilly was given a new job title reflecting enhanced responsibilities, a substantial increase in remuneration and a longer notice period. When Mr Neilly acknowledged the variation to the contract by signing a declaration that he “agree[d] that all other terms and conditions outlined in my original documentation remain unchanged”, Pat Systems argued that he should be treated as entering into the restrictive covenant afresh and that is the date at which its reasonableness should be judged.

The court disagreed. If the restrictive covenant was void in 2000, it would be necessary for Pat Systems to show that a fresh covenant was entered into in July 2005. A general acknowledgement that the individual’s previous terms “remain unchanged” could not be construed as an agreement to reinstate a term which was in fact a nullity. If a restrictive covenant is void when initially entered into, it is wrong that it should be revived unless the parties have used unequivocal words to do so. Here they had not.

The High Court stressed that the time for ascertaining the reasonableness of a restrictive covenant is the time of the making of the contract. If the covenant is unreasonable at that date, it cannot be saved simply because a subsequent change of circumstances means that it would have been reasonable at the time that it falls to be enforced.

Practical pointers:

The court gave some helpful guidance as to what it believed the company would have needed to do when varying terms to have made the covenant’s validity be considered as at the date of variation:

  • Require the individual to explicitly indicate his or her acceptance of the restrictive covenants in the previous contract, irrespective of whether the covenants have been enforceable up until now; or
  • Require the individual to sign a complete new agreement. It is likely this would be sufficient even if the individual’s attention was not specifically drawn to the restrictive covenant.

Therefore employers should consider whether promotion or some other substantial change in the employee’s terms or circumstances requires an explicit reconsideration of what restrictive covenants are reasonable and be careful in the wording used if they want employees to restate their agreement to covenants.

How limited does a non-solicitation covenant need to be to be enforceable?

Most non-solicitation covenants are limited to solicitation of employees or clients with whom the employee has worked with in the previous 12 months. Is this level of restriction necessary for the covenants to be enforceable?

Two recent cases have seen the courts take two different approaches to this issue.

In Safetynet Security Limited v Coppage, until 17 April 2012 Mr Coppage worked for Safetynet Security Limited. Safetynet is a relatively small business, with one branch and just 94 customers. It was Mr Coppage’s own case that he was instrumental to the success and growth of Safetynet and was seen by many, including himself, as the “face of the business”. Mr Coppage’s contract of employment contained a non-solicitation restriction, preventing him from poaching clients after he left employment. The covenant covered all clients of Safetynet and was not limited to those with whom Mr Coppage had personally worked in the 12 months prior to termination.

After being put at risk of redundancy by Safetynet, Mr Coppage resigned the next day. The following day, through a 21 year old trainee electrician and part time door supervisor, Mr Coppage set up a competitor company and immediately began soliciting Safetynet clients. The question was whether the restrictive covenant was too broad to be enforceable.

The court held that the covenant was valid: it provided wholly appropriate protection for Safetynet and its customer base whilst allowing for limits so that Mr Coppage was and is able to continue earning a living. Indeed, Mr Coppage’s own evidence was that he and his new business had not had any problems obtaining work outside of the Safetynet’s customer base.

The court held that on the specific facts of this case limiting the covenant to those customers with whom Mr Coppage had personally dealt in the previous 12 months was not a necessary limitation to stop the covenant from being too broad, for two reasons:

  • Mr Coppage played a large role in the Claimant and as “the face” of the Claimant he was readily identifiable with the goodwill built up within the Claimant’s customer base; and
  • Mr Coppage admitted in cross examination that he had contact with all of the customers of the Claimant since taking on the role of Operation Director in May 2010, in which case such a restriction would not have added anything.

The other case recently discussing this point was CEF Holdings Limited v Mundey and others. CEF Holdings Limited is a very large company employing around 3,000 people.

When a number of employees left CEF, joined a competitor and solicited employees to join them, CEF tried, amongst other things, to enforce the following non-solicitation covenant that was aimed at preventing the poaching of existing staff:

"you will not at any time during the continuance of your employment or within a period of six months after its termination induce, solicit or endeavour to entice away from the Company any employee of the Company”.

Given the size and structure of CEF, the court held that this covenant was not enforceable.

In this case - where thousands of employees are spread across numerous branches, and the restriction relates to all fellow employees, a very large proportion of whom were not know to the defendants with whom the defendants have had no contact, and who the defendants could not identify - such a restriction would not be acceptable.

The court said that the restriction was wider than necessary: a more limited covenant (for example, catching only those staff with whom Mr Mundey had personally worked or supervised during his last  12 months) would have provided sufficient protection in which case the covenant is not enforceable.

Practical pointers:

Employers should match their covenants to the company as well as to the employee. A covenant that is enforceable in a small, one office organisation will not necessarily be enforceable in a large, multi-national organisation!

Does it matter what other employees’ covenants are?

Yes!

When considering whether there is a legitimate business interest the court may consider what other employees’ covenants are, as well as other surrounding factors like an employee’s notice period.

In Pat Systems, the court said that it was “reinforced in [the] conclusion [that the covenants were not enforceable], though it [was] not at the centre of [its] reasoning, by the evidence that most of ...[Mr Nielly]’s colleagues were subject to non-compete covenants with a duration of no more than six months. Most of the colleagues in question were less senior than him, but their access to confidential information and their trade connections would not necessarily be any less than his.”

Similar reasoning was used by the court in CEF. In that case, the most senior employees who left CEF and began the process of soliciting employees to join their competitor business had no restrictive covenants. Their more junior colleagues did have contractual post-employment restrictions. CEF tried to enforce the more junior employees’ restrictive covenants in relation to their behaviour. The court held that it was “fortified in reaching [the] conclusion[that the restrictive covenants were unenforceable] by [certain] other factors [including], ... the absence of any comparable restriction in the contracts of employment of their superiors."

The court also found that the defendants’ short notice period also strengthened its decision to find that the covenants were unenforceable. The court said that “if the mangers like the individual defendants were so important to CEF and so difficult to replace, so that [a non-solicitation of employees restrictive covenant] was required, it would surely follow that these employees would have been required to give substantially more than one week’s notice of their intention to leave, but that is all the notice that was required of the [defendants]. No reason has been given to justify this surprisingly short period of notice.”

Practical pointers:

It is important to take a consistent approach to covenants across teams. If a more junior employee has a post employment restriction in their contract, employers should think carefully before not including a similar provision in more senior team members’ contracts if they want those restrictions to be enforceable.
Employers should also think about an employee’s notice period when setting restrictive covenants to make sure that the two tie together. As is often the case, a longer notice period (even placing the employee on “garden leave”) will often be easier to enforce and police than a post-employment non-compete or non-solicitation clause.